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noting "there is no authority that suggests that Delaware law requires a formal 'report' as a matter of law"
Summary of this case from Zucker v. HassellOpinion
Civil Action No. 174-N.
Date Submitted: August 12, 2004.
Dated Decided: November 5, 2004.
Alan J. Stone, R. Judson Scaggs, Jr., James G. McMillan, III, and Jerry C. Harris, Jr., of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; OF COUNSEL: Thomas H. Dahlk, Michael S. Degan, and Trenten P. Bausch, of BLACKWELL SANDERS PEPER MARTIN, Omaha, Nebraska, Attorneys for Plaintiffs.
John L. Reed, Daniel V. Folt, Gary W. Lipkin, and Matt Neiderman, of DUANE MORRIS LLP, Wilmington, Delaware, Attorneys for the Former Regency Directors.
Kevin R. Shannon, Brian C. Ralston, and Catherine A. Strickler, of POTTER ANDERSON CORROON LLP, Wilmington, Delaware, Attorneys for Defendant Statesman Group, Inc.
Gregory P. Williams, Peter B. Ladig, and Steven L. Brinker, of RICHARDS, LAYTON FINGER, P.A., Wilmington, Delaware, Attorneys for Defendants Royalty Holdings, L.L.C., Royalty Management, Inc., Laurence Levy, Neil N. Hasson, Stanley Fleishman and Errol Glasser.
MEMORANDUM OPINION
Plaintiffs, Edward Gatz and Donald Graham, bring this action alleging that defendants, a sundry cast of characters associated with Regency Affiliates, Inc. ("Regency" or the "Company"), committed various transgressions in their long-running campaign to "loot" the Company for their personal benefit. The complaint challenges several discrete transactions over the course of two years. For the reasons below, I dismiss plaintiffs' claims with respect to all but one of these transactions.
I. BACKGROUND
The background section is drawn from allegations in the complaint. If the reader finds the background section somewhat disjointed, he or she can take solace in the fact that the complaint is much worse.
Nominal defendant Regency, a publicly traded Delaware corporation, was, in 1992, a company emerging from bankruptcy with little assets other than considerable net operating loss carry forwards ("NOLs"). Beginning in 1992, Regency began a restructuring which culminated in a transaction in the summer of 1993 with defendant Statesman Group, Inc. ("Statesman"), a Bahamian corporation. Statesman was led by defendant William Ponsoldt. In that transaction, Regency acquired Statesman's interest in 75 million tons of rock ("the Aggregate") in exchange for 28.73% of Regency's common stock, irrevocable proxies over approximately an additional 5% of the common stock, and 100% of Regency's Series C Preferred Stock. The Series C Preferred Stock carried redemption and liquidations rights tied to the value of the Aggregate. The Aggregate, as of the summer of 1993, was valued at $15 million for financial statement purposes, but, according to the complaint, Ponsoldt knew that the Aggregate was not very marketable.
The transaction was more involved than described, but the description will suffice for purposes of this Opinion.
In conjunction with the transaction, Statesman was able to designate persons to fill vacancies on Regency's board. Among those designees were defendants William Ponsoldt, Jr. ("Ponsoldt, Jr."), Stephanie Carey, and Martin Craffey. Ponsoldt, Jr. is the adult son of Ponsoldt and a beneficiary of the Statesman Irrevocable Trust. The Statesman Irrevocable Trust, settled by Ponsoldt, allegedly controls Statesman. Ponsoldt, Jr., Carey, and Craffey all received shares of Regency stock from Statesman or options to purchase Regency's Series C Preferred Shares from Statesman. Later, in August 1999, Marc Baldinger became a member of the Regency board and served as CFO.
In late 1994, a little more than a year after the Statesman/Regency transaction, Regency acquired a partnership interest in Security Land Development Company L.P. ("Security Land"). Security Land owns a large office building in Maryland leased by the United States Social Security Administration ("SSA"). In exchange for, among other things, 95% of Security Land's profits through 2003 and 50% thereafter, Regency provided Security Land with $300,000 in capital and over $60 million in NOLs. Regency's NOLs effectively sheltered the over $12 million annual rent of the SSA from income tax.
In August of 1996, two years after the Security Land transaction, Ponsoldt was elected chairman of the Regency board. Ponsoldt fired the existing CEO and president and a search for a new chief executive began. On June 3, 1997, the Regency board, without looking far, hired Ponsoldt as CEO and president. Ponsoldt's base compensation was $250,000 per year with annual cost of living increases. Furthermore, Ponsoldt received additional salary based on the overall net worth of Regency. According to the complaint, the Security Land transaction was structured in such a way as to continually increase Regency's asset value, i.e., Ponsoldt's salary increased as time progressed. On the same day that Ponsoldt was hired as CEO and president (June 3, 1997), the Regency board issued an option to Statesman allowing Statesman to acquire 6.1 million shares of the common stock of Regency. Ponsoldt represented at the time that the option would only be used to prevent a hostile takeover of Regency.
Four years later, in the summer of 2001, Ponsoldt began negotiations with Laurence Levy, sole director, sole stockholder, and president of Royalty Management, Inc., a Delaware corporation. Royalty Management is the managing member of Royalty Holdings, L.L.C. ("Royalty"), a Delaware limited liability company. The negotiations between Ponsoldt and Levy related to a transaction involving Statesman, Regency, and Royalty that was eventually consummated on October 17, 2002. Levy, Royalty, and Royalty Management are defendants in this litigation.
On October 15, 2001, Statesman exercised its option to acquire 6.1 million shares of Regency stock. Statesman paid the exercise price by delivering a promissory note to Regency with a principal amount of approximately $2.44 million. Statesman's exercise of its option reduced the percentage ownership of the class plaintiffs purport to represent (all shareholders except defendants and their affiliates) from 89.1% to 61.1%. On the next day, Ponsoldt allegedly directed Regency to divest the Company's controlling interest in a subsidiary, Glas-Aire Industries Group Limited, in exchange for 4,040,375 shares of Regency common stock owned by Glas-Aire and $2.5 million in cash. The complaint alleges that $1.3 million of the cash obtained in the transaction was used to pay Ponsoldt compensation that was accrued and unpaid.
Hereinafter the "Public Shareholders."
Two months later, during December 2001, one Regency subsidiary sold the Aggregate to another Regency subsidiary for $18.2 million, payable with interest at 2.46% in 96 equal payments commencing December 2003. The complaint alleges that this sale was intended to artificially increase the value of Statesman's Series C Preferred Stock — the value of such stock being tied to the value of the Aggregate. A month later, on January 16, 2002, Ponsoldt allegedly orchestrated the adoption of a 1-for-10 reverse split and the reduction of the par value of the common stock of Regency from $.40 to $.01. Plaintiffs allege this caused immediate and substantial dilution of the Public Shareholders and facilitated further dilution of the liquidation value and voting power of the Public Shareholders.
In April of 2002, the sale of the Aggregate was publicly disclosed by Regency. Shortly thereafter, plaintiffs brought suit in a Nebraska federal court against Ponsoldt, Regency's other directors, and Statesman. The federal action sought relief under the RICO statute and asserted various claims based on state law, including breach of fiduciary duty.
In June of 2002, Regency attempted to restructure its partnership interest in Security Land. Specifically, the restructuring would have included: (1) a $2 million loan from the other partners of Security Land to Regency; (2) an amendment to the partnership agreement providing that Regency would receive proportionately less of the proceeds of a sale or refinancing of the office building owned by Security Land; and (3) an option in favor of the non-Regency partners to purchase Regency's partnership interest for a price between $36 million and $38.5 million. Shortly after the attempted restructuring, plaintiffs sought and obtained an order from a federal magistrate judge that prevented Regency from entering into a transaction that would "monetize," i.e., cash-out, Regency's interest in Security Land. Upon defendants' representation that a monetization of Regency's interest in Security Land was necessary to the Company's continued financial health, that order was modified on September 11, 2002 to allow such a transaction to move forward on certain conditions.
Allegedly, the loan would have been used to pay Ponsoldt's accrued compensation.
After the federal order preventing a monetization was modified, plaintiffs made a commitment to provide Regency with $17 million or more in credit on favorable terms. The complaint alleges that this offer was an effort to avoid forfeiting Regency's rights to share in the proceeds of a sale or refinancing of the office building owned by Security Land and to prevent further dilution of the Public Shareholders. On September 30, 2002, almost immediately after plaintiffs' financing offer, and following months of private negotiations, Levy forwarded a recapitalization proposal to Regency. On that same day, the Regency board appointed a three-member special committee, consisting of defendants Baldinger, Carey and Craffey, to analyze Levy's proposal.
The complaint details numerous e-mails between Levy and Ponsoldt. See Compl. ¶¶ 44-46, 49, 52.
The special committee process was, according to plaintiffs' allegations, a "sham." The complaint charges four specific factors, which impugn the independence of the special committee. (1) The special committee members had ties to Ponsoldt that rendered them unable to appropriately consider the recapitalization proposal, (2) the special committee did not conduct reasonable due diligence into the proposed recapitalization, (3) defendants Baldinger and Ponsoldt did not provide the special committee with all of the material information necessary to analyze the transaction, and (4) the special committee was biased against plaintiffs' alternative proposal. Notwithstanding these problems (or perhaps because of them), the Regency board went forward with the recapitalization.
In particular, Ponsoldt and Baldinger allegedly knew that a monetization of Regency's interest in Security Land was imminent and that this impending monetization rendered the recapitalization unnecessary. Nonetheless, Ponsoldt and Baldinger allegedly did not share this information with Carey and Craffey.
Shortly after the recapitalization, defendant and board member Craffey received a $100,000 wire transfer from Statesman.
The recapitalization, once completed, included the following elements: (1) redemption of 754,950 shares of Regency common stock owned by Statesman; (2) payment of $1,020,000 to Statesman for the redeemed shares; (3) payment of an additional $2,730,000 "fee" to Statesman; (4) payment of $250,000 to Statesman in exchange for an option granting Regency the right to purchase Statesman's interest in one of Regency's subsidiaries; (5) transfer of office equipment and furniture to Statesman; and (6) modification of the promissory note Statesman delivered to Regency in October of 2001 when Statesman exercised its option to acquire 6.1 million shares of Regency stock. Royalty provided the money distributed to Statesman to Regency. Specifically, Royalty provided Regency with $4,750,000 in exchange for a $3,500,000, 5% convertible promissory note and a $1,250,000, 9% promissory note. The convertible note gave Royalty the right to acquire 1,750,000 shares of Regency common stock at $2.00 per share.
As part of the recapitalization, the members of Regency's board of directors resigned and were replaced by persons of Royalty's choosing. Defendants Levy, Neil Hasson, Stanley Fleishman, and Errol Glasser became Regency directors on October 28, 2002. Levy replaced Ponsoldt as president and CEO. Hasson replaced Baldinger as CFO.
Glasser is alleged to have had significant prior business dealings with Levy. What those dealings were is left unspecified.
Baldinger still serves as a consultant to the Company.
On November 8, 2002, Regency announced that Royalty partially exercised the convertible note and obtained 750,000 shares of common stock or approximately 38.45% of the outstanding shares. On the same day, plaintiff Graham sent a letter to the new Regency board requesting that Regency "`[s]eek a court order preventing the payment of any further compensation to William R. Ponsoldt, Sr.'" On November 12, 2002, the Regency board formed an independent committee consisting of defendants Glasser and Fleishman to evaluate Graham's request. The independent committee interviewed Levy and Baldinger in connection with its investigation. However, to date, the independent committee has not issued a report of any sort.
Compl. ¶ 92.
On July 3, 2003, Royalty converted the balance of the convertible note into Regency common stock and now holds approximately 59.31% of the outstanding common stock of Regency. The aggregate ownership interest of the Public Shareholders went from a majority interest of 62% to a combined minority interest of only about 40%.
On November 25, 2003, after the lifting of a procedurally defective order (arising out of the plaintiffs' federal action) barring the distribution of compensation to Ponsoldt, the Regency board paid Ponsoldt $820,105.32 (plus income tax withheld) to satisfy his claims for unpaid, accrued compensation. The federal action was dismissed on December 18, 2003 and plaintiffs initiated this proceeding shortly thereafter.
See Gatz v. Ponsoldt, 297 F. Supp. 2d 719 (D. Del. Nov. 7, 2003). The federal action was transferred from Nebraska to Delaware during those proceedings.
II. ANALYSIS
Plaintiffs have enumerated three counts in their complaint. In Count I, plaintiffs derivatively challenge what the complaint describes as "excessive compensation paid to Ponsoldt." In Count II, plaintiffs purport to directly challenge a series of transactions, including: (1) Statesman's exercise of its option to acquire 6.1 million shares of the common stock of Regency; (2) the sale of the Aggregate from one Regency subsidiary to another for $18,200,000; (3) the failure to disclose the timing of the monetization of Regency's interest in Security Land to the special committee; and (4) the recapitalization between Regency and Royalty. In Count III, plaintiffs charge Royalty, Royalty Management, and Levy with knowing participation in breaches of fiduciary duty relating to the recapitalization. I will address each count in turn.
Compl. ¶ 97.
A. Count I
Although labeled as a single count related to Ponsoldt's compensation, this claim actually involves two discrete acts — two years apart and authorized by two different Regency boards. The first payment for accrued compensation was made to Ponsoldt in October 2001 during the tenure of the old Regency board, i.e., the pre-recapitalization board. The second payment for accrued compensation was made to Ponsoldt in November 2003 — after plaintiff Graham sent a letter to the current, post-recapitalization board asking it to seek a court order preventing the payment of any further compensation to Ponsoldt. Plaintiffs' Rule 23.1 argument, as it appears to the Court, is that: (a) demand wrongfully was refused regarding the 2003 payment; and (b) demand was futile regarding the 2001 payment.
1. 2003 Payment
On November 8, 2002, Graham sent a letter self-styled as a "demand" to the current Regency board stating that Regency should "`[s]eek a court order preventing the payment of any further compensation to William R. Ponsoldt, Sr.'" The complaint does not reveal any other contents of the demand letter. Four days later, on November 12, Levy wrote to Graham and stated that the current Regency board created an independent committee, consisting of Glasser and Fleishman, to investigate the demand. The independent committee interviewed Levy and Baldinger. The independent committee has not issued, according to the complaint, a report regarding Graham's demand. The current Regency board, however, never sought the court order Graham requested and, on November 25, 2003 (over a year after the formation of the independent committee), authorized payment of over $800,000 to Ponsoldt to satisfy his claims for accrued compensation.
Id. ¶ 92.
It seems clear, however, that Graham's letter only requested action as to future payments, as the letter refers to "further compensation."
Under Rule 23.1, plaintiffs "must demonstrate either that no pre-suit demand was made because it would have been futile, or that a demand was made but wrongfully refused." As noted, plaintiffs argue that the Graham letter was a "demand" and that the demand wrongfully was refused. Plaintiffs are incorrect on both points.
Yaw v. Talley, 1994 Del. Ch. LEXIS 35, at *19 (Del.Ch. Mar. 2, 1994). Rule 23.1 pertinently provides: "The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and the reasons for his failure to obtain the action or for not making the effort." CH. CT. R. 23.1.
Former Vice Chancellor, now Justice, Jacobs, in reviewing the relevant precedents on the question of what constitutes a demand, stated:
[I]t is possible to distill three elements essential to a determination that a demand has been made. To constitute a demand, a communication must specifically state: (i) the identity of the alleged wrongdoers, (ii) the wrongdoing they allegedly perpetrated and the resultant injury to the corporation, and (iii) the legal action the shareholder wants the board to take on the corporation's behalf.
Yaw, 1994 Del. Ch. LEXIS 35, at *22-*23.
Without these three elements, a board cannot "perform its duty to make a good faith investigation of claims of alleged wrongdoing." Here, the Graham letter fails to provide the first two elements.
Id. at *23.
The current Regency board was asked to "`[s]eek a court order preventing the payment of any further compensation to William R. Ponsoldt, Sr.'" This is terminally vague for two reasons. First, the letter does not identify who was in the wrong. Second, the letter does not identify what the unspecified wrongdoers did. Given "the severe procedural consequences to a plaintiff found to have made a presuit demand," "ambiguous communications" are "construed against a finding of a demand."
Compl. ¶ 92.
Yaw, 1994 Del. Ch. LEXIS 35, at *24.
Even if I were to find that the one sentence request by Graham was a demand, plaintiffs have not adequately alleged that the demand wrongfully was refused. Plaintiffs, if they made a valid demand, "concede the independence of a majority of the board to respond." "[T]he only issues to be examined are the good faith and reasonableness of the investigation." Plaintiffs' complaint fails to plead with particularity that the investigation was done in bad faith or was unreasonable.
Speigel v. Buntrock, 571 A.2d 767, 777 (Del. 1990).
Id.
Plaintiffs point to three items as demonstrating the bad faith and unreasonableness of the independent committee's investigation. First, the complaint alleges that the independent committed "interviewed only Levy and Baldinger." This allegation falls short because "[i]n any investigation, the choice of people to interview or documents to review is one on which reasonable minds may differ." Second, the complaint alleges that the independent committee "never learned of the $100,000 payment made by Statesman to Craffey following the Recapitalization. . . ." The complaint fails to allege why this fact was material to an investigation into whether to seek an order preventing payment of accrued compensation due Ponsoldt. How can one fault an investigator for not being aware of irrelevant facts? Third, the complaint alleges that the independent committee "has not issued a report." But there is no authority that suggests that Delaware law requires a formal "report" as a matter of law — "there is obviously no prescribed procedure." And the complaint contains no allegations to suggest that the failure to draft a report in this circumstance rendered the investigation inadequate. In short, plaintiffs have not pled particularized facts that create a reasonable doubt that the independent committee conducted its investigation reasonably and in good faith.
Compl. ¶ 94.
Mt. Moriah Cemetery v. Moritz, 1991 Del. Ch. LEXIS 68, at *10-11 (Del.Ch. Apr. 4, 1991).
Compl. ¶ 94.
Id. ¶ 95.
Levine v. Smith, 591 A.2d 194, 214 (Del. 1991).
The independent committee could have easily concluded that the issue raised by Graham was so without merit that it did not justify a formal report, especially given the imprecise nature of Graham's letter. In addition, there is no indication that the findings of the independent committee were not communicated to the relevant persons even though not memorialized in a formal report.
Given that the plaintiffs' complaint is framed around the assumption that the November 8, 2003, letter by Graham constituted a demand and that Graham's "demand" was wrongfully refused, it is unsurprising that the complaint will not support a reading that that demand is futile. The complaint simply does not "allege with particularity" that the current Regency board is "incapable of making an impartial decision regarding" Ponsoldt's compensation. Although the complaint alleges that one of the members of the independent committee, Glasser, has had "significant prior business dealings with Levy," such a conclusory allegation does not demonstrate that Glasser has an inability to consider impartially issues related to potential transgressions involving Levy, let alone Ponsoldt.
Ch. Ct. R. 23.1.
Beam v. Stewart, 845 A.2d 1040, 1048 (Del. 2004).
Compl. ¶ 94.
See Stein v. Orloff, 1985 WL 11561, at *4 (Del.Ch. May 30, 1985) (naked allegation of business ties between board members does not rebut the presumption of independence).
2. 2001 Payment
Even if one were to consider the Graham letter a demand regarding "`further compensation,'" it clearly is not a demand regarding the $1.3 million payment made to Ponsoldt in 2001 during the old Regency board's reign. Rather, plaintiffs argue that demand was futile vis-à-vis the old Regency board and that the present lawsuit, initiated on January 20, 2004, should relate back to the federal litigation initiated in 2001 before the current Regency board undertook its duties. Support for this remarkable proposition supposedly is found in Harris v. Carter. Nothing in Harris supports plaintiffs' position, however.
Compl. ¶ 92.
582 A.2d 222 (Del.Ch. 1990).
Harris held that a plaintiff does not need to make demand before amending a complaint where an independent board comes into power after the time of the "challenged transaction" if the derivative claims relating to the challenged transaction were "validly in litigation" before the new board assumed control. Here, plaintiffs are not seeking to amend their complaint simply to add or to change claims that were currently pending in litigation. The federal litigation initiated by plaintiffs was dismissed in its entirety, after which there were no claims "validly in litigation." Harris is therefore inapplicable and the appropriate demand board is the current Regency board. As noted above, there are no particularized allegations creating a reasonable doubt as to the current Regency board's ability to make an impartial decision regarding Ponsoldt's compensation. B. Count II
Id. at 230.
Gatz v. Ponsoldt, 297 F. Supp. 2d 719 (D. Del. 2003).
See In re Fuqua Indus. Shareholder Litig., 1997 Del. Ch. LEXIS 72, at *51-*52 (Del.Ch. May 13, 1997) ("[W]hen the majority of the board is replaced between the challenged transaction and the filings of the first complaint, the appropriate demand board . . . is the board in existence when the first complaint is filed.").
Reading Harris as broadly as plaintiffs suggest would also undermine the policy reasons behind Rule 23.1 — protecting the right of a corporation to manage its own business and affairs.
Although grouped into a single count, Count II challenges four discrete transactions. Specifically, Count II challenges: (1) Statesman's exercise of its option to acquire 6.1 million shares of the common stock of Regency; (2) the sale of the Aggregate from one Regency subsidiary to another for $18,200,000; (3) the failure of Ponsoldt and Baldinger to disclose the timing of the monetization of Regency's interest in Security Land to the special committee; and (4) the recapitalization. Because Count II does not contain the demand futility allegations necessary for claims brought derivatively, the issue with respect to these transactions is whether plaintiffs may challenge them directly pursuant to Tooley v. Donaldson, Lufkin Jenrette, Inc. and Agostino v. Hicks. I will address each transaction in turn.
See CT. CH. R. 23.1.
845 A.2d 1031 (Del. 2004).
845 A.2d 1110 (Del.Ch. 2004).
1. 2001 Option Exercise
The complaint alleges "Ponsoldt and Statesman breached their fiduciary duties . . . by fraudulently exercising the option that allowed Statesman to acquire 6.1 million shares of the common stock of Regency." Supposedly, "[t]he exercise of the option was in direct contravention of Ponsoldt's representations that it would only be exercised to avoid a hostile takeover" and, as a result of the option exercise, the ownership interest of the Public Shareholders fell from 89.1% to 61.1%.
Compl. ¶ 101.
Id.
Plaintiffs do not challenge the granting of the option.
The Supreme Court's Tooley decision simplified the analysis required to distinguish between direct and derivative actions, discarding the old "special injury" test. The analysis now focuses on the following questions: "Who suffered the alleged harm — the corporation or the suing stockholder individually — and who would receive the benefit of the recovery or other remedy?" This inquiry requires the Court to look: "at the body of the complaint and considering the nature of the wrong alleged and the relief requested, has the plaintiff demonstrated that he or she can prevail without showing an injury to the corporation?"
Tooley, 845 A.2d at 1035.
Agostino, 845 A.2d at 1122. Under Tooley, the quoted language from Agostino "is helpful in analyzing the first prong of the analysis: what person or entity has suffered the alleged harm." Tooley, 845 A.2d at 1036. Tooley also found that "[t]he second prong of the analysis [who would benefit from the recovery] should logically follow." Id.
Thus, the relevant inquiry is "the nature of the wrong alleged, not merely . . . the form of words used in the complaint." "As this court recently said, `even after Tooley, a claim is not `direct' simply because it is pleaded that way. . . . Instead, the court must look to all the facts of the complaint and determine for itself whether a direct claim exists.'"
In re Syncor Int'l Corp. S'Holders Litig., 2004 Del. Ch. LEXIS 133, at *7-*8 (Del.Ch. Sept. 15, 2004) (citing Dieterich v. Harrer, 2004 Del. Ch. LEXIS 115, 2004, at *9 (Del.Ch. Aug. 3, 2004)).
Id.
Mere claims of dilution, without more, cannot convert a claim, traditionally understood as derivative, into a direct one. Clearly, a corporation is free to enter into (in good faith) numerous transactions, all of which may result legitimately in the dilution of the public float. Such dilution is a natural and necessary consequence of investing in a corporation. Once the options at issue in this case were granted, any restrictions on their exercise were created either by the terms of the option contract, or by the fiduciary duties the holder of the option may have to the corporation. The only cognizable injuries, if any, would be a failure to act in the best interest of Regency or the breach of the promise to Regency not to exercise the options. In either event, these alleged harms were inflicted upon the corporation itself and could be asserted only by or on behalf of the corporation. Naturally, any damages, rescissory or otherwise, would flow to the corporation as the aggrieved party, not the Public Shareholders. Applying the teaching of Tooley, I conclude that this portion of Count II states a derivative claim that must be dismissed for failure to comply with Rule 23.1.
See Tooley 845 A.2d at 1036-37 (citing with approval Elster v. American Airlines, Inc., 100 A.2d 219, 222 (Del.Ch. 1953)).
Because I ultimately concluded that this portion of Count II states a derivative claim and that plaintiffs fail to comply with Rule 23.1, I do not conclude here that Statesman in fact owed fiduciary duties to Regency.
2. The Aggregate Sale
The complaint alleges that the old Regency board and Statesman "breached their fiduciary duties . . . by effectuating a plan to sell the Aggregate to increase the Redemption Price and Liquidation Preference of the Series C Preferred Stock . . . to $18,200,000, thereby entitling the Series C Preferred Stock to preferential liquidation status over the shares owned by the Class." Defendants argue that any harm to plaintiffs would be a result of an improper book transaction between two Regency subsidiaries and that the remedy, i.e., non-recognition of the book transaction, would flow through Regency. Defendants' arguments are unpersuasive.
Compl. ¶ 103.
Generally, the value of the Public Shareholders stock is determined by the projected net present value of the cash streams Regency produces. The Series C Preferred Stock therefore directly connects the value of the public shares to the value of the liquidation rights prescribed, which in this case is useful to think of as a liability of Regency. When the Aggregate transaction was consummated, the overall value of Regency remained unaffected; it was, as the defendants contend, merely a book transaction. Thus, in light of Tooley, the corporation has suffered no harm. That is not to say, however, that no harm occurred. Because of Regency's Series C Preferred, the Public Shareholders are subrogated and the holders of the Series take first — the residual then accruing to the Public Shareholders. Whatever the Public Shareholders were entitled to take after the Series C holders, that amount was reduced by the increase to the Series C Preference, an amount affected by the Aggregate sale.
Acker v. Transurgical, Inc., 2004 Del. Ch. LEXIS 49, at *5 (Del.Ch. April 22, 2004) is instructive here. Decided after Agostino, Acker held that plaintiffs had stated a direct claim. Acker involved the reorganization of a corporation's capital structure to the benefit of one shareholder and the detriment of another. Two aspects of Acker should be noted. First, the reorganization was "a net wash from the Company's perspective." Second, the harm to the plaintiff flowed "from an alleged bias between . . . classes of stock." Id., at *5 n. 6. These two factors were important to the Court's determination that plaintiff had stated a direct claim.
At this stage of litigation it is not necessary to delve into the factors influencing the Aggregate sale. Suffice it to say, the insiders of Regency approved a transaction to the benefit of those insiders and to the detriment of the Public Shareholders. This inflicted harm upon the Public Shareholders directly and it is the Public Shareholders " who would receive the benefit of the . . . remedy," i.e., an unwinding of the transaction. Therefore, this portion of Count II states a direct claim.
Tooley, 845 A.2d at 1035 (emphasis added).
Appropriate to this conclusion is the fact that an unwinding of the transaction would not benefit the corporation, as the overall value of Regency would remain unchanged.
3. Non-disclosure of the "Monetization"
Plaintiffs next assert that "Ponsoldt and Baldinger breached their fiduciary duties by failing to disclose their beliefs regarding the timing of the monetization of the Security Land asset to the non-management members of the Regency Board, instead allowing the Board to proceed with its consideration of the Recapitalization." The only harm alleged to have flowed from the non-disclosure is that defendant Carey "had she known about the imminent `monetization' . . . would not have approved the Recapitalization." Based on this allegation, the injury suffered is indistinguishable from any alleged harm resulting from the recapitalization itself. As such, I will not analyze this alleged breach separately.
Compl. ¶ 105.
Id. ¶ 70.
4. The Recapitalization
The complaint alleges that the recapitalization was a transfer of control of Regency and that the Public Shareholders were "deprived of control of Regency without the payment of a control premium." The complaint also alleges that the purported class "was harmed because its ownership interest was diluted . . . from a majority of approximately 62% to a minority interest of only about 40% resulting in a "non-control position." The ensuing "cash-value of the harm" is estimated in plaintiffs' complaint "to be in excess of $20 million." From these allegations one can extract two harms: (1) the loss of a control premium and (2) share dilution. The first alleged injury is wholly illusory. The second is derivative.
Shortly after the October 2002 recapitalization, Royalty partially exercised its conversion rights and acquired 750,000 shares of Regency. Several months later, on July 3, 2003, Royalty fully exercised those rights and owned almost 60% of Regency's outstanding common stock. See Compl. ¶ 106.
Id. ¶ 107-08.
Id.
One of the few things that the complaint makes clear is that the ostensible class did not exercise control over Regency. For example, the second paragraph of the complaint alleges that Ponsoldt "use[d] his power to control the affairs of Regency. . . ." Two paragraphs later, the old Regency board is described as "hand-picked" and "beholden" to Ponsoldt. Further averments describe Ponsoldt as "causing" Regency to enter into various transactions. Allegedly, even the special committee investigating the recapitalization is purported to have had "extensive ties to Ponsoldt." Count II quite literally acknowledges that Ponsoldt and Statesman had "de facto control over Regency."
Id. ¶ 2.
Id. ¶ 4. See also id. ¶ 7 (describing payments made by Statesman to members of the old board).
Id. ¶¶ 33 37.
Id. ¶ 66.
Id. ¶ 100.
Notwithstanding plaintiffs' own allegations, they argue that before Royalty's exercise of the convertible note the Public Shareholders held a majority of Regency's outstanding common stock. This argument is flawed. Unless the majority actually exercises "the consequent privilege of exerting the powers of majority ownership," an aggregate of outstanding shares held by the public does not translate into a right to a control premium. Here, because of the restructuring, control shifted from Ponsoldt to Royalty. That is not the same as a shift from a fluid aggregate of public shares to a unitary holder. Thus, the Public Shareholders are not entitled to a control premium — they never controlled Regency.
Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34, 43 (Del. 1994).
Agostino 845 A.2d at 1124.
What I have said here disposes of plaintiffs' argument that they have stated a claim under Revlon, Inc. v. McAndrews Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). In In re Paxson Commun. Corp. S'Holders Litig., 2001 Del. Ch. LEXIS 95, at *22 (Del.Ch. July 10, 2001) this Court held that " Revlon does not apply where the plaintiffs cannot allege that a sale or change of control has taken place or necessarily will take place such that the Public Shareholders of a corporation have been or will be deprived of a control premium." There, as here, after the transaction at issue, "[t]he only difference would be the identity of [the] controlling shareholder." Id. Hence, Revlon is inapplicable.
Moving beyond the control premium question, plaintiffs allege that the exercise of the conversion rights prescribed in the note resulted in the dilution of the Public Shareholders position in Regency. As averred by plaintiffs, the restructuring included a loan (secured by a convertible note) from Royalty to Regency. In turn, Regency paid certain proceeds from that loan to Statesman. These interrelated transactions are characterized best as a financing transaction — one where Royalty, before lending money, required Regency to procure certain concessions from Statesman and the consideration demanded by Statesman to give those concessions.
Under the facts presented here, plaintiffs' stock devaluation, which resulted from the exercise of Royalty's conversion rights, "was the natural and expected consequence of the [alleged] injury initially borne by the company" and is not a direct shareholder harm. Therefore, without a viable dilution claim, it is appropriate to look beyond plaintiffs' pleading to discern the true nature of the harm allegedly caused by the restructuring. Clearly, this question turns on the following: What harm occurred from the exercise of the rights flowing from the convertible note. To answer quite simply, any resulting harm occurred only if the stock issued upon conversion did not represent the fair value of the loan to Regency. In this circumstance, Regency would be harmed by a bad bargain entered into on its behalf by the Regency board. To the extent that a bad bargain warrants relief, Regency would receive the benefit as a party to the contract. Count II, as it relates to the restructuring, pleads a derivative claim that must be dismissed for failure to comply with Rule 23.1.
Agostino, 845 A.2d at 1124.
See id. (questioning the adequacy of the consideration the Company received . . . [is] undoubtedly a derivative claim); see also id. at 1124n. 66 ("Mismanagement resulting in corporate waste, if proven, represents a direct wrong to the corporation that is indirectly experienced by all shareholders") (internal citation omitted).
Important to this conclusion is the distinction I draw between the facts presented here and the decision reached in Acker. See supra note 52.
C. Count III
Count III is directed towards Levy, Royalty, and Royalty Management (the "Levy defendants"). The Levy defendants are alleged to have aided and abetted the old Regency board and Statesman's breaches of fiduciary duty in connection with the recapitalization. As noted above, plaintiffs' claim with respect to the recapitalization is derivative and fails to comply with Rule 23.1. As a consequence, the antecedent aiding and abetting claim alleged in Count III necessarily fails.
See Manzo v. Rite Aid Corp., 2002 Del. Ch. LEXIS 147, at *21 (Del.Ch. Dec. 19, 2002), aff'd, Manzo v. Rite Aid Corp., 825 A.2d 239 (Del. 2003) (dismissing aiding and abetting fiduciary duty claim when underlying fiduciary duty claim was dismissed under Rule 23.1); In re Rexene Corp. S'holders Litig., 1991 Del. Ch. LEXIS 81, at *12-*13 (Del.Ch. May 8, 1991) (same).
III. CONCLUSION
For the reasons stated above, Count I is dismissed for failure to comply with Rule 23.1. Plaintiffs' claim regarding the 2001 sale of the aggregate may proceed as a direct claim, but Count II otherwise is dismissed for failure to comply with Rule 23.1. Count III is dismissed since its underpinning is the also dismissed breach of fiduciary duty claims regarding the recapitalization.IT IS SO ORDERED.