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stating "the directors of a constituent corporation whose shareholders are to vote on a proposed merger, have a fiduciary duty to disclose to the shareholders the available material facts that would enable them to make an informed decision, pre-merger, whether to accept the merger consideration or demand appraisal"
Summary of this case from Mehta v. Mobile Posse, Inc.Opinion
C.A. No. 16190.
Submitted: October 27, 1998.
Decided: February 9, 1999.
James L. Holzman and Ronald A. Brown, Jr., Esquires, of PRICKETT, JONES, ELLIOTT, KRISTOL SCHNEE, Wilmington, Delaware; and Frank P. DiPrima and David M. Hoffman, Esquires, of DIPRIMA HOFFMAN, Madison, New Jersey, Attorneys for Plaintiff.
Gregory V. Varallo and Russell C. Silberglied, Esquires, of RICHARDS, LAYTON FINGER, Wilmington, Delaware; and Michael S. Poulos and Jennifer A. Barrett, Esquires, of RUDNICK WOLFE, Chicago, Illinois, Attorneys for Defendant Joel E. Bernstein, M.D.
R. Judson Scaggs, Jr. and Christopher F. Carlton, Esquires, of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; and David J. Zott and Geoffrey M. Davis, Esquires, of KIRKLAND ELLIS, Chicago, Illinois, Attorneys for Defendants Currie, Ehmann, Penneys, Silverman, Pearl and Kuehn.
Henry N. Herndon, Jr. and Michael A. Weidinger, Esquires, of MORRIS, JAMES, HITCHENS WILLIAMS, Wilmington, Delaware; and Troy B. Froderman and Merritt L. Bingham, Esquires, of BRYAN CAVE LLP., Phoenix, Arizona, Attorneys for Defendant GenDerm Corporation.
Pending are two motions. The first is the defendants' motion to dismiss the three-count complaint in this action, which is brought individually and on behalf of a shareholder class. The second is the plaintiffs' motion for an order granting them partial summary judgment on Count One of their complaint. This case involves a challenge to a merger of GenDerm Corporation ("GenDerm") into a wholly owned subsidiary of Medicis Pharmaceutical Corporation ("Medicis") in December 1997. The plaintiffs' claim is that the merger was invalid because (i) GenDerm's shareholders did not receive material information regarding their right to seek an appraisal (Count One), (ii) the surviving corporation failed to comply with the statutory requirements for a certificate of merger (Count Two), and (iii) a former GenDerm director was involved in self-dealing transactions that diminished the corporation's worth (Count Three).
The class is said to consist of all GenDerm common stock holders and their successors in interest, transferees, and assigns who owned GenDerm common stock on December 3, 1997, excluding the defendants and their affiliates.
For the reasons discussed below, Counts Two and Three will be dismissed as to all defendants for failure to state a legally valid claim. Count One, which is found to state a valid claim against the former GenDerm directors, will be dismissed only as to the remaining defendants; and the plaintiff's motion for partial summary judgment on Count One will be denied.
I. BACKGROUND
A. The Parties
1. GenDerm and Medicis
Before it was acquired by Medicis in the merger, GenDerm was a nonpublic Delaware corporation that developed and marketed pharmaceutical products for topical application. GenDerm was founded in 1984 by Dr. Joel E. Bernstein ("Dr. Bernstein"), who served as Chairman of the Board from GenDerm's inception until December 1997. At the time of the merger, GenDerm had issued and outstanding 11, 545, 801 shares of common stock held by approximately 150 stockholders of record. On December 3, 1997, GenDerm was merged into Medicis, a Delaware corporation whose shares are publicly traded on NASDAQ.
Although GenDerm retained that name after the merger, for purposes of clarity the premerger entity is referred to as "GenDerm, " and the post-merger entity is referred to as "Medicis."
2. The Plaintiffs and the Director Defendants
The plaintiffs are former stockholders of GenDerm who together own 110,000 shares of GenDerm common stock. Both plaintiffs were cashed out in the merger. The individual defendants are the former directors of GenDerm, one of whom is Dr. Bernstein.
The GenDerm Board at the time of the merger consisted of Dr. Bernstein, Neal S. Penneys, James L. Currie, Frank A. Ehmann, Jeremy Silverman, and Laura Pearl. Dr. Bernstein is not related to the plaintiff Richard A. Bernstein.
B. The Merger
GenDerm entered into an agreement to merge with Medicis (the "Merger Agreement") on December 1, 1997. Under the Merger Agreement GenDerm's stockholders would receive, in exchange for each share of their GenDerm stock, $3.64 per share cash, plus the right to receive additional future contingent payments of up to $2.33 per share. The Merger Agreement also designated two of GenDerm's former directors, Dr. Bernstein and Jeremy Silverman, and a former officer, Henry Kuchn, to serve as Target Stockholder Representatives ("TSRs"). The duties of the TSRs involved coordinating the distribution of the merger consideration and answering questions posed by the GenDerm stockholders.
The plaintiffs contend that Mr. Kuehn is liable to them under Count One by reason of his position as a TSR. See infra note 28.
C. The Consent Solicitation Package
GenDerm's by-laws required that the merger be approved by a two-thirds shareholder vote. GenDerm's directors unanimously favored the merger and collectively owned enough shares to guarantee the merger's approval. Nonetheless, the board caused to be mailed to selected GenDerm shareholders a Consent Solicitation Package ("CSP") dated December 1, 1997. The plaintiffs, it appears, were not included among the recipients. The CSP included a two-page written consent form that stockholders were asked to sign; a copy of the Delaware appraisal statute, 8 Del. C. § 262; a copy of the Merger Agreement without disclosure schedules; and a Consent Solicitation Letter (the "Consent Letter").
The Consent Letter was addressed to "COMMON STOCKHOLDERS AND SERIES C PREFERRED STOCKHOLDERS OF GENDERM CORPORATION." The Consent Letter recipients were asked to sign and date the enclosed consent forms, which evidenced (i) the shareholders' approval of the Merger Agreement and of a proposed amendment to GenDerm's Certificate of Incorporation, and (ii) their waiver of certain merger-related rights — including the right to elect appraisal. The Consent Letter stated that "[t]he closing of the transaction is expected to occur on or about next Wednesday, December 3, 1997" and that "[g]iven the December 3 target date for the transaction, [the directors] . . . ask that you return your signed consent of stockholder immediately."
Emphasis in original.
The plaintiffs allege that they never received the CSP or any of the information it contained, or any other information that would inform their decision whether to accept the merger consideration or elect the appraisal remedy. The plaintiffs also point out that because the CSP mailing date (December 1, 1997) was only two days before the stated December 3, 1997 merger closing date, even those stockholders who did receive the CSP had, at most, one day to review its contents.
D. The Merger is Approved
On December 3, 1997, a majority of GenDerm's shareholders, most of whom were either directors or affiliated with members of GenDerm's board of directors, approved the GenDerm-Medicis merger by written consent in lieu of a meeting. On that same date, a Certificate of Merger was filed with the Delaware Secretary of State in accordance with 8 Del. C. § 251. As a consequence of the merger, GenDerm became a wholly owned subsidiary of Medicis.
In their complaint the plaintiffs allege that the Certificate of Merger was defective because it did not recite that the shareholders had approved the merger by written consent in accordance with 8 Del. C. § 228. On April 15, 1998, after this lawsuit was filed and in response to that claim, a certificate correcting that alleged "mistake" (the "Certificate of Correction") was filed with the Delaware Secretary of State.
E. The Notice of Appraisal Rights and the Transmittal Letter
On December 12, 1997, Medicis sent to each record holder of GenDerm stock a notice of the merger (the "Merger Notice") in accordance with 8 Del. C. § 262(b)(2). The Merger Notice informed each GenDerm shareholder that the Merger Agreement and the merger had been approved. The Merger Notice also included a copy of 8 Del. C. § 262, advised shareholders of their right to seek appraisal under that statute, and informed them that the merger had become effective on December 3, 1997.
Both the Merger Agreement and 8 Del. C. § 262 required Medicis to notify former stockholders of their appraisal rights under Delaware law. The Merger Agreement relevantly stated that:
Within ten days after the Effective Time, the Buyer [Medicis] and the Surviving Corporation [New GenDerm] shall notify each Target Stockholder as provided in Section 262(d)(2) of the Delaware Corporation Law."
Merger Agreement, § 2(e). 8 Del. C. § 262(d)(2) pertinently states that:
If the merger or consolidation was approved pursuant to § 228 or § 253 of this title, each constituent corporation, either before the effective date of the merger or consolidation or within 10 days thereafter, shall notify each of the holders of any class or series of stock of such constituent corporation who are entitled to appraisal rights of the approval of the merger or consolidation and that appraisal rights are available for any or all shares of such class or series of stock of such constituent corporation, and shall include in such notice a copy of this section; provided that, if the notice is given on or after the effective date of the merger or consolidation, such notice shall be given by the surviving or resulting corporation to all such holders of any class or series of stock of a constituent corporation that are entitled to appraisal rights.
As previously noted, the Merger Agreement designated Dr. Bernstein, and Messrs. Silverman and Kuchn as TSRs, who would receive and disburse the merger consideration from escrow accounts established for that purpose. To facilitate the distribution of the merger consideration, the TSRs sent a Transmittal Letter to all GenDerm stockholders. The Transmittal Letter — which was separate from and in addition to the Merger Notice disseminated by Medicis — (i) advised shareholders that the merger had been approved and described the merger consideration; (ii) explained that shareholders could receive the merger consideration by signing and returning the Transmittal Letter, and (iii) advised shareholders who had additional questions to contact the TSRs' counsel.
Importantly, both the Letter of Transmittal and the Merger Notice informed the GenDerm shareholders that by accepting the merger consideration, they would waive any rights to demand an appraisal of the fair value of their shares. The plaintiffs elected, however, to accept the merger consideration, and executed and returned the Transmittal Letters to the TSRs. Indeed, all of GenDerm's former stockholders elected to receive the merger consideration; none of them elected to pursue the appraisal remedy.
The Transmittal Letter stated, in bold-faced capital letters, that:
THE UNDERSIGNED UNDERSTANDS THAT (1) SUBMISSION OF THIS LETTER OF TRANSMITTAL TO THE TARGET STOCKHOLDERS REPRESENTATIVE CONSTITUTES A WAIVER OF HIS, HER OR ITS RIGHT TO DEMAND PAYMENT OF THE FAIR VALUE OF HIS, HER OR ITS SHARES PURSUANT TO SECTION 262 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE AND (2) IF HE, SHE OR IT HAS PREVIOUSLY FILED A DEMAND FOR APPRAISAL WITH RESPECT TO HIS, HER OR ITS SHARES, SUBMISSION OF THIS LETTER OF TRANSMITTAL TO THE TARGET STOCKHOLDERS REPRESENTATIVE CONSTITUTES A WITHDRAWAL OF SUCH DEMAND. THE UNDERSIGNED ACKNOWLEDGES THAT HE, SHE OR IT HAS RECEIVED A COPY OF SECTION 262 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE.
F. Dr. Bernstein's Alleged Self-Dealing Transactions
Count Three of the complaint alleges that Dr. Bernstein was involved in two self-dealing transactions. The first, which took place in connection with the merger, involved (a) the extension of a preexisting License Agreement with Medicis under which Dr. Bernstein received royalties for topical uses of Civamide, and (b) an alleged severance payment to Dr. Bernstein of $1,377,580 in cash.
Civamide is a patented compound that Dr. Bernstein invented. It is chemically related to capsaicin, the active ingredient in ZOSTRIX. Civamide is claimed to have significant potential in a cream for relief of pain from rheumatoid arthritis, osteoarthritis, painful diabetic neuropathy, post-herpetic neuralgia, muscle aches and pains, and certain pain resulting from cancer and pain following surgery. Civamide is also claimed to have potential for other non-topical uses, including intranasal and internal applications.
Under the License Agreement, Medicis agreed to pay Dr. Bernstein a sign-up fee of $75,000 within 30 days, another $75,000 within 18 months, another $500,000 within 30 days of FDA approval, and a 7% royalty for the life of a patent or for 10 years if no patent was issued. The License Agreement provided that if there were no sales of Civamide, Dr. Bernstein would still be guaranteed at least $4,450,000 over the next eight years, and that if Medicis failed to make those payments, Dr. Bernstein (through a privately owned entity) would obtain the ownership rights to Civamide.
The second transaction occurred several months before the merger, in June 1997. According to the complaint, Dr. Bernstein negotiated and approved the divestiture and sale of old GenDerm's European subsidiary, Euroderma Ltd. ("Euroderma"), a United Kingdom ("UK") Corporation, to Bioglan Ltd. ("Bioglan"), another UK corporation. Euroderma held the European rights to GenDerm's key products and marketed certain of those products in the UK. Present and future sales of GenDerm's products in the UK and elsewhere in Europe were subject to licenses calling for the payment of royalties to Dr. Bernstein or his privately owned and controlled entities. The plaintiffs allege that in addition to paying approximately $2 million to GenDerm for Euroderma, Bioglan agreed to extend certain of Dr. Bernstein's royalty rights for an additional six years. The plaintiffs claim that Dr. Bernstein sold Euroderma at a bargain basement price to obtain the six year extension of his royalty stream, and thereby breached his duty of loyalty to GenDerm.
The royalty rights, which allegedly would expire in the year 2002, were extended to approximately 2008.
II. TILE CONTENTIONS
The Complaint contains three counts. Count One alleges that the former directors of GenDerm (including Dr. Bernstein) failed to provide material information about GenDerm that would enable its stockholders to decide whether or not to execute a written consent approving the merger or demand appraisal. Specifically, the plaintiffs claim that they were not furnished basic financial information concerning GenDerm's business; information about business plans or recent or planned transactions or agreements; or any description of GenDerm's material products, pharmacological categories, or markets in which such products compete. That failure to disclose is said to constitute a breach of the former GenDerm directors' fiduciary duties of loyalty and disclosure, and to entitle the shareholder class to damages and an accounting in a "quasi-appraisal action" to determine GenDerm's fair value.
Count Two alleges that the merger itself was void or voidable, because the Certificate of Merger was by statute required to — but did not — recite that the shareholders had approved the merger by written consent in accordance with 8 Del. C. § 228. That statutory violation, the plaintiffs claim, entitles the shareholder class to compensatory and/or rescissory damages from Medicis.
Count Three alleges that Dr. Bernstein breached his fiduciary duties of loyalty to GenDerm by renegotiating the License Agreement and by selling GenDerm's UK subsidiary, Euroderma, on the terms described above. The plaintiffs claim also that GenDerm's former outside directors knowingly participated with Dr. Bernstein in those breaches of fiduciary duty.
All defendants have moved to dismiss the complaint. The plaintiffs oppose that motion and have moved for partial summary judgment on Count One.
Where appropriate, the defendants adopt each other's respective arguments.
* * *
Because the parties' lengthy (and oft-times repetitive) paper submissions were less than clear, the parties' positions needed to be, and eventually were, clarified at the October 27, 1998 oral argument. As a result of that clarification, it now appears that the former GenDerm directors contend that Count One is dismissable on the ground that Medicis and its directors — but not the former GenDerm directors — owed the former GenDerm shareholders statutory, contractual, and fiduciary duties to disclose material appraisal-related information. Medicis denies liability on the grounds that no claim is asserted against it in Count One, and that even if a claim is being asserted, the claim is dismissable because Medicis had no contractual, statutory, or fiduciary duty to disclose such information to GenDerm's shareholders. The plaintiffs claim that some party defendant — either GenDerm's former directors or Medicis — owed GenDerm's shareholders a duty to disclose material appraisal-related information, and that under either scenario Count One states a legally valid claim.
Nine separate briefs plus numerous letter submissions were filed with the Court in connection with these motions.
Medicis also argues that Count Two fails to state a legally cognizable claim, because 8 Del. C. § 251(c), the controlling statute, does not require certificates of merger to recite the details or mechanics of the approving shareholder vote. Specifically, Medicis contends that where a certificate of merger is filed, § 251(c) does not incorporate 8 Del. C. § 228(d)'s requirement of a statement that the merger was approved by written consent. Alternatively, Medicis argues that even if § 251(c) could be read to mandate that requirement, the April 1998 Certificate of Correction included such a statement, thereby curing any arguable defect in the original Certificate of Merger.
Finally, Dr. Bernstein contends that Count Three must be dismissed because it alleges derivative claims that, as a result of the merger, the plaintiffs no longer have standing to assert. The plaintiffs respond that Count Three alleges an individual (and class) claim, based on "the cash value dilution" theory announced in In re Tri-Star Pictures, Inc., Litig. ("Tri-Star").
Del. Supr., 634 A.2d 319 (1993).
These contentions are now addressed.
III. ANALYSIS
To prevail on a motion to dismiss under Court of Chancery Rule 12(b)(6), a plaintiff must allege facts that, when taken as true, establish each and every element of a claim upon which relief could be granted. A motion to dismiss "does not concede conclusory allegations of law or fact where there are no allegations of specific fact that would support such conclusions, " but rather "concedes only well pleaded allegations of fact." That is, while "all facts of the pleadings and reasonable inferences to be drawn therefrom are accepted as true . . . neither inferences nor conclusions of fact unsupported by allegations of specific facts upon which the inferences or conclusions rest are accepted as true." Each Count is analyzed under this well established standard.
Lewis v. Honeywell, Inc., Del. Ch., C.A. No. 8651, mem. op at 8, Jacobs, V.C. (July 28, 1987).
Id.
Grobow v. Perot, Del. Supr., 539 A.2d 180, 187 n. 6 (1988).
A. Motion To Dismiss Count One
For purposes of this motion, the Court assumes (as Count One alleges) that GenDerm's former shareholders did not receive all material information necessary to an informed decision on whether or not to elect their appraisal remedy. From that assumption two separate issues flow. The first is which party, GenDerm or Medicis — the "merging" or the surviving corporation — had the duty to disclose that material information. The second issue (which goes to the plaintiffs' motion for summary judgment) is whether the plaintiffs, by accepting the merger price, waived their statutory rights to elect appraisal and/or attack the merger on appraisal-related disclosure grounds.
1. Which Defendant Had The Disclosure Duty?
GenDerm's former directors argue that they had no contractual, statutory, or fiduciary duty to provide disclosure about appraisal rights to GenDerm's former shareholders, because that duty had shifted to Medicis. The reason, the former directors argue, is that Medicis had both a contractual duty (under the Merger Agreement) and a statutory duty (under 8 Del. C. § 262(d)) to provide "notice" of the appraisal action to GenDerm's former shareholders.
Medicis disagrees. It argues that GenDerm's former directors owed a fiduciary duty to disclose, pre-merger, material information to GenDerm's former shareholders, and that no contract or statute relieved the former directors of that duty. I conclude, for the following reasons, that Medicis is correct, and that the disclosure duty which Count One seeks to enforce fell exclusively to the former GenDerm directors.
The fiduciary duty of disclosure flows from the broader fiduciary duties of care and loyalty. That disclosure duty is triggered (inter alia) where directors (as GenDerm's former directors did here) present to stockholders for their consideration a transaction that requires them to cast a vote and/or make an investment decision, such as whether or not to accept a merger or demand appraisal. Stockholders confronted with that choice are entitled to disclosure of the available material facts needed to make such an informed decision. Specifically in the merger context, the directors of a constituent corporation whose shareholders are to vote on a proposed merger, have a fiduciary duty to disclose to the shareholders the available material facts that would enable them to make an informed decision, pre-merger, whether to accept the merger consideration or demand appraisal.
Cinerama, Inc. v. Technicolor, Inc., Del. Supr., 633 A.2d 1152, 1163 (1995); Zirn v. VLI Corp., Del. Supr., 621 A.2d 773, 778 (1993) ("Zirn I"). See generally, Lawrence A. Hamermesh, Calling Off the Lynch Mob: The Corporate Director's Fiduciary Disclosure Duty, 49 Vand. L. Rev. 1087 (1996).
Sealy Mattress Co. of New Jersey, Inc. v. Sealy, Inc., Del. Ch., 532 A.2d 1324, 1340 (1987) ("The defendants' duty of candor required them to provide the minority stockholders with sufficient information to enable them to make an informed, reasoned investment decision.").
See Sealy, 532 A.2d at 1340 (holding that defendant directors breached fiduciary duty plaintiffs because "plaintiffs should not be required to make . . . choices [between selecting a merger price or electing appraisal] in the informational vacuum into which the defendants have thrust them."); see also Zirn v. VLI Corp., Del. Supr., 681 A.2d 1050, 1059 (1996) ("Zirn II") (holding that majority stockholder seeking to complete short-form merger bears burden of disclosure of all material facts relevant to minority shareholder's decision whether to accept short-form merger consideration or seek an appraisal); Smith v. Shell Petroleum, Inc., Del. Ch., C.A. No. 8395, Hartnett, V.C. (Nov. 26, 1990), rehearing denied (Jan. 2, 1991),aff'd, Del. Supr., 606 A.2d 112, 114 (1992) (holding that majority shareholder must disclose all material facts relevant to minority shareholder's decision whether to accept merger consideration or seek appraisal); Seagraves v. Urstaft Property Co., Del. Ch., C.A. No. 10307, mem. op. at 12-13, Jacobs, V.C. (Apr. 1, 1996) ("Delaware law imposes a fiduciary obligation to disclose all material information that would affect a minority stockholder's decision whether to accept the merger consideration or to seek an appraisal or other available litigation remedy."); Nebel v. Southwest Bancorp, Inc., Del. Ch., C.A. No. 13618, mem. op. at 9, Jacobs, V.C. (July 5, 1995) ("The defendants' duty was to disclose all facts material to the minority stockholders' decision whether to accept the short form merger consideration or seek an appraisal.").
Where, as here, the directors own sufficient stock to control the outcome of that vote, the case for the application of fiduciary disclosure standards is even more compelling. Sealy, 532 A.2d at 1338;Wachts v. Continental Hosts, Ltd., Del. Ch., C.A. No. 7954, Berger, V.C. (April 11, 1986).
GenDerm's former directors do not dispute that they had that disclosure duty at one point in time. What they argue is that in this case the duty was shifted from themselves to Medicis by operation of statute and contract. They point to 8 Del. C. § 262(d)(2), which provides that "if [appraisal] notice is given on or after the effective date of the merger or consolidation, such notice shall be given by the surviving or resulting corporation." That language, the former directors claim, shifted the disclosure duty to the surviving corporation (Medicis). To buttress their position, the former directors also rely' upon the descriptive language in Arnold v. Society for Sav. Bancorp, Inc. ("Arnold") that "[t]he duty of disclosure is a judicially imposed fiduciary duty which applies as a corollary to the statutory requirements."
Del. Supr., 678 A.2d 533, 537 (1996) (emphasis added); see also Stroud v. Grace, Del. Supr., 606 A.2d 75, 87 (1992).
The former directors advance a similar, parallel argument based upon the Merger Agreement. They contend that because that Agreement fixes upon Medicis the responsibility to notify GenDerm's former stockholders of their appraisal rights under 8 Del. C. § 262, that responsibility also imposed upon Medicis a concomitant ("corollary") duty to disclose, in connection with that notice, all facts material to a shareholder decision whether to exercise those rights. That is, the former directors argue that Medicis' limited duty under the contract (and the statute) to provide appraisal notice became enlarged so as to encompass a broader duty to disclose all material information relating to the merits of the merger.
The Merger Agreement provided that: "Within ten days of the Effective Time, the Buyer [Medicis] and the Surviving Corporation [New GenDerm] shall notify each Target Stockholder as provided in Section 262 (d)(2) of the Delaware Corporation Law."
That is, the former directors now take the position that although these statutory and contractual provisions themselves literally required only a narrow, specific kind of disclosure, those provisions had the "corollary" legal effect of imposing on Medicis a broader duty to make disclosures that were coextensive with the fiduciary duty of disclosure. As a consequence, the former directors conclude, they were relieved of any fiduciary duty of disclosure they otherwise might have owed to GenDerm's stockholders.
Medicis responds that this argument finds no basis in any statute, contract, or common law principle; and that it (Medicis) never owed any such all-inclusive disclosure obligation to the GenDerm former shareholders. Indeed, as Medicis points out, Count One does not even charge Medicis with a disclosure violation, and advances the disclosure claim only against the former directors. Medicis contends that (i) its only disclosure duty was imposed by the Merger Agreement and consisted of the limited obligation to provide notice of the appraisal fights prescribed by 262(d)(2); and (ii) there is no claim that Medicis did not provide such notice. Medicis also contends that it had no fiduciary or other relationship with GenDerm's former shareholders that could have given rise to any broader disclosure obligation. Finally, Medicis argues that the fiduciary duty of disclosure owed to GenDerm's former shareholders could only be owed by fiduciaries — GenDerm's former directors. The duty could not be, and was not, owed by Medicis because Medicis never occupied a fiduciary relationship to the former shareholders.
Nevertheless, the plaintiffs argue that Medicis is potentially liable under Count One.
Medicis' arguments are correct. Count One charges only GenDerm's former directors — not Medicis — with having failed to provide shareholders with information that would have been material to their investment decision. Delaware law imposed upon the GenDerm directors a fiduciary duty to provide that information. Statutory and contractual provisions that required the surviving corporation (Medicis) to give notice of appraisal rights after the merger could not diminish or extinguish the bedrock fiduciary duties that the former directors owed to the shareholder plaintiffs before the merger when shareholder approval was being sought.
See Sealy, 532 A.2d at 1340.
Nor does the plaintiffs' claim that the appraisal statute and the Merger Agreement imposed a fiduciary disclosure obligation upon Medicis find any basis in law. The plaintiffs' reliance on Shell Petroleum, Inc. v. Smith is misplaced. Shell holds that a parent corporation owes fiduciary duties to its subsidiary's minority shareholders only where it is the majority shareholder of the subsidiary. Our Supreme Court so recognized in Arnold:
Arnold, 678 A.2d at 539; Gaffin v. Teledyne, Del. Ch., CA. No. 5786, mem. op. at 6, Hartnett, V.C. (Oct. 9, 1987), rev'd on other grounds, Del. Supr., 611 A.2d 467 (1992) ("liability for breach of a director's fiduciary obligation cannot run against the corporation itself"); Emerald Partners v. Berlin, Del. Ch., C.A. No. 9700, mem. op. at 20, Steele, V.C. (Sept. 22, 1995) (the "corporation itself is not liable for a breach of fiduciary duties by its directors").
Del. Supr., 606 A.2d 112 (1992) ("Shell Petroleum").
Id. at 113; see also Zirn II, 681 A.2d at 1059; Bershad v. Curtiss-Wright Corp., Del. Supr., 535 A.2d 840, 845 (1987); Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 703 (1983).
Shell Petroleum does not support the imposition of liability on an unaffiliated third party simply because that party participates substantially in the preparation of disclosure materials. Holdings was a majority stockholder attempting to squeeze out the minority shareholders of Shell. As such, it directly owed fiduciary duties to these stockholders.
Arnold, 678 A.2d at 541.
Because the plaintiffs do not allege that Medicis was a majority or controlling stockholder of GenDerm, no valid claim that Medicis owed fiduciary duties to GenDerm's former shareholders, is stated.
The former directors also contend that at the time the disclosures were required to be made (i.e., after the merger), their fiduciary relationship and any duties flowing therefrom had ceased to exist because they were no longer directors. That argument is unresponsive, because the plaintiffs do not base their claim upon alleged deficiencies in the post-merger appraisal notice. Rather, the plaintiffs allege that the former directors failed to provide material information before the vote on the merger, at which time the directors did have a fiduciary duty of disclosure.
In summary, I conclude that Count One states a cognizable claim against the GenDerm former directors, but not against the remaining defendants. Accordingly, Count One will be dismissed as to all defendants except GenDerm's former directors.
The plaintiff also contends that even though defendant Kuehn, one of the TSRs, was not a director of GenDerm, he was a fiduciary to the GenDerm shareholders in his capacity as a TSR, and thus had a parallel duty of disclosure. I disagree. The complaint levels no allegations against Mr. Kuchn in his capacity as a TSR. Nor does it claim that the TSRs owed or breached any fiduciary duty of disclosure to the shareholders. In any event, Mr. Kuchn owed no fiduciary duty of disclosure in that capacity, because the TSRs' duties under the Merger Agreement did not include any duty of disclosure.
2. Did The Plaintiffs Make An Informed Waiver?
The second Count One-related issue implicates the plaintiffs' motion for partial summary judgment. The defendants argue that by accepting the merger consideration, the plaintiffs waived their appraisal rights and their right to challenge the validity of the merger. In response, the plaintiffs contend that they waived no rights, because as a matter of law the "waiver" was not fully informed. The reason, they urge, is that they were not provided sufficient information to make an informed waiver. Therefore, plaintiffs conclude, the Court should deny the motion to dismiss Count One, and should grant their motion for partial summary judgment on that Count.
Our case law recognizes that a stockholder who surrenders his shares in a merger and accepts the merger consideration and the other benefits of the merger, will be deemed to have waived his right to seek appraisal or otherwise to challenge the transaction, provided that the decision to accept the merger was fully informed. The question presented here is whether the undisputed facts are sufficient to establish as a matter of law that the plaintiffs were not fully informed when they elected to accept the merger consideration.
Bershad, 535 A.2d at 848 ("when an informed minority shareholder either votes in favor of the merger, or . . . accepts the benefits of the transaction, he or she cannot thereafter attack its fairness");Iseman v. Liquid Air Corp., Del. Ch., CA. No. 9694, mem. op. at 4, Berger, V.C. (Feb. 11, 1993) (only "where an informed minority stockholder accepts the offered merger consideration [may] he or she . . . not later challenge the transaction"); Siegman v. Columbia Pictures Entertainment, Inc., Del. Ch., C.A. No. 11152, mem. op. at 16-21, Hartnett, V.C. (Jan. 12, 1993) (holding that "[t]he prohibition against the right to continue to maintain a suit . . . expressly applies only to an informed minority shareholder who voted for the merger or surrendered his shares").
Summary judgment is appropriate where the moving party can demonstrate that there are no genuine issues of material fact and that the moving party is entitled to judgment as a matter of law. On a motion for summary judgment the Court must treat all facts in the light most favorable to the non-moving party (here, the former GenDerm directors) and it must deny summary judgment where "there is any reasonable hypothesis by which the opposing party may recover, or if there is a dispute as to a material fact or inferences to be drawn therefrom." Summary judgment may also be denied if the court, upon reviewing the record, determines that "it is more desirable to inquire into or develop more thoroughly the facts in order to clarify application of the law to the circumstances."
Court of Chancery Rule 56(c).
Arnold, 678 A.2d at 535.
Seagraves, supra note 18, at 7; Smith v. Wallace, Del. Supr., 701 A.2d 86, 89-90 (1997) (involving record that was ambiguous over plaintiffs knowledge of material facts and the timing thereof); In re Asbestos Litig., Del Supr., 673 A.2d 159, 163 (1996) (finding summary judgment inappropriate when material factual disputes exist regarding party's knowledge).
Mentor Graphics Corp. v. Quickturn Design Systems, Inc., Del. Ch., C.A. No. 16584, 16588, mem. op. at 7, Jacobs, V.C. (Oct. 9, 1998).
The former directors argue that the record on this issue involves disputed fact questions. They contend that the plaintiffs received GenDerm's most recent financial statements shortly before the merger. They also point out that plaintiff Bernstein and GenDerm's former president and CEO, Mr. DiPrima, had a longstanding relationship that was a potential channel for plaintiffs to have private access to information about GenDerm's pre-merger financial status. The defendants underscore that both plaintiffs signed consent forms that expressly and pointedly told them that signing the consents would operate as a waiver of appraisal rights, and that the plaintiffs then accepted the merger consideration. Lastly, the defendants point out that although the Letter of Transmittal invited the recipients to call a telephone number if they needed more information, the plaintiffs did not do so. These facts, the defendants argue, create sufficient reason to doubt the plaintiffs' professions of ignorance of GenDerm's pre-merger financial condition, and preclude the entry of judgment as a matter of law.
I agree that a grant of summary judgment would be imprudent. Further discovery is needed to flesh out what specific facts the plaintiffs knew or had available to them when they decided to accept the merger consideration. Because the present record on that issue is not adequate, the plaintiffs' motion for partial summary judgment on Count One will be denied.
B. Motion to Dismiss Count Two
On December 3, 1997, Medicis filed, as 8 Del. C. § 251(c) required, a Certificate of Merger that included the following recital:
An Agreement of Merger (the "Merger Agreement") has been approved, adopted, certified, executed and acknowledged by each constituent corporation and Medicis Corporation (that parent of the Transitory Subsidiary) in accordance with the requirements of Section 251 of the General Corporation Law of the State of Delaware.
The plaintiffs contend that the Certificate of Merger failed to comply with the statutory requirement set forth in 8 Del. C. § 228(d), that:
In the event that the action which is consented to is such as would have required the filing of a certificate under any other section of this Title, if such action had been voted on by stockholders or by members at a meeting thereof, the certificate filed under such other section shall state, in lieu of any statement required by such section concerning any vote of stockholders or members, that written consent has been given in accordance with this section.
Specifically, the plaintiffs argue as follows: § 251(c) mandates that a Certificate of Merger must include a statement concerning the shareholders' approving vote. Section 228(d) requires that whenever a statute requires a statement concerning a shareholder vote and where that vote is accomplished by written consent, the fact that the approval was by written consent must be included in the required statement. Plaintiffs argue that those two statutory requirements, when read together, compel the conclusion that the statement required by § 228 must be included in a certificate of merger executed and filed under § 251(c). Accordingly, plaintiffs conclude, because Medicis failed to state in the Certificate of Merger that the merger was approved by written shareholder consent in accordance with § 228(d), the merger was a legal nullity.
Medicis argues that this claim is dismissable because (i) § 251(c) does not require "any statement . . . concerning any vote of stockholders or members" in a certificate of merger; (ii) accordingly, § 228 did not, in this case, require a recital in the Certificate of Merger a recital that the shareholders approved the merger by written consent; and (iii) therefore, Count Two fails to state a legally valid claim. Alternatively, Medicis argues that, in any event, the filing of the Certificate of Correction in April 1998 pursuant to § 103(f) retroactively cured any arguable deficiency in the original Certificate of Merger.
For present purposes, it is unnecessary for the Court to address the parties' statutory construction arguments, because the Certificate of Correction added to the Certificate of Merger the language that the plaintiffs claim was required by § 251(c) and § 228(d). Accordingly, the sole issue to be decided whether the Certificate of Correction cured the alleged defect. I find that it did.
Under 8 Del. C. § 103(f), a corporation may correct any inaccurate or defectively executed instrument authorized under the Delaware General Corporation Law to be filed with the Delaware Secretary of State. That section also provides that the correction will operate retroactively to the date of the original certificate, except as to persons who would be "substantially and adversely" affected by the correction. The complaint does not allege that any persons have been or would be adversely affected by the Certificate of Correction that Medicis filed on April 15, 1998. Therefore, assuming without deciding that the originally-filed Certificate of Merger was defective, the Certificate of Correction operated to cure any defect and mooted the invalidity claim set forth in Count Two.
The statute reads in relevant part that:
Whenever any instrument authorized to be filed with the Secretary of State under any provision of this title, has been so filed and is an inaccurate record of the corporate action therein referred to, or was defectively or erroneously executed, sealed or acknowledged, the instrument may be corrected by filing with the Secretary of State a certificate of correction of the instrument which shall be executed, acknowledged and filed in accordance with this section. The certificate of correction shall specify the inaccuracy or defect to be corrected and shall set forth the portion of the instrument in corrected form. . . . An instrument corrected in accordance with this section shall be effective as of the date the original instrument was filed, except as to those persons who are substantially and adversely affected by the correction and as to those persons the instrument as corrected shall be effective from the filing of date.8 Del. C. § 103(f).
8 Del. C. § 103(f); See also Siegman v. Palomar Medical Technologies, Del. Ch., C.A. No. 15894, mem. op. at 11-15, Jacobs, V.C. (Mar. 9, 1998).
C. Motion to Dismiss Count Three
Count Three of the complaint alleges that Dr. Bernstein mismanaged and wasted GenDerm's assets in connection with both the sale of Euroderma (GenDerm's UK subsidiary), and the License Agreement for Civamide. Dr. Bernstein contends that these claims belonged solely to GenDerm, and that the plaintiffs lost standing to maintain them derivatively by reason of the merger between GenDerm and Medicis. I concur.
The plaintiffs maintain that all former outside directors are liable under Count Three. Because this Court finds that Count Three's claims are derivative, the plaintiffs lack standing to pursue them, and Count Three will be dismissed as to all director defendants including the former outside directors.
See Lewis v. Anderson, Del. Supr., 477 A.2d 1040, 1049 (1984).
Once a plaintiff who sues derivatively on behalf of a corporation is no longer a shareholder, "whether by reason of a merger or for any other reason, [he or she] loses standing to continue a derivative suit." The plaintiffs contend that Count Three states an individual (and not a derivative) claim, for which reason they continue to have standing to maintain the action.
Id. at 1049; In re First Interstate Bancorp Consolidated Shareholder Litig., Del. Ch., C.A. No. 14623, mem. op. at 29, Lamb, V.C. (October 7, 1998); 8 Del. C. § 327 (derivative stockholder must be stockholder at time of alleged wrong and throughout the course of litigation). See also Kramer v. Western Pac. Indus., Inc., Del. Supr., 546 A.2d 348, 351 (1988); Parnes v. Bally Entertainment Corp., Del. Ch., C.A. No. 15192, mem. op. at 5, Chandler, C. (Feb. 3, 1998) ("Absent a showing that the injury was a direct harm to the shareholder and independent of any wrong suffered by the corporation, plaintiff may not proceed with an individual claim.") rev'd on other grounds, Del. Supr., A 2d___ C.A. No. 85, 1998, Berger, J. (Jan. 25, 1999).
Whether or not a claim is individual turns on the existence of direct or "special" injury to the plaintiff stockholder. A special injury occurs when either the plaintiff has suffered a wrong that was not suffered by all other stockholders generally, or where the wrong involves contractual stockholder rights, such as the right to vote. If neither of these prongs is satisfied, the claim is regarded as derivative, not direct.
First Interstate, supra note 38, at 13; Kramer, 546 A.2d at 351.
Tri-Star, 634 A.2d at 330.
Katell v. Morgan Stanley Group, Inc., Del. Ch., C.A. No. 12343, mem. op. at 7, Chandler, V.C. (Jan. 14, 1993); Kramer, 546 A.2d at 352 (citations omitted) (to determine whether the claim is derivative or individual in nature, the Court must look to "the nature of the wrong alleged and the relief, if any, which could result if plaintiff were to prevail, " and to "the body of the complaint, not to the Plaintiff's designation or stated intention.").
As our Supreme Court recently recognized in Parnes v. Bally Entertainment Corporation ("Parnes"), a thin grey line often marks the difference between derivative and individual claims that arise in the merger context. Parnes holds that "[i]n order to state a direct claim with respect to a merger, a stockholder must challenge the validity of the merger itself, usually by charging the directors with breaches of fiduciary duty resulting in unfair dealing and/or unfair price." On the other hand, challenges to alleged wrongs that areassociated with the merger but do not involve a challenge to the validity of the merger itself, are derivative claims." Parnes exemplifies the distinction. There, the plaintiffs directly challenged the fairness of the process and price in a merger between Bally Corporation and Hilton Hotels Corporation. Rally's CEO and Chairman, had allegedly demanded that any potential acquiror would have to obtain his consent, and pay him substantial sums of money (and valuable Rally assets), to obtain his approval of any merger. The complaint alleged that the CEO had breached his fiduciary duty of loyalty by so preferring his interests over those of Rally and its stockholders; and that Rally's other directors had acquiesced in these self-interested actions by approving a merger that involved side payments to the CEO with a resulting unfair merger price paid to Rally shareholders. The Supreme Court concluded that the plaintiff had stated a direct claim because the complaint alleged that the merger price was unfair and had resulted from unfair dealing.
Del. Supr., ___ A.2d ,___ C.A. No. 85, 1998, mem. op. at 4, Berger, J. (Jan. 25, 1999) (noting the difficulty in determining "whether a stockholder is challenging the merger itself, or alleged wrongs associated with the merger, such as the award of golden parachute employment contracts.").
Parnes, supra note 38, at 6.
Id.; see Kramer, 546 A.2d at 350 (finding as derivative a claim that alleged corporations' directors breached their fiduciary duties by "diverting to themselves eleven million dollars . . . of sale proceeds through their receipt of stock options and golden parachutes and incurring eighteen million dollars of excessive or unnecessary fees and expenses in connection with the sale of Western Pacific.").
Id. at 9.
In this case, the plaintiffs contend that because Dr. Bernstein's wrongful actions did not affect all GenDerm shareholders equally, their claims are not derivative and, thus, were not extinguished by the merger. Plaintiffs rest their argument on the cash value dilution concept articulated in In re Tri-Star Pictures, Inc., Litig. ("Tri-Star") They claim that Dr. Bernstein, the shareholder who received the exclusive benefit from the extension of the License Agreement and the sale of Euroderma, caused a cash value dilution of the shares owned by GenDerm's other shareholders (i.e., the class). Plaintiffs argue that the challenged transactions directly diverted to Dr. Bernstein, value that all remaining shareholders would (absent any wrongdoing) have received. In essence, the plaintiffs argue that in a merger, where a significant stockholder enters into a related transaction with the corporation for no or inadequate consideration that involves that stockholder receiving value that is not shared with the remaining shareholders, the resulting "cash value dilution" may be challenged in an individual claim.
Del.Supr., 634 A.2d 319 (1993).
The plaintiffs misread Tri-Star. Their effort to characterize their claim as direct by forcing it into the Tri-Star "cash value dilution" mold, fails for two reasons. First, in challenging the Bernstein transactions, the plaintiffs have not (as Parnes requires) "question[ed] the fairness of the price offered in the merger or the manner in which the agreement was negotiated." All the plaintiffs have alleged (in the language of Parnes) is
Parnes, supra note 38, at 5.
a claim alleging corporate mismanagement, and a resulting drop in the value of the company's stock . . . is a classic derivative claim; the alleged wrong harms the corporation directly and all of its stockholders indirectly. . . . [T]hat such a claim is asserted in the context of a merger does not change its fundamental nature.
Id. at 6; see also Kramer, 546 A.2d at 353 ("[W]here a plaintiff shareholder claims that the value of his stock will deteriorate and that the value of his proportionate share of the stock will be decreased as a result of the alleged director mismanagement, his cause of action is derivative in nature.").
Second, the pleaded facts do not square with the cash value dilution concept described in Tri-Star. There, the plaintiffs, who were former minority shareholders of Tri-Star Pictures, Inc. ("Tri-Star"), challenged a transaction between Tri-Star and Coca-Cola Company ("Coca-Cola"), a 36.8% stockholder, wherein Coca-Cola's entertainment division assets were sold to Tri-Star in exchange for Tri-Star stock. Before the transaction, the Tri-Star public stockholders owned 43.4% of Tri-Star's common voting stock. The complaint alleged that Coca-Cola (and significant stockholders allied with it) had wrongfully manipulated the transaction so as to cause Coca-Cola to receive excessive Tri-Star shares in exchange for Coca-Cola assets having a lesser value. As a result, Coca-Cola obtained an 80% controlling stock interest, and the public shareholders ended up with a 20% stock interest, and a corresponding dilution of the asset value of that stock interest.
Id.
Id. at 330-31.
The Tri-Star plaintiffs argued that the assets-for-stock transaction diluted not only the cash value of their Tri-Star shares, but also their percentage ownership of the company, thereby leaving them with diluted voting power as well. Because Coca-Cola did not suffer a similar dilution, the Tri-Star plaintiffs argued, they had suffered a special injury not shared equally by all shareholders, that rendered their claim individual in nature. The Supreme Court agreed, holding that "although . . . claims of waste are derivative, a claim of stock dilution and a corresponding reduction in a stockholder's voting power is an individual claim."
Id. at 330.
Tri-Star, 634 A.2d at 330.
Id. (emphasis added).
In this case, the plaintiffs' cash value dilution claim is legally insufficient because such a claim, in my view, arises only in transactions where a significant stockholder sells its assets to the corporation in exchange for the corporation's stock, and influences the transaction terms so that the result is (i) a decrease (or "dilution") of the asset value and voting power of the stock held by the public stockholders and (ii) a corresponding increase (or benefit) to the shares held by the significant stockholder. The complaint here does not plead a transaction of that kind. It alleges a waste of corporate funds, which is classically derivative. Because that claim was extinguished by the merger, the plaintiffs no longer have standing to maintain Count Three, and that Count must be dismissed.
Parnes, supra note 38, at 4.
IV. CONCLUSION
For the foregoing reasons, the motion to dismiss Count Two and Three of the complaint is granted. The defendants' motion to dismiss Count One is denied as to the former GenDerm directors, and is granted as to all other defendants. The Plaintiffs' motion for partial summary judgment is denied. IT IS SO ORDERED.