The Ravenswood Investment Company, L.P. v. Winmill, C.A. No. 3730-VCN (Del. Ch. May 31, 2011).

Brief Overview

This case involved a plaintiff who is a significant stockholder in a holding company managed by the individual defendants, a father and his two sons.  The complaint alleges breaches of fiduciary duty regarding the adoption of a stock buyback plan, the adoption of an options plan, the issuance of options to themselves, and the decision by the company to vote in favor of a transaction involving the sale of the interest of a subsidiary in a third entity.  This memorandum opinion grants in part and denies in part a motion to dismiss.  The Court only denied a motion to dismiss to the extent that the Court allowed a claim to proceed regarding the vote of the defendants in favor of the sale of an interest in an affiliated third entity that was alleged to be both self-interested and unfair to the company.

Brief Overview of Legal Analysis

First, the Court reviewed the familiar standard for a motion to dismiss under Court of Chancery Rule 23.1 based on the two-pronged test of Lewis v. Aronson to determine whether presuit demand was excused.  See 473 A.2d 805, 814 (Del. 1984).  The Court also discussed the separate analysis under Rule 12(b)(6) for a motion to dismiss for failure to state a claim. 

(1) Adoption of Stock Option Plan

The Court observed the well-known deference that applies to compensation decisions by a company for its executives but also recognized the exception where the individuals comprising the board and the management of the company are the same as those receiving the compensation. In those instances, the board bears the burden of proving that the salary and bonuses they pay themselves are entirely fair unless the board employs an independent compensation committee or submits the compensation plan to shareholders for approval.  See footnote 44.  Neither safeguard was employed here, and therefore, the defendants had the burden of demonstrating that the stock option plan was entirely fair to the company and its shareholders, although the plaintiff bears the burden of alleging facts that suggest the absence of fairness.  See footnote 45.

The plaintiff here alleged that defendants adopted the stock option plan with the intention to acquire a larger percentage of the shares of the company in order to dilute the public shareholders’ equity.  Of course, the Court cited to other decisions holding that an options plan is not necessarily unfair simply because it has a dilutive effect on shareholders’ equity.  Moreover, the motion to dismiss in this case did not seek dismissal of the claims regarding the issuance of the options, and therefore, the Court did not need to address the dilution claim.  However, a problem for the plaintiff in this case was that it did not allege facts suggesting unfairness in adopting the options plan because even if all the options were exercised the defendants would not obtain a majority, and therefore, the Court dismissed the claims challenging the adoption of the plan–as opposed to the issuance of the options.

(2) Claims Regarding the Adoption and execution of a Stock Buyback Plan

The Court regarding these claims as derivative  in nature, and interpreted the claims as challenging the buyback plan in terms of either: (i) diminishing the value of the company, or (ii) reducing the proportional ownership of the public shareholders.  However, the Court found that the plaintiff did not allege with sufficient particularity facts indicating that the defendants were interested parties to the stock buyback plan or that the decision to engage in the buyback program was not the product of a valid business judgment.  In sum, the Court could not discern any “particularized allegation that would excuse Ravenswood from making demand with regard to this plan.”

(3) Sale by Company of its Interest Affiliate

The plaintiff challenged the approval by the company, as a 22% shareholder in an affiliate, of the sale of the affiliate’s 50% interest in a company called York and the acceptance by two directors of the company of separate compensation in connection with that sale.  The allegation is that the acceptance of that compensation tainted the decision of the company to vote its shares in favor of selling the interest that the company owned in the affiliate.  The Court discussed whether those claims were direct or derivative and whether the derivative claims survived the motion to dismiss under Rule 23.1. 

Because two of the three directors involved had a “material, disqualifying self interest” when they voted the shares of the company in favor of the sale of York, the claims did survive a motion to dismiss under Rule 23.1.  Likewise, the claims survived a motion to dismiss under Rule 12(b)6 because the allegations in the complaint were that the compensation was wrongfully paid to the directors in connection with the transaction which resulted in a benefit to the company from the transaction being smaller than it should have been.

This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

On May 31, 2011, in In Re: Massey Energy Company Derivative and Class Action Litigation, C.A. No. 5430-VCS, Vice Chancellor Strine, in an 81-page opinion, denied the plaintiffs’ request for a preliminary injunction against a merger between Massey Energy Company and Alpha Natural Resources, Inc.  The Merger had been unanimously approved by the Massey Board on January 27, 2011 and the stockholders were scheduled to vote on the Merger on June 1, 2011.

The plaintiff stockholders of Massey alleged that the Massey Board breached their fiduciary duties by not negotiating to have the pending “Derivative Claims” transferred into a litigation trust for the exclusive benefit of Massey stockholders.  The Derivative Claims were the result of an April 5, 2010 explosion which occurred at Massey’s Upper Big Branch mine in West Virginia and as a result, 29 miners died. In addition to the subsequent lawsuits and regulatory proceedings brought by families of the lost and injured miners and regulators seeking a reason as to what caused the disaster, stockholders of Massey filed derivative suits, seeking to ensure that “to the extent that Massey itself was harmed by the legal obligation to pay fines, judgments to the lost miners’ families, and by the lost cash flows from the destroyed mine, the corporate directors and officers who managed the firm were held responsible for what the plaintiffs argued was a failure to make a good faith effort to make sure that Massey complied with mine safety regulations.”

The plaintiffs argued that the Merger was unfair because it would result in Alpha being able to acquire Massey without paying fair value for the economic value of the Derivative Claims. In addition, plaintiffs alleged that the Massey Board never attempted to value the Derivative Claims but proceeded on the assumption that the Derivative Claims would survive the Merger.  The Court noted that:

[a]s a matter of black letter law — see Lewis v. Anderson — the Derivative Claims will pass to Alpha in the Merger unless the Merger itself is merely a fraudulent attempt to deprive the Massey stockholders of their derivative standing, or the Merger is a mere reorganization that otherwise does not affect the Massey stockholders’ relative ownership in the resulting corporate enterprise.  The Merger with Alpha was not a mere reorganization, and given the record here, it appears highly doubtful that the plaintiffs will be able to show that Massey’s directors and officers sought to sell the company to Alpha solely in order to extinguish their potential liability for the pending Derivative Claims… [or] that the Merger was inspired solely, or even in any material way, by a desire of the Massey directors to extinguish the Derivative Claims or to insulate themselves from liability.

The Court noted that “the Massey Board’s failure to address the value of the Derivative Claims is regrettable in view of the economic impact the Upper Big Branch Disaster had on Massey.”  While the Court found that the Derivative Claims likely stated a claim for director oversight liability under Caremark, the record did not support the inference that the Derivative Claims were material in comparison to the overall value of Massey as an entity and that the record did not persuade the Court that the Merger would likely be found to be economically unfair to the Massey stockholders.  Moreover, the Court found that the plaintiffs had failed to show that they faced irreparable injury by essentially admitting that a later award of monetary damages could make Massey and its current stockholders whole.

In rejecting the plaintiffs’ arguments and concluding that the record did not support the issuance of a preliminary injunction, the Court stated:

The question is whether there is a sound basis to enjoin the Massey stockholders from deciding for themselves whether to exchange their status as Massey stockholders for a chance to receive substantial value from a third party in an arms-length Merger. The record will not bear the inference that any bidder prepared to pay more has been prevented from doing so. The Massey Board seems to have exerted reasonable efforts to get the highest price it could from Alpha. If Massey stockholders believe that the company can do better by remaining independent, they have the uncoerced, informed chance to make that decision for themselves. If they choose to remain independent, the Massey stockholders will have the chance to enjoy the fruits of any derivative recovery secured on the company’s behalf.

Given that reality, it would threaten more harm than good for me to usurp the ability of Massey stockholders to decide this economic question themselves. That is especially the case when it is possible to craft a monetary remedy in the event that it were found, on a full record, that the Merger was tainted by non-exculpated breaches of fiduciary duty. Likewise, if the plaintiffs are correct about their view of the facts and the law, then they will be able to continue to prosecute the Derivative Claims even after the Merger under their reading of Lewis v. Anderson and a recent Supreme Court case, Arkansas Teacher Retirement System v. Caiafa, they believe modifies Lewis v. Anderson in their favor. Because of these factors, the plaintiffs have not proven that the Merger’s consummation presents them with a threat of irreparable injury.

Supplement: Kevin LaCroix, on his blog called The D & O Diary, provides a characteristically insightful analysis of the opinion here, including references to the realities of D & O coverage and overviews of a footnote that he counts as being over 1,000 words.

Whittington v. Dragon Gp., C.A. No. 2291-VCP (Del. Ch. April 15, 2011), read opinion here. Five prior Chancery decisions (and one Supreme Court opinion), in this long-running internecine saga were highlighted on these pages here, here, here, here, here and here. In this latest opinion, the Court of Chancery examined the doctrines of claim preclusion, issue preclusion and judicial estoppel.   

Procedural Setting

This suit stems from a dispute over one member’s ownership interest in Dragon Group, L.L.C., a family-run business.  The plaintiff, Frank C. Whittington, II, (“Frank”), filed a complaint to compel his four siblings (the defendants) to recognize his membership interest in Dragon Group.  Additionally, Frank asked the court to determine his overall percentage of ownership in the company, conduct an accounting of the company, and determine his appropriate share of past distributions and profits with interest.

The defendants, who have been challenging Frank’s membership in Dragon Group for years, argue that the Agreement in Principle (“AIP”), the document that governs the membership interests, requires Frank to provide further documentation or performance to become a member.  However, Frank contends that these challenges are barred by the doctrines of claim preclusion and issue preclusion because prior litigation between the parties has already determined that the AIP is an “enforceable and freestanding agreement and contract” and that it needs no further documentation or performance by Frank to cement his membership.

Claim Preclusion

The Opinion addresses claim preclusion first by setting out the elements as follows:

(1) the original court had jurisdiction over the subject matter and the parties; (2) the parties to the original action were the same as those parties, or in privity, in the case at bar; (3) the original cause of action or the issue[] decided was the same as the case at bar; (4) the issues in the prior action must have been decided adversely to [the party opposing preclusion] in the case at bar; and (5) the decree in the prior action was a final decree.

The doctrine of claim preclusion not only applies to claims which were raised and decided in earlier litigation, “but also to claims that could have been raised and decided.”

Issue Preclusion

Issue preclusion “prevents a party from relitigating matters of fact that ‘were, or necessarily must have been, determined’ in a prior decision.” The elements of issue preclusion are:

(1) the same issue is presented in both actions; (2) the issue was litigated and decided in the first action; and (3) the determination was essential to the prior judgment.

The court found that all five elements of claim preclusion along with all three elements of issue preclusion were fulfilled in this matter.  Claim preclusion barred any argument that the AIP required further documentation or performance for Frank to become a member of Dragon Group,” and because the court already decided that Frank was a member of Dragon Group in prior litigation, that holding precludes the defendants from arguing that Frank is not a member.

The Doctrine of Judicial Estoppel

Frank claims, in addition to claim and issue preclusion, that his siblings are judicially estopped from denying his claim of 23.65% interest in Dragon Group.  Frank argues that his siblings’ representations in the earlier litigation suggesting that Frank’s membership interest was 23.65%, should estop them from contending otherwise in the present litigation.

Citing Capaldi v. Richards, the court found that “[U]nder the doctrine of judicial estoppel, a party may be precluded from asserting in a legal proceeding a position inconsistent with a position previously taken by him in the same or in an earlier legal proceeding.”  The doctrine of judicial estoppel exists to “protect the integrity of the judicial process by prohibiting parties from deliberately changing positions according to the exigencies of the moment.”  The Court looks to several factors in determining whether the doctrine of judicial estoppel applies:

First, a party’s later position must be clearly inconsistent with its earlier position.  Second, courts regularly inquire whether the party has succeeded in persuading a court to accept that party’s earlier position, so that acceptance of an inconsistent position in a later proceeding would create the perception that either the first or second court was misled….A third consideration is whether the party seeking to assert an inconsistent position would derive an unfair advantage or impose an unfair detriment if not estopped.

Additionally, “the contradictory statement must have been accepted by the court in the earlier action and relied upon by it in reaching its decision.”

The court found that the prior litigation did not result in a determination as to Frank’s ownership percentage in Dragon Group.  Thus, the court concluded that judicial estoppel did not bar the defendants from challenging the amount of Frank’s membership interest.  Following a trial on the merits, the court determined Frank’s membership percentage to be 18.81%.

Prejudgment Interest

In addition to the determination of membership and interest in Dragon Group, Frank sought prejudgment interest on any amounts due to him. 

Current Delaware law holds that “a successful plaintiff may be awarded prejudgment interest as a matter of right,” but that this is not a self-executing procedure.  The court explained that in order to get prejudgment interest, “the plaintiff must ask for it by way of at least a general allegation of damages in an amount sufficient to cover actual damages plus interest.” It is within the court’s discretion to award either compound or simple interest.

The court found that Frank was entitled to prejudgment interest compounded monthly at the legal rate that applied as of the first day of each month.

Graulich v. Dell, Inc., 2011 WL 1843813 (Del. Ch. May 16, 2011).

What this case is about:

This Court of Chancery opinion involved a demand by a shareholder for books and records of Dell, Inc. for the ostensible purpose of enabling him to investigate possible mismanagement. Further summary and commentary follows, but first a word from our sponsor.

[Editor’s note: Regular readers are undoubtedly aware that in addition to the recently installed new graphics that gave this homepage its first facelift in the six years of its existence, the last few weeks may have witnessed the fewest number of case summaries in the six-plus years of this blog’s existence. The diminution in output is due to my concurrent affiliation with a new firm and the concomitant extra time devoted to that exercise in addition to the demands of paying clients. I plan to catch up imminently and I am grateful for the patience of my many (free) subscribers. Civil and constructive comments on the new graphics are welcomed.]

The Corporate Statute that this Chancery Opinion is Based on:

Section 220 of the Delaware General Corporation Law (DGCL) allows a stockholder to demand certain books and records under circumscribed circumstances if various prerequisites are satisfied. For example, in order to prevail on a Section 220 demand, a stockholder must demonstrate: (i) that she is actually a stockholder of the corporation during the relevant periods involved; (ii) certain format and content requirements of the demand have been met; and (iii) the stockholder has a “proper purpose” reasonably related to her interest as a stockholder. Moreover, the courts have superimposed the requirement of a “credible basis” for alleged wrongdoing onto DGCL Section 220 in order for one to support the stated purpose of investigating even potential wrongdoing.

Factual Background of Decision

The stockholder in this case sought books and records in order to allow him investigate possible mismanagement and thereafter to pursue derivative claims based on Dell’s sale of OptiPlex computer systems sold from 2003 to 2005. The allegation was that certain parts related to those systems required Dell to incur costs for replacement and servicing, and that the problems had a negative impact on its brand name. In addition, the allegation was that the board of Dell failed to monitor or otherwise address the situation appropriately.

Highlights of Court’s Decision

The Court rejected the demand for books and records in a thoroughly reasoned opinion that was based on three fundamental points:

(i) The claims were barred by a settlement agreement and release in a prior class action styled as In Re Dell, Inc., Derivative Litigation,

(ii) The applicable statute of limitations on any such claim (that could be brought in a later derivative action) had already run.

(iii) The stockholder did not satisfy the “proper purpose” requirement of Section 220 because the only purpose stated was to pursue a derivative suit with the data requested, and the stockholder would not be able to bring a derivative suit because he was not a stockholder during the time period in which the matters complained of were alleged to have taken place. Plus, even if that hurdle were to have been overcome, the Court cast doubt on the ability to satisfy the substantive challenge of prevailing on a Caremark claim based on the facts presented.

Short Commentary

We have written frequently on these pages about Section 220 decisions and their nuances.  See, e.g., compilation of Section 220 cases and commentary highlighted on this blog here. This most recent Chancery decision is another example of how difficult Section 220 demands for books and records can be. (Although this case may not be the best example because it seems to have been based on a comparatively weak Section 220 argument.) Many decisions from Delaware’s Supreme Court and Court of Chancery exhort practitioners to use what the courts refer to as the “tools at hand” (i.e., Section 220), to obtain detailed information from a company before filing a derivative action. However, this case demonstrates that not all efforts to obtain books and records pursuant to Section 220 prevail–despite the apparent simple provisions of the statute. And there are ample examples of a stockholder pursuing his case all the way to the Delaware Supreme Court only to be told by the court after the time and expense of that appeal, that the stockholder is not entitled to books and records based on the particular facts presented.

One “take-away” message based on the decisions summarized on this blog over the past six years, is that it is not cheap, simple or fast to pursue a Section 220 demand, especially if a company is committed to making the shareholder spend as much time and money as possible, and if the company intends to make it as difficult as possible for the stockholder to obtain any data. Admittedly, the stockholder in this case had at least 3 strikes against him before those considerations came into play.

But even in those cases where a stockholder prevails in his Section 220 demand after trial, the company may further frustrate the intent of Section 220 by playing a game of “hide the ball” and the stockholder can spend substantial money and time trying to force the company to produce all the data to which the stockholder is entitled –even after a ruling in favor of the stockholder.

Still more time and money needs to be spent if the stockholder seeks electronic data. The statistics in the business world today indicate that most data produced today is produced electronically–but  is never printed in hard paper format.

So, if a company only produces hard copies of the data requested, and refuses to produce electronic data, the stockholder is faced with spending more money to fight that issue because I am here to tell all readers that, (as hard as it may be to believe), there is no authoritative Delaware court opinion that squarely addresses the issue of whether electronic data must be produced under Section 220–even when a court has ruled that a stockholder is entitled to “books and records” under Section 220. I am co-authoring an article on that very issue that we hope to publish in the near future.

Case Financial, Inc. v. Alden, C.A. No. 1184-VCP (Del. Ch. May 11, 2011). The Delaware Court of Chancery has rendered several prior decisions in this somewhat obstreperous litigation, two of which have been highlighted on this blog here and here. See also 2009 WL 2581873 (Del. Ch. Aug. 21, 2009).

The central issue in this case was whether the claims alleged by the plaintiff were barred by a prior release signed by the parties.

This 67-page decision can be highlighted in short order. The claims brought in this matter were lodged against the former CEO of Case Financial, Inc., Eric Alden, who was retained by the new owners in a management role until he was forced out after issues arose about his handling of the company’s money. Case Financial is in the business of lending money to lawyers for the financing of contingency cases. The prior release signed between the parties in connection with a prior settlement, carved out an exception for criminal conduct–claims which Case Financial thought would not be covered by the release.

This post-trial opinion addressed whether the allegations of embezzlement and related criminal allegations  brought by the corporation were the types of criminal actions that were exceptions to the claims covered by the release. California law applied to most of the criminal allegations. The Court explains in detail why it concluded that none of the allegations of criminal conduct against the former CEO fit within the limited definition of “criminal behavior” as an exception to the release, and therefore, the court dismissed the claims with prejudice.

Moral of This Story

If one seeks to carve out an exception to a release for claims that one seeks to retain a right to pursue, this thorough opinion is a helpful example of why it is essential to describe those “hopefully retained” claims with specificity in order to avoid the claim preclusion suffered by the plaintiff in this case.