Opinion
C.A. No. 20360-NC.
Date Submitted: October 14, 2004.
November 30, 2004.
Bayard J. Snyder, Esquire, Snyder Associates, P.A., Wilmington, DE.
Michael F. Bonkowski, Esquire, Saul Ewing LLP, Wilmington, DE.
Mr. J. Patrick Nicholson, Toledo, OH.
Dear Counsel and Mr. Nicholson:
Plaintiff Strategic Asset Management, Inc. ("SAMI"), with the concurrence of all but one of the Defendants, has sought, under Court of Chancery Rule 23.1, approval of a settlement of this derivative action brought on behalf of Nominal Defendant N-Viro International Corporation ("N-Viro"). During the settlement hearing, the Court learned that SAMI, the only plaintiff, has not continuously held N-Viro stock throughout the course of this proceeding. The parties were directed to explore the history of SAMI's ownership of N-Viro stock and to explain why SAMI was not deprived of standing to pursue this action and its settlement as the result of SAMI's failure to maintain "continuous ownership" of stock in the Nominal Defendant. Counsel have confirmed that, as of March 28, 2004, SAMI held no stock in N-Viro. This letter opinion addresses the consequences of that fact.
I. FACTS
N-Viro is a Delaware corporation. On June 11, 2003, SAMI, a derivative plaintiff, filed this action and sought a temporary restraining order to which the Defendants consented. Settlement discussions began. An initial settlement was reached in December 2003, but the Court rejected this proposed settlement on May 20, 2004. Subsequent negotiations produced a second settlement agreement that was filed on June 29, 2004. However, at a hearing to consider the settlement on October 14, 2004, it came to the Court's attention that there was a question as to whether SAMI had continuously owned shares of N-Viro. The Court did not approve the settlement but, instead, directed SAMI to show proof of continuous ownership in N-Viro or to submit a brief explaining why this Court should stray from the "continuous ownership requirement." SAMI submitted its brief on October 28, 2004, in which it conceded that "[a]s of March 28, 2004, [SAMI] had . . . sold the small balance of public market shares, leaving it without any shares of N-Viro."
Strategic Asset Mgmt., Inc. v. Nicholson, 2004 WL 1192088 (Del.Ch. May 20, 2004).
See, e.g., In re New Valley Corp. Deriv. Litig., 2004 WL 1700530 (Del.Ch. June 28, 2004).
Pl. Br. re Requirement for Continuous Ownership of Shares, at 5 (Oct. 28, 2004).
II. CONTENTIONS
In its October 28, 2004, brief, SAMI advanced three arguments as to why this Court should divagate from its "continuous ownership requirement" for derivative actions: (1) that the facts of the case at hand are not analogous to the facts set forth in other cases concerning the "continuous ownership requirement," namely, that those cases involve mergers and no merger is involved in this case; (2) that the policy concerns behind the "continuous ownership requirement" are not applicable to this case; and (3) that since all that was left in this litigation was the mere ministerial act of approving a settlement agreement, practically and legally, SAMI did not cease to own N-Viro stock during the "course of litigation."III. ANALYSIS
A. The "Continuous Ownership Requirement"
The "continuous ownership requirement" is a fundamental and ongoing burden that a plaintiff in a Delaware derivative action must satisfy. "A plaintiff who is not a shareholder, or who ceases to be a stockholder during the pendency of his suit, loses standing to maintain a derivative action." The statutory source for the "continuous ownership requirement" begins with 8 Del. C. § 327, which reads,
1 R.F. BALOTTI J.A. FINKELSTEIN, DELAWARE LAW OF CORPORATIONS AND BUSINESS ORGANIZATIONS § 13.10, 13-29 (2004).
In any derivative suit instituted by a stockholder of a corporation, it shall be averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction of which such stockholder complains or that such stockholder's stock thereafter devolved upon such stockholder by operation of law. Caseaw applying § 327 has amplified its terms to require that a derivative plaintiff maintain ownership throughout the course of litigation. As expressed in Lewis v. Anderson:
We conclude that 8 Del. C. §§ 259, 261 and 327, read individually and collectively, permit one result which is not only consistent but sound: A plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing to continue a derivative suit.
See also Court of Chancery Rule 23.1 ("[T]he [derivative] complaint shall allege that the plaintiff was a shareholder . . . at the time of the transaction of which the plaintiff complains.").
In re New Valley, 2004 WL 1700530, at *3 ("Although section 327 does not explicitly require continuous stock ownership to maintain a derivative action, that requirement has been a staple of Delaware law for over two decades.").
477 A.2d 1040, 1049 (1983).
No exception to this rule is present here.
There are two well-recognized exceptions, both in the merger context: a merger, subject to a claim of fraud, that occurs merely to deny shareholders the opportunity to pursue a derivative action and a merger that is nothing more than a mere reorganization. See Lewis v. Ward, 852 A.2d 896, 902-04 (Del. 2004).
Delaware courts adhere to this rule because it is supported by important policy considerations. These considerations include theoretical underpinnings (as derivative actions involve a plaintiff who is enforcing the rights of a separate entity; without ownership it is difficult to explain why a plaintiff has a right to bring a derivative claim) and practical underpinnings (namely, the Court is attempting (a) to insure that the derivative plaintiff is representative of the shareholders and has the incentive to pursue the litigation in the best interest of the shareholders and (b) to prevent "strike suits").
Alabama By-Products Corp. v. Cede Co., 657 A.2d 254, 265 (Del. 1995) ("The continuous ownership requirement similarly recognizes the power of the board to manage the business and affairs of the corporation. Essentially, a shareholder is permitted to intrude upon the authority of the board by means of a derivative suit only because his status as a shareholder provides an interest and incentive to obtain legal redress for the benefit of the corporation.").
See Lewis, 477 A.2d at 1046. See also BALOTTI FINKELSTEIN, supra note 5, at 13-29 (citing cases).
B. SAMI's Arguments as to why the "Continuous Ownership Requirement" Should Not Apply Here
SAMI advances three arguments as to why this Court should bend the "continuous ownership requirement" in this case. Each must be rejected.
1. The case at hand is dissimilar from other "continuous ownership requirement" cases
SAMI asserts that "[t]he rationale of In re New Valley Corp. is the `incentive' rationale of Lewis v. Anderson, which under the specific factual circumstances of this action is inapplicable." SAMI then observes that "the majority of the cases involve mergers." One reading of this argument is that, since this case does not involve a merger, the holdings of In re New Valley and Lewis are inapplicable. However, the test prescribed in Lewis is in the disjunctive and, thus, is not limited solely to merger situations.
2. The facts of this case can be distinguished from other cases in this area
Pl. Br., supra note 3, at 6 (citations omitted).
Id.
Another reading is that the policy rational behind this line of cases is not applicable to this matter. For a discussion of this argument, see infra Part II.B.3.
See Lewis, 477 A.2d at 1049 ("A plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing to continue a derivative suit.") (emphasis added).
While the Court has not concluded that SAMI pursued this litigation for reasons other than the best interests of N-Viro shareholders, there are no facts that distinguish this case on the basis that SAMI's actions are outside of the policy concerns behind the continuous ownership requirement. One of the benefits of the "continuous ownership requirement" is that it is straightforward. Moreover, the decision to eliminate its equity holding was made voluntarily by SAMI. Thus, SAMI's comparison of this case to the various merger cases brings forth a factual distinction which makes SAMI's argument even less appealing. In the merger context, stockholders may involuntarily lose their equity interest in a particular corporation. Here, SAMI fails the continuous ownership requirement by virtue of its own volitional acts.
For a discussion of these policy concerns, see supra notes 10-11 and accompanying text.
3. The litigation of this matter is complete
SAMI's next argument as to why the continuous ownership requirement should not apply in this situation is that the litigation has ended. In other words, some cases have articulated the continuous ownership requirement by noting that ownership is required "throughout the litigation." SAMI argues that, since a settlement was reached and all that was left was court approval of this settlement, the lawsuit was essentially finished. Simply put, "[SAMI] respectfully suggests that the phrase `course of litigation' or Harff's `throughout the litigation' mean that period while the issue, the disputes, are being contested."
See, e.g., Harff v. Kerkorian, 324 A.2d 215, 219 (Del. Ch. 1974) ("But Delaware law seems clear that stockholder status at the time of the transaction being attacked and throughout the litigation is essential.") (emphasis added).
Pl. Br., supra note 3, at 9.
SAMI's argument fails. First, without a final judgment by the Court the litigation is not terminated. In accordance with Court of Chancery Rule 23.1, any settlement, to be effective, must first be approved by the Court. Since this Court has not approved the settlement, final judgment has not been entered and the "continuous ownership requirement" — which SAMI has failed — remains intact.
Second, SAMI overlooks the significance of the fact that this Court rejected the first proposed settlement. The second proposed settlement was submitted after SAMI had disposed of its N-Viro stock. Thus, by the time that the second settlement was submitted to the Court, SAMI no longer had a stake in the corporate venture. By that point, SAMI did not share a common interest with other N-Viro shareholders, and, thus, it is difficult to accept that SAMI was motivated by the best interests of its former fellow shareholders.
IV. CONCLUSION
For the reasons set forth above, I conclude that, once SAMI ceased to be a shareholder in N-Viro while it was pursuing a derivate action, it lost its standing as a derivative plaintiff and must be dismissed from the case. However, under the Court's equitable discretion, the dismissal of SAMI as derivative plaintiff (and this action) will be stayed until February 1, 2005, in order to afford an opportunity to any other appropriate N-Viro shareholder to seek to intervene.
See Hutchinson v. Bernhard, 220 A.2d 782, 784 (Del.Ch. 1965). There, the original derivative plaintiff had to be dismissed because she no longer owned any shares of the company's stock. The Court then mapped out the proper course. "The remaining question then is whether there are any equities here which move the court to adopt any conditions to the granting of the motion. I conclude on balance that an order should first be entered directing Fund to notify its stockholders that defendants' motion has been filed and the basis of the motion; that if no other qualified stockholder seeks to intervene before a date to be fixed in the order, the court will grant defendants' motion. If an application to intervene is made it will be decided first. . . . I conclude that this approach accommodates the conflicting considerations involved in disposing of defendants' motion in the light of the reason for plaintiff's inability to proceed and the other factors here present." Id. Similarly, this Court exercises its equitable powers to provide time for an adequate derivative plaintiff to come forth and substitute itself for SAMI.