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Atlantic Coast Airlines Holdings, Inc. v. Mesa Air Group

December 18, 2003

ATLANTIC COAST AIRLINES HOLDINGS, INC., PLAINTIFF,
v.
MESA AIR GROUP, INC., DEFENDANT.



The opinion of the court was delivered by: Rosemary M. Collyer United States District Judge

MEMORANDUM OPINION

At its core, this case involves a dispute over the future of Atlantic Coast Airlines Holdings, Inc. ("Atlantic Coast" or "ACA"): will it be a regional carrier for major airlines or an independent low-fare operator? It is presented to the Court in the context of a consent solicitation to replace the company's Board of Directors.

Atlantic Coast currently operates as a regional air carrier under the United Express and Delta Connection brands in the Eastern and Midwestern United States, as well as Canada. On July 28, 2003, Atlantic Coast announced plans to transform itself into an independent, low-fare airline based at Washington Dulles International Airport ("Dulles"). This new strategy was prompted in large measure by the bankruptcy reorganization of United Airlines, Inc. ("United") and the expectation that United would reject the current United/ACA code-sharing agreement under which ACA operates as a United Express ("UAX") carrier. On October 6, 2003, Mesa Air Group, Inc. ("Mesa"), a fellow regional air carrier and ACA shareholder, submitted an unsolicited proposal to acquire Atlantic Coast for the stated purposes of keeping Atlantic Coast in its traditional role as a UAX carrier and creating the leading regional airline in the United States. When the Atlantic Coast Board of Directors ("ACA Board") rejected the proposal, Mesa filed a preliminary consent statement with the Securities and Exchange Commission ("SEC"), pursuant to which Mesa seeks the consent of Atlantic Coast shareholders to replace the ACA Board with Mesa nominees.

Pending before the Court is Atlantic Coast's Amended Motion for a Preliminary Injunction, in which ACA asks the Court to prevent the consent solicitation from going forward. Atlantic Coast brings both securities and antitrust claims against Mesa. ACA alleges that Mesa has violated §§ 14(a) and (e) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78n(a) and (e), by issuing a preliminary and two revised preliminary consent statements, press releases, and other public statements that contain materially false and misleading statements and omissions. ACA also alleges that Mesa has violated § 1 of the Sherman Act, 15 U.S.C. § 1, § 7 of the Clayton Act, 15 U.S.C. § 18, and the District of Columbia Antitrust Act, D.C. CODE § 28-4502, by entering into an agreement with United that will have the effect of eliminating competition by blocking the entry of ACA's planned low-fare airline into the marketplace. Mesa counters that its solicitation materials fully and accurately disclose all pertinent information, including the allegations of this lawsuit, and that its actions to continue Atlantic Coast as a feeder airline for United do not run afoul of the antitrust laws. Following a deluge of briefs and exhibits, and a preliminary injunction hearing, the parties agreed that the Court would have ten days to render its decision. Having considered all the materials submitted, the entire record in this matter, and the demeanor and credibility of the testimony of the witnesses, the Court will grant a preliminary injunction enjoining Mesa from proceeding with the consent solicitation or exchange offer until this matter can be heard and decided on the merits. The defendant's motion to dismiss will be denied without prejudice. A confirming order will be issued.

I. FACTUAL BACKGROUND

Atlantic Coast has operated as a regional air carrier for United at Dulles since 1989. At the beginning of the business relationship between these two airlines, Atlantic Coast received a prorated portion of the revenues collected when a passenger connected from an Atlantic Coast aircraft to a United aircraft. Although all seats were sold as United seats, Atlantic Coast selected which routes to fly and how frequently to fly them. In January 2000, United and Atlantic Coast switched to a "feeper-departure" arrangement, under which United assumed substantially more control over Atlantic Coast's operations. United now sets the fares for UAX flights, selects which routes ACA flies, and determines how frequently Atlantic Coast serves those routes. In return, United pays Atlantic Coast a pre-negotiated fee for each flight ACA operates as United Express. ACA is the largest UAX carrier; it flies approximately 500 flights per day serving approximately 50 cities.

Atlantic Coast began to explore alternative business strategies in early 2001 to supplement or replace its operations as a regional air carrier servicing major airlines. United's bankruptcy filing on December 9, 2002, added to Atlantic Coast's concern about the wisdom of continuing to do business as a feeder airline. The fact that United has used the bankruptcy process to re-negotiate for significantly lower costs in its UAX agreements with regional airlines across the country has not helped to assuage ACA's concerns. After months of unsuccessful negotiations with United, Atlantic Coast publicly announced on July 28, 2003 that it anticipated that United would reject the existing United/ACA code-share agreement through the bankruptcy court and that Atlantic Coast planned to establish an independent, low-fare airline based at Dulles. Since that time, Atlantic Coast has taken extensive steps to prepare for the launch of "Independence Air," including commitments for route planning consultants, reservations systems, call center ticket counters, gate luggage handling, aircraft servicing, and advertising, to augment its fleet of regional jets and departure/arrival gates at Dulles. In addition, Atlantic Coast announced on November 18, 2003, that it had reached a memorandum of understanding with Airbus Industrie AVSA ("Airbus") to lease and purchase 25 narrow-body planes to fly larger numbers of passengers over longer distances than ACA's current complement of 87 regional jets flies.

In the meantime, while Atlantic Coast was looking to change business models, Mesa sought to regain its stature as a regional air carrier for United following United's 1998 termination of a prior code-share agreement between United and Mesa. Those parties reached a new agreement on February 27, 2003, pursuant to which Mesa would operate ten aircraft under the United Express brand. On July 1, 2003, Mesa and United agreed that Mesa would operate an additional 35 UAX regional jets, with the option of adding 25 regional jets at a later date. The July agreement became effective in August 2003 and will expire in December 2013.

Mesa followed the United/ACA negotiations with a high degree of interest and incredulity that ACA would walk away from its relationship with United. Immediately after ACA announced its July 2003 decision to forego the United relationship and establish a low-cost airline at Dulles, Mesa contacted United and offered its assistance, in whatever way would help. United declined this offer, preferring to continue to negotiate with Atlantic Coast and to maintain its longstanding arrangements for feeder service at Dulles. Nonetheless, Mesa retained an advisor on August 1, 2003, to provide advice on an acquisition and began to acquire large amounts of ACA stock.

The record before the Court reveals that United had two concerns with ACA's announcement of its plans. To those who fly out of Dulles Airport frequently, it will come as no surprise that United depends heavily on the feeder traffic brought to Dulles from the surrounding states by UAX flights operated by Atlantic Coast. The entire hub-and-spoke system of the larger airlines depends on regional feeder airlines, like Atlantic Coast, to return a profit. Therefore, United could ill afford to lose the support of the ACA service at Dulles (or O'Hare Airport in Chicago, where Atlantic Coast is also a mainstay support to United's hub operations). In addition, the parties to this action estimate a potential loss in passenger traffic to United valued at about one-half billion dollars in two years if United were to face competition from a low-fare airline as planned by Atlantic Coast. The record supports the conclusion that potential competition from a low-fare airline operated by ACA is a significant concern to United, even if United believes that such a new airline could only survive for a few years.*fn1

On October 6, 2003, Mesa announced a bid to acquire Atlantic Coast in a tax-free stock exchange offer because Mesa "[r]ecogniz[ed] both the ill-advised nature of Atlantic's abandonment of its code-sharing model, as well as the strategic benefits associated with combining Atlantic's and Mesa's operations[.]" Defendant's Opposition to Plaintiff's Amended Motion for a Preliminary Injunction ("Defendant's Opposition") at 9. Atlantic Coast issued a press release on October 16, 2003, stating that the ACA Board would consider the merger proposal.

The day before, October 15, 2003, Mesa filed its first preliminary consent statement with the SEC, to which the SEC subsequently provided comments. Eight days later, Atlantic Coast announced its rejection of Mesa's exchange offer and reaffirmed its strategy to establish an independent low-fare airline. Atlantic Coast also set the record date for Mesa's consent solicitation at October 23, 2003, although Mesa challenged this date in a lawsuit in Delaware Chancery Court and ACA later withdrew it. Mesa filed a revised preliminary consent statement on November 21, 2003, and a second revised preliminary consent statement on December 2, 2003, which is the version to be referenced hereafter as the "Consent Statement." On December 9, 2003, the second day of the preliminary injunction hearing, counsel for Mesa reported that the SEC had approved the Consent Statement. (Mesa formally requested a list of shareholders and a record date and Atlantic Coast set the record date at December 12, 2003.)

On November 12, 2003, Mesa and United announced that they had entered into a non-binding Memorandum of Understanding ("United MOU"), agreeing in principle to terms under which both Atlantic Coast and Mesa "would operate as United Express carriers... subject to the parties entering into definitive agreements and a successful consent solicitation." Jaskow Decl. Exh. 5; see Taylor Dep. Exh.14.

II. ANALYSIS

A. Legal Standard

In considering a request for preliminary injunctive relief, a district court must examine whether "(1) there is a substantial likelihood plaintiff will succeed on the merits; (2) plaintiff will be irreparably injured if an injunction is not granted; (3) an injunction will substantially injure the other party; and (4) the public interest will be furthered by an injunction." Davenport v. Int'l Bhd. of Teamsters, 166 F.3d 356, 360 (D.C. Cir. 1999); see also Serono Lab. v. Shalala, 158 F.3d 1313, 1317-1318 (D.C. Cir. 1998). These factors "interrelate on a sliding scale" and a particularly strong showing on one may compensate for a weak showing on another. Vencor Nursing Ctrs., L.P. v. Shalala, 63 F. Supp. 2d 1, 7 (D.D.C. 1999) (quoting Davenport, 166 F.3d at 361).

B. Securities Claims

Atlantic Coast brings securities claims under two provisions of the Securities Exchange Act of 1934, § 14(a) and (e). Section 14(a) prohibits the solicitation by a proxy statement "in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors[.]" 15 U.S.C. § 78n(a). In conjunction with Rule 14a-9, 17 C.F.R.§ 240.14a-9, this section "disallow[s] the solicitation of a proxy by a statement that contains either (1) a false or misleading declaration of a material fact, or (2) an omission of a material fact that makes any portion of the statement misleading." Desaigoudar v. Meyercord, 223 F.3d 1020, 1022 (9th Cir. 2000). "To prevail on a Section 14(a) claim, a plaintiff must show that (1) a proxy statement contained a material misrepresentation or omission which (2) caused the plaintiff injury and (3) that the proxy solicitation... was 'an essential link in the accomplishment of the transaction.'" Gen. Elec. Co. v. Cathcart, 980 F.2d 927, 932 (3d Cir. 1992) (quoting Mills v. Elec. Auto-Lite Co., 396 U.S. 375, 385 (1970)). In general, the term "solicitation" includes any "communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy." 17 C.F.R. § 240.14a(l)(1)(iii). A misrepresentation or omission is material if "there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).

Section 14(e) prohibits, in connection with a tender offer, any person from making untrue statements of material fact or leaving material omissions that would be necessary to make previous statements not misleading. 15 U.S.C. § 78n(e). For a plaintiff to succeed on a claim under § 14(e), there must be established "(i) a misrepresentation or omission of material fact; (ii) the requisite intent to deceive; and (iii) detrimental shareholder reliance." Salsitz v. Peltz, 227 F. Supp. 2d 222, 225 (S.D.N.Y. 2002). With respect to the second element, "a plaintiff must plead and prove an intent to defraud, knowledge of falsity, or a reckless disregard for the truth." Conn. Nat'l Bank v. Fluor Corp., 808 F.2d 957, 961 (2d Cir. 1987) (internal quotations omitted).

As an overarching matter, ACA argues that Mesa has been engaged in solicitation within the meaning of the Exchange Act since its first, allegedly incomplete, consent statement was filed and that these earlier drafts of the Consent Statement remain available for investors to review on Mesa's web site. Accordingly, Mesa is alleged to continue to engage in solicitation based on bad documentation despite any corrections or additions in the revised statements.

More specifically, the Atlantic Coast Reply in Support of Its Amended Motion for a Preliminary Injunction ("ACA Reply") sets forth a virtual laundry list of ways in which it believes Mesa has violated §§ 14(a) and (e) of the Exchange Act, which the Court will address in turn.*fn2

First and most critically, Atlantic Coast contends that Mesa has failed to disclose its own direct and material interests in seeking to remove the ACA Board, interests that are not shared by other Atlantic Coast shareholders. It is argued that Mesa will benefit from eliminating a potential competitor for United by receiving increased profit margins on trips that Mesa flies as United Express, even if the merger between Mesa and ACA is not consummated. In addition, if Mesa acquires Atlantic Coast and scuttles Independence Air, Mesa could use ACA's cash reserves, valued at more than $200 million, to alleviate Mesa's alleged financial difficulties. Mesa responds that it provided sufficient information in the Consent Statement for ACA shareholders to know that it benefits from the United MOU:

Furthermore, in the event that a Mesa/Atlantic Coast business combination is successfully consummated or if the Mesa nominees are elected to the Atlantic Coast board of directors pursuant to this consent solicitation and enter into a definitive code share agreement with United Airlines on terms substantially similar to those contained in the United MOU, the adjusted margins will apply to all Mesa aircraft that fly code share service for United Airlines. The revised margins are an improvement in the current Mesa relationship with United Airlines.

Lipton Decl. Exh. 49.

Second, Atlantic Coast argues that Mesa has failed to disclose United's alleged role as a participant in the consent solicitation process in violation of § 14(a). This "participation" was allegedly revealed by an answer from Jonathan Ornstein, Mesa's chief executive officer, to a financial analyst on October 7, 2003. Asked during a teleconference, "Where is United in all of this?", Mr. Ornstein responded that Mesa is

partnered with United Airline[s]. When [Mesa] announced that [Mesa] had discussed it with United, United has reaffirmed the fact to [Mesa] that they would like to come to an agreement with Atlantic [C]oast, they would like to maintain that Atlantic [C]oast has a feed operation and to the exten[t] that [Mesa] could be involved in that decision it would be helpful.

Lipton Decl. Exh. 1 at 15. Further evidence of United's "participation" is allegedly found in financial support from United to Mesa when United paid Goldman Sachs to give advice on the structure of the United MOU to avoid dilution of Mesa shareholder interest. Finally, Atlantic Coast notes that the first revised consent statement was delayed in its filing until after the United MOU was reached because the United MOU made the solicitation stronger to induce Atlantic Coast shareholders to vote in favor of Mesa's nominees to the ACA Board. Mesa denies that United is a participant or that it has contributed financially to the consent solicitation effort. Mr. Ornstein has testified that United is ...


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