In re Molycorp, Inc. Shareholder Derivative Litigation
Submitted: January 16, 2015
This is a dispute about whether a secondary stock offering at an unusually high price, demanded by private equity investors that together owned 44.1% of a corporation's stock and facilitated by directors they appointed, impermissibly allowed select shareholders to benefit to the detriment of the corporation. Complaints related to the sale of stock in June 2011 (albeit presenting different legal theories) were filed from as early as 2012, and Plaintiffs in this derivative action assert demand futility based on the composition of the board at the time of earlier-filed complaints. Although not without some questions regarding demand futility, the Court dismisses Plaintiffs' claims (for breach of fiduciary duties, aiding and abetting, and unjust enrichment) for failure to state a claim, in light of the investors' contractual right to sell and the absence of a demonstrable basis for recovery.
Plaintiffs Resource Equities, G.P. ("Resource Equities") and Ira Gaines (individually and as trustee of the Paradise Wire & Cable Defined Benefit Plan Dated 11/1/84, "Gaines") are shareholders of Nominal Defendant Molycorp, Inc. ("Molycorp"). Molycorp is a publicly traded Delaware corporation "engaged in the production and sale of rare earth oxides in the western hemisphere." Defendants fall into three categories: (1) TNA Moly Group LLC ("TNA"), Traxys North America, LLC ("Traxys"),  RCF Management LLC ("RCF"), and Pegasus Capital Advisors, L.P. ("Pegasus, " collectively, the Private Equity Investors ("PEIs")); (2) Ross R. Bhappu ("Bhappu"), Mark A. Smith ("Smith") and his entity KMSMITH, LLC ("KMSMITH"), Charles R. Henry ("Henry"), Mark S. Kristoff ("Kristoff"), Jack E. Thompson ("Thompson"), Alec Machiels ("Machiels"), Brian T. Dolan ("Dolan"), and Russell D. Ball ("Ball, " collectively, the "Director Defendants"); and (3) groups (1) and (2) above with the exception of Ball (the "Selling Defendants").
Defendants are linked in a number of ways. At the time the SAC was filed, Pegasus indirectly controlled Traxys and TNA, and was a "shareholder partner" of the Traxys Group with RCF. Bhappu formed Molycorp's predecessor in 2008, in which the PEIs (among others) joined to acquire a rare earth element mine. In 2010, in preparation for Molycorp's initial public offering ("IPO"), "investors and insiders rolled up their assets into Molycorp." The PEIs and KMSMITH also executed a Stockholders Agreement and a Registration Rights Agreement, both dated April 15, 2010. Effective until the IPO, the Stockholders Agreement gave the PEIs the right to nominate members to the board (among other rights). This power resulted in Bhappu, Dolan, Machiels, and Kristoff serving as partners and directors of multiple parties at the time of the June Offering. The Registration Rights Agreement secured the PEIs' rights to have Molycorp register their shares for a secondary offering. As of spring 2011, RCF held 23.4% of Molycorp's shares, Pegasus (and affiliates) held 13.4%, and TNA held 7.3%-collectively 44.1%.
In its IPO prospectus, Molycorp announced a vision including "build[ing] the largest, most advanced and efficient fully integrated [rare earth oxide] processing facility in the world." Molycorp's July 2010 IPO, however, generated a "disappointing" $360.4 million. Yet, rare earth element prices shot up after China, which controls the market, limited its exports in September 2010. The Defendants benefited from this price spike early on through a secondary offering of Molycorp stock in February 2011. Plaintiffs do not contest the February offering, although Molycorp did not share in the over $675 million ($50 per share) gross proceeds. In March 2011, Molycorp had $492.5 million in cash, as compared to a capital budget of approximately $781 million through 2013.
By May, Molycorp knew that a $280 million loan guarantee from the Department of Energy ("DOE") would not come through as planned and that financing and joint venture opportunities with Sumitomo Banking Corp. ("Sumitomo") and Hitachi Metals, Ltd. ("Hitachi") were in danger. Rare earth element prices follow a "classic boom-bust cycle" typical of (but more extreme than other) commodities prices, and the prices were not showing the same rate of growth. Some analysts had predicted "that market adjustment of [rare earth element] prices was inevitable."
It was at this time when Defendants exercised the demand registration rights at the heart of this dispute. Section 2 of the Registration Rights Agreement provided the authority for the PEIs to demand priority registration of their shares:
[T]he Corporation shall be required to include in such Registration Statement only such number of securities as is equal to the Underwriter's Maximum Number and the Corporation and the Requesting Holders shall participate in such offering in the following order of priority:
(i) First, the Corporation shall be obligated and required to include in the Registration Statement the number of Registrable Securities that the Requesting Holders have requested to be included in the Registration Statement and that does not exceed the Underwriter's Maximum Number . . . .
(ii) Second, the Corporation shall be entitled to include in such Registration Statement and underwriting that number of shares of Common Stock and/or other securities of the Corporation that it proposes to offer and sell for its own account or the account of any other Person to the full extent of the remaining portion of the Underwriter's Maximum Number.
This "Demand Registration" right was subject to certain conditions, such as Molycorp's ability to delay action for up to ninety days based on a good faith judgment of the board and its counsel that "it would be materially detrimental to the Corporation or its stockholders for such Registration Statement either to become effective or to remain effective." The PEIs could not demand registration "for one hundred twenty (120) days immediately following the effective date of a Registration Statement filed pursuant to the prior exercise of any Holder's [S-1] registration rights" and six months of a primary offering. Furthermore, they were limited in the number of S-1 registration requests they could make. Of course, the Registration Rights Agreement did not permit any fiduciary to breach its fiduciary duties.
The Registration Rights Agreement contemplates other types of registrations as well. Notably, there is the provision whereby Molycorp can elect to register and sell shares for its own account but, to the extent that the Underwriter's Maximum Number has not been reached, must include additional shares requested by covered shareholders (a "Company Registration"). A Company Registration does not trigger explicit frequency restrictions or delay provisions beyond certain notice periods.
The PEIs invoked their right to a Demand Registration, and Molycorp filed a registration statement on May 24, 2011. In the offering that followed (the "June Offering"), Smith and KMSMITH, Kristoff, Henry, Thompson,  Pegasus, TNA, and RCF sold at $51 per share. Altogether, the Selling Defendants received approximately $575 million (gross) in the June Offering. The sale allegedly saturated the market for Molycorp stock and caused media concern that insiders were "abandon[ing]" the company. Molycorp, on the other hand, conducted a private offering of convertible notes on June 15, 2011. The offering raised $223 million, but Molycorp's cash on hand was still more than $100 million short of its core operating ...