Jesse Small v. Monty J. Bennett (Cir. Ct. Balto. City)

Filed:  February 5, 2018

Opinion by:  Pamela J. White

Holding:  Demand for attorney's fees and costs incurred prior to the mooting of a shareholder derivative suit (1) failed to satisfy the requirements of the "corporate benefit rule" because the suit was frivolous and causally unrelated to the corporate benefit in question, and (2) failed to meet the requirements for a discretionary award under Maryland Rule 2-703.

Facts:  Defendants are a Texas-based publicly traded real estate investment trust ("Company"), the management group that conducts Company's day-to-day business affairs ("Advisor"), and Company's managing board ("Directors").

Company became a publicly traded corporation in late 2013 and soon entered into an advisory agreement engaging Advisor to perform management functions.  In mid 2015, concerned about a hostile takeover, Directors adopted a poison pill in the form of an amended advisory agreement; one which would impose an onerous termination fee payable by Company to Advisor upon a change in control or termination of the agreement by either side.

Displeasure over the termination fee's size and triggering mechanism was swiftly communicated by a minority shareholder ("Minority") who commenced derivative suits in early 2016.   Minority sued first in Maryland and weeks later in Texas, alleging breach of fiduciary duty for failing to approve candidates for a proxy battle and adopting a termination fee that threatened to reduce the firm's current equity by 50% in the event of a change in control.  Minority was ultimately unable to overcome the business judgment rule presumption and suffered the dismissal of all claims in February 2016.

Though they prevailed in their suit against Minority, Directors were not deaf to the rising noise of discontent.  Between February and April 2016, Directors established a committee to explore negotiation of a termination fee reduction.  Insufficiently placated by the measure, Plaintiff, a separately situated shareholder ("Shareholder") entered the scene and served a demand letter on Directors in April mirroring the claims made by Minority and requesting an investigation and recommendation on the merits of litigation.  

By that time, the record confirmed much of Advisor's and Directors' energies to be centered on the termination fee provision.  Independent directors of Company and Advisor began negotiations and  drafted revisions to the advisory agreement.  An unsolicited takeover offer received Directors' favorable attention and protracted discussions regarding the import and impact of the termination fee.  Directors retained outside counsel to conduct Shareholder's demanded investigation and to report findings at the upcoming December 2016 board meeting.

Directors described these events in several letters to Shareholder between April and October, but Shareholder considered his demand as having been refused.  In October 2016, Shareholder filed a derivative complaint in the Circuit Court for Baltimore City largely regurgitating the content and form of Minority's prior suits: naming the same defendants (Company, Advisor, and Directors) and alleging breach of fiduciary duty with focus on the "unconscionable" fee provision.

Meanwhile, negotiations over the fee provision continued into 2017.  In January, Company's independent directors approved and recommended the amended advisory agreement.  In June 2017 at Company's annual shareholder meeting, shareholders approved the amended advisory agreement which softened its termination fee calculation and trigger mechanism.

That approval served to moot Shareholder's derivative suit; however, arguing that his litigation had led directly to substantial and valuable benefit for Company's shareholders, Shareholder moved for an award in the amount of attorneys' fees and expenses.

Analysis:  The court began by outlining the standard for an award of discretionary fees according to the corporate benefit doctrine, which required Shareholder to demonstrate three elements: (a) that his suit was meritorious when filed, (b) that Directors' action to benefit the corporation was taken prior to judicial resolution, and (c) that the corporate benefit was causally related to the suit.

To the first, the court examined whether Shareholder's suit would have survived the motion to dismiss - and were left wanting.  Shareholder neglected to allege sufficient facts in his complaint to show that Directors had failed to act in accordance with the Business Judgment Rule or made anything other than good faith, informed business decisions.

To the third, the court's examination of the chronology of events led to a finding that neither the termination fee negotiations nor subsequent approval had been causally related to Shareholder's demand letter or threat of litigation.  Instead, the train of activity as to challenging and rectifying the termination fee and trigger mechanisms had already left the station following Minority's suit - and months prior to Shareholder's involvement by demanding an investigation or filing the instant litigation.  Finding insufficient support for the required elements, the court determined Shareholder's litigation to have yielded no corporate benefit.

The court finally turned to Maryland Rule 2-703 which might have permitted a discretionary award in consideration of factors such as (a) time and labor required, (b) novelty and difficulty of questions raised, (c) legal skills required,... (e) customary fees for such services, (f) contingent or fixed fee agreement, (g) time-limiting circumstances,... or (i) experience and ability of counsel, among other factors.  Even had Shareholder been able to meet his burden to show a corporate benefit, his neglect to support the 2-703 showing with sufficient evidence about any of the recited factors and inability to explain or justify the difference between an initial demand for $565,000 and an amended demand for $272,347 were fatal to a request for a discretionary award.

Accordingly, the court denied Shareholder's motion for award of attorneys' fees and expenses.

The full opinion is available in PDF.

Greenspring Quarry Assoc., Inc. v. Beazer Homes Corp. (U.S.D.C.)

Filed:  June 26, 2017

Opinion by:  James K. Bredar

Holding:  Where (1) a principal exerts control over a corporation’s board via a majority acting within the principal’s scope of employment, (2) the board takes actions in breach of contract and in contravention of principal’s express statements, and (3) sufficient privity exists to survive a challenge based on economic loss doctrine, well-pleaded allegations of fraudulent misrepresentation against the principal are sufficient to survive a motion to dismiss for failure to state a claim.

Facts:  Plaintiffs (“Owners”) are members of master and subordinate property owners’ associations in a mixed residential and commercial development.  Defendant (“Developer”) is the developer of the relevant properties.

Development began in 2005, and Developer incorporated master and subordinate owners’ associations one year later.  Soon thereafter, Developer caused its employees to occupy the initial positions on both associations’ boards.  Developer filed on behalf of each association similar covenants under which a management company would maintain common areas, with Developer to pay costs until such time as it transferred title to the common area property to the associations.  Developer began billing Owners in 2008 but did not transfer title to the common areas until December 2015.

Owners, as members of the master and subordinate associations, brought separate but practically identical actions alleging breach of contract, negligent misrepresentation, and fraudulent misrepresentation.  Developer removed both actions under diversity jurisdiction and moved to dismiss the tort claims for failure to state a claim.  Removal was granted, and both actions were joined for convenience and efficiency.

Analysis:  Developer first argued that Owners’ allegations sounded only in contract.  The court began by noting that under the doctrine of respondeat superior, because Developer’s employees joined the boards under its direction and in furtherance of its objectives, Developer would be vicariously liable for any tortious acts committed by the board.  By extension, because board members of Maryland non-stock corporations owe the same fiduciary obligations as any other Maryland corporation, breach of duty accompanying a contractual obligation would be sufficient to support a tort claim.  So finding, the court permitted Owners’ tort claims.

Developer next argued that the economic loss doctrine barred any tort claims, such that its alleged negligence causing purely economic harms ought not create tort liability in the absence of privity, actual physical injury, or risk thereof.  However, noting that Maryland has traditionally permitted tort actions for purely economic losses in the context of fraud, and finding more than sufficient allegation of privity between the parties via the intimate nexus between Owners and the associations, and Developer’s control of the boards, the court deemed risk of tort liability reasonably foreseeable.

Third, Developer argued that Owners’ reliance on Developer’s allegedly negligent or fraudulent statements was unreasonable.  Avoiding the factual question of whether reliance was reasonable, the court evaluated the board’s alleged conduct under the adverse domination doctrine, where knowledge or actions of an agent whose interests are adverse to the principal cannot be imputed to the principal.  Because corporate entities act through agents who wouldn’t rationally be expected to communicate their own wrongdoing to the principal, equitable considerations lean in favor of the corporation and create a rebuttable presumption.  Here, a cause of action against the board (and vicariously, Developer) would not accrue if a disinterested majority board could be proven.  In the court’s view, Developer had not alleged sufficient facts to show that the boards contained a disinterested majority during the time period at issue.

Lastly, Developer argued that Owners’ claims failed to meet FRCP Rule 9(b)’s particularity requirements that time, place, and contents of allegedly fraudulent statements and the person making such statements be pled with sufficiency.  Finding the complaint to contain sufficiently complete allegations (an accounting of dated bills approved by the boards while under Developer’s control, with identities of the board members responsible), the court found Owners to have met their Rule 9(b) burden.

Accordingly, the court found Owners to have survived Developer’s motions to dismiss.

The full opinion is available in PDF.

In re American Capital, Ltd. Shareholder Litigation (Cir. Ct. Mont. Cnty)

Filed: July 12, 2017

Opinion by: Ronald B. Rubin

Holding:  A claim that a transaction is subject to the entire fairness standard of review survives a motion to dismiss under Delaware law where a minority shareholder exercised actual control over corporate decision-making by apparently forcing a quick sale for its own short-term gain, threatening ouster of the board to pressure members to ignore other serious bids and alternative courses of action at better values, and demanding unique and unjustifiable compensation for the deal.

Facts: 

Plaintiffs are the common shareholders of American Capital Ltd. (the “Company”). Following a settlement with the Company’s directors and officers, the only remaining Defendant was a management corporation described as being an activist hedge fund. From 2014 to 2015, the Company’s board regularly considered strategic options for the Company and eventually decided on a plan to spin the Company off into a new business development company, which the Company would manage. On September 20, 2015, the Company announced the spin-off plan and requested shareholder approval.

On November 16, 2015, Defendant emailed the Company CEO reporting an 8.4% ownership interest in the Company, and stating their intention to file a preliminary proxy contesting the spin-off plan. This was followed up by a telephone call informing him of their intention to remove him, the management and the board. Shortly thereafter, Defendant sent a letter criticizing the management and board, an attack on the spin-off plan, and a press release. Defendant urged the Company to drop the spin-off plan, replace the board, and undertake a strategic review. Defendant also filed a proxy statement with the SEC contesting the spin-off and urging shareholders to vote against any proposal by the board. After threatening to publicly call for the resignation of the CEO, Defendant began to by-pass him in dealings with the Company.

Shortly thereafter, the Company announced the formation of a strategic review committee to review the Company’s prospects, including a possible sale. Defendant reported an increase in ownership to 9.1%, and on that same day, a Capital Corporation sent the CEO a letter urging the Company to enter into a transaction with them. Defendant made recommendations regarding the review and sought to meet with the committee and the Company’s investment bankers. It continued to demand a sale and to threaten to seek the replacement of the Company’s board and management. It provided a list of potential buyers and continued to report increases in its ownership. When the board announced the decision to solicit purchase offers, Defendant called it the right course of action. Defendant also requested that the Company postpone the annual shareholder meeting and director nomination deadline.

After the Capital Corporation made an unsolicited purchase offer, Defendant urged the Company to reach a deal as soon as possible. The Company’s financial advisers met with the Defendant’s representatives. Defendant encouraged the investment bankers to finalize the sale even if it meant selling at a loss. In February 2016, the Company proposed three alternative scenarios to a quick sale of the whole Company. The Company’s management believed the shareholders would receive greater returns through an orderly liquidation or by remaining a standalone company. Yet the Company’s board continued to push for a sale, as demanded by the Defendant. The board once again pushed back its annual meeting, which extended the deadline for the Defendant to file a competing proxy. Furthermore, the committee and investment bankers withheld the liquidation scenario projections from the Company’s board.

The Company received several bids to acquire it. Defendant signed confidentiality agreements with the Company affording it unfettered access to the review process, and with the Capital Corporation to view its bid information. In a meeting with the Company’s legal and financial advisers, Defendant expressed a strong preference for the Capital Corporation’s bid—even though other offers appeared to have a better value. It also expressed a preference for a quick sale over an orderly liquidation—even at a lower value.

Soon after, the Company’s board outright rejected a competing bidder who increased its proposal subject to an exclusivity provision. The Capital Corporation submitted a revised bid and negotiated a voting agreement to lock in Defendant’s support. Defendant threatened the Company that if it failed to settle with Defendant for its expenses and close the deal, the Company’s board would be reconstituted. When the Company tried to revise terms of settlement, the Defendant threatened another strategic review unless the sale closed.

In May 2016, a merger with the Capital Corporation was announced. The Company approved a settlement agreement on the following terms: if the deal did not close, the board members would be replaced by the Defendant’s selections, the chairman would resign, and another review would be undertaken. In exchange, the Defendant would not launch a proxy fight before the next annual meeting. The Company also agreed to pay the Defendant $3 million.

Defendant filed a Motion to Dismiss the Plaintiff’s Amended Complaint on the grounds that personal jurisdiction is lacking, and that the transaction is not subject to entire fairness review under Delaware law. The Court denied both Motions.

Analysis: 

Defendant satisfied the transacting business prong of the Maryland long-arm statute and the purposeful availment requirement of the Due Process clause because: the Company was headquartered in Maryland where it employed hundreds  (many of which were laid off due to the sale); Defendant initiated many calls to Maryland; Defendant triggered the process and events that led to the filing of the case when it sent the initial email (followed by many others) to the Company; and until the deal closed, Defendant enmeshed itself in the Company’s strategic review process and the board’s deliberations. These constitute repeated and intentional efforts towards the sale of a Maryland-based company. From the facts pleaded, it also appears that Defendant intentionally acquired a large portion of Company stock and increased it for a single purpose—to force a sale and make a short-term gain.

As for the substantive issue, Plaintiffs viewed the merger as the predictable result of Defendant’s pressuring the board to sell or be ousted. Defendant counters that the merger was the best value reasonably available, was vetted through a competitive bidding process, and that the Company’s board merely took the input of a large shareholder seriously.

Where, as here, a shareholder owns less than 50% of the Company’s stock, Plaintiffs must allege domination through actual control of corporate conduct. Under Delaware law, a minority shareholder is a controller if it has such formidable power that it exercises actual control over corporate decision-making. Here, Plaintiffs allege that Defendant was a controller for the specific purpose of forcing the sale, and that Defendant reaped unique benefits unavailable to the other shareholders. The controller test is a fact-based inquiry difficult to satisfy, but this case meets the threshold.

Here, the facts if proven would amount to actual control over the sale. No other shareholder received separate monetary compensation for the deal. The sale was already vetted by the financial advisers, and it is not clear what value Defendants added to merit the $3 million payment. The Plaintiffs adequately laid out the profit-making playbook for activist hedge funds, by forcing quick sales such as this one, which took only about six months.

Also, enough facts were pleaded to show that the board did not act independently. Defendant dominated the process and favored the Capital Corporation to the exclusion of other serious bidders that offered better long-term value. The board effectively took no actions to negotiate with those bidders. Collectively, the active role played by Defendant, the apparent willingness of bidders to pay a higher price, and the discount to book value of the stock gives credence to contention that the board knew the Capital Corporation undervalued the Company, but brushed this concern aside in order not to lose a proxy battle to Defendant. This amounts to a colorable claim of board domination. Thus, Plaintiffs sufficiently invoke the benefit of the entire fairness standard of judicial review.

The full opinion is available in PDF.

Karen R. Goozh v. Howard Richmond (Cir. Ct. Mont. Cnty.)

Filed: July 8, 2014

Opinion by: Ronald B. Rubin

Holding: A stockholders’ agreement that expired upon the “dissolution” of the company was terminated when the company was administratively dissolved for failure to file a regular report, despite having its charter later reinstated when the failure was cured.

Facts: Stockholders in a Washington, D.C., company entered into a stockholders’ agreement that included a provision whereby the agreement would terminate upon the “liquidation or dissolution of the Company.” The company’s charter was then revoked twice after it failed to file a required biennial report with the District of Columbia Department of Consumer and Regulatory Affairs. In each instance, the revocation was eventually annulled, but the Plaintiffs argued that the stockholder’ agreement remained terminated after the first revocation despite such reinstatement.

Analysis: The court noted that a different District of Columbia statute applied to each administrative dissolution of the company. In the second instance, the law stated that when a company’s charter was revoked and later restored, the restoration would “relate back” to the date of the administrative dissolution. In other words, the gap in the company’s continuity would effectively be erased.

The court found two D.C. cases instructive: In Accurate Construction Co. v. Washington, a contract entered into while a company’s charter was revoked was held to be unenforceable, and in T.K., Inc. v. National Community Reinvestment Coalition, Inc., the tenant under a commercial lease was found to have remained a valid party to the lease despite the revocation and subsequent reinstatement of its charter during the lease term.

Finding neither case dispositive, the court said that because the stockholders’ agreement failed to define the term dissolution, the plain meaning of the word should apply. The court acknowledged that the drafters may not have intended a “technical” or “administrative” dissolution of the company to terminate the agreement. Nevertheless, it held that a reasonable person would understand the word dissolution to include such events.

Although the case hinges on D.C. law, the court occasionally draws comparisons with Maryland law and cites Maryland law when discussing the effects of revival.

Full opinion is available in PDF.

Tackney v. United States Naval Academy Alumni Association, Inc. (Ct. of Appeals)

Filed May 14, 2009.
Opinion by Judge Clayton Greene, Jr.

Held: Ordinarily, Maryland courts will not interfere in the internal affairs of a voluntary membership organization unless there is evidence of fraud, irregularity, or arbitrary action.

Affirming the Circuit Court's dismissal of a challenge to an election of trustees in a voluntary membership organization for failure to state a claim. Pursuant to the standard elucidated in NAACP v. Golding, 342 Md. 663, 678, 679 A.2d 554, 561 (1996), the Court of Appeals found the board's actions not sufficiently arbitrary to warrant intervention in the organization's internal affairs.

The full opinion is available in PDF.