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TERRY v. PENN CENT. CORP.

October 22, 1981

Howard L. TERRY and W. H. Hunt,
v.
The PENN CENTRAL CORP., and Colt Industries, Defendants. *



The opinion of the court was delivered by: POLLAK

This is an action for an injunction and for declaratory relief brought by the plaintiffs, Messrs. Terry and Hunt-Messrs. Terry and Hunt are citizens of Texas-against the Penn Central Corporation.

Colt, on its application resisted by plaintiffs, was permitted by me to intervene as a party defendant.

 The shape of this proceeding has changed in the course of the very brief time since the initial papers were filed in the sense that what was initially sought was a preliminary injunction, but the parties have agreed that the hearing which has been conducted which involved two days of evidentiary hearings and a day of argument would constitute a hearing on the merits. What follows will comprise my findings of fact and conclusions of law with respect to this matter.

 Some background may be useful at the start. As I have said, this is an action for injunctive and declaratory relief. It rests on a variety of bases both as to jurisdiction and as to cause of action. It is in some of its aspects a diversity action between citizens of Texas and a corporation which is incorporated in Pennsylvania and with its principal place of business in New York, namely, Penn Central. In that posture the case is one in which plaintiffs claim entitlements under the amended articles of Penn Central of which they, plaintiffs, are shareholders, holders of shares of stock in what is entitled a first series preference. They claim also under provisions of the New York Corporation Law and under the Pennsylvania Business Corporation Law and, finally, they make claims which, as will appear shortly, are, in effect, cumulative of the common law and statutory claims under the Federal Securities Statutes.

 The plaintiffs Terry and Hunt own substantial blocks of the so-called $ 5.27 convertible preference stock, first series, of Penn Central which was issued to them, as will shortly appear, as the fruit of a transaction under which Marathon, in which Messrs. Terry and Hunt and others were principal shareholders, was acquired on Penn Central's behalf through the medium of a wholly-owned subsidiary of Penn Central, namely, Holdings.

 Mr. Terry, in addition to his substantial shareholdings, is a director of the Penn Central Corporation. It was one of the terms of the Penn Central/Marathon transaction that two members of the Marathon board, Mr. Terry, who was chairman of Marathon's executive committee, and Mr. Woodfin, who was its chief executive officer, became members of the Penn Central board. Mr. Woodfin is not a plaintiff in this action.

 Defendant Penn Central is the reorganized successor to the Penn Central Transportation Company, it having emerged from reorganization in October of 1978. The Penn Central Corporation is engaged in a variety of lines of business, of which railroading is not one.

 The defendant Colt is likewise a Pennsylvania corporation with its principal place of business in New York.

 What is sought under this lawsuit is to enjoin Penn Central and Colt from proceeding further with a proposed acquisition by Penn Central through Holdings of Colt unless and until the plaintiffs are afforded the rights that they assert that they are entitled to in connection with the Penn Central/Colt transaction.

 In summary form, plaintiffs argue that they are entitled by the amended articles of Penn Central to a separate vote of the series of first preference shares of which they are members and that without approval of two-thirds of that series the Penn Central/Colt transaction cannot go forward. The same entitlement is claimed by plaintiffs pursuant to certain provisions of the New York Business Corporation Law. This claim of entitlement is at odds with the position of defendant Penn Central and also defendant Colt, though, of course, it's not up to defendant Colt to be determining who votes for Penn Central.

 It is Penn Central's intention at the shareholders meeting now scheduled for October 29 that approval be conditioned on the achieving of a majority vote of that quorum of shareholders present or by proxy at the shareholders meeting and it is the position of Penn Central that that much will conform with requirements of the New York Stock Exchange and that no additional approval is required.

 It is the further prayer of plaintiffs that they be held to be entitled to dissenters' rights with respect to the proposed transaction, at least unless they have been determined under their initial claim to be entitled to the two-thirds series vote, whether under the articles or under New York law.

 Under the third count of plaintiffs' complaint they assert that, in any event, the transaction cannot be validly approved from the standpoint of Penn Central unless there is approval at the shareholders meeting by an absolute majority of all holders of all series and classes of Penn Central stock, not merely a majority of the quorum. That claim is said to arise under Pennsylvania law, statutory and/or case law, as, indeed, is the claim for dissenters' rights under count two.

 Finally, the claim under the Federal Securities Laws which is the basis for count four is that the proxy materials distributed by Penn Central and by Colt in connection with the proposed Penn Central/Colt transaction are misleading in numerous respects insofar as they do not specify the variety of entitlements which plaintiffs have asserted in their first three counts.

 The origin of this dispute can really be traced to Penn Central's emergence from reorganization. At that point in 1978 one of Penn Central's principal assets was a huge loss carry forward and it was a major part of-and remains to this day and can be expected to continue for some years into the future-a major part of Penn Central's business strategy, to develop ways in which that loss carry forward could be given maximum utility. The particular dominating strategy was to be the acquisition by Penn Central of various enterprises with strong income prospects, which income, turned to the benefit of Penn Central, would be sheltered for some extended period of time by this loss carry forward.

 It was also a part of the Penn Central strategy that the acquisition program should be with a view to making Penn Central, indeed, a diverse collective of enterprises.

 The first step taken by Penn Central to implement this strategy was to create the wholly-owned subsidiary, Holdings, which was to be the acquirer of the enterprises to be acquired. The first step in the program was the acquisition in 1979 of Marathon. As I have noted, Marathon was an enterprise which was substantially dominated as to direction by the group of persons of whom Mr. Terry and Mr. Hunt are prominent members in association with Mr. Woodfin.

 To accomplish that transaction, basically what was proposed, put in simplest terms for summary purposes, was to make available through Penn Central a new class of preferred stock, a first series of which would be issued to Marathon shareholders in exchange for their Marathon interests. Penn Central authorized the issuance of 30 million shares of a new class of special preference stock. This was a series, of course, intended to be superior to its 100 million authorized shares of common stock.

 The proxy statement describing these shares characterized the new preference stock in the following form: "In order to provide the company with maximum flexibility, and as permitted by Pennsylvania law, article 8 would vest authority in the company's board of directors to issue from time to time the new preference stock in such series as it shall create and in connection with the creation of each such series to fix by resolution the full, limited, multiple, fractional or no voting rights and the designations, preferences, qualifications, privileges, limitations, restrictions, options, conversion rights and other special or relative rights of such series."

 In article 6(a) of the present amended articles of Penn Central, it says with respect to preference stock: "The board of directors of the corporation shall have the full authority permitted by law to fix by resolution full, limited, multiple, fractional or no voting rights and the designations, preferences, qualifications, limitations, restrictions, options, conversion rights and other special or relative rights of the preference stock or any series of the preference stock that may be desired and which have not been fixed in these articles."

 Utilizing the authorized preference stock, the Marathon deal was negotiated and implemented. That deal contemplated and resulted in the issuance by Penn Central of 6,646,182 shares of what were designated first series preference stock. The terms of issuance of that first series were negotiated out between representatives of Marathon and representatives of Penn Central and the results of those negotiations were an agreement of merger. It was pursuant to that agreement and completed Penn Central/Marathon transaction that Messrs. Hunt and Terry acquired their large blocks of first series preference stock; and their first claim, which will be examined in detail in a minute or two, rests on what they assert to be rights accruing to them from the provisions of 5(d) of article 6 of the amended articles which, in their view, set limits on the manner in which Penn Central can go forward to issue any further series of preference stock-limits which, it is plaintiffs contention, bind Penn Central with respect to the Colt transaction now contemplated and about to be consummated.

 The Colt transaction has been generated in this past summer and autumn. It follows in its general pattern the Marathon transaction, Holdings to acquire Colt as an operating subsidiary and Penn Central, which owns all of Holdings, to issue a substantial new series of preference stock.

 The negotiations were reported to the Penn Central board at a meeting in early summer by the chairman, Mr. Dicker, who there asked and received authorization to enter into a letter of intent with Colt. The letter of intent described a transaction which was contemplated but which was somewhat modified by late September.

 The board continued to consider the matter as the summer advanced. Though Mr. Terry had joined his fellow directors in authorizing Mr. Dicker to enter into the letter of intent, he and Mr. Woodfin and two other board members voted against further pursuit of the transaction at the August meeting. At the September meeting, the last one to consider the transaction, the board approved the proposal (as subsequently communicated to the shareholders of the two corporations in the proxy materials referred to) by a vote of 13 to 3, Mr. Terry again one of those opposed, Mr. Woodfin this time with the majority.

 In the proxy materials Mr. Terry's ground of opposition was set forth as follows: "In my opinion, the Colt acquisition would not be in the best interests of Penn Central's shareholders and Penn Central would be a better and stronger company without Colt. Also four directors voted against the Colt merger at the August 27 board meeting and any change was made after the adjournment."

 A few days following the September meeting, proxy materials were sent out and those materials described the substance of the transaction. The full details I think need not be described at this point except to say that the Colt shareholders are offered a combination of preference stock and common stock of Penn Central or $ 100 in cash for each of their shares, and the entitlement and total entitlement of Penn Central shareholders with respect to the transaction is to vote at the shareholders meeting at the end of October at which a majority of the quorum will suffice for Penn Central approval.

 In summary form, the comparative features of the first and second series of preference stock-the first series which exists, the second series which is to be issued as a result of the Colt transaction-are as follows: The number of first series preference shares is 6,646,182. The proposed second series would be 9,297,163. The preferred dividend to which the first series has entitlement out of Penn Central's earnings is $ 5.27 to a total of some $ 35 million. The second series entitlement is to a $ 4.75 dividend aggregating some $ 44.2 millions. The liquidation preference of the first series is forty-seven and a quarter, that of the second series fifty. The relative conversion ratios are 1.63 for the first series, .9091 for the second and, with respect to voting rights, in normal times each member of the first series and each member of the proposed second series would vote with the common as a class. In the event of default on dividends for four successive quarters, the first series preference would be entitled to vote for two additional directors, an election to which the common would not be party. The proposed second series shareholders would also be entitled to vote for those two additional directors and would, in addition, be entitled to vote with the common for the balance of the directors.

 It may be noted that with respect to that discrepancy between the voting rights of the first series and of the second series-that is to say, that the second series would be entitled to vote with the common as well as for the two additional directors in the event of default-it may be worth noting that that discrepancy is hard to square with the text of language contained in the Marathon proxy materials which says in the second to last paragraph on page 21: "So long as the holders of special preference stock are entitled to such class voting rights they shall not be entitled to vote in the election of PCC directors other than such two additional directors," the prior text, which I won't belabor, having used the phrase "new preference stock" to refer to what we would understand to be the first series preference and "special preference stock" as meaning the entire class. There is a way of meeting that textual discrepancy which counsel for defendants have labored with which involves noting that all of that discussion is under captions which are descriptive of the first series preference stock or what is there called the new preference stock and, in short, that it is accurate as to them, even if it is not accurate as to the newly emerging proposed second preference stock.

 I think that substantially identifies the relative features of the two series-the one existing series, the one proposed series of special preference stock. It was against this background that on September 30th the complaint in this proceeding was filed.

 I propose to address first the claims made under count one. As I have indicated, they are of two sorts, but both to the same point, namely, both to the point that Mr. Terry and Mr. Hunt and other members of the first series preference group are entitled to participate in a series vote in which two-thirds would be required to vote in favor as a condition of Penn Central approval of the Colt transaction.

 The two different bases for making this claim are: (1) Article 6, section 5(d) of the amended and restated articles of incorporation of Penn Central; and (2) The New York Business Corporation Law.

 Let me turn first to section 5(d) of article 6. Section 5(d) begins by saying: "The corporation may, in the manner provided by article 9 hereof and as permitted by Pennsylvania law, from time to time alter or change the voting rights, preferences, qualifications, privileges, limitations, restrictions, options, conversion rights or other special or relative rights of the first series preference stock; provided, however, that without the affirmative vote of the holders at least two-thirds of the outstanding shares of all series of preference stock, the corporation shall not amend, alter, change, add or insert any provision in these articles which, or authorize the merger or consolidation of the corporation with any other corporation if the plan of such merger or consolidation contains any provision which if contained in these articles, would (i) make any adverse change in the voting rights, preferences, qualifications, privileges, limitations, restrictions, options, conversion rights or special or relative rights of preference stock, (ii) authorize a new class of stock senior or superior to preference stock, or (iii) increase the number of authorized shares of a senior or superior class of stock."

 I will pause at that point to see how that language is parsed. It is the claim of plaintiffs that the proposed Colt transaction would, within the meaning of subdivision one, "make (an) adverse change in the voting rights, preferences, qualifications, privileges, limitations, restrictions, options, conversion rights or special or relative rights of preference stock."

 Since at this present time the first series preference stock constitutes by itself the entire class of preference stock, it is plaintiffs' assertion that they, as a class, are entitled to the two-thirds vote by reason of the impact on the existing class members, namely, themselves, of the proposed second series preference stock.

 Now, I have noted that there were three distinct contingencies which give rise to the two-thirds class vote relied on by the language I have quoted. The second and third of these relate respectively to authorizing a new class of stock senior or superior to preference stock or increasing the number of authorized shares of a senior or superior class of stock. What is contemplated here, of course, is the issuance of another series of preference stock. Accordingly, that is not covered by authorizing a new class of stock senior or superior to preference stock or increasing the number of authorized shares of a senior or superior class of stock. The claim here is that the new series, by virtue of its terms, which are different from the terms of the first series in certain respects which I have summarized, would, when issued, constitute an adverse change in the voting rights, preferences, qualifications and so forth of preference stock, namely, the first series.

 The second and third contingencies not relied on here which require a two-thirds vote on the authorization of a new class of stock senior or superior or increasing the number of authorized shares of a senior or superior class of stock would seem to suggest very strongly that the authorization of a new class of stock or increasing the number of authorized shares of a class of stock equivalent to the preference stock would not be within the proscription of section 5(d), and yet it is plaintiffs' legal claim that the Penn Central board of directors is, indeed, inhibited from creating an equal or pari passu class, inhibited, that is, to the extent of having any such issuance or authorization contingent on a two-thirds vote of the existing members of the class. Plaintiffs' reply memorandum says this: "Nor do plaintiffs contend that PCC can never issue a superior or parallel series of preference stock. Plaintiffs simply contend that they are entitled to a class vote whenever the board proposes to issue such shares."

 Taken in that broad posture, I find that the construction which plaintiffs put upon this portion of 5(d)-and I will deal with its later portion in a moment-cannot be supported; that is, it seems to me to inhere in the logic of 5(d) and in the broader language of authorizing a huge class of preference stock of which the stock issued to the Marathon shareholders was explicitly understood to be only a first series, that subsequent series of preference stock would be or at least could be equivalent in status.

 I would think it clear, given the organization of the three sub-provisions which I have read, that if there were any intention to inhibit the board from issuing equivalent series, such inhibition would have been made explicit not only in ...


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