On August 12, 2013, the United States Court of Appeals for the Fifth Circuit in Joe W. and Dorothy Dorsett Brown Foundation, et. al. v. Frazier Healthcare V, L.P., et al. affirmed the decision of the United States District Court for the Western District of Texas dismissing with prejudice all claims stemming from the 2011 acquisition of Ascension Orthopedics, Inc. (“Ascension”) by Integra LifeSciences (“Integra”). In a case of first impression for the Fifth Circuit, applying Delaware law, the Court of Appeals affirmed the derivative (as opposed to direct) nature of claims primarily grounded in shareholder dilution and agreed that Delaware law does not recognize a common law claim for minority shareholder oppression.
Haynes and Boone, LLP, represented the alleged controlling majority shareholders in the district court and on appeal.
In 2010 and 2011, Ascension (a Delaware corporation, headquartered in Austin, Texas) was in need of additional capital to survive. After several bridge financings, it issued a new series of Series E preferred stock carrying a 300 percent liquidation preference. All stockholders, including plaintiffs, were invited to participate. Several stockholders – including Defendant Frazier Healthcare V, L.P. – chose to participate. Others – including plaintiffs and Defendants Frazier Healthcare III, L.P. and Frazier Affiliates III, L.P. – did not. Late in 2011, Ascension was sold to Integra for a price that did not fully satisfy the 300 percent liquidation preference of the Series E stockholders. As a result, plaintiffs and other stockholders did not receive any of the merger consideration. Plaintiffs made no effort to enjoin the transaction.
II. District Court Proceedings
Plaintiffs filed suit in the Western District of Texas against members of Ascension’s board of directors and the three Frazier funds, who were alleged to have controlled the board. Plaintiffs alleged claims for breach of fiduciary duty and minority shareholder oppression.
The trial court granted defendants’ motions to dismiss, finding that plaintiffs’ claims (sounding primarily in shareholder dilution) were derivative rather than direct under Delaware law. Any alleged injury from the Series E stock issuance could only have been suffered by Ascension (and by extension all shareholders, derivatively), thus precluding plaintiffs from bringing a direct claim. Central to the court’s ruling was the fact that plaintiffs could have participated in the transactions they were challenging. Because the allegedly dilutive Series E stock issuance was not for the “exclusive benefit” of defendants, the suit did not fall under Delaware’s narrow exception for direct pursuit of shareholder dilution claims. See Gentile v. Rossette, 906 A.2d 91 (Del. 2006). The trial court also found that Delaware does not recognize a cause of action for minority shareholder oppression and dismissed plaintiffs’ claims under that theory as well. See Brown Foundation, et. al. v. Frazier Healthcare V, L.P., 2012 WL 3834029 (W.D. Tex., Aug. 27, 2012).
III. The Fifth Circuit’s Affirmance
The Fifth Circuit panel (Judges Garza, Smith, and Southwick) heard oral argument on August 6, 2013, and summarily affirmed the dismissal of all claims in a per curiam opinion on August 12. The affirmance reinforces that would-be minority shareholders who are considering investing in Delaware corporations should bargain for the protections they believe they need prior to investing rather than expecting courts to craft special rules to protect them. See Nixon v. Blackwell, 626 A.2d 1366 (Del. 1993). The decision also adds to a growing body of case law addressing whether minority shareholders of Delaware corporations can bring direct claims when their equity is allegedly diluted. Where, as where, minority shareholders were invited to participate in the transactions that they later challenge as dilutive, it is clear that they cannot sue directly.