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In re Nine Systems Corporation Shareholders Litigation

Court of Chancery of Delaware

February 28, 2013

IN RE NINE SYSTEMS CORPORATION SHAREHOLDERS LITIGATION

Date Submitted: October 17, 2012

Anne C. Foster, Esquire and Blake Rohrbacher, Esquire of Richards, Layton & Finger, P.A., Wilmington, Delaware; Lawrence D. Rosenberg, Esquire, Paul V. Lettow, Esquire, James M. Burnham, Esquire, Matthew F. Kuhn, Esquire of Jones Day, Washington, D.C.; and Robert C. Michelletto, Esquire of Jones Day, New York, New York, Attorneys for the Fuchs Plaintiffs.

Richard D. Heins, Esquire, Andrew D. Cordo, Esquire, and Stacy L. Newman, Esquire of Ashby & Geddes, Wilmington, Delaware, and Richard G. Haddad, Esquire, Stanley L. Lane, Jr., Esquire, and Denaka L. Perry, Esquire of Otterbourg, Steindler, Houston & Rosen, P.C., New York, New York, Attorneys for Defendants.

MEMORANDUM OPINION

NOBLE, Vice Chancellor

Many shareholders of Nine Systems Corporation, formerly Streaming Media Corporation, (the "Corporation" or "NSC") were surprised to receive notice in 2006 that Akamai Technologies, Inc. ("Akamai") was proposing to acquire the Corporation for $175 million. Those shareholders had heard virtually nothing from NSC during the preceding four years. When last heard from, NSC was in dire financial straits. Those shareholders soon came to appreciate—maybe some had been afforded some timely knowledge—that three large shareholders in late 2001 and 2002 had expropriated much of the minority shareholders' economic interests and voting power. Those shareholders objected to the series of events— the "self-dealing transactions, " as they call them—and brought this action well after Akamai completed its acquisition of the Corporation.

Those shareholders—and the Court for that matter—are now confronted with Defendants' summary judgment motion that, if successful, will defeat many of their claims. In addition to several relatively narrow issues, the major questions posed by the pending motion are (1) whether there was a control group that, under the teaching of Gentile v. Rossette, [1] would allow those former shareholders to continue to have standing to pursue their claims of dilution that supposedly occurred some four years before the Akamai acquisition; (2) whether various groups of shareholders were not owed fiduciary duties at the time of the self- dealing transactions because they either were debt (and not equity) holders or held their interests in the Corporation through yet another entity whose dissolution and subsequent transfer of NSC shares may not have occurred until after those acts; and (3) whether NSC's disclosure of some facts about the dilutive acts provided certain shareholders with enough knowledge to conclude that they were guilty of laches.

I. BACKGROUND[2]

The Plaintiffs are former shareholders of NSC.[3] Some of the Plaintiffs purchased NSC common stock in the spring of 2000. Some invested in NSC through Streaming Media Investment Group, LLC ("SMIG"), which had been established to facilitate investment in NSC.[4] Plaintiffs who invested in 2000 had stock purchase agreements with most-favored nation clauses.[5] In 2001, other Plaintiffs purchased NSC Subordinated Notes with warrants.[6] These were later converted into NSC common stock; they also received anti-dilution protection for their shares.[7] Finally, yet another group of Plaintiffs acquired Senior Secured Notes and Warrants in August 2001.[8] In the spring of 2002, they agreed to surrender the warrants and convert the notes into equity with Preferred A stock issued in August 2002.

The Plaintiffs contend that NSC's three largest shareholders—Defendants Wren Holdings, LLC ("Wren"), Javva Partners, LLC ("Javva"), and Catalyst Investors, L.P. ("Catalyst") (collectively, the "Entity Defendants")—conspired in 2002 to recapitalize the Corporation to the Plaintiffs' detriment. With their ownership of 54.3 percent of NSC, the Entity Defendants designated three of the five members of the board. Defendant Howard Katz served as Javva's managing member and representative on NSC's board. Defendant Christopher Shipman represented Catalyst on the board until 2006 when he was replaced by Tyler Newton. Defendant Dort A. Cameron, III was a co-owner and the board designee of Wren.[9]

The Plaintiffs were generally persuaded to invest in NSC by Abraham Biderman, who then worked for Lipper & Company ("Lipper") and who, on June 12, 2001, also became a director of NSC.[10] Some agreed to a collective holding of NSC shares by SMIG, which may have been established under the auspices of Biderman and which was dissolved on April 22, 2002.[11]

NSC had been founded in 1999 to profit from video streaming on the internet. It struggled financially. Javva invested in late 1999 or early 2000.[12] In March and June 2000, Wren invested. It was roughly October 2000 when Catalyst invested.[13] Lipper began working with NSC in March 2000. Many of its investors—some who are Plaintiffs—accepted membership units in SMIG, but others—some also Plaintiffs—chose to be direct stockholders. In December 2000, Lipper assisted NSC in offering Subordinated Notes that were convertible into NSC common stock at $10 per share, a number that could be adjusted, but not below $5 per share.[14]

By the spring of 2001, NSC's financial troubles necessitated additional funding; initially, relatively small loans met its short-term needs. A new round of equity was considered. After some negotiations, Catalyst, Wren, Javva, those Plaintiffs who would eventually acquire Preferred A shares, and others to a lesser degree purchased the Secured Notes, consisting of a senior note and a warrant convertible into common stock.[15] Conversion of the Secured Notes was changed from a floor of $5 per share to $0.50 per share, which also aided those with most-favored nation rights.[16]

Despite turnover in upper management, NSC continued to struggle to pay its bills. A series of board meetings began on December 20, 2001. At that point, the board consisted of Art Williams, NSC's then-new Chief Executive Officer, Katz, Cameron, Shipman, and Biderman. Not only did the board discuss NSC's short-term funding needs during this telephonic meeting, but it also considered a possible route to profitability through acquiring the assets of e-Media, a failing competitor that was approaching bankruptcy, and the streaming division of NaviSite, which was abandoning that aspect of its business. The Plaintiffs claim that the meeting was scheduled for the afternoon (a Friday) that, for religious reasons, made it impossible for Biderman to attend. Defendants contest this claim of motive[17] and assert that Biderman was promptly informed of what occurred at the meeting by the following Monday.[18]

During a meeting on January 7, 2002, Williams pushed the acquisition strategy even though it would require additional funding. All directors, but for Biderman who abstained, voted in favor of the growth effort. The board, on January 10, 2002, with Biderman as the lone dissenter, agreed to acquire e-Media and the streaming division of NaviSite. Wren and Javva would each loan $2.5 million to finance the transactions. Catalyst did not participate. Biderman's opposition was tied to his perception that, as a consequence of the loans, NSC shareholders' interests would be diluted.

NSC revised its acquisition strategy a week later in response to a change in the terms of the NaviSite transaction that required additional cash. The revised plan for recapitalization (the "Recapitalization") was approved unanimously. Two new series of preferred stock would be issued: Series A would be issued in exchange for the existing secured debt (20 percent) and Series B would be issued for the new money raised for the transaction (seven percent). Also, without a change in control, Biderman would remain a director through 2004, and any subsequent equity issuance, absent unanimous board approval, would allow the Series A Preferred holders to redeem their shares with a 50 percent premium to the face amount. This latter provision was designed to assuage concerns about further dilution.

A board meeting scheduled for February 25, 2002, turned into an informational meeting when a quorum was not achieved.[19] Williams reported that e-Media's integration into NSC was requiring more effort than anticipated, that its revenues were less than anticipated, and that the NaviSite transaction was plagued by a shortage of working capital ($1.3 million). Additional funding was already necessary. Wren and Javva agreed to provide about three-quarters of the funds ($900, 000), but Catalyst and Lipper both passed on the opportunity.

Grad and Koo, in Biderman's place, attended the next board meeting on March 6, 2002.[20] The NaviSite acquisition's cash shortfall was the primary topic. Outside financing (and financing from Catalyst and Lipper) still had not been obtained. Wren agreed to a significant increase in the amount it would put up, but insisted that its equity be limited. Eventually, Wren loaned $500, 000, and Wren's $700, 000 and Javva's $100, 000 equity contributions would be covered by additional Preferred B-1 shares. There was discussion at the meeting about the need for the holders of the Secured Notes (in part, Plaintiffs) to agree to a debt exchange for Preferred A shares.

The board next met on April 11, 2002, [21] and the meeting addressed several topics that had been considered during a telephonic meeting a few days before but without Biderman as an invitee.[22] Williams was leaving NSC, and certain issues regarding the Recapitalization were discussed. Grad attended the April 11 meeting in Biderman's place. The need to garner the support of all secured debt holders for the Recapitalization was recognized, but this was the last time that the Recapitalization was addressed specifically by the board. Apparently, it had been decided during the April 9 telephonic gathering—but not discussed at the April 11 board meeting—that Snyder, who had come to NSC as part of the NaviSite acquisition, would take Williams's place as Chief Executive Officer.[23] Snyder was elected to the board and formally designated as NSC's CEO on May 22, 2002.[24]

Although SMIG's Certification of Cancellation was filed on April 22, 2002, its members did not receive certificates for their NSC shares until at least May 30, 2002.[25] Before then, the SMIG Plaintiffs did not own NSC stock.

In addition, during the same period, additional shares were issued because of most-favored nation provisions, including some about which the Defendants now complain because they claim two Plaintiffs were not ...


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