Delaware Court of Chancery Dismisses Shareholder Derivative Action Against Interested Directors Following Secondary Offering

By Annette Becker and Mark Hammes

In In re Molycorp, Inc. Shareholder Derivative Litigation, the Delaware Court of Chancery dismissed claims brought against director representatives of private equity investors for breach of fiduciary duties, aiding and abetting, and unjust enrichment for failure to state a claim.  The Court held that the private equity investors along with certain directors exercised their contractual rights to sell their stock in Molycorp Inc. a publicly traded corporation (“Molycorp”) in a secondary offering and the directors were under no obligation to delay such a demand registration during a time in which Molycorp was experiencing a cash shortfall.

Molycorp was engaged in the production and sale of rare earth oxides. Before Molycorp’s July 2010 IPO, three initial private equity investors (PEIs) negotiated a Registration Rights Agreement. The agreement secured the PEIs right to demand that Molycorp register their shares in a secondary offering. The results of the July 2010 IPO did not yield the funds expected, and a secondary offering of Molycorp shares in February 2011 left the company still short on cash. A potential loan from the Department of Energy fell through, and potential financing arrangements with two other companies looked increasingly unlikely. In May 2011, the PEIs exercised their demand registration rights, and the offering was held in June 2011. Due to a recent spike in the price of rare earth oxides, the PEIs (and several directors appointed by the PEIs) sold their shares in the resulting June offering at an inflated value. In September 2011, the rare earth oxide bubble burst. Subsequent efforts by Molycorp to make up for its cash shortfall by issuing convertible notes left it with inadequate funds to implement its planned production increase. As a result Molycorp missed out on potential profits from the rare earth element bubble.

Plaintiffs contend that the directors of Molycorp, many of whom held significant positions within the PEIs and several of whom personally sold in the June 2011 offering, violated their fiduciary duties by favoring the PEIs and their own interests in failing to delay the demand registration. A delay would have allowed Molycorp to take advantage of the spike in mineral prices by holding its own offering at a time when it was short on cash. Plaintiffs also contend that the PEIs violated their duties as a control group and aided and abetted the directors’ breach of fiduciary duties. Finally, the Plaintiffs contend that members of the board who sold their shares during the June offering were unjustly enriched. The Court dismissed all three claims for failure to state a claim on which relief could be granted.

The directors were found not liable because of their contractual obligations under the Registration Rights Agreement. Although the Registration Rights Agreement allowed the board to delay action for 90 days if “it would be materially detrimental to the Corporation or its stockholders for such Registration Statement either to become effective or to remain effective,” the Court found that the pleaded facts did not state a reasonable claim that the directors needed to rely on this provision and delay the demand registration. Most importantly, the directors had no way of knowing when or if the market for rare earth minerals would falter and hinder Molycorp’s ability to raise capital. The pleadings contained “no allegations that the Director Defendants knew that the market would rise and fall as dramatically as it did, when it did.”

The Court found that the PEIs were not liable for violating their duties as a control group because they simply “exercised rights that benefited themselves but were fairly extracted and disclosed in public filings.” The value of Molycorp’s shares remained strong until the bubble burst at the end of the summer of 2011. The demand registration in June 2011 did not deflate Molycorp’s value. The Court stated that allowing the claim to proceed “could discourage would-be investors from funding start-ups for fear that their investment value will not be preserved despite disclosed, carefully negotiated agreements.” In addition, because the directors were not liable for violating their fiduciary duties, the secondary aiding and abetting claims against the PEIs also failed.

Finally, the directors who sold shares in the June 2011 offering were not liable for unjust enrichment because of the validly negotiated Rights Agreement and a failure by the plaintiffs to allege wrongful conduct. Because the Registration Rights Agreement was not challenged as unfair or invalid, the lack of culpable conduct by the directors or the PEIs defeated any claims for unjust enrichment.

In Re Molycorp, C.A. No. 7282-VCN (Del. Ch. May 27, 2015)(Noble, V.C)

 

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