In Sheldon v. Pinto Technology Ventures, C.A. No. 2017-0838-MTZ (Del. Ch. Jan. 25, 2019), the Delaware Court of Chancery in a Memorandum Opinion granted a motion to dismiss breach of fiduciary duty claims and other allegations brought by the founder and an early stockholder (“Plaintiffs”) of non-party IDEV Technologies, Inc., a Delaware corporation (“IDEV”). The Court found that Plaintiffs’ primary claims were derivative, rejecting Plaintiffs’ assertion that Defendants were judicially estopped by a Texas state court ruling from arguing for that characterization of the claims, and dismissed the complaint for failure to comply with Chancery Court Rule 23.1’s derivative claims demand or demand futility pleading requirements.Read More
by David L. Forney and Tom Sperber
In Klein v. H.I.G. Capital, L.L.C., et. al, C.A. No. 2017-0862-AGB, the Delaware Chancery Court issued a Memorandum Opinion granting in part and denying in part a motion to dismiss under Court of Chancery Rule 23.1 for failing to make a demand and under Court of Chancery Rule 12(b)(6) for failing to state a claim of relief. Melvyn Klein (“Plaintiff”), a stockholder of Surgery Partners, Inc. (“SP”), brought direct and derivative claims against one of SP’s directors Michael Doyle (“Doyle”), SP’s controlling stockholder H.I.G. Capital, L.L.C. (“HIG”), and Bain Capital Private Equity, LP (“Bain”) (collectively, “Defendants”), alleging breaches of fiduciary duty against Defendants stemming from three interdependent transactions that were allegedly conflicted and unfair. The Court found that demand was futile because the Plaintiff sufficiently alleged that the board was interested, and found that Plaintiff stated claims for breach of fiduciary and aiding and abetting breach of fiduciary duty by HIG and Bain, respectively, because Defendants failed to show that the conflicted transactions were entirely fair.
The board of directors of SP (the “Board”) approved, and SP entered into, three transactions on May 9, 2017 (the “Transactions”). The Transactions consist of: (1) SP acquiring National Surgical Healthcare for $760 million; (2) HIG selling its shares of SP to Bain at a price of $19 per share; and (3) SP issuing to Bain 310,000 shares of a new class of stock of SP at a price of $1,000 per share. These transactions were interrelated and dependent on each other; if one fell through, the others would fail as well. The Board approved the Transactions without a special committee and with no publicly disclosed abstentions. No public stockholders voted on the transactions as HIG approved each by written consent as majority stockholder. Bain and SP used the same law firm and accounting firm to represent them during negotiations. Once the Transactions were finalized, Bain was SP’s controlling stockholder.
Plaintiff filed a complaint alleging eight claims. Of those claims, four were pled directly and four were pled derivatively. Each direct claim had a corresponding derivative claim. Counts I and V asserted claims for breach of fiduciary duty against the Board of LP (all of whom were dropped from the complaint except for Doyle) for entering into the Transactions without ensuring that the share issuance to Bain was entirely fair. Counts II and VI were claims for breach of fiduciary duty against Bain and HIG for entering into a conflicted transaction in the share issuance to Bain. Counts III and VII alleged claims of breach of fiduciary duty against HIG, in the alternative, as the sole controlling stockholder for entering into the conflicted transaction. Lastly, Counts IV and VIII asserted that Bain aided and abetted breaches of fiduciary duty by HIG and Doyle.
In deciding Defendants’ motion to dismiss, the Court first turned to whether Counts I-IV were properly brought as direct claims. The Court observed that the claims brought by Plaintiff constitute “a classic form of an ‘overpayment’ claim,” which must normally be pled derivatively. Plaintiff, however, argued that his claim resembles the claim brought in Gentile v. Rosette, where the Delaware Supreme Court recognized a situation where a corporate overpayment claim implicated both direct and derivative injury. The Court, in rejecting Plaintiff’s argument, cited several subsequent Delaware cases that limited the holding in Gentile to its facts and applied it only where the challenged transaction resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder. The Court also observed that not only was Bain not yet the controlling stockholder before the share issuance, but that even if it was, its increase in voting power would not have been so great as to have triggered the Gentile rule. Furthermore, the Court pointed to the structure of the share issuance for the proposition that common stockholders’ shares will only be diluted if and when Bain converts its preferred shares into common stock. Ultimately, the Court found that Plaintiff’s claims could not be brought directly, and therefore dismissed Counts I-IV.
The Court next turned to the question of whether Plaintiff was excused from making demand on the Board on the basis of demand futility. In assessing Plaintiff’s futility allegation, the Court applied the test articulated in Aronson v. Lewis, under which a Plaintiff must “provide particularized factual allegations that raise a reasonable doubt that (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” Of the Board’s seven members, Plaintiff conceded that two were disinterested, while Defendants conceded that three were interested. The Court, therefore, was tasked with determining whether either of the two remaining directors, Doyle and Brent Turner, were conflicted. The Court found that the complaint raised a reasonable doubt as to whether Doyle could make decisions regarding the Transactions independently by alleging that SP engaged him in a consulting agreement that paid him more per month than he made as SP’s CEO. On that basis, the Court found that Plaintiff had properly alleged that making demand on the board was futile.
Once the Court determined that demand was excused, it addressed the merits of Plaintiff’s remaining claims (V-VIII). First, the Court turned to Count VI, which argued in the alternative that Bain and HIG had breached fiduciary duties by acting as a “control group.” The Court dispatched Plaintiff’s argument quickly by pointing out that there was never any allegation that Bain owned any stock, let alone a controlling percentage of stock, prior to the Transactions. Ultimately, the Court dismissed Count VI for failing to state a claim.
The Court then examined Count VII, in which Plaintiff alleged that HIG breached its fiduciary duty by issuing the new shares to Bain. The Court determined that entire fairness was the proper standard of review, observing that that standard is triggered when a controlling stockholder effectuates a conflicted transaction. The Court determined that HIG was conflicted in entering into the issuance of new shares to Bain because that transaction was a condition precedent to HIG’s sale of its own shares to Bain. Entire fairness is an onerous standard for a defendant to overcome, requiring the controlling stockholder to “show, conclusively, that the challenged transaction was entirely fair based solely on the allegations of the complaint and the documents integral to it.” Because Defendants failed to show entire fairness, the Court denied Defendants’ motion to dismiss Count VII.
Count VIII alleged that Bain aided and abetted HIG’s breach of fiduciary duty. The Court found that Plaintiff’s allegations that Bain was aware of its shared legal representation with HIG, as well as the interrelated nature of the three transactions, and the lack of a stockholder vote, inferred Bain’s “knowing participation” in HIG’s breach. The Court, therefore, denied Defendants’ motion to dismiss as to Count VIII.
Lastly, due to the inclusion of an exculpatory provision in SP’s certificate of incorporation, the Court dismissed Plaintiff’s Count V for failing to allege that Doyle acted in bad faith or had personal interest in the transactions.
In In re Tangoe, Inc. Stockholders Litigation, C.A. No. 2017-0650-JRS (Del. Ch. Nov. 20, 2018), the Delaware Court of Chancery denied the director defendants’ motion to dismiss the stockholder plaintiffs’ claim for breach of fiduciary duties on the basis that the stockholder vote approving the transaction was not informed and the defendants were therefore not entitled to business judgment rule deference at the pleading stage. The Court also found that the plaintiffs had adequately pled a breach of the fiduciary duty of loyalty against each of the director defendants, which would not be covered by the exculpatory clause in the company’s certificate of incorporation.Read More
In Tilden v. Cunningham et. al., C.A. No. 2017-0837-JRS (Del. Ch. Oct. 26, 2018), the Delaware Court of Chancery granted the motion of directors of Delaware corporation Blucora, Inc. (“Blucora”) named as Defendants to dismiss a derivative action and dismissed Plaintiff’s complaint with prejudice, holding that the Plaintiff, a Blucora stockholder, failed to plead demand futility and failed to state viable claims under Rule 12(b)(6). This derivative action stems from three transactions Blucora entered into between 2013 and 2015: 1) an acquisition of Monoprice, Inc. (“Monoprice”), 2) the acquisition of HD Vest (“HD Vest”), and 3) several stock repurchases.
CSH Theatres, LLC v. Nederlander of San Francisco Associates, CA No. 9830-VCMR (Del. Ch. July 31, 2018) concerns the dramatic break-up of a prominent theater company partnership in San Francisco involving claims and counterclaims alleging violations of contractual and fiduciary duties and charges of self-dealing and bad faith conduct. The Delaware Court of Chancery found that no enforceable contract to renew the lease to San Francisco’s Curran Theater existed but the Court did grant the theater operator a declaratory judgment that the principals of the owner had breached their common law fiduciary duties while they were also serving as managers of the theater operator.
In Sciabacucchi v. Liberty Broadband Corp., et al., C.A. No. 11418-VCG (Del. Ch. July 26, 2018), the Delaware Court of Chancery denied in part a motion to dismiss brought by defendants Liberty Broadband Corporation (“Liberty”), Liberty’s largest stockholder, and the board of directors of Charter Communications, Inc. (“Charter,” and collectively “Defendants”), for failure to plead demand futility. The Court ruled that the Plaintiff, a stockholder of Charter, pleaded sufficient facts to support a reasonable inference that the influence of Liberty’s largest stockholder would prevent the Charter board of directors from exercising independent and disinterested business judgment when considering a demand to bring a lawsuit on behalf of the corporation.
In Feldman v. Soon-Shiong, et al. (C.A No. 2017-0487-AGB), the Delaware Court of Chancery denied in part and granted in part a motion to dismiss claims involving, among other things, breach of contract and breach of the fiduciary duty of loyalty, following a defendant’s withdrawal of $47 million from a company bank account.
In Ravenswood Investment Company v. Winmill & Co. (C.A. No. 3730-VCS and 7048-VCS (Del Ch. March 21, 2018)), plaintiff Ravenswood Investment Company (“Ravenswood”), a stockholder of Winmill & Co. (the “Company”), brought a derivative suit against the directors of the Company, Bassett, Thomas and Mark Winmill (“Defendants”) alleging that Defendants breached their fiduciary duties in two respects. First, they granted overly generous stock options to themselves (as Company officers). Second, they caused the Company to forgo audits of the Company’s financials and to stop disseminating information to the Company’s stockholders in retaliation for Ravenswood’s assertion of inspection rights. Following a trial, the Delaware Chancery Court entered judgment for Ravenswood as to the first theory and for Defendants as to the second. After finding that there was insufficient evidence to support cancellation, rescission, rescissory damages or some other form of damages, the Court awarded nominal damages to the Company of $1 per Defendant.
In Ravenswood, the Company provided investment management services and its shares were traded on NASDAQ until it was delisted in 2004, and then over-the-counter on the Pink Sheets. During all relevant time periods, Defendants comprised the entirety of the board of directors of the Company. They were also founders, stockholders, and officers of the Company. When the Company’s 1995 stock option plan expired in 2005, Defendants, in their capacity as directors, adopted a new performance equity plan (the “PEP”). Each Defendant, in his capacity as an officer of the Company, received options to purchase 100,000 shares of stock at $2.948 per share under the PEP. At the time, approximately 1.5 million shares were outstanding and the Company’s stock traded at $2.68 per share. The Defendants chose not to hire a compensation consultant, instead relying on their own ad-hoc analysis of comparable companies, many of which were much larger than the Company.
Approximately 18 months later, each of the Defendants exercised options to purchase 66,666 shares. Each Defendant paid $1,532.39 in cash and gave a $195,000 promissory note to the Company for the remainder of the purchase price. Following the exercise, each of the Defendants paid interest on the notes, but a little over a year later, in April 2008, in their capacity as board members, they forgave Thomas’ note entirely and forgave Mark’s note in three tranches over three years. Although Bassett’s note was not forgiven, later he became unable to pay the note when due and entered into a replacement note with a longer maturity. Years later, following his death, his estate finally paid off the note.
In addition, following the Company’s delisting, it continued to prepare audited financial statements until 2011, when, for cost reasons, the Defendants decided not to engage in further audits and ceased distributing financial information to stockholders.
Plaintiffs brought suit on a number of theories, which by the time of the trial, had been reduced to two theories for violation of the Defendants’ fiduciary duty of loyalty: first, that the stock options were improperly authorized and granted, and second, that the Defendants’ decision to cease distributing financial information was an improper decision in retaliation against Plaintiff, who had previously brought an action against Defendants.
After a two-day trial, the Court entered judgment for the Plaintiff on the first theory and for Defendants on the second. As to the first claim, the Court first held that the entire fairness standard applied to the PEP adoption and stock option grants as “[d]irectors who stand on both sides of a transaction have the burden of establishing its entire fairness.” The Court explained that entire fairness requires a showing that directors acted with utmost good faith and the most scrupulous inherent fairness of the bargain. This requires a showing of both fair dealing and fair price.
In analyzing fair dealing, the Court described the Defendants’ process as “neither well-documented nor well-substantiated” and in fact stated that “the term ‘process’ does not really fit here; the evidence reveals that there really was no process.” There were no contemporaneous records and no indication that the board sought the advice of any outside advisor or consulted any literature or other sources. Defendants’ only decision-making tool appeared to be comparing the PEP and proposed options to compensation plans of alleged peer companies, but the Court described this tool as “severely flawed” due to labelling companies as peers in a way that was “simply not credible” because nearly all of them were much larger than the Company. Thus the Court concluded that the stock option grants were not the result of fair dealing.
The Court next analyzed the fairness of the pricing of the options. The Court held that the initial price was fair, but the Company’s actions in forgiving notes resulted in a total payment for the options that was not fair. The Court explained that these decisions may have made perfect sense if this family business were really a family business where the Defendants were the only stakeholders, but in a public company setting these decisions resulted in an unfair price and thus a breach of the Defendants’ fiduciary duties.
The Court denied the Plaintiff’s second theory, explaining that Delaware law presumes that the directors of a Delaware corporation make business decisions on an informed basis and in the honest belief that their decision is in the corporation’s best interests. To overcome that presumption, plaintiffs must show that directors “appeared on both sides of the transaction or derived a personal benefit from a transaction in the sense of self-dealing.” The Court held that since Plaintiff had presented no evidence that the Directors ceased distributing financial information due to an improper motive rather than their claimed rationale of lowering costs and reducing the risk of disclosure-related litigation, Defendants were entitled to the protection of the business judgment rule and did not breach their fiduciary duty with respect to the second theory.
Finally, the Court discussed potential remedies. Plaintiff sough compensatory damages, but the Court held that it failed to present any evidence upon which the Court could award compensatory damages to the Company. Plaintiff also sought cancellation of the shares or rescission, but the Court explained that cancellation and rescission would not be appropriate without returning the parties to the status quo ante, which would require returning to Defendants what money they had paid for the shares. Since the Company lacked the funds to do so, these remedies were not appropriate. Finally, the Court held that Plaintiff had also failed to present evidence on which the Court could award rescissory damages. Thus, with no other measure of damages available, the Court awarded nominal damages to the Company in the amount of $1 per Defendant.
In In Re Tesla Motors, Inc. Stockholder Litigation, the Delaware Chancery Court denied Defendants’ motion to dismiss an action brought by plaintiffs (Tesla stockholders) against nominal Defendant Tesla Motors in connection with Tesla’s acquisition of SolarCity Corporation. Plaintiffs alleged that Tesla’s board of directors breached their fiduciary duties by approving the acquisition of SolarCity, which benefitted SolarCity stakeholders but negatively affected Tesla stockholders. SolarCity is a public Delaware corporation founded by Elon Musk and his cousins, Peter and Lyndon Rive. Musk and his cousins sit on the SolarCity Board. Lyndon was SolarCity’s CEO and Peter was its CTO.
In Cumming v. Edens, et al., C.A. No. 13007-VCS (Del. Ch. Feb. 20, 2018), the Court of Chancery denied a motion to dismiss a derivative suit for breach of fiduciary duties brought by a stockholder of New Senior Investment Group, Inc. (“New Senior”) against New Senior’s board of directors (the “Board”) and related parties in connection with New Senior’s $640 million acquisition of Holiday Acquisition Holdings LLC (“Holiday”). The Court made clear that compliance with Section 144 does not necessarily provide a safe harbor against claims for breach of fiduciary duty and invoke business judgment review of an interested transaction. Because the complaint alleged with specificity “that the Board acted out of self-interest or with allegiance to interest other than the stockholders,” the court applied the entire fairness standard of review and concluded that the transaction was not fair to New Senior stockholders. Read More
In Lavin v. West Corporation, C.A. No. 2017-0547-JRS (Del. Ch. December 29, 2017), the Court of Chancery held that stockholder plaintiff Mark Lavin (“Lavin”) had adequately demonstrated a credible basis from which the Court could infer that wrongdoing had occurred regarding the merger of West Corporation (the “Company”) and Apollo Global Management (“Apollo”) in support of Lavin’s Section 220 demand for inspection, and that a Corwin defense (that the transaction at issue was approved by a majority of disinterested and informed stockholders) is not a bar to an otherwise properly supported Section 220 demand for inspection.
In Ryan v. Armstrong, et al., C.A. No. 12717-VCG (Del. Ch. May 15, 2017), the Delaware Chancery Court dismissed the derivative action brought by a Plaintiff-shareholder (“Plaintiff”) against specified members of the board of directors (“Defendants”) of nominal defendant The Williams Companies (“Williams”). Plaintiff brought his claim against the Defendants without first demanding that the board pursue an action following Williams’ decision to allegedly undertake defensive measures against a takeover. The court granted Defendants’ motion to dismiss holding that Plaintiff failed to plead facts demonstrating that an exception to the demand requirement of Court of Chancery Rule 23.1 applied.