MEMORANDUM AND ORDER
In this class action, the plaintiff, MAZ Partners LP (MAZ), alleges in Count I of its second amended complaint that the directors of PHC, Inc. (PHC), breached their fiduciary duty by approving inadequate compensation for Class A shareholders in connection with PHC's merger with Acadia Healthcare, Inc. (Acadia). In Count II, MAZ contends that one director, Bruce Shear, then CEO of PHC, breached his fiduciary duty as PHC's controlling shareholder by negotiating a $5 million sweetener for his Class B shares at the expense of the Class A shareholders. Finally, in Count III, MAZ alleges that Acadia aided and abetted these breaches of fiduciary duty.
After hearing, the Court allowed the plaintiff's motion to certify a class of all Class A shareholders who voted against the merger or abstained.
The plaintiff's motion for partial summary judgment (Docket No. 182) and the defendants' motion for summary judgment (Docket No. 181) are
The facts below are taken from the record, and are undisputed except where stated.
PHC was a publicly traded behavioral healthcare company organized under Massachusetts law. MAZ is a partnership that owned over 100,000 shares of stock in PHC. PHC had two classes of common stock, Classes A and B. Class B common stock had enhanced voting rights entitling holders to five votes per share; holders of Class A common stock were entitled to one vote per share. PHC's board consisted of six directors. Bruce Shear, a defendant, served as a director, chairman of the board, and chief executive officer of PHC. Shear held 93% of PHC's outstanding Class B shares and approximately 8% of Class A shares. Combined, Shear exercised approximately 20% of the total outstanding voting rights for all combined PHC shares. Class A shareholders elected two out of six board members. Class B shareholders elected the other four directors. Because Shear held 93% of the Class B stock, he had the power to elect four directors to the PHC board.
In January 2011, Shear and Acadia CEO Joey Jacobs began meeting to discuss a possible merger of the two companies. Shear served as PHC's main negotiator during this phase. The two corporations, through Shear and Jacobs, agreed that PHC shareholders would own 22.5% and Acadia shareholders would own the remaining 77.5% of the newly merged corporation's stock. To accomplish this split, each PHC share, both Classes A and B, would be exchanged for a one-quarter share of the newly merged Acadia entity. The different classes would disappear. Prior to the merger, due to relative differences in the corporations' overall market value, Acadia would issue a $90 million dividend to its shareholders to effectuate the proper 22.5/77.5 percentage split. Significantly, the Class B shareholders would receive a pro rata share of an additional $5 million as consideration for the Class B shareholders' enhanced voting rights. As the holder of 93% of outstanding Class B shares, Shear received approximately $4.7 million of the additional consideration. The remaining seven percent of Class B stock was held by approximately 300 other PHC shareholders.
On March 22, 2011, Joey Jacobs, Acadia's CEO, signed a letter of intent (LOI) and sent it to the PHC board. The LOI contained the major details of the proposed merger. It included: (1) a prohibition on PHC shopping the offer to other potential merger partners; (2) a deal termination fee if PHC backed out of the merger; (3) the 22.5/77.5 percentage stock split; (4) the $5 million payment for Class B shares; (5) a provision that Shear would select two directors of the newly merged company; and (6) the $90 million dividend to Acadia shareholders pre-merger. On March 23, 2011, all the PHC directors entered into voting agreements to vote all of their shares for the merger and against any alternative merger proposition. Together, all directors owned approximately 25% of outstanding PHC voting shares.
The PHC board retained Arent Fox to advise it on transactional matters, Pepper Hamilton LLP to advise it on issues of Massachusetts corporate law, and Stout Risius Ross, Inc. (SRR), to provide the board with an opinion on the merger's overall fairness. SRR determined that the share price for Class A shareholders was fair, but it did not analyze the additional $5 million consideration for Class B shareholders or the $90 million pre-merger dividend. PHC declined to form an independent committee to evaluate the merger's fairness.
On May 19, 2011, at the PHC board meeting, SRR presented its opinion that the merger consideration for Class A shares was fair, and the board voted to recommend the merger to the shareholders. Shear abstained from the board vote to avoid any apparent or actual conflict of interest. The other five directors, none of whom owned any Class B shares, voted to approve and recommend the merger to the shareholders.
Acadia and PHC signed the merger agreement on May 23, 2011. On September 27, 2011, PHC disseminated its Final Proxy Statement to the PHC shareholders that disclosed the following details of the merger: (1) Shear would receive most of the additional $5 million consideration as the holder of 93% of Class B common stock; (2) Shear would serve as the merged company's executive vice president and a director, and Grieco would serve as a director; (3) PHC directors' vesting schedule for share options would be accelerated to avoid forfeiture of compensation; (4) the directors had entered into voting agreements to vote their shares for the merger; (5) Acadia shareholders would receive a pre-merger $90 million dividend; and (6) the PHC board declined to form a special committee to evaluate the merger based upon advice of counsel. The full SRR fairness opinion was attached to the Final Proxy, which was nearly 500 pages long including attachments.
Merger approval required a two-thirds majority shareholder vote of (1) Class A voting stock alone, (2) Class B voting stock alone, and (3) Class A and B voting stock together. The PHC directors together held approximately 11% of PHC's outstanding Class A stock and 93.2% of its Class B stock. Together the directors held a total of 24.8% of PHC's outstanding voting power. On October 26, 2011, the PHC shareholders voted in favor of the merger with 88.7% of Class A shares and 99.9% of Class B shares voting for the merger. On November 1, 2011, the merger was fully consummated. After the merger, MAZ's PHC shares were automatically converted to Acadia shares. In January 2012, MAZ sold all of its Acadia shares at a profit.
Summary judgment is appropriate when there is "no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a). To succeed on a motion for summary judgment, the moving party must demonstrate that there is an "absence of evidence to support the nonmoving party's case."
"A genuine issue exists where a reasonable jury could resolve the point in favor of the nonmoving party."
In its review of the evidence, the Court must "examine the facts in the light most favorable to the nonmoving party," and draw all reasonable inferences in its favor, to "determine if there is sufficient evidence favoring the nonmoving party for a jury to return a verdict for that party."
Defendants' Motion for Summary Judgment
A. Count I: The Directors' Fiduciary Duty
The defendants argue that, because the directors are protected by an exculpation provision, they are entitled to summary judgment on all of MAZ's duty of care claims — including the claim for material omissions in the Final Proxy — and that the plaintiff has put forth insufficient evidence that the directors violated their duty of loyalty. The plaintiff responds that the stock option acceleration provision, director voting agreements, Shear and Grieco's post-merger employment, the $5 million Class B sweetener, and Shear's influence over the merger negotiations show that the directors failed to act in the best interests of the PHC shareholders in approving the merger.
The defendants argue that PHC's exculpation clause immunizes them from any claim that they violated their duty of disclosure in the Final Proxy. Although the plaintiff failed to amend its complaint to include § 14(a) claims, the plaintiff's second amended complaint included a common law fiduciary duty claim for failure to disclose material information to PHC shareholders. Docket No. 177 at 9. The complaint alleged thirty separate omissions and misrepresentations in the Final Proxy.
In its articles of organization, a Massachusetts corporation may set forth "a provision eliminating or limiting the personal liability of a director to the corporation for monetary damages for breach of fiduciary
Docket No. 185, Ex. 4 at 16.
Because the defendants are exculpated from all duty of care claims, this Court must determine whether a director's omission or misrepresentation in the Final Proxy falls under the duty of loyalty.
The parties cite extensively to Delaware law. Because of Delaware courts' expertise in corporate matters, Massachusetts courts regularly find their decisions persuasive.
The "duty of disclosure is not an independent duty, but derives from the duties of care and loyalty."
Disclosure violations in proxy statements can fall within the protections of a corporate exculpation clause.
The plaintiff alleges that the Final Proxy contained numerous material omissions and misrepresentations. Docket No. 177 at 55-64. At the hearing, MAZ highlighted what it considered to be the most
The plaintiff can only prevail on its disclosure claim if it can show intentional, knowing, or reckless conduct on the part of the directors. The plaintiff has presented evidence from which a jury could find that the defendants failed to fully inform the shareholders that the SRR fairness opinion did not address the $5 million Class B payment or the $90 million pre-merger dividend. The Final Proxy itself was over 200 pages long and over 500 pages long with attachments. What shareholder is going to wade through the proxy and then jump into the attachments? Even Grieco was confused about the scope of the fairness opinion. Still, particularly since the SRR opinion was attached, there is no evidence of intentional, reckless, or bad faith misconduct. At most, the plaintiff's disclosure allegations constitute violations of the duty of care, not the duty of loyalty, and the directors are protected by the exculpation clause for such violations. Therefore, the Court allows the defendants' motion for summary judgment with respect to the directors' liability for any disclosure violations.
Duty of Loyalty
The plaintiff argues that because of the stock option acceleration provision, the voting agreements, Grieco and Shear's post-merger employment with Acadia, and the $5 million Class B payment, the directors received improper personal financial benefits as part of the merger at the expense of the PHC shareholders. MAZ also contends that Shear, although he abstained from the merger vote, improperly controlled the other directors' merger votes. The defendants respond that these provisions and agreements are standard for most mergers and are not separate financial benefits sufficient to show a violation of the duty of loyalty, and that the directors exercised their independent business judgment in voting to approve the merger.
"To rebut successfully business judgment presumptions ... thereby leading to the application of the entire fairness standard, a plaintiff must normally plead facts demonstrating that a
"There is no bright-line rule for determining whether additional, merger-related compensation constitutes a disabling interest."
The PHC directors, other than Shear, each owned
The plaintiff first contends that the board of directors received inappropriate compensation because the directors' stock option vesting schedules accelerated. The directors were not issued additional stock options as part of the merger; rather, the acceleration provision applied only to their existing options to avoid forfeiture of those options post-merger. "The accelerated vesting of options does not create a conflict of interest because the interests of the shareholders and directors are aligned in obtaining the highest price."
Next, the plaintiff points to voting agreements under which the directors committed to vote their shares for the merger and not solicit other offers. The merger agreement also contained a termination fee if PHC chose to back out of the merger. These provisions are common in
The plaintiff also highlights the fact that Grieco and Shear secured post-merger director positions on the Acadia board. As the defendants point out, in the context of corporate mergers, officers and directors from the discontinued company often assume positions of leadership in the newly formed corporation. This practice assures some continuity post-merger. This type of post-merger employment is not an inappropriate personal benefit. "[M]anagement's expectation of employment with the new company is not, in itself, sufficient to establish a conflict of interest on the part of the directors."
The plaintiff's last argument is its strongest. MAZ alleges that the voting directors, even if not financially interested in the merger, were dominated and controlled by Shear, a materially interested director. With respect to domination of the voting directors by Shear, a "director may be considered beholden to another when the allegedly controlling entity has the unilateral power to decide whether the challenged director continues to receive a benefit, financial or otherwise."
Shear was a hands-on CEO and selected four of six board members. He negotiated directly with Acadia's CEO, outside the supervision of the other board members, for the $5 million Class B payment and his post-merger director position. The directors later approved this payment without asking SRR to independently determine its fairness. Although Shear could not approve the merger himself, he could veto it based on his majority control of the Class B shares. Although in their affidavits the directors flatly denied any coercion or intimidation by Shear, the plaintiff has provided sufficient evidence to create a genuine dispute about whether Shear controlled the directors' merger votes. Therefore, the defendants' motion for summary judgment on Count I is denied.
B. Count II: Shear as Controlling Shareholder
The plaintiff argues that Shear, as PHC's controlling shareholder, violated his fiduciary duty by competing with the public shareholders for merger consideration. The defendants respond that Shear was not the controlling shareholder and did not owe any independent fiduciary duty to shareholders outside of his duty as director.
A "shareholder owes a fiduciary duty only if it owns a majority interest
"[I]t is clear that there is no absolute percentage of voting power that is required in order for there to be a finding that a controlling stockholder exists...."
In making this factual inquiry into a control relationship, courts look to a number of different factors. The
Shear was a minority shareholder who controlled approximately twenty percent of PHC's outstanding voting rights. MAZ relies heavily on Shear's ownership of 93% of Class B shares enabling him to select four out of six PHC directors. Although he was unable to approve the merger on his own, he did have the power to veto the merger if he was unsatisfied with the terms based on his almost total control of Class B shares.
Shear was a hands-on CEO and founder who remained active in the management of the company. Starting in January 2011, Shear was the primary player in the merger negotiations. He initially met with Jacobs, Acadia's CEO, and they agreed on the major issues for the eventual merger. Notably, this framework, which the board adopted and the shareholders eventually approved, included the $5 million sweetener for Class B shareholders and Shear's Acadia board seat post-merger. Shear received approximately $4.7 million of that sweetener. Even after the board appointed Grieco as the "lead independent director," Shear remained actively involved in the negotiations.
In PHC's 2011 10-K filings, PHC disclosed to shareholders that Shear was "in control of the Company since he is entitled to elect and replace a majority of the Board of Directors." Docket No. 187, Ex. 2 at 23. Although this SEC filing does not precisely track the corporate law definition of control, it is evidence that Shear had power over the direction of PHC. However, the defendants emphasize the plaintiff's admission in its second amended complaint, which stated: "The public stockholders of PHC (in the aggregate) owned a majority of PHC voting stock. Control of the corporation was not vested in a single person, entity, or group, but vested in the fluid aggregation of unaffiliated stockholders (except with respect to electing directors which Defendant Shear alone controlled)." Docket No. 177 at 38.
Finally, the defendants argue that MAZ has produced no evidence that Shear actually controlled the board through threats, financial incentives, or other inducements. The PHC directors submitted affidavits in which they denied any undue influence or domination by Shear. For example, Director Douglas Smith stated:
Docket No. 195, Ex. 5 at 3-4.
However, the defendants' expert Andrew Capitan testified about the merger that: "unless [Shear] wanted to do it, it wouldn't happen. And I think that's a very powerful position from the point of view of if you want to buy this company, you got to make a deal with Mr. Shear." Docket No. 192, Ex. 1 at 31. Additionally, director Robar testified about the $5 million Class B sweetener that "most of it was going to Bruce [Shear], and he was giving up something he had built up his whole life, his company, it was a publicly traded company, but he had controlling interest, and he was giving up his controlling interest in the company, which is huge." Docket No. 192, Ex. 1 at 129. The directors did not ask SRR to perform an independent evaluation of the $5 million Class B payment. Although there is no evidence of direct threats made to the other directors, MAZ has supplied sufficient evidence that Shear controlled the merger negotiations, was a hands-on CEO, and the board deferred to
The Court finds that MAZ has provided sufficient evidence to show a genuine dispute of material fact regarding Shear's status as the controlling shareholder of PHC. The defendants' motion for summary judgment with respect to Count II of the plaintiff's second amended complaint is denied.
C. Shareholder/Director Ratification
The defendants argue that, even if Shear had a conflict of interest, the merger transaction is valid under Massachusetts law because the shareholders and the disinterested directors voted to ratify the merger. Under Massachusetts law:
M.G.L. ch. 156D, § 8.31(a). "The statute makes the automatic rule of voidability inapplicable to transactions that [are] fair to the corporation or that have been approved by directors or shareholders after disclosure of the material facts."
The Court has not found, and the defendants have not cited, any Massachusetts case where a director has used this statute as a shield to liability for a violation of his fiduciary duty of loyalty in the merger context. Delaware courts themselves struggle with the impact of a fully informed shareholder vote on claims against the directors.
Assuming without deciding that the Massachusetts statute does apply to mergers, the plaintiff has provided sufficient evidence to create a genuine dispute about whether the shareholder vote was fully informed. Even though the Court has determined that the directors did not engage in intentional or reckless violations of their duty of loyalty with respect to the plaintiff's disclosure allegations, there is a fact question about whether the directors breached their duty of care by failing to explicitly disclose in the Final Proxy that the SRR opinion did not address the fairness of the $5 million sweetener or the $90 million pre-merger Acadia dividend.
Moreover, the Court has already ruled that, although the voting directors were not financially interested in the transaction, a genuine dispute remains as to whether Shear controlled their merger votes. Therefore, at this stage, there is a dispute of material fact about whether M.G.L. ch. 156D, § 8.31 protects the directors from liability.
Acadia Aiding and Abetting
The defendants argue that MAZ has produced no evidence to support its claim that Acadia knowingly aided and abetted the defendants' breach of fiduciary duty. The plaintiff responds that Acadia's CEO negotiated almost exclusively with Shear and agreed to additional merger compensation for Shear, not shared by the majority of PHC's Class A shareholders.
"[T]he elements of the tort of aiding and abetting a fiduciary breach are: (1) there must be a breach of fiduciary duty, (2) the defendant must know of the breach, and (3) the defendant must actively participate or substantially assist in or encourage the breach to the degree that he or she could not reasonably be held to have acted in good faith."
Here, Shear and Acadia's CEO, Jacobs, began negotiating for the possible sale of PHC in January 2011. Without any outside involvement, the two agreed to the $5 million payment for Class B shares and Shear's post-merger employment with Acadia. Jacobs signed and submitted the LOI to the PHC board with these provisions. The plaintiff has provided sufficient evidence to create a genuine dispute about whether Acadia knowingly aided and abetted Shear's alleged breach of his fiduciary duty. The Court denies the defendants' motion for summary judgment on Count III of the plaintiff's second amended complaint.
Plaintiff's Motion for Summary Judgment
A. Entire Fairness Review
The plaintiff argues that, because the directors were controlled by Shear, a materially interested director and controlling
"Ordinarily, in a challenged transaction involving self-dealing by a controlling shareholder, the substantive legal standard is that of entire fairness, with the burden of persuasion resting upon the defendants."
The Court has already found that the defendants are not entitled to summary judgment on the questions of whether Shear was PHC's controlling shareholder and whether he dominated the other directors in their merger votes. Because there is a genuine dispute on these issues, the Court denies the plaintiff's motion for summary judgment to establish the standard of review for the merger transaction.
B. Defendants' Affirmative Defenses
The defendants assert the defense that they are immune from suit under state law for breaches of fiduciary duty under M.G.L. ch. 156D, § 2.02 (b)(4). As stated in more detail above, based on the exculpation clause in PHC's articles of organization, the directors are protected from paying monetary damages for breaching their duty of care, but not their duty of loyalty.
The plaintiff argues that the equitable defense of unclean hands is inapplicable to this action at law for monetary damages. "Unclean hands is an equitable remedy that allows a court to refuse to aid one tainted with inequitableness or bad faith relative to the matter in which he seeks relief, however improper may have been the behavior of the defendant."
The plaintiff argues a shareholder has no duty to mitigate damages in a case alleging a breach of fiduciary duty. The defendants respond that appraisal is the sole remedy available to shareholders who are unsatisfied with their share price merger compensation. However, appraisal is not the sole remedy "if the corporation attempts an action by deception of shareholders," and in this situation, "the court's freedom to intervene or to award damages should be unaffected by the presence or absence of appraisal rights...." M.G.L. ch. 156D, § 13.02 cmt. 3. In a previous opinion written by Judge O'Toole, the Court rejected the defendants' appraisal argument.
The defendants assert the defense that the plaintiff waived its disclosure related claims by failing to amend its complaint in light of the Final Proxy. Even though the plaintiff failed to amend its complaint to add § 14(a) allegations, it did properly include
Laches and Estoppel
The plaintiff moved for summary judgment on the defendants' affirmative defenses of laches and estoppel and the defendants failed to oppose. Therefore, summary judgment on these defenses is allowed.