Squeeze Out Mergers
“Squeeze out” mergers are one of the (many) threats faced by minority owners of corporations.[1] In a typical squeeze out, the majority owner sells the business to another corporation controlled by the majority owner – which the minority owner is not part of. This action can effectively create a forced sale of the minority owner’s shares. (See, for example, Schreiber v. Burlington N., Inc., 472 U.S. 1, 3 n.1 (1985).)
State statutes often govern squeeze outs, setting forth when and how they may be done. In Minnesota, Minn. Stat. §§ 302A.621 and 661 address two ways in which a squeeze out might be attempted for a corporation.
Shepard v. Employers Mutual Casualty Co.
A recent decision of the federal Eighth Circuit Court of Appeals, Shepard v. Employers Mutual Casualty Co., highlights some issues that may arise in the context of a squeeze out. In Shepard, a corporation called Employers Mutual spun off part of itself as an Iowa corporation called EMC Insurance Group (EMCI) in 1974. Employers Mutual retained a majority share of the stock of EMCI (54%), but the remaining stock (46%) eventually passed to others, including Gregory Shepard. In November 2018, Employers Mutual began a squeeze out merger of EMCI. A deal was created in which all the stock of EMCI would be sold for $36 per share, and the deal was approved by a majority of the stockholders other than Employers Mutual (a “majority of the minority”).
But Shepard sued Employers Mutual, saying the price for his stock was too low because breaches of fiduciary duties by the chief executive officer of EMCI during previous years had depressed the company’s value. Shepard claimed the CEO and Employers Mutual had managed EMCI so as to favor Employers Mutual, to the detriment of himself and the other minority owners of EMCI, and that the stock price should have been higher except for the fiduciary breaches.
Fatal Roadblock
Shepard’s lawsuit was dismissed, and the dismissal affirmed on appeal, because he failed to account for another doctrine of corporate law: the concept of a “derivative” claim.
The law takes great pains to distinguish between an individual shareholder and the corporation itself. This overarching principle plays out in different ways. One manifestation is the separation of the shareholder’s right to sue from the corporation’s right to sue. A shareholder may not sue for harms suffered by the corporation – even though a harm suffered by the corporation indirectly hurts the shareholder by reducing the corporation’s profits (and therefore the shareholder’s stock value). For example, if the corporation owned a vehicle that was destroyed in an accident caused by another driver, none of the shareholders could personally sue the driver who caused the accident. Instead, the corporation itself would have to decide whether it wanted to bring a lawsuit. If a shareholder tried to personally sue for the loss of the vehicle, the claim would be called a “derivative” claim, and ordinarily the court would not allow it.
Gregory Shepard’s lawsuit against Employers Mutual was dismissed because the court found that the lawsuit was based on a harm suffered by the corporation, EMCI, and not a harm suffered directly by Shepard. (The harm, remember, was diminished stock value resulting from alleged misconduct by the CEO.) The Shepard court’s decision on this point was quite typical. Legal claims regularly fail when they say the plaintiff was harmed because another person did something to wrongfully decrease the value of stock in the corporation. It is the corporation, not the shareholders, that must sue to recover for damage to its stock value.
Exceptions
There are exceptions to the rule prohibiting stockholders from bringing derivative claims. Shepard argued that two exceptions established in Iowa law applied to him – that his injury resulted from a “special duty” owed to him, and that he suffered an injury “separate and distinct from” the other shareholders. He failed to persuade the court on either of these arguments, because a claim that one’s stock has lost value is a quintessential example of a derivative claim and because Shepard did not identify any unusual or unique facts to remove his claim from the ordinary rule.
A stockholder may also attempt to deal with the problem that his or her claim is a derivative claim by asking the corporation to bring a lawsuit to pursue the claim itself. Then, if the corporation refuses to bring its own lawsuit, courts will sometimes allow the stockholder to pursue the claim individually. Minnesota Rule of Civil Procedure 23.09 sets forth the guidelines for this option in Minnesota. In Shepard, the plaintiff failed to address in his complaint whether he had complied with Iowa or Federal Rules of Civil Procedure requirements for petitioning the corporation to bring the derivative claim he sought to bring himself, so this avenue was closed to him.
Of course, simply asking the corporation to pursue the claim is not a silver bullet. The corporation may in response to such a request create a “special litigation committee,” or SLC, to investigate the potential claim. Special litigation committees bring into the picture another whole set of complicated rules and procedures, and they are a topic for another day.
Do you have a legal question regarding Squeeze Out Mergers or an employment related matter? Give Parker Daniels Kibort a call at 612.355.4100.
[1] In this context, “minority” means an owner holding less than 50% of the stock in a corporation.