Court Rejects Post-Merger Challenges by Former Shareholders of California Corporations
November 5, 2012
A California Superior Court in the County of Santa Clara recently sustained demurrers without leave to amend in two parallel cases, each of which involved post-merger challenges by former shareholders of a California corporation. Sullivan v. Actel Corporation, Case No. 1-10-CV-184257 (Oct. 29, 2012); Jarackas v. Applied Signal Technology, Inc., Case No. 1-11-CV-191643 (tentative issued on Oct. 25, 2012, and adopted on Oct. 26, 2012).1 Given the prevalence of suits challenging mergers involving public companies, these rulings are an important development where the target company is incorporated in California.
As has become commonplace, shareholder class action complaints were filed against Actel Corporation and Applied Signal Technology, Inc., and their respective boards of directors after each company announced a merger with another company (Microsemi Corporation in the case of Actel and Raytheon Company in the case of Applied Signal). Both Actel and Applied Signal were incorporated in California. Shareholders of Actel and Applied Signal claimed that their respective boards had breached their fiduciary duties in entering into agreements whereby the acquiring companies would make a tender offer followed by a short-form merger. Each of the merger agreements included an option allowing the acquiring company to purchase additional shares to reach the 90 percent threshold required to effect a short-form merger under California law (commonly called a "top-up option").
The plaintiffs in each of the cases sought temporary restraining orders to prevent the acquiring companies from accepting tendered shares, claiming that the top-up option in each deal violated California law. The court denied the TROs.
The cases continued after the mergers closed, with the plaintiffs seeking damages for alleged breaches of fiduciary duty by the target companies' boards of directors and for alleged aiding and abetting of such breaches by the acquiring companies. While the gravamen of each complaint was that shareholders had received an inadequate price for their shares, each complaint also challenged the merger process, adequacy of disclosures, and top-up option.
The Court's Decisions
In March 2012, Judge James P. Kleinberg of the Superior Court sustained demurrers in both cases based on the plaintiffs' lack of standing to bring derivative claims. The court applied California law (as the target companies were incorporated in California) and found that the plaintiffs' breach of fiduciary duty claims were derivative—not direct—under California law. As Judge Kleinberg noted in Actel, "These claims appear to be derivative because the alleged injury—that Actel shareholders received an unfair price for their stock—falls on all shareholders alike, with no severance of distribution among them." In so holding, the court rejected the plaintiffs' reliance on Delaware law, finding that California and Delaware law on the matter were not the same.
Given that the court held that the claims were derivative, the question then became whether the plaintiffs had standing to maintain the actions since they had lost their shareholder status upon the consummation of the mergers at issue. The court held that as California law requires that a derivative plaintiff maintain continuous stock ownership throughout the pendency of the litigation, the plaintiffs had lost standing to continue the litigation.
In both cases, the court allowed the plaintiffs leave to amend. The plaintiffs in both cases amended their complaints and the defendants filed a second round of demurrers.
Recently, the court sustained the demurrers in both cases without leave to amend, reiterating its prior holdings that the plaintiffs' claims were derivative. As explained in Actel, "The main thrust of Plaintiffs' allegations is that Actel shareholders received an unfair price for their Actel stock and Defendants unfairly deprived them of the true value of their investment in Actel." Accordingly, these "claims are derivative because the alleged injury falls on all shareholders alike."
As in its earlier decisions, the court held that the plaintiffs lacked standing to bring derivative claims because they were no longer shareholders as a result of a merger. In denying leave to amend, the court noted that the plaintiffs had not shown how this standing defect could be cured with further amendment.
It has now become typical for the board of a public company to be sued for alleged breach of fiduciary duty shortly after the announcement that the company has agreed to be acquired.2 Where the target is a California corporation, these decisions, to the extent that they are followed by other California courts, may change the way such cases are pursued, as plaintiffs likely will face greater pressure to succeed in enjoining the merger or obtain a settlement before the merger closes.
For more information about this case or any other related litigation matter, please contact a member of Wilson Sonsini Goodrich & Rosati's securities litigation practice.
2 Douglas J. Clark & Marcia Kramer Mayer, "Anatomy of a Merger Litigation," boardmember.com (Feb. 2012), available at http://www.wsgr.com/publications/PDFSearch/anatomy-of-a-merger-litigation-clark.pdf (study showing that shareholder suits were filed challenging a majority of deals announced in 2009 and 2010).