McMahan & Co. v. Wherehouse Entertainment, Inc.

Pursuant to offering materials, Wherehouse Entertainment, Inc. (Wherehouse) (defendant) sold debentures that included a right of the holder to tender the debenture back to Wherehouse upon the occurrence of certain transactions that might negatively impact the debentures’ value. One event that would trigger the tender right of the debenture holder was a merger, unless approved by a majority of “independent directors.” McMahan & Company (plaintiff) and other financial companies (the debenture holders) bought 34 percent of the debentures in the offering. Approximately 18 months after the debentures were bought, Wherehouse merged with another company pursuant to a merger agreement structured as a leveraged buyout. The new debt structure created by the leveraged buyout greatly reduced the value of the debentures. As a result, the debenture holders elected to exercise their tender rights. Wherehouse, however, claimed that because the merger had been approved by the board of directors, the debenture holders were not entitled to exercise the tender rights. All but one director on the board was an “independent director,” as defined in the offering materials. The debenture holders sued Wherehouse and alleged that the offering materials contained material misrepresentations and omissions in violation of §§ 11 and 12 of the Securities Act of 1933, and also constituted fraud under § 10(b) of the Securities Exchange Act of 1934. Specifically, the debenture holders alleged that the tender right was misleading and misrepresented as a valuable right for the protection of debenture holders in takeover scenarios and that “independent directors” implied something more than merely regular directors who are tasked with protecting shareholders (as opposed to debt holders). The debenture holders claimed the tender right was, in effect, illusory. The district court granted summary judgment to Wherehouse, and the debenture holders appealed.