Opinion
Civil Action No. 4032-CC.
Submitted: April 22, 2009.
Decided: May 15, 2009.
Carl L. Green, Dawn Martinson Green, Duluth, MN.
Brett D. Fallon, Jason C. Jowers, Morris James LLP, Wilmington, DE.
Dear Counsel and Mr. and Ms. Green:
I have carefully reviewed the papers filed on behalf of LocatePlus Holdings Corporation ("LocatePlus"), Jon Latorella, James Fields, Sonia Bejjani, Ralph Caruso, and David Skerrett (collectively the "Director Defendants") in support of their motion to dismiss plaintiffs' amended complaint, as well as the opposition filed by plaintiffs Carl L. Green and Dawn Martinson Green. For reasons stated briefly below, I grant defendants' motion to dismiss plaintiffs' amended complaint without prejudice for failure to comply with Court of Chancery Rule 23.1. This letter is the Court's ruling on the motion.
I. BACKGROUND
The issues before the Court procedurally arise on defendants' motion to dismiss plaintiffs' amended complaint. Consequently, I will only consider the facts provided in plaintiffs' amended complaint. The facts provided by plaintiffs, however, are sparse, opaque, and insufficient. In order to adequately provide even an abbreviated factual account of the background in which to place this case's relevant issues, I have supplemented the facts with information taken from the parties' briefs.
According to plaintiffs, LocatePlus effectuated a transaction that allegedly diluted the value of LocatePlus' common equity. On March 20, 2007, LocatePlus issued a secured convertible debenture to Cornell Capital Partners L.P. ("CCP") in the amount of $6,000,000. According to the purchase agreement, the holder of the debentures may convert at any time the outstanding principal into shares of common stock of LocatePlus at a fixed conversion price of $0.314 per share. Any conversion, however, cannot provide CCP with more than a 4.99% ownership in LocatePlus. The debentures are secured by substantially all of LocatePlus' assets, and the debentures carry an annual interest rate of 8.5% payable in quarterly installments. Under the terms of the deal, CCP can choose to receive installment payments by converting them into common stock.
Shortly after LocatePlus issued the debentures, plaintiffs allege that LocatePlus issued approximately 7,350,793 additional shares. LocatePlus states that the share issuance was done to pay off its outstanding debt owed to CCP. Plaintiffs allege that the reason for the dilution and economic collapse was to benefit the Director Defendants by granting them additional voting power at the upcoming shareholder meeting. As of September 30, 2008, the outstanding principal of the debentures stood at $2,514,070. As a result of the share issuance, plaintiffs claim that their interest in LocatePlus was diluted from 5% to 3%.
II. ANALYSIS
Plaintiffs assert the right to bring a direct claim against LocatePlus and the Director Defendants. In Tooley v. Donaldson, Lufkin Jenrette, Inc., the Supreme Court set forth the test to determine whether a stockholder can bring a direct claim. The Court held that the distinction between derivative and direct claims "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)?" In other words, "[t]he stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation." In plaintiffs' amended complaint, they allege that they were directly harmed by the dilution of stock. This conclusion, however, is a mere conclusory allegation of a direct injury. Plaintiffs fail to allege specific facts or even explain how the dilution harmed them directly or how the harm they suffered differed from the harm suffered by LocatePlus itself or the other holders of LocatePlus' stock. There are insufficient factual allegations in the complaint to support plaintiffs' claim that they were harmed independent of LocatePlus.Classically, Delaware law has viewed as derivative claims by shareholders alleging that they have been wrongly diluted by a corporation's overpayment of shares. Explaining the reasoning behind this position, the Supreme Court stated:
Gentile v. Rossette, 906 A.2d 91, 99 (Del. 2006); see also In re J.P. Morgan Chase Co. S'holder Litig., 906 A.2d 808, 819-20 (Del. Ch. 2005), aff'd, 906 A.2d 766 (Del. 2006).
In the typical corporate overpayment case, a claim against the corporation's fiduciaries for redress is regarded as exclusively derivative, irrespective of whether the currency or form of overpayment is cash or the corporation's stock. Such claims are not normally regarded as direct, because any dilution in value of the corporation's stock is merely the unavoidable result (from an accounting standpoint) of the reduction in the value of the entire corporate entity, of which each share of equity represents an equal fraction. In the eyes of the law, such equal "injury" to the shares resulting from a corporate overpayment is not viewed as, or equated with, harm to specific shareholders individually.
Gentile, 906 A.2d at 99.
There is "one transactional paradigm," however, that Delaware law recognizes as being both direct and derivative. This specific situation arises in the controlling shareholder context where: (1) a controlling shareholder causes the corporation to issue excessive shares of its stock in exchange for assets of an unreasonably lesser value; and (2) the exchange results in the controlling shareholder owning an increased percentage of the outstanding shares, and the minority shareholders owning a corresponding decrease in the percentage of outstanding shares. In such situation, not only is the corporation harmed because the over-issuance gives the corporation the right to compel the restoration of the overpaid value, but also because the voting power, through the dilution, is shifted from the minority shareholders to the controlling shareholder. The minority shareholders are harmed separate and apart from the corporation and the controlling shareholder. This creation of a separate class of injury suffered by the minority shareholders gives rise to a separate direct claim. In such circumstances, the minority shareholders are entitled to recover the value, resulting from the overpayment, that may be claimed by the minority shareholders directly and without regard to the corporation's claims. These specific circumstances, however, do not exist in this case.
Id. at 99-100.
In their amended complaint, plaintiffs have failed to allege facts that would lead this Court to conclude that there is a controlling shareholder or that a controlling shareholder caused the dilution. Consequently, this is not one of the specific circumstances where dilution of stock gives rise to a direct claim. Thus, I conclude that plaintiffs' claims alleging they were harmed by the dilution of their stock are strictly derivative.
Given that plaintiffs, in order to sustain their claims against LocatePlus and the Director Defendants, must allege derivative claims on behalf of LocatePlus, plaintiffs must comport with the requirements of Rule 23.1. "The decision whether to initiate or pursue a lawsuit on behalf of the corporation is generally within the power and responsibility of the board of directors." "Therefore, the right of a stockholder to prosecute a derivative suit is limited to situations where either the stockholder has demanded the directors pursue a corporate claim and the directors have wrongfully refused to do so, or where demand is excused because the directors are incapable of making an impartial decision regarding whether to institute such litigation." Plaintiffs have not made a demand upon the board of directors of LocatePlus to pursue their claim, and thus, plaintiffs must plead why demand should be excused in this case.
In re Citigroup Inc. S'holder Derivative Litig., 964 A.2d 106, 120 (Del.Ch. 2009) (citing 8 Del. C. § 141(a)).
Stone ex rel. AmSouth Bancorp. v. Ritter, 911 A.2d 362, 366-67 (Del. 2006).
Rule 23.1(a) provides that "[t]he complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort." In addition, to determine demand futility the Court must exercise its discretion in deciding whether "a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." Plaintiffs have failed to comply with this pleading standard. In their amended complaint, plaintiffs have not alleged that demand is excused or pled with any measure of particularity facts that would demonstrate that the Director Defendants are not disinterested or independent, or that the dilution was not a proper exercise of the board's business judgment. Indeed, plaintiffs' conclusory allegation that the Director Defendants caused the dilution to enrich themselves is insufficient to meet the standard under Rule 23.1. Plaintiffs fail even to allege how the dilution in exchange for financing from CCP was not in the best interests of LocatePlus. In fact, plaintiffs state that "the complaint does not allege the exchange of debt for shares was unfair." Furthermore, plaintiffs fail to allege facts that would support a claim that the Director Defendants were motivated by a perceived vulnerability to removal from the LocatePlus board. Practically speaking, plaintiffs fail to allege any set of facts with sufficient particularity to meet either prong of the Aronson test. Thus, I conclude that plaintiffs have not satisfied the requirements of Rule 23.1.
Ct. Ch. R. 23.1(a) (emphasis added).
Brehm v. Eisner, 746 A.2d 244, 253 (Del. 2000) (quoting Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984)).
Greenwald v. Batterson, 1999 WL 596276, at *4 (Del.Ch. July 26, 1999) (quoting Grobow v. Perot, 539 A.2d 180, 187 (Del. 1988) ("In weighing the adequacy of the complaint under Rule 23.1, `only well-pleaded allegations of fact may be accepted as true; conclusory allegations of fact or law not supported by allegations of specific fact may not be taken as true. A trial court need not blindly accept as true all allegations, nor must it draw all inferences from them in plaintiffs' favor unless they are reasonable inferences.'").
Compl. ¶ 21.
Plaintiffs have also failed to comply with the procedural requirements for an inspection of books and records under 8 Del. C. § 220. Plaintiffs contend that LocatePlus has wrongfully refused to allow them access to LocatePlus' books and records, yet in their letters requesting the inspection dated January 19, 2008, February 19, 2008, and March 13, 2008, plaintiffs failed to set forth any purpose for their inspection. Plaintiffs also neglected to send the letters under oath. Section 220(b) clearly states that "[a]ny stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose." There are also additional material defects in plaintiffs request for an inspection of LocatePlus' books and records, including failure to provide proper evidence of beneficial ownership. Section 220 provides shareholders with a qualified right to inspect corporate books and records. Indeed, all shareholders have the right, at any time, to inspect the books and records of the company in which they own common shares, yet they must comply with the statutory requirements of § 220. Plaintiffs, to this point, have failed to meet those requirements, but the deficiencies in their request can be easily remedied.
8 Del. C. § 220(b) (emphasis added).
Melzer v. CNET Networks, Inc., 934 A.2d 912, 916 (Del.Ch. 2007) (citing La. Mun. Police Employees' Ret. Sys. v. Countrywide Fin. Corp., 2007 WL 2896540, at *9 (Del.Ch. Oct. 2, 2007)).
"Before shareholders may inspect books and records, they must (1) comply with the technical requirements of section 220 and (2) demonstrate a proper purpose for seeking inspection. There is no shortage of proper purposes under Delaware law, but perhaps the most common `proper purpose' is the desire to investigate potential corporate mismanagement, wrongdoing, or waste." Id. (citing 1 EDWARD P. WELCH, ANDREW J. TUREZYN ROBERT SAUNDERS, FOLK ON THE DELAWARE GENERAL CORPORATION LAW § 220.6.3 (supp. 2007-2) (listing over ten examples of broad categories of proper purposes under section 220)).
III. CONCLUSION
For the foregoing reasons, I grant defendants' motion to dismiss plaintiffs' amended compliant. I do so, however, without prejudice and strongly encourage plaintiffs to obtain counsel to assist them in properly obtaining access to LocatePlus' books and records, and in adequately articulating their allegations.
IT IS SO ORDERED.