In this decision, the Court of Chancery declined to certify a class of stockholder plaintiffs where the sole claim was for breach of fiduciary duty arising from alleged disclosure violations made in an after-the-fact notice of corporate action by written consent pursuant to 8 Del. C. § 228(e). Specifically, the Court held that common questions of law or fact did not exist among the putative class members because the alleged inadequate disclosures were not made in connection with a request for stockholder action. Thus, the elements of reliance, causation, and damages had to be alleged and proven by each individual stockholder.
The plaintiffs, Sheldon Dubroff and Mervyn Klein, were former minority stockholders of Nine Systems Corporation (“NSC”), a privately held Delaware corporation. The defendants were certain former NSC stockholders and debtholders (the “Entity Defendants”), former members of NSC’s board of directors, and NSC. The Entity Defendants had significant ties to NSC’s directors.
The plaintiffs’ complaint asserted breach of fiduciary duty claims arising from alleged disclosure violations in a Section 228(e) notice regarding a recapitalization transaction that was approved by written consent of fewer than all of NSC’s stockholders. The recapitalization transaction allowed the Entity Defendants to convert preferred debt into preferred stock and thereby increase their collective equity stake from 56% to almost 80%. Following consummation of the recapitalization transaction, NSC sent a notice, as required by Section 228(e) of the Delaware General Corporation Law, to those stockholders, including the plaintiffs, who did not consent to the transaction, but who would have been entitled to notice of a stockholders meeting had the recapitalization transaction been approved at such a meeting. The plaintiffs alleged NSC’s Section 228(e) notice failed to disclose the debtholders’ identities, their connections to the Board, or the price at which their debt was converted into equity.
The Court rejected class certification, reasoning the plaintiffs failed to demonstrate the putative class would share common questions of law or fact, as required by Chancery Court Rule 23(a)(2). Because the alleged disclosure violations occurred in an after-the-fact Section 228(e) notice, and thus were not part of disclosures requesting stockholder action, the Court concluded that each putative class member must make an individualized showing of reliance, causation, and damages.
The Court explained that such individualized showings were required by reason of the Delaware Supreme Court’s decision in Malone v. Brincat, 722 A.2d 5 (Del. 1998). In Malone, the Delaware Supreme Court stated that an “action for a breach of fiduciary duty arising out of disclosure violations in connection with a request for stockholder action does not include the elements of reliance, causation, and . . . damages.” The negative implication drawn by the Court from Malone is that where stockholder action is not requested, those additional elements must be shown individually. While conceding that Malone did not explicitly prohibit class certification in a breach of fiduciary duty action arising from alleged disclosure violations where stockholder action is not requested, the Court explained that from a practical standpoint it would be difficult to find class members who shared these elements in common.
The full opinion is available here.