Dubroff v. Wren Holdings, LLC, C.A. No. 3940-VCN (Del. Ch. Oct. 28, 2011) (Noble, V.C.)
In this memorandum opinion, the Court of Chancery granted in part and denied in part defendants’ motion to dismiss claims arising from a recapitalization plan that diluted equity holdings of minority stockholders to a controlling stockholder group’s benefit. In so doing, the Court held that although the minority stockholders failed to satisfy the continuous ownership requirement for maintaining a stockholder derivative suit under Chancery Court Rule 23.1, plaintiffs could bring a direct claim of equity dilution under the circumstances. The Court also invoked the class action tolling rule, which tolls the statute of limitations for all members of a putative class until a court denies class certification.
Morris Fuchs and forty-two other former minority stockholders (the “Fuchs Plaintiffs”) brought this action challenging a 2002 recapitalization plan (the “Recapitalization”) at Nine Systems Corporation (“NSC”), a privately held Delaware corporation. As a result of the Recapitalization, the majority stockholders, which consisted of Wren Holdings, LLC (“Wren Holdings”), Javva Partners, LLC (“Javva Partners”), and Catalyst Investors, L.P. (“Catalyst Investors,” and collectively, “NSC’s Control Group”), moved from holding approximately 56% of NSC’s equity value to approximately 90%. The Fuchs Plaintiffs suffered a corresponding decrease in their holding from 20–25% of NSC’s equity to less than 5%. Shortly after the Recapitalization, NSC stockholders (including the Fuchs Plaintiffs) received an update notice (the “Update”) informing them that NSC achieved the Recapitalization through a one-for-twenty reverse stock split, but the Update did not disclose who benefitted from the Recapitalization or what benefits they received. Later, in 2006, NCS delivered proxy materials to its stockholders seeking approval of a transaction with Akamai Technologies, Inc. (“Akamai”). These materials provided the first notice to the Fuchs Plaintiffs of the new equity percentages. In December 2006, Akamai purchased all of NSC’s then outstanding shares for $175 million through a merger.
In August 2008, a group of NSC’s former stockholders (the “Dubroff Plaintiffs”) filed a purported class action alleging breach of fiduciary duties against NSC’s former directors and NSC’s Control Group. The Court dismissed all claims other than those related to Section 228 disclosure violations and aiding and abetting liability. In a subsequent 2010 decision, the Court refused to certify the Dubroff Plaintiffs’ purported class action, requiring them to pursue their disclosure and aiding and abetting claims individually. The Fuchs Plaintiffs then brought the immediate action against NSC’s Control Group, four of NSC’s former directors (the “Director Defendants”), Cameron Family Partnership, L.P. (“CFP”, which was not in NSC’s Control Group but benefitted from the Recapitalization), and Andrew T. Dwyer (a 50% equity holder in Wren Holdings, a member of the control group). The Complaint sought, among other things, rescission of the Recapitalization or rescissory damages as well as damages for defendants’ alleged fiduciary duty breaches. The Fuchs Plaintiffs moved to intervene in and consolidate with the Dubroff Plaintiffs’ actions. Defendants moved to dismiss the Fuchs lawsuit pursuant to Court of Chancery Rules 12(b)(6) and 23.1, and objected to intervention.
With respect to defendants’ Rule 23.1 argument, the Court noted that although equity dilution claims are typically viewed as derivative and the Fuchs Plaintiffs failed to satisfy the continuous ownership rule because of the 2006 Akamai merger, the Delaware Supreme Court’s decision in Gentile v. Rossette set forth circumstances where direct equity dilution claims can survive a merger. The Court of Chancery began its analysis of whether plaintiffs had stated a direct claim for equity dilution by evaluating whether the complaint pleaded sufficient facts from which the Court could infer, for purposes of the motion to dismiss, that NSC’s Control Group acted as a controlling stockholder group. The Court recognized that a number of stockholders could collectively form a control group if connected in a legally significant way and, as such, would owe fiduciary obligations to the minority stockholders. The Court determined that the Fuchs Plaintiffs adequately alleged that Wren Holdings, Javva Partners, and Catalyst Investors met that standard by working together to establish the exact terms and timing of the Recapitalization. The Court also rejected defendants’ argument that under Gentile, pleading a direct equity dilution claim required an exact match between the controlling stockholder’s increase in ownership and the minority’s decrease. The Court explained that under Gatz v. Ponsoldt, “as long as the controller’s holders are not decreased, and the holdings of the minority stockholders are, the latter may have a direct equity dilution claim.”
The Court next determined that the Fuchs Plaintiffs adequately pled their Section 228 disclosure claim against the Director Defendants. Because the Recapitalization was approved by written consent of NSC’s Control Group, the Director Defendants were obligated to provide prompt notice to the stockholders pursuant to 8 Del. C. § 228(e). The Court explained that the “precise parameters of the disclosure required by § 228(e) have not yet been delineated,” but the Fuchs Plaintiffs stated a claim that defendants did not meet them because defendants never informed the Fuchs Plaintiffs of who benefited from the Recapitalization and what benefits they received.
The defendants also contended that laches barred Fuchs Plaintiffs’ claims. Although statutes of limitations are not automatically controlling in actions in equity, the Court noted that the analogous three-year statute of limitations for the Fuchs Plaintiffs’ claims would be given great weight in determining whether they were barred by laches. The Court held that this presumptively applicable time period tolled, however, because the Fuchs Plaintiffs did not receive notice of the Recapitalization until they received proxy materials sent in connection with the 2006 Akamai merger. That period further tolled while the Dubroff Plaintiffs’ putative class action was pending. The Court thus adopted a class action tolling rule, explaining, “[o] ce the statute of limitations has been tolled, it remains tolled for all members of the putative class until class certification is denied.” The Court held that the Fuchs Plaintiffs asserted their claims in a reasonable amount of time after the Court denied the Dubroff Plaintiffs’ class certification.