Dubroff v. Wren Holdings, LLC,
C.A. No. 3940-VCN (Del. Ch. Oct. 28, 2011), read 45-page opinion here.
See prior Chancery decisions in this case highlighted on these pages here
The issues addressed in this gem of an opinion include:
(i) whether and when a minority shareholder's claim for breach of fiduciary
duty against a control group based on equity dilution is a direct or derivative
claim; (ii) whether a disclosure claim regarding a recapitalization plan can
proceed despite alleged "inquiry notice" or alleged ratification via a
stockholders agreement; (iii) whether the conspiracy theory of jurisdiction
applied to several defendants; as well as (iv) unjust enrichment; (v) whether
the statute of limitations for individual claims by members of a class action
is tolled while the class action is pending; (vi) motions to intervene and
consolidate; and (vii) motions to dismiss on several bases, including lack of
Video: Francis Pileggi and Kevin Brady discuss the case:
Brief Procedural History and Factual
This case involves two sets of plaintiffs both of whom
were minority shareholders in Nine Systems Corporation (NSC). The Court
referred to the two groups as the Dubroff Plaintiffs and the Fuchs Plaintiffs.
In the two prior decisions in this case linked above, the Court dismissed many
of the claims of the Dubroff Plaintiffs and also denied class certification,
leaving them to pursue individual claims. The Fuchs Plaintiffs had filed
a separate suit and they seek to both intervene in the complaint filed by the
Dubroff Plaintiffs and consolidate their case with the pending suit filed by
the Dubroff Plaintiffs. Defendants filed motions to dismiss the complaint filed
by the Fuchs Plaintiffs, a group that includes 43 shareholders each pursuing
direct, individual claims.
NSC shareholders representing a majority of the shares
(the "Control Group") approved by written consent a reorganization plan
in 2002 that involved a reverse stock split, issuance of new classes of shares
and an amendment to the certificate of incorporation (the "Recapitalization").
The net result of the Recapitalization was to increase the percentage of equity
ownership of the Control Group and dilute the equity ownership of the minority
shareholders. Many of the Fuchs Plaintiffs signed a stockholders agreement in
connection with the Recapitalization in which certain disclosures were made
(but ultimately, according to this decision, not enough to prevail on a motion
to dismiss). The Fuchs Plaintiffs argue that the stockholders agreement does
not bar their claims because that agreement was deceptive and failed to reveal
certain material terms of the Recapitalization.
Equity Dilution Claim
Several years ago in Gentile v. Rossette, 906 A.2d
91 (Del. 2006), the Delaware Supreme Court established that certain equity dilution
claims may be pled both derivatively and directly, although equity dilution
claims are typically viewed as derivative under Delaware law. See Feldman v.
Cutaia, 956 A.2d 644, 655 (Del. Ch. 2007). Defendants argued that Gentile
is inapplicable because some of the Fuchs Plaintiffs benefited from the
Recapitalization and thus there was not an "exact match" between the
controlling shareholder's increase in ownership and the minority's decrease in
The Court criticized the syllogism used by the defendants
and even was critical of other Delaware decisions that suggested if anyone
other than the controller benefits from the transaction, then the minority may
not assert a direct dilution claim. Rather, the Court explained that:
"A corporation's minority shareholders should
not be denied a direct equity dilution claim where a controller expropriates,
from them, a large percentage of the corporation's equity, keeps most of that
expropriated equity for itself, and gives a small amount to other people."
Relying on the Supreme Court's opinion in Gatz v.
Ponsoldt, 925 A.2d 1265 (Del. 2007), the Court of Chancery in this case
"minority shareholders may have a direct
equity dilution claim when their holdings are diluted, and those of the corporation's
controller are not. In other words, as long as the controller's holdings are
not decreased, and the holdings of the minority shareholders are, the latter
may have a direct equity dilution claim."
Fiduciary Duties of Control Group
The Court reiterated well-settled Delaware law that when
a control group exists, and it is given controlling shareholder status, its
members owe fiduciary duties to the minority shareholders. See n. 24.
The Control Group, as holders of a majority of the stock
of NSC, approved the Recapitalization by written consent. DGCL Section 228(e)
requires that after a majority approves a transaction by written consent:
"prompt notice of the taking of the corporate action without a meeting by less
than unanimous consent shall be given to those stockholders...who have not
consented in writing...." Neither the notice sent under Section 228(e), nor the
notice in the stockholders agreement disclosed either: (i) who benefited from
the Recapitalization, or (ii) what benefits they received. The Fuchs Plaintiffs
argue that these material omissions prevented them from bringing an earlier
action to rescind the Recapitalization.
The Court acknowledged that the precise
contours of the disclosure required under DGCL Section 228(e) have not yet been
defined under Delaware law, but notwithstanding that lack of guidance, there
were sufficient facts pled in this case for the Court to: "infer
reasonably that the board deliberately omitted material information with the
goal of misleading the Plaintiffs and other shareholders about the Defendants'
material financial interest in, and benefit conferred by, the Recapitalization
not shared with other shareholders."
Likewise, there was sufficiency in the pleadings for a
fiduciary duty claim to proceed on the disclosure issue. See n. 48: "...
when directors communicate publicly or directly with shareholders about
corporate matters the sine qua non of directors' fiduciary duty to
shareholders is honesty." (citing Malone v. Brincat, 722 A.2d 5, 10
Statutes of Limitations for Individual Claims
of Class Members
It remains axiomatic that Chancery, as a court of equity,
is not strictly bound by the statute of limitations that would otherwise apply
to a claim, although absent a tolling of the limitation period they are given
great weight. Claims for breach of fiduciary duty are typically subject to a
three-year statute of limitations. n. 66. Neither the stockholders agreement
nor the subsequent notice of written consent put the shareholders on "inquiry
notice" of an alleged self-dealing transaction. The stockholders agreement was
not intended as a disclosure document. In addition, as for tolling, the U.S.
Supreme Court has interpreted Rule 23 to mean that class members' individual
claims are tolled while a putative class action is pending. n. 76
The Court of Chancery reasoned that a "class action
tolling rule makes sense" and announced that rule as Delaware law.
Otherwise, the intent of class action litigation-to simplify litigation
involving a large number of class members with similar claims-would be
defeated, especially if each of them was forced to intervene to preserve their
Motions to Intervene and to Consolidate
A helpful analysis of Court of Chancery Rules 24(a) and
24(b) regarding mandatory and permissive intervention awaits the reader of this
opinion. However, the Court determined that instead of intervention, the
appropriate approach in this case was consolidation under Rule 42 in order to
join the claims of the two sets of plaintiffs. The Court required the parties
to submit a form of order to consolidate the related actions.
Conspiracy Theory of Jurisdiction
There was nothing particularly noteworthy about the
thorough analysis of the conspiracy theory of personal jurisdiction in this
case so I refer the reader interested in that issue to the opinion linked
Read more Delaware business
litigation case summaries and commentary on Delaware
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