The Matter of Kenneth Cole Productions, Inc., Shareholder Litigation , Erie County Employees Retirement System v. Michael J. Blitzer , 27 N.Y.3d 268 ( 2016 )

This opinion is uncorrected and subject to revision before
publication in the New York Reports.
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No. 54
In the Matter of Kenneth Cole
Productions, Inc., Shareholder
Litigation
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Erie County Employees Retirement
System,
Appellant,
v.
Michael J. Blitzer, et al.,
Respondents,
Marlin Equities VII, LLC,
Defendant.
Lee D. Rudy, for appellant.
Tariq Mundiya, for respondents Cole, et al.
Andrew W. Stern, for respondents Blitzer, et al.
Eastern New York Laborers' District Council, amicus
curiae.
STEIN, J.:
In this shareholder class action challenging a going-
private merger, we adopt the standard of review recently
announced by the Delaware Supreme Court in Kahn v M & F Worldwide
Corp. (88 A3d 635, 648-649 [Del 2014]) (MFW). Specifically, in
reviewing challenges to going-private mergers, New York courts
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should apply the business judgment rule as long as certain
shareholder-protective conditions are present; if those measures
are not present, the entire fairness standard should be applied.
Applying the MFW standard to the case before us, we affirm the
dismissal of the complaint.
I.
Kenneth Cole Productions, Inc. (KCP) is a New York
corporation that designs and markets apparel, footwear, handbags
and accessories. KCP was organized with two classes of common
stock. As of June 2012, there were approximately 10,706,723
outstanding shares of Class A stock, which were traded on the New
York Stock Exchange. Each Class A share entitled the holder to
one vote, and defendant Kenneth D. Cole held approximately 46% of
these shares. As of June 2012, there were approximately
7,890,497 outstanding shares of Class B stock, all of which were
held by Cole. Class B shares entitled the holder to 10 votes,
giving Cole approximately 89% of the voting power of the KCP
shareholders. At the time in question, KCP's board of directors
consisted of Cole and the other individual defendants herein.
Defendants Michael J. Blitzer and Philip R. Peller were elected
by Class A shareholders. Notably, defendants Denis F. Kelly and
Robert C. Grayson held directorships voted on by both Class A and
Class B shareholders, effectively giving Cole sole authority to
fill these positions.
At a meeting held in February 2012, Cole proposed a
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going-private merger by informing KCP's board of his intention to
submit an offer to purchase the remainder of the outstanding
Class A shares and, in effect, take the publicly-traded company
private. After making this announcement, Cole left the meeting,
and the board established a special committee to consider the
proposal and negotiate any potential merger. The special
committee consisted of directors Grayson, Kelly, Blitzer and
Peller. On February 23, 2012, Cole made an initial offer of
$15.00 per share. The offer was conditioned on approval by (1)
the special committee, and, then, (2) a majority of the minority
shareholders. At that time, Cole indicated that he had no desire
to seek any other type of merger and, as a stockholder, would not
approve of one. He also stated that, if the special committee
did not recommend approval or the stockholders voted against the
proposed transaction, his relationship with KCP would not be
adversely affected.
Within a few days of Cole's announcement, several
shareholders, including plaintiff Erie County Employees
Retirement System, commenced separate class actions alleging,
among other things, breach of fiduciary duty by Cole and the
directors. The committee retained legal counsel and a financial
advisor, and proceeded to negotiate the terms of the going-
private merger with Cole. The committee asked Cole to increase
his offer several times, which he ultimately raised to $15.50 and
then $16.00. Within a week of the $16.00 offer, Cole reduced his
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offer to $15.00, citing the alleged recent emergence of problems
in the company and the economy. Finally, after months of
negotiations, the special committee again asked Cole to increase
his offer and, thereafter, approved Cole's offer of $15.25 for
each outstanding share of Class A stock, which it recommended to
the minority shareholders. Although the shareholder vote
apparently occurred after an amended complaint was filed in this
action,1 and is not mentioned therein, 99.8% of the minority
shareholders voted in favor of the merger.
In the amended complaint, plaintiff sought, among other
things, (1) a judgment declaring that Cole and the directors had
breached the fiduciary duties they owed to the minority
shareholders, (2) an award of damages to the class, and (3) a
judgment enjoining the merger. Defendants separately moved to
dismiss the complaint on the ground that it failed to state a
cause of action.
Supreme Court granted defendants' motions and dismissed
the complaint. The court determined that the complaint "fail[ed]
to set forth facts demonstrating a lack of independence on the
part of any of the . . . individual defendants." Further, the
court held that "the complaint d[id] not adequately allege any
facts that, if true, demonstrate[d] that the decision not to seek
1
After the special committee recommended that Cole's $15.25
offer be accepted, plaintiff amended its complaint to reflect
what had occurred since the action was commenced. This action
was ultimately consolidated with five other class actions.
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other bids constituted a breach of fiduciary duty," as
"plaintiff[] acknowledge[d] that the special committee negotiated
with Cole over a period of months and obtained an increase in the
price he would pay . . . where the original price represented a
premium over the stock's most recent selling price." Ultimately,
the court reasoned that, "absent a showing of specific unfair
conduct by the special committee, the [c]ourt will not second
guess the [special] committee's business decisions in negotiating
the terms of [the] transaction." The court further held that
"the complaint d[id] not contain adequate statements regarding a
breach" of Cole's fiduciary duty. Plaintiff appealed, on behalf
of itself and the class.
The Appellate Division affirmed, holding that,
"[c]ontrary to plaintiff's claim, the motion court was not
required to apply the 'entire fairness' standard to the
transaction" (122 AD3d 500, 500 [1st Dept 2014]). The Court
noted that, unlike in Alpert v 28 Williams St. Corp. (63 NY2d 557
[1984]), "the merger in the case at bar required the approval of
the majority of the minority (i.e., non-Cole) shareholders" (122
AD3d at 500). In addition, Cole, an interested party, "did not
participate when [KCP]'s board . . . voted on the merger," and
plaintiff did "not allege[] that the remaining members of the
board . . . were self-interested" (id.). The Court held that
"there [were] no allegations sufficient to demonstrate that the
members of the board or the special committee did not act in good
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faith or were otherwise interested" (id. at 501). This Court
granted plaintiff leave to appeal (25 NY3d 909 [2015]).
II.
The primary issue before us is what standard should be
applied by courts reviewing a going-private merger that is
subject from the outset to approval by both a special committee
of independent directors and a majority of the minority
shareholders. Plaintiff urges that we apply the entire fairness
standard, which places the burden on the corporation's directors
to demonstrate that they engaged in a fair process and obtained a
fair price. Defendants seek application of the business judgment
rule, with or without certain conditions. We are persuaded to
adopt a middle ground. Specifically, the business judgment rule
should be applied as long as the corporation's directors
establish that certain shareholder-protective conditions are met;
however, if those conditions are not met, the entire fairness
standard should be applied.
We begin with the general principal that courts should
strive to avoid interfering with the internal management of
business corporations. To that end, we have long adhered to the
business judgment rule, which provides that, where corporate
officers or directors exercise unbiased judgment in determining
that certain actions will promote the corporation's interests,
courts will defer to those determinations if they were made in
good faith (see 40 W. 67th St. v Pullman, 100 NY2d 147, 153
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[2003]; Chelrob, Inc. v Barrett, 293 NY 442, 459-460 [1944]).
The doctrine is based, at least in part, on a recognition that:
courts are ill equipped to evaluate what are essentially business
judgments; there is no objective standard by which to measure the
correctness of many corporate decisions (which involve the
weighing of various considerations); and corporate directors are
charged with the authority to make those decisions (see Auerbach
v Bennett, 47 NY2d 619, 630-631 [1979]). Hence, absent fraud or
bad faith, courts should respect those business determinations
and refrain from any further judicial inquiry (see id. at 631).
We have, therefore, held that the substantive determination of a
committee of disinterested directors is beyond judicial inquiry
under the business judgment rule, but that "the court may inquire
as to the disinterested independence of the members of that
committee and as to the appropriateness and sufficiency of the
investigative procedures chosen and pursued by the committee"
(id. at 623-624).
A freeze-out merger is typical of situations in which a
director's loyalty may be divided or compromised, thereby calling
into question the applicability of the business judgment rule.
In such a merger, the majority stock owner or group in control
attempts to freeze out the interests of minority shareholders.
There are three main types of freeze-out mergers: (1) two-step
mergers, in which an outside investor purchases control of the
majority shares of a target company, then uses that control to
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merge the target with a second company, thereby freezing out the
minority shareholders of the target and forcing a cash-out of
their shares; (2) parent-subsidiary mergers; and (3)
going-private mergers, in which the majority shareholder seeks to
remove public investors and gain ownership of the entire company.
This Court's seminal decision regarding freeze-out
mergers is Alpert v 28 Williams St. Corp. (63 NY2d 557 [1984]).
In that case, we recognized that, where there are common
directors or majority ownership between the parties involved in a
transaction, "the inherent conflict of interest and the potential
for self-dealing requires careful scrutiny of the transaction"
(id. at 570). In reviewing a two-step merger in Alpert, we held
that while, "[g]enerally, the plaintiff has the burden of proving
that the merger violated the duty of fairness, . . . when there
is an inherent conflict of interest, the burden shifts to the
interested directors or shareholders to prove good faith and the
entire fairness of the merger" (id.; see Chelrob, Inc., 293 NY at
461-462). This "entire fairness" standard has two components:
fair process and fair price (see Alpert, 63 NY2d at 569-570).
The fair process aspect concerns timing, structure, disclosure of
information to independent directors and shareholders, how
approvals were obtained, and similar matters (see id. at
570-571). The fair price aspect can be measured by whether
independent advisors rendered an opinion or other bids were
considered, which may demonstrate the price that would have been
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established by arm's length negotiations (see id. at 571).
Considering the two components, the transaction is viewed as a
whole to determine if it is fair to the minority shareholders
(see id. at 567; see also Kahn v Lynch Communication Sys., Inc.,
638 A2d 1110, 1115 [Del 1994]).
In Alpert, we specifically stated that we were not
deciding whether the circumstances that would satisfy fiduciary
duties in a two-step merger would be the same for other types of
mergers (see Alpert, 63 NY2d at 567 n 3). Thus, that decision is
not dispositive of the standard for reviewing a going-private
merger, such as the one now before us. The present case is also
distinguishable because, in Alpert, there was no independent
committee and no minority shareholder vote.
The parties here debate whether we should apply the
entire fairness standard, as in Alpert, or, alternatively,
whether we should adopt the test recently established by the
Delaware Supreme Court in Kahn v M & F Worldwide Corp. (88 A3d
635, 648-649 [Del 2014]) (MFW). In MFW, a controlling
shareholder sought to purchase all of the shares of stock and
take the corporation private, but made the proposal contingent
from the outset upon two shareholder-protective measures --
negotiation and approval by a special committee of independent
directors, and approval by a majority of shareholders that were
unaffiliated with the controlling shareholder (see id. at 638).
As in the case before us, the controlling shareholder also made
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it clear that it was not interested in selling any of its shares,
would not vote in favor of any alternative sale or merger and, if
the merger was not recommended, its future relationship with the
company -- including its desire to remain a shareholder -- would
not be adversely affected (see id. at 641).
In MFW, the question before the Delaware Supreme Court
was framed as "what standard of review should apply to a going
private merger conditioned upfront by the controlling stockholder
on approval by both a properly empowered, independent committee
and an informed, uncoerced majority-of-the-minority vote" (id. at
639 [internal quotation marks omitted]). We are presented with
the same question here. In prior cases, the Delaware Supreme
Court had applied the entire fairness standard when reviewing
mergers with interested directors, although the court had created
a burden shift -- placing the burden on the objecting minority
shareholders -- in situations in which the interested director
required approval by an independent committee or a majority of
the minority shareholders (see Americas Mining Corp. v Theriault,
51 A3d 1213, 1240 [Del 2012]; Kahn v Tremont Corp., 694 A2d 422,
428-429 [Del 1997]; Kahn v Lynch Communication Systems, Inc., 638
A2d at 1115-1116). Never before had that Court addressed a
situation in which both of those protections were present (see
MFW, 88 A3d at 642).
The Delaware Supreme Court opined in MFW that the
opportunity for review under the business judgment rule -- as
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opposed to the entire fairness standard -- created a strong
incentive for controlling shareholders to provide a structure for
freeze-out mergers that is most likely to protect the interests
of minority shareholders, because when both protections are in
place, the situation replicates an arm's length transaction and
supports the integrity of the process (see id. at 643). That
Court ultimately held that "business judgment is the standard of
review that should govern mergers between a controlling
stockholder and its corporate subsidiary, where the merger is
conditioned ab initio upon both the approval of an independent,
adequately-empowered Special Committee that fulfills its duty of
care; and the uncoerced, informed vote of a majority of the
minority stockholders" (id. at 644). The Court articulated a
number of reasons for the adoption of this new standard,
including that: where the controlling shareholder clearly
disabled itself from using its control to dictate the outcome,
the merger acquired the characteristics of "third-party, arm's
length mergers" that are reviewed under the business judgment
rule; "the dual procedural protection merger structure optimally
protects the minority stockholders in controller buyouts"; it is
consistent with the tradition of courts deferring to informed
decisions by impartial directors, especially when approved of by
disinterested and informed stockholders; and it will provide an
incentive to create structures that best protect minority
shareholders (id.). The standard was summarized as follows:
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"in controller buyouts, the business judgment
standard of review will be applied if and
only if: (i) the controller conditions the
procession of the transaction on the approval
of both a Special Committee and a majority of
the minority stockholders; (ii) the Special
Committee is independent; (iii) the Special
Committee is empowered to freely select its
own advisors and to say no definitively; (iv)
the Special Committee meets its duty of care
in negotiating a fair price; (v) the vote of
the minority is informed; and (vi) there is
no coercion of the minority" (id. at 645).
We now adopt that standard of review for courts
reviewing challenges to going-private mergers. The standard set
forth in MFW reinforces that the business judgment rule is our
general standard of review of corporate management decisions, and
is consistent with this Court's statement in Auerbach that the
substantive determination of a committee of disinterested
directors is beyond judicial inquiry under the business judgment
rule, but that courts "may inquire as to the disinterested
independence of the members of [a special] committee and as to
the appropriateness and sufficiency of the investigative
procedures chosen and pursued by the committee" (47 NY2d at
623-624). While the business judgment rule is deferential to
corporate boards, minority shareholders are sufficiently
protected by MFW's conditions precedent to the application of
that standard in going-private mergers. Overall, the MFW
standard properly considers the rights of minority shareholders
-- to obtain judicial review of transactions involving interested
parties, and to proceed to trial where there is adequate proof
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that those interests may have affected the transaction -- and
balances them against the interests of directors and controlling
shareholders in avoiding frivolous litigation and protecting
independently-made business decisions from unwarranted judicial
interference.
According to the Delaware Supreme Court, for purposes
of this rule, a complaint is sufficient to state a cause of
action for breach of fiduciary duty -- and the plaintiff may
proceed to discovery -- if it alleges "a reasonably conceivable
set of facts" showing that any of the six enumerated shareholder-
protective conditions did not exist (MFW, 88 A3d at 645).
Conclusory allegations or bare legal assertions with no factual
specificity are not sufficient, and will not survive a motion to
dismiss (see Godfrey v Spano, 13 NY3d 358, 373 [2009];
Health-Loom Corp. v Soho Plaza Corp., 209 AD2d 197, 198 [1st Dept
1994] [conclusory allegations that two directors control the
remaining directors are insufficient; a complaint must contain
specific allegations of coercive power over others or that
interested or controlled directors constitute a majority]). Mere
speculation cannot support a cause of action for breach of
fiduciary duty (see e.g. Kassover v Prism Venture Partners, LLC,
53 AD3d 444, 450 [1st Dept 2008]). If the pleading requirements
are met, in order to defeat summary judgment, a plaintiff must
then demonstrate that there is a question of fact as to the
establishment or efficacy of any of the enumerated conditions
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designed to protect the minority shareholders (see MFW, 88 A3d at
645-646). Finally, if the evidence demonstrates that any of the
protections were not in place, then the business judgment rule is
inapplicable and the entire fairness standard applies.
Reviewing the complaint here under the MFW standard, we
conclude that the courts below properly determined that the
allegations do not withstand defendants' motions to dismiss.
Plaintiff did not sufficiently and specifically allege that any
of MFW's six enumerated conditions were absent from the merger
here. Beginning with the first condition, plaintiff concedes
that Cole conditioned the merger, from the outset, upon approval
by both a special committee of independent directors and a
majority of the minority shareholders.
Next, in challenging the independence of the special
committee, plaintiff alleged that Cole and/or his personally
selected directors were responsible for nominating and electing
the committee members to KCP's board. In this regard, the
question is whether a director is beholden to the controlling
party or so under that party's influence that the director's
discretion would be compromised (see MFW, 88 A3d at 648-649).
Friendships, traveling in the same circles, some financial ties,
and past business relationships are not enough to rebut the
presumption of independence; the ties must be material in the
sense that they could affect impartiality (see id. at 649). None
of the allegations of the complaint, even if true, indicate that
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any of the members of the special committee engaged in fraud, had
a conflict of interest or divided loyalties, or were otherwise
incapable of reaching an unbiased decision regarding the proposed
merger (compare Marx v Akers, 88 NY2d 189, 202 [1996]).
As to the third MFW condition, the complaint does not
allege that the special committee lacked the freedom to reject
Cole's offer or was prevented from hiring its own advisors, nor
does it dispute that the committee did, in fact, select its own
financial advisors and legal counsel. Plaintiff's speculation
that the committee merely submitted to Cole's wishes is
insufficient to state a cause of action for breach of fiduciary
duty, particularly in view of Cole's statement at the time of his
initial proposal that, if the committee did not recommend
approval or the minority shareholders did not vote in favor of
the proposed transaction, such a determination "would not
adversely affect [his] . . . relationship" with KCP.
Turning to the fourth condition, while the complaint
contains various allegations suggesting that the special
committee could have been more effective in negotiating a higher
buy-out price, none of those allegations are sufficient to
support more than conclusory assertions that the committee failed
to meet its duty of care in negotiating a fair price.
Significantly, the complaint fails to allege any basis to
conclude that the committee had an incentive to accept an
inadequate price without meaningful negotiations or that it
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engaged in any unfair conduct. Additionally, the final price of
$15.25 per share was higher than the original offer, was within
the range of value determined by the committee's independent
financial analysts, was recommended by the committee's
independent legal counsel and financial advisors, and was higher
than the stock's price prior to Cole's announcement that he
intended to take the company private.2
Regarding the fifth condition, the complaint lacks any
specific challenges to the information contained in, or allegedly
omitted from, the proxy statement provided to the minority
shareholders prior to the vote, such that it could be said that
the shareholders were not informed (see Kimeldorf, 309 AD2d at
158). Finally, plaintiff did not allege any coercion of the
minority shareholders in relation to the vote.
Because plaintiff has not sufficiently alleged that any
of the six enumerated MFW conditions were absent, the business
judgment standard of review applies to the transaction at issue
(see MFW, 88 A3d at 645). Pursuant to that standard, absent
fraud or bad faith, we defer to the determinations of the special
committee and the KCP board of directors in recommending and
approving the merger (see Auerbach, 47 NY2d at 630-631).
2
Although the complaint cites rising KCP stock prices and
positive financial analyses following Cole's announcement that he
planned to take the company private, defendants correctly note
that this information cannot be used to properly value the stock
because those figures reflect an artificial increase in the price
due to the prospect of the merger.
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Inasmuch as no fraud or bad faith has been alleged here, the
complaint was properly dismissed. Accordingly, the Appellate
Division order should be affirmed, with costs.
* * * * * * * * * * * * * * * * *
Order affirmed, with costs. Opinion by Judge Stein. Judges
Pigott, Rivera, Abdus-Salaam, Fahey and Garcia concur. Chief
Judge DiFiore took no part.
Decided May 5, 2016
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