DocketNumber: Nos. C 05-4642 JF (PVT), C 06-2971 JF (PVT)
Citation Numbers: 487 F. Supp. 2d 1132
Judges: Fogel
Filed Date: 5/29/2007
Status: Precedential
Modified Date: 11/26/2022
ORDER GRANTING MOTIONS TO DISMISS FOR LACK OF STANDING WITHOUT LEAVE TO AMEND
I. BACKGROUND
1. The Consolidated Action
Plaintiff Robert Korhely, an owner of common stock of Mercury Interactive Corporation (“Mercury” or “the company”), filed the original derivative complaint in action number C 05-4642 JF (PVT) (“the Consolidated Action”) on November 14, 2005. The complaint named nominal defendant Mercury and nine former board members and officers of Mercury. It alleged illegal backdating of stock options and asserted claims for (1) breach of the fiduciary duties of loyalty and good faith;
On February 14, 2006, the Court consolidated four other derivative actions
On June 13, 2006, pursuant to a stipulation by the parties, the Court stayed the Consolidated Action pending the outcome of consolidated derivative actions filed in the Santa Clara Superior Court. On February 5, 2007, that court dismissed the state law action for lack of standing in light of the acquisition of Mercury by Hewlett Packard Corporation (“HP”). See Scott Decl. Ex. C. On January 29, 2007, this Court directed the parties to brief the issue of standing with respect to the Consolidated Action. On February 23, 2007, two of the Consolidated Defendants moved to dismiss the action for lack of standing. The remaining Consolidated Defendants have joined in the motion.
2. The Klein Action
On May 2, 2006, Plaintiff Terry Klein (“Klein”), then an owner of Mercury common stock, filed the initial complaint in action number C 06-2971 JF (PVT) (“the Klein Action”). The initial complaint, filed derivatively on behalf of nominal defendant Mercury, named as defendants eight former board members and officers of Mercury. It asserted a claim under Section 16(b) of the Securities Exchange Act, 15 U.S.C. § 78p, seeking the disgorgement of short-swing profits obtained by defendants as a result of options backdating.
On May 17, 2006, the Court related the Klein Action to the Consolidated Action.
II. LEGAL STANDARD
1. Motion to Dismiss
For purposes of a motion to dismiss, the plaintiffs allegations are taken as true, and the Court must construe the complaint in the light most favorable to the plaintiff. Jenkins v. McKeithen, 395 U.S. 411, 421, 89 S.Ct. 1843, 23 L.Ed.2d 404 (1969). Leave to amend must be granted unless it is clear that the complaint’s deficiencies cannot be cured by amendment. Lucas v. Dep’t of Corrs., 66 F.3d 245, 248 (9th Cir.1995). When amendment would be futile, however, dismissal may be ordered with prejudice. Dumas v. Kipp, 90 F.3d 386, 393 (9th Cir.1996).
2. Federal Rule of Civil Procedure 28.1
Federal Rule of Civil Procedure 23.1 requires that a derivative complaint allege “that the plaintiff was a shareholder or member at the time of the transaction of which the plaintiff complains or that the plaintiffs share or membership thereafter devolved on the plaintiff by operation of law.” This rule “requires that a derivative plaintiff be a shareholder at the time of the alleged wrongful acts and that the plaintiff retain ownership of the stock for the duration of the lawsuit. The latter requirement, although not expressly stated in the rule, has been inferred from its language.” Lewis v. Chiles, 719 F.2d 1044, 1047 (9th Cir.1983). The Ninth Circuit has held that “Rule 23.1’s continuous ownership requirement is procedural in nature and thus applicable in diversity actions.” Kona Enters., Inc. v. Estate of Bishop, 179 F.3d 767, 769 (9th Cir.1999). It also has identified two situations in which equitable standing for non-shareholders has been granted: (1) in foreclosure or forced sale cases; and (2) in merger cases where “the plaintiffs contended they had lost their stock due to the same wrongful conduct that was the subject of the derivative suit they were trying to bring.” Id. at 770 (citing Keyser v. Commonwealth Nat’l Fin. Corp., 120 F.R.D. 489 (M.D.Pa.1988); Miller v. Steinbach, 268 F.Supp. 255 (S.D.N.Y.1967)).
III. DISCUSSION
1. The Consolidated Action
a. Standing as Currently Pled
It now is undisputed that HP purchased Mercury in a cash-out merger.
First, the Consolidated Plaintiffs argue that the issue of standing under “Rule 23.1 is irrelevant because Mercury already decided in June to pursue claims against defendants.” Consolidated Opposition 2. The Consolidated Plaintiffs contend that “Mercury has exercised control and directed that the claims proceed, such that these claims are no longer derivative in nature.” Id. at 2-3. However, the Consolidated Plaintiffs cite no authority supporting their assertion that their derivative action somehow has assumed a “direct character” through the company’s endorsement of the derivative action or that Rule 23.1 became “irrelevant” when the company allowed certain aspects of the derivative claims to proceed. See id. at 9-10.
Next, the Consolidated Plaintiffs argue that their ownership of Mercury shares at the time suit was filed satisfies Rule 23.1. See id. at 10-13. This argument contradicts the Ninth Circuit’s statement in Lewis that Rule 23.1 “requires that a derivative plaintiff be a shareholder at the time of the alleged wrongful acts and that the plaintiff retain ownership of the stock for the duration of the lawsuit. ” Lewis, 719 F.2d at 1047 (emphasis added).
Finally, the Consolidated Plaintiffs argue that they have equitable standing under the fraudulent merger exception to Rule 23. I.
i. Amendment to Bring the Instant Action Within the Merger Exception to the Continuous Ownership Requirement
The Consolidated Plaintiffs seek leave to amend to allege facts that would bring this case within the merger exception to Rule 23.1’s continuous ownership requirement. The Consolidated Plaintiffs state that they would allege that “the challenged merger was subject to the claim of fraud” in that the “HP merger was approved by Mercury’s Board to avoid personal liability for backdating which included millions gained through the exercise of their options as well as damage to the Company.” Consolidated Opposition 14. The Court concludes that such amendment would be futile.
The merger exception does not apply simply because a bad act led to a depressed share price in a merger. Instead, it applies where fraud occurred during the merger. Moreover, the limited instances in which the exception has been applied indicate that the surviving corporation must participate in the fraud in order for the merger exception to apply. See Keyser, 120 F.R.D. at 491 (describing Mellon Bank as “the surviving corporation”); id. at 493 (“[I]f plaintiffs are unable to establish at trial any wrongdoing on the part of Mellon, or if they are unable to raise a material fact dispute on that issue in the face of a dispositive motion by Mellon, it would appear that the right to bring a derivative suit had passed to Mellon upon consummation of the merger and that plaintiffs had, at that point, lost their standing to pursue the derivative action.”); Miller, 268 F.Supp. at 267 (applying Pennsylvania law and stating that “[t]o hold that the surviving corporation inherits a derivative right of action where said corporation has wrongfully taken part in the very acts complained of would be to reach an incongruous and highly inequitable result”). These cases explain that the merger exception does not remove an asset acquired in a merger from the surviving corporation unless the surviving corporation acquired that asset by fraud or other wrongful conduct. The equitable merger exception prevents an acquiring and surviving corporation from benefitting from a fraud in which it participated, but it does not deprive it of an acquired asset when it committed no wrongful conduct in the acquisition of that asset.
In the instant ease, if HP engaged in fraudulent conduct during its merger with Mercury and consequently paid an unreasonably low price for Mercury shares, it would not be equitable to allow HP to recover damages in a derivative action against the Consolidated Defendants. Under such circumstances, the Consolidated Plaintiffs might retain equitable standing and be entitled to recover damages from the Consolidated Defendants on a quasi-direct or flow-through basis. On the other hand, if HP did not participate in fraud in the merger, the Court would have no basis, as a matter of equity, for interfering with HP’s decision as to whether to prosecute a derivative action against the Consolidated Defendants. In the absence of wrongful conduct by HP, it would be inequitable to rewrite the terms of the merger by assigning the right to prosecute such a derivative action to the Consolidated Plaintiffs.
The Consolidated Plaintiffs do not suggest that they can or would allege that HP’s conduct during the merger with Mercury was fraudulent or otherwise wrongful. Accordingly, the merger exception would not apply to the instant case. Neither Keyser nor Miller supports an argument that equitable standing should be granted in the Consolidated Action. Instead, those cases suggest that any right to proceed
The Court recognizes that this conclusion may foreclose recovery by some or all of the Consolidated Plaintiffs, as the wrongful acts alleged in this case fall outside the relevant class period in the securities class-action against Mercury’s former officers and directors that also is pending before this Court.
ii. Amendment of the Complaint to Include HP as a Nominal Defendant
Perhaps anticipating the foregoing analysis, the Consolidated Plaintiffs also seek leave to amend, if necessary, to add HP as a nominal defendant in the Consolidated Action. The Court concludes that such an amendment would be inappropriate for at least two reasons. First, continuation of the Consolidated Action as a derivative action on behalf of HP would require reevaluation of the standing of the Consolidated Plaintiffs, many of whom may lack an ownership interest in HP. The executive committee in this case was created on the basis of claims arising from the ownership of Mercury stock, and there is no indication that the same executive committee would be appropriate in an amended consolidated action brought on behalf of HP. Second, inclusion of HP as a nominal defendant would give rise to a new demand requirement. Fulfillment of such a demand requirement likely would cause significant delay in the existing action and burden the Court’s docket unnecessarily. If the Consolidated Plaintiffs believe that claims against HP as a nominal defendant are warranted, such claims may be asserted in a separate action.
Because of the apparent futility of any amendment intended to bring the Consolidated Plaintiffs within the exception to the continuous ownership requirement and the undue delay associated with adding HP as a nominal defendant in the Consolidated Action, the Court concludes that it should dismiss the Consolidated Action without leave to amend. Such dismissal necessarily is without prejudice to any derivative claim that may be asserted against HP as a nominal defendant.
2. The Klein Action
Klein filed his Section 16(b) action as an owner of Mercury stock. Klein subsequently sold his Mercury stock for cash to HP. However, between the filing of the suit and the completion of the cash-out merger,
Klein argues that Gollust controls and that he has continued standing to pursue a Section 16(b) action on behalf of Mercury. However, in Gollust, the shareholders of the extinguished corporation did not sell the assets of their corporation, including any right they may have had to recover in a Section 16(b) action, solely for cash; instead, they received cash and stock in the surviving corporation. The new securities thus included a stake in any recovery under Section 16(b). In the instant action, on the other hand, HP paid cash for all of Mercury’s assets, including implicitly the right to recover any proceeds of a Section 16(b) action. Klein does not suggest that anything in the transaction between HP and Mercury would allow former Mercury shareholders to receive further compensation if, as a result of a successful Section 16(b) action, the value of the assets they sold was found to be higher than what they actually received. Because they received cash, the Mercury shareholders lost any financial stake in a recovery from a subsequent Section 16(b) action.
Klein’s argument that he differs from other Mercury shareholders because he purchased HP stock during the instant litigation thus is unpersuasive. Klein began the instant litigation with a financial stake in the outcome, but that stake was extinguished when he received cash for his Mercury shares. His entirely voluntary purchase of HP stock does not alter the fact that he, along with the other Mercury shareholders, sold his right to pursue a Section 16(b) action and share, indirectly, in the recovery.
IV. ORDER
Good cause therefor appearing, IT IS HEREBY ORDERED that the motions to dismiss the Consolidated Action, No C 05-4642 JF (PVT), and the Klein Action, No. C 06-2971 JF (PVT), for lack of standing are GRANTED without leave to amend. This order is without prejudice to any derivative claim one or more of the plaintiffs may assert against HP.
. Gupta v. Boston, Case No. C 05-4685 JF (PVT); Casey v. Landan, Case No. C 05-4690 JF (PVT); Selig v. Landan, C 05-4703 JF (PVT); and City of New Orleans Employees’ Retirement System v. Boston, Case No. C 05-4704 JF (PVT).
. Amnon Landan, Douglas P. Smith, Susan J. Skaer, Giora Yaron, Igal Kohavi, Yair Sha-mir, Clyde W. Ostler, Brad Boston, and Anthony Zingale.
. The Consolidated Plaintiffs object to the inclusion of argument and evidence not properly before the Court in the joinders filed on March 20, 2007 and March 23, 2007, four and seven days, respectively, after the deadline for filing a reply to the Consolidated Plaintiffs’ opposition. The Court need not resolve these objections because it concludes that the Consolidated Plaintiffs lack standing irrespective of the arguments included in the joinders. Because the Consolidated Plaintiffs lack standing, the Consolidated Action will be dismissed as to all defendants.
.Klein argued in opposition to the motion to relate the cases that the actions should not be related because the Klein Action asserts a claim under Section 16(b) that was not in-
. The Court received notice of voluntary dismissal of three of the original individual defendants on September 15, 2006, and of another two of the original individual defendants on September 18, 2006. The Klein FAC names the three remaining individual defendants: Amnon Landan, Sharlene Abrams, and Kenneth Klein.
. The Court explained that it would determine if and when to hear the motion to dismiss if it did not dismiss the action for lack of standing.
. The Consolidated Plaintiffs cite Keyser, 120 F.R.D. at 493, for the proposition that standing under Rule 23.1 exists after a merger. However, that case does not support the broad proposition that "Plaintiffs fulfill Rule 23.1 because they contemporaneously held shares when the alleged transaction occurred and when the suit was filed accordingly they have an interest in recovering from defendants for the harm done to Mercury.” Consolidated Opposition 12. Instead, Keyser holds that fraud during or in connection with a merger may give rise to an exception to the general rule that standing is lost when a company ceases to exist as a result of the merger. The court explained that: "Plaintiffs will be afforded the opportunity to prove that [the surviving corporation] participated in wrongdoing during the [merger at issue] and related events. Conversely, if plaintiffs are unable to establish at trial any wrongdoing on the part of [the surviving corporation], or if they are unable to raise a material fact dispute on that issue in the face of a dispositive motion by [the surviving corporation], it would appear that the right to bring a derivative suit had passed to [the surviving corporation] upon consummation of the merger and that plaintiffs had, at that point, lost their standing to pursue the derivative action.” Keyser, 120 F.R.D. at 493.
. The Consolidated Plaintiffs argue extensively that California and Delaware law suggest that they have equitable standing. See Consolidated Opposition 16-20. However, the Consolidated Plaintiffs fail to explain the relevance of these states' laws to the instant question under federal law. "Rule 23.1's continuous ownership requirement is procedural in nature and thus applicable in diversity actions.” Kona Enters., 179 F.3d at 769. "Erie principles apply equally in the context of pendent jurisdiction.” Mangold v. Cal. Pub. Utils. Comm’n, 67 F.3d 1470, 1478 (9th Cir.1995).
. The only case within the Ninth Circuit cited by the Consolidated Plaintiffs that has recognized equitable standing under the merger exception, Mroz v. Hoaloha Na Eha, Inc., 360 F.Supp.2d 1122 (D.Haw.2005), is distinguishable from the instant case in that it involved derivative claims brought on behalf of the surviving corporation. In Mroz, the district court concluded that former shareholders who were divested of their shares by the merger could bring derivative actions on behalf of the surviving company because they alleged that they would have remained shareholders if not for fraud during the merger. Id. at 1136. The Consolidated Plaintiffs do not make such allegations, and they do not suggest that they would be able to do so.
The Consolidated Plaintiffs have filed notice of a decision in the case, In re Caremark RX Inc. Stock Option Litigation, 06C-1329 (Tenn.Cir.Ct. 1st, March 26, 2007). However, the cited order does not contain sufficient explanation of the procedural posture of the case or relevant analysis to aid the Court in resolving the instant motion.
. See In re. Mercury Interactive Corp. Securities Litigation, Case No. C 05-3395 JF (PVT).
. Klein asserts this ownership of HP stock in his opposition papers. The Klein FAC does not allege ownership of HP stock. The Klein Defendants state in reply that they are not opposed to treating these allegations as a proposed amendment to the complaint.
. That section provides in relevant part:
"Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized.” 15 U.S.C. § 78p(b).
. Counsel for Klein contended at oral argument that the right to pursue a claim under Section 16(b) had become Klein's and no longer belonged to Mercury after Klein fulfilled the demand requirement. Even if that is the case, Klein subsequently sold that right to HP.
. The Court finds DiLorenzo v. Edgar, 2004 WL 609374 (D.Del.2004) (unpublished) unpersuasive in the present context. It is unclear to what extent the facts of that case are
In re XO Communications, 330 B.R. 394 (Bank.Ct.S.D.N.Y.2005), also provides minimal support for Klein's position. The bankruptcy court in that case noted that the bondholders would receive stock under the reorganization plan. Id. at 423. This receipt of stock would assure a continuing interest in the outcome of the litigation. While the form of the security may have changed, at no point were the security-holders divested of a financial interest in the issuing entity by their own sale of the security. The court also speculated, without deciding, that a common shareholder divested of ownership by the reorganization might have retained standing by exercising "some right to acquire a financial interest through some other mechanism (such as purchase of a warrant provided for in the [reorganization pilan).” Id. at 422-23. The purchase of a warrant on the basis of a retained right is distinguishable from an open-market purchase of stock in a parent company after the announcement of a cash-out merger.
. This conclusion is in keeping with the principle that a securities plaintiff may not "buy a lawsuit.” Klein argues that this principle is inapplicable in the Section 16(b) context. The Court need not decide whether or not that is the case.
. The Consolidated Plaintiffs also include a Section 16(b) claim in the Consolidated Complaint. The Consolidated Plaintiffs do not discuss this claim in their papers and do not assert any continuing financial interest in a Section 16(b) claim. Importantly, they do not assert, as does Klein, that they own stock in HP. Accordingly, the Consolidated Plaintiffs' arguments pertaining to standing to pursue such a claim are weaker than those advanced by Klein.