Dubroff v. Wren Holdings, LLC, Del. Ch., C.A. No. 3940-VCN (May 22, 2009) (Noble, V.C.)

Among other things, the Court: (1) dismissed a breach of fiduciary duty claim for lack of standing because plaintiffs’ claims were derivative rather than direct given plaintiffs’ failure to sufficiently plead that several majority stockholders were a “control group” and (2) denied a motion to dismiss a challenge to the sufficiency of a Section 228(e) notice. Former minority stockholders of a corporation sued three former majority stockholders of the corporation and their principals, some of whom served on the corporation’s board of directors, for breach of their fiduciary duties. The transaction at issue was a recapitalization whereby the majority stockholders converted their preferred debt into preferred stock via “written consent of the holders of a majority of the . . . [corporation’s] stock.” As a result, the majority stockholders increased their ownership of the corporation while diluting the ownership of the minority stockholders.

The Court first considered plaintiffs’ claim for breach of fiduciary duty in connection with the dilution of their equity, noting this was a claim for corporate overpayment. Corporate overpayment claims are typically derivative; but the Court explained that there is a species of corporate overpayment claim that is both derivative and direct where “a corporation issues more shares to its controlling shareholder and dilutes the minority shareholders’ equity.” Because the corporation was subsequently merged into another corporation of which plaintiffs owned no stock, they lacked the requisite derivative standing. Plaintiffs, however, sought to pursue a direct claim under this theory alleging that the three stockholders collectively acted as a controlling stockholder even though none was individually a majority stockholder. The Court recognized the viability of such a “control group” for fiduciary duty purposes but nonetheless dismissed plaintiffs’ claims, with prejudice, because plaintiffs failed to allege facts or attach documents to the Complaint establishing that the defendants were “connected in some legally significant way” as to constitute a “control group.” Mere allegations of “parallel interests” among the defendants were insufficient.

Plaintiffs also asserted disclosure claims in connection with the approval of the recapitalization by written consent. The Court agreed with plaintiffs that the Section 228(e) notice was insufficient because “material facts—who benefited from the [r]ecapitalization and what benefits . . they achieve[d]—were omitted.” Noting that Delaware courts have not passed upon the level of disclosure required under Section 228(e), the Court found that regardless of the level of disclosure required, the Complaint contained facts allowing “the Court to infer reasonably that the board deliberately omitted material information with the goal of misleading . . [p]laintiffs and other shareholders about the [d]efendants’ material financial interest in, and benefit conferred by, the recapitalization not shared with other shareholders.” The motion to dismiss this claim was therefore denied.

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