Walter J. Schloss Associates v. Chesapeake & Ohio Railway Co.

WILNER, Judge. One hundred sixty years and two months after its creation by the Maryland Legislature, the Baltimore and Ohio Railroad Company (B & 0) went out of existence. It was merged into the Chesapeake and Ohio Railway Company (C & 0) which, for many years, had had a controlling interest in B & O. Appellants are former minority stockholders of ⁷²⁹ B & O. Convinced that they were ill treated by B & 0, C & 0, and C & O’s parent company, CSX Corporation, they brought this action in the Circuit Court for Baltimore City to enjoin the merger. Denied that relief, they sought to recover substantial damages in excess of the fair value of their stock.

The denial of that relief is what sparked this appeal. Background At all times relevant to this action, CSX owned all of the outstanding shares of C & 0; C & 0, in turn, owned at least 95% of the outstanding common stock and 99% of the outstanding preferred stock of B & O. Through these subsidiaries and through its own operations, CSX had a number of business lines. In December, 1985, it announced a realignment of them into four major groupings—transportation, energy, properties, and technology. The merger of B & 0 and C & 0 was part of that restructuring.

According to the Information Statement published by B & 0 in connection with the merger: “The restructuring of the railroad companies is designed to streamline the overall operations of CSX Transportation and to enable each of the railroads to operate more efficiently by combining them into a single entity, thereby profiting from the synergistic effects of operating one company as opposed to separate entities. The Merger of the B & 0 into the C & 0 is one step in this overall process to consolidate the rail companies into one efficient operating company. The Merger of the B & 0 into the C & 0 will remove the administrative burdens of maintaining separate corporate entities, including keeping separate records, when the B & 0 operationally is already an integral part of CSX Transportation. By maintaining separate corporate entities, each company is required to keep a separate set of books and records.

This activity is economically unproductive and the maintenance of separate entities creates a potential conflict of interest in all intercompany transactions because of the existence of minority share ⁷³⁰ holders in some but not all of the related entities. B & 0 must structure transactions between it and its affiliates as ‘arms’ length transactions’ which in turn require substantial administrative effort and expense. The requirements of separate entities diverts management’s attention from more productive and substantive efforts. It is increasingly uneconomical to maintain this system of doing business.” Because C & 0 owned more than 90% of the outstanding common stock of B & 0, it was able to proceed with the merger pursuant to Md. Code Ann.Corp. & Ass’ns art., § 3-106, which permits a merger to be achieved, under that circumstance, upon a resolution of the respective boards of directors without the need for stockholder approval.

The rights of minority stockholders in such a merger are set forth in § 3-106(d), as follows: “Rights of minority stockholder.—(1) Unless waived by all minority stockholders, at least 30 days before the articles are filed with the Department, a parent corporation which owns less than all of the outstanding stock of the subsidiary shall give notice of the transaction to each of the subsidiary’s minority stockholders of record on the date of giving of the notice or on a record date fixed for that purpose which is not more than 10 days before the date of giving notice. (2) A minority stockholder of the subsidiary has the right to demand and receive payment of the fair value of his stock as provided in Subtitle 2 of this title relating to objecting stockholders.” Subtitle 2, referred to in § 3-106(d)(2), comprises §§ 3-201—3-213. With exceptions not relevant here, § 3-202(a) confirms the right of a stockholder of a merging corporation “to demand and receive payment of the fair value of the stockholder’s stock from the successor....” In a merger under § 3-106, fair value is to be determined as of the close of business on the day the notice provided for in § 3-106(d)(l) is given or waived. Subsequent sections in subtitle 2 set forth certain conditions to, procedures for, and ⁷³¹ consequences of demanding and obtaining payment of fair value.

Essentially, if an agreement as to fair value cannot be reached, the Circuit Court, upon petition by the objecting stockholder, appoints three disinterested appraisers to determine fair value. The appraisers’ report is subject to confirmation by the court. Ultimately, whether the court confirms the report or rejects it and determines fair value itself, a judgment for the fair value is entered in favor of the stockholder. In anticipation of the merger and in recognition of the fact that the merger would not be an arms-length transaction, B & 0 employed Morgan Stanley & Co. as a financial advisor to provide its opinion of the fair value of B & O’s common stock.

Morgan Stanley, a national investment banking firm, was no stranger to the CSX family. It had provided a variety of financial services to CSX and had underwritten several CSX offerings; it maintained a trading position in CSX stock, held options in CSX stock, and also, allegedly, had purchased in the open market B & 0 convertible debentures that would be called, and thus forcibly converted, as part of the B & O/C & 0 merger. Morgan Stanley’s relationship with CSX was fully disclosed to the minority stockholders of B & 0 in the B & 0 Information Statement. On December 1, 1986, Morgan Stanley rendered an opinion to the Board of Directors of B & 0 on the fair value, as of October 31, 1986, of the common shares of B & 0 “from the standpoint of the minority shareholders in connection with [the proposed merger].” On advice of counsel, it took as the standard of fair value “the economic value of the common stock of B & 0 assuming that the shares of stock were broadly held and freely-traded in the financial marketplace.” 1 In preparing its opinion, Morgan Stanley said that it had reviewed the financial and operating record of B & 0, including “projected income statements for 1986 and 1987” supplied by B & 0, and that it had “discussed the business ⁷³² and prospects of B & 0 with members of its management____” It did not seek to verify public information or information supplied by B & O. Its conclusion was that the fair value of the B & 0 common stock as of October 31, 1986, was $300 million, or approximately $113/share.

The next day, December 2, the directors of B & O and C & 0 gave preliminary approval to the proposed merger by adopting a plan of merger. The plan called for the merger to become effective 30 days or more after notice of the proposal was mailed to the B & 0 stockholders, and provided for payment to the minority common stockholders of B & 0 of $113 per share. That action prompted three groups of minority B & 0 stockholders to file separate actions in the Circuit Court for Baltimore City. On March 6, 1987, the court consolidated the three cases.

Pursuant to that consolidation, the various plaintiffs promptly filed a Consolidated Amended Complaint. The Consolidated Amended Complaint purported to be a class action by all minority stockholders of B & O. Its “substantive allegations” concerned three separate transactions: (1) the transfer by B & 0 of all of its non-rail assets to a CSX affiliate in December, 1977 (1J1Í18-23); (2) the sale by B & 0 of its controlling interest in the Western Maryland Railway Company to C & 0 in February, 1983 (MI 24-28); and (3) the proposed merger (MI 29-50). At a hearing on the defendants’ motions to dismiss that complaint, the plaintiffs conceded that the issues arising from the first two transactions had been resolved in other judicial proceedings and were no longer being pressed in this action. The focus, then, was solely on the proposed merger.

In that regard, the plaintiffs began with a general, nonspecific complaint that the defendants had contrived to “siphon off B & O’s earnings to defendants C & O and CSX, thereby artificially depressing B & O’s earnings at the expense of B & O’s minority shareholders____” They averred that, since 1979, the defendants had caused B & O ⁷³³ to pay annual dividends of $8/share, thereby “upstreaming B & O’s assets for the principal benefit of C & 0” (¶ 30), although no claim was made that those dividends were in any way improper or that the minority stockholders did not share pro rata in them. They next contended that, in 1985, the defendants caused B & 0 to take a special $178 million charge against earnings “to reduce B & O’s assets to their realizable value,” resulting in a $21/share loss (¶ 31). Once again, there was no averment that there was any impropriety in that charge. The balance of the complaint attacked the $113 price set by the B & 0 directors, the Morgan Stanley opinion, and the purpose for the merger.

As to the price itself, the plaintiffs alleged that, according to B & O’s 1985 annual report, shareholder equity was $939 million, or $340/share (¶ 32), that B & O’s asset value increased by $355 million between 1983 and 1985 (¶ 33), and that the $113 was “grossly inadequate” (¶ 45). 2 Their attack on the Morgan Stanley opinion was based on allegations that B & 0 had provided to that firm “projected income statements for 1986 and 1987” that had not been provided to the minority stockholders (II37), that neither the Morgan Stanley letter nor releases from CSX and its affiliate revealed the business relationship between Morgan Stanley and CSX (¶ 38) and (¶ 39) that: “The Morgan Stanley ‘fairness opinion’ was not rendered in accordance with acceptable valuation standards applied from the point of view of B & O’s minority stockholders, whose interests Morgan Stanley had purportedly undertaken to represent. Defendants have fraudulently and misleadingly failed to disclose that $113 per share was in the lower end of the range of fairness which Morgan Stanley arrived at. Morgan Stanley had a duty to negoti ⁷³⁴ ate and defendants had a duty, as fiduciaries, to pay a per share price at the high end of the range of fairness.” Finally, plaintiffs charged generally that “[tjhere is no proper business purpose for the proposed Merger” (It 44) and that C & O and CSX, as controlling shareholders of B & 0, had a fiduciary duty to the plaintiffs which they violated “by engaging in unfair dealing, coercion, deception, manipulation and gross and palpable overreaching tantamount to fraud.” Upon these allegations, plaintiffs sought (1) a declaration that the defendants had violated their fiduciary duties to the plaintiffs, (2) an injunction against the merger, (3) an injunction against the mailing of notice of the proposed merger, (4) a revocation of the merger if it was consummated, (5) an accounting of the profits realized by the defendants from their wrongful conduct, (6) damages, and (7) attorneys fees. Undeterred by this lawsuit, B & 0 and C & 0 proceeded with their planned merger.

At some point, not clear in the record before us, B & 0 asked Morgan Stanley to review and update its December 1 opinion as to fair value. The firm did so and, on March 10, 1987, informed the B & 0 directors that the fair value of the B & 0 common stock as of March 9, 1987 was $330 million, or $123.71/share for the minority shares. Based in part on that revised opinion and in part on their own analysis, the directors, on March 10, formally approved the plan of merger and the payment of $124/share for the minority shares of B & O. Ten days later, the plaintiffs moved to enjoin B & 0 from mailing a notice of the merger and an accompanying information statement until the court could rule on their request for class certification. The principal bases of the motion were that it would be premature for B & 0 to communicate ex parte with the minority stockholders until their status as a class could be determined and that any communication regarding the merger would be incomplete and misleading in that it could not include the court’s decisions (not yet ⁷³⁵ made) on class certification and on anticipated motions to dismiss the complaint.

The plaintiffs were particularly concerned that the notice would inform the minority stockholders that they had only the appraisal rights provided by § 3-106(d)(2) and §§ 3-201—3-213 and that they would have to elect to pursue those rights within 30 days. After a hearing on March 24, 1987, the court denied the motion, finding that the proposed notice and information statement fairly summarized the pending litigation and were neither premature nor incomplete or misleading. On March 26, the defendants moved to dismiss the complaint on the grounds that (1) the plaintiffs’ exclusive remedy was the statutory appraisal rights provided in the Maryland Code, (2) injunctive relief was inappropriate because the plaintiffs had an adequate remedy at law, and (3) CSX in particular had no duty to the plaintiffs. The next day, March 27, the notice required under § 3-106(d)(l) was sent by B & 0; the merger itself became effective April 30, 1987.

Defendants’ motion to dismiss was heard on April 13. After plaintiffs’ counsel virtually conceded that the case was one for money damages, the court determined that injunctive relief against the merger was inappropriate. It found plaintiffs’ allegations of fraud to be entirely too general and thus concluded that the dispute was essentially over the value of the stock, which could be resolved through the statutory appraisal process. At plaintiffs’ request, however, the court gave counsel 10 days in which to file a motion for leave to file a second amended complaint.

A formal order embodying the court’s findings was filed the next day. Thirteen days later, plaintiffs filed a motion for leave to amend their complaint. Attached to the motion was a second amended complaint that they proposed to file. The proposed complaint dropped B & O as a defendant, retained C & O and CSX, and added Morgan Stanley.

It omitted any reference to the earlier transactions complained of, i.e., the sale by B & 0 of its non-rail assets and its interest in ⁷³⁶ Western Maryland Railway and focused entirely on the merger. The “substantive allegations” with respect to B & 0, C & O, and CSX, with some updating, were similar to those in the first consolidated complaint. The plaintiffs sought to complain about the $8/share dividends, the special $178 million charge, the difference between the stockholder equity shown on the latest annual report and the $113/share price initially approved by the B & 0 directors, and the additional assets generated by B & 0 between 1983 and 1986. The principal expansion in the new complaint concerned Morgan Stanley and its opinion letters.

Plaintiffs charged that the information statement sent by B & 0 with the notice of merger was fraudulent because (1) it asserted that Morgan Stanley was “independent” when in fact the firm was not “independent,” (2) it asserted that Morgan Stanley’s opinion of fair value was from the standpoint of the minority stockholders when in fact it was not, (3) it failed to disclose that, though Morgan Stanley was asked to render an opinion as to fair value “from a financial point of view,” Morgan Stanley did not do so, and (4) it failed to disclose that Morgan Stanley was instructed by the B & 0 board not to take book or liquidation value into account. The new complaint ended with general averments that the $124/share price “is so grossly inadequate as to constitute ... a fraud on B & O’s minority stockholders,” that C & 0, as controlling shareholder of B & 0, had breached fiduciary duties owed to the minority stockholders of B & 0, and that CSX and Morgan Stanley “aided and abetted” C & 0 in the breach of its fiduciary duties. On May 13, 1987, the court denied leave to file the second amended complaint, thereby terminating plaintiffs’ ability to proceed further in the Circuit Court. In this appeal, filed the next day, plaintiffs make two arguments: Statutory appraisal rights do not preclude maintenance of an action by minority stockholders against the majority stockholder and others for unfair deal ⁷³⁷ ing and overreaching in connection with a short-form cash-out merger.

Appellants have adequately alleged facts which, if proved, entitle them to appropriate relief under Maryland law.” At oral argument, plaintiffs abandoned any reliance on the Consolidated Amended Complaint and asked that we focus exclusively on the Consolidated Second Amended Complaint. The issue, then, is whether, on the facts pled in that complaint, the plaintiffs are entitled to any relief beyond payment of the fair value of their stock, provided for in § 3-106(d)(2) and determined in accordance with §§ 3-201—3-213. Legal Analysis Fletcher Cyclopedia Corporations, § 5906.1 provides a good introduction to the issue before us: “At common law, unanimous consent of the stockholders was necessary to warrant certain corporate acts, such as consolidation or merger, transfer of all the corporate assets, and any fundamental charter amendment. These restrictions on the majority were serious impediments to the sweeping reorganizations in structure which modern needs had made the order of the day.

Consequently statutes were passed in most states conferring wide powers on the majority or a specified percent of the stock, to amend the charter, sell, consolidate, merge, etc. In enacting such statutes, however, it was realized that it was necessary to afford some relief to dissenters, with the result that in most jurisdictions statutes were enacted which give the dissenters the right to receive the cash value of their stock and provide for an appraisal where no agreement as to value can be reached. The dissenter’s appraisal remedy is entirely the product of statute.” (Footnotes omitted.) See also Voeller v. Neilston Co., 311 U.S. 531 , 535 n. 6, 61 S.Ct. 376 , 377-78 n. 6, 85 L.Ed. 322 (1941); Thompson, Squeeze-Out Mergers and the “New” Appraisal Remedy, 62 Wash.U.L.Q. 415, 416-18 (1984). ⁷³⁸ Sections 3-105 and 3-106 of the Corp. & Ass’ns art. represent two types of statutes allowing a majority of the ownership interest, in effect, to oust a minority interest against its will. Section 3-106 is, of course, the more extreme provision; because one stockholder, the parent, has such a thoroughly controlling interest in the subsidiary corporation, acquiescence by the subsidiary in the merger between parent and subsidiary is always assured. That is why the formality of stockholder approval is dispensed with; it is also why mergers under such statutes are commonly referred to as “freeze-out,” “squeeze-out,” or “cash-out” mergers.

As we observed, § 3-106(d)(2) gives an objecting minority stockholder in such a merger the right to receive the fair value of his, her, or its stock in accordance with the provisions of §§ 3-201—3-213. Unlike similar statutes in a few other States, there is nothing in § 3-106(d) to indicate whether the Legislature intended for that remedy to be exclusive or non-exclusive; it is simply afforded. Defendants argue that the “payment of fair value” remedy in § 3-106 mergers is, or should be, exclusive. Plaintiffs, of course, have a different view.

Relying principally on Twenty Seven Trust v. Realty Growth Investors, 533 F.Supp. 1028 (D.Md.1982), and Weinberger v. UOP, Inc., 457 A.2d 701 (Del.1983), they contend that, at least where allegations of fraud, breach of fiduciary obligation, overreaching, or lack of fair dealing are made (and ultimately proved), they are not limited to the payment of fair value, even after the merger is consummated, but may, in the alternative, sue for rescissory or other damages. On this rather general question, we agree with the plaintiffs. Even in States having statutes purporting to make the “payment of fair value” an exclusive remedy, the courts have allowed at least injunctive relief under special, compelling circumstances. See, for example, Pa.Stat.Ann., title 15, § 1515 K (dissenting shareholders “shall be limited to the rights and remedies prescribed under this section, and the rights and remedies prescribed by this section shall ⁷³⁹ be exclusive”), but compare In re Jones & Laughlin Steel Corp., 412 A.2d 1099 (Pa.1980), and Miller v. Steinbach, 268 F.Supp. 255, 269-71 (S.D.N.Y.1967).

See also J. Vorenberg, Exclusiveness of the Dissenting Stockholder’s Appraisal Right, 77 Harv.L.Rev. 1189, 1207 (1964). In terms of