Sydell Protas v. Richard E. Cavanagh, et al., C.A. No. 6555-VCG (Del. Ch. May 4, 2012) (Glasscock, V.C.)

In this opinion, the Court of Chancery granted Defendants’ motion to dismiss Plaintiff’s claims of breach of fiduciary duty by corporate waste, the aiding and abetting of such corporate waste, and unjust enrichment.  Plaintiff sued in her capacity as a common stockholder of BlackRock Credit Allocation Income Trust IV, a Delaware statutory trust (the “Fund”).  The Fund invests in securities as a closed-end investment company.  Plaintiff primarily claimed that the Fund’s board of trustees caused the Fund to pay an excessive price to redeem certain auction market preferred stock (the “Preferred Shares”) issued by the Fund, and that the payment of such excessive price and the allegedly unreasonably expensive and risky financing obtained by the board of trustees on behalf of the Fund to pay for such redemption, harmed the Fund and the common stockholders of the Fund.   

BlackRock, Inc. (“Blackrock”) served as the Fund’s sponsor, investment adviser and managed the Fund’s operations.  Holders of the Preferred Shares included Merrill Lynch & Co., Inc. (“ML”) and PNC Financial Services Group, Inc. (“PNC”), who were market makers in auction market preferred stock like the Preferred Shares. Plaintiff’s aiding and abetting allegations were made against Blackrock, PNC, ML, and ML’s parent, Bank of America Corporation (collectively with ML and PNC, the “Bank Defendants”).  The claims arose partly out of the market downturn of 2008, which resulted in an arguably complete lack of liquidity for the Fund’s Preferred Shares.  While the common stockholders of the Fund could trade their stock on an exchange, the holders of Preferred Shares generally could not do so after the 2008 downturn.  Plaintiff claimed ML’s pressuring of Blackrock, the sponsor of the Fund, caused the Fund to redeem all of the outstanding Preferred Shares.  That redemption allegedly resulted in corporate waste and fewer funds available for distribution to the Fund’s common stockholders.             

Analyzing the Plaintiff’s claims under well-established Delaware corporate precedent, the Court decided that the claims of harm to Fund stockholders resulting from the board of trustees’ allegedly causing the Fund to pay too much and deplete Fund assets would not harm only the common stockholders.  The Plaintiff’s alleged injury was not viewed as distinct from any injury that would have been suffered by all Fund stockholders and the Fund as a whole.  As such, the Court held that Plaintiff’s claims were derivative in nature.   The Court agreed with Defendants’ argument that in making such derivative claims, Plaintiff failed to satisfy Section 3816 of the Delaware Statutory Trust Act (the “DSTA”).  Section 3816 of the DSTA governs the standards applicable to derivative actions on behalf of Delaware statutory trusts.     

Analogizing to Delaware corporate law, the Court held that Section 3816 of the DSTA requires that a beneficial owner of a Delaware statutory trust like the Fund bringing derivative claims must allege with particularity her attempts to demand that the trustees bring the applicable action on behalf of the statutory trust or, in the alternative, why such attempts would be futile. The Plaintiff failed to make any demand on the board of trustees.  Instead, to survive the motion to dismiss, the Plaintiff sought to show, under the second prong of the test announced by the Delaware Supreme Court in Aronson v. Lewis, 473 A.2d 805, 813 (Del. 1984), that a reasonable doubt existed as to whether the challenged transactions deserved the protection of the business judgment rule.  The first prong of the Aronson test asks whether the trustees were disinterested and independent.  The Plaintiff conceded that each of the members of the board of trustees were independent based on the definition of “Independent trustee” under Section 3801(d) of the DSTA.   
The Court ultimately dismissed Plaintiff’s claims because it found them to be too generalized.  Plaintiff’s lack of specificity failed to overcome the presumption of good faith and valid business judgment afforded the Fund’s trustees under the business judgment rule. 

This case is one of few in which a Delaware court has had the opportunity to interpret the DSTA.  The Court’s holding and analysis shows that as with the statutes governing other Delaware non-corporate entities (i.e. alternative entities like limited liability companies and limited partnerships), Delaware courts will construe the DSTA by looking to analogous Delaware corporate precedent.

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