Court Of Appeal Says Legislature Was “willing to tolerate some dead cats to keep management honest.”

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Chapter 13 of the California General Corporation Law establishes the rights of “dissenting shareholders” (defined in Section 1300(c)) to demand payment of cash for their shares in reorganizations and short-form merger transactions. Section 1312(a) generally provides that these shareholders do not have any right at law or in equity to attack the validity of these transactions, or to have the transaction set-aside or rescinded.  See Steinberg v. Amplica, Inc., 42 Cal. 3d 1198 (1986).  Section 1312(b), however, provides that if one of the parties to a reorganization or short-form merger is directly or indirectly controlled by, or under common control with, another party to the reorganization or short-form merger, Subdivision (a) does not apply to any shareholder of that party who has not demanded payment of cash for that shareholder’s shares pursuant to Chapter 13.  In an opinion issued last week, the California Court of Appeal took up the question of whether a shareholder in a common control situation may obtain “rescissionary damages”, Busse v. United Panam Financial Corp., 2014 Cal. App. LEXIS 11 (Cal. App. 4th Dist. Jan. 8, 2014).

Writing for the court, Justice William W. Bedsworth deemed the question “a real doozy of a puzzle” (citing Halbert’s Lumber, Inc. v. Lucky Stores, Inc., 6 Cal. App. 4th 1233, 1235 (1992).  He attacked the problem by reviewing the development of dissenters’ rights both legislatively and in the court.  He noted that by 1975, when Subdivision (b) was enacted, a “string of California cases had already held that appraisal was the exclusive remedy of dissenting shareholders.”  Thus, he divined that the legislature’s intent was not to grant shareholders a right to seek monetary damages, but to provide some restraint on management in common control situations:

Common control under subdivision (b), then, is one of those times when the Legislature is willing to allow a little dice to be played over the survivability of a corporate reorganization. Subdivision (b) is like physicist Schrödinger’s famous cat in a box, which might, or might not, have been exposed to a puff of deadly gas.  If a management buyout were analogized to that cat, one would never know if the box contains a live cat or a dead cat until the outcome of the set-aside litigation becomes final and the box, so to speak, is opened.  Given the history of subdivision (a) with its antipathy to litigation seeking to set aside corporate reorganizations, it is evident that the Legislature had a different attitude for subdivision (b) common control situations: It was willing to tolerate some dead cats to keep management honest.

For those not familiar with Schrödinger’s cat, Justice Bedsworth is alluding to a famous thought experiment devised by the Austrian physicist Erwin Schrödinger in 1935.  The experiment involves a hypothetical feline in a box with a vial of poison, a radioactive source, a hammer and a Geiger counter.  If the source atomic particle decays, the Geiger counter detects the emission, trips the hammer which breaks the vial and kills the cat.  The problem is that in quantum mechanics, particles are thought to exist in all possible states (called quantum supposition) so that they are paradoxically both decayed and not decayed at the same time.  This means that the cat is both dead and alive at the same time and an observer won’t know the cat’s state until the box is opened.

Justice Bedsworth must have had physics on his mind while penning this opinion.  In addition to mentioning Schrödinger by name, he alludes to Albert Einstein “I, at any rate, am convinced that He does not throw dice.”  Letter to Max Born December 4, 1926 The Born-Einstein Letters (translated by Irene Born) (Walker and Company, New York, 1971).  He also lards the opinion with other reference to physics, including:

  • “The minority shareholders read subdivision (b) at something like a quantum . . . .”
  • ” . . . the two decisions are on the same wavelength.”
  • a string of California cases had already held . . . .”
  • “. . . created ex nihilo, like some exotic massless subatomic particle . . . .”

Coincidentally, the plaintiff’s case, like Schrödinger’s cat, also turns out to be both alive and dead.  The case is dead (subject to possible further appellate review) insofar as the plaintiffs’ ability to seek monetary damages. The Court of Appeal, however, reversed the trial court’s ruling to the extent that it precluded on demurrer the plaintiffs from seeking to unwind the buyout.  Thus, the case may live on in part.