Posts tagged Derivative Claims

Court of Chancery Explains Options Cases

Weiss v. Swanson, C.A. No. 2828-VCL (Del Ch. March 7, 2008)

In the latest of the Chancery decisions on complaints challenging the grant of options, the Court has explained what it takes to state a derivative complaint that excuses demand on the Board. Briefly, the Court here focused on what was disclosed to the stockholders when they were asked to approve option plans or elect directors who had received option grants. First, full disclosure is required, particularly of practices that are likely to lead to increasing the value of the options, such as the bullet-dodging alleged in this case.

Second, the fact that a majority of the board received the options also made them interested enough to excuse demand.

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Court of Chancery Denies Standing For Lost Shares

Postorivo v. AG Paintball Holdings Inc., C.A. No. 2991-VCP (Del. Ch. February 29, 2008)

It has long been recognized that a stockholder may lose her standing to bring derivative litigation by losing her shares in a merger.  There is a recognized exception to this rule for mergers designed just to eliminate derivative litigation.

Here, the plaintiff  sold the assets of his company in return for cash and stock in the buyer. The stock was held in escrow and when a dispute arose, the buyer revoked the stock as compensation for its claims against the seller. When the seller brought a derivative suit, the court dismissed it as he no longer owned stock in the buyer. Thus, the court refused to make another exception to the rule that a derivative plaintiff must continue to be a stockholder through out the litigation.

  More ›

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Additional Complaints Filed Against Yahoo! in Delaware

Yesterday, February 27, 2008, two new complaints were filed against Yahoo! in the Court of Chancery. The first is a class and derivative action, Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust Fund v. Yahoo!, C.A. 3578. The second, Mercier v. Yahoo!, C.A. 3579, an additional class action to those previously filed.

The plaintiff in the second action, Vernon A. Mercier, was also the lead plaintiff in Mercier v. Inter-Tel (Delaware), Inc., 929 A.2d 786 (Del. Ch. 2007). In a decision in that action last August, Vice Chancellor Strine denied the plaintiff’s application for a preliminary injunction and found that directors fearing that stockholders are about to make an unwise decision that poses the threat that all stockholders will irrevocably lose a unique opportunity to receive a premium for their shares have a compelling justification for a short postponement in the merger voting process to allow more time for deliberation.  The decision is worth reviewing for its interesting discussion of the interplay between the Blasius and Unocal doctrines.    

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Court of Chancery Explains Requirements For SLC Report

Sutherland v. Sutherland, C.A. No. 2399-VCL (February 14, 2008).

This is another decision that explains what must be done to have the report of a special litigation committee ("SLC") respected by the court. To begin with, the use of a single board member for the SLC "pressed the theory of Zapata to the extreme". Thus, one-member SLCs are generally not a good idea.

In addition, the report of an SLC needs to include sufficient detail to support its conclusions. It is better practice to include documentation of the report's conclusions, such as the documents it relied on, the interviews it conducted and the advice it received. This is controversial for a good reason. If the court refuses to dismiss the derivative litigation despite the SLC recommendation, then the report may serve as a roadmap for the plaintiff going forward.  Thus, the decision on whether to use a SLC should be considered carefully. There are still excellent reasons for using a SLC, but it must be done correctly.

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District Court Applies Delaware Statute of Limitations Carve Out For Fiduciary Claims, Denies Summary Judgment

Norman v. Elkin, 2007 WL 2822798 (D.Del. Sept. 26, 2007)

In this action the District Court evaluated the application of the statute of limitations to claims that a corporate fiduciary engaged in self-dealing at the corporation’s expense. Plaintiff was a 25% shareholder in a closely-held Delaware corporation with Pennsylvania headquarters, formed to participate in the wireless communications industry. Defendant #1 owned the remaining shares of the corporation, and also served as its President and sole director. Plaintiff alleged that Defendant #1 breached his duties to the corporation when he personally obtained newly-issued communications licenses from the FCC, then sold them along with the corporation’s pre-existing licenses to a third party, keeping the proceeds of the sale himself. Plaintiff further alleged that Defendant #1 took the action without notifying Plaintiff in his capacity as a shareholder, without holding an annual meeting, and without making any disclosure of the sale. Plaintiff sued Defendant #1, along with his wholly owned corporation and another corporate officer, in the Delaware Court of Chancery for breach of contract, unjust enrichment, declaratory relief, and breach of various fiduciary duties. Defendants removed the action to District Court based on diverse citizenship and moved for summary judgment, arguing that all claims were time-barred. More ›

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Court of Chancery Permits Option Backdating Case To Proceed

Conrad v. Blank, C.A. No. 2611-VCL (September 7, 2007).

In the latest of the Delaware option cases, the Court of Chancery permits the action to go forward when it appears that the Board considered the option backdating and did nothing about it. It is noteworthy from its decision that this apparent indifference to a wrong served to distinguish this case from others where the backdating appeared to be a simple mistake.  In the case of a simple mistake, the error would not be enough to expose the board to liability and that would excuse demand before the derivative suit was filed.

The Court also declined to apply the "continuing wrong" theory. Under that theory, a plaintiff who acquires her stock during the series of wrongful acts has the right to challenge all the actions including even those that occurred before she acquired her stock. Instead, here the court held that each backdated option was a separate wrong and the plaintiff could only sue for those that had occurred  after she bought her stock.

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Court of Chancery Limits Dilution Claims

Feldman v. Cutaia, C.A. No. 1656-VCL (August 1, 2007), affrimed, Del Supr. (May 30, 2008).

Classifying a claim as derivative has big consequences. Among those is that the claim is then subject to the continuous ownership rule that requires the plaintiff to hold his shares throughout the litigation to maintain his standing. A merger that eliminates the plaintiff's ownership thus also eliminates his ability to proceed with a derivative suit.

In an effort to avoid this problem, plaintiffs that bring dilution claims asserting their interests have been wrongfully diminished need to fit into an exception to the general rule that dilution claims are derivative. This decision illustrates the limits on such claims. Basically, a dilution claim is derivative unless the claim is that a controlling stockholder has wrongly diluted the interests of the minority stockholders. For this purpose, "control" means having a greater than 50% interest or active domination of a board. Moreover, it is not possible to aggregate the stock holdings of a group of stockholders to get over the 50% threshold.

This opinion also discusses the exceptions to the general rule that a merger deprives a stockholder of standing, such as when the merger itself is an attempt to fraudulently end the derivative suit. It also notes that aiding and abetting claims based on derivative claims are themselves also derivative and subject to the same standing rules.

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Court of Chancery Expands Right To Bring Direct Claims

Rhodes v. Silkroad Equity LLC, C.A. No. 2133-VCN (July 7, 2007).

The line between what is a direct claim and a derivative claim is frequently critical. Derivative claims can only be brought by stockholders and have other procedural hurdles to jump to survive a motion to dismiss. In this decision, the Court permitted what appeared to be a derivative claim to go forward as a direct claim by a former stockholder. Thus, the Court has expanded the type of claim that may be brought as a direct claim. While the facts of this case may seem unusual, the claims made in this case have come up before and now will certainly take on new life.

Briefly, the plaintiff alleged that the majority stockholder had run down the business of the company to force out the plaintiffs as minority owners at a reduced price under a stockholders' agreement. The damage to the company from their actions would seem to be a classic derivative claim for it was the company that suffered the injury and to whom damages would seem to flow for such a claim. However, the Court held that this conduct also would support a direct claim because the conduct in effect permitted the majority to increase its interest in the company while diluting the interest of the minority stockholders. In that sense, the claim of the minority interest was also a direct claim suffered by them alone.

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Court of Chancery Broadens Discovery of Single Member Special Committee

Sutherland v. Sutherland, C.A. No. 2399-VCL (July 2, 2007).

On several occasions, the Delaware courts have questioned why only a single member is appointed to a special committee. However, the practice continues.This decision illustrates the price to be paid by such a bad practice.

Normally, Zapata Corp. v. Maldonado, 430 A2d 779 (Del. 1981) limits discovery of a special committee to materials that reflect on the independence and diligence of the committee. Discovery into the merits of the committee's conclusions is limited. The theory behind this limitation is that to permit broad discovery into the allegations that lead to the committee's creation would effectively undermine the reasons the committee was appointed in the first place.

This decision permitted much broader discovery into the merits of the one person committee's conclusions because of the special circumstances involved in this battle between family members and the limited disclosures given about the reasons for selecting the single member of the committee. The rationale behind the decision still applies to increase discovery of other single member special committees.

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District Court Declines to Exercise Supplemental Jurisdiction Over Fiduciary Duty Claims, Grants Motion to Dismiss

Lemon Bay Partners LLP v. Hammonds, C.A. No. 05-327 (D.Del. June 26, 2007)

 

In this shareholder derivative action for breach of fiduciary duties against various corporate defendants, the Court held that the state law claims asserted so predominated the lone federal claim that exercise of supplemental jurisdiction was inappropriate. Plaintiffs, former shareholders of MBNA Corporation, asserted various claims against the defendants based on breach of fiduciary duties in connection with earnings reports and the merger of MBNA with Bank of America. Defendants moved to dismiss based on lack of subject matter jurisdiction, arguing that the Plaintiffs’ sole claim that rested on federal jurisdiction was so predominated by the state law claims as to make the exercise of the Court’s supplemental jurisdiction inappropriate. The Court concurred with the defendants, concluding that Plaintiffs’ federal law claim bore only a tangential relationship to the rest of the claims. The Court therefore granted Defendants’ motion to dismiss for lack of subject matter jurisdiction.  More ›

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Supreme Court Explains Its Rossette Decision

Gatz v. Ponsoldt, C.A. No. 298 (Del. Supr., April 16, 2007).

The dividing line between what is a derivative suit and what claims may be filed directly on behalf of stockholders is undergoing a rapid development in Delaware. This decision is the latest in that recent line of decisions.

This decision makes it clear that under the recent Rossette decision, claims for dilution may be filed by a class of stockholders whose interest in the entity have been diluted by the issuance of stock to "a significant or controlling stockholder'" in a dilutive transaction.  Before Rossette, it was generally thought those claims belonged to the entity that did not get fair consideration for its stock and thus, were derivative claims only. More ›

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District Court Applies SEC Rules Amendments to Transaction, Grants Summary Judgment

Levy v. Sterling Holding Co., LLC, 2007 WL 582555 (D.Del. Feb. 13, 2007).

In this shareholder derivative action, the plaintiff shareholder sued two defendants, both of whom occupied board positions with the corporation, for allegedly purchasing stock in the corporation and then selling it at a profit within six months, in violation of Section 16(b) of the Securities and Exchange Act of 1934. After each side filed cross-motions for summary judgment, the SEC adopted Amendments to SEC Rules 16b-3 and 16b-7, which exempt certain transactions from the prohibitions of Section 16(b). Defendants argued that the transaction that formed the basis of Plaintiff’s complaint, whereby Defendant’s preferred stock in the corporation was “automatically” converted to common stock upon completion of an IPO, was an exempt “reclassification” transaction under the SEC Rules. Conversely, Plaintiff argued that the exemption did not apply. The Court found that the SEC had acted within its power in exempting reclassification transactions from Section 16(b), and that as a result of that exemption, Defendants were entitled to judgment as a matter of law.  More ›

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District Court Grants Motion for Judgment on the Pleadings

Magten Asset Mgmt. Corp. v. Paul Hastings Janofsky & Walker LLP, No. 04-1256-JJF (D.Del. Jan. 12, 2007)

In this opinion, the District Court of Delaware found that both Montana’s substantive fraudulent transfer law and Plaintiff’s inability to establish standing warranted granting Defendant’s motion for judgment on the pleadings. Plaintiff, a creditor of a Montana limited liability company by virtue of an indenture agreement, sued Defendant, alleging that Defendant assisted the LLC in transferring assets to its parent corporation in order to defraud the LLC’s creditors. Defendant moved for judgment on the pleadings, arguing that as a non-transferee of the assets, it could not be held liable for any alleged fraudulent transfer under Montana’s fraudulent transfer act, and that as a creditor of the LLC, Plaintiff did not have standing to bring its derivative claims against Defendant on behalf of the LLC. The court agreed with Defendant, and granted the motion for judgment on the pleadings. More ›

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Court of Chancery Approves Awards Large Fees!

A few recent articles have questioned the willingness of the Court of Chancery to award adequate fees in class and derivative litigation. These articles focus on one or two instances where fee requests were not met with full approval. This anecdotal approach is misleading. After all, it would be a sign of a failing system if every fee request were given blanket approval regardless of its merits.

Two more recent decisions by the Court of Chancery show it is fully responsive to appropriate fee requests and is willing to award large fees when appropriate. In the McKesson/HBOC litigation, Chancellor Chandler  awarded the plaintiff's attorneys $10 Million for their years of hard work on behalf of McKesson in a derivative suit. More recently, Vice Chancellor Strine in the Hollinger case awarded plaintiff's counsel $2,500,000 in fees for his work in a case where the actual litigation work was fairly brief, but the results were outstanding.

Both of these cases were what are known as Caremark cases alleging that the Board had failed to perform its oversight duty to avoid accounting and other problems. That type of case is fairly characterized as among the most difficult to prove, given the high standard to establish liability.  Thus, when the plaintiffs won a good settlement, their attorneys were rewarded, fairly and even generously.

In short, bring a good case, fight hard, achieve a decent result and the Court of Chancery will reward your effort. That is all we should expect.

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Court of Chancery Explains When Directors Are Interested In The Deal

In Re Primedia Inc. Derivative Litigation, C.A. No. 1808-N (Del. Ch. November 15, 2006).

This case dealt with when directors would be considered interested in a deal so as to preclude the application of the business judgment rule and permit the suit to proceed.  Many of the directors were affiliated with the controlling stockholder who had purchased the corporation's preferred stock at a deep discount just before the board voted to redeem that stock at its face value. That decision was justified, it was argued, because the coupon rate on the stock was higher than market rate. The Court held that might well be so, but at the pleading stage it was too soon to accept that as a justification for the purchase that gave the controlling stockholder a big gain. The decision is particularly interesting for its discussion of when directors are considered sufficiently connected to a controlling stockholder so as to preclude application of the business judgment rule. More ›

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