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A federal judge in New York has made a key decision on which classes of shareholders can sue for the damages caused by a collapsed merger. Southern District Judge John G. Koeltl found that the third-party beneficiaries of a scheduled merger between Consolidated Edison and Northeast Utilities in 2001 are those shareholders who owned the stock on the day the merger broke down. Deciding a case of first impression that he said has “far-reaching” effects on litigation involving large-scale transactions, Judge Koeltl rejected the position of Northeast Utilities, which argued that New York commercial law dictates that the right to sue for damages from a broken merger is passed on to the purchaser of the stock. “The decision clarifies that a shareholder who is injured by breach of a merger agreement has the right to assert a claim rather than somebody who is not injured and who buys a stock later based on prices that reflect the prior breach,” said Ira A. Schochet. With Lawrence A. Scharow and Lisa Buckser-Schulz of Goodkind Labaton Rudoff & Sucharow, Schochet represented a shareholder who intervened in the case to make a claim on shares he had already sold. Consolidated Edison signed an agreement on Oct. 13, 1999, to purchase all outstanding shares of Northeast Utilities for $26.50 per share. The share price of Northeast, (NU) was $18.56 before news of the proposed merger became public. But on March 5, 2001, Con Ed said it would not proceed and sought a declaratory judgment relieving it of obligations under the agreement. Among the claims made by Con Ed was that Northeast Utilities fraudulently induced it to enter into agreement and that Northeast breached part of the agreement. Northeast counterclaimed for the $27 million it spent on regulatory approval and $1.2 billion based on the “lost premium” that would have been paid its shareholders had the merger been completed. Robert Rimkoski, a shareholder who sold the bulk of his stock upon hearing of the failed merger, later intervened in the action, claiming he had a right to recover the lost premium. On March 21, 2003, Judge Koeltl dismissed some of Con Ed’s claims and ruled that Northeast Utilities shareholders were third-party beneficiaries — and that Northeast had standing to sue on their behalf. But the judge’s decision did not address whether current or former shareholders were the appropriate beneficiaries. On Monday, Koeltl resolved a motion to dismiss and a motion for summary judgment, saying the motions raised “a controlling question of New York state law that is an issue of first impression with little case law that is even closely analogous.” The question posed he said, was, “Where shareholders are third-party beneficiaries of a contract between the corporate issuer and a third party, is the right to sue that third party for breach of contract automatically transferred to a subsequent purchaser of the stock?” Koeltl noted that “disputes between former and current shareholders over the right to sue have arisen under federal law in the securities fraud context, where it is well established that only those individuals who relied on and were injured by the misleading acts or omissions may seek damages.” There have also been, he said, disputes between former and current shareholders over claim proceeds held by a trust. UNIFORM COMMERCIAL CODE However, Judge Koeltl said there is no case “directly addressing this situation, which involves the assignment of claims between former and current shareholders as third-party beneficiaries to a contract between the issuer and a third party.” Northeast argued that a provision of the New York Uniform Commercial Code, � 8-302(a), calls for the automatic assignment of stock-related contract claims against third parties. That section says that, unless otherwise provided, a purchaser of a security acquires “all rights in the security.” But Koeltl said the section “does not define ‘rights in a security’ or codify a rule assigning to purchasers any claim accrued while possessing the security.” “The provision simply provides that whatever ‘rights in the security’ are, they are automatically transferred to a purchaser unless (a) the transferor did not own or control them, (b) the purchase was for a limited interest, or (c) the purchaser is a prior holder with notice of an adverse claim taking from a protected purchaser,” he said. “Nothing in the provision’s language, its history, or the statutory structure indicates that the statute governs the claim arising under the Merger Agreement, as opposed to an action arising from a contract transferring the security or a defense by an insurer in an action under the security.” And “there is no support,” he said, for Northeastern’s “proposition that ‘rights in the security’ include rights from a separate contract as to which shareholders are third-party beneficiaries.” “In sum, upon the transfer of stock, the transferee receives rights in the security vis-�-vis the issuer and rights vis-�-vis other potential holders, including, for example, good title and bona fide purchaser status,” he said. “Nothing in the text of � 8-302(a), in its history or commentary, or in other provisions of the U.C.C. supports NU’s proposition that ‘rights in the security’ include contract rights against third parties or that � 8-302(a) codifies a rule for the automatic transfer of such rights to subsequent purchasers of the stock.” Northeastern had argued that the realities of the market, and of the litigation process, made it logical that claims should run with the stock. Allowing a former shareholder such as Rimkoski to make a claim after he had sold the stock, they argued, would create uncertainty in the marketplace and damage liquidity because people would be less inclined to buy the shares if the potential loss premium did not run with the shares. And while the judge disagreed, he did note that there “is a substantial ground for differences of opinion.” Given that the implications of the decision “in this case are far reaching, potentially affecting billion-dollar transactions in this case and in others,” Koeltl said, he was certifying an interlocutory appeal to the U.S. Court of Appeals on two issues — whether Northeast shareholders are intended third-party beneficiaries under the merger agreement and, if so “whether the claims for damages for breach of contract against Con Ed was automatically transferred from the shareholders who owned NU shares on March 5, 2001 to subsequent purchasers of NU shares.” Douglas M. Kraus and Joseph N. Sacca of Skadden, Arps, Slate, Meagher & Flom, who represented Northeast Utilities, declined to comment on the ruling. Kenneth M. Kramer, Stuart Baskin and John Gueli of Shearman & Sterling, representing Con Ed, declined comment.

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