Chancery Analyzes Limits of 'Reasonable Conceivability'
In 2011, the Delaware Supreme Court in Central Mortgage v. Morgan Stanley Mortgage Capital Holdings, 27 A.3d 531, 537 (Del. 2011), unequivocally stated that the "pleading standard in Delaware to survive a motion to dismiss is reasonable 'conceivability.'" That standard remains the benchmark plaintiffs must meet when asserting claims subject to a motion to dismiss in Delaware. For stockholder plaintiffs, however, what is "reasonable" is often measured by what pre-suit investigation the plaintiff's counsel undertakes in support of the plaintiff's claims. Stated simply, if a stockholder plaintiff fails to utilize its Section 220 rights for books and records prior to filing a lawsuit, the plaintiff's claims better include all necessary facts that could have been discovered through a Section 220 demand.
In Thermopylae Capital Partners v. Simbol, C.A. No. 10619-VCG (Del. Ch. Jan. 29, 2016), the Court of Chancery dismissed a complaint for failing to assert sufficient facts to satisfy the aforementioned "reasonable conceivability" standard. The plaintiffs in Thermopylae were stockholders of Simbol Inc., a Delaware corporation that specializes in sustainable materials technology. The plaintiffs alleged that Simbol was controlled by Mohr Davidow Ventures (MDV) and, through MDV's control, the plaintiffs' equity interests in Simbol were wrongfully diluted. The complaint alleged that plaintiff M. Scott Conley was a founder of Simbol, which was created to profit on the increasing need for lithium in the production of electronic vehicles. According to the complaint, Conley and his founding partner, Luka Erceg, developed a business model for extracting lithium from geothermal brine employing an environmentally friendly production process. Simbol's concept began garnering attention in 2008. That same year, Conley and Erceg agreed to accept an investment from MDV and others, in exchange for Simbol preferred stock, to support Simbol's growth. Over the course of the next few years, Simbol received substantial investments from MDV, and others, to foster its growth.
Following MDV's initial investment, the plaintiffs contend that MDV engaged in a scheme to financially "choke" Simbol so that the company would be forced to seek financing from MDV at terms favorable to MDV, but unfavorable to Simbol's other stockholders. By 2011, Simbol's financial condition was worsening and the company was in need of additional capital investment, according to the opinion. The complaint presents a series of allegations aimed at MDV and its confederates, targeting the defendants for breaches of fiduciary duty related to the exploitation of Simbol's worsening financial condition as well as the purported dilutive effect defendants' actions had on plaintiffs' equity holdings in Simbol. Specifically, the complaint asserted claims for breaches of fiduciary duties relating to MDV unilaterally re-pricing preferred shares, which the plaintiffs argue was dilutive to their interests, and a claim against the defendants for wrongfully transferring shares surrendered by Erceg when he was ousted as CEO of Simbol to the subsequent CEO despite the existence of a right of first refusal agreement that required notice be given to Conley.
The court first analyzed the plaintiffs' claim that MDV caused the re-pricing of Simbol preferred stock at a value that wrongfully diluted the plaintiffs' equity in Simbol. Upon consideration, however, the court noted that it could not effectively analyze the plaintiffs' claim. For instance, the complaint was devoid of sufficient information for the court to reasonably conclude that either MDV controlled Simbol or that a majority of Simbol's directors lacked independence or was disinterested in the alleged re-pricing. Without facts supporting the proposition that MDV was a controlling stockholder of Simbol, the court could not find that MDV owed Simbol or its minority stockholders fiduciary duties. The court noted the recent decision in In re Morton's Restaurant Group Shareholders Litigation, 74 A.3d 656 (Del. Ch. 2014), where then-Chancellor Leo E. Strine Jr. held that conclusory allegations of the exercise of actual domination and control by a minority stockholder are insufficient to defeat a motion to dismiss under Rule 12(b)(6). Notably, the court deemed the complaint "sparse" insofar as it omitted many pertinent facts that were presumably available to Simbol stockholders prior to initiating the litigation. The court described the missing facts to include (1) when the alleged re-pricing took place, (2) the board membership and size throughout the relevant time period, (3) whether the re-pricing was subject to a vote of the board or a contractual right held by MDV, and (4) how the alleged re-pricing was dilutive to the common stockholders. Based on the dearth of pertinent information, the court dismissed the plaintiffs' claim regarding the alleged re-pricing.
The court also noted insufficient facts when analyzing the plaintiffs' claim regarding the alleged wrongful transfer of Erceg's shares, which were purportedly subject to a right of first refusal agreement whereby Conley was entitled to notice prior to any transfer of the shares. Specifically, the court stated that the missing pertinent facts included (1) whether Conley knew of the transfer of the Erceg shares prior to its occurrence, (2) whether Conley would have attempted to repurchase some or all of the allegedly wrongfully transferred Erceg shares, (3) the composition of the Simbol board at the time of the transfer of the Erceg shares, and (4) the date on which the transfer of the Erceg shares was approved.
While recent Delaware decisions encourage stockholder litigants to utilize their "tools at hand," typically Section 220 demands for corporate books and records, Vice Chancellor Sam Glasscock III's decision in Thermopylae highlights the necessity for stockholder litigants to fully engage in pre-suit investigation activities should that stockholder plaintiff present the court with a complaint lacking pertinent facts. In Thermopylae, the plaintiffs made a Section 220 demand but chose not to pursue litigation following an allegedly incomplete document production from the company. Had the plaintiffs successfully litigated their Section 220 demand, the plaintiffs may have received sufficient facts to satisfy the "reasonable conceivability" pleading requirement. Or, to the contrary, if after litigating the Section 220 matter it was clear that the company's records were devoid of pertinent information, the court may have been sympathetic to the plaintiffs' inability to plead all the pertinent facts and denied a motion to dismiss. In any event, stockholder plaintiffs must now consider Section 220 demands, and Section 220 litigation, a virtual prerequisite before initiating litigation in the Court of Chancery.