Paskowitz v. Wohlstadter

DEBORAH S. EYLER, J. In the Circuit Court for Montgomery County, Laurence Paskowitz, the appellant, filed a multi-count amended complaint against IGEN, a Delaware corporation with its principal place of business in Gaithersburg, Maryland, an appellee, and certain past and present officers and directors of IGEN (“the individual appellees”). 1 Ultimately, the court dismissed all of Paskowitz’s claims. ⁴ In this appeal, Paskowitz challenges the court’s dismissal of Count V of the amended complaint. He contends the circuit court was legally incorrect in ruling that the claim in Count V was derivative, not direct, and that he did not have standing to pursue a direct claim. 2 For the following reasons, we shall affirm the judgment of the circuit court. FACTS AND PROCEEDINGS IGEN is a biological technology company that was founded in 1982 and became publicly traded in 1994. It manufactures sophisticated biological detection systems using technology it patented under the name “ORIGEN.” In 1995, IGEN entered into a joint venture agreement with Meso Scale Technologies, LLC (“MST”), and formed a joint venture entity named “Meso Scale Diagnostics, LLC” (“the Joint Venture”).

Paskowitz claims that the Joint Venture constituted a waste of corporate assets and self-dealing on the part of certain of the individual appellees who, together with some of their family members, used it to position themselves to profit financially at the expense of IGEN and its shareholders. ⁵ Paskowitz did not own IGEN stock when the Joint Venture was formed. He became a shareholder in IGEN two years later, in May 1997, upon purchasing 600 shares of stock. He alleges that he inadvertently sold those shares, in March 2000, and that a month later, when he realized what had happened, he repurchased another 600 shares of IGEN stock, in two lots. Members of the IGEN board of directors hold staggered three-year terms.

Every year, at its annual meeting, IGEN holds an election for those director positions with expiring terms. Proxy statements are issued to the shareholders in advance in connection with the elections. At the IGEN annual meetings in 1997, 1998, and 1999, certain of the individual appellees were candidates for election to the board. IGEN circulated proxy statements to shareholders pertaining to those elections in September 1997, July 1998, and July 1999, respectively.

The proxy statements related information about the Joint Venture. Paskowitz alleges that certain representations about the Joint Venture in the proxy statements were materially misleading partial disclosures. On August 3, 2000, a creditor of IGEN made a demand on IGEN’s board of directors, asserting that the Joint Venture amounted to corporate waste and self-dealing by certain of the individual appellees. The board responded by establishing a committee of independent directors to investigate the demand and recommend whatever measures it deemed appropriate.

The independent committee and its mission were publicly disclosed. In November 2000, before the independent committee concluded its investigation, another of IGEN’s creditors, Brown Simpson Partners I, Ltd. (“Brown Simpson”), purchased 100 shares of IGEN stock and filed, in the Circuit Court for Montgomery County, a shareholder’s derivative action naming the individual appellees and IGEN as defendants. Brown Simpson alleged, inter alia, that the Joint Venture constituted corporate waste and self-dealing on the part of the individual appellees. ⁶ On March 13, 2001, soon after Brown Simpson filed its suit, Paskowitz filed his original complaint in this case, also in the Circuit Court for Montgomery County and also naming the individual appellees and IGEN as defendants. Paskowitz’s complaint stated four counts, each alleging what Paskowitz labeled a “derivative” claim, and copied almost word for word the Brown Simpson complaint.

Because of their common subject matter, the two cases were specially assigned to the same judge and thereafter were handled in a consolidated fashion. On August 14, 2001, Paskowitz filed an amended complaint, restating his “derivative” claims and adding what he designated as two “direct” claims against the individual appellees, in Counts V and VI, both personally and as a putative class representative. In Count V, entitled “Breach of Duty of Candor v. the Individual Defendant Directors,” Paskowitz alleged that, in the course of and for the purpose of soliciting shareholder votes in the elections for directorships held at IGEN’s annual meetings in 1997, 1998, and 1999, the individual appellees made materially false and misleading disclosures about the Joint Venture in its proxy statements; and by doing so, breached their fiduciary duty of candor to the shareholders. Paskowitz further alleged that by virtue of the breach, he “ha[d] been damaged” and that “IGEN would continue to be irreparably injured and damaged.” He asserted that the individual appellees should be removed and replaced as directors and “[a] new election of directors should be held because, among other reasons, the [individual appellees] were elected pursuant to the [1997, 1998, and 1999 proxy statements].” In Count VI, Paskowitz alleged that the material partial disclosures about the Joint Venture contained in the proxy statements had caused a dilution in the value of his IGEN stock.

By the time Paskowitz filed his amended complaint, motions to dismiss or for summary judgment by the individual appel- ⁷ lees and IGEN in his case and the Brown Simpson case already had been filed and were pending. On September 19, 2001, the individual appellees responded to Counts V and VI of the amended complaint by filing additional motions to dismiss or for summary judgment directed to those counts, on four grounds: 1) the claims in Counts V and VI were derivative, not direct, and for reasons argued in the pending motions on the derivative claims, failed to state causes of action for which relief could be granted; 2) the alleged misdisclosures were not material; 3) the claim for equitable relief was moot because the terms of the directors elected in 1997, 1998, and 1999 had expired; and 4) Paskowitz had not suffered any damages. Paskowitz filed an opposition to the individual appellees’ motion. In the meantime, the independent committee completed its investigation and issued a report concluding that the Joint Venture was for the most part beneficial to the corporation but recommending some changes to it.

Soon thereafter, Brown Simpson added William Shaffer as a plaintiff. Shaffer had purchased stock in IGEN in 1995, before the Joint Venture was formed. A central issue in the pending motions concerned two requirements, under Delaware law, that a plaintiff must meet to proceed with a derivative claim. First, the plaintiff must satisfy the “Continuous Ownership Rule.” Under that rule, the plaintiff must have been a shareholder at the time of the corporate action that is the subject of his complaint.

Del.Code Ann., Corporations, tit. 8 § 327 (2000). Neither Paskowitz nor Brown Simpson owned stock in IGEN when the Joint Venture was formed. Paskowitz owned stock in IGEN when the proxy statements were issued, but, as noted, before filing suit sold his stock—and then repurchased stock. Shaffer owned stock when the Joint Venture was formed and thereafter.

Second, the plaintiff must meet the “Demand Futility Rule.” That rule requires the plaintiff to have made demand on the corporation’s board of directors to take action, which the board then refused; or to be excused from making demand ⁸ because it would have been futile. Del. Ch. Ct. R. 23.1.

See also Grimes v. Donald, 673 A.2d 1207, 1216 (Del.1996) (pointing to this rule as “a matter of substantive law embodied in the procedural requirements of Chancery Rule 23.1”). On December 18, 2001, the court held a consolidated hearing on pending motions in the Brown Simpson and Paskowitz cases. The court dismissed all of Brown Simpson’s derivative claims and three of the four claims Paskowitz labeled derivative on the ground that they did not meet the Continuous Ownership Rule. The court also dismissed Count V of the appellant’s amended complaint.

As noted, that ruling is the sole subject of this appeal. The court explained the basis for its ruling on Count V as follows: [T]he court finds as to count five that the claim which complains about having voted for bad directors is a derivative claim, not a direct claim. In an instance such as this where the plaintiff seeking to bring the action did not have a particular specific interest in the election and was not himself running for office, but rather complains about the governance of the board as it affects the corporation [the action is derivative under Delaware law]. Finally, the court dismissed the appellant’s claim in Count VI, stating that because IGEN’s stock price had risen since the appellant purchased his shares, he had not suffered compensatory damages.

Paskowitz filed a motion for reconsideration of the dismissal of Count V, which the individual appellees opposed. On March 7, 2002, the court held a hearing on all pending motions. On May 21, 2002, it issued a memorandum opinion and order dismissing the derivative claims of all the plaintiffs on one or more of the following grounds: limitations; failure to meet the Demand Futility Rule; and failure to state a viable claim for waste of corporate assets. The court also denied the appellant’s motion to reconsider its ruling on Count V. ⁹ The appellant then noted this appeal.

Neither Brown Simpson nor Shaffer took an appeal. DISCUSSION The parties agree that Delaware law is controlling. Before stating their contentions, we shall review enough of the relevant general principles of Delaware corporate law to provide context. A “derivative” action is a claim asserted by a shareholder plaintiff on behalf of the corporation to redress a wrong against the corporation.

The defendant in a derivative action may be a corporate fiduciary, such as a director, who committed a wrong against the corporation. The action is “derivative” because it is brought for the benefit of the corporation, not for the shareholder plaintiff. Kramer v. Western Pacific Industries, Inc., 546 A.2d 348, 351 (Del.1988). For that reason, ordinarily, damages recovered in a derivative suit are paid to the corporation.

Id. By contrast, a “direct” action is a claim asserted by a shareholder, individually, against a corporate fiduciary, such as a director, to redress an injury personal to the shareholder. Kramer, supra, 546 A.2d at 351 (quoting R. Clark, Corporate Law 639-40 (1986)). Because damages recovered in a direct action are to remedy the shareholder plaintiff individually, they are payable to him, not to the corporation.

Direct claims often are filed as class actions. For a shareholder to assert a direct action against a corporate fiduciary, he must have been injured “directly or independently of the corporation,” Kramer, supra, 546 A.2d at 352 (emphasis in original) (citing Bokat v. Getty Oil Co., 262 A.2d 246, 249 (1970)), and “must allege more than an injury resulting from a wrong to the corporation.” Kramer, supra, 546 A.2d at 351 . The test to distinguish between derivative and direct harm is whether the plaintiff suffered a “special injury.” Lipton v. News International, Plc, 514 A.2d 1075, 1078 (Del.1986). In Moran v. Household International, Inc., 490 A.2d 1059 , (Del.Ch.1985), aff'd, 500 A.2d 1346 (Del.1985), ¹⁰ the Delaware Chancery Court stated: “[T]he plaintiff [in a direct action] must allege either an injury which is ‘separate and distinct from that suffered by other shareholders,’ or a wrong involving a contractual right of a shareholder, such as the right to vote, or to assert majority control, which exists independently of any right of the corporation.” Id. at 1070 quoting 12b Fletcher’s Cyclopedia Corps., § 5921, p. 451 (Perm.Ed., Rev.Vol.(1984)).

See also In re Tri-Star Pictures, Inc., Litigation, 634 A.2d 319, 330 (Del.1993). Whether a claim is derivative or direct is not a function of the label the plaintiff gives it. Moran v. Household International, supra, 490 A.2d at 1069-70 ; Elster v. American Airlines, Inc., 100 A.2d 219, 223 (Del.Ch.1953)(quoting Selman v. Allen, 121 N.Y.S.2d 142 , 146 (1953)). Rather, the nature of the action is determined from the body of the complaint.

Moran v. Household International, supra, 490 A.2d at 1070 . It is a legal question, and frequently is not a simple one. “ ‘Although the tests have been articulated many times, it is often difficult to distinguish between a derivative and an individual action.’ ” Grimes v. Donald, supra, 673 A.2d at 1213 (quoting In re Rexene Corp. Shareholders Litig., 17 Del. J. Corp. L. 342 , 348, Fed. Sec. L. Rep. P 96010 (1991)).

The facts alleged will not necessarily be determinative because sometimes a single set of facts will support a derivative action and a direct action. Grimes, supra, 673 A.2d at 1213 . When a shareholder’s complaint states a cause of action that is both direct and derivative, the shareholder may proceed with the direct action. Elster v. American Airlines, Inc., supra, 100 A.2d at 222 .

Under Delaware corporate law, the members of the board of directors of a Delaware corporation are corporate fiduciaries who owe a triad of duties to the corporation’s shareholders: the duties of care, loyalty, and good faith. Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170, 1172 (Del.2000) (citing Malone v. Brincat, 722 A.2d 5, 10 (Del.1998)). These fiduciary duties give rise to certain disclosure obligations. Malone v. Brincat, supra, 722 A.2d at 11 ; O’Reilly v. Trans- ¹¹ world Healthcare, Inc., 745 A.2d 902 (Del.Ch.1999).

Often, the obligation to disclose will arise in the context of a communication being made by the directors to the shareholders about stockholder action that is being considered or solicited. In Count V, Paskowitz alleges that the individual appellees violated their disclosure obligations in the 1997, 1998, and 1999 proxy statements by making materially misleading partial disclosures about