Lanotte v. Highland Capital ( 2023 )

Case: 20-10649 Document: 00516692730 Page: 1 Date Filed: 03/28/2023
United States Court of Appeals
for the Fifth Circuit United States Court of Appeals
Fifth Circuit
____________ FILED
March 28, 2023
No. 20-10649 Lyle W. Cayce
____________ Clerk
Susan Lanotte, derivatively on behalf of Highland Global
Allocation Fund, and on behalf of herself and all others similarly
situated,
Plaintiff—Appellant,
versus
Highland Capital Management Fund Advisors, L.P.;
Timothy Hui; Bryan Ward; Bob Froehlich; John Honis;
Ethan Powell; Highland Global Allocation Fund,
Nominal Defendant,
Defendants—Appellees.
______________________________
Appeal from the United States District Court
for the Northern District of Texas
USDC No. 3:18-CV-2360
______________________________
Before Wiener, Dennis, and Duncan, Circuit Judges.
James L. Dennis, Circuit Judge:*
Plaintiff Susan Lanotte appeals the district court’s dismissal of her
shareholder derivative suit on behalf of the Highland Capital Global
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*
This opinion is not designated for publication. See 5th Cir. R. 47.5.
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Allocation Fund after the court found a majority of the independent trustees
constituting a quorum voted to reject Plaintiff’s demand after a reasonable
and good faith investigation. Finding no error, we AFFIRM.
I.
Susan Lanotte is a shareholder of nominal defendant Highland Capital
Global Allocation Fund (“GA Fund”), a business trust organized under the
laws of Massachusetts. Highland Capital Management Fund Advisors, L.P.
(“Advisor”), manager of the GA Fund, had the GA Fund invest in the
Highland Energy MLP Fund (“MLP Fund”)—which the Advisor also
managed—at a time when the MLP Fund’s value was dropping. Proceeding
under the federal district court’s diversity jurisdiction, Lanotte brought a
shareholder derivative action under Massachusetts law on behalf of the GA
Fund against the Advisor and five of the GA Fund’s six trustees—Timothy
Hui, Brwayn Ward, Bob Froehlich, John Honis, and Ethan Powell
(“Trustees”) (collectively, “Defendants”).1 Lanotte alleged breach of
contract and breach of fiduciary duty.
The Defendants brought a motion to dismiss the derivative suit
pursuant to chapter 156D, § 7.44 of the Massachusetts General Laws,
arguing that a quorum of its independent trustees—the five Trustees
above—voted to reject Lanotte’s demand after a reasonable and good faith
investigation.2 The district court agreed and dismissed the suit. Lanotte
appealed.
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1
Lanotte also styled the case as a purported class action on behalf of the GA Fund’s
other shareholders.
2
The parties agree the sixth trustee was not independent. This trustee did not
participate in the meeting and recused himself from the evaluation of Lanotte’s demand.
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II.
There is no established standard of review in this circuit for an appeal
from a district court’s granting of a § 7.44 motion to dismiss. However, as
this case concerns a motion similar to either a Rule 12(b)(6) motion to dismiss
or Rule 56 motion for summary judgment, de novo review is appropriate. See
Halebian v. Berv (Halebian VI), 548 F. App’x 641, 642 (2d Cir. 2013); see also
Booth Family Tr. v. Jeffries, 640 F.3d 134, 139–41 (6th Cir. 2011) (reviewing
de novo under similar circumstances, applying Delaware state law regarding
dismissal by special litigation committee).
III.
“The derivative form of action permits an individual shareholder to
bring ‘suit to enforce a corporate cause of action against officers, directors,
and third parties.’” Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95 (1991)
(quoting Ross v. Bernhard, 396 U.S. 531, 534 (1970)). “Devised as a suit in
equity, the purpose of the derivative action was to place in the hands of the
individual shareholder a means to protect the interests of the corporation
from the misfeasance and malfeasance of ‘faithless directors and
managers.’” Id. (quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548
(1949)). Shareholder derivative suits in Massachusetts are governed by the
Massachusetts Business Corporation Act (“MBCA”). See Mass. Gen.
Laws ch. 156D, §§ 7.40-7.47.3
The focus of this appeal is chapter 156D, § 7.44 of the Massachusetts
General Laws, which states, in pertinent part, that a derivative proceeding
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3
The GA Fund is a “business trust” organized under the laws of Massachusetts,
not a corporation. However, the Massachusetts Supreme Judicial Court has held that the
MBCA’s shareholder derivative provisions apply to business trusts as if they were
corporations. See Halebian v. Berv (Halebian III), 931 N.E.2d 986, 988 n.4 (Mass. 2010).
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“shall be dismissed by the court on motion by the corporation” if “a majority
vote of independent directors present at a meeting of the board of directors
if the independent directors constitute a quorum” “has determined in good
faith after conducting a reasonable inquiry upon which its conclusions are
based that the maintenance of the derivative proceeding is not in the best
interests of the corporation.” Id. §§ 7.44(a), (b)(1). According to the
Massachusetts Supreme Judicial Court, § 7.44 “incorporate[s]” the
“business judgment doctrine.” Halebian III, 931 N.E.2d at 991; see id. at 991,
n.11 (“In the context of a derivative proceeding, the business judgment
doctrine protects a corporation’s decision that prosecution of the claim
demanded by the shareholder is not in the best interests of the corporation
where the decision is made in good faith by independent decision makers
after reasonable inquiry.”).
Lanotte contends on appeal that the district court (1) utilized the
wrong legal standard to evaluate whether trustees were “independent,” (2)
erred by finding that a majority of the trustees were independent, and
(3) erred by finding that the decision to reject Lanotte’s demand was made in
good faith and based on a reasonable investigation. We address each issue in
turn.
The MBCA does not define what makes a director (or in this case, a
trustee) “independent,” and there is no state appellate case law on the
question. See Blake v. Friendly Ice Cream Corp. (Blake II), No. Civ. 03-0003,
2006 WL 2714976, at *1 (Mass. Super. Ct. Aug. 24, 2006). The parties
disagree on the correct legal standard. Lanotte cites a “totality of the
circumstances” test described in a trial court decision, Blake v. Friendly Ice
Cream Corp. (Blake I), No. Civ. 03-0003, 2006 WL 1579596, at *12–13 (Mass.
Super. Ct. May 24, 2006). Defendants cite a different section of the
Massachusetts General Laws, chapter 182, § 2B, which states that “a trustee
of a trust who with respect to the trust is not an interested person, as defined
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in [the] Investment Company Act of 1940, shall be deemed to be independent
and disinterested when making any determination or taking any action as a
trustee.” Section 2B applies to a “a trust that is an investment company, as
defined in the Investment Company Act of 1940” and is registered with the
U.S. Securities and Exchange Commission.4 Mass. Gen. Laws ch. 182,
§ 2B. The GA Fund meets these requirements. The district court agreed with
the Defendants and applied § 2B in determining whether the trustees were
“independent.” We agree as well.
The district court properly applied the rules of statutory
interpretation in concluding that § 2B is the relevant standard for a trust that
is an investment company like the GA Fund. Section 2B was in force at the
time that § 7.44 was enacted. The Legislature is presumed to “act[] with full
knowledge of existing laws,” such that courts should be hesitant to imply that
a new law has repealed or superseded a prior law in whole or in part. All. to
Protect Nantucket Sound, Inc. v. Energy Facilities Siting Bd., 932 N.E.2d 787,
796 (Mass. 2010). “In the absence of explicit legislative commands to the
contrary, we construe statutes to harmonize and not to undercut each other.”
Sch. Comm. of Newton v. Newton Sch. Custodians Ass’n, 784 N.E.2d 598, 608
(Mass. 2003). The district court correctly reasoned that there is not
necessarily a conflict between § 7.44 and § 2B because the two statutes can
be applied together, but that to the extent there is a conflict, § 2B should
govern as the more specific statute applicable to the trustees. See Bos. Hous.
Auth. v. Labor Relations Comm’n, 500 N.E.2d 802, 804 (Mass. 1986) (“[I]n
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4
Blake I, cited by Lanotte, did not involve a trust that is an investment company,
so § 2B was not at issue. See Blake I, 2006 WL 1579596, at *1. No courts have definitively
held whether § 2B supplies the independence standard for a trust that is an investment
company after enactment of the MCBA, although one court applied it in the alternative
when all parties agreed it was a relevant standard. See Halebian v. Berv (Halebian V), 868 F.
Supp. 2d 420, 447-48 & n.26 (S.D.N.Y. 2012), aff’d, Halebian VI, 548 F. App’x 641.
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the case of conflicting statutes, normally the more specific statute will prevail
over the more general statute.”); N. Shore Vocational Reg’l Sch. Dist. v. City
of Salem, 471 N.E.2d 104, 107 (Mass. 1984) (“In the absence of irreconcilable
conflict between an earlier special statute and a later general one the earlier
statute will be construed as remaining in effect as an exception to the general
statute.”).5
Nor did the district court err in concluding a majority of the board of
trustees was independent under § 2B. Section 2B states a trustee is
independent if he or she is not an “interested person” as defined in the
Investment Company Act of 1940 (“ICA”), 15 U.S.C. § 80a-2. As relevant
here, the ICA defines an interested person as “any affiliated person” of an
investment company or investment advisor, “any member of the immediate
family” of an “affiliated person,” or an “interested person of any investment
advisor” for the investment company. Id. § 80a-2(a)(19)(A)(i)-(iii), (B)(i)-
(ii). An “affiliated person” of another is defined, in relevant part, as “any
person directly or indirectly controlling, controlled by, or under common
control with, such other person” or “any officer, director, partner,
copartner, or employee of such other person.” Id. § 80a-2(a)(3). “Control”
is defined as “the power to exercise a controlling influence over the
management or policies of a company, unless such power is solely the result
of an official position with such company,” and “[a] natural person shall be
presumed not to be a controlled person.” Id. § 80a-2(a)(9).
The Defendants set forth adequate facts to show a majority of the
board of trustees was independent at the time it rejected Lanotte’s demand,
and the burden was on Lanotte to “allege[] with particularity facts rebutting
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5
Because the issue of the proper standard is resolved through application of the
rules of statutory interpretation, we decline Lanotte’s request to certify the question to the
Massachusetts Supreme Judicial Court. See Mass. Sup. Jud. Ct. R. 1:03.
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the corporation’s filing.” Ch. 156D, § 7.44(d). Lanotte does not meaningfully
argue her allegations show the Trustees were under the controlling influence
of another. Lanotte reiterates her arguments made before the district court
that all five trustee defendants lacked independence due to “structural
conflicts,” because (1) they all held “dual role” as board members of both
the GA Fund and the MLP Fund; (2) they face substantial risk of personal
liability; and (3) they were all appointed by other board members instead of
elected by shareholders. She further argues that the Trustees had a variety
of personal conflicts arising from past employment, business, and personal
relationships with the Advisor. We agree with the district court’s analysis
and conclusion that these allegations do not show a controlling influence over
the Trustees.
Finally, the district court correctly found the Trustees’ decision to
reject Lanotte’s demand was made in good faith and based on a reasonable
investigation. Because a majority of the board of trustees was independent at
the time the determination was made, the burden is on Lanotte to show these
requirements have not been met. Id. § 7.44(e). In such a case,
“Massachusetts presumes that a decision to reject a shareholder demand was
the exercise of valid business judgment, ‘absent a showing of bad faith or lack
of investigation into the demand.’” Halebian VI, 548 F. App’x at 646
(quoting Harhen v. Brown, 730 N.E.2d 859, 867 (Mass. 2000)). Mere “failure
to interview certain individuals or review the documents” identified by a
plaintiff is insufficient to overcome a presumption that an investigation was
reasonable when a committee considers other relevant witnesses and
documents that relate to the same issue and produces a report that provides
“plausible reasons.” See Averbuch v. Arch, No. SUCV201102502, 2013 WL
5531396, at *4–5 (Mass. Super. Ct. Aug. 27, 2013); see also Harhen, 430
N.E.2d at 847 (“[L]engthy explanations of a demand refusal are not
required.”).
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In this case, the board of trustees formed a Demand Review
Committee consisting of two independent board members, which held
sixteen meetings; hired independent counsel, who billed for one-thousand
hours of attorney time; reviewed thousands of pages of documents;
interviewed ten witnesses; met with Lanotte; and asked Lanotte for any
relevant documents she had. The Committee produced a ninety-six-page
report recommending rejecting Lanotte’s demand.
Lanotte’s attacks on the Committee’s investigation are unavailing.
She argues the Committee improperly considered the independence of the
Trustees by relying on § 2B, but we have already rejected that argument.
Further, Lanotte’s arguments that the Committee did not address whether it
was proper to invest in the MLP Fund and did not investigate the Advisor’s
motivations for investing in the MLP Fund are contradicted by the report,
and her arguments that the Committee did not review certain non-public
documents and did not interview more witnesses are largely vague and
speculative and do no show the other relevant evidence the Committee
considered in their place to be inadequate. We agree with the district court’s
analysis and conclusion that the alleged shortcomings identified by Lanotte
do not show the board of trustees’ decision to reject her demand was made
in bad faith or based on an unreasonable investigation.
IV.
The judgment of the district court is AFFIRMED.
8