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Matthew P. Amos, et al. v. Franklin Financial Services Corporation

November 22, 2011


The opinion of the court was delivered by: William W. Caldwell United States District Judge


I. Introduction and Procedural History

Matthew P. Amos and the other twenty-four plaintiffs are former shareholders in Community Financial, Inc. (CFI). Defendant, Franklin Financial Services Corp. (Franklin Financial), acquired CFI in a merger whereby CFI ceased to exist and its shareholders were paid cash for their shares. Plaintiffs filed this suit against Franklin Financial and seven individual defendants, mostly shareholders and officers of CFI. Plaintiffs alleged that in the years leading up to the merger, the individual defendants operated CFI in a way that diluted the value of Plaintiffs' shares upon the merger relative to the value of Defendants' shares. To accomplish this goal, Defendants "devised a scheme or artifice to defraud" and engaged in fraudulent conduct directed at Plaintiffs and other non-defendant shareholders.*fn1

Plaintiffs made claims under the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §§ 1961-1968, and under state law for conversion, unjust enrichment, breach of fiduciary duty, fraud and waste of corporate assets, conspiracy, and a violation of the Pennsylvania Uniform Commercial Code.

Two motions to dismiss were filed under Fed. R. Civ. P. 12(b)(6), one by Franklin Financial and the other by the individual defendants. In part, both motions argued that the RICO claims lacked merit because Plaintiffs were basing them on fraud in the sale of securities (by way of the merger) and RICO excludes from the reach of the statute claims that would be actionable as securities fraud.*fn2 We agreed with this argument. See Amos v. Franklin Fin. Services Corp., 2011 WL 2111991, at *4 (M.D. Pa. May 26, 2011). Since the RICO claims were the only federal ones, and diversity jurisdiction did not exist, we declined to exercise supplemental jurisdiction over the state-law claims and dismissed the entire action on May 26, 2011. Id., at *6.

Plaintiffs have filed a motion for reconsideration. Franklin Financial has filed a brief in opposition and so have the individual defendants. Plaintiffs argue we erred in concluding that their RICO claims were actionable as a Rule 10b-5 securities-fraud claim. Plaintiffs contend that because the defendant shareholders controlled the majority of the shares in CFI, and a majority of the shares were all that was needed to accomplish the merger, the merger was a "freeze-out merger." As a freeze-out merger, it was immaterial whether other shareholders were fraudulently induced into voting for it because the defendants had no need for the votes of other shareholders. It follows that Plaintiffs have no actionable 10b-5 claim because as a matter of law they could not show the requisite element of causation.

For the reasons set forth below, we agree with Plaintiffs' argument concerning causation and that their motion should be granted. Thus, we will vacate our previous order. Nonetheless, for other reasons advanced by Defendants in support of dismissal of the RICO claims we will enter another order which, once again, dismisses the RICO claims and declines to exercise jurisdiction over the state-law claims.*fn3

II. Plaintiffs Are Entitled to Reconsideration of the May 26, 2011, Order

As It Was Based on a Clear Error of Law

The May 26, 2011, order dismissing the action was final because it left nothing more to be done by this court. See Dotzel v. Ashbridge, 438 F.3d 320, 323 (3d Cir. 2006). Plaintiffs' motion for reconsideration challenges the legal correctness of that order. The motion is therefore treated as one under Fed. R. Civ. P. 59(e) to alter or amend the judgment. Holland v. Holt, 409 F. App'x 494, 496 (3d Cir. 2010)(per curiam)(nonprecedential). A motion for reconsideration under Rule 59(e) is used "'to correct manifest errors of law or fact or to present newly discovered evidence.'" Lazaridis v. Wehmer, 591 F.3d 666, 669 (3d Cir. 2010)(quoting Max's Seafood Cafe ex rel. LouAnn, Inc. v. Quinteros, 176 F.3d 669, 677 (3d Cir. 1999)). "A proper Rule 59(e) motion therefore must rely on one of three grounds: (1) an intervening change in controlling law; (2) the availability of new evidence; or (3) the need to correct a clear error of law or fact or to prevent manifest injustice." Id.

"A motion for reconsideration may not be used as a means to argue new facts or issues that were not presented to the court in the context of the matter previously decided." Worbetz v. Ward North America, Inc., 54 F. App'x 526, 533 (3d Cir. 2002) (nonprecedential). It cannot be used to raise new legal issues. United States v. Metropolitan St. Louis Sewer Dist., 440 F.3d 930, 933 (8th Cir. 2006)(quoted case and internal quotation marks omitted). Nor can it be used to reargue issues that the court has already considered and disposed of. Blanchard v. Gallick, No. 09-1875, 2011 WL 1878226, at *1 (M.D. Pa. May 17, 2011)(Caldwell, J.)(citing Ogden v. Keystone Residence, 226 F. Supp. 2d 588, 606 (M.D. Pa. 2002)).

In opposing the motion, Defendants first argue that it is untimely because Local Rule 7.10 requires that motions for reconsideration be "filed within fourteen (14) days after the entry of the order concerned" and Plaintiffs filed the motion on June 13, 2011, eighteen days after May 26, 2011, the date of the order. We reject this argument. Local Rule 7.10 specifically excludes from its scope a motion to alter or amend under Fed. R. Civ. P. 59, and as noted above, Plaintiffs' reconsideration motion is governed by Fed. R. Civ. P. 59(e).*fn4 Rule 59(e) allows a party twenty-eight days from the entry of the order to file a motion to alter or amend. Plaintiffs' motion for reconsideration was therefore timely as the Rule 59(e) deadline expired on June 23, 2011, and Plaintiffs' motion was filed on June 13, 2011, ten days before.

Defendants next argue that the motion must be denied because the argument raised in the motion was not presented in opposing the motions to dismiss. As noted above, a reconsideration motion cannot be used to argue legal issues not presented in connection with the proceedings leading to the challenged order.

Defendants correctly point out that Plaintiffs' argument is new. In opposing dismissal, Plaintiffs never said that the merger was a freeze-out merger,*fn5 nor did they cite in support of the argument Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 111 S.Ct. 2749, 115 L.Ed.2d 929 (1991), and Scattergood v. Perelman, 945 F.2d 618 (3d Cir. 1991), the two cases they cite now in support of their no-causation argument.*fn6 It is also true that, generally, new arguments cannot be considered on a motion for reconsideration under Rule 59(e). This general principle, however, does not apply to clear errors of law or fact. For example, in Max's Seafood Cafe ex rel. Lou-Ann, Inc., supra, while the Third Circuit recognized that courts take a "'dim view of issues raised for the first time in post-judgment motions,'" 176 F.2d at 678 (quoted case omitted), the court nonetheless decided that the district court had abused its discretion in refusing to consider a factual argument first raised by the corporate defendant on a motion to alter or amend. The district court had held the corporate defendant in contempt of a consent decree. The new argument was that the corporation had not come into existence until after the statements in violation of the consent decree at issue had been made. The court of appeals ruled that this factual issue was "so fundamental," id., that it should have been considered on reconsideration, noting that "reconsideration is the appropriate means of bringing to the court's attention manifest errors of fact or law." Id. (citing Harsco Corp. v. Zlotnicki, 779 F.2d 906, 909 (3d Cir. 1985)). See also In re: Linerboard Antitrust Litig., 361 F. App'x 392, 397 n.2 (3d Cir. 2010)(nonprecedential)(district court properly granted reconsideration to correct the court's error of law in vacating an injunction on the mistaken belief that the court would lose jurisdiction after the end of the underlying class action).

In light of Virginia Bankshares and Scattergood, we believe we made a clear error of law, even though that error resulted from Plaintiffs' failure to present us with the argument at the time Defendants moved to dismiss. In Virginia Bankshares, the Supreme Court held that shareholders whose votes were not needed either by law or by corporate bylaw to authorize a merger could not bring a section 14(a) securities-fraud claim for misrepresentations in a proxy statement issued in connection with the merger. The Court ruled that the shareholders could not show the necessary causation. 501 U.S. at 1087, 111 S.Ct. at 2755. In Scattergood, the Third Circuit followed Virginia Bankshares in ruling that, without more, shareholders whose votes were not needed for the freeze-out merger could not show causation for both a section 14(a) claim and a Rule 10b-5 claim. 945 F.2d at 625-26.

Application of Virginia Bankshares and Scattergood is clear and straightforward. Plaintiffs draw our attention to the allegations of their amended complaint. They allege that defendant Gates exercised warrants in December 2006 which had the effect of giving the defendant shareholders ownership or control of 50.36% shares, giving them "voting control of the company," (Am. Compl. ¶ 56), and, as of September 2007, "enabling them to control the direction of the company, including effectuating the merger with Franklin Financial and ensuring the demise of CFI." (Id. ¶ 57). As Plaintiffs argue, since these allegations mean that Defendants had no need for minority shareholders to vote for the merger, our conclusion that Plaintiffs had an actionable Rule 10b-5 securities-fraud claim was mistaken. Since our conclusion was also contrary to direct and controlling Supreme Court precedent, we must grant the motion for reconsideration to correct this clear error of law.

In opposing the reconsideration motion, the individual defendants and Franklin Financial argue that the amended complaint does not show that a freeze-out merger occurred. They contend the above allegations only establish that the defendants owned a controlling number of shares in December 2006 and September 2007, and that the amended complaint is silent on the number they owned on August 8, 2008, the record date for being able to vote on the merger.*fn7 We reject this argument. Viewing the allegations in the light most favorable to Plaintiffs, a reasonable inference is that the defendants not only acquired the majority of the shares but maintained their majority control at all relevant times; paragraph 57 identifies a point in time but also alleges the majority control in existence at that time enabled the defendants to "effectuat[e] the merger with Franklin Financial and ensur[e] the demise of CFI."

Additionally, the individual defendants argue that the allegations fail to show that the merger was a freeze-out merger because the proxy statement stated that CFI's directors and officers owned 91,036 shares and that this was about 43.65% of the shares, (Am. Compl., Ex. D, CM/ECF p. 24), making the votes of the minority shareholders critical to the merger. We reject this argument. It ignores defendant Habacivich's 14,000 shares. The defendants are not all alleged to be directors at the time of the merger. Plaintiffs allege they were directors at various times. (Am. Compl. ¶ 13). Habacivich's shares gives the individual defendants the 50.36% control alleged in paragraphs 56 and 57. These defendants cite no authority for their proposition that a freeze-out merger occurs only when the officers and directors of a corporation own enough stock to control a merger vote. The crucial allegation is that while neither Habacivich nor Linda Lee Gates were officers or directors at the time of the merger, they had agreed with the remaining defendants to vote for the merger, thereby rendering the votes of the non-defendant shareholders irrelevant.

Having decided to grant reconsideration, we turn to Defendants' argument that there is still an actionable securities-fraud claim even though Defendants did not need minority shareholder votes to effect the merger. They contend that for the RICO bar to apply they need not show that Plaintiffs themselves have an actionable securities-fraud claim, only that the conduct upon which they base their claim is actionable as securities fraud. They cite in support MLSMK Inv. Co. v. JP Morgan Chase & Co., 651 F.3d 268, 277-78 (2d Cir. 2011); and Gatz v. Ponsoldt, 297 F. Supp. 2d 719, 730 (D. Del. 2003)(RICO exclusion applies "regardless of whether a particular plaintiff has standing to bring a civil action under § 10b or Rule 10b-5"). Defendants assert that even if Plaintiffs have no securities-fraud claim, the non-defendant shareholders who voted for the merger based on the alleged misrepresentations do, and that the existence of the latter claim bars the RICO claims.

In making the argument, Defendants point to the allegations in the amended complaint that "[m]any non-defendant shareholders voted to approve the sale of CFI" based on the proxy statement's estimate that shareholders would have received $2.79 per share if the merger had occurred on July 1, 2008, Am. Compl. ¶ 61), and that this was a "'classic bait and switch' fraudulent sales technique." (Id.).*fn8 Defendants argue that these allegations support an actionable securities-fraud claim because the shareholders who voted for the merger lost their right to a state appraisal remedy by voting for the merger. The loss of this right supplies the causation element missing in the freeze-out mergers presented in Virginia Bankshares and Scattergood. Defendants cite in support Wilson v. Great Am. Indus., Inc., 979 F.2d 924, 931 (2d Cir. 1992)(minority shareholders in a freeze-out merger can establish loss causation for a securities-fraud claim if they voted for the merger and lost state appraisal rights as a result); and Howing Co. v. Nationwide Corp., 972 F.2d 700, 707-09 (6th Cir. 1992)(same).

We agree with Defendants, and the cases cited, that Defendants need not show that the plaintiffs in this action have an actionable securities-fraud claim as long as Defendants show that the conduct upon which Plaintiffs base their RICO claims is actionable as a securities fraud claim. Hence Defendants could rely on a securities fraud-claim that could have been brought by others, shareholders who are neither plaintiff nor defendant. We also accept that these other shareholders could show causation by loss of a state appraisal remedy. However, we are not convinced that the allegations of the amended complaint show that these shareholders have an actionable claim, and we will therefore not dismiss the RICO claims on the basis of the RICO exclusion for securities fraud claims.

As Plaintiffs point out, Wilson is distinguishable because under New York law appraisal was the exclusive remedy and by voting for the merger shareholders lost the only remedy under state law that would have given them fair value for their stock. In In re Digital Island Sec. Litig., 223 F. Supp. 2d 546, 559 (D. Del. 2002), the court distinguished Wilson on this basis in concluding there was no securities-fraud claim in that case because Delaware allowed shareholders to file an equitable action as well. Hence there was no injury.

Similarly, Pennsylvania has an appraisal remedy for minority shareholders, but it may not be the exclusive remedy. It may be that shareholders may also bring a claim, as Plaintiffs have here, for damages for breach of the majority shareholders' fiduciary duty in connection with a freeze-out merger. See Mitchell Partners, L.P. v. Irex Corp., 656 F.3d 201, 216 (3d Cir. 2011), panel rehearing granted, F.3d , 2011 WL 4448604 (3d Cir. 2011)(question of exclusiveness of appraisal remedy certified to the Pennsylvania Supreme Court).

But we do not base our decision solely on the fact that the appraisal remedy is, or may not be, exclusive. Franklin Financial argues that it is irrelevant whether the remedy was exclusive or not; the shareholders still lost a remedy. We disagree. We think to show that the RICO exclusion applies, Defendants had to show that the appraisal remedy had some distinct advantage that was lost when the minority shareholders voted for the merger. We base this requirement on Wilson's rationale for accepting the loss of a state remedy to show the necessary causal link; the loss of a state remedy satisfies the element of loss causation for a securities-fraud claim, that is, the requirement of showing economic harm. Wilson, 979 F.2d at 931. Defendants have not shown that Plaintiffs would suffer economic harm by pursuing other state remedies. In this regard, we note that in Howing Co. the Sixth Circuit observed that the appraisal remedy "would have been more attractive," 972 F.2d at 710, if the proxy statement had provided the required information, basically concluding that the appraisal remedy had some advantage.

In the absence of injury, there does not appear to be a securities-fraud claim.*fn9 Since we have decided that Defendants have failed to show that the RICO exclusion applies, we will address the other arguments they made against the RICO claims, presented in their motions to dismiss.

III. Standard of Review

In considering a motion to dismiss, "[w]e 'accept all factual allegations as true, construe the complaint in the light most favorable to the plaintiff, and determine whether, under any reasonable reading of the complaint, the plaintiff may be entitled to relief.'" Byers v. Intuit, Inc., 600 F.3d 286, 291 (3d Cir. 2010)(quoted case omitted). The court is not limited to evaluating the complaint alone. It may consider documents that form the basis of a claim. Lum v. Bank of America, 361 F.3d 217, 221 n.3 (3d Cir. 2004). It may also consider "documents whose contents are alleged in the complaint and whose authenticity no party questions," even though they "are not physically attached to the pleading . . . ." Pryor v. Nat'l Collegiate Athletic Ass'n, 288 F.3d 548, 560 (3d Cir. 2002).

A complaint has to plead "enough facts to state a claim to relief that is plausible on its face." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 1974, 167 L.Ed.2d. 929 (2007). Detailed factual allegations are not required, id. at 555, 127 S.Ct. at 1964; Pryor, supra, 288 F.3d at 564, only a "short and plain statement" showing the right to relief. Pryor, supra, 288 F.3d at 564 (citing Swierkiewicz v. Sorema N.A., 534 U.S. 506, 122 S.Ct. 992, 152 L.Ed.2d 1 (2002) and quoting Fed. R. Civ. P. 8(a)(2)). "The plausibility standard is not akin to a 'probability requirement,' but it asks for more than a sheer possibility that a defendant has acted unlawfully." Ashcroft v. Iqbal, 556 U.S. 662, , 129 S.Ct. 1937, 1949 (2009)(quoting Twombly, 550 U.S. at 556, 127 S.Ct. at 1965). "[M]ore than labels and conclusions" are required. Twombly, 550 U.S. at 555, 127 S.Ct. at 1964-65. In addition, allegations of fraud must be pled with particularity. Lum, supra, 361 F.3d at 223.*fn10

IV. The RICO Claims Lack Merit

A. Plaintiffs Fail to Show Proximate Cause Because the Injury

Alleged Is Derivative of Injury to CFI, Not a Direct ...

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