ronald-e-ingalls-as-trustee-of-the-advent-networks-inc-bankruptcy ( 2015 )


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  • Opinion issued January 15, 2015
    In The
    Court of Appeals
    For The
    First District of Texas
    ————————————
    NO. 01-13-00711-CV
    ———————————
    RONALD E. INGALLS, AS TRUSTEE OF THE ADVENT NETWORKS,
    INC. BANKRUPTCY ESTATE AND ON BEHALF OF ADVENT
    NETWORKS, INC., Appellant
    V.
    SOUTHERN UNION COMPANY D/B/A SOUTHERN UNION
    TECHNOLOGY PARTNERS, L.P., TOM KARAM, AND JOHN E.
    BRENNAN, Appellees
    On Appeal from the 129th District Court
    Harris County, Texas
    Trial Court Case No. 2009-06063
    MEMORANDUM OPINION
    Plaintiff-appellant Ronald E. Ingalls, as trustee of the Advent Networks, Inc.
    Bankruptcy Estate and on behalf of Advent Networks, Inc., sued defendants-
    appellees Southern Union Company d/b/a Southern Union Technology Partners,
    L.P., Tom Karam, and John E. Brennan (collectively, “Southern Union
    defendants”). The trial court granted summary judgment in favor of the Southern
    Union defendants. We affirm.
    BACKGROUND
    Advent was a telecommunications equipment provider formed in 1999 that
    developed, manufactured, and sold a patented networking platform to cable
    operators and distributors.   Those customers in turn use Advent’s product to
    provide subscribers with high-bandwidth commercial service.
    Southern Union was an investor in Advent from Advent’s 1999 inception
    until Advent filed for bankruptcy in 2005.     Southern Union owned 14% of
    Advent’s stock and was also one of Advent’s creditors. Two of Southern Union’s
    employees, Tom Karam and John E. Brennan, served on Advent’s seven-member
    board of directors.
    A.    Plaintiff’s Claims
    Ingalls’s petition alleged that Southern Union “owned a large enough
    interest in Advent to exercise de facto control over key parts of its business.”
    Ingalls complained that the Southern Union defendants used that control to kill
    potential venture capital financing that could have saved Advent from insolvency
    in 2005. As described by Ingalls’s petition:
    2
    Although Advent generated revenue of approximately $1.5
    million in 2004, its operations were still largely supported by outside
    venture capital and institutional investment. . . . Advent raised over
    $24 million in equity and over $22 million in debt through convertible
    promissory notes issued in 2002 through 2005. In 2004, Advent
    began negotiations with a syndicate of venture investors to raise
    another round of equity financing. This round was intended to fund
    operations for approximately 18 months until Advent’s sales would
    support operations. Specifically, in late 2004, Advent had a firm
    proposal from Gefinor Ventures to finance Advent’s Series D round
    of financing to the tune of $7,000,000.00. That round was essential
    for obtaining working capital and building out inventory for Advent to
    continue selling products.
    After initially supporting the Gefinor proposal, Brennan
    advised of Southern Union’s intention to prevent the Gefinor
    financing from occurring, to the detriment of Advent. During the
    Board’s crucial vote on the issue on January 31, 2005, and in the face
    of otherwise unanimous support from the rest the Board, Brennan and
    Karam voted against the Gefinor financing proposal in the sole
    interest of Southern Union and to the detriment of Advent.
    Thereafter, they acted on Southern Union’s behalf to ensure that the
    financing would fail by refusing to agree to Gefinor’s proposed terms,
    explaining to the Board that approval would result in Southern Union
    owning a greater interest in Advent (at no additional cost to Southern
    Union, though) and, thus, it would have to publically report its
    investment in Advent, which it did not want to do.
    The Gefinor financing did not occur as a result of Southern
    Union’s de facto control and, as a result, Advent did not have the
    funds to acquire the necessary inventory to meet orders that had been
    placed for its products. As a result, Advent was forced to seek
    protection under Chapter 11.
    Ingalls’s petition alleged that Karam and Brennan owed a fiduciary duty of
    loyalty to act in the best interest of Advent by virtue of their position as directors
    of Advent. Ingalls’s petition also alleged that, “as the controlling shareholder of
    3
    Advent, Southern Union owed Advent a duty of loyalty and of due care.”1 Ingalls
    made claims against each Southern Union defendant, alleging that they “breached
    their fiduciary duties to [Advent] by exercising bad faith and killing Advent’s
    Gefinor financing with the full knowledge of the harm to Advent,” and that the
    breach “resulted in injury to Plaintiff and benefit to Defendants.” As a result,
    Ingalls sought actual damages of at least $7,000,000 and exemplary damages.
    B.    Southern Union Company’s Motion for Summary Judgment
    Southern Union filed a traditional motion for summary judgment, arguing
    that, “[a]s a matter of law, Southern Union was not a controlling shareholder of
    Advent and thus did not have a fiduciary duty to Advent.” Alternatively, Southern
    Union argued that summary judgment was appropriate because, even if Southern
    Union were considered a controlling shareholder of Advent, as a matter of law it
    had no duty to forgo contractual rights it was afforded as a preferred shareholder
    and noteholder, as it would have been required to do if the Gefinor deal had been
    accepted.
    C.    John Brennan’s and Tom Karam’s Motions for Summary
    Judgment
    Brennan and Karam also filed a traditional motion for summary judgment,
    arguing that “the undisputed facts establish that neither Brennan nor Karam took
    1
    Although Ingalls pleaded that Southern Union owed a duty of due care, his
    allegations and arguments focus only on alleged breaches of the duty of loyalty.
    4
    any action that caused damages to Advent.” They also contended that Ingalls’s
    real argument is that the tentative financing proposal fell through because Southern
    Union refused to support the restructuring, not because of something Brennan or
    Karam did. They assert that, as a matter of law, they are not vicariously liable for
    Southern Union’s actions. 2
    D.     The Trial Court’s Judgment
    The trial court granted summary judgment in favor of all the Southern Union
    defendants without specifying the grounds. Ingalls appealed, arguing in a single
    issue that the “trial court erred by granting Appellees’ motions for summary
    judgment.”
    STANDARD OF REVIEW
    We review a trial court’s summary judgment de novo. Travelers Ins. Co. v.
    Joachim, 
    315 S.W.3d 860
    , 862 (Tex. 2010). If a trial court grants summary
    judgment without specifying the grounds for granting the motion, we must uphold
    the trial court’s judgment if any of the grounds are meritorious. Beverick v. Koch
    Power, Inc., 
    186 S.W.3d 145
    , 148 (Tex. App.—Houston [1st Dist.] 2005, pet.
    denied).
    2
    Brennan and Karam also filed a no-evidence motion for summary judgment,
    arguing that there was no evidence that (1) either of them received a personal
    benefit through the actions Ingalls’s petition complains of, or (2) either of them
    failed to act in good faith.
    5
    In a traditional summary judgment motion, the movant has the burden to
    show that no genuine issue of material fact exists and that the trial court should
    grant judgment as a matter of law. TEX. R. CIV. P. 166a(c); KPMG Peat Marwick v.
    Harrison Cnty. Hous. Fin. Corp., 
    988 S.W.2d 746
    , 748 (Tex. 1999). A defendant
    moving for traditional summary judgment must conclusively negate at least one
    essential element of each of the plaintiff’s causes of action or conclusively
    establish each element of an affirmative defense. Sci. Spectrum, Inc. v. Martinez,
    
    941 S.W.2d 910
    , 911 (Tex. 1997).
    SOUTHERN UNION
    Southern Union argues that summary judgment in its favor on Ingalls’s
    breach-of-fiduciary-duty claim was proper because (1) “Southern Union did not
    owe any fiduciary duty to Advent as a matter of law because it was not a
    controlling shareholder, where Southern Union held only 14% of the stock in
    Advent and only two seats on the seven-member Advent board,” 3 and (2)
    “Southern Union was entitled to act in its own self-interest regardless of whether it
    was a controlling shareholder, where Southern Union, acting as a creditor of
    3
    Relatedly, Southern Union notes that Delaware law focuses on control of the
    board rather than control over some aspect of a transaction when assessing
    control. Given our disposition of this appeal, we need not, and do not, opine about
    whether—and under what circumstances—a minority shareholder can be
    considered controlling without control over the company’s board of directors.
    6
    Advent, relied on contractual provisions to refuse the modification of existing
    financial agreements.”
    A.    Applicable Law
    The parties agree that, under the internal affairs doctrine, Delaware law as
    the state of Advent’s incorporation governs this dispute. See TEX. BUS. ORG. CODE
    ANN. § 1.102 (West 2012); see also Pride Int’l., Inc. v. Bragg, 
    259 S.W.3d 839
    ,
    848 n.2 (Tex. App.—Houston [1st Dist.] 2008, no pet.) (“[R]ights and duties of
    directors and stockholders in corporate matters are governed by the laws of the
    state of incorporation.”). And they agree that a shareholder owes a fiduciary duty
    if (1) it owns a majority of the company’s shares, or (2) exercises control over the
    business affairs of the corporation. Ivanhoe Partners v. Newmont Mining Corp.,
    
    535 A.2d 1334
    , 1344 (Del. 1987).
    B.    The Summary Judgment Evidence
    Southern Union’s summary-judgment evidence reflects that Advent sought
    financing from Gefinor Venture Partners as it ran out of capital. As Advent
    acknowledged in its pleadings, Southern Union initially supported Advent’s
    seeking funds from Gefinor. Indeed, minutes from Advent’s November 2004
    Board of Directors meeting reflect that Gefinor and Southern Union were actively
    negotiating to reach mutually acceptable terms.
    7
    Gefinor’s proposal provided for Gefinor to invest $2,000,000 in exchange
    for Series D stock and for existing or new investors to contribute $5,000,000 in
    additional capital in exchange for Series D stock. Southern Union had previously
    secured Advent’s $4,000,000 line of credit with a certificate of deposit. Gefinor’s
    proposal required Southern Union to pay $2,000,000 to retire half of that debt in
    return for Series C-1 stock. The remaining $2,000,000 credit line balance would
    be retired with funds from other investors. Southern Union would also receive
    some liquidity preference in the event the company was liquidated.
    Southern Union’s summary judgment evidence also established that, under
    Gefinor’s proposal, the Series D stock received by Gefinor and other investors
    would be superior to the Series C-1 stock Southern Union would receive. Gefinor
    also requested that all convertible debt holders, including Southern Union, be
    asked to waive the right to interest payments and warrants that were provided by
    their financing agreements. Finally, the Gefinor transaction would require that
    funds be allocated in a manner that essentially wiped out the value of some of the
    company’s founders’ existing shares. 4
    On January 31, 2005, Advent’s board voted on whether to sign Gefinor’s
    term sheet containing these proposals. A majority of the board approved signing
    the term sheet and continuing with the negotiations. Jack Brennan voted against
    4
    It is not clear from the record how this allocation would impact Southern Union, if
    at all.
    8
    the proposal. Brennan voted Tom Karam’s proxy the same way, resulting in a 7-5
    vote by the board. At the same meeting, Brennan notified other members of the
    board that Southern Union would not be agreeing to terms required by Gefinor.
    In response to Southern Union’s traditional motion for summary judgment,
    Ingalls proffered summary-judgment evidence about the control Southern Union
    had over parts of Advent, including a requirement that Advent obtain Southern
    Union’s consent before pursuing certain ventures. Advent’s CEO, Edward Perry,
    testified in his deposition that although Southern Union’s representatives did not
    make up a majority of Advent’s board members, he felt that Brennan had
    significant control over decisions given Southern Union’s role as an investor. The
    specific areas over which Perry testified that Southern Union exerted control were
    leadership, sales, and financial. Perry testified to his understanding that Southern
    Union had decided not to support Gefinor’s proposal if it required conversion of
    debt to stock because Southern Union did not want to push its ownership
    percentage in Advent to a higher level, which in turn would trigger certain public
    disclosures. Finally, Perry testified that shareholders vote in blocks among the
    share classes, meaning that Southern Union could have blocked the Gefinor deal if
    it had gone to a shareholder vote.
    Dennis Murphree, another Advent board member, testified that a Southern
    Union representative told him that Gefinor’s low valuation of Advent made
    9
    accepting the Gefinor financing proposal unacceptable because it would require
    Southern Union to write off the difference between the $82 million prior valuation
    of Advent and Gefinor’s current $10 million valuation, which would result in a
    stock market hit to Southern Union.
    Finally, Advent proffered an expert affidavit opining that accepting terms of
    the Gefinor deal would have been more economically advantageous to Southern
    Union than letting Advent go bankrupt.
    C.    Analysis
    It is undisputed that Southern Union did not own a majority of Advent’s
    stock or control a majority of Advent’s board. It is also undisputed that Southern
    Union possessed certain contract rights that it would be required to give up under
    the Gefinor deal, and that the Gefinor deal required Southern Union to convert
    some existing debt to stock, which Southern Union did not want to do.
    Ingalls argued, in his appellant’s brief, that “sufficient evidence was
    presented to show that Southern Union acted as a controlling shareholder and note-
    holder of [Advent], thus giving rise to fiduciary duties.”      Stated differently,
    Ingalls’s position is that Southern Union’s rights, which it possessed as a
    noteholder, gave it control over Advent such that Southern Union should be treated
    as a controlling shareholder even though it owned less than a majority of the
    company’s stock. In response, Southern Union argued that “Delaware law is clear
    10
    that contract rights, regardless of how much ‘control’ they impart, do not make the
    holder of such rights a controlling shareholder, and do not impose fiduciary
    duties.” Moreover, Southern Union contended Ingalls’s brief wholly ignored one
    of Southern Union’s summary-judgment grounds, i.e., that even if Southern Union
    were deemed to be a controlling shareholder, “Delaware law recognizes that
    controlling shareholders may act in their own self-interest.” In his reply brief,
    Ingalls acknowledges that “controlling shareholders are not required to act
    altruistically towards minority shareholders, or to their own financial detriment,”
    but argues that this rule is inapplicable because “[n]othing about the Gefinor
    proposal would have placed Southern Union in a worse-off financial stance.”
    We agree with Southern Union that, even if it were a controlling
    shareholder, its refusing to forgo contract rights and refusing to convert debt to
    stock as required by the Gefinor deal would not amount to a breach of fiduciary
    duty as a matter of law. Accordingly, the trial court properly granted summary
    judgment in Southern Union’s favor.
    Delaware law does not “require that directors or controlling shareholders
    sacrifice their own financial interest in the enterprise for the sake of the corporation
    or its minority shareholders.” Jedwab v. MGM Grand Hotels, Inc., 
    509 A.2d 584
    ,
    598 (Del. Ch. 1986). In Odyssey Partners, L.P. v. Fleming Companies, Inc., the
    11
    Delaware Chancery Court recognized that controlling shareholders do not have a
    duty of self-sacrifice:
    Fleming’s refusal to waive its preemptive rights or to assume further
    financial obligations on behalf of ABCO without adequate
    compensation cannot seriously be thought to have been a breach of its
    fiduciary duties. As Chancellor Allen observed in Thorpe v.
    CERBCO, Del. Ch., C.A. No., Allen, C., 
    1993 WL 443406
    , *7, mem.
    op. at 14 (Oct. 29, 1993), “controlling shareholders, while not allowed
    to use their control over corporate property or processes to exploit the
    minority, are not required to act altruistically towards them.”
    
    735 A.2d 386
    , 411 (Del. Ch. 1999); S. Muojo & Co. LLC v. Hallmark Entm’t Invs.
    Co., No. 4729-CC, 
    2011 WL 863007
    , at *11 (Del. Ch. 2011) (holding that debt
    holder and majority stockholder “did not have any legal obligation to continue to
    waive Crown’s debt obligations, . . . defer payments or to make other financial
    concessions for the sake of Crown, or its minority stockholders.”).
    The only response Ingalls offers is the assertion that Southern Union’s
    accepting the Gefinor deal would not be detrimental to Southern Union financially.
    In support, he cites Advent’s own expert’s conclusion that agreeing to the Gefinor
    deal would have been a better economic choice for Southern Union. Ingalls,
    however, does not cite any authority for our engaging in such analysis. Given that
    the parties do not dispute that Southern Union relied on its existing contractual
    rights in refusing to accept concessions required by the Genfinor deal, the inquiry
    ends. Because Southern Union’s refusing to forego contractual rights does not, as
    12
    a matter of law, amount to a breach of fiduciary duty under Delaware law, the trial
    court properly granted summary judgment in Southern Union’s favor.
    BRENNAN AND KARAM
    Brennan and Karam argue that summary judgment was appropriate
    because, as a matter of law, nothing Brennan or Karam did caused injury to
    Advent.      Ingalls responds that Brennan and Karam voted to benefit Southern
    Union rather than Advent, which is a breach of their duty of loyalty. He further
    contends that Delaware courts “loosen normally stringent requirements of
    causation and damages” when a breach of loyalty is at issue. Thorpe v. CERBCO,
    Inc., 
    676 A.2d 436
    , 445 (Del. 1996).
    Directors are required to hold “an undivided and unselfish loyalty to the
    corporation” and be free from “conflict between duty and self-interest.” Cede &
    Co. v. Technicolor, Inc., 
    634 A.2d 345
    , 361 (Del. 1993). “Essentially, the duty of
    loyalty mandates that the best interest of the corporation and its shareholders takes
    precedence over any interest possessed by a director, officer or controlling
    shareholder and not shared by the stockholders generally.” 
    Id. As he
    did in the trial court, Ingalls focuses here on the evidence he contends
    establishes that Brennan and Karam were beholden to Southern Union and, thus,
    had divided loyalties. We agree with Brennan and Karam, however, that Ingalls
    has failed to articulate any action by Brennan or Karam that impacted, much less
    13
    harmed, Advent. Ingalls’s real complaint is that Southern Union refused to agree
    to Gefinor’s terms for providing Advent additional financing. At the board level,
    Brennan and Karam did vote against continued negotiation with Gefinor—a vote
    aligned with Southern Union’s plans to reject the deal. But Brennan and Karam
    were outvoted at the board level, and the majority of the board voted to continue
    forward with negotiations. It was Southern Union, in its capacity as a creditor, that
    had the ultimate power to accept or reject Gefinor’s terms.         Ingalls has not
    articulated any other action by Brennan and Karam that allegedly harmed Advent.
    The trial court, thus, correctly granted summary judgment in Brennan’s and
    Karam’s favor.
    CONCLUSION
    We overrule Ingalls’s sole issue and affirm the trial court’s judgment.
    Sherry Radack
    Chief Justice
    Panel consists of Chief Justice Radack and Justices Jennings and Keyes.
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