Opinion
No. C 03-3657 CW (Related Case) C 03-5023.
March 7, 2005
ORDER GRANTING DEFENDANTS' MOTION TO DISMISS SECOND AMENDED AND SUPPLEMENTAL COMPLAINT
Defendants William M. Hawkins III, William A. Hall, H. William Jesse, Jr. and Richard Lehrberg move, pursuant to Federal Rule of Civil Procedure 12(b)(6), to dismiss the second amended and supplemental complaint (SAC) filed by Plaintiffs Gaia Offshore Master Fund, Ltd. and HFTP Investments, LLC. Plaintiffs oppose the motion. The matter was taken under submission on the papers. Having considered the parties' papers, the Court GRANTS Defendants' motion to dismiss.
BACKGROUND
Plaintiffs' SAC alleges as follows. Plaintiffs Gaia Offshore Master Fund, Ltd. and HFTP Investments, LLC are shareholders in The 3DO Company, a computer software and game company incorporated in Delaware. Most of the assets of The 3DO Company are held in a wholly-owned California subsidiary also called The 3DO Company; the companies are alter-egos of one another (and will hereinafter collectively be referred to as "3DO"). Defendants comprise 3DO's board of directors, and Defendant Hawkins is also the founder, chief executive officer and controlling shareholder of 3DO.
On December 7, 2001, Plaintiffs purchased, for $12.5 million, 12,500 shares of 3DO Series A Convertible Preferred Stock pursuant to a securities purchase agreement (SPA). Plaintiffs' rights as preferred shareholders are outlined in the SPA and in a certificate of designations, preferences and rights (Certificate) that 3DO filed with the Secretary of State of Delaware. The Certificate gives Plaintiffs redemption preference over holders of common stock in the event of liquidation or dissolution. It also provides Plaintiffs the ability, upon the occurrence of certain "triggering events," to redeem their preferred stock at favorable rates. The SPA lists several possible "triggering events," including (1) 3DO issuing stock of senior distribution preference to Plaintiffs', (2) 3DO entering into any agreements with its officers or directors without approval by a majority of 3DO's disinterested directors, and (3) delisting from the NASDAQ national market.
3DO's financial stability deteriorated in 2002 and, by the spring of that year, Hawkins knew that the company would not survive. Faced with that realization, Hawkins devised a plan through which he could avoid potential "triggering events" and also gain priority in 3DO's impending dissolution. From October, 2002 to January, 2003, 3DO and Hawkins undertook four transactions whereby Hawkins transferred a total of $12 million to 3DO in the form of secured loans guaranteed by 3DO assets that included the company's intellectual property. Directors Hall, Jesse and Lehrberg approved these transactions.
Plaintiffs contend that the Hawkins loans were in fact contributions of equity with rights senior to Plaintiffs' preferred shares. That is true, according to the SAC, because the Hawkins loans bore none of the hallmarks of a legitimate "arm's length" loan. Plaintiffs maintain that Defendants mischaracterized the loans in order to interfere improperly with Plaintiffs' contractual rights and protections. Had the loans been properly characterized, they would have resulted in a "triggering event" because they, inter alia, would have constituted issuance of stock senior in preference to Plaintiffs' preferred shares.
3DO filed for Chapter 11 bankruptcy on March 28, 2003, and the case was converted to Chapter 7 on November 7, 2003. In a related case, the trustee of 3DO's bankrupt estate has filed a lawsuit against Defendants that includes sixteen claims for relief, several of which arise from allegations surrounding the $12 million Hawkins loan. The 3DO Company v. Hawkins, et al., C 03-5023.
Plaintiffs filed their first amended and supplemental complaint (FAC) on June 16, 2004, alleging causes of action for (1) tortious interference with contract and (2) breach of fiduciary duty. On November 5, 2004, the Court granted Defendants' motion to dismiss (FAC order). Principally, the Court found that Plaintiffs had failed to satisfy the standing requirements set forth in Tooley v. Donaldson, Lufkin Jenrette, 845 A.2d 1031 (Del. 2004), for a direct stockholder claim. Plaintiffs were given leave to amend to plead facts sufficient to meet the Tooley standing test. Plaintiffs filed the SAC on December 8, 2004, which states a single cause of action for tortious interference with contract.
LEGAL STANDARD
Dismissal of a complaint can be based on either the lack of a cognizable legal theory or the lack of sufficient facts alleged under a cognizable legal theory. Balistreri v. Pacifica Police Dep't, 901 F.2d 696, 699 (9th Cir. 1988). A motion to dismiss for failure to state a claim will be denied unless it appears that the plaintiff can prove no set of facts which would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957);Fidelity Fin. Corp. v. Fed. Home Loan Bank of S.F., 792 F.2d 1432, 1435 (9th Cir. 1986). All material allegations in the complaint will be taken as true and construed in the light most favorable to the plaintiff. NL Indus., Inc. v. Kaplan, 792 F.2d 896, 898 (9th Cir. 1986).
When granting a motion to dismiss, a court is generally required to grant a plaintiff leave to amend, even if no request to amend the pleading was made, unless amendment would be futile.Cook, Perkiss Liehe, Inc. v. N. Cal. Collection Serv. Inc., 911 F.2d 242, 246-47 (9th Cir. 1990). In determining whether amendment would be futile, a court examines whether the complaint could be amended to cure the defect requiring dismissal "without contradicting any of the allegations of [the] original complaint." Reddy v. Litton Indus., Inc., 912 F.2d 291, 296 (9th Cir. 1990).
DISCUSSION
I. Whether Tooley Applies
The parties agreed, in their papers on Defendants' motion to dismiss the FAC, that Tooley set forth the applicable standard for whether shareholders' claims properly belong to the estate of a bankrupt corporation, that is, they are derivative claims, or to the shareholders individually, that is, they are direct claims. Plaintiffs now contend that it is unnecessary to reach the Tooley test because the SAC omits the breach of fiduciary duty claim that was in the FAC and contains only a claim for tortious interference. That argument is not welltaken. Plaintiffs acknowledged, and the Court ruled, that the Tooley test applied to both of Plaintiffs' claims in the FAC, including their claim for tortious interference with contract.
Plaintiffs nevertheless argue that their claim is direct because only they, and not the trustee of the bankrupt estate, may assert it. They argue, "Since the Company was the party that breached the agreements with Plaintiffs and the Trustee stands in the Company's shoes, the Trustee cannot possibly have standing to sue for the Company's own breach." Pl.'s Opp'n at 11. However, Plaintiffs are not suing the company for tortiously interfering with the contracts; they are suing the directors, just as the trustee is doing in C 03-5023. The Court rules, as it did in the FAC order, that the Tooley test applies to Plaintiffs' claim for tortious interference with contract.
II. Standing
Defendants argue that the SAC, like the FAC, fails to satisfy the requirements of the Tooley test. Whether a claim is derivative or direct is a matter to be determined by State law.In re Van Dresser Corp., 128 F.3d 945, 947 (6th Cir. 1997). The issue of "whether a stockholder's claim is derivative or direct must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?" Tooley, 845 A.2d at 1033.
In the FAC order, the Court ruled that Plaintiffs had failed to meet the first prong of the Tooley test because they had not alleged an injury independent of the injury to 3DO. FAC order at 8-9. Specifically, the Court held that the injuries alleged in the FAC, namely (1) loss of priority upon liquidation and
(2) deprivation of opportunity to redeem shares, required a finding of mismanagement of the company. Thus, the injuries alleged by Plaintiffs in the FAC were dependent upon first alleging injury to 3DO. The Court further ruled that Plaintiffs had failed to satisfy the second prong of Tooley because the remedies they sought depended upon recharacterizing the Hawkins loans as equity investments, which would have restored assets to, and thus benefitted, 3DO. Here, Defendants argue that the SAC has not alleged any new facts relevant to the Tooley analysis; instead, Defendants argue, the SAC has merely omitted certain facts from the FAC that made the previous complaint defective.
A. Who Suffered the Alleged Harm
Defendants first argue that the SAC does not allege harm to Plaintiffs that is independent of harm to 3DO. Under Tooley, a shareholder must show that its claims can survive without showing injury to the company. 845 A.2d at 1039. Defendants contend that the injuries complained of by Plaintiffs in the SAC still require first showing that 3DO suffered from mismanagement. Plaintiffs maintain that the Hawkins capital infusions, which breached the SPA and Certificate and therefore constituted "triggering events," did not harm the company. However, in the FAC, Plaintiffs alleged that, by accepting the Hawkins loans, 3DO "operated in a manner that caused it to incur expenses and to enter into commitments that served to deepen its insolvency, to the detriment of those to whom Defendants owed fiduciary duties." FAC ¶ 39. Plaintiff cannot now amend their complaint to contradict allegations made in the FAC.
The Court rules, as it did in the FAC order, that Plaintiffs do not allege injury that is independent of harm to the company. While it may be true, as Plaintiffs argue, that the alleged injury they suffered was distinct from the injury suffered by 3DO, that fact is not dispositive. The critical inquiry is whether Plaintiffs can allege harm without showing injury to 3DO. The Hawkins loans, the FAC alleged, were part of a reckless business plan that deprived Plaintiffs of their contractual rights and deepened 3DO's insolvency. Because the SAC cannot contradict that allegation, the Court rules that the SAC fails to satisfy the first prong of the Tooley test.
B. Who Would Receive the Benefit of Recovery or Remedy
Under the second prong of Tooley, Defendants argue that any recovery obtained by Plaintiffs would benefit 3DO. In the FAC order, the Court ruled, and Plaintiffs conceded, that recovery on their claims would require the recharacterization of the Hawkins loans as equity investments. In the SAC, Plaintiffs again allege that the loans were, in fact, infusions of equity. However, as found in the FAC order, recharacterizing the debts as such "would cause legal rights to the intellectual property encumbered by the loan to be restored to the estate. Thus, benefit to the 3DO estate (and its creditors) comes before, and is a necessary predicate of, any benefit to Plaintiffs." FAC order at 9.
Plaintiffs now argue that they seek damages, which would benefit them alone, and not the equitable remedy of recharacterization. However, they have already conceded, and do not now dispute, that the availability of damages is entirely dependent upon recharacterization of the Hawkins loans. The SAC reads, "Although the four transactions were characterized by defendants as secured loans from Hawkins to the Company, they were, in fact, contributions of equity with rights senior to the Preferred Shares or purchase proceeds to the Company." SAC ¶ 43. Indeed, the gravamen of Plaintiffs' SAC is that the relevant contracts were breached when Hawkins mischaracterized the capital infusions as secured loans, thereby avoiding potential "triggering events" that would have allowed Plaintiffs immediately to redeem their shares. Although recharacterizing the loans would demonstrate that Defendants breached the SPA and Certificate, it would also restore assets to the 3DO bankruptcy estate.
Plaintiffs have failed to satisfy the second prong of theTooley analysis.
CONCLUSION
For the foregoing reasons, the second amended and supplemental complaint filed by Plaintiffs is dismissed. Because the Court has already granted Plaintiffs leave to amend to plead facts sufficient to satisfy the Tooley test, and because Plaintiffs have again failed to meet its requirements, the Court dismisses with prejudice the second amended and supplemental complaint. The Clerk shall enter judgment and close the file.
IT IS SO ORDERED.