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Klaassen v. Allegro Development Corporation

Court of Chancery of Delaware

November 7, 2013

ELDON KLAASSEN, Plaintiff and Counterclaim-Defendant,
v.
ALLEGRO DEVELOPMENT CORPORATION, RAYMOND HOOD, GEORGE PATRICH SIMPKINS, JR., MICHAEL PEHL, and ROBERT FORLENZA, Defendants and Counterclaimants.

Submitted: October 31, 2013

R. Judson Scaggs, Jr., Kevin M. Coen, Frank R. Martin, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; George Parker Young, Kelli Larsen Walter, HAYNES AND BOONE, LLP, Fort Worth, Texas; Attorneys for Plaintiff and Counterclaim-Defendant Eldon Klaassen.

Peter J. Walsh, Jr., Ryan T. Costa, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Van H. Beckwith, Jonathan R. Mureen, Jordan H. Flournoy, BAKER BOTTS L.L.P., Dallas, Texas; Attorneys for Defendants/Counterclaimants Allegro Development Corporation, Raymond Hood, and George Patrick Simpkins, Jr.

Lisa A. Schmidt, Jacob A. Werrett, Adrian D. Boddie, RICHARD LAYTON & FINGER, P.A., Wilmington, Delaware; Robert B. Lovett, Karen Burhans, COOLEY LLP, Boston, Massachusetts; Attorneys for Defendants/Counterclaimants Michael Pehl and Robert Forlenza.

MEMORANDUM OPINION

LASTER, VICE CHANCELLOR.

This court's post-trial memorandum opinion held that the doctrines of laches and acquiescence barred plaintiff Eldon Klaassen from challenging his removal as CEO of Allegro Development Corporation ("Allegro" or the "Company"). Klaassen v. Allegro Dev. Corp., 2013 WL 5739680 (Del. Ch. Oct. 11, 2013) (the "Opinion"). As a predicate to this holding, the Opinion reasoned that because Klaassen challenged his removal on equitable grounds, the defendants could raise equitable defenses to defeat his claims. Translated into corporate terms, the Opinion held that when the Allegro board of directors (the "Board") removed Klaassen, that action was at most voidable, not void. Based in part on these rulings, the Opinion determined that Raymond Hood is currently Allegro's CEO and that the Board comprises Michael Pehl and Robert Forlenza as Series A Directors, John Brown as the Common Director, and Klaassen and Hood as Remaining Directors, using the categories of directors that were defined in the Opinion.

The rulings in the Opinion were implemented in a final order dated October 18, 2013 (the "Final Order"). To give Klaassen an opportunity to seek a full or partial stay pending appeal, the Final Order provided that paragraphs 2-4 of a status quo order entered on June 25, 2013 (the "Status Quo Order") would remain in effect until November 8, 2013. Klaassen noticed an appeal, and the Supreme Court granted his motion to expedite. Klaassen has now moved for a stay pending appeal. This opinion grants his motion in part.

I. LEGAL ANALYSIS

A motion for a stay pending appeal is governed by Court of Chancery Rule 62(d), which provides that "[s]tays pending appeal . . . shall be governed by article IV, § 24 of the Constitution of the State of Delaware and by the Rules of the Supreme Court." Ct. Ch. R. 62(d). Court of Chancery Rule 62(d) does not otherwise provide guidance on handling a motion to stay.

Article IV, § 24 of the Constitution of the State of Delaware requires adequate security for a stay pending appeal. Section 24 states: "Whenever a person . . . appeals or applies to the Supreme Court for a writ of error, such appeal or writ shall be no stay of proceedings in the court below unless the appellant or plaintiff in error shall give sufficient security" to satisfy the final judgment below if the appeal is unsuccessful. Article IV, § 24 does not address matters other than the need for security.

Supreme Court Rule 32(a) covers motions for stay in greater detail. It states:
A motion for stay must be filed in the trial court in the first instance. The trial court retains jurisdiction over the initial motion and must rule on the initial motion regardless of whether the case is on appeal to this Court. A stay or an injunction pending appeal may be granted or denied in the discretion of the trial court, whose decision shall be reviewable by this Court. The trial court or this Court, as a condition of granting or continuing a stay or an injunction pending appeal, may impose such terms and conditions, in addition to the requirement of indemnity, as may appear appropriate in the circumstances.

Supr. Ct. R. 32(a). A motion to stay thus turns on the trial court's discretion.

In Kirpat, Inc. v. Delaware Alcoholic Beverage Control Commission, 741 A.2d 356 (Del. 1998), the Supreme Court identified four factors to guide a trial court when exercising its discretion under Rule 32(a). They are (1) "a preliminary assessment of likelihood of success on the merits of the appeal, " (2) "whether the petitioner will suffer irreparable injury if the stay is not granted, " (3) "whether any other interested party will suffer substantial harm if the stay is granted, " and (4) "whether the public interest will be harmed if the stay is granted." Id. at 357. The Kirpat factors are not a checklist; rather, the trial court must "consider all of the relevant factors together to determine where the appropriate balance should be struck." Id.

In Kirpat, the Supreme Court reversed the denial of a stay pending appeal because the trial court focused too narrowly on the first factor, "a preliminary assessment of likelihood of success on the merits of the appeal." Id. As Kirpat explained, this element "cannot be interpreted literally or in a vacuum when analyzing a motion for stay pending appeal." Id. at 358. In an appeal from a final judgment, the trial court has already issued a decision in the case, so a literal reading "would lead most probably to consistent denials of stay motions . . . because the trial court would be required first to confess error in its ruling before it could issue a stay." Id. (internal quotation marks omitted). Instead, "[i]f the other three factors strongly favor interim relief, then a court may exercise its discretion to reach an equitable resolution by granting a stay if the petitioner has presented a serious legal question that raises a fair ground for litigation and thus for more deliberative investigation." Id. (internal quotation marks omitted). Informed by Kirpat, this decision analyzes the second, third, and fourth factors, then returns to the first.

A. Whether The Petitioner Will Suffer Irreparable Injury Without A Stay

The second Kirpat factor is "whether the petitioner will suffer irreparable injury if the stay is not granted." 741 A.2d at 357. Because of the nature of Klaassen's claims, there is a risk that Klaassen will suffer irreparable injury without a stay.

Klaassen brought this litigation pursuant to Section 225 of the Delaware General Corporation Law (the "DGCL"), 8 Del. C. § 225, after he purported to change the composition of the Board. Klaassen's ability to do so turned in part on whether he remained CEO. The outcome of this litigation, therefore, will determine who has the authority under Section 141(a) of the DGCL to direct and oversee the business and affairs of Allegro. See 8 Del. C. § 141(a). The Final Order established a Board that includes individuals who Klaassen does not believe should be directors. If Klaassen prevails on appeal, then the Board will comprise different directors.

"[I]t has become customary in § 225 actions to put into place, either by agreement of the parties or court order, a status quo arrangement that precludes the directors presently in control of the corporation from engaging in transactions outside the ordinary course of the corporation's business until the control issue is resolved." Arbitrium (Cayman Is.) Handels AG v. Johnson, 1994 WL 586828, at *3 (Del. Ch. Sept. 23, 1994). This custom derives from the recognition that "the exercise of corporate power by one group or the other always risks being the exercise of power by an unauthorized party, . . . [a]nd it is that risk, the risk that an unauthorized party will ultimately have power over corporate assets and processes, that is the risk that justifies some reasonable restrictions." CreditLyonnais BankNederland, N. V. v. Pathe Comm'cns Corp., C.A. No. 12150, at 27-28 (Del. Ch. July 9, 1991) (Allen, C.) (TRANSCRIPT). Consistent with Arbitrium and Credit Lyonnais, this court entered the Status Quo Order at the outset of the case.

The same risk of unauthorized Board action that undergirded the entry of the Status Quo Order supports finding a threat of irreparable harm for purposes of the second Kirpat factor. It is entirely possible that the Supreme Court could reverse the Opinion and vacate the Final Order. If so, and if the Board installed by the Final Order is not restricted in the interim by some form of stay, then there might well be a variety of actions and decisions that Klaassen or other Allegro stockholders could challenge. If the unauthorized actions could not be unwound or remedied, then irreparable injury would result. Consequently, there is a threat of irreparable injury if a stay is not granted.

B. Whether Any Other Interested Party Will Suffer Substantial Harm If The Stay Is Granted

The third Kirpat factor is "whether any other interested party will suffer substantial harm if the stay is granted." 741 A.2d at 357. The defendants contend that a further stay will harm Allegro by interfering with its rapidly improving business. Hood asserts that "Allegro is currently performing above expectations and has achieved year-to-date revenue of 7% over the 2013 budget and is poised to register greater than 25% growth over 2012—it's [sic] fastest growth in 5 years." Hood Aff. \ 3. Forlenza adds that "[a]s of September 30, 2013, Allegro is over 3 million dollars ahead of plan for revenue, 1.3 million dollars ahead of plan for EBITDA, and is forecasting year end revenue growth of 26% and EBITDA growth of 66% over 2012." Forlenza Aff. If 4. According to the defendants, granting a stay of the Final Order pending appeal will impair Allegro's ability to continue along its upward trajectory.

The defendants' position reduces to an argument that if there is a stay, then Allegro will not be able to achieve as much as it otherwise would. They do not contend that Allegro's progress will reverse itself. Therefore, the defendants have not shown that Allegro or other parties will suffer substantial harm from a stay. Their concerns can best be addressed by tailoring the stay narrowly.

C. Whether The Public Interest Will Be Harmed If The Stay Is Granted

The fourth Kirpat factor is "whether the public interest will be harmed if the stay is granted." 741 A.2d at 357. Allegro is a privately held company that provides software for energy trading and risk management. Who controls the Board of Allegro is critically important to the litigants, and the outcome will affect the lives of the Company's employees and the fortunes of its suppliers and customers. Those interests, however, are private interests of particular corporate constituencies. To the extent they affect the outcome of Klaassen's motion, they weigh in favor of a stay to ensure that the wrong Board does not take unauthorized actions with implications for those constituencies

D. The Appeal Presents Serious Legal Questions

Taken together, the second, third, and fourth factors all support some form of stay pending appeal. Under Kirpat, therefore, the operative question is whether Klaassen has presented a serious legal question that raises a fair ground for appeal. 741 A.2d at 357. Klaassen's appeal meets that standard.

1. Klaassen's Super-Director Theory

Klaassen has stated that he plans to argue on appeal that the Opinion erred by crediting affirmative defenses to validate a void act, which he claims a court of equity cannot do. See STAAR Surgical Co. v. Waggoner, 588 A.2d 1130, 1137 (Del. 1991); Waggoner v. Laster, 581 A.2d 1127, 1137 (Del. 1990). According to Klaassen, the Board's actions were void, even if the steps taken complied in all respects with the DGCL, the Charter, and the Bylaws, and even if the directors fulfilled their fiduciary duties. In making this argument, Klaassen relies on four decisions from this court that supposedly recognize a special equitable notice requirement that benefits any individual who is (i) both an officer and a director and (ii) can exercise a right that could alter the composition of the board.[1] Klaassen reads these cases to say that a board of directors cannot terminate such an officer without first providing advance notice of the board's plans sufficient to enable the officer to preempt the board by changing its composition. Under this reading, such an officer becomes a super-director whose powers trump the board's statutory authority under Section 141(a).

Klaassen contends that he fits the super-director paradigm. He was Allegro's CEO and a director, he held sufficient common stock to allow him to vote a majority of the Company's outstanding voting power, and he enjoyed contract rights in his capacity as CEO to designate two outside directors. In his view, therefore, the Board could not terminate him unless the directors first provided him with sufficient notice so that he could preempt the Board by changing its composition. Klaassen asserts that his termination was void because the Board did not respect his special equitable notice right and permit him to exercise his hybrid superpowers.

A review of Klaassen's four decisions reveals tensions with prior case law and, more critically, with Delaware's director-centric system of corporate governance.[2] As will be seen, however, the cases do present serious legal questions for appeal.

a. Yrt-Koch Case Law

Assessing the seriousness of Klaassen's super-director argument requires an understanding of how Delaware case law in this area has developed. The Delaware courts first addressed the importance of a director receiving advance notice of board meetings in Lippman v. Kehoe Stenograph Co., 95 A. 895 (Del. Ch. 1915). There, a director who had not received notice of the corporation's initial board meeting and who did not attend the meeting challenged actions taken at the meeting. This court wrote:

It is, of course, fundamental that a special meeting held without due notice to all the directors is not lawful, and all acts done at such meeting are void. As to regular, or stated, meetings the rule is different. Presence at the meeting waives the notice, and so may a waiver be properly ...

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