EFiled: May 15 2009 1:43PM EDT
Transaction ID 25206351
Case No. 4032-CC
COURT OF CHANCERY
OF THE
STATE OF DELAWARE
WILLIAM B. CHANDLER III
CHANCELLOR
COURT OF CHANCERY COURTHOUSE
34 THE CIRCLE
GEORGETOWN, DELAWARE 19947
Submitted: April 22, 2009
Decided: May 15, 2009
Carl L. Green
Dawn Martinson Green
523 East 11th Street
Duluth, MN 55805
Brett D. Fallon
Jason C. Jowers
Morris James LLP
500 Delaware Avenue, Suite 1500
Wilmington, DE 19801
Re:
Green v. LocatePlus Holdings Corp., et al.
Civil Action No. 4032-CC
Dear Counsel and Mr. and Ms. Green:
I have carefully reviewed the papers filed on behalf of LocatePlus Holdings
Corporation (“LocatePlus”), Jon Latorella, James Fields, Sonia Bejjani, Ralph
Caruso, and David Skerrett (collectively the “Director Defendants”) in support of
their motion to dismiss plaintiffs’ amended complaint, as well as the opposition
filed by plaintiffs Carl L. Green and Dawn Martinson Green. For reasons stated
briefly below, I grant defendants’ motion to dismiss plaintiffs’ amended complaint
without prejudice for failure to comply with Court of Chancery Rule 23.1. This
letter is the Court’s ruling on the motion.
I. BACKGROUND 1
Plaintiffs allege that Dawn Martinson Green is the stockholder of record and
that both Carl Green and Dawn Green are the beneficial owners of 904,000 shares
of common stock in LocatePlus, a Delaware corporation providing public
information and online investigative solutions to law enforcement, legal and
insurance professionals, licensed investigators, and other related businesses.
LocatePlus provides commercial and professional users with access to databases of
public records and business information. This information is used to locate
individuals, to verify identities, and to perform background checks.
According to plaintiffs, LocatePlus effectuated a transaction that allegedly
diluted the value of LocatePlus’ common equity. On March 20, 2007, LocatePlus
issued a secured convertible debenture to Cornell Capital Partners L.P. (“CCP”) in
the amount of $6,000,000. According to the purchase agreement, the holder of the
debentures may convert at any time the outstanding principal into shares of
common stock of LocatePlus at a fixed conversion price of $0.314 per share. Any
conversion, however, cannot provide CCP with more than a 4.99% ownership in
LocatePlus. The debentures are secured by substantially all of LocatePlus’ assets,
and the debentures carry an annual interest rate of 8.5% payable in quarterly
installments. Under the terms of the deal, CCP can choose to receive installment
payments by converting them into common stock.
Shortly after LocatePlus issued the debentures, plaintiffs allege that
LocatePlus issued approximately 7,350,793 additional shares. LocatePlus states
that the share issuance was done to pay off its outstanding debt owed to CCP.
Plaintiffs allege that the reason for the dilution and economic collapse was to
benefit the Director Defendants by granting them additional voting power at the
upcoming shareholder meeting. As of September 30, 2008, the outstanding
principal of the debentures stood at $2,514,070. As a result of the share issuance,
plaintiffs claim that their interest in LocatePlus was diluted from 5% to 3%.
1
The issues before the Court procedurally arise on defendants’ motion to dismiss plaintiffs’
amended complaint. Consequently, I will only consider the facts provided in plaintiffs’ amended
complaint. The facts provided by plaintiffs, however, are sparse, opaque, and insufficient. In
order to adequately provide even an abbreviated factual account of the background in which to
place this case’s relevant issues, I have supplemented the facts with information taken from the
parties’ briefs.
2
II. ANALYSIS
Plaintiffs assert the right to bring a direct claim against LocatePlus and the
Director Defendants. In Tooley v. Donaldson, Lufkin & Jenrette, Inc., 2 the
Supreme Court set forth the test to determine whether a stockholder can bring a
direct claim. 3 The Court held that the distinction between derivative and direct
claims “must turn solely on the following questions: (1) who suffered the alleged
harm (the corporation or the suing stockholders, individually); and (2) who would
receive the benefit of any recovery or other remedy (the corporation or the
stockholders, individually)?” 4 In other words, “[t]he stockholder must demonstrate
that the duty breached was owed to the stockholder and that he or she can prevail
without showing an injury to the corporation.” 5 In plaintiffs’ amended complaint,
they allege that they were directly harmed by the dilution of stock. This
conclusion, however, is a mere conclusory allegation of a direct injury. Plaintiffs
fail to allege specific facts or even explain how the dilution harmed them directly
or how the harm they suffered differed from the harm suffered by LocatePlus itself
or the other holders of LocatePlus’ stock. There are insufficient factual allegations
in the complaint to support plaintiffs’ claim that they were harmed independent of
LocatePlus.
Classically, Delaware law has viewed as derivative claims by shareholders
alleging that they have been wrongly diluted by a corporation’s overpayment of
shares. 6 Explaining the reasoning behind this position, the Supreme Court stated:
In the typical corporate overpayment case, a claim against the
corporation’s fiduciaries for redress is regarded as exclusively
derivative, irrespective of whether the currency or form of
overpayment is cash or the corporation’s stock. Such claims are not
normally regarded as direct, because any dilution in value of the
corporation’s stock is merely the unavoidable result (from an
accounting standpoint) of the reduction in the value of the entire
corporate entity, of which each share of equity represents an equal
fraction. In the eyes of the law, such equal “injury” to the shares
2
Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004).
Id. at 1033.
4
Id.
5
Id. at 1039.
6
Gentile v. Rossette, 906 A.2d 91, 99 (Del. 2006); see also In re J.P. Morgan Chase & Co.
S’holder Litig., 906 A.2d 808, 819-20 (Del. Ch. 2005), aff’d, 906 A.2d 766 (Del. 2006).
3
3
resulting from a corporate overpayment is not viewed as, or equated
with, harm to specific shareholders individually. 7
There is “one transactional paradigm,” however, that Delaware law recognizes
as being both direct and derivative. This specific situation arises in the controlling
shareholder context where: (1) a controlling shareholder causes the corporation to
issue excessive shares of its stock in exchange for assets of an unreasonably lesser
value; and (2) the exchange results in the controlling shareholder owning an
increased percentage of the outstanding shares, and the minority shareholders
owning a corresponding decrease in the percentage of outstanding shares. 8 In such
situation, not only is the corporation harmed because the over-issuance gives the
corporation the right to compel the restoration of the overpaid value, but also
because the voting power, through the dilution, is shifted from the minority
shareholders to the controlling shareholder. The minority shareholders are harmed
separate and apart from the corporation and the controlling shareholder. This
creation of a separate class of injury suffered by the minority shareholders gives
rise to a separate direct claim. In such circumstances, the minority shareholders
are entitled to recover the value, resulting from the overpayment, that may be
claimed by the minority shareholders directly and without regard to the
corporation’s claims. These specific circumstances, however, do not exist in this
case.
In their amended complaint, plaintiffs have failed to allege facts that would
lead this Court to conclude that there is a controlling shareholder or that a
controlling shareholder caused the dilution. Consequently, this is not one of the
specific circumstances where dilution of stock gives rise to a direct claim. Thus, I
conclude that plaintiffs’ claims alleging they were harmed by the dilution of their
stock are strictly derivative.
Given that plaintiffs, in order to sustain their claims against LocatePlus and
the Director Defendants, must allege derivative claims on behalf of LocatePlus,
plaintiffs must comport with the requirements of Rule 23.1. “The decision whether
to initiate or pursue a lawsuit on behalf of the corporation is generally within the
power and responsibility of the board of directors.” 9 “Therefore, the right of a
7
Gentile, 906 A.2d at 99.
Id. at 99-100.
9
In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 120 (Del. Ch. 2009) (citing 8
Del. C. § 141(a)).
8
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stockholder to prosecute a derivative suit is limited to situations where either the
stockholder has demanded the directors pursue a corporate claim and the directors
have wrongfully refused to do so, or where demand is excused because the
directors are incapable of making an impartial decision regarding whether to
institute such litigation.” 10 Plaintiffs have not made a demand upon the board of
directors of LocatePlus to pursue their claim, and thus, plaintiffs must plead why
demand should be excused in this case.
Rule 23.1(a) provides that “[t]he complaint shall also 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.” 11 In addition,
to determine demand futility the Court must exercise its discretion in deciding
whether “a reasonable doubt is created that: (1) the directors are disinterested and
independent [or] (2) the challenged transaction was otherwise the product of a
valid exercise of business judgment.” 12 Plaintiffs have failed to comply with this
pleading standard. In their amended complaint, plaintiffs have not alleged that
demand is excused or pled with any measure of particularity facts that would
demonstrate that the Director Defendants are not disinterested or independent, or
that the dilution was not a proper exercise of the board’s business judgment.
Indeed, plaintiffs’ conclusory allegation that the Director Defendants caused the
dilution to enrich themselves is insufficient to meet the standard under Rule 23.1. 13
Plaintiffs fail even to allege how the dilution in exchange for financing from CCP
was not in the best interests of LocatePlus. In fact, plaintiffs state that “the
complaint does not allege the exchange of debt for shares was unfair.” 14
Furthermore, plaintiffs fail to allege facts that would support a claim that the
Director Defendants were motivated by a perceived vulnerability to removal from
the LocatePlus board. Practically speaking, plaintiffs fail to allege any set of facts
10
Stone ex rel. AmSouth Bancorp. v. Ritter, 911 A.2d 362, 366-67 (Del. 2006).
Ct. Ch. R. 23.1(a) (emphasis added).
12
Brehm v. Eisner, 746 A.2d 244, 253 (Del. 2000) (quoting Aronson v. Lewis, 473 A.2d 805, 814
(Del. 1984)).
13
Greenwald v. Batterson, 1999 WL 596276, at *4 (Del. Ch. July 26, 1999) (quoting Grobow v.
Perot, 539 A.2d 180, 187 (Del. 1988) (“In weighing the adequacy of the complaint under Rule
23.1, ‘only well-pleaded allegations of fact may be accepted as true; conclusory allegations of
fact or law not supported by allegations of specific fact may not be taken as true. A trial court
need not blindly accept as true all allegations, nor must it draw all inferences from them in
plaintiffs’ favor unless they are reasonable inferences.’”).
14
Compl. ¶ 21.
11
5
with sufficient particularity to meet either prong of the Aronson test. Thus, I
conclude that plaintiffs have not satisfied the requirements of Rule 23.1.
Plaintiffs have also failed to comply with the procedural requirements for an
inspection of books and records under 8 Del. C. § 220. Plaintiffs contend that
LocatePlus has wrongfully refused to allow them access to LocatePlus’ books and
records, yet in their letters requesting the inspection dated January 19, 2008,
February 19, 2008, and March 13, 2008, plaintiffs failed to set forth any purpose
for their inspection. Plaintiffs also neglected to send the letters under oath.
Section 220(b) clearly states that “[a]ny stockholder, in person or by attorney or
other agent, shall, upon written demand under oath stating the purpose thereof,
have the right during the usual hours for business to inspect for any proper
purpose.” 15 There are also additional material defects in plaintiffs request for an
inspection of LocatePlus’ books and records, including failure to provide proper
evidence of beneficial ownership. Section 220 provides shareholders with a
qualified right to inspect corporate books and records.16 Indeed, all shareholders
have the right, at any time, to inspect the books and records of the company in
which they own common shares, yet they must comply with the statutory
requirements of § 220. 17 Plaintiffs, to this point, have failed to meet those
requirements, but the deficiencies in their request can be easily remedied.
III. CONCLUSION
For the foregoing reasons, I grant defendants’ motion to dismiss plaintiffs’
amended compliant. I do so, however, without prejudice and strongly encourage
plaintiffs to obtain counsel to assist them in properly obtaining access to
LocatePlus’ books and records, and in adequately articulating their allegations.
15
8 Del. C. § 220(b) (emphasis added).
Melzer v. CNET Networks, Inc., 934 A.2d 912, 916 (Del. Ch. 2007) (citing La. Mun. Police
Employees’ Ret. Sys. v. Countrywide Fin. Corp., 2007 WL 2896540, at *9 (Del. Ch. Oct. 2,
2007)).
17
“Before shareholders may inspect books and records, they must (1) comply with the technical
requirements of section 220 and (2) demonstrate a proper purpose for seeking inspection. There
is no shortage of proper purposes under Delaware law, but perhaps the most common ‘proper
purpose’ is the desire to investigate potential corporate mismanagement, wrongdoing, or waste.”
Id. (citing 1 EDWARD P. WELCH, ANDREW J. TUREZYN & ROBERT SAUNDERS, FOLK ON THE
DELAWARE GENERAL CORPORATION LAW § 220.6.3 (supp. 2007-2) (listing over ten examples of
broad categories of proper purposes under section 220)).
16
6
IT IS SO ORDERED.
Very truly yours,
William B. Chandler III
WBCIII: tet
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