Last week's Order in Gusinsky v. Flanders Corp., 2013 NCBC 46, should be required reading for lawyers thinking of suing the directors of a corporation in North Carolina over a merger transaction. It provides guidance on the duties of directors in those transactions, whether the claims are derivative or direct, and lays down some heightened pleading requirements for some of those types of claims.
You probably wouldn't be surprised to have never heard of Flanders Corporation. Flanders, based in Washington, NC, says it is the largest United States manufacturer of air filters. It was publicly traded until its shareholders approved a sale of the company via a merger in May 2012.
That approval by the shareholders came nearly a year and a half ago, but it was only last week that the NC Business Court dismissed a shareholder class action challenging the merger. In its Order, the Court dismissed the claims by the Plaintiff (a trust) for breach of fiduciary duty and for aiding and abetting breach of fiduciary duty.
One claim of breach of fiduciary duty was an alleged failure to "maximize shareholder value" in the sale of the company, which Plaintiff claimed was a duty owed by the directors of Flanders to all shareholders. The other was an alleged failure to disclose information material to the deal.
There Is Rarely A Fiduciary Duty Owed Directly From A Corporation's Directors To Its Shareholders
In dismissing the claim, the Business Court underscored the principle that directors virtually never owe a fiduciary duty directly to shareholders. The duty is owed to the corporation, not shareholders. Those claims therefore must be made derivatively, unless the circumstances of the "Barger rule" are met. (I've written about the Barger rule before).
It seems so obvious that this type of claim is derivative that you might be wondering how this class action plaintiff even argued its position. All it made was a couple of pretty anemic arguments which Judge Jolly shot down.
One was that the General Statutes contemplate fiduciary duties owed directly to shareholders. Plaintiff said that G.S. Section 55-8-30, which delineates the duties of directors, contains only one reference to a duty to the corporation and that the other duties prescribed therefore must be owed directly to shareholders.
That's so wrong. The North Carolina Court of Appeals held last year that:
The drafters [of the Business Corporation Act] recognized that directors have a duty to act for the benefit of all shareholders of the corporation, but they intended to avoid stating a duty owed directly by the directors to the shareholders that might be construed to give shareholders a direct right of action on claims that should be asserted derivatively.
Estate of Browne v. Thompson. __ N.C. App. __, 727 S.E.2d 573, 576 (2012)(quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 14.01 (7th ed.) (citing Official Commentary, N.C. Gen. Stat. § 55-8-30 (1989)).
The Plaintiff also failed in its argument that it met the requirements of the "Barger rule." Plaintiff struck out on that score because the Flanders directors owed no duty to the class Plaintiff that was personal to the Plaintiff. The cases that the Plaintiff relied on were cases involving closely held corporations controlled by a majority shareholder. Judge Jolly found them not to be apposite.
Judge Jolly also ruled that a claim alleging inadequate consideration in a merger transaction was a harm to the corporation itsself, not to shareholders individually. He said that:
[t]his is so because a claim for inadequate consideration is, functionally, a claim for the diminution of the value of shares held by all Flanders shareholdrs. Without more, the 'lost value' of all shares of Flanders' stock does not describe an injury peculiar and personal to Plaintiffs.
Op. Par. 32.
You can probably guess the rest of this story. If you can't, remember that derivative claims require the prospective Plaintiff to make a demand on the corporation to pursue the claim before being allowed to file a complaint. This Plaintiff made no demand. As the Court observed, "A plaintiff's failure to fulfill the statuory requirements for bringing a shareholder derivative action [is an] . . insurmountable bar [to recovery]." (quoting Allen v. Ferrera, 141 N.C. App. 284, 287, 546 S.E.2d 761, 764 (2000)).
So the first claim for breach of fiduciary duty for "failure to maxinize shareholder value" was dismissed.
Claims For Failure To Disclose Material Information Are Most Likely Direct Claims, But Must Be Pled With Particularity
The Court struggled a bit more with the Plaintiff's second claim for breach of fiduciary duty, which was that the directors had failed to disclose certain information concerning the proposed merger. This, it said, deprived the class members of the opportunity to cast a meaningful and informed vote on the merger transaction.
It is settled under North Carolina law that "North Carolina directors 'are under a fiduciary duty to disclose fully and fairly all material information within the board's control when it seeks shareholder action." Op. Pr. 40 (citing Ehrenhaus v. Baker, __ N.C. App. __, ___, 717 S.E.2d 9, 28 (2011)).
There is no North Carolina law on whether a claim alleging a failure to disclose is derivative or direct. But in Delaware, "where it is claimed that a duty of disclosure violation impaired the stockholders' right to cast an informed vote, that claim is direct." In re J.P. Morgan Chase & Co. S'holder Litig. v. Harrison, 906 A.2d 766, 772 (Del. 2006).
Although Judge Jolly said that it was appropriate to consider the non-disclosure claim as a direct claim, he dismissed it based on pleading deficiencies. He ruled that:
in order to state a claim for a director's breach of the duty to disclose, a plaintiff must articulate how and why the inadequate disclosures complained of significantly altered the 'total mix' of information made available to shareholder. It is insufficient to simply note, without more, certain pieces of information that were omitted from the body of information provided to shareholders.
Op. Par. 47.
Although the Plaintiff had identified in its Complaint the omissions it claimed to be material, the Court said that it would "not assume the materiality of omissions. It is Plaintiffs' burden to explain why the alleged omissions were material." Op. Par. 48.
Oh, let's not forget that aiding and abetting a breach of fiduciary duty claim. With the dismissal of the fiduciary claims, the aiding and abetting claim had nothing to support it. It was dismissed as well.