MIZEL v. CONNELLY, 16638 (Del.Ch. 7-22-1999)

STEVEN M. MIZEL, Plaintiff, v. JOHN E. CONNELLY, JOHN S. AYLSWORTH, TERRENCE L. WIRGINIS, KARL G. ANDREN, and ROYAL P. WALKER, JR, Defendants, and PRESIDENT CASINOS, INC., Nominal Defendant.

Civil Action No. 16638.Court of Chancery of Delaware, New Castle County.Date Submitted: July 19, 1999.
Date Decided: July 22, 1999.

Norman M. Monhait, Carmella P. Keener, of ROSENTHAL MONHAIT GROSS GODDESS, OF COUNSEL: Matthew M. Houston, of WECHSLER HARWOOD HALEBIAN FEFFER, Attorneys for Plaintiffs.

Stephen E. Herrmann, of RICHARDS, LAYTON FINGER, OF COUNSEL: Gerard K. Sandweg, Jr., Lawrence C. Friedman, of THOMAS COBURN, Attorneys for Defendants.

MEMORANDUM OPINION
STRINE, Vice Chancellor

The derivative complaint in this case challenges a transaction between nominal defendant President Casinos, Inc. and a corporation wholly owned by President Casinos’ Chairman, Chief Executive Officer (“CEO”), and largest stockholder, John E. Connelly. Connelly and two of Connelly’s management subordinates (one of whom is Connelly’s grandson) comprise a majority of the board of directors (the “Board”) of President Casinos. Since Connelly was clearly interested in the challenged transaction and is in a position to “exert considerable influence” over the economic fates of his two subordinates, a reasonable doubt exists regarding the independence of the President Casinos’ Board. Rales v. Blasband, Del.Supr., 634 A.2d 927, 937 (1993). As such, demand is excused and the defendants’ motion to dismiss under Court of Chancery Rule 23.1 will be denied.

I.
A brief recitation of the pertinent facts from the complaint is all that is necessary to resolve the current motion.

Nominal defendant President Casinos, a Delaware corporation, “develops, owns and operates riverboat and/or dockside casinos through its subsidiaries.” Compl. ¶ 3. The non-nominal defendants in this action are the five directors of President Casinos, who have been in service at all times relevant to this motion. The pertinent facts regarding the defendant directors’ employment and ownership interests in President Casinos are as follows:

John E. Connelly — President Casinos’ Chairman, CEO, and 32.7% stockholder;
John S. Aylsworth — President Casinos’ President, Chief Operating Officer (“COO”), and director;
Terrence L. Wirginis — President Casinos’ Vice Chairman of the Board, Vice President, consultant, and director, as well as Connelly’s grandson;
Karl G. Andren — President Casinos’ director, whose full-time occupation is as the Chairman of Circle-Line Sightseeing Yachts, Inc. (“Circle-Line”). Circle-Line is a corporation allegedly controlled by Connelly through his 100% ownership of Circle-Line’s parent corporation, New York Cruise Lines, Inc.; and
Royal P. Walker — President Casinos’ director whose independence is conceded by the plaintiff.

Compl. ¶¶ 4-8.

The complaint seeks rescission of a July 24, 1997 transaction (the “Transaction”) whereby President Casinos acquired the Broadwater Resort and Broadwater Tower (the “Broadwater Properties”) in Biloxi, Mississippi. According to the defendants, the Broadwater Properties are located adjacent to President Casinos’ existing casino operations in Biloxi and are a “destination resort property.” Defs.’ Br. at 1. President Casinos purchased the Broadwater Properties from J. Edward Connelly Associates (“JECA”) for approximately $40.5 million.

JECA was wholly-owned by defendant Connelly at the time of the Transaction. The Broadwater Properties constituted substantially all of JECA’s assets. According to the complaint, the Transaction was defective in the following material respects:

• The $40.5 million Transaction price was excessive since JECA had suffered significant losses in the two years prior to the Transaction and the “Broadwater Properties were old, suffered from deferred maintenance and were considered obsolete compared to newer resorts in the Biloxi area;”
• The financing for the Transaction was procured at a price “far in excess of commercial norms for such transactions;”
• The President Casinos’ Board, under the control of Connelly, did not obtain information to permit a determination that the consideration to be paid for the Broadwater Properties was fair and reasonable . . .;” and
• The President Casinos’ Board did not exercise a good faith business judgment in agreeing to the Transaction. Instead, the Board “preferred the interests of Connelly . . . over the interests of the Company and its shareholders.”

Compl. ¶¶ 14, 16, 19, 21.

As a result, plaintiff alleges that the Transaction is wasteful and the product of breaches of the defendant directors’ fiduciary duties of care and loyalty. By this action, plaintiff seeks rescission of the Transaction or other relief to make President Casinos whole for the damages caused by the Transaction.

II.
This matter is before me on the defendants’ motion to dismiss under Court of Chancery Rule 23.1. The defendants contend that the complaint fails to raise a reasonable doubt regarding the ability of any of the defendants, other than Connelly, to consider a demand impartially. Furthermore, the defendants argue that the complaint fails to plead particularized facts raising a reasonable doubt that the Transaction was not otherwise the product of a valid exercise of business judgment. As such, the defendants contend that the complaint must be dismissed since plaintiff has failed to satisfy either prong of the familia Aronson test. Aronson v. Lewis, Del.Supr., 473 A.2d 805, 814-815
(1984).

For his part, plaintiff alleges that he need not make a demand on the Board because he has pled particularized facts demonstrating that Connelly has a direct, personal interest in the Transaction and that defendants Aylsworth, Wirginis, and Andren are beholden to him for their livelihoods. Since these directors constitute four of the five members of the Board, plaintiff contends that demand is excused under the first prong of the Aronson test. Aronson, 473 A.2d at 814-815. Plaintiff also argues that he has properly pled a waste claim, thus excusing demand under the second prong of Aronson. Id.

III.
A plaintiff prosecuting a derivative action must “allege with particularity . . . the reason for . . . not making” a demand on the board of directors. Ch.Ct. Rule 23.1. In considering the defendants’ motion to dismiss under Rule 23.1, the well-pleaded allegations of the derivative complaint must be accepted as true Grobow v. Perot, Del.Supr., 539 A.2d 180, 186 (1988). Conclusory allegations, however, will not be accepted as true. Id. at 187 see also Rales, 634 A.2d at 931.

To determine whether demand is excused, I must evaluate whether, under the particularized facts alleged, a reasonable doubt is created that either: i) a majority of “the directors are disinterested and independent;” or ii) the “challenged transaction was otherwise the product of a valid exercise of business judgment.” Aronson, 473 A.2d at 814-815. In this case, I need only address the first prong of Aronson.

In addressing motions to dismiss under Rule 23.1, this court often confronts the question of whether directors without personal interests in a challenged transaction are so beholden to another director, who does possess such a self-interest, that they cannot consider the demand solely on its merits. Aronson, 473 A.2d at 814; Rales, 634 A.2d at 936-937. This case is no different.

Here, it is unquestionable that Connelly cannot impartially consider a demand that the Board take legal action to rescind the challenged Transaction. Such a decision would have “potentially significant financial consequences” for Connelly. Rates, 634 A.2d at 936.

To excuse demand, plaintiff must therefore demonstrate a reasonable doubt whether two of the four remaining Board members can impartially consider a demand. To establish a lack of independence, plaintiff must plead particularized facts suggesting that two of the directors are “beholden” to Connelly or so under his influence that “their discretion would be sterilized.” Rates, 634 A.2d at 936.

Plaintiff alleges that defendants Aylsworth, Wirginis, and Andren suffer from such a dependence on Connelly. I will address plaintiffs contentions, starting with defendants Aylsworth and Wirginis.

IV.
Aylsworth is the President and COO of President Casinos. “His positions with President Casinos constitute his principal employment and means of earning a living. During the Company’s 1998 fiscal year, Aylsworth received more than $620,000 in compensation from President Casinos.” Compl. ¶ 5.

Wirginis is Vice Chairman of the Board, Vice President, and consultant to President Casinos. “Wirginis is the grandson of defendant Connelly. His positions with President Casinos constitute his principal employment and means of earning a living. During the Company’s 1998 fiscal year, Wirginis received more than $239,000 in compensation from President Casinos.” Compl. ¶ 6.

Given these facts, I have a reasonable doubt that Aylsworth and Wirginis can impartially consider a demand calling upon them to take action materially adverse to Connelly’s interests. Connelly is their management superior — in common parlance, their “boss.” Connelly is also the largest stockholder of President Casinos.[1]

This fact powerfully strengthens the inference that he — as their boss — exerts “considerable influence” over Aylsworth and Wirginis. Since Aylsworth and Wirginis each derive their principal income from their employment at President Casinos, it is doubtful that they can consider the demand on its merits without also pondering whether an affirmative vote would endanger their continued employment.[2]
Rales supports this conclusion. In Rales, the Supreme Court considered whether George Sherman, the President and CEO of Danaher Corporation, was beholden to the Rales brothers such that he could not impartially consider a stockholder demand that, if granted, would have resulted in a suit adverse to the Rales brothers’ financial interests. Collectively, the Rales brothers owned 44% of the stock of Danaher. Steven Rales was Danaher’s Chairman of the Board; Mitchell Rales was Chairman of the Executive Committee of the Danaher Board.

The Supreme Court concluded:
Although Sherman’s continued employment and substantial remuneration may not hinge solely on his relationship with the Rales brothers, there is little doubt that Steven Rales’ position as Chairman of the Board of Danaher and Mitchell Rales’ position as Chairman of its Executive Committee place them in a position to exert considerable influence over Sherman. In light of these circumstances, there is a reasonable doubt that Sherman can be expected to act independently considering his substantial financial stake in maintaining his current offices.

634 A.2d at 937; see also Steiner v. Meyerson, Del.Ch., C.A. No. 13139, mem.op. at 23, Allen, C. (July 18, 1995) (Chairman and CEO of a company — who was not a controlling stockholder — was in a position to exert “considerable influence” over a director who was the company’s President, COO, and CFO, thereby disabling the subordinate from impartially considering a demand adverse to the CEO’s interests.); Kahn v. Tremont Corp., Del.Ch., C.A. No. 12339, mem.op.. at 6-7, Allen, C. (Apr. 22, 1994) (excusing demand because controlling shareholder indirectly controlled the livelihoods of a majority of the directors).

A further fact supports Wirginis’ inability to consider a demand impartially. Wirginis is Connelly’s grandson. That fact is of great consequence. I would like to believe (for Wirginis’ and Connelly’s sakes) that it would be difficult for Wirginis to consider impartially a demand that would be adverse to his grandfather’s personal interests. As an objective matter, this relationship gives me “reason to doubt” that Wirginis can impartially consider a demand. Grimes v. Donald, Del.Supr., 673 A.2d 1207, 1217 (1996). I could not consider impartially such a demand as to my own grandfather and would recuse in any comparable situation that required me to do so. Cf DelawareJudges’ Code of Judicial Conduct Canon 3.C.(1)(d) (1999) (judge should disqualify himself when a relative within the third degree of consanguinity of judge or judge’s spouse is a party to the proceeding or an officer, director, or trustee of a party because the judge’s “impartiality might reasonably be questioned”). While there is nothing wrong with far-Ply members serving together on a board, in my view a reasonable doubt” is raised when a demand would require a director to support a suit contrary to the interests of a close family member. The logic of analogous authorities supports this conclusion. 1 Principles of CorporateGovernance: Analysis and Recommendations §§ 1.03, 1.23 (1994) (director is interested in a transaction if the director’s grandchild is a party to the transaction); Model Business Corp.Act § 8.60 (1996) (conflicting interest exists when the director knows at the time of commitment that her grandchild is a party to the transaction)[3] see also Grimes, 673 A.2d at 1216
(indicating that a “material financial or familial interest” can disable a director) (emphasis added). While it is doubtless true that the traditional ties of loyalty and affection that exist between close family members may not exist in a particular case, the burden should not be on plaintiff to plead that such ties do not exist. See Grobow, 539 A.2d at 186 (“Reasonable doubt must be decided by the trial court on a case-by-case basis employing an objective analysis.”) (emphasis added). The existence of a very close family relationship between directors should, without more, generally go a long (if not the whole) way toward creating a reasonable doubt.[4]

V.
Finally, plaintiff also pleads that defendant Andren is beholden to Connelly because Andren is the Chairman of Circle-Line, a company that is allegedly a wholly-owned subsidiary of New York Cruise Lines, Inc., which is in turned wholly-owned by Connelly. Since Andren’s “position with Circle-Line constitutes his principal employment and means of earning a living,” Compl. ¶ 7, the complaint raises a reasonable doubt that Andren can Impartially consider a demand. Rales, 634 A.2d at 937.

Somewhat troubling to me, however, is the fact that Andren has submitted an affidavit stating that neither Circle-Line nor New York Cruise Lines is controlled in any way by Connelly. Andren Aff. ¶ 3. Contrary to plaintiffs assertions, Andren contends that Connelly controlled a partnership that was merged into New York Cruise Lines in 1988, and now has no legal or ownership interest in that company or Circle-Line. Id.

I cannot, however, consider Andren’s affidavit in determining this motion to dismiss since such a motion is directed to the face of the complaint. Good v. Texaco, Inc., Del.Ch., C.A. No. 7501, 1984 WL 8220, at *2, Brown, C. (May 14, 1984) (“[I]n view of Aronson’s requirement that the issue of the futility of a demand must be measured against the factual allegations of the complaint, . . . the record on a motion to dismiss for failure to make a demand under Rule 23.1 cannot properly be supplemented by affidavit or discovery by either the plaintiff or the defendants.”). Indeed, allowing a defendant to introduce affidavits in support of a Rule 23.1 motion to dismiss would create a gross imbalance since “plaintiffs . . . are not entitled to discovery to assist their compliance with the particularized pleading requirement of Rule 23.1. . . .” Scattered Corp. v. Chicago Stock Exch., Inc., Del.Supr., 701 A.2d 70, 77 (1997) see also Levine v. Smith, Del.Supr., 591 A.2d 194, 208-210
(1991) (same). Instead, plaintiffs are required to utilize the “tools at hand,” such as public filings and corporate records obtained under 8 Del. C. § 220. Scattered Corp., 701 A.2d at 78; Grimes, 673 A.2d at 1216 nn. 10, 11.[5]

VI.
Since plaintiff has pled facts creating a reasonable doubt whether four of the five President Casinos’ directors can impartially consider a demand, defendants’ motion to dismiss is DENIED. IT IS SO ORDERED.

[1] To prevail in a President Casinos’ stockholder vote involving a 100% turnout, Connelly need only persuade 17.31% of the remaining 62.3% of the votes to vote with him (that is, he need obtain less than one-third of the remaining votes). In a vote involving only a 90% turnout (e.g., to elect directors) where only a plurality of the quorum is required, Connelly’s burden would be even lighter. It is undoubtedly true that a 32.7% block may not be sufficient to constitute control for certain corporation law purposes. See, e.g., Paramount Communications Inc. v. QVC Network Inc., Del.Supr., 637 A.2d 34, 44 (1994) (subsequent history omitted) (indicating that Revlon duties are invoked when a transaction would effect a “change in control” from disaggregated stockholders to a single stockholder with the unilateral power to, inter alia, elect directors, cause a corporate break-up, or effect a merger); Unitrin, Inc. v. Am. Gen. Corp., Del.Supr., 651 A.2d 1361, 1388 (1995) (fact that a repurchase program would have created a 25% block of stock in insider hands was not preclusive of a proxy fight). In deciding a motion to dismiss under Rule 23.1, however, the pragmatic, realist approach dictated by Rales requires me to accord great weight to the practical power wielded by a stockholder controlling such a block and to the impression of such power likely to be harbored by the stockholder’s fellow directors.

[2] Friedman v. Beningson, Del.Ch., C.A. No. 12232, mem.op.., Allen, C. (Dec. 4, 1995) dealt with a similar situation. In that case, Mr. Beningson held 36% of the company’s stock and served as the company’s Chairman, CEO, and President. Based on these facts, Chancellor Allen came to the following conclusion regarding Beningson’s influence over the company: “From a practical perspective, this confluence of voting control with directoral and official decision making authority . . . is . . . itself quite consistent with control of the board.” Id. at 10. Since this control gave Beningson considerable influence over another director’s ability to continue to receive consulting fees, the Chancellor found that the other director was beholden to Beningson for demand excusal purposes. Id. at 11; cf Robbins Co. v. A.C. Israel Enter., Inc., Del.Ch., C.A. No. 7919, mem. op. at 13, Berger, V.C. (Oct. 2, 1985) (“This Court and others have recognized that substantial minority interests ranging from 20% to 40% often provide the holder with working control.”).

[3] Rather oddly, the American Law Institute’s Principles ofCorporate Governance: Analysis and Recommendations and the ModelBusiness Corporation Act do not include grandparents in their definitions of “related persons” or “associates,” perhaps because the drafters did not foresee an occasion when a grandchild-director would be evaluating a transaction involving his or her grandparent. Logically, it only makes sense to include grandparents within these definitions if grandchildren are included and I hesitate to ascribe a one way view of grandparent-grandchild loyalty to the authors of these respected authorities (even to the authors of the MBCA, who claim to have set forth an exclusive, “bright line” definition). The fact that a demand would require a director to consider authorizing suit against his grandfather implicates the general requirements of interestedness under these authorities. See, e.g., 1 Principlesof Corporate Governance: Analysis and Recommendations § 1.23(2) (1994) (“A director . . . is `interested’ in a transaction . . . if . . . the director . . . has a . . . familial relationship with a party to the transaction . . . and that relationship would reasonably be expected to affect the director’s . . . judgment with respect to the transaction in a manner adverse to the corporation.”).

[4] The defendants argue that the case of Seibert v. Harper Row, Publishers, Inc., Del.Ch., C.A. No. 6639, 1984 WL 21874, Berger, V.C. (Dec. 5, 1984) is to the contrary. Seibert cannot be read as broadly as defendants wish. The allegation in Seibert was that a director was disabled from considering a demand because the director’s fellow director was his cousin and a manager of the defendant company. The familial bonds between cousins are often more attenuated than those between grandfather and grandson. Moreover, in Seibert, the cousin, who was a manager, had a very tangential personal interest in the challenged transaction quite unlike the direct and substantial personal interest Connelly has in this case. I do not read Seibert as holding that a plaintiff pleading a close familial relationship between an otherwise disinterested director and a director who would be substantially and adversely affected if the challenged transaction were rescinded cannot, in appropriate circumstances, thereby meet its burden to create a reasonable doubt that the otherwise disinterested director cannot impartially consider a demand. To the extent that Seibert can be read as standing more broadly for the proposition that familial relationships cannot be consequential in the demand excusal inquiry, I believe the case gives too little weight to the deep bonds that most people have to members of their families and too much credit to the capacity of humans to set aside instinctive feelings of love and loyalty and to deal objectively with the merits when the “well-being of a close relative is at stake.

[5] Although I am discomforted by the possibility that the facts in the complaint that create a reasonable doubt about Andren’s independence from Connelly may in fact not be “facts,” I am bound to accept them as true. See Kahn v. Tremont Corp., Del. Ch., C.A. No. 12339, mem.op. at 3-4, 8, Allen, C. (Apr. 22, 1994) (Indicating that it is improper to consider evidence submitted by defendants in support of a Rule 23.1 dismissal motion. “If a factual allegation that establishes as a pleading matter a demand-excused case can be conclusively shown to be false, there is no principle of law that prevents the defendant from showing that fact on a Rule 56 application. In that event the Court, of course, would be free to dismiss the case at that stage.”); Kahn v. Tremont Corp., Del.Ch., C.A. No. 12339, mem. op. at 4, n. 2, Allen, C. (Aug. 21, 1992) (same). Even though this requirement might seem a bit disturbing in this precise circumstance, I note that Court of Chancery Rule 11 would seem to provide at least some protection from abuse in the Rule 23.1 context. If a defendant can later demonstrate that a company’s public filings and easily obtainable corporate documents would have demonstrated the falsity of important elements of a complaint leading to a prior judicial finding of demand excusal, that demonstration would raise a serious question regarding whether the plaintiff’s attorney had drafted the factual allegations in the complaint in good faith and after “an inquiry reasonable under the circumstances.” After the repeated admonitions of the Supreme Court to use the “tools at hand,” see Rales, 634 A.2d at 934-935 n. 10; Grimes, 673 A.2d at 1216, 1218 Scattered Corp., 701 A.2d at 78, lawyers who fail to use those tools to craft their pleadings do so at some peril. At oral argument, however, counsel for the plaintiff contended that he derived the complaint’s allegation that Connelly controls New York Cruise Lines from President Casinos’ own public filings.