Minority Shareholders Given More Ammunition

             Traditionally, in Pennsylvania, shareholders of a closely held corporation are limited under the Pennsylvania Business Corporation Law (BCL) in asserting their dissenters’ rights to two actions:  (1) moving to enjoin the undesired transaction or (2) receiving a value and payment for shares owned in the corporation.  See 15 Pa.C.S. § 1105.  However, a recent decision in the Pennsylvania Court of Common Pleas of Philadelphia County expanded those limitations.  If the majority shareholders of the closely-held corporation are alleged to have engaged in misfeasance, the minority shareholders are not limited to the two actions set forth in § 1105.

Getting More Than You Bargained For

            Purchasers of a company’s assets can generally rest assured that they are not also bargaining for that company’s liabilities.  However, there are always exceptions, and in this case, that exception is a de facto merger.  

            A de facto merger will occur when the surrounding circumstances of the transaction have similar elements and effects of a merger.  To determine the existence of a de facto merger, Pennsylvania examines four factors:  (1) continuity of management, personnel, physical location, assets, and general business operations, (2) continuity of shareholders, (3) whether the seller corporation ceases to conduct business, and (4) whether the purchaser corporation continues the business of the seller corporation uninterrupted.   

            In a recent case, the Supreme Court of Pennsylvania considered the importance of the first factor:  continuity of management.  See Fizzano Bros. Concrete v. XLN, Inc., 2012 Pa. LEXIS 636 (Pa. 2012).  In Fizzano, Appellant, Fizzano Brothers sought relief from XLN based on breach of contract and breach of express warranty claims from appellant’s inability to properly implement XLN’s software.  After Appellant purchased the software from XLN, XLN sold virtually all its assets to XLNT.  Based on the general rule that an asset purchase transaction does not subject the purchaser to seller’s liabilities, XLNT argued that they were not liable to appellant for any breach which occurred as a result of the software sale.  The case turned on the importance of the first factor:  continuity of ownership.  XLN argued that this was an essential element in determining de facto merger while Appellant argued it was a mere factor to consider in light of the others.  Traditionally, in a cause of action such as this which is rooted in contract law rather than public policy concerns, continuity of ownership must be shown for a finding of de facto merger.  

            Ultimately, the court reached a decision which broadened the Superior Court’s narrow application of continuity of ownership.  Rather than merely analyze form of the transaction, Pennsylvania will look to the substance and surrounding circumstances of the transaction to determine if a de facto merger transpired. 

Non-Party Ordered to Participate in Discovery Without Subpoena

             A recent decision by the Court of Common Pleas of Philadelphia County held that non-parties could be subject to document production where the non-party is not a separate entity for the purposes of discovery.

            After filing a judgment by confession against the Defendants, John J. Martucci and Washington Abstract, LLC, the Plaintiff TD Bank sought to compel document production and deposition attendance of a non-party.  See TD Bank v. Wash. Abstract, LLC, No. 1584, 2012 Phila. Ct. Com. Pl. LEXIS 67 (Feb. 21, 2012).  In response, Defendants argued that requiring Martucci Law Offices, LLC, a non-party, to produce documents was in error.  

            Defendants based their argument on Leonard v. Latrobe Area Hosp., 379 Pa. Super. 243, 247 (Pa. Super. Ct. 1988) which held that plaintiffs should have directly subpoenaed non-parties for document production rather than have the defendants retrieve documents.  

            The Defendants’ argument was found to be without merit in this case because unlike in Leonard, the court reasoned that:

Although Martucci Law Offices might have a legal existence separate from Defendant for some legal and business purpose, it is not a separate entity for the purpose of discovery. . . Pennsylvania courts have treated corporations and their agents as identical for discovery purposes under some circumstances.  TD Bank at *6.   

            Thus, where a non-party and party both have authorization to documents and records, a motion to compel the non-party to produce documents may be proper.

Bound by an Arbitration Agreement You Never Made?

            Although it may seem contrary to common contractual practice, it is possible that non-signatory parties to an arbitration agreement may be compelled to arbitrate under the terms of an agreement.  

            In Barletto v. Heuschkel, 2011 Pa. Dist. LEXIS 318 (Feb. 7, 2011), Charles Barletto alleged, among other claims, that Mark Heuschkel engaged in corporate oppression of Barletto as a minority shareholder.  Barletto claimed that Heuschkel’s company Ferrotech avoided allocating profits to Barletto by funneling the profits to Ferrotech’s parent company Ferromet.  Barletto asserted that the court was the proper venue to resolve this dispute rather than arbitration because only Ferrotech signed the arbitration agreement.  

            Although three of the four named defendants in this case were non-signatory parties to the arbitration agreement, the court still upheld that arbitration was the proper venue for this matter.  The court derived its decision to bind non-signatories to the arbitration based on contract and agency law principles:  “1) incorporation by reference; 2) assumption; 3) agency; 4) veil-piercing/alter ego; and 5) equitable estoppel.”  Furthermore, the court focused its decision on whether there existed an “obvious and close nexus between the non-signatories and the contract or contracting-parties.” Barletto at *16.

            Unfortunately for Barletto, the court in this case recognized the close nexus between the defendants: 

Ferrotech is a subsidiary of Ferromet, Ferrotech Reality is a sister-corporation to Ferrotech, and Heuschkel, who as president and owner of all three corporations, was the agent through which the corporate entities functioned.  The claims filed by Plaintiff Barletto all arise as a result of actions Heuschkel took on behalf of the corporate entities, and therefore the interests of the Defendants are indistinguishable.  Barletto at *26-27.

           Moreover, the court relied on the theory of equitable estoppel by reasoning that arbitration cannot merely be avoided because it does not work to Barletto’s advantage.

            Thus, minority shareholders should be aware that they may be compelled to resolve disputes in arbitration with parties who were not original signatories to the agreement where the disputes with the parties arise out of a close nexus with the contracting parties and where the theory of equitable estoppel compels arbitration.