Misconduct could cost minority shareholders millions

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Wisconsin justices agree to consider case this term

When company founders Terrance and Judith Paul decided to sell their majority interest in Wisconsin Rapids-based Renaissance Learning Inc. for $455 million in 2011, they offered a $1.60 per share bonus just to minority shareholders to keep them happy with the transaction.

It didn’t work.

Now, Data Key Partners v. Permira Advisors LLC et al., 2012 AP 1967, is before the Wisconsin Supreme Court, mired in allegations of director misconduct, majority shareholder self-dealing and bad faith negotiations that spawned trips to both state and federal courts.

According to Wood County trial court Judge Jon Counsell, a motion to dismiss favoring the Pauls was appropriate because the Business Judgment Rule applied to shield the directors and their decisions, with no circumstances under which the minority shareholders could prevail.

But the appellate court reversed two of the four counts, in part saying that Counsell wrongly applied the Business Judgment Rule and never should have used it as a basis to dismiss the lawsuit.

The appellate court reversal has given traction to minority shareholder’s claims that the Pauls and Renasissance’s board of directors ignored their fiduciary duties when they failed to follow through and negotiate a second bid from Plato Learning Inc. that could have given the minority shareholders another 1.8 percent payment boost for their shares, totaling millions.

The case throws a spotlight on what, if any, is the duty of a majority shareholder towards the rights of the minority. Doesn’t the status of being a majority shareholder, by its nature, create the right to protect your own interests over those of the minority?

Furthermore, are Wisconsin’s Business Judgment Rule and the Director Immunity Rule merely evidentiary presumptions or affirmative defenses, or full-blown immunizing statutes that required a more stringent level of fact pleading on the complaint?

The Wisconsin Supreme Court has now agreed to hear the case.

Case history 

The Pauls founded Renaissance Learning in their garage in 1984, after Judith Paul created a popular K-12 reading program called “Accelerated Reader.” Over the years, the burgeoning company added teacher training, and student assessment, quizzing and testing tools to its line of educational software and hardware products.

In 2007, New-York based Data Key Partners purchased an interest in Renaissance stock, ultimately accumulating almost 8 million shares. The Pauls retained approximately 69 percent of the corporate stock, nearly 20 million shares.

In 2010, a European- based company Permira Advisors LLC offered to buy all outstanding shares of Wisconsin-based Renaissance for $14.85 per share in a merger deal. The stock had recently closed at $11.85 per share.

Another bidder, Plato Learning Inc., countered with an offer of $15.50 per share. Less than a week later, Permira revised its bid to $16.60 for all minority shares, giving the Pauls $15.00 per share for their majority interest, for a total of $455 million.

Before Plato could get in another offer, which would have bumped its total offer to $496 million, Renaissance accepted the earlier Permira bid and refused to consider any more offers from Plato. The minority shareholders rushed to federal court and filed a class action to enjoin the sale but failed, sending the case back to state court.

When the sale went through in October 2011, the plaintiffs’ eight million minority shares were involuntarily converted to cash. Minority shareholders walked away with a total of more than $149 million from the merger; a tidy sum but less than what they deserved, according to the minority.

The final accepted bid was a bad deal for the minority, according to documents filed with the trial and appellate courts by the minority shareholders. That bid included a Permira promise to immunize the Pauls and all board directors from liability. It also allowed the Pauls license to use certain Renaissance software for another business controlled by the Pauls, and provided other financial benefits to board members.

The Pauls, Permira and defendant board directors argued that the board had good reason to accept the Permira bid.

The final bid by Permira was 40 percent more than the stock’s closing price just weeks earlier, according to the Pauls. Also, the Plato bid did have bank involvement, which could take longer to close, involve risk that would be avoided by the cash-basis Permira deal, and was burdened with a $13 million termination fee if Renaissance failed to close the deal.

On appeal

In its reversal and remand to the trial court, the appellate court found that the Business Judgment Rule and Director Immunity statutes, in this case, were better viewed as an “evidentiary presumption,” and not immunizing theories or legal presumptions. So it was not properly applied in a motion to dismiss in that it created an improper “fact pleading” standard.

The Wisconsin Business Judgment Rule states that “a director is not liable arising from a breach of, or failure to perform, any duty resulting solely from his or her status as director” unless there has been a “willful failure to deal fairly with the corporation or its shareholders in a … matter … of conflict of interest” or “willful misconduct.”

In Reget the court found that the Business Judgment Rule was properly applied during summary judgment, and described the rule as “evidentiary presumption” and not a legal presumption.

Counsel for the Pauls argued that the appellate court’s decision to call the Business Judgment Rule and the Director Immunity Rule “evidentiary presumptions” was plain error, illogical and functionally inappropriate. The Pauls’ brief quoted the 4th Edition Model Business Corporation Act, Annotated, stating, “to overcome the Business Judgment Rule, a Plaintiff must allege facts demonstrating self-dealing, bad faith, or gross negligence.”

“[The statutes] were designed to limit judicial intervention in the internal affairs of a corporation,” counsel wrote. “If they can’t be raised at the outset of a case … but instead held in reserve through years of discovery and litigation, those doctrines will serve little real purpose.”

The majority shareholders also noted that Wisconsin, and other jurisdictions, have a long history of applying these rules at the pleadings stage, citing Polacheck v. Michiwaukee Golf Club , 198 Wis. 78 (1929), and Thauer v. Gaebler, 202 Wis. 296 (1930), where both cases were dismissed at the demurrer stage.

Counsel for the Pauls further asserted that the appellate court ruling will have a chilling effect on people wanting to sit on corporate boards, because defending oneself through an entire discovery process can cost tens of thousands of dollars, and take years before trial or a summary judgment motion is heard at the end of discovery. That could scare away well qualified people, counsel argued, and make directors afraid to support bold or aggressive board decisions.

Counsel for the Pauls further alleged that the majority has no obligation to look out for the interests of majority shareholders, and could dispose of their shares in any way they saw fit, quoting In re the Petition of Klaus, 67 Wis. 401 (1886).

Yet this power to sell is not unchecked, responded counsel for minority shareholders, particularly when the majority owners are directors, and have allegedly swayed other board members from doing their duties. Counsel for the minority insisted that it wasn’t just the fact that the majority asserted itself to support the sale to Permira, but how the Pauls asserted themselves, which made their actions intolerable.

“The Pauls have engaged in repressive conduct towards minority shareholders,” the minority shareholders’ counsel argued, “and have broken their fiduciary duties.”

A ruling from the state justices is expected by the end of this term.