IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
KEITH A. FOTTA, TELEMARK )
TECHNOLOGY, INC., GERALD A. )
CLARK, JAMES B. RICH, ILENE )
RICH, DIANE JURMAIN, and PETER )
JURMAIN, )
)
Plaintiffs, )
)
v. ) C.A. No. 8230-VCG
)
CHARLES D. MORGAN, individually )
and as Trustee of the CHARLES D. )
MORGAN REVOCABLE TRUST, and )
JEFFERSON D. STALNAKER, )
)
Defendants, )
)
and )
)
FIRST ORION CORP., )
)
Nominal Defendant. )
MEMORANDUM OPINION
Date Submitted: November 16, 2015
Date Decided: February 29, 2016
Evan O. Williford and Andrew J. Huber, of THE WILLIFORD FIRM, LLC,
Wilmington, DE; OF COUNSEL: Grant E. Fortson and Roger D. Rowe, of LAX,
VAUGHAN, FORTSON, ROWE & THREET, P.A., Little Rock, AR, Attorneys for
the Plaintiffs.
Andrew L. Cole, William A. Crawford, Daniel A. O’Brien, and Theodore J. Segletes,
III, of FRANKLIN & PROKOPIK, Wilmington, DE; OF COUNSEL: Chad W.
Pekron, of QUATTLEBAUM, GROOMS, TULL & BURROW PLLC, Little Rock,
AR, Attorneys for Defendants Charles D. Morgan, individually and as Trustee of the
Charles D. Morgan Revocable Trust, and Jefferson D. Stalnaker.
GLASSCOCK, Vice Chancellor
This matter involves what I perceive to have become a common scenario in
this Court:1 plaintiff stockholders allege that a significant creditor to the company
has used its control over the corporate board together with contractual rights it has
been granted to divert corporate wealth or equity to itself, in breach of fiduciary or
statutory duties owed the common stockholders. Here, the Plaintiffs—stockholders
in First Orion Corp.—contend that the Defendants used the method described above
to inequitably seize from them control of the company, and seek a declaration
rescinding the issuance of stock, together with damages and other relief. The matter
is before me on cross motions for summary judgment. Because the issues so
presented turn on contested issues of fact, those motions are largely denied. With
respect to one claim brought derivatively, however, demand on the board was neither
made nor excused, and I find that the Plaintiffs lack standing under Rule 23.1. My
reasoning follows.
I. BACKGROUND
A. The Parties
Nominal Defendant First Orion Corp. (“First Orion” or the “Company”) is a
privately held Delaware corporation,2 which developed and sells Privacy Star, a
mobile smartphone application that blocks unwanted calls and reports the caller to a
1
Of course, my perception may merely reflect the Baader-Meinhof fallacy.
2
Verified Second Amended Complaint (“Compl.”) ¶¶ 9, 19.
1
regulatory body.3
Plaintiff Keith Fotta is the founder of First Orion.4 Fotta owns approximately
98.3% of the outstanding stock of Plaintiff Telemark Technology, Inc. (“Telemark”
and together with Fotta, the “Fotta Plaintiffs”), a Delaware Corporation.5 The Fotta
Plaintiffs are stockholders of First Orion. Plaintiffs Gerald Clark, James B. Rich,
Illene Rich, Diane Jurmain, and Peter Jurmain (collectively, the “Individual
Plaintiffs”) are also common stockholders of First Orion.
Defendant Charles Morgan is the current Chairman of the Board of First Orion
(the “Board”) and is the Trustee of the Charles D. Morgan Revocable Trust, through
which Morgan holds various interests in First Orion.6 Defendant Jefferson D.
Stalnaker was hired by First Orion in 2008 and has held multiple executive positions,
including President and CEO, and was a director of the Company from January 27,
2010 through July 18, 2013.7
B. Morgan’s Initial Investment in First Orion
Fotta founded First Orion in 2007 to develop and market technology for
blocking unwanted callers and filing complaints against unwanted callers with the
Federal Trade Commission.8 All of the Plaintiffs have been stockholders of the
3
Id. at ¶ 31.
4
Id. at ¶ 19.
5
Id. at ¶ 5.
6
Id. at ¶ 10.
7
Id. at ¶ 11.
8
Id. at ¶ 19.
2
Company since 2007.9 In 2008, Morgan entered into a stock purchase agreement
(the “SPA”) with First Orion that allowed Morgan to invest in the Company’s Series
A Convertible Preferred Stock (“Preferred Stock”).10 In addition, Morgan was
appointed to the Company’s Board.11 Each share of Preferred Stock was convertible
into one share of common stock.12 By the end of September 2009, Morgan had
invested $1,100,000 in exchange for 1,100,000 shares of Preferred Stock,13 which at
that time represented approximately 70% of the then-outstanding Preferred Stock of
the Company.14
In October 2009, Fotta informed Morgan that the Company needed to raise
additional capital to fund its operations.15 In response, Morgan agreed with Fotta
and First Orion to advance the Company $500,000 (the “2009 Letter Agreement”).16
Pursuant to the 2009 Letter Agreement, the Fotta Plaintiffs agreed to provide
Morgan irrevocable voting proxies (the “Proxies”) for their common shares of stock
in the Company.17 According to the 2009 Letter Agreement, the Proxies were to
become effective in the event First Orion failed to repay the balance of the advanced
9
Id. at ¶ 20.
10
Id., Ex. 4, at 1.
11
Id.
12
Id.
13
Id.
14
Id. at ¶ 24.
15
Defs.’ Br. in Supp. of Mot. to Dismiss the Second Am. Compl. and/or for Summ. J. (“Defs’
Opening Br.”), Ex. 17, at 71–72; Compl., Ex. 4, at 1–2.
16
Compl., Ex. 1.
17
Id., Ex. 1, at 2.
3
funds by January 15, 2010.18 When effective, the Proxies granted Morgan the right
to “exercise all of the Grantor’s rights as a shareholder of [First Orion],” and were
to remain effective until the Company experienced a “net positive cash flow” for
three consecutive quarters.19 At the time of the 2009 Letter Agreement, Fotta owned
3,880,597 shares of common stock and 100 shares of Preferred Stock, and Telemark
owned 2,940,122 shares of common stock.20 Together, the Fotta Plaintiffs’ stock
ownership represented 72.8% of the outstanding capital stock. Conversely, the
Individual Plaintiffs owned approximately 2.86% of the outstanding capital stock,
collectively.21
The 2009 Letter Agreement also provided Morgan other valuable incentives.
For each dollar Morgan advanced the Company pursuant to the 2009 Letter
Agreement, Morgan was to receive a specified number of warrants to purchase
common shares of First Orion for $1.50 per share.22 In addition, if the Company
failed to repay the advance in full by January 15, 2010, Morgan would receive one
Preferred Share for each dollar advanced. Between October 15, 2009 and January
15, 2010, Morgan advanced $400,000 to the Company pursuant to the 2009 Letter
Agreement.23 Accordingly, Morgan received 1,500,000 warrants to purchase shares
18
Id.
19
Id. at Attachments 2, 3.
20
Id. at ¶ 30.
21
Id.
22
Id., Ex. 1, at 2; Defs’ Opening Br., Ex. 2E, at 1.
23
Compl., Ex. 4, at 2.
4
of common stock for $1.50 per share (the “Morgan Warrants”).24
First Orion failed to repay the advanced funds by January 15, 2010.25
Consequently, the Proxies became effective immediately, and First Orion was forced
to issue Morgan 400,000 additional shares of Preferred Stock in satisfaction of the
2009 Letter Agreement.26 According to the Plaintiffs, through the “combination of
his stock ownership, his possession of the Proxies, and his position as one of the
Company’s two Directors, Morgan was on and after January 15, 2010 the sole
controlling stockholder of First Orion.”27
C. Morgan Solidifies his Control of First Orion
On January 27, 2010, Morgan, acting via written consent, voted his shares and
the newly-obtained Proxies to remove Fotta as a director and officer of the Company,
and to select Stalnaker to succeed Fotta as director and CEO.28 Weeks later, on
February 16, 2010, Morgan and Stalnaker, as sole directors of First Orion, declared
a dividend (the “2010 Stock Dividend”) whereby holders of Preferred Stock would
receive 73.9901 shares of common stock for each share of Preferred Stock.29 On
that same day, in order to facilitate the 2010 Stock Dividend, Morgan, again acting
via written consent, voted his shares and the Proxies to authorize an amendment to
24
Defs’ Opening Br., Ex. 2E.
25
Compl. ¶ 32.
26
Id.
27
Id. at ¶ 34.
28
Defs’ Opening Br., Ex. 2B, at 3020.
29
Compl., Ex. 4.
5
the Company’s Certificate of Incorporation to increase the number of authorized
shares of common stock from 25,000,000 to 275,000,000 shares and to increase the
number of shares of authorized Preferred Stock to 100,000,000 shares.30
Immediately prior to the 2010 Stock Dividend, Morgan held 1,500,000 shares
of Preferred Stock, representing approximately 76% of the Preferred Stock then-
outstanding.31 A total of 145,541,519 common shares were issued in the 2010 Stock
Dividend.32 As a result, Morgan’s “total ownership” interest increased from
approximately 15% to 72% and the Plaintiffs’ collective “ownership interest”
decreased from approximately 72.5% to 4.5%.33 In addition, Morgan’s Warrants—
which originally provided Morgan the right to purchase 1,500,000 shares of common
stock for $1.50 per share—were adjusted, in accordance with their terms,34 to give
Morgan the right to purchase 110,985,175 shares of common stock for $.02030 per
share.35 The Plaintiffs characterize this adjustment as an issuance of additional
warrants (the “Additional Warrants”).
On February 19, 2010, three days after the 2010 Stock Dividend was declared,
Stalnaker sent the Company’s stockholders, including the Plaintiffs, a letter (the
30
Id., Ex. 5. Stalnaker filed with the Delaware Secretary of State a Certificate of Amendment to
the Certificate of Incorporation reflecting the increase in authorized shares of stock. Id., Ex. 6.
31
Id. ¶ 51.
32
Pls.’ Opening Br. in Supp. of Mot. for Partial Summ. J. and Answering Br. in Opp. to Defs.’
Mot. to Dismiss and/or for Summ. J. (“Pls’ Answering Br.”), Ex. 10, at ¶ 7.
33
Compl. ¶ 55.
34
Defs’ Opening Br., Ex. 2E, at 3–5.
35
Compl. ¶ 68; Pls’ Opening Br., Ex. 1.
6
“Stalnaker Letter”) that enclosed (1) the Written Consent of the Shareholders, dated
January 27, 2010, to remove Fotta as officer and director of the Company and elect
Stalnaker in his place; (2) the Written Consent of the Board, dated February 16,
2010, to authorize the 2010 Stock Dividend; and (3) the Written Consent of the
Shareholders, also dated February 16, 2010, to approve an amendment to the
Company’s Certificate of Incorporation to increase the number of authorized shares
of capital stock and to approve the 2010 Stock Dividend.36
D. Morgan Leads Subsequent Funding of First Orion
In the years following the 2010 Stock Dividend, the Company completed four
rounds of equity financing through the private placement of Series B Convertible
Preferred Stock: (1) the Company raised approximately $600,000 shortly after the
2010 Stock Dividend;37 (2) the Company raised $4,000,000 starting October 2010;38
(3) the Company extended the second issuance to raise an additional $2,000,000
starting September 2011;39 and (4) the Company raised more than $3,500,000
starting in July 2012.40 The majority of each investment was provided by Morgan
and a small group of other individual investors, most of whom had prior relationships
36
Defs’ Opening Br., Ex. 2B; id., Ex. 2C.
37
Id., Ex. 2, at ¶ 14; id., Ex. 2H.
38
Id., Ex. 2P.
39
Id., Ex. 2R.
40
Id., Ex. 2S.
7
with Stalnaker.41 In addition to equity financing, the Company entered into a line of
credit agreement with Arvest Bank for $250,000, which was personally guaranteed
by Morgan and Stalnaker.42
For each round of funding, the Company sent Fotta a private placement
memorandum providing details of the offering. Furthermore, for at least the first
and second rounds of funding, the Company sent Fotta a “Preemptive Rights Notice”
pursuant to the “Preemptive Rights Agreement,” dated August 4, 2008, which
entitled certain investors “preemptive rights upon the issuance of certain securities
by First Orion.”43 In addition to receiving the formal notices sent by the Company,
Fotta periodically communicated with the Company, at times via email, to request
additional financial information and to obtain the status of the Company’s
offerings.44 Notably, Fotta did not object to the 2010 Stock Dividend or the 2010
Amendment to the Certificate of Incorporation before or during the rounds of
financing culminating in 2012.
41
Stalnaker avers that the large majority of financing was provided by Morgan, Rodger Kline,
Jerry Adams, James Womble, and Kenneth Lee, most of whom Stalnaker has known for many
years through other business ventures. See id., Ex. 2, at ¶ 14. Nearly 90% of the first round of
funding and nearly 75% of the second and third round of funding was provided by that group of
investors. Id. at ¶ 14, 22. Further, of the $3,500,000 raised in the fourth round of financing, over
80% was provided by the same group of investors, with the addition of Kent Burnett. Id. at ¶ 23.
I note that, with the exception of Morgan, none of these investors are parties to the action.
42
The Company’s line of credit is described in the Company’s private placement memorandum
dated October 29, 2010. Id., Ex. 2P, at 3557.
43
Id., Ex. 2B; id., Ex. 2N.
44
Id., Ex. 2J; id., Ex. 2K; id., Ex. 2L; id., Ex. 2M; id., Ex. 2Q.
8
E. Stalnaker is Granted Stock Options
When Stalnaker was first hired as President of First Orion in 2008, he believed
that the Company was going to grant him stock options that represented between
3.5% and 5% of the Company’s outstanding shares.45 The Company failed to grant
Stalnaker stock options when he started, however. Years later, on September 30,
2011, the First Orion Board, which then consisted of Stalnaker and Morgan, adopted
the 2011 Nonqualified Stock Option Plan (the “2011 Stock Option Plan”) that
authorized the Board to issue stock options to its members. 46 On that same day,
Morgan, in his capacity as majority stockholder, voted to approve the 2011 Stock
Option Plan.47 With the 2011 Stock Option Plan in place, the Company granted two
series of stock options to Stalnaker (together, the “Stalnaker Options”). The first,
which the Company granted to Stalnaker on the day the 2011 Stock Option Plan was
approved, provided Stalnaker the right to purchase 19,797,879 shares of common
stock for $0.01553 per share.48 The second stock option grant, dated November 28,
2011, gave Stalnaker the right to purchase an additional 37,488,121 shares of
45
Stalnaker avers that Fotta presented to him an offer letter containing the terms of the
contemplated stock options but that Fotta failed to execute the offer. Id., Ex. 18, at 292–94; see
also id., Ex. 26.
46
Compl., Ex. 9. According to the Written Consent of the Board of September 30, 2011, the
Company reserved 20% of its common stock for stock issued pursuant to the 2011 Stock Option
Plan. Id.
47
Defs’ Opening Br., Ex. 31.
48
Compl., Ex. 9.
9
common stock for $0.0203 per share.49 In total, the Stalnaker Options represent
between 8% and 8.5% of the ownership of the Company.50
On December 11, 2014—nearly three years after the Stalnaker Options were
granted and two days after the Plaintiffs filed their Second Amended Complaint—
First Orion directors James Womble and Kent Burnett, who are not parties to this
action, purported to ratify the Stalnaker Options.51
F. Procedural History and Contentions of the Parties
The Fotta Plaintiffs filed a Verified Complaint on January 17, 2013 (the
“Original Complaint”) and a First Amended Complaint on May 23, 2013, which
added the Individual Plaintiffs. The Plaintiffs filed a Second Amended Complaint
on December 9, 2014, in which they allege seven derivative claims on behalf of
Nominal Defendant First Orion, four direct claims on behalf of all of the Plaintiffs,
and three direct claims on behalf of the Fotta Plaintiffs. In general, the Plaintiffs
challenge the 2010 Stock Dividend, the Additional Warrants, and the Stalnaker
Options by asserting “claims for breach of fiduciary duty, gift and waste against
Morgan and Stalnaker, for conversion and unjust enrichment against Morgan, for
aiding and abetting against Stalnaker, and for a declaratory judgment that the stock
49
Id. at ¶ 97; Defs’ Opening Br., Ex. 18, at 303–09.
50
Compl. ¶ 97; Defs’ Opening Br., Ex. 18, at 303–09.
51
Defs’ Opening Br., Ex. 27.
10
issued as the dividend is void ab initio.”52 The Fotta Plaintiffs also “assert[] claims
against Morgan for breach of fiduciary duty and of the implied covenant of good
faith and fair dealing.”53
The Defendants filed a Motion to Dismiss the Second Amended Complaint
and/or for Summary Judgment on January 23, 2015. Pursuant to their motion, the
Defendants argue that the Plaintiffs’ claims regarding the 2010 Stock Dividend are
barred by the doctrine of acquiescence; that the Plaintiffs’ equitable claims are time-
barred by the doctrine of laches; and that the Plaintiffs’ claims regarding the
Stalnaker Options must fail because the Plaintiffs failed to make a demand on the
First Orion Board and because the Stalnaker Options were ratified by a disinterred
majority of the Board.
In addition to opposing the Defendants’ motion, the Plaintiffs filed a Motion
for Partial Summary Judgment on March 13, 2015. The Plaintiffs assert that the
stock issued in the 2010 Stock Dividend is void as a matter of law because it was
issued in violation of the Delaware General Corporation Law (“DGCL”).
Furthermore, the Plaintiffs argue that the Defendants cannot avoid a finding that this
stock is void despite the Defendants’ assertion of the defenses of acquiescence and
laches.
52
Compl. ¶ 3.
53
Id.
11
II. STANDARD OF REVIEW
All of the motions, except for the Defendants’ motion regarding the Plaintiffs’
failure to make a demand, rely upon matters that are outside the pleadings, and
therefore are analyzed pursuant to Court of Chancery Rule 56. In accordance with
Rule 56, a party is entitled to summary judgment if the evidence demonstrates that
“there is no genuine issue as to any material fact and that the moving party is entitled
to judgment as a matter of law.”54
I treat the portion of the Defendants’ motion challenging the Plaintiffs’ failure
to make a demand as a motion to dismiss pursuant to Rule 23.1. Generally, if a
stockholder wishes to initiate an action on behalf of the corporation, she must make
a demand on the board to assert the rights of the corporation or explain why such a
demand would be futile.55 If the stockholder wishes to pursue an action on behalf of
the corporation, Rule 23.1 requires that the plaintiff stockholder “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.”56 The standard articulated
in Rule 23.1 “imposes a more arduous pleading standard than Rule 8(a), and a
plaintiff must allege sufficient particularized facts showing that demand on the board
54
Ct. Ch. R. 56(c).
55
See Seinfeld v. Sager, 2012 WL 2501105, at *2 (Del. Ch. June 29, 2012).
56
Ct. Ch. R. 23.1.
12
would have been futile.”57
III. ANALYSIS
I address the parties’ motions separately below and find that both motions are
denied, with one exception: I grant the portion of the Defendants’ motion seeking
dismissal for failure to comply with Rule 23.1 for the claims challenging the
Stalnaker Options.
A. The Plaintiffs’ Motion for Summary Judgment
The Plaintiffs moved for summary judgment with respect to their claims that
the common stock issued pursuant to the 2010 Stock Dividend and the related
Additional Warrants are void as in violation of the DGCL. Specifically, the
Plaintiffs refer to their allegations in Counts I, V, and VI of their Second Amended
Complaint. These counts raise both equitable and statutory claims; the Plaintiffs’
motion is addressed only to the statutory claims and, in the alternative, claims of
waste. Notwithstanding the resolution of the Plaintiffs’ motion, the equitable claims
for breach of duty will remain for trial. The Plaintiffs also note that they move for
summary judgment on only the liability portion of their claims and do not request
that the Court fashion a remedy at this stage in the litigation. Essentially, the
Plaintiffs in this motion seek a declaration that the 2010 Stock Dividend did not
comply with the DGCL.
57
Seinfeld, 2012 WL 2501105, at *2 (citations omitted).
13
In Counts I and V, the Plaintiffs allege that the 2010 Stock Dividend and
issuance of the Additional Warrants amount to waste of corporate assets. In Count
I, which is asserted as a derivative claim against Morgan and Stalnaker for breaches
of fiduciary duty, the Plaintiffs allege that “First Orion received no consideration of
any kind in exchange for the issuance of the dividend shares of common stock,” and
that “the issuance of [the] Additional Warrants was not approved by Board action
nor by a vote of the shareholders.” In sum, in Count I the Plaintiffs allege that “[t]he
2010 Stock Dividend and the issuance of the Additional Warrants were self-dealing,
bad faith transactions which benefited Morgan personally and amounted to a gift or
waste of corporate assets.” In Count V, which is asserted as a derivative claim
against Morgan for violation of various provisions of the DGCL, 58 the Plaintiffs
allege that “shares of common stock issued by the Company . . . [were] issued to
Morgan and the other preferred shareholders for no consideration”—in violation of
Section 153—and that the “Defendants granted Morgan the Additional Warrants . . .
without any action by the Board to approve the issuance . . . and for no
consideration,” in violation of Sections 152 and 153. In their opening brief, the
Plaintiffs clarified that Counts I and V are relevant to this motion only to the extent
58
Specifically, the Plaintiffs allege that “8 Del. C. §§ 151, 152, 153, 157, 161 and 166 govern the
issuance of stock in First Orion, and require Board approval of the issuance of stock, including of
any transaction that binds the corporation to issue stock in the future.” Compl. ¶ 133. Additionally,
the Plaintiffs allege that “8 Del. C. § 153 provides that stock with par value may be issued for
consideration having a value not less than the par value thereof.” Id. at ¶ 134 (emphasis in the
original).
14
the 2010 Stock Dividend is “characterized as an issuance of stock pursuant to a
recapitalization rather than a dividend.”59 Although the 2010 Stock Dividend has
been characterized as a recapitalization at times in this litigation,60 both parties have
represented in their briefs and at oral argument that the 2010 Stock Dividend was a
dividend transaction. For the purposes of this Memorandum Opinion, I will treat the
2010 Stock Dividend as a dividend transaction and, therefore, I do not address
Plaintiffs’ Motion for Summary Judgment as it pertains to Counts I and V.
That leaves Plaintiffs’ allegations in Count VI that the 2010 Stock Dividend
violated Sections 170 and 173 of the DGCL and that, therefore, the common stock
issued therein is void.61 I address each section of the DGCL and find that issues of
material fact exist such that summary judgment is inappropriate.
The Plaintiffs allege that the 2010 Stock Dividend is void because the
Company did not have sufficient capital surplus nor net profits in accordance with
Section 170 of the DGCL. Section 170 states, in part, the following:
(a) The directors of every corporation, subject to any restrictions
contained in its certificate of incorporation, may declare and pay
59
The Plaintiffs argue that “[i]f characterized as an issuance of stock pursuant to a recapitalization
rather than a dividend, the Dividend Stock is nevertheless void because the issuance of stock in
exchange for no consideration violates section 153 of the DGCL and constitutes waste.” Pls’
Opening Br. 21.
60
The Plaintiffs point to deposition testimony in which Morgan and Stalnaker refer to the 2010
Stock Divided as a “recapitalization.” Id. at 21 n.7.
61
In the alternative, the Plaintiffs seek damages pursuant to 8 Del. C. § 174. I do not address
Section 174 here since the Plaintiffs’ Motion for Summary Judgment is limited to the issue of
liability only, nor do I address whether a finding that stock was issued as a dividend in violation
of statute should result in a determination that the stock so issued is void.
15
dividends upon the shares of its capital stock either:
(1) Out of its surplus, as defined in and computed in accordance
with §§ 154 and 244 of this title; or
(2) In case there shall be no such surplus, out of its net profits
for the fiscal year in which the dividend is declared and/or the
preceding fiscal year.62
As a threshold matter, the Defendants contend that Section 170, based on their
understanding of the purpose of the statue, does not apply to dividends paid in stock.
The actions of the General Assembly indicate, however, that it did intend Section
170 to apply to stock dividends.63 Therefore, for the purposes of the Plaintiffs’
Motion for Summary Judgment, I assume that Section 170 applies here.
The Plaintiffs assert that the 2010 Stock Dividend violated Section 170
because, at the time of the dividend, the Company’s balance sheet indicated a
deficient surplus.64 By that measure, the surplus was indeed inadequate to absorb
62
8 Del. C. § 170(a)(1)–(2).
63
Folk on the General Corporation Law explains that the General Assembly amended Section 173
in 1985 and, in doing so, indicated that the restrictions provided in Section 170 pertain to stock
dividends:
The 1985 amendment replaced references to transfers from surplus to the capital
account in respect of dividend shares with references to designation as capital of
the par or stated value of such shares. The amendment was designed to make clear
that stock dividends may be distributed by a corporation even when it has no
surplus, so long as it has net profits for the fiscal year in which the dividend is
declared and/or the preceding fiscal years, as provided by Section 170.
Edward P. Welch et al., Folk on the Delaware General Corporation Law § 173.02 (6th ed. 2015)
(citing S. 116, 133d Gen. Assembly 4–5, 65 Del. Laws, c. 127, § 5 (1985)).
64
According to the Plaintiffs, First Orion’s balance sheet revealed a surplus of approximately
$83,000, which is less than the aggregate par value of the common stock issued in the 2010 Stock
Dividend of over $1.4 million.
16
the dividend declared. However, when calculating a corporation’s surplus in
accordance with Section 154, as instructed by Section 170, the directors are not
constrained by the balances of assets and liabilities as stated on the balance sheet.
Instead, a corporation may revalue its assets and liabilities to reflect market
conditions.65 Since the Plaintiffs solely rely on First Orion’s balance sheet as an
indication of surplus, and since the record does not adequately reflect the Company’s
revalued net surplus, I find that material issues of fact remain, and cannot determine
as a matter of law that the 2010 Stock Dividend violated Section 170.
The Plaintiffs also contend that the 2010 Stock Dividend is illegal because the
Board failed to cause the Company to designate the issued stock as capital in
accordance with Section 173 of the DGCL. Section 173 states, in part, the following:
If the dividend is to be paid in shares of the corporation's theretofore
unissued capital stock the board of directors shall, by resolution, direct
that there be designated as capital in respect of such shares an amount
which is not less than the aggregate par value of par value shares being
declared as a dividend and, in the case of shares without par value being
declared as a dividend, such amount as shall be determined by the board
of directors.66
The Plaintiffs argue that the Company failed to designate as capital the aggregate
par value of the common shares issued in the 2010 Stock Dividend and, therefore,
65
See e.g., Klang v. Smith’s Food & Drug Ctrs., Inc., 702 A.2d 150, 154 (Del. 1997) (“Allowing
corporations to revalue assets and liabilities to reflect current realities complies with the statue and
serves well the policies behind the statute.”).
66
8 Del. C. § 173.
17
the issued shares are void. I note that in the board resolution declaring the dividend,
the Board indicated that it complied with Section 173.67 However, financial
statements produced after the 2010 Stock Dividend reveal an inconsistent accounting
of the dividend and, therefore, it remains an issue of fact whether or when the
Company designated as capital the aggregate par value of the common stock issued.
Finally, the Plaintiffs argue that the adjustment to the Morgan Warrants
triggered by the 2010 Stock Dividend—referred to as the “Additional Warrants”—
must be void because the 2010 Stock Dividend is void. I have already determined
that issues of material fact remain and that I cannot conclude that the 2010 Stock
Dividend is void as a matter of law. Likewise, I am unable to conclude that the
Additional Warrants are void.
Based on my findings above, I conclude that issues of material facts exist and
that the Plaintiffs are not entitled to judgment as a matter of law. Therefore, the
Plaintiffs’ Motion for Partial Summary Judgment is denied.
B. The Defendants’ Motion to Dismiss and/or for Summary Judgment
The Defendants moved for summary judgment on two theories. First, the
Defendants argue that all of the Plaintiffs’ claims regarding the 2010 Stock Dividend
67
In an action by unanimous written consent on February 16, 2010, the Board adopted a resolution
that stated that, “in accordance with Section 173 of the Delaware General Corporation Law, there
is designated as capital of the Company an amount which is not less than the aggregate par value
of the shares being issued as a dividend by the Company.” Defs’ Opening Br., Ex. 2B, at 3025.
18
are barred by the doctrine of acquiescence. Second, the Defendants assert that the
Plaintiffs’ equitable claims are barred by laches. I find that the resolution of these
arguments requires further factual development and deny that portion of the
Defendants’ motion. Finally, the Defendants argue that the Plaintiffs’ claims that
challenge the Stalnaker Options—raised for the first time in the Second Amended
Complaint—should be dismissed pursuant to Rule 23.1 for failure to make a demand
on the Board. I find that the Plaintiffs failed to sufficiently plead demand futility as
to those claims. Therefore, I grant the Defendants’ motion to the extent it seeks
dismissal of the Plaintiffs’ claims challenging the Stalnaker Options.
1. Acquiescence
According to the Defendants, the Plaintiffs learned of the 2010 Stock
Dividend on February 19, 2010 and remained silent for nearly three years, thereby
acquiescing to the 2010 Stock Dividend. The Plaintiffs’ acquiescence, the
Defendants argue, now bars their legal and equitable claims. At the outset, I note
that the doctrine of acquiescence has not been applied in a consistent manner.68
68
See Lehman Bros. Holdings Inc. v. Spanish Broad. Sys., 2014 WL 718430, at *9 (Del. Ch. Feb.
25, 2014). In Lehman Brothers, the Court identified three separate species of acquiescence. In
the first, which is inapplicable here, a stockholder is said to have acquiesced to a merger and cannot
challenge the transaction if the stockholder accepted the merger consideration. Id. at *9 n.54.
Second, the doctrine of acquiescence has been used to estop a claimant from seeking equitable
relief where the claimant has unreasonably delayed in silence, thereby prejudicing the defendant.
Id. (citing 3 Pomeroy’s Equity Jurisprudence § 817 (5th ed. 1941)). In Klaassen v. Allegro Def.
Corp., 106 A.3d 1035, 147 (Del. 2014), the Delaware Supreme Court explicitly noted that, in order
to show acquiescence in Delaware, a defendant is not required to allege that it suffered prejudice
as the result of the plaintiff’s delay. Finally, the doctrine of acquiescence has been applied, as it
19
However, this Court has noted that “inaction or silence on the part of a plaintiff, in
certain circumstances, can bar a plaintiff from relief both equitable and legal.”69
The Delaware Supreme Court has established a clear test which states that the
doctrine of acquiescence applies where a claimant
has full knowledge of his rights and the material facts and (1) remains
inactive for a considerable time; or (2) freely does what amounts to
recognition of the complained of act; or (3) acts in a manner
inconsistent with the subsequent repudiation, which leads the other
party to believe the act has been approved.70
In order to show that a claimant acquiesced, a defendant need not prove a “conscious
intent to approve the act,”71 nor a “change of position or resulting prejudice.”72
Unlike the doctrine of laches, which is addressed below, acquiescence centers on the
“[d]efendant and its understanding that complained-of acts were acquiesced in.”73
In sum, the doctrine of acquiescence focuses on “why the plaintiff must be adjudged
complicit in the very breach for which she seeks damages.”74
In this case, the Defendants argue that the Individual Plaintiffs were fully
was in Lehman Brothers, as an “estoppel by silence” or “inaction,” where a claimant, with full
knowledge of the facts, stands by while the defendant commits the alleged wrongdoing. See 2014
WL 718430, at *9 n.56.
69
Lehman Bros., 2014 WL 718430, at *9 (citations omitted).
70
Klaassen, 106 A.3d at 1047 (quoting Cantor Fitzgerald, L.P. v. Cantor, 724 A.2d 571, 582 (Del.
Ch. 1998)).
71
Id. (citing Frank v. Wilson & Co., 9 A.2d 82, 87 (Del. Ch. 1939), aff’d, 32 A.2d 277 (Del. 1943)).
72
Id. (citations omitted).
73
Brevan Howard Credit Catalyst Master Fund Ltd. V. Spanish Broad. Sys., Inc., 2015 WL
2400712, at *2 (Del. Ch. May 19, 2015) (emphasis in the original).
74
Id.
20
informed of the 2010 Stock Dividend by the Stalnaker Letter of February 19, 2010,
only three days after the dividend was declared, and that the Plaintiffs remained
silent until the filing of this action, evidencing that they had acquiesced in the
transaction. The Defendants note that one of the Individual Plaintiffs, Ms. Jurmain,
contacted the Company in 2012, but did not express an objection to the 2010 Stock
Dividend. The Defendants argue that the Fotta Plaintiffs were similarly fully
informed by the Stalnaker Letter and that, in addition, they received private
placement memorandums, sent in conjunction with the Company’s subsequent
financing efforts, which again disclosed the critical facts surrounding the 2010 Stock
Dividend. In addition to the Fotta Plaintiffs’ silence regarding the 2010 Stock
Dividend, the Defendants point to periodic communications between Fotta and
Stalnaker in which Fotta acknowledges Stalnaker and Morgan as controlling First
Orion and makes comments on the Company’s successes. According to the
Defendants, the Fotta Plaintiffs’ silence regarding the 2010 Stock Dividend amongst
ongoing communication is evidence of their acquiescence.
The Defendants argue that Lehman Brothers Holdings, Inc. v. Spanish
Broadcasting Systems, Inc.75 and Klaassen v. Allegro Development Corp.,76 in which
the Court found that the claimants had acquiesced, support their theory. I find,
75
2014 WL 718430 (Del. Ch. Feb. 25, 2014).
76
106 A.3d 1035 (Del. 2014).
21
however, that the factual circumstances in this case are dissimilar to the cases relied
on by the Defendants.
In Lehman Brothers, the plaintiffs held preferred stock that entitled holders to
accrued dividends quarterly. If the dividends were not paid for four consecutive
quarters, the preferred stockholders were entitled to certain rights, including the right
to fill seats on the board and to constrain the company from acquiring certain
additional debt. Eventually, the company failed to pay dividends to preferred
stockholders for four consecutive quarters, thereby triggering those additional rights.
The plaintiffs did not immediately assert their rights to designate a board member,
however, and later, when the company’s board publicly announced its intention to
acquire debt, the plaintiffs again remained silent. Almost three years after the
preferred stockholders’ rights were triggered, and one year after the latest debt
incurrence, the plaintiffs filed suit challenging the debt transactions. The Court
found that the plaintiffs were estopped under the doctrine of acquiescence because
they knowingly stood by, witnessed a breach, and permitted the accrual of damages
that could have been prevented had the plaintiffs not stood silent.77
In Klaassen, the defendant directors intended to fire the plaintiff CEO and
director at the next regularly scheduled board meeting. During the meeting, the
defendant directors initiated an executive session, for which the CEO was asked to
77
Lehman Bros., 2014 WL718430, at *12.
22
leave the room. During the executive session, the defendant directors agreed to
terminate the CEO’s employment. Upon the CEO’s return to the board meeting, the
board voted to terminate his employment. The CEO failed to challenge his
termination at the meeting, however. About seven months after his termination—
during which time the then-former CEO initially offered to help train the new CEO
and also began negotiating a consulting agreement with the company—the former
CEO filed suit alleging that his removal was invalid.
Based on the circumstances in both Lehman Brothers and Klaassen, the
plaintiff had the ability to challenge the breach at the time of the alleged wrongdoing,
or as damages were incurred thereby, such that the plaintiff was adjudged complicit
in the very breach for which it sought relief.78 Here, however, the Defendants have
made no assertions regarding their own view of the Plaintiffs’ knowledge of the 2010
Stock Dividend and their inaction at the time it was declared. Nor have the
Defendants sufficiently explained how the Plaintiffs’ inaction led them to believe
the 2010 Stock Dividend had been approved. Instead, the Defendants largely focus
on the Plaintiffs’ knowledge after the alleged wrongdoing and have merely asserted
78
See id. at *9. In Espinoza v. Zuckerberg, this Court noted that it appeared that the standard
articulated in Klaassen could be applied to the claimant’s action after the fact and, therefore,
implicated conduct that had been traditionally characterized as ratification. 124 A.3d 47, 60 n.68
(Del. Ch. 2015) (referring to the form of “ratification” explained in Frank, 32 A.2d 277). I note,
however, that Klaassen involved the type of facts typically present where estoppel by acquiescence
is involved. Although Klaassen referenced behavior occurring after the alleged breach, the case
involved an actor who was present and able to acquiesce from the time of the alleged wrongdoing.
23
that they were aware of the Plaintiffs’ inaction. Although Fotta affirmatively acted
in a way that could potentially give rise to estoppel by acquiescence—including
standing mute while Morgan and third parties participated in the several financing
rounds after the 2010 Stock Dividend—a more developed record would be helpful
to assess the Defendants’ understanding of the Fotta Plaintiffs’ actions. There
remain questions of fact, the resolution of which is required to determine if the
Plaintiffs may be adjudged complicit in the 2010 Stock Dividend. The Defendants’
Motion for Summary Judgment based on acquiescence is, accordingly, denied.
Before turning to the defense of laches, I note that many of the facts and
circumstances discussed in the laches analysis overlap with those discussed in the
acquiescence analysis above.79 This reverberation is an artifact of what appears to
me a misapplication of the acquiescence doctrine: where the claimants are informed
of the alleged wrong after its completion and thereafter fail to take action for an
extended period. That set of circumstances, to me, implicates a ratification or laches
defense, the latter of which I discuss below.
2. Laches
The Defendants allege that laches bars the Plaintiffs’ request for equitable
relief because the Plaintiffs unreasonably delayed in bringing a claim. The equitable
79
The Defendants concede the similarities in their opening brief: “The facts and analysis set forth
in the preceding section demonstrate the defense of laches as readily as they demonstrate the
defense of acquiescence.” Defs’ Opening Br. 45.
24
doctrine of laches is rooted in the maxim that “equity aids the vigilant, not those who
slumber on their rights.”80 Fundamentally, laches protects a defendant when a
plaintiff has unreasonably delayed in seeking relief and the defendant thereby suffers
prejudice. Generally, in order to establish a laches defense, a defendant must show:
(1) that the plaintiff had knowledge of a legal claim; (2) that the plaintiff
unreasonably delayed in bringing the claim; and (3) that the defendant has suffered
a resulting prejudice.81
a. The Plaintiffs’ Knowledge of an Equitable Claim
The Defendants assert that the Plaintiffs first attained knowledge of their
equitable claims upon receipt of the Stalnaker Letter on February 19, 2010, which
purports to inform the Plaintiffs of the 2010 Stock Dividend. According to the
Defendants, upon receipt of that letter, the Plaintiffs were given actual notice of the
self-dealing nature of the 2010 Stock Dividend and inquiry notice as to any other
claims that may arise from the 2010 Stock Dividend. The Plaintiffs, however, assert
that the Stalnaker Letter did not provide the Plaintiffs adequate knowledge to pursue
their claims because its contents misrepresented the nature of the transaction, 82 and
because it omitted facts material to their claims.83 I disagree.
80
Whittington v. Dragon Grp., LLC, 991 A.2d 1, 8 (Del. 2009) (citing Adams v. Jankouskas, 452
A.2d 148, 157 (Del. 1982)).
81
See, e.g., Reid v. Spazio, 970 A.2d 176, 182–83 (Del. 2009).
82
Pls’ Opening Br. 47.
83
The Plaintiffs list eight omitted facts that they assert were omitted: (1) “The current list of
shareholders in First Orion”; (2) “The number of common and preferred shares owned by each
25
On the face of the letter, Stalnaker, as President and CEO of the Company,
stated the following:
As a shareholder of First Orion Corp. I have enclosed copies of the
following:
1. Written Consent of the shareholders of First Orion dated January
27, 2010.
2. Unanimous Written Consent of the Board of Directors of First
Orion dated February 16, 2010.
3. Written Consent of the shareholders of First Orion dated February
16, 2010. 84
Accordingly, each stockholder received copies of the three documents listed above.
The Written Consent of the Shareholders dated January 27, 2010, was an action by
Morgan, acting as a stockholder and pursuant to the proxies received from Fotta, to
remove Fotta as officer and director and to install Stalnaker in his place.85
The Written Consent of the Board of Directors dated February 16, 2010, was
an action by Morgan and Stalnaker, as sole directors of the Company, to declare the
2010 Stock Dividend and to propose an amendment to the Certificate of
Incorporation to increase the number of authorized shares needed to complete the
dividend.86 Included in the preamble is a chronological summary of First Orion that
shareholder”; (3) “The total number of shares of Dividend Stock being issued”; (4) “The
percentage of the Dividend Stock that was given to Charles Morgan”; (5) “The percentage of
outstanding shares of First Orion that Charles Morgan would own after the issuance of the
Dividend Stock”; (6) “The percentage of outstanding shares of First Orion that the common
shareholders would own after the issuance of the Dividend Stock”; (7) “The balance of First
Orion’s surplus”; and (8) “The balance of First Orion’s capital accounts.” Pls’ Opening Br. 33–
34.
84
Defs’ Opening Br., Ex. 2C.
85
Id., Ex. 2B, at 3020.
86
Id. at 3021–25.
26
states the initial capital structure of the Company; describes Morgan’s investment in
the Company’s Preferred Stock; and provides details of the 2009 Letter Agreement
between Morgan and the Company that resulted in the transfer of majority voting
control to Morgan.87 Furthermore, in the preamble the directors expressed the
Company’s desperate need of additional capital; it noted the Company’s intention to
raise $600,000 in the near future; and it listed the objectives necessary to attract
potential investors.88 Finally, the directors endorsed the 2010 Stock Dividend as in
the best interest of the Company:
In order to accomplish these objectives, the Board has determined that
it is in the best interest of the Company and its common and preferred
shareholders to issue a Common Stock dividend to current holders of
Preferred Stock which will result in a restructuring of the capital and
stock ownership of the Company to reflect stock ownership among the
common and preferred stockholders in proportion to each shareholder’s
total cash contribution to the Company since its inception, . . .89
Following the preamble, the Board resolved and recommended to stockholders that
the Company adopt the 2010 Stock Dividend, which entitled preferred stockholders
to 73.9901 shares of common stock for each share of Preferred Stock.90
The third and final enclosure was the Written Consent of the Shareholders
dated February 16, 2010. Morgan, again acting as a stockholder and pursuant to the
87
Id. at 3021–23.
88
Id. at 3024.
89
Id.
90
Id. at 3025.
27
Proxies received from the Fotta Plaintiffs, approved the recommendations of the
Board to amend the Certificate of Incorporation and declare the 2010 Stock
Dividend.91
In addition to the three enclosures described above, Fotta, as a party to the
“Preemptive Rights Agreement of First Orion Corp.,” received a Preemptive Rights
Notice with the Stalnaker Letter on February 19, 2010. The Preemptive Rights
Notice notified Fotta that the Company planned to offer newly authorized Series B
Convertible Preferred Stock, which stock Fotta had a preemptive right to purchase.92
Attached to the Preemptive Rights Notice was a Term Sheet providing details of the
upcoming offering.93
Upon reading the documents enclosed with the Stalnaker Letter, I find that the
Plaintiff stockholders had sufficient information to bring a claim challenging the
2010 Stock Dividend. The Written Consent of the Board of Directors of February
16, 2010, described the events leading up to the 2010 Stock Dividend and provided
enough facts for a stockholder to conclude that Morgan, while temporarily in control
of the corporate machinery by virtue of the Proxies, had transferred permanent
control of First Orion to himself. Specifically, the document disclosed that Fotta and
Telemark together owned approximately 87% of the Company when it was formed;
91
Id. at 3026.
92
Id. at 3015.
93
Id. at 3016.
28
that Morgan later contributed $1,100,000 to the Company in exchange for 1,100,000
shares of Preferred Stock; that Fotta, Morgan, and the Company entered into the
2009 Letter Agreement, through which Morgan obtained the Proxies representing
voting control of the Company; that Morgan utilized the Proxies to remove Fotta as
an officer and director of the Company; that the Board had recommended a stock
dividend that would give preferred stockholders 73.9901 shares of common stock
for each outstanding share of Preferred Stock; that the proposed stock dividend
would result in a restructuring of the capital and stock ownership of the Company
by transferring control to the current holders of preferred stock; and that Morgan and
Stalnaker, representing the sole directors of First Orion, had approved the resolution.
In addition, the Actions by Consent of the Shareholders of February 27, 2010 and of
February 16, 2010, indicated that Morgan, via the Proxies granted by the Fotta
Plaintiffs and also as a Preferred Stockholder, had enough voting power to control
the Company. Therefore, as of February 19, 2010, the Plaintiffs held sufficient
information to pursue an equitable claim regarding the 2010 Stock Dividend.
The Plaintiffs stress that the Stalnaker Letter did not provide sufficient
information regarding the Company’s capital accounts and thus the Plaintiffs were
unable to evaluate First Orion’s surplus at the time of the 2010 Stock Dividend. This
information, however, is pertinent only to their legal claims against the Defendants,
which claims have not been challenged under the statute of limitations and are not
29
subject to the equitable defense of laches.94
b. The Reasonableness of the Plaintiffs’ Delay and Resulting
Prejudice to the Defendants
Once the claimants are charged with sufficient knowledge of a potential claim,
the Court must determine if the claimant’s delay was reasonable. The Fotta Plaintiffs
filed the Original Complaint on January 17, 2013, nearly three years after the
Stalnaker Letter. Over five months later, on May 23, 2013, the Plaintiffs filed their
Amended Complaint, which for the first time included the Individual Plaintiffs. To
determine the bounds of unreasonable delay, the Court typically refers to the statute
of limitation by analogy.95 However, Courts in equity are not confined by the statute
of limitation; where unusual conditions or extraordinary circumstances are present,
the Court may assess unreasonable delay as equity requires.96 In sum, the “length of
delay is less important than the reasons for it.”97
The Defendants argue that the Plaintiffs have failed to articulate a reasonable
justification for their delay, pointing mostly to deposition testimony taken as part of
this litigation. For example, when asked why he waited until 2013 to bring this
action, Fotta averred that he was busy working for another company and that he did
94
Laches in that context could have an effect on any equitable remedy for disregard of the statutes,
however.
95
See Bean v. Fursa Capital Partners, LP, 2013 WL 755792, at *4 (Del. Ch. Feb. 28, 2013).
96
See IAC/InterActiveCorp v. O’Brien, 26 A.3d 174, 177–78 (Del. 2011) (citing Wright v. Scotton,
21 A. 69, 73 (Del. 1923)).
97
Id. at 177 (citing Whittington, 991 A.2d at 8).
30
not have the necessary financial resources to engage legal representation.98
Similarly, the Individual Plaintiffs were each asked why they failed to file suit
shortly after receiving the Stalnaker Letter, and each averred that either they did not
truly understand that they had a potential claim or that the size of their investment
in First Orion could not justify the expense of a suit.99 It is the Defendants not-
inconceivable theory that in 2010, the Plaintiffs were content to see Morgan take the
reins of a failing, near worthless First Orion, an attitude that only changed years
later, after Morgan’s effort and investment had made the Company valuable.
The Plaintiffs failed to deny or further explain their reasons for delay in their
briefing. Instead, the Plaintiffs argue that their claims were filed within the
analogous statute of limitation. The parties agree that the analogous statute of
limitation for a claim of breach of duty is three years; the Plaintiffs, however,
contend that their “illegal dividend claims” are subject to the analogous six-year
statute of limitation set out in Section 174.100 To the extent the Plaintiffs refer to
their claims based on violations of Sections 170 and 173 of the DGCL, I need not
determine the analogous statute of limitation because those claims are legal in nature
and uncontested by the Defendants in their laches defense. Otherwise, to the extent
98
Defs’ Opening Br., Ex. 17, at 224:18–225:12.
99
See id., Ex. 12, at 60–61; id., Ex. 13, at 28, 43–44; id., Ex. 14, at 30–31; id., Ex. 15, at 38, 55.
100
Section 174 states, in part: “In case of any willful or negligent violation of § 160 or § 173 of
this title, the directors under whose administration the same may happen shall be jointly and
severally liable, at any time within 6 years after paying such unlawful dividend.” 8 Del. C. §
174(a).
31
the Plaintiffs intend to use the statutory violations as support for their breach of duty
claims, the appropriate analog is the three-year statute of limitation.
The Court’s application of laches is not a rigid test under which I must
evaluate the Plaintiffs’ delay in isolation. Instead, like most equitable doctrines,
laches requires a balancing, where the claimant’s delay, and the reasons for it, are
balanced against the resulting prejudice to the defendant under the specific factual
circumstances in each case.101 Here, the Plaintiffs have failed to assert a sufficient
reason why they waited until the analogous statute of limitation had nearly run—or
had already run, in the case of the Individual Plaintiffs case. I therefore turn to
resulting prejudice.
The final inquiry in a laches analysis is whether the Defendants suffered
prejudice as the result of the Plaintiffs’ unreasonable delay. The Defendants argue
that they and third-party investors would be prejudiced by the Plaintiffs’ delay if
relief is granted. The Defendants assert that, since the Stalnaker Letter of February
19, 2010, the Defendants have raised additional capital from new investors who
would not have invested if the Defendants had not controlled the Company.
101
See Quill v. Malizia, 2005 WL 578975, at *14 (Del. Ch. Mar. 4, 2005) (“Incorporating the
concept of ‘unreasonable’ delay, laches seeks to equitably balance the factual circumstances of
each case.”) (citing Fed. United Corp. v. Havender, 11 A.2d 331, 343 (Del.1940) (“What
constitutes unreasonable delay is a question of fact dependent largely upon the particular
circumstances. No rigid rule has ever been laid down.”)); see also Houseman v. Sagerman, 2015
WL 7307323, at *5 (Del. Ch. Nov. 19, 2015) (“[L]aches entails a balancing: has a plaintiff's
dilatory approach to litigation disadvantaged the defendant so that equity should deny the plaintiff
the right to a decision on the merits?”).
32
Furthermore, in reliance on that additional capital, the Defendants contend that they
transformed First Orion from a marginal business to a successful enterprise. To
illustrate the increase in value, the Defendants point to the implied valuations
resulting from equity raised after the 2010 Stock Dividend. According to the
Defendants, shortly after the 2010 Stock Dividend, the Company raised capital based
on a valuation of $3 million. Conversely, over two years later, the Company initiated
an offering that valued the Company at more than $26 million. The Defendants
argue that, had the Plaintiffs sought relief sooner, the Defendants would not have
continued to control First Orion and would, therefore, lack sufficient incentive to
oversee its success. Moreover, the Defendants argue that third-party investors would
not have supplied the capital necessary to drive First Orion’s growth had Defendants
not controlled the Company. In sum, the Defendants argue that the Plaintiffs’ “wait
and see” approach has prejudiced the Defendants because as the value of First Orion
increased over time, the amount of rescission damages that the Plaintiffs now seek
have also increased.
The Plaintiffs argue that cancellation of the common stock issued in the 2010
Stock Dividend, or rescission damages that emulate a cancellation, will not harm
third parties because their stock ownership can be weighted retroactively to maintain
the same percentage ownership of the Company. To the extent the Defendants suffer
financial loss as the result of the cancellation of the 2010 Stock Dividend, the
33
Plaintiffs argue, that loss is the sole result of their breaches of fiduciary duty.
Given the facts and circumstances in this case, it is clear to me that the
Plaintiffs were aware of the facts necessary to bring an equitable claim in February
2010 and that as the result of their delay, the Defendants and third parties have
suffered some quantum of prejudice. What is unclear to me, however, is the extent
to which those parties suffered prejudice; the extent to which equity requires me to
disregard such prejudice as resulting from those parties’ breaches of duty; and to
what extent the Plaintiffs should have known that their active delay was causing the
Defendants that resulting prejudice. These questions of fact are also interwoven with
the remedy, if any, that will ultimately be crafted in this case. Therefore, the second
and third inquiries required in consideration of laches can only be determined on a
more developed record. The Defendants’ Motion for Summary Judgment for laches
is, accordingly, denied.
3. The Claims Challenging the Stalnaker Options
The Defendants argue that the Plaintiffs’ claims regarding the Stalnaker
Options should be dismissed because the Plaintiffs failed to make a demand on the
Company’s Board and have not sufficiently pled that its failure is excused. In their
Second Amended Complaint, filed December 9, 2014, the Plaintiffs, for the first
time, challenged the grant of the Stalnaker Options. In their derivate claim against
Morgan and Stalnaker in Count I, the Plaintiffs added in the Second Amended
34
Complaint that “[t]he grant of the Stalnaker Options was a self-dealing, bad faith
transaction which benefited Stalnaker personally and amounted to a gift or waste of
corporate assets.”102 The Plaintiffs also added Count VII, a derivative claim against
Stalnaker for “Declaratory Judgment that the Second Stalnaker Options are Void Ab
Initio.”
Generally, when claims are already properly before the Court, Rule 23.1 does
not require a plaintiff to reevaluate compliance with the rule merely because the
composition of the board has changed before the filing of an amended complaint.103
Such a rule avoids an undue pleading burden and inefficient inquiry, and allows
litigation to proceed in an orderly fashion. However, where the composition of a
board changes after the complaint is filed, and then a plaintiff amends her complaint
to challenge a transaction that is not “already in litigation,” the plaintiff may be
required to excuse (or make) a demand on the board as then constituted regarding
the new claim.104 In other words, an amendment to assert a claim based on a new
and distinct cause of action derivatively—made after the board composition has
changed—implicates the same interests as any derivative claim, and is subject to
compliance with Rule 23.1. Therefore, where a plaintiff amends to add a new
102
Compl. ¶ 109.
103
Harris v. Carter, 582 A.2d 222, 231 (Del. Ch. May 4, 1990) (“When claims have been properly
laid before the court and are in litigation, neither Rule 23.1 nor the policy it implements requires
that a court decline to permit further litigation of those claims upon the replacement of the
interested board with a disinterested one.”).
104
See id. (citing Kaufman v. Beal, 1983 WL 20295 (Del. Ch. Feb. 25, 1983)).
35
derivative claim after a change in the composition of the board, in order to avoid
renewed review under Rule 23.1, the plaintiff must show that:
[F]irst, the original complaint was well pleaded as a derivative action;
second, the original complaint satisfied the legal test for demand
excusal; and third, the act or transaction complained of in the
amendment is essentially the same as the act or transaction challenged
in the original complaint.105
The Defendants concede that the Original Complaint was well pleaded as a
derivative action and that demand was excused at the time of the Original Complaint,
when the Board was composed of Morgan and Stalnaker. However, the Defendants
argue that the Stalnaker Options represent a distinct transaction that was not
challenged in the Original Complaint. I examine the claims relating to the Stalnaker
Options in light of the following rubric: In order to constitute a new claim such that
a plaintiff is charged with again establishing demand futility, the amended complaint
must not merely “elaborate upon facts relating to acts or transactions” alleged in the
initial complaint, nor simply “assert new legal theories of recovery based upon the
acts or transactions that formed the substance of the original pleading;”106 instead, it
will only trigger review under Rule 23.1 where it is based on an independent cause
of action.
In this case, the Original and First Amended Complaints alleged facts and
105
Braddock v. Zimmerman, 906 A.2d 776, 786 (Del. 2006) (citing Uni-Marts, Inc. v. Stein, 1996
WL 466961, at *12 (Del. Ch. Aug. 12, 1996)).
106
Harris, 582 A.2d at 231.
36
claims surrounding the 2010 Stock Dividend, which occurred in February 2010. The
Stalnaker Options, however, were issued almost two year later, in late 2011. In order
to complete the Stalnaker Options transaction, the Board approved the 2011 Stock
Options Plan and Morgan, acting as majority stockholder, approved the stock option
issuances that, together, form the Stalnaker Options. I find that the 2010 Stock
Dividend and the Stalnaker Options are two discrete transactions. The 2010 Stock
Dividend involved Morgan’s cementing control of the Company; the Stalnaker
Options rewarded a corporate executive with stock in 2011. While either, or both,
may be wrongful, they are distinct temporally, factually, and in motivation. The
mere fact that the 2010 Stock Dividend possibly enabled Morgan and Stalnaker to
issue the Stalnaker Options does not merge the two as one “act or transaction.”
Therefore, at the time of the Second Amended Complaint, the Plaintiffs were
required to plead the additional claims challenging the Stalnaker Options in
compliance with Rule 23.1.
According to the Defendants, at the time of the Second Amended Complaint,
the Board was composed of Morgan, Womble, and Burnett—Stalnaker was
allegedly removed from the Board in July 2013. The Plaintiffs’ Second Amended
Complaint, mirroring the two complaints filed before it, alleges only that a demand
would be futile because First Orion’s Board consisted of Morgan and Stalnaker. The
Second Amended Complaint thus fails to mention that the composition of the Board
37
had changed, and fails to assert why Womble and Burnett could not apply business
judgment in consideration of any demand relating to the Stalnaker Options; it,
therefore, fails to properly plead that demand is futile in accordance with Rule
23.1.107
I note that the Plaintiffs have not disputed that the Board composition has
changed, or that the two new directors were capable of considering a demand that
Morgan and Stalnaker be sued for breaches of duty. Instead, the Plaintiffs point to
this Court’s holdings in Seinfeld v. Slager,108 which, according to the Plaintiffs,
states that demand is excused if a claimant properly pleads a waste claim. The
Plaintiffs misunderstand Seinfeld. In Seinfeld, the plaintiff, without making a
demand on the board, filed a derivative suit that challenged multiple compensation
decisions by the board and asserted that many of the challenged decisions constitute
107
The parties have not reached the issue of whether I should employ either the Aronson or Rales
test to determine whether the Plaintiffs’ demand is futile. I need not make that determination here.
The Court has recognized that “the Rales test functionally covers the same ground as the Aronson
test in determining the impartiality of directors” for the purpose of assessing demand futility.
Sandys v. Pincus, WL 2016 —, (Del. Ch. Feb. 29, 2016) (citations omitted). The Plaintiffs have
made no attempt to argue that Womble and Burnett were beholden to someone interested in the
issuance of the Stalnaker Options such that they would be unable to consider the demand
impartially. See Sandys v. Pincus, WL 2016 —, (Del. Ch. Feb. 29, 2016) (citing Beam v. Stewart,
845 A.2d 1040, 1050 (Del. 2014)). Furthermore, even if I assume that, for the purpose of the
Defendants’ motion, Morgan was a controller at the time of the Second Amended Complaint, the
presence of a controller is not itself sufficient to overcome the directors’ presumption of
independence. See Teamsters Union 25 Health Servs. & Ins. Plan v. Baiera, 119 A.3d 44, 66 (Del.
Ch. 2015) (citing Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984), overruled in part on other
grounds by Brehm v. Eisner, 746 A.2d 244, 253 (Del. 2000)).
108
2012 WL 2501105 (Del. Ch. June 29, 2012).
38
corporate waste.109 The plaintiff, implicating the second prong of the well-known
Aronson test, argued that demand was excused because the challenged transactions
were not the product of business judgment. Under Aronson, to show that demand is
futile under Rule 23.1, the plaintiff must allege particularized facts that raise a reason
to doubt that “(1) the directors are disinterested and independent [or] (2) the
challenged transaction was otherwise the product of a valid exercise of business
judgment.”110 At the time of the complaint, the board in Seinfeld was the same as
that against whom waste was pled. In assessing the plaintiff’s compliance with
Aronson’s second prong, the Court stated that, “[d]emand may be excused under the
second prong of Aronson if a plaintiff properly pleads a waste claim.”111 The Court
then described the stringent requirements of pleading a waste claim.
Seinfeld, unremarkably, held that a particularized pleading of waste
committed by the board on whom demand would otherwise be made may excuse
demand under Aronson, but that circumstance is absent here: the Second Amended
Complaint does not allege that waste was committed by Womble or Burnett, who
constituted the majority of the Board when the claim based on the Stalnaker Options
was filed.
109
Id. at *1.
110
Id. at *2 (citing Brehm, 746 A.2d at 253 (Del. 2000) (quoting Aronson, 473 A.2d at 814 (Del.
1984))).
111
Id. at *3 (citing Orloff v. Shulman, 2005 WL 3272355, at *11 (Del. Ch. Nov. 23, 2005)).
39
Since the Plaintiffs have failed to plead particularized facts excusing demand
on the Board as constituted at the time of their Second Amended Complaint, I find
that they have not complied with Rule 23.1. Therefore, the Plaintiffs’ claims
challenging the Stalnaker Options are dismissed.112
IV. CONCLUSION
Based on the reasons stated above, the Plaintiffs’ Motion for Summary
Judgment is denied. Likewise, the Defendants’ Motion to Dismiss and/or for
Summary Judgment is denied, with the exception that the claims challenging the
Stalnaker Options in Counts I and VII are dismissed. To the extent the foregoing
requires an Order to take effect, IT IS SO ORDERED.
112
Because of this determination, I do not address the Defendants’ argument that summary
judgment is appropriate because the Stalnaker Options were ratified by a disinterested majority of
the Board.
40