The corporation of which you are a shareholder just sent you notice that it plans to merge with another corporation. And although the other existing shareholders will have their shares exchanged for shares of the new corporation, your shares will be cancelled and exchanged for cash. Once the merger closes, you are out.
You resolve to challenge the merger. You’ve done nothing wrong, and you’d like to continue as a shareholder rather than have your investment liquidated. Where do you begin?
Any challenge to any merger of a New York Corporation starts with: (i) the rules, which are set forth in Article 9 of New York’s Business Corporation Law and (ii) the principles set forth by the Court of Appeals in Alpert v 28 Williams St. Corp., 63 NY2d 557, 569 (1984).
Van Horne v Ben-Dov, 2023 NY Slip Op 05212 (1st Dept Oct. 12, 2023), a recent decision from the First Department—and a case that Peter Mahler and I had the pleasure of litigating—provides the playbook for turning those rules and principles into a successful challenge, and it adds some additional wrinkles along the way.
The Guidelines: Alpert v 28 Williams St. Corp.
The statutory requirements governing a corporation’s use of a freeze-out merger are set forth in Article 9 of the BCL. Article 9 incorporates Section 623, which contains the rights of shareholders to dissent from the Merger (which Frank McRoberts summarizes here). The principles set forth in the Court of Appeals’ 1984 decision, Alpert v 28 Williams St. Corp., 63 NY2d 557, 569 (1984) are equally important:
- Those in control of a corporation must treat all shareholders, majority and minority, fairly. So the key inquiry in a challenge to a freeze-out merger is whether the transaction, viewed as a whole, was “fair” as to all concerned.
- “Fairness” in this context, has two components: Fair dealing and fair price.
- Generally the party challenging the merger has the burden of proving that the merger violated the duty of fairness. “When, however, there is a common directorship or majority ownership [between the entities in the merger], the inherent conflict of interest and the potential for self-dealing requires careful scrutiny of the transaction.” And so where that “inherent conflict,” exists, the “burden shifts to the interested directors or shareholders to prove good faith and the entire fairness of the merger.”
- “Fair dealing and fair price alone will not render the merger acceptable. . . [there also] exists a fiduciary duty to treat all shareholders equally.” Since a freeze-out merger does not treat all shareholders equally, it is permissible only where necessitated by the “overriding duty to provide good and prudent management” of the Corporation as a whole.
- But, “[d]eparture from precisely uniform treatment of stockholders”—i.e., a freeze-out merger, “may be justified, of course, where a bona fide business purpose indicates that the best interests of the corporation would be served by such departure.”
- A bona fide business purpose is one that furthers the objective of conferring some general gain upon the Corporation, not just upon the remaining shareholders.
The Application: Van Horne v. Ben Dov
Peter Mahler previously covered the Trial Court’s decision granting a preliminary injunction enjoining the freeze-out merger. Read that decision and Peter’s helpful summary of the parties and contentions here.
74-84 Third Avenue Corp., the corporation at the heart of the dispute in Van Horne, is a single-purpose realty holding entity. It owns property on Third Avenue in Manhattan, which it leases pursuant to a long-term ground lease. As a result, the activities of the corporation are minimal and ministerial: essentially, it collects rent and pays taxes. The ground lessee takes care of everything else.
A revocable trust owned by Zohar Ben-Dov owns 95% of the outstanding shares. The Allen S. Greene Irrevocable Trust (the “Greene Trust”) owns the remaining 5%.
The Cash Out-Merger and Trial-Court Injunction
After a personal falling out between Ben-Dov and Greene, Ben-Dov called a meeting of the directors of the corporation, the purpose of which was to vote on and approve a freeze-out merger extinguishing the Greene Trust’s shares.
Mr. Greene attended the directors meeting. He asked Ben-Dov several times what the business purpose of the proposed freeze-out merger was, and each time Ben-Dov responded only that Greene’s question was “duly noted.” Without any further discussion, Ben-Dov called the matter to a vote, and two of the corporation’s three directors (Ben-Dov and his employee) approved the proposed freeze-out merger.
Subsequently, Ben-Dov called a shareholders’ meeting for the purpose of securing shareholder approval of the proposed freeze-out merger. And since Ben-Dov controlled 95% of the outstanding shares, approval was a foregone conclusion.
Armed with a transcript of the directors’ meeting at which Ben-Dov refused to discuss a business purpose, the Greene Trust sought an injunction enjoining the shareholders meeting called to approve the merger.
Manhattan Commercial Division Justice Jennifer G. Schecter issued an injunction, first preliminary (order here), then permanently (order here), enjoining the proposed freeze-out merger. Justice Schecter found that “No actual corporate benefit has been stated and there is no evidence that proper judgment was exercised either.”
Ben-Dov appealed the permanent injunction, insisting that despite his silence at the directors’ meeting, his bid to freeze-out the Greene Trust was motivated by several bona fide business purposes, including the need to protect the subchapter S tax status of the corporation (due to the risk that the Greene Trust may transfer its shares to an unqualified entity), the need for the corporation to raise capital, and the need for a shareholders’ agreement. Given the deferential standard applied to business decisions, Ben-Dov argued, those justifications were sufficient to justify the attempted freeze-out merger.
Finally, Ben-Dov argued that because the Greene Trust had a dissent and appraisal remedy in BCL 623 (i.e., money damages), equitable relief in the form of an injunction was improper. Indeed, said Ben-Dov, the Greene Trust’s damages were the loss of its investment—which can be restored with money damages.
The Greene Trust responded that all of Ben-Dov’s purported justifications were after-the-fact, “rank pretext” concocted after Ben-Dov elected to proceed with the freeze-out merger and after the directors’ meeting where Ben-Dov could not state a business purpose for the freeze-out merger.
Addressing Ben-Dov’s insistence that the Court should defer to the business judgment of those in control of the corporation, the Greene Trust argued that because Ben-Dov stood on both sides of the Merger, careful scrutiny (rather than broad deference) was required (see Coggins v New England Patriots Football Club, Inc., 492 NE2d 1112, 1117 [Mass. 1986] [“The dangers of self-dealing and abuse of fiduciary duty are greatest in freeze-out situations.”]).
Finally, as to the availability of equitable relief, the Greene Trust explained that BCL § 623 expressly states that the dissent and appraisal remedy:
[S]hall not exclude the right of such shareholder to bring or maintain an appropriate action to obtain relief on the ground that such corporate action will be or is unlawful or fraudulent as to him.”
(BCL § 623[k] [emphasis added]). A fortiori, then, the dissent and appraisal remedy set forth earlier in BCL 623 does not constitute “available monetary damages” precluding equitable relief.
The First Department’s Decision
By decision entered October 12, 2023, the Appellate Division, First Department, affirmed Justice Schecter’s injunction permanently enjoining the merger. With the Alpert guidelines as its roadmap, the First Department held:
- Ben-Dov and the other defendants were “interested parties” who therefore bore the burden to establish fair dealing, fair price, and a bona fide business purpose.
- As to fair dealing, the defendants “did not attempt to establish this element . . . by introducing evidence of any efforts taken in this respect in connection with the proposal of the merger, such as the appointment of an independent negotiating committee or disclosures made to shareholders.”
- And as to the business purpose, the First Department agreed (albeit with less colorful language) with Justice Schecter’s conclusion that Ben-Dov’s purported business purposes were insufficient pretext:
Moreover, the court correctly found that the only evidence provided by defendants to establish that they proposed a merger that was intended to serve an independent corporate purpose were self-serving affidavits of defendant Ben–Dov containing pretextual and post-hoc explanations.
The Court did not expressly consider, but by affirming the injunction sub silentio rejected, Defendants’ contention that equitable relief was not available due to the dissent and appraisal remedy set forth in BCL 623.
One need not explore the pages of this blog too deep to learn why cash-out mergers can be an extraordinarily powerful and useful tool in the resolution of disputes in closely-held businesses. They provide an effective, indirect expulsion mechanism where the owners’ agreement or other applicable law may not otherwise provide one.
And in the context of New York LLCs or Partnerships, the power and utility of the freeze-out merger is almost unlimited — subject, of course, to the operating or partnership agreement which may require unanimous owner consent to any merger. See this recent post explaining why.
With all their utility, freeze-out mergers bring some critical caveats. Particularly in the context of corporations, the process of executing a freeze-out merger has plenty of room for missteps. And because BCL 623(k) and its interpreting caselaw allow for a minority shareholder to seek equitable relief in the case of an improper merger (a right which is not available to a LLC member or partner), a misstep could fatally and permanently impair the utility of the freeze-out merger.
That includes the bona fide business purpose requirement. As the First Department’s affirmance in Van Horne makes clear, a freeze-out merger of a corporation that the majority initiates without consideration of a business purpose may be enjoined, regardless of whatever after-the-fact business purposes may (or may not) have justified the merger.