Philip Beck v. Thomas Dobrowski ( 2009 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 07-3967
P HILIP B ECK, individually and
on behalf of all others similarly
situated, and derivatively on behalf of
Equity Office Property Trust,
Plaintiff-Appellant,
v.
T HOMAS E. D OBROWSKI, et al.,
Defendants-Appellees.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 06 C 6411—Harry D. Leinenweber, Judge.
A RGUED S EPTEMBER 24, 2008—D ECIDED M ARCH 20, 2009
Before P OSNER, W OOD , and T INDER, Circuit Judges.
P OSNER, Circuit Judge. The plaintiff sued the members
of the board of directors of the former Equity Office
Property Trust charging that they had violated section
14(a) of the Securities Exchange Act, 15 U.S.C. § 78n(a),
and the SEC’s implementing Rule 14a-9, 17 C.F.R.
§ 240.14a-9, which forbid material misrepresentations or
2 No. 07-3967
omissions in soliciting a shareholder’s proxy vote. There
is also a state-law claim. The district judge dismissed
the federal part of the suit for failure to state a claim. Fed.
R. Civ. P. 12(b)(6). He ruled that the Private Securities
Litigation Reform Act, 15 U.S.C. § 78u-4, is applicable to
suits under section 14(a), which is correct, §§ 78u-4(b)(1),
(2), (4), and that it required the complaint to state
“with particularity facts giving rise to a strong inference
that the defendant acted with the required state of
mind,” § 78u-4(b)(2), which is incorrect. Invoking the
doctrine of abstention, he dismissed the state-law claim
as well and thus the entire suit.
There is no required state of mind for a violation of
section 14(a); a proxy solicitation that contains a mislead-
ing misrepresentation or omission violates the section
even if the issuer believed in perfect good faith that there
was nothing misleading in the proxy materials. Kennedy
v. Venrock Associates, 348 F.3d 584, 593 (7th Cir. 2003);
In re Exxon Mobil Corp. Securities Litigation, 500 F.3d 189,
196-97 (3d Cir. 2007); Shidler v. All American Life & Financial
Corp., 775 F.2d 917, 926-27 (8th Cir. 1985); Gerstle v. Gamble-
Skogmo, Inc., 478 F.2d 1281, 1300-01 (2d Cir. 1973); 3 Alan R.
Bromberg & Lewis D. Lowenfels, Bromberg & Lowenfels on
Securities Fraud & Commodities Fraud § 8.4(430), pp. 204.71-
72 (2d ed. 1996). The requirement in the Private Securities
Litigation Reform Act of pleading a state of mind arises
only in a securities case in which “the plaintiff may
recover money damages only on proof that the defendant
acted with a particular state of mind.” 15 U.S.C. § 78u-
4(b)(2). Section 14(a) requires proof only that the proxy
solicitation was misleading, implying at worst negligence
No. 07-3967 3
by the issuer. Kennedy v. Venrock Associates, supra, 348
F.3d at 593. And negligence is not a state of mind; it is a
failure, whether conscious or even unavoidable (by the
particular defendant, who may be below average in his
ability to exercise due care), to come up to the specified
standard of care. E.g., Desnick v. ABC, 233 F.3d 514, 518
(7th Cir. 2000); United States v. Ortiz, 427 F.3d 1278, 1283
(10th Cir. 2005); W. Page Keeton et al., Prosser and Keeton on
the Law of Torts § 31, p. 169 (5th ed. 1984) (“negligence
is conduct, and not a state of mind”). That is a basic
principle of tort law, though it is sometimes overlooked,
as in Dasho v. Susquehanna Corp., 461 F.2d 11, 29-30 n. 45
(7th Cir. 1972).
The problems with the complaint are profound, but lie
elsewhere. Bell Atlantic Corp. v. Twombly, 550 U.S. 544(2007), teaches that a defendant should not be burdened
with the heavy costs of pretrial discovery that are likely
to be incurred in a complex case unless the complaint
indicates that the plaintiff’s case is a substantial one. As
the Supreme Court had earlier explained, a litigant must
not be permitted to use “a largely groundless claim to
simply take up the time of a number of other people, with
the right to do so representing an in terrorem increment
of the settlement value, rather than a reasonably founded
hope that the [discovery] process will reveal relevant
evidence.” Blue Chip Stamps v. Manor Drug Stores, 421
U.S. 723, 741 (1975); see also Limestone Development Corp.
v. Village of Lemont, 520 F.3d 797, 802-03 (7th Cir. 2008).
He is not to be allowed to extort a settlement by reason
of the defendant’s having to incur heavy litigation ex-
penses if the suit proceeds beyond the pleading stage
even if it is a groundless suit.
4 No. 07-3967
The essential facts in this case, either as alleged in the
complaint or judicially noticeable, are (with some simplifi-
cation) as follows. Equity Office Property Trust (we’ll
abbreviate it to “EO”) was a real estate investment
trust—the equivalent of a corporation—and the plaintiff
was one of its shareholders. On November 19, 2006, EO’s
board of directors signed an agreement with Blackstone
Group L.P., the private-equity firm, to sell EO to
Blackstone for $48.50 per share, all cash, for a total of
$36 billion. The agreement, which was subject to ap-
proval by EO’s shareholders, allowed EO to terminate the
agreement if it received a better offer, but in that event
it would have to pay Blackstone a termination fee of
$200 million.
A shareholders’ meeting to consider the deal with
Blackstone was scheduled for February 5, 2007. EO’s board
mailed a proxy solicitation to its shareholders in the
hope of collecting enough proxies to assure a favorable
vote at the meeting.
A bidding war ensued, for on January 17, 2007, EO
received an offer from Vornado Realty Trust to buy EO
for $52 per share, payable 60 percent in cash and 40 per-
cent in Vornado stock; the purchase would have to be
approved by Vornado’s shareholders. EO issued a
press release describing the offer; filed the press release
electronically with the Securities and Exchange Com-
mission, which published it on its website; and mailed
its shareholders a supplemental proxy solicitation.
A week later, Blackstone raised its offer to $54 per share.
EO’s board promptly accepted the offer and agreed to
increase the termination fee to $500 million. There was
No. 07-3967 5
the same flurry of publicity, press release, filing with the
SEC, and mailing of a supplemental proxy solicitation to
the shareholders.
Vornado responded on February 1 by raising its offer
for EO to $56 per share but reducing the percentage of
payment that would be in cash rather than stock from
60 percent to 55 percent. There was the same flurry of
publicity, filing, etc., but in a supplemental proxy solicita-
tion EO’s board continued to recommend that the share-
holders approve the acquisition by Blackstone. So on
February 4 Vornado proposed a new deal: an initial cash
tender offer for up to 55 percent of EO’s shares to be
followed by the acquisition of the remaining shares by
swapping Vornado shares for them. The advantage to EO
of this alternative would be speed; a shareholder vote
would not be required for acceptance of the cash tender
offer.
Blackstone counterattacked by raising its all-cash offer to
$55.25. EO’s board responded by demanding $55.50, and
Blackstone agreed but on the condition (to which the
board acceded) that the termination fee be raised from
$500 million to $720 million. There was again a flurry
of publicity, filing, etc., and a supplemental proxy solicita-
tion in which EO’s board recommended approval of the
Blackstone proposal. Vornado threw in its hand. It an-
nounced that it was dropping out of the bidding for EO
because “the premium it would have to pay to top
Blackstone’s latest bid, protected by a twice increased
breakup fee [the $720 million], would not be in its share-
holders’ interest.” On February 7, EO’s shareholders voted
overwhelmingly to approve Blackstone’s new bid.
6 No. 07-3967
The plaintiff intimates a possible impropriety in
Blackstone’s having demanded a stiff termination fee,
which would have increased the cost to Vornado of
outbidding Blackstone. That would not be a proper claim
under section 14(a) of the Securities Exchange Act, how-
ever, because it has nothing to do with misrepresent-
ations and anyway Blackstone is not a defendant. The fee
was disclosed to EO’s shareholders and they could have
voted against accepting Blackstone’s final offer precisely
because it would end the bidding war by making a
higher bid too expensive for Vornado to be willing to
make.
As we noted in Stark Trading v. Falconbridge Ltd., 552
F.3d 568, 572 (7th Cir. 2009), the antifraud provisions of
federal securities law are not a general charter of share-
holder protection—which is not to suggest that termi-
nation fees in bidding contests are generally improper
under any body of law with which we are familiar. See
Venture Associates Corp. v. Zenith Data Systems Corp., 96
F.3d 275, 278 (7th Cir. 1996); Cottle v. Storer Communication,
Inc., 849 F.2d 570, 578-79 (11th Cir. 1988); Brazen v. Bell
Atlantic Corp., 695 A.2d 43, 48-50 (Del. 1997). Blackstone
was forgoing other investment opportunities in prepara-
tion for having to shell out $39 billion in cash to buy
EO. Granted, if the fee were a high percentage of the bid,
then, as the cases we have cited suggest, its acceptance
by the board of the target company might disserve the
target’s shareholders by ending the bidding war prema-
turely. That is not the case here (or for that matter in most
cases involving “deal protection” provisions of that sort,
see Micah S. Officer, “Termination Fees in Mergers and
No. 07-3967 7
Acquisitions,” 69 J. Fin. Econ. 431, 462-63 (2003)), but the
essential point is that, to repeat, the termination fee
had nothing to do with any representations or omissions
in the proxy solicitations.
But the plaintiff also argues that had it not been for
misleading proxy solicitations, EO’s shareholders would
have rejected the merger and by doing so have “reaped the
economic benefits of continuing to own [EO] shares.” That
there would have been net benefits is proved, he argues,
by the fact that Vornado’s offer of $56 in cash and stock
was superior to Blackstone’s final all-cash offer of $55.50,
which shows that EO shares had been sold to Blackstone
for less than their market value. But the premise is incor-
rect. Vornado’s offer was not superior to Blackstone’s.
The difference between $55.50 and $56 is less than
1 percent, and while Blackstone was prepared to pay the
full price for EO on closing, Vornado could not
have completed the purchase of EO until and unless
its shareholders approved the acquisition, which would
take months. At any plausible discount rate, a delay of
several months in EO’s receipt of 45 percent of the pur-
chase price (the percentage that was to be paid for in
stock, thus requiring the approval of Vornado’s share-
holders, rather than in cash) would reduce the present
value of Vornado’s offer by more than 1 percent.
In addition, the sale of EO for cash was less risky than
would have been a sale almost half of which would have
been in Vornado’s stock, a risky asset. A purchase for
cash reduces the seller’s risk compared to a purchase for
stock (in whole or part), and that is a benefit for which
8 No. 07-3967
many sellers will pay. E.g., Frank C. Evans & David M.
Bishop, Valuation for M&A: Building Value in Private Compa-
nies 226-27 (2001). It is true that some taxpayers reap tax
advantages from the sale of a company for stock rather
than cash, Dale Arthur Oesterle, The Law of Mergers
and Acquisitions 800-14 (3d ed. 2005), but the plaintiff
does not claim to be one of them.
A suit of this kind if it succeeded would place corporate
management on a razor’s edge. Had EO’s board accepted
Vornado’s offer in lieu of Blackstone’s, the plaintiff
would be suing the board members for having turned
down a better offer, especially since the price of Vornado’s
stock plunged in the months following the sale to
Blackstone. Had EO turned down both offers, the plain-
tiff would be suing the board members for having failed
to foresee the calamitous fall in real estate prices after
the acquisition (remember, EO was a real estate invest-
ment trust). Any evidence that the plaintiff would have
presented, either in this case or in our hypothetical cases,
concerning the optimal strategy for EO to have pursued
would have been heavy on hindsight and speculation,
light on verifiable fact.
Even if the complaint could survive the criticisms that
we have made so far (and it could not), the plaintiff’s
allegations that the proxy solicitations contained mis-
representations or misleading omissions were too feeble
to allow the suit to go forward under the standard set
forth by the Supreme Court in the Bell Atlantic case. The
plaintiff contends that the shareholders might have liked
to have more backup information, and perhaps some of
No. 07-3967 9
them would have. But there is nothing in the complaint to
suggest that any shareholder was misled or was likely to
be misled by the dearth of backup information—that is,
that the shareholder drew a wrong inference from that
dearth. The complaint does allege that the proxy materials
failed to specify the benefits that top executives of EO
would receive from Blackstone, but there is no suggestion
that these gains were greater than what the executives
would have received from Vornado. Nor is there any
indication of what other executives receive in similar
acquisitions. So again there is no evidence of loss, or
indeed of materiality.
It is true that besides forbidding misleading state-
ments or omissions in proxy materials, section 14(a)
requires that the materials contain such information as the
SEC may require be included. 15 U.S.C. § 78n(a); Resnik v.
Swartz, 303 F.3d 147, 151 (2d Cir. 2002); Jonathan M. Hoff,
Lawrence A. Larose & Frank J. Scaturro, Public Companies
§ 3.08[4][b], pp. 3-31 to 3-32 (2006). But the complaint
does not allege that Blackstone omitted any required
information.
The plaintiff’s main argument for why the proxy solicita-
tions were (he thinks) misleading has, paradoxically,
nothing to do with their content. It is that the last solicita-
tion, the one recommending against acceptance of
Vornado’s sweetened offer of February 1, was mailed
too soon before the February 7 meeting of EO’s share-
holders to enable them to cast an informed vote. More
precisely—since the solicitation was mailed promptly
after Vornado announced the sweetened offer—the argu-
10 No. 07-3967
ment is that the meeting should have been postponed to
February 15, for the plaintiff contends that a proxy solicita-
tion must be mailed at least 14 days before the sharehold-
ers’ meeting. But that is not a rule for a court to impose. It
is a matter for the SEC to consider if it wants, because it
involves a delicate tradeoff best confided to specialists
in the securities markets. On the one hand, the longer the
interval between mailing a proxy solicitation and the
shareholders’ meeting the more time shareholders have
to consider the solicitation carefully. On the other hand,
the longer the interval the likelier the proposed trans-
action is to fall apart because of a change in the price of
the stock of the firm to be acquired (or a change in the
relative stock prices of the acquiring and the to-be-acquired
firm if it is not an all-cash transaction), or because of the
unwillingness or inability of one or both of the parties to
remain in limbo waiting for the deal to close. In favor of
giving more weight to the costs of delay is the electronic
revolution, as a result of which financial like other infor-
mation spreads far more rapidly than it used to. Of course
not all owners of stock in EO read the financial media
daily, but many of them did, or were advised by brokers
or investment advisers, and in either case would have
sold their stock well before the shareholders’ meeting.
In fact, as soon as Blackstone’s first offer was
announced, speculators would have bought EO stock in
the expectation that a bidding war would ensue and the
price of EO stock be bid higher, Basic Inc. v. Levinson, 485
U.S. 224, 234-35 (1988); speculators do not await the arrival
of proxy solicitations by snail mail to decide how to vote
their shares. Such speculation might, by making EO seem
No. 07-3967 11
more valuable, have increased the price that Blackstone
would have had to offer for EO to close the deal. See
Flamm v. Eberstadt, 814 F.2d 1169, 1176 (7th Cir. 1987);
James Harlan Koenig, “The Basics of Disclosure: The
Market for Information in the Market for Corporate
Control,” 43 U. Miami L. Rev. 1021, 1054-57 (1989). That
possibility in turn might have reduced the price that
Blackstone was willing to offer to pay, and is another
reason not to prescribe a waiting period for consideration
of competing offers.
Worse, if the plaintiff prevailed in this suit, he would
have succeeded in sinking the process of corporate acquisi-
tion into a sea of molasses by requiring that every fresh
offer to buy a company reset the clock for shareholder
approval. If Vornado’s offer of February 1 required delay-
ing EO’s shareholder meeting to February 15, then
Vornado’s amended offer of February 4 required a
further delay of the meeting to February 19. During
that interval, Vornado might have amended the offer
further, producing indefinite delay and escalating termina-
tion fees and perhaps causing Blackstone to abandon its
offer, which was conditional on the shareholders’
meeting being held on February 7.
We have now to consider the plaintiff’s state-law claim,
which is that EO’s directors violated their fiduciary
duties to the corporation’s shareholders, duties created
by the law of Maryland, the state in which EO was incorpo-
rated. The claim reflects the fact noted earlier that the
plaintiff’s quarrel with the defendant is not primarily over
alleged misrepresentations in proxy materials but is
12 No. 07-3967
rather over the failure, as it seems to the plaintiff, of EO’s
board to maximize shareholder value. The district judge
dismissed this claim in an exercise of Colorado River
abstention—abstention by a federal court in favor of the
court in which a parallel proceeding is pending. E.g.,
Colorado River Water Conservation District v. United States,
424 U.S. 800, 817-18 (1976); Starzenski v. City of Elkhart, 87
F.3d 872, 878 (7th Cir. 1996); 17A Charles Alan Wright
et al., Federal Practice & Procedure § 4247 (2008). Other
shareholders of EO had filed in Maryland state
courts suits identical to the plaintiff’s state-law claim in
this suit, and those suits had gone to judgment in favor
of the defendants and were on appeal when the
district judge abstained; they are still on appeal.
The plaintiff was not a party to the Maryland litigation,
but that is not critical. Clark v. Lacy, 376 F.3d 682, 684-87
(7th Cir. 2004); Caminiti & Iatarola, Ltd. v. Behnke Warehous-
ing, Inc., 962 F.2d 698, 700-01 (7th Cir. 1992); Romine v.
Compuserve Corp., 160 F.3d 337, 340 (6th Cir. 1998). For if
it were, different members of what should be a single
class could file identical suits in federal and state courts
to increase their chances of a favorable settlement. The
state-law issues that our plaintiff has presented to the
federal court will be definitively resolved by the courts
of the state whose law governs those issues, and our
court would be required to defer to that resolution be-
cause state courts are the authoritative expositors of their
own state’s laws.
So the judge acted well within his discretion in
declining to exercise jurisdiction over the plaintiff’s state-
No. 07-3967 13
law claim. But insofar as the plaintiff based federal juris-
diction over that claim on the district court’s supple-
mental jurisdiction, invocation of the doctrine of Colorado
River was unnecessary, in view of the presumption that
when a federal suit is dismissed before trial the court
should relinquish any supplemental state-law claim to the
state courts. 28 U.S.C. § 1367(c)(3). The presumption is
strengthened when, as in this case, an identical case is
already pending in state court and is nearer final
resolution than the claim in the federal suit. Tyrer v. City
of South Beloit, 456 F.3d 744, 755 (7th Cir. 2006); Caminiti &
Iatarola, Ltd. v. Behnke Warehousing, Inc., supra, 962 F.2d
at 702; Cruz v. Melecio, 204 F.3d 14, 23-24 (1st Cir. 2000).
But abstention was the proper course if, despite the
plaintiff’s invocation of the supplemental jurisdiction,
there is also diversity jurisdiction. That may seem doubt-
ful. Some members of his class are citizens of states of
which one or more of the defendants are also citizens; and
the Class Action Fairness Act, which creates federal
diversity jurisdiction of class actions that lack complete
diversity between the plaintiffs and the defendants, has
an exception for suits relating to the internal affairs of a
corporation, or other business enterprise, that might be
(though we need not decide whether it is) applicable to
a suit such as this. See 28 U.S.C. § 1332(d)(9)(B); Steven
M. Puiszis, “Developing Trends with the Class Action
Fairness Act of 2005,” 40 John Marshall L. Rev. 115, 138-39
(2006). Furthermore, the plaintiff purports to be suing on
behalf of EO, which has the same citizenship as several
defendants. But this is just to say that the suit is a deriva-
14 No. 07-3967
tive suit, the benefits of which, if the suit succeeds, will
accrue to the shareholders, who are the owners of EO.
A corporation is controlled by its management, and when
the management opposes the derivative suit the corpora-
tion is treated as a defendant rather than as a plaintiff
for purposes of determining whether there is diversity
jurisdiction. Smith v. Sperling, 354 U.S. 91, 95-97 (1957);
Doctor v. Harrington, 196 U.S. 579, 587 (1905); In re
Digimarc Corporation Derivative Litigation, 549 F.3d 1223,
1234-35 (9th Cir. 2008); Gabriel v. Preble, 396 F.3d 10, 14-15
(1st Cir. 2005). In effect, this suit is a revolt by share-
holders against the members of the board that engineered
EO’s sale to Blackstone.
But what of the citizenship of the shareholders on
whose behalf the plaintiff is suing? Because it is a deriva-
tive suit, a favorable judgment would accrue to all the
shareholders, many of whom are citizens of the same
states as the defendants. Does this destroy complete
diversity? As a matter of logic, yes. But concerned that
such logic would have the practical effect of precluding
diversity jurisdiction of derivative suits, the courts do not
consider the citizenship of individual shareholders (other
than a named party) in a derivative suit when deter-
mining whether there is diversity jurisdiction. New
Albany Waterworks v. Louisville Banking Co., 122 F. 776, 778-
79 (7th Cir. 1903); 7C Wright et al., supra, § 1822, pp. 19-20.
So Colorado River abstention was the right doctrine
after all for deciding whether to retain the plaintiff’s state-
law claim in federal court.
No. 07-3967 15
The judgment of the district court is
A FFIRMED.
3-20-09