Disenfranchised Shareholders Had Individual Claims For Breach Of Fiduciary Duty

The alleged efforts of a board of directors to entrench itself – which included refusing to permit dissent shareholders to vote at a shareholders meeting and issuing additional shares to give the board majority control of the company – were the subject of the Business Court’s opinion last Friday in Green v. Condra, 2009 NCBC 21 (N.C. Super. Ct. August 14, 2009).

Among other things, the Court held that a shareholder can maintain an individual (i.e. not derivative) claim for breach of fiduciary duty when his right to vote his shares is disallowed, and also let the Plaintiffs go forward on derivative claims for gross mismanagement and unjust enrichment.

Background

The parties were shareholders and/or directors of MedOasis, which provided billing services to anesthesiology practices. In November 2005, the Board removed the Plaintiffs, Green and Ellington, as directors and also fired Plaintiff Green as CEO. The company offered Green a buyout of his shares. He refused.

The other Plaintiff, Ellington, had been an anesthesiologist at MedOasis’ first and largest client, AAA. In May 2008, the company terminated its management contract with AAA. It then told Ellington that it was as a result required to repurchase his shares. It based the right to repurchase on a bylaw provision saying that MedOasis shareholders had to be members of medical practices under contract with MedOasis.

Other AAA shareholders had been offered redemption, and had also refused the offer. Twenty of those shareholders gave Ellington their proxies, giving him control over 481,000 shares. Combined with Green’s shares, the two Plaintiffs had control over 707,000 shares of the company’s 1,147,109 shares outstanding, a clear majority.  The members of the board held the remaining 440,109 shares that had been issued.

The Board Actions At Issue

Green then called a shareholders’ meeting. The Board, concerned about its minority position and the impending vote, called an emergency meeting at which it took a number of defensive steps which formed the basis for the lawsuit.

First, the board decided that it would not let Ellington and Green vote the shares they controlled. Next, it issued an additional 280,000 shares to two of the defendants at a below market value price. Those additional shares gave the board members a majority of the outstanding shares. Last, it decided that it wouldn’t give notice of the shareholders meeting to Ellington and Green or the shareholders whose shares they controlled.

Ellington and Green showed up at the shareholder meeting notwithstanding the lack of notice. The company refused to let them vote their shares or the shares over which Ellington held a proxy. It did count the newly issued shares, and defeated motions proposed by Green to change the composition of the board.

The Plaintiffs then made a written demand on the company for it to take “suitable action.”  The board refused to act. The lawsuit, raising a fusillade of individual and derivative claims, followed.

In the opinion on Defendants' motion to dismiss, which for the most part denied the motion, Judge Diaz dealt with a series of corporate law issues:

Exculpatory Provision

The Defendants first said that they were immune from suit based upon an exculpatory provision in the company’s articles of incorporation. That provision, however, didn't extend to claims arising from “any transaction from which the director derived an improper personal benefit.”

Judge Diaz held that Plaintiffs’ allegations regarding the issuance of the new shares “at a stated price well below its market value or fair value” in order to “ensur[e] that the board could protect itself from being unseated,” did not fall within the scope of the exculpation clause.

Individual Claims For Breach Of Fiduciary Duty

Most of the claims asserted by the Plaintiffs were derivative in nature, but Plaintiffs also raised their own individual claims for breach of fiduciary duty and constructive fraud. Defendants asserted that all of the claims were derivative in nature and that they could not be maintained on an individual basis.

Judge Diaz acknowledged that the fiduciary duty owed by the MedOasis directors was owed to the corporation as opposed to the individual shareholders, and that such claims are generally derivative, but nevertheless held that Plaintiffs could proceed on their individual claims.

The Court focused on the refusal of the board to permit the Plaintiffs to vote their shares, ruling that the right to vote “is specifically recognized by statute” per G.S. §55-7-21(a). Judge Diaz referenced Delaware precedent holding that when “a plaintiff shareholder alleges that Company stock was issued for grossly inadequate consideration and primarily for entrenchment purposes, the claim “may state either an individual or derivative claim.” (quoting Avacus Partners, L.P. v. Briani, Civil Action No. 11001, 1990 Del. Ch. LEXIS 178, at *22 (Del. Ch. Oct. 24, 1990)). Op. ¶158.

Judge Diaz concluded by holding that the individual claims raised “statutory violations of Plaintiffs’ right to vote their shares at the 18 August 2008 shareholders’ meeting,” and that claims of this nature “are properly pled as individual claims.” Op. ¶159.

Derivative Claim For Breach Of Fiduciary Duty

The Court held that the derivative allegations regarding the board’s efforts to entrench itself made out a claim for breach of fiduciary duty. It said that this conduct would be “a breach of their fiduciary duty to discharge their duties in ‘good faith,’ which includes a responsibility to act with undivided loyalty to the Company.” Op. ¶122. 

Furthermore, the Court held that the Defendants were not protected by the Business Judgment Rule because the “sole purpose” of the challenged conduct was to “thwart a shareholder vote.” Op. ¶123. The claimed misconduct amounted to bad faith, which “rebutt[ed] the deference normally afforded a Board by the business judgment rule.” Op. ¶124.

The Court further held that Plaintiffs could proceed on their claim for constructive fraud based upon the same allegations.

Derivative Claims For “Abuse Of Control,” Corporate Waste, and “Gross Mismanagement”

Derivative claims made by the Plaintiffs for abuse of control and corporate waste were dismissed by Judge Diaz, who ruled these claims were “not recognized as independent torts in North Carolina.” Op. ¶¶127-28. He said, however, that these claims were embraced by the derivative claims for breach of fiduciary duty, gross mismanagement, and constructive fraud.

The claim for gross mismanagement survived. The Court ruled that this was essentially a claim for a violation of the statutory duty of care under G.S. §55-8-30(a)(2), which requires a director to exercise his duties “with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” It observed that North Carolina “courts have recognized that a claim for gross mismanagement against a director is a proper derivative claim.” Op. ¶133.

Derivative Claim For Unjust Enrichment

The alleged conduct of the Defendants in entrenching themselves on the board also made out a derivative claim for unjust enrichment. The Court held:

Plaintiffs allege that Defendants unlawfully circumvented Plaintiffs’ voting rights so as to retain their seats on the Board, and, as a result, Defendants will continue to receive salaries, benefits, bonuses, stock issues, etc., at the Company’s expense and ‘under circumstances where it would be unfair for [Defendants] to retain [these benefits] without [the Company] being repaid or compensated.’ These allegations are sufficient to make out a claim for unjust enrichment. 

Op. ¶¶145-46.

Brief in Support of Motion to Dismiss

Brief in Opposition to Motion to Dismiss

Reply Brief in Support of Motion to Dismiss

 

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