In recently dismissing a group of shareholders’ derivative claims, the Business Court emphasized the importance of each shareholder making a proper, specific pre-suit demand on the corporation. Kane v. Moore, 2018 NCBC 120 and 2018 NCBC 124 (J. McGuire). If no proper demand was made, any derivative claims would be dismissed.
Plaintiffs were investors in Lookout Capital, LLC, a Delaware
e private equity entity founded by Defendants Bill and Merrette Moore,. Lookout’s business model was to find investment opportunities, create a separate North Carolina LLC for each opportunity, and offer Lookout’s investors the opportunity to invest in each entity. Lookout created a total of seven separate entities (“Investment Entities”), but Plaintiffs invested in and were members of only four of the seven. After a falling out with the plaintiffs, the Moores formed a new entity, Tidewater Equity Partners, LLC, that began to operate in a fashion similar to Lookout. According to Plaintiffs, Tidewater competed with and took away opportunities from Lookout in the private equity market. As a result, Plaintiffs brought derivative claims of mismanagement and breach of fiduciary duties against the Moores and Tidewater on behalf of Lookout and all of the Investment Entities. All Defendants moved to dismiss the complaint, contending that Plaintiffs lacked standing to pursue the derivative claims.
The Court analyzed each of the plaintiff’s derivative claims on a “party-by-party analysis of Plaintiffs’ standing and demand requirements…” (Opinion, ¶31). The Court dismissed claims asserted on behalf of the three Investment Entities in whom none of the plaintiffs were members. The Court rejected the plaintiffs’ contention that they need not be members of each Investment Entity because they had alleged: “all of the Investment Entities were mere instrumentalities of Lookout.” Id. The Court rejected the argument that a “mere instrumentality” theory could excuse failure to make a demand, finding no case law to support it. The Court further concluded that even if such law did exist, the complaint’s bare allegations were insufficient to maintain a “mere instrumentality” theory.
The Court then dismissed the plaintiffs’ derivative claims made on behalf of the other four Investment Entities, finding that the plaintiffs had made no pre-suit demand on those specific Investment Entities. The Court found the only demand any of the plaintiffs had made was on Lookout. However, because the demand made no reference to or demanded the Investment Entities take any action, that demand was insufficient to satisfy the plaintiffs’ pre-suit demand requirement.
The Court then turned its attention to the demand made on Lookout. While the demand was made on behalf of a “group of investors and Members of Lookout, including but not to [Plaintiffs Kane and O’Donnell]” (Opinion, ¶61), the Court found it did not apply to Plaintiff Skelton because Skelton was not specifically listed in the letter as one of the demanding parties. The Court held Skelton’s argument that it should be included within the group of unnamed investors bore “little consideration,“ as no Delaware court had found that a demand that merely referenced “unnamed other [members]” satisfied the particularity requirement of Delaware Chancery Rule 23.1. (Id., ¶62). The Court also rejected Skelton’s contention that its self-declared “intervenor” status absolved it of making a pre-suit demand, finding that Delaware requires even intervenors to comply with the pre-suit demand requirements of Chancery Rule 23.1. (Id, ¶59).
Defendants further claimed that neither Kane nor O’Donnell could satisfy Delaware Chancery Rule 23.2’s “adequate representative” requirement. In applying the eight-factor, “adequate representative” test employed by Delaware Courts, Judge McGuire found that while Kane failed the test, O’Donnell passed and could serve as an adequate representative for any derivative claims brought on behalf of Lookout. As a result, only O’Donnell’s derivative claims on behalf of Lookout survived.
In his subsequent decision, Kane v. Moore 2018 NCBC 124, Judge McGuire examined whether O’Donnell’s derivative claims of unfair and deceptive trade practices (“UDTP”) against the Moores stated a claim for relief. Notwithstanding the fact that the Moores occupied positions of trust and management within Lookout, the Court dismissed the derivative UDTP claim, finding that because the Moores’ purported diversion and usurpation of corporate opportunities affected only Lookout, such actions did not satisfy Chapter 75’s “in and affecting commerce” element (Id., ¶¶21-22).
The Court also dismissed the claim for aiding and abetting breach of fiduciary duty, expressly relying on former Chief Judge Gale’s decision earlier this year in Zloop, Inc. v. Parker Poe Adams & Bernstein, LLP, 2018 NCBC LEXIS 16, at *33 (Feb. 16, 2018). Recognizing that the Court of Appeals has not expressly addressed the issue and that Judge Gale’s decision was not binding precedent, the Court “nevertheless [found] Judge Gale’s reasoning and conclusion highly persuasive.” (Id. ¶29.)
For companies faced with derivative claims by one or more shareholders, the Kane decisions emphasize the importance of the company and other defendants analyze any pre-suit demand on a party-by-party basis. If the demand is lacking, the company would have a quick way to end any derivative action.