Opinion
Civil Action No. 11001.
Date Submitted: July 25, 1990.
Date Decided: October 24, 1990.
Howard M. Handelman, Esquire, Peter J. Walsh, Esquire, and John H. Newcomer, Jr., Esquire, of BAYARD, HANDELMAN MURDOCH, P.A., Wilmington, Delaware; Attorneys for Plaintiff.
Lawrence C. Ashby, Esquire, and Keith R. Sattesahn, Esquire, of ASHBY, MCKELVIE GEDDES, Wilmington, Delaware; Attorneys for Defendants Earl W. Brian, M.D., John E. Koonce, John H. Abeles, M.D., Dwight Geduldig, and Wallace O. Sellers.
Kenneth J. Nachbar, Esquire, of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; Mitchell A. Karlan, Esquire, of GIBSON, DUNN CRUTCHER, New York, New York; Attorneys for Defendant Infotechnology, Inc.
MEMORANDUM OPINION
Avacus Partners, L.P. brings this action individually as a shareholder of Infotechnology, Inc. ("Infotech") and derivatively on behalf of Infotech against the directors of that company. Broadly speaking, Avacus alleges that Infotech's directors participated in the misappropriation of a corporate opportunity, wasted corporate assets, and engaged in a series of transactions designed for the principle purpose of entrenching themselves in office. Defendants have moved to dismiss all claims. Infotech argues that Avacus has no standing to challenge the alleged misappropriation of a corporate opportunity because the disputed events occurred before Avacus became a shareholder of Infotech. With respect to the claims of entrenchment and waste, Infotech argues first, that they are derivative in nature so Avacus has no standing to bring them individually, and, second, as derivative claims they must be dismissed because Avacus made no demand before bringing the suit and demand would not have been futile.
The company itself is necessarily named as a defendant as well.
Infotech has filed three affidavits in support of its motion to dismiss, which, under Chancery Rule 12(b)(6), converts the motion into a motion for summary judgment. Thus, I take the facts as those pleaded in the complaint except to the extent they are otherwise established by uncontradicted affidavits. From those sources the following facts appear.
I.
The facts are involved. They find their beginning in a failed takeover attempt. In 1985, Infotech and a group of investors (the "1985 Investors Group") attempted to gain control of United Press International, Inc. ("UPI"), which at that time was emerging from bankruptcy. This attempt failed, and UPI was purchased by a Mexican investor and newspaper publisher named Mario Vazquez-Rana.
Some members of the 1985 Investors Group initiated litigation against Mr. Vazquez-Rana over the bidding for UPI. As part of a settlement agreement in that litigation, Mr. Vazquez-Rana transferred 40% of the common stock of Comtex Scientific Corporation to FNN Group, Inc. a corporation all of whose shareholders were members of the 1985 Investors Group. FNN Group then transferred a block of Comtex shares amounting to 8% of Comtex's stock to a wholly owned subsidiary of Infotech, leaving FNN Group with a 32% share of Comtex's stock. Also as part of the 1986 settlement agreement with Vazquez-Rana, approximately twenty-seven members of the 1985 Investors Group purchased Comtex notes that were convertible into Comtex stock. At that time Infotech entered into put/call agreements with these noteholders permitting them to put the notes to Infotech in exchange for Infotech stock. Infotech entered into a similar agreement with FNN Group and its shareholders.
Comtex is UPI's principal distributor of newswires to electronic data base vendors and publishers. The 40% block of Comtex stock transferred to FNN were shares owned by UPI, and apparently constituted all such shares held by UPI.
Perhaps coincidentally, FNN is the acronym used to refer to the company that is Infotech's primary asset, Financial News Network, Inc. FNN Group also has the same address as Infotech, but no direct corporate connection is alleged between Infotech and FNN Group.
According to an affidavit submitted by defendants, in early 1989 the WNW Group shareholders numbered nineteen, FNN Group shareholders numbered seven, and the Comtex shareholders numbered twenty-three, but some individuals or entities were members of two or all three of the groups. The record contains no evidence of the number of Comtex noteholders, FNN Group shareholders, and WNW Parent shareholders before that time.
After Vazquez-Rana's acquisition of UPI in 1985, that company continued to incur substantial losses. By late 1987, Infotech learned that Vazquez-Rana was willing to sell his interest in UPI allegedly "for a negligible amount" (Am. Cmpl. ¶ 37). In January 1988, Dr. Earl Brian, Infotech's CEO, formed WNW Group, Inc. ("WNW Sub") to acquire control of UPI. WNW Sub is a Delaware corporation and is a wholly-owned subsidiary of a Turks and Caicos corporation, also called WNW Group, Inc. ("WNW Parent"). WNW Parent was owned by approximately nineteen individuals and entities, three of whom were also shareholders of FNN Group, and all of whom were members of the 1985 Investors Group. Infotech became a stockholder of WNW Parent at some point, but it is unclear whether Infotech was a WNW Parent stockholder in January 1988.
On February 19, 1988, Vazquez-Rana sold a ten-year irrevocable proxy to vote the shares of New UPI, Inc. ("NewUPI") to WNW Sub for $110,000. NewUPI owns a controlling interest in UPI, and evidently has no other significant assets. Dr. Brian, apparently acting for WNW Sub, then replaced the officers and directors of UPI with himself and other persons affiliated with him. Infotech immediately began to make direct and indirect loans (via WNW Sub) to UPI, allegedly to fund UPI's working capital needs. Infotech also participated in a $15 million private placement of UPI convertible preferred stock, purchasing at least $2 million of such stock and purchasing an option for an additional $2 million of such stock. The remaining shares were acquired by persons and entities who were shareholders of WNW Parent and FNN Group.
This is the allegation in the amended complaint. There is some indication in the record that there may have been additional, contingent consideration. That matter is left unclear currently.
In September 1988, NewUPI increased its authorized capital and granted an option to WNW Sub to acquire 100,000 shares of common stock allegedly for no consideration. This option provided WNW Sub with the opportunity to own 99% of NewUPI's equity and to reduce Mr. Vazquez-Rana's interest in NewUPI's equity from 95% to less than 1%.
To review this chain of ownership as of the end of 1988, NewUPI owned a controlling interest in UPI, WNW Sub owned a proxy to vote NewUPI's shares and an option to acquire 99% of NewUPI's equity, and WNW Parent owned WNW Sub. Infotech owned a 20% interest in WNW Parent, and many of the officers and directors of WNW Sub, NewUPI, and UPI were also officers or directors of Infotech.
* * *
Infotech is a publicly traded company that holds, as its primary asset, a 45% interest in Financial News Network, Inc. ("FNN"). In late 1988, reports in the financial press indicated that there was lively interest in acquiring FNN. One route to that objective could have entailed a hostile takeover of Infotech. Avacus maintains that the Infotech board responded to these rumors by amending Infotech's corporate by-laws and issuing stock into "friendly" hands to consolidate the board's control over the corporation. At a series of board meetings in early 1989, the Infotech directors discussed amending the corporate by-laws to increase the difficulty of removing directors from office. Chief among these amendments was a provision requiring the vote of 80% of the outstanding stock in order to remove a director from office. The board voted to amend the by-laws at meetings on January 6, and March 23, 1989.
At a January 6, 1989 meeting the Infotech board also discussed increasing Infotech's ownership in Comtex (recall that Infotech had acquired 8% of that stock after the settlement with Vazquez-Rana) and discussed acquiring UPI for stock. At a meeting on February 3, the Infotech board resolved to exercise its rights under the 1986 put/call agreements to exchange Infotech stock for the Comtex stock owned by FNN Group, as well as for the convertible Comtex notes held by members of the 1985 Investors Group. These exchanges together with Infotech's existing 8% stock interest in Comtex, would apparently give Infotech a controlling interest in Comtex.
At the February 3, 1989 board meeting, the Infotech board also affirmed its desire to acquire UPI, and the directors instructed management to hire Prudential-Bache to advise the company in that connection.
In three transactions in February and March of 1989 (the "Comtex Exchanges"), Infotech issued shares of its common stock in exchange for the Comtex stock and notes. The exchange rate was based on a $10 million asset valuation of Comtex obtained from an independent appraiser.
* * *
Plaintiff alleges that all of this activity was directed at placing Infotech stock in friendly hands to protect against a threatened takeover. Avacus had been acquiring stock; rumors about FNN had been in the press. On February 27, 1989 Avacus delivered a Schedule 13D to Infotech, indicating that it was considering seeking control of Infotech. At 10:00 p.m. that night the Infotech board met to consider the acquisition of UPI by merging WNW Sub into Infotech with Infotech surviving (the "WNW Merger"). The merger was to be structured so that Infotech would issue stock to WNW Parent in exchange for WNW Parent's shares in WNW Sub. WNW Parent would then dissolve, distributing the Infotech stock to its shareholders other than Infotech. Prudential-Bache advised Infotech that it believed it would be in a position to conclude its work and give an opinion to the effect that the exchange ratio contemplated by the proposed merger agreement was fair to the stockholders of Infotech. The board was informed that the merger agreement provided for an adjustment in the exchange ratio if Prudential-Bache could not render a fairness opinion with respect to the ratio as it was set at that time. The board then approved the proposed merger. Press releases announcing a merger agreement, however, actually were released to the public about five hours before the Infotech board met to pass upon the merger on February 27. The merger agreement was filed with the Secretary of State of Delaware on February 28, the morning after the board meeting approving the merger.
* * *
Avacus claims that the Comtex Exchanges and the WNW Merger served to entrench the Infotech directors by placing a substantial block of shares in "friendly" hands. A total of twenty-seven individuals and entities received Infotech stock in the Comtex Exchanges and in the WNW Merger. All of these shareholders were members of the 1985 Investors Group. All had a history of investing in projects with Dr. Brian.
See note 4, supra.
Altogether Infotech issued a total of approximately 2 million shares in the WNW Merger and the Comtex Exchanges, increasing the number of its outstanding shares from approximately 7.3 million to approximately 9.3 million. Avacus alleges that these transactions increased the number of shares in the hands of the directors or persons friendly to them from 13% to 32%. The transactions also diluted Avacus's holdings in Infotech from 9.88% to 7.78%.
Avacus also claims that Infotech received grossly inadequate consideration in exchange for its stock. In the Comtex Exchanges, Avacus claims that Infotech exchanged stock that the directors valued at approximately $5 million for 1,786,181 Comtex shares with a market value of $279,000 and Comtex notes convertible into shares with a market value of about $125,000. In the WNW Merger, Infotech issued shares the directors valued at over $16 million for a company whose primary asset, the option to vote NewUPI's stock, had been acquired one year earlier for $110,000. According to the amended complaint, NewUPI did not appreciate in value during this year since UPI had continued to lose millions of dollars. Moreover, at the time of the merger, NewUPI owed Infotech $4.5 million, which could constitute additional consideration for the merger.
II.
The amended complaint contained five counts alleging breach of fiduciary duty or interference with voting rights. As characterized by plaintiff:
The amended complaint also contained a Count VI alleging breach of the duty of candor for failing to disclose information about the complained of transactions in the proxy materials issued before the November 20, 1989 shareholders meeting. Avacus's brief states that this claim is moot. It will be dismissed on that ground.
Count I alleges that the Directors converted to themselves and/or persons closely associated with them the corporate opportunity to acquire the controlling interest of United Press International, Inc. ("UPI") and that they then financed the operation of UPI with the corporate treasury of Infotech. Am. Cmpl. ¶ 3-5, 92.
Count II alleges that the Directors caused Infotech to enter into an agreement to acquire WNW Group, Inc. (the "WNW Merger") and to issue to themselves and/or persons closely associated with them the equivalent of 19.74 percent of Infotech's then outstanding stock in exchange for grossly and fraudulently inadequate consideration. The Directors failed to candidly disclose the terms and effect of the transaction to the stockholders. A purpose of the transaction and of the nondisclosure was entrenchment. Am. Cmpl. ¶ 7, 96-97.
Count III alleges that the Directors caused Infotech to enter into three separate transactions involving stock and notes of Comtex Scientific Corporation (the "Comtex Transactions") and to issue to themselves and/or persons closely associated with them the equivalent of approximately 5 percent of Infotech's then outstanding stock in exchange for grossly and fraudulently inadequate consideration. The Directors failed to candidly disclose the terms of these transactions to the stockholders. A purpose of these transactions and of the nondisclosure was entrenchment. Am. Cmpl. ¶ 7, 101-102.
Count IV alleges that the challenged transactions resulted in a dilution of Avacus's Infotech stock and significant reduction in Avacus's voting power. Am. Cmpl. ¶ 106.
Count V alleges that the Directors enacted certain by-law amendments for the purposes of entrenchment and protection from liability for their wrongful conduct. Am. Cmpl. ¶ 111.
Avacus seeks an order canceling the shares issued in the complained of transactions; enjoining the exercise of their voting rights, declaring the transactions void and rescinding the transactions. Avacus also seeks the appointment of a receiver to manage the affairs of Infotech, and an equitable accounting and damages from the Infotech directors for the complained of transactions.
* * *
Infotech has moved to dismiss the individual claims in Counts II through V and the derivative claim in Count I on the grounds that Avacus lacks standing to litigate all those matters. It has moved to dismiss all the derivative claims on the grounds that pre-suit demand on the board of directors was not excused and was not made. In support of its motion, Infotech has filed several affidavits, which under Chancery Rule 12(b)(6) converts its motion to dismiss into a motion for summary judgment. None of the affidavits touch on Infotech's grounds for seeking dismissal of the various individual claims, however, so these claims will be evaluated under the test for motions to dismiss.
Infotech also argues that the requests to rescind the transactions and cancel the newly issued shares should be stricken because the individuals receiving the stock are indispensable parties but were not joined. This argument is, in effect, an invitation to determine an appropriate remedy should a claim be stated and proved. A more appropriate time to determine the nature of a remedy is after a right to a judgment has been established. Therefore, I will not rule now on the possible availability of rescission-type remedies.
The legal standard for determining the pending application is not controversial. A motion to dismiss will be granted only when no state of facts reasonably foreseeable under the well pleaded allegations of the complaint would entitle plaintiff to relief.Delaware State Troopers Lodge v. O'Rourke, Del. Ch., 403 A.2d 1109 (1979). Generally "mere conclusions" are not to be considered. Grobow v. Perot, Del. Supr., 539 A.2d 180 (1988).
A motion for summary judgment is to be granted only when no material facts are in dispute and the moving party is entitled to judgment as a matter of law. Bershad v. Curtiss-Wright Corp., Del. Supr., 535 A.2d 840, 844 (1987).
A. Plaintiff has no Standing to Litigate Claims of Misappropriation of Infotech Opportunity
Count I alleges that the Infotech directors participated in the misappropriation of a corporate opportunity in breach of their fiduciary duties when they caused WNW Sub to purchase a proxy to vote the shares of NewUPI rather than having Infotech itself purchase that proxy. Avacus alleges further that the directors caused Infotech to finance WNW Sub's acquisition of the proxy by loaning money to WNW Sub to cover the operating expenses of UPI. The act of loaning money, if it constitutes a wrong at all, could be seen either as an independent wrong or as a constituent part of the diversion of the claimed corporate opportunity. The amended complaint is consistent with either interpretation, but seems to emphasize the latter.
How the amended complaint is interpreted on this score is important to Avacus because Avacus was not a shareholder of Infotech on February 19, 1988, when WNW Sub purchased the proxy, but was a shareholder when Infotech loaned money to WNW Sub the following summer. Section 327 of the Delaware General Corporation Law requires that the plaintiff in a derivative suit be a shareholder at the time of the transaction it complains about. Thus, Avacus lacks standing to challenge a wrong to the Company that occurred on February 19. Avacus argues that the wrong it complains about was the acquisition of ownership (rather than control) of NewUPI (and hence of UPI) at a bargain price. WNW Sub did not acquire ownership of NewUPI, it is argued, until September 1988 when NewUPI increased its authorized capital and, apparently for no consideration, granted an option to WNW Sub to vote 99% of NewUPI's stock.
This attempt to move back the date of the alleged wrong is unavailing in my opinion. Acquisition of control over NewUPI is plainly the relevant event. If that were no wrong to Infotech, on what possible basis could the acquisition of ownership by WNW Sub be thought to be a wrong to Infotech? If, however, acquisition of the proxy was a misappropriation of an opportunity that rightfully belongs to Infotech, then all that flowed from that wrong could be compensable to Infotech. In either event, it is the acquisition of control that is the critical event. When that occurred Avacus was not a stockholder of Infotech. It therefore has no standing to litigate the claim that the proxy transaction constituted a wrong to the company. See Levien v. Sinclair Oil Corp., Del. Ch., 261 A.2d 911, 921-22 (1969), rev'd on other grounds, Del. Supr., 280 A.2d 717 (1971). Avacus asserts that, even if the diversion of the corporate opportunity occurred with the sale of the proxy on February 19, 1988, it nevertheless has standing to challenge the transaction because it is in privity with an individual who did purchase shares on February 19. This individual, Johannes Nyks, the president and general partner of Avacus, placed an order with a broker on February 19 to purchase Infotech stock. He did not take title to these shares, however, until the trade settled. An affidavit filed by Infotech establishes that the trade did not settle until February 26.
Count I can also be read to allege that the Infotech directors breached their fiduciary duties when they thereafter approved loans to WNW Sub and UPI. Plaintiff plainly was a shareholder at the time such loans were made. If they were made for an improper purpose defendants will be liable for any injury to the corporation that arose from them. There is no defect in plaintiff's standing to litigate a claim of that sort. Infotech is not entitled to summary judgment on these latter allegations.
This argument raises the question of when does a purchaser of stock become a stockholder of the firm for purposes of Section 327. This court has had occasion to note that the purpose of Section 327 is to deter individuals from purchasing stock solely to institute litigation. E.g., Newkirk v. W.J. Rainey, Inc, Del. Ch., 109 A.2d 830 (1954). This policy might be easily frustrated if individuals could place orders to purchase stock on the same day the challenged transaction occurred. The wholesome policy of Section 327 will be best promoted by regarding a buyer of stock to qualify as a stockholder under Section 327 only upon the settlement of the trade. Since it appears undisputed that Mr. Nyks did not get title to his stock until February 26, he also has no standing to challenge Infotech's failure to acquire UPI. Infotech, therefore, is entitled to summary judgment of dismissal on the allegations in Count I pertaining to the acquisition of the proxy to vote NewUPI's shares.
This holding makes it unnecessary to decide whether Avacus's privity with Nyks would have given Avacus standing to challenge the loss of corporate opportunity.
B. Claims of Entrenchment Are, in the Circumstances Alleged, Individual, Not Corporate Claims
Count II alleges that the Infotech directors breached their fiduciary duties because they approved the WNW Merger for grossly inadequate consideration, and for the purpose of entrenching themselves in office. Count III contains identical allegations about the Comtex Exchanges. Count V alleges that the directors breached their fiduciary duties by amending the company's by-laws to entrench themselves in office. These counts were brought individually and derivatively. Count IV alleges that the WNW Merger and the Comtex Exchanges improperly reduced Avacus's voting power. This count was brought individually.
Infotech moved to dismiss the individual claims in each of these counts, arguing that the claims are for waste and entrenchment and may only be brought derivatively.
* * *
An alleged wrong involving a corporation is individual in nature when it injures the shareholders directly or independently of the corporation. Kramer v. Western Pac. Indus., Del.Ch., 546 A.2d 348, 351; Moran v. Household Int'l., Inc., Del.Ch., 490 A.2d 1059, 1070 (1985), aff'd, Del. Supr., 500 A.2d 1346 (1985). A wrong is derivative in nature when it injures the shareholders indirectly and dependently through direct injury to the corporation. Kramer, 348 A.2d at 353.
To illustrate, if a board of directors authorizes the issuance of stock for no or grossly inadequate consideration, the corporation is directly injured and shareholders are injured derivatively. The claim that this act constituted waste of corporate assets could be asserted only by the corporation itself or, in proper circumstances, by a shareholder derivatively. If, instead, a board issues stock for adequate consideration but with the wrongful intent of entrenching itself, there is no injury to the corporation. The corporation has been fully compensated for its stock. But if one accepts that the stock was issued primarily for entrenchment purposes (to an associate, let's suppose, who had confidentially promised to keep the board in office), it may constitute a wrong to the shareholders. What has arguably been affected is not a corporate property or right, but the right of shareholders to elect the board without unfair manipulation. In all events, whether it is a strong claim or a weak claim, such a claim as may exist is individual, not corporate. The fact that all shareholders have been affected equally does not make this claim of improper interference with the right to vote a corporate claim.
Claims of waste will always be derivative claims, but claims of entrenchment may be either individual or derivative or both depending on the circumstances. An entrenchment claim will be an individual claim when the shareholder alleges that the entrenching activity directly impairs some right she possesses as a shareholder, such as the right to vote her shares. Shareholders do have a right to vote their shares, however, so a claim that the board improperly acted to entrench itself by issuing stock that impacts the shareholders' voting power may state either an individual or a derivative claim. Lipton v. News Int'l., PLC, Del.Supr., 514 A.2d 1075, 1078-79 (1986); see also Williams v. Geier, Del.Ch., C.A. No. 8456, Berger, V.C. (May 20, 1987) (allegation that a recapitalization plan impaired shareholders' voting power states an individual claim). Assuming the stock is issued for an adequate consideration, the claim will be only individual. If the stock is issued for inadequate consideration, the corporation itself will be directly injured as well and both individual and derivative wrongs might be alleged.
Cf. Moran v. Household Int'l., Inc., Del. Ch., 490 A.2d 1059, 1070 (1985), aff'd, Del. Supr., 500 A.2d 1346 (1985) where it was held that shareholders have no individual right to receive takeover bids and therefore any wrongfully motivated board activity that deters such bids and protects incumbency states only a corporate action.
Applying this analysis to the amended complaint, it is clear that the entrenchment claims in Counts II and III are individual in nature, as is the claim of stock dilution in Count IV. The claim in Count V that the board amended the by-laws to entrench itself in office also is an individual claim. The changed by-laws can harm only the shareholders directly because this change in the governance structure of the corporation is a matter that directly involves the shareholders rights to elect and remove directors. The claims of waste in Counts II and III are derivative claims.
Infotech argues that Avacus cannot ground any individual claims on diminished voting power because Infotech has not eliminated the shareholders' power to vote. This argument, I think, is based on a misreading of the cases discussed above. These cases make clear that arguments about the degree of interference with the shareholders' right to vote go to the validity of a claim, not to its nature as individual or corporate. Lipton, 514 A.2d at 1079 n. 4. That issue cannot be resolved on the current record.
C. Derivative Claims: Pre-Suit Demand on the Board was Excused in the Circumstances Alleged
The preceding discussion indicates that Avacus has asserted two possible derivative claims — the claims of waste in Counts II and III attacking the WNW Merger and the Comtex Exchanges. Infotech argues that it is entitled to summary judgment of dismissal on these claims because demand on the board would not have been futile but nevertheless was not made. Avacus alleged several reasons in the amended complaint why demand is excused; I need discuss only one. Accepting the allegations made as true, the disparity between value received by Infotech in the Comtex Exchanges and the WNW Merger and the value it paid out was such that one cannot say now that they were not wasteful. For the reasons that follow, I conclude that this state of affairs excuses pre-suit demand in this instance.
Rule 23.1 looks to the allegations in the complaint, therefore a motion made under that rule seems to demand resolution pursuant to the test governing a motion to dismiss. If, however, the allegations of the complaint can satisfy the test of Rule 23.1 but a defendant files affidavits definitively rebutting the allegations of the complaint, the defendant would be entitled to summary judgment dismissing the complaint.
The test for deciding when demand is excused is whether the facts alleged in the complaint, if true, create a reasonable doubt that 1) the directors are disinterested and independent, and 2) the challenged transaction was otherwise the product of a valid business judgement. Aronson v. Lewis, Del. Supr., 473 A.2d 805, 815 (1984). The first prong of this test appears to be directed to the interestedness of the directors at the time the action was filed, while on the second prong focuses on the board's approval of the challenged transaction. Pogostin v. Rice, Del. Supr., 480 A.2d 619, 624 (1984). If the court concludes that the facts alleged create room for a reasonable doubt about the availability of business judgment protection at either time, then demand is excused. Id. at 624-25.
I focus here only on the second aspect of the test and conclude that the pleading does raise a reasonable doubt that the Comtex Exchanges and the WNW Merger constituted waste and hence were not the product of a valid business judgment. The question for the court when a plaintiff alleges waste is whether the consideration received by the corporation was "so inadequate that no person of ordinary, sound business judgment would deem it worth that which the corporation paid." Grobow v. Perot, Del. Supr., 539 A.2d 180, 189 (1988); Saxe v. Brady, Del. Ch., 184 A.2d 602, 610 (1962).
In the Comtex Exchanges, Avacus alleges that Infotech exchanged stock worth $5 million for Comtex shares and notes with a market value of about $400,000. In the WNW Merger, Avacus alleges that Infotech exchanged stock worth $16 million to gain control of a company whose primary asset, according to the complaint, had been purchased a year earlier for $110,000. In both cases Avacus has alleged a litigable case of waste under the Grobow test. More importantly, Avacus has alleged specific facts that quantify the alleged inadequacy of the consideration received. The facts alleged in the complaint indicate that Infotech paid over 10 times fair market value for a large block of stock and convertible notes of one company, and that Infotech paid 100 times the price paid a year earlier for control of a second company. To corroborate the claim that the value of these two companies could not possibly justify the amount of consideration paid, the complaint also includes specific allegations about the dismal operating performance of both companies.
Infotech argues that Avacus can only state a valid claim of waste if the corporation received no consideration for what it paid. As is clear from the statement of the law quoted above, this is not the law of Delaware. I cannot say as a matter of law that transactions as disproportionate as these are alleged to be do not constitute actionable waste.
Infotech argues further that the board's reliance on a report of an independent appraiser when it set the exchange rate for the Comtex Exchanges, and its reliance on an independent fairness opinion when it approved the WNW Merger, insulates the board from any claim that the decisions were not the product of valid business judgments. Defendants here attempt to raise an evidentiary matter to the status of a rule of law. I cannot say as a matter of law that a plaintiff cannot prove a claim of waste because the board acts on the basis of an independent asset appraisal or fairness opinion. These are matters — the reliability of these opinions (see Smith v. Van Gorkom, Del. Supr., 488 A.2d 858 (1985)) — that require adjudication.
Turning to the record, Infotech cites facts that it maintains rebut Avacus's claim of waste. With regard to the Comtex Exchanges, Infotech argues that the Comtex stock was so thinly traded that its market value was not a good measure of its intrinsic value. While this may be so, it serves only to raise an issue of fact, which itself precludes summary judgment. Next, Infotech argues that the Comtex Exchanges cannot be unfair because the exchange ratio was determined according to agreements entered into in 1986. This, too, raises triable issues of fact. The exchange ratio was set based on an asset appraisal the accuracy of which plaintiff seeks to draw into question.
Infotech also argues that the facts surrounding the WNW Merger rebut any claim that that transaction was wasteful. Specifically, Infotech claims that a private placement by UPI of stock worth $15 million indicates that outside investors valued UPI at over $30 million. The record indicates, however, that many of the investors in this private placement may have been shareholders of WNW Parent. In all events, this again, raises triable issues of fact.
* * *
Finally, Infotech argues that its response to a demand by another dissatisfied shareholder conclusively demonstrates that demand by Avacus would not have been futile. The same month Avacus filed its original complaint, Infotech received a demand from another shareholder challenging the same transactions challenged by Avacus. The Infotech board established a special committee consisting of two newly appointed board members to investigate the transactions. Neither member of the special committee had any prior connections with Infotech or the challenged transactions. The special committee retained independent counsel, and, in April, 1989, issued a report recommending that Avacus not take any action with respect to the challenged transactions. There has been no discovery of the work of that committee.
Infotech argues that these events establish that demand upon the board would not have been futile. While this argument has some intuitive appeal, it misapprehends the issue presented to the court when a shareholder institutes a derivative litigation without first making a demand upon the board. The court is to decide whether the complaint has alleged "with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors [or] the reasons . . . for not making the effort." Chancery Court Rule 23.1. If a shareholder chooses to forego demand, he bears the burden of pleading that demand is excused. The Aronson test sets forth the standards the court should apply to decide whether the shareholder has met this burden.
Once a plaintiff has alleged facts to establish that demand is excused, the corporation is required to meet the different test of Zapata Corp. v. Maldonado before it can prevail on an argument that the suit should be dismissed. Del. Supr., 430 A.2d 779 (1981); Allison on Behalf of G.M.C. v. General Motors Corp., 604 F.Supp. 1106, 1120-21 (D. Del. 1985). Zapata shifts to the corporation the burden of proving the independence, good faith, and reasonableness of the special committee's investigation. In addition, it requires the court to decide independently if the committee's decision to dismiss the case should be respected. Zapata, 430 A.2d at 788-89. The Supreme Court created a heightened standard of review in Zapata in recognition that the members of a special committee, even if they otherwise adhere to the standards of "independence, good faith, and reasonable investigation," may not be able to objectively review their peers on the board. Id. 430 A.2d at 787. In other words, demand may be futile even if the board responds in a procedurally correct manner.
Zapata establishes a special process that places weight upon the trial court's discretionary judgment. When a shareholder can allege such facts excusing demand (a question that is determined under the test in Aronson), then the more exacting review ofZapata is required before the board can take control and seek dismissal if it so desires. Avacus has met the requirements of the Aronson test, so the responses of the Infotech board to another shareholder's demand is not sufficient to compel dismissal of Avacus's claims at this point. The case is not in a posture for any responsible decision by the court of the kindZapata requires.
* * *
Infotech's motion for summary judgment on Count I of the amended complaint is granted only insofar as that Count purports to allege a claim of misappropriation of a corporate opportunity in WNW Sub's acquisition of control over NewUPI; it is denied insofar as that count alleges corporate wrongs arising from improperly made loans. The motion to dismiss the individual claims of entrenchment in Counts II, III, IV, and V is denied. The motion for summary judgment on the claims of waste in Counts II and III is denied.
The stay of discovery in this matter is hereby lifted.