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Fotta v. Morgan, C.A. No. 8230-VCG (Del. Ch. Feb. 29, 2016) (Glasscock, V.C.)

February 29, 2016

In this memorandum opinion, the Court of Chancery denied cross motions for summary judgment and granted defendants’ motion to dismiss for failure to comply with Rule 23.1.

Plaintiff Keith Fotta founded First Orion Corp. (“First Orion”) in 2007. In 2008, defendant Charles Morgan invested in First Orion’s preferred stock and was appointed to First Orion’s board of directors. By the end of September 2009, Morgan controlled approximately 70% of the then-outstanding preferred stock of First Orion. In October 2009, Morgan, Fotta, and First Orion entered into a letter agreement, pursuant to which Morgan agreed to advance First Orion money in exchange for irrevocable voting proxies over the common stock controlled by Fotta and in exchange for warrants and additional preferred stock if First Orion failed to repay Morgan. First Orion failed to repay Morgan, and accordingly, in January 2010, he gained sufficient control of First Orion’s voting power to remove Fotta as an officer and director by written consent, and to appoint Jefferson Stalnaker as a director and the chief executive officer. In February 2010, Morgan and Stalnaker declared a dividend whereby holders of preferred stock received approximately 74 shares of common stock for each share of preferred stock. Morgan’s warrants were similarly adjusted. Three days after the declaration of the dividend, Stalnaker sent First Orion’s stockholders a letter advising of these developments.

In 2011, the First Orion board of directors, then comprised of Morgan and Stalnaker, adopted a stock option plan that authorized the board to issue stock options to its members. Morgan voted in favor of the plan in his capacity as majority stockholder. First Orion then granted two series of stock options to Stalnaker. Shortly after plaintiffs filed their second amended complaint, First Orion directors James Womble and Kent Burnett, who were subsequently appointed to First Orion’s board of directors and were not parties to the action, ratified the options.

Plaintiffs moved for summary judgment seeking a declaration that the stock issued pursuant to the dividend was void as a matter of law because it was issued in violation of the DGCL. The Court denied the motion, finding that further factual development was needed to determine whether common stock issued pursuant to the stock dividend and adjustments to warrants based on the dividend were void because the dividend allegedly violated Sections 170 and 173 of the DGCL.

The Court also denied defendants’ motions for summary judgment, which argued that plaintiffs’ claims regarding the stock dividend were barred by the doctrine of acquiesce and that plaintiffs’ equitable claims were barred by laches. In so holding, the Court provided some guidance as to the distinction between acquiescence and laches, explaining that the relevant time frame for laches is after a plaintiff was informed of an alleged breach and any subsequent inaction, while the relevant time frame for acquiescence is at the time of the alleged breach. The Court also explained that laches focuses solely on a plaintiff’s action, whereas in assessing acquiescence, the Court must look to both the plaintiff’s and the defendant’s actions. The Court noted that defendants had not explained how plaintiffs’ actions led defendants to believe that plaintiffs approved of the dividend, and that therefore a more developed factual record was needed regarding plaintiffs’ alleged acquiescence. Similarly, the Court found that further factual development was needed to determine whether plaintiffs’ alleged delay in bringing its claim regarding the stock dividend prejudiced the defendants.

The Court granted defendants’ motion to dismiss plaintiffs’ derivative claims regarding the grant of stock options to Stalnaker in 2011 for failure to make a demand on the board of directors. Plaintiffs, alleging that the grant of the options constituted corporate waste, added the claims to their second amended complaint after the composition of the company’s board of directors had changed. The Court noted that Rule 23.1 generally does not require plaintiffs to reevaluate compliance with the rule if the board of directors changes subsequent to the filing of the complaint. However, because plaintiffs amended the complaint after the composition of the board of directors changed to add claims regarding a transaction that was not “already in litigation,” they were required to either make a demand on the board or plead facts alleging demand futility. The Court found that the stock dividend and the grant of options were two distinct transactions. Because plaintiffs had neither made a demand on the board nor pled demand futility with respect to the grant of stock options, the Court granted defendants’ motion to dismiss this claim.

The full opinion is available here