What rights do minority shareholders have to oppose a merger? In short—almost no rights at all. In Allentoff v. Red Lion Hotels Corporation, No. 83576-9-I, 2023 WL 21338 (Wn. App. Jan. 3, 2023), the Division One Court of Appeals reiterated the now-concrete principal that, absent a showing of fraud, a minority shareholder dissenting from a merger may only contest the value of their shares. Practitioners and shareholders alike should be aware of this case law as the merger presents a fan-favorite tool for getting rid of unwanted minority shareholders.
Red Lion Hotels Merger
Red Lion Hotels Corporation owns various hotels and franchises hotels throughout the United States, and in 2019, they began considering a merger. In November 2020, Red Lion formally considered proposals from three different entities, including Sonesta International Hotels Corporation. In January 2021, Red Lion delivered a proxy statement to its shareholders that included various financial information and the notice that shareholders that the right to dissent from the merger and demand “fair value of their shares pursuant to Chapter 23B.12 of the Washington Business Corporation Act.” The proxy statement related to a potential merger between Red Lion and Sonesta, which was scheduled for a vote on March 16, 2021.
After issuance of the proxy statement, but before the merger vote, a shareholder filed a class action asserting, among other things, breach of fiduciary duty related to improprieties in the proxy statement. The complaint alleged that Red Lion and its board (i) “knowingly undervalued [Red Lion] by at least $.54 per share;” (ii) “acted dishonestly and misled shareholders regarding critical facts, most notably regarding…standalone revenue projections…and the adequacy of the Merger Consideration;” and (iii) engaged in “dishonest, bad faith conduct in orchestrating the unfair Buyout.”
After the shareholders’ class action, Red Lion filed a motion to dismiss on grounds that the shareholders could only advance an appraisal proceeding under RCW 23B. Therefore, according to Red Lion, the shareholders’ class action was procedurally improper. The trial court agreed and dismissed the complaint, resulting in an appeal.
Shareholder’s Complaint Dismissed
In its analysis, the Court of Appeals first noted that “shareholders are entitled to dissent from and obtain payment of the fair value of the shareholder’s shares when a corporation performs a corporate action such as a merger with another company.” Allentoff, 2023 WL 21338 at *4. As such, “[d]issenting shareholders cannot bring claims outside of the appraisal proceeding absent a showing of fraud.” Id. Therefore, the question before the Court of Appeals was whether the shareholders sufficiently plead facts showing fraud.
The Court of Appeals determined the pleaded facts did not amount to fraud. Significantly, the Court noted that a shareholder cannot advance a lawsuit outside an appraisal proceeding “by merely alleging fraudulent conduct.” Id. (emphasis from Court). Rather, “Courts must look at the actual facts of the case to determine whether the corporate action was fraudulent.” Id.
The Court proceeded to analyze the facts advanced by the shareholders, particularly with respect to the financial information disclosed by Red Lion. Ultimately “[a]side from the shareholders’ conclusory statements that the respondents were ‘dishonest’ and ‘misled shareholders regarding critical facts’ and engaged in ‘bad faith conduct,’ the pleadings do not present facts that show fraudulent conduct.” In support of this finding, the Court noted how the shareholders’ complaint contradicted itself—the shareholders complained of a lack of information, but the proxy statement actually contained the information the shareholders complained they were missing. Indeed, Red Lion continued to produce additional financial documentation after the proxy statement was filed (but before merger vote) that supplemented information the shareholders believed was missing. As such, the Court dismissed the shareholders’ complaint.
Considerations for Practitioners and Shareholders
Even though Allentoff involves a (former) publicly traded company, the legal principles relating to mergers and the rights of minority shareholders are just as relevant to closely held business divorce disputes. Indeed, Sound Infiniti arose out of a closely held corporation.
Majority shareholders frequently use mergers to rid themselves of unwanted minority shareholders for the exact reasons laid out in Allentoff. The burden on minority shareholders necessary to maintain an action outside of the appraisal process is very high: the minority shareholders need to show fraud, rather than simply pleading fraud. As such, it is important for minority shareholders to bargain for protections from mergers at the outset of a business arrangement. But, if minority shareholders fail to bargain for those protections and a merger occurs, Allentoff and Sound Infiniti reinforce the concept that minority shareholders need to come prepared with specific facts of fraud when contesting a merger.
To learn more about Minority Shareholders Must Show Fraud When Blocking Mergers, please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-410