Erie Cnty. Emps. Ret. Sys. v. Blitzer (In re Kenneth Cole Prods., Inc., S'holder Litig.)

• Decision Date: 05 May 2016
• Docket Number: No. 54.,54.
• Parties: In the Matter of KENNETH COLE PRODUCTIONS, INC., Shareholder Litigation. Erie County Employees Retirement System, Appellant, v. Michael J. Blitzer et al., Respondents, et al., Defendant.
• Court: New York Court of Appeals Court of Appeals

27 N.Y.3d 268

52 N.E.3d 214

32 N.Y.S.3d 551

2016 N.Y. Slip Op. 03545

In the Matter of KENNETH COLE PRODUCTIONS, INC., Shareholder Litigation.Erie County Employees Retirement System, Appellant

v.Michael J. Blitzer et al., Respondents, et al., Defendant.

No. 54.

Court of Appeals of New York.

May 5, 2016.

Kessler Topaz Meltzer & Check, LLP, Radnor, Pennsylvania (Lee D. Rudy, Michael Wagner and Leah Heifetz of counsel), and Bernstein Litowitz Berger & Grossmann LLP, New York City (Mark Lebovitch, Jeroen van Kwawegen and Adam Hollander of counsel), for appellant.

Willkie Farr & Gallagher LLP, New York City (Tariq Mundiya, Sameer Advani and Benjamin P. McCallen of counsel), for Kenneth D. Cole and others, and Sidley Austin LLP, New York City (Andrew W. Stern, Nicholas P. Crowell, David L. Breau and David W. Denton, Jr., of counsel), and Kaye Scholer LLP, New York City (Vincent A. Sama, Catherine B. Schumacher and Daphne Morduchowitz of counsel), for Michael J. Blitzer and others, respondents.

Whiteman Osterman & Hanna LLP, Albany (Howard A. Levine and Alan J. Goldberg of counsel), and Hach Rose Schirripa & Cheverie LLP, New York City (Frank R. Schirripa of counsel), for Eastern New York Laborers' District Council, amicus curiae.

OPINION OF THE COURT

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 A.3d 635, 644–645 (Del.2014) [MFW ]. Specifically, in reviewing challenges to going-private mergers, New York courts 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 10,464,627 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 6% 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 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 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” (2013 N.Y. Slip Op. 32114[U], *7, 2013 WL 4767369 [Sup.Ct., N.Y. County 2013] ). 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 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” (id. at *7–8). 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” (id. at *9). The court further held that “the complaint d[id] not contain adequate statements regarding a breach” of Cole's fiduciary duty (id. at *11). 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 A.D.3d 500, 500, 998 N.Y.S.2d 1 [1st Dept.2014] ). The Court noted that, unlike in Alpert v. 28 Williams St. Corp., 63 N.Y.2d 557, 483 N.Y.S.2d 667, 473 N.E.2d 19 (1984), “the merger in the case at bar required the approval of the majority of the minority (i.e., non-Cole) shareholders” (122 A.D.3d at 500, 998 N.Y.S.2d 1 ).

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 faith or were otherwise interested” (id. at 501, 998 N.Y.S.2d 1 ). This Court granted plaintiff leave to appeal (25 N.Y.3d 909, 2015 WL 3605136 [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 principle 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 N.Y.2d 147, 153, 760 N.Y.S.2d 745, 790 N.E.2d 1174 [2003] ; Chelrob, Inc. v. Barrett, 293 N.Y. 442, 459–460, 57 N.E.2d 825 [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 N.Y.2d 619, 630–631, 419 N.Y.S.2d 920, 393 N.E.2d 994 [1979] ). Hence, absent fraud or bad faith, courts should respect those business determinations and refrain from any further judicial inquiry (see id. at 631, 419 N.Y.S.2d 920, 393 N.E.2d 994 ). 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...