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Pagliara v. Federal National Mortgage Association

Court of Chancery of Delaware

May 31, 2017

Timothy Pagliara
v.
Federal National Mortgage Association,

          Submitted: May 2, 2017

          C. Barr Flinn, Esquire Emily V. Burton, Esquire Lakshmi A. Muthu, Esquire Gregory J. Brodzik, Esquire Young Conaway Stargatt & Taylor, LLP.

          S. Mark Hurd, Esquire Zi-Xiang Shen, Esquire Morris, Nichols, Arsht & Tunnell LLP.

          Robert J. Stern, Jr., Esquire Blake Rohrbacher, Esquire Richards, Layton & Finger, P.A.

         Dear Counsel:

         Pending before the Court is a motion to dismiss or to substitute the plaintiff in this 8 Del. C. § 220 proceeding. For the reasons stated herein, the motion to dismiss is granted.

         I. BACKGROUND

         The facts in this letter opinion derive from Plaintiff's Verified Complaint (the "Complaint") and the documents attached to it. Plaintiff Timothy J. Pagliara is a preferred stockholder of Federal National Mortgage Association, a federally chartered corporation governed by the "corporate governance practices and procedures of" the Delaware General Corporation Law ("Fannie Mae"). Fannie Mae was designed by the federal government to create liquidity in the mortgage market and facilitate the extension of credit to American homebuyers. Between 1968 and 1970, Fannie Mae became largely privately owned and publicly traded on the New York Stock Exchange.[1] But Fannie Mae remained subject to extensive federal regulation. In 2002, Fannie Mae's then-regulator, the Office of Federal Housing Enterprise Oversight, directed Fannie Mae to follow the "corporate governance practices and procedures of" the law of the jurisdiction containing Fannie Mae's principal office, the Delaware General Corporation Law, or the Revised Model Business Corporation Act.[2] Fannie Mae chose the Delaware General Corporation Law, and a certificate of incorporation was filed in Delaware for Federal National Mortgage Association, Inc.[3]

         During the U.S. housing crisis, Congress passed the Housing and Economic Recovery Act of 2008 ("HERA") to stabilize the mortgage market. Under HERA, Fannie Mae's regulator was replaced by the newly created Federal Housing Finance Agency (the "FHFA"). HERA authorized the FHFA to put Fannie Mae into conservatorship or receivership, [4] and the FHFA placed Fannie Mae into conservatorship on September 7, 2008.[5]

         On the same day, the U.S. Department of the Treasury (the "Treasury Department") entered a Preferred Stock Purchase Agreement with Fannie Mae under which Fannie Mae agreed to issue one million shares of Senior Preferred Stock to the Treasury Department. The Senior Preferred Stock had an initial liquidation preference of $1, 000 per share and was senior to all other classes of Fannie Mae stock.[6] The Treasury Department also received a warrant to purchase 79.9% of Fannie Mae's common stock. The Senior Preferred Stock was entitled to a 10% cumulative cash dividend or a 12% stock dividend. The Preferred Stock Purchase Agreement was restated and then amended twice to make minor changes and to increase the Treasury Department's funding commitment to Fannie Mae.[7]

         On August 17, 2012, after Fannie Mae allegedly had become profitable again, the Treasury Department and Fannie Mae entered the Third Amendment to the Restated Preferred Stock Purchase Agreement (the "Third Amendment"). The Third Amendment changed the Treasury Department's 10% dividend to a "net worth sweep" such that Fannie Mae would distribute the bulk of its quarterly net worth to the Treasury Department every quarter for an indefinite period of time.[8] As of the date of Pagliara's Complaint, the Treasury Department's Fannie Mae dividends allegedly had increased by $78.2 billion as a result of the Third Amendment.[9]

         On January 19, 2016, counsel for Pagliara served a Section 220 demand on Fannie Mae, which sought documents to investigate whether the decisions to approve the Third Amendment, Fannie Mae's subsequent payment of dividends under the Third Amendment, and certain other Fannie Mae investments constituted misconduct. Pagliara also sought to communicate with other stockholders regarding the misconduct and to value his shares. Fannie Mae, through the FHFA, rejected Pagliara's demand on January 27, 2016.

         On March 14, 2016, Pagliara filed the Complaint in this action, and on March 25, 2016, Fannie Mae removed the case to federal court. The U.S. District Court for the District of Delaware remanded the case on March 8, 2017, and Fannie Mae filed a motion to dismiss or, in the alternative, to substitute the FHFA as the plaintiff on March 31, 2017. The Court heard oral argument on the motion on May 2, 2017.

         II. ANALYSIS

         Fannie Mae moves to dismiss under Court of Chancery Rule 12(b)(2) for lack of personal jurisdiction and under Rule 12(b)(6) for failure to state a claim. I first consider the Rule 12(b)(2) motion because "[a] court without personal jurisdiction has no power to dismiss a complaint for failure to state a claim."[10]

         A. Pagliara's Complaint Survives a Motion to Dismiss for Lack of Personal Jurisdiction

         On a Rule 12(b)(2) motion to dismiss for lack of personal jurisdiction, "the plaintiff bears the burden of showing a prima facie basis for the Court's exercise of personal jurisdiction over a nonresident defendant . . . ."[11] "[W]hen no evidentiary hearing has been held, the plaintiffs' burden is a relatively light one."[12] "'[T]he record is construed in the light most favorable to the plaintiff, ' and the plaintiff need not rely solely on the allegations in the complaint but may employ extra-pleading material as a supplement to establish jurisdiction."[13] The Delaware Supreme Court recognized in General Parts Company v. Cepec that a corporation is subject to general jurisdiction in its state of incorporation.[14]

         The Complaint in this case sufficiently alleges a prima facie basis for personal jurisdiction over Fannie Mae in Delaware. The Complaint alleges that Fannie Mae filed a certificate of incorporation in Delaware on August 21, 2002, sixteen days after the Office of Federal Housing Enterprise Oversight's corporate governance regulation requiring that Fannie Mae choose a corporation law became effective.[15]The Complaint also points to Fannie Mae's bylaws, which reference a certificate of incorporation. The bylaws state that the inclusion of certain provisions in them "shall constitute inclusion in the corporation's 'certificate of incorporation' for all purposes of the Delaware General Corporation Law."[16] Thus, Plaintiff argues that the Complaint establishes a prima facie basis for personal jurisdiction.

         Defendant responds that the certificate does not refer to Fannie Mae because it incorporates "Federal National Mortgage Association, Inc." instead of "Federal National Mortgage Association." Further, Defendant argues that the certificate of incorporation was voided in 2004 for failure to pay annual taxes.[17] As to the legal point, Delaware and federal courts have exercised personal jurisdiction over defendant Delaware corporations that have not filed a certificate of dissolution but whose certificates of incorporation were voided for failure to pay franchise taxes.[18] As to the factual argument regarding Fannie Mae's name, the alleged facts and Defendant's arguments would be sufficient to entitle Pagliara to jurisdictional discovery to prove whether Fannie Mae is subject to personal jurisdiction in Delaware. But Plaintiff has requested that "the Court not delay this matter further for jurisdictional discovery, "[19] and Defendant has also argued against jurisdictional discovery.[20] In accordance with the parties' requests and because, for the reasons explained below, jurisdictional discovery would be futile, I address the Rule 12(b)(6) motion to dismiss.

         B. Pagliara's Complaint Is Dismissed on Issue Preclusion Grounds

         Fannie Mae moves to dismiss under Court of Chancery Rule 12(b)(6) and argues that the dispositive issue in this case—whether Pagliara has a right to inspect Fannie Mae's books and records—has been decided against Pagliara in Pagliara v. Federal Home Loan Mortgage Corporation, [21] a case from the Eastern District of Virginia. As such, Defendant argues that this case should be dismissed on issue preclusion grounds. "This Court will grant a motion to dismiss under . . . Rule 12(b)(6) only if the 'plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof.'"[22] On a Rule 12(b)(6) motion to dismiss, the Court "must accept as true all of the well-pleaded allegations of fact and draw reasonable inferences in the plaintiff's favor."[23] The Court, however, is "not . . . required to accept as true conclusory allegations 'without specific supporting factual allegations.'"[24]

         Federal law determines the effect of a federal judgment for issue preclusion purposes.[25] Under federal common law, when state law is the substantive law at issue, the law of the state where a federal court sits determines the effects of that court's judgments.[26] When federal law is the substantive law at issue, federal preclusion law determines the effect of federal court judgments.[27] The evaluation of Fannie Mae's defense under HERA Section 4617(b)(2)(A)(i) is a question of federal law, and federal preclusion law, thus, applies. Applying federal law, the U.S. Supreme Court "regularly turns to the Restatement (Second) of Judgments for a statement of the ordinary elements of issue preclusion."[28] Pagliara also relied on the Restatement (Second) of Judgments at oral argument and in his brief.[29] Under the Restatement, a party to a prior proceeding is precluded from relitigating an issue when (1) the "issue of fact or law is actually litigated" in the prior proceeding, (2) the issue is "determined by a valid and final judgment, " and (3) "the determination is essential to the judgment."[30] Section 28 of the Restatement includes an exception when "[t]he issue is one of law and (a) the two actions involve claims that are substantially unrelated, or (b) a new determination is warranted in order to take account of an intervening change in the applicable legal context or otherwise to avoid inequitable administration of the laws."[31]

         The Eastern District of Virginia's judgment in Pagliara is preclusive on the issue of whether Section 4617(b)(2)(A)(i) of HERA transferred the Fannie Mae stockholders' right to seek books and records to the FHFA. Pagliara had a full opportunity to oppose the motion to dismiss in Pagliara; he filed a 33-page brief on that motion; and his counsel appeared and argued at oral argument on the motion.[32]The decision was reduced to a final judgment, which Pagliara appealed.[33] Pagliara subsequently voluntarily dismissed his appeal.[34] And the interpretation of Section 4617(b)(2)(A)(i) was essential to the court's decision.[35] Pagliara's Virginia action sought books and records pursuant to Virginia corporate law from Freddie Mac, a "regulated entity"[36] under HERA like Fannie Mae. The court was faced with the question of whether Freddie Mac stockholders retained the right to obtain corporate books and records from a regulated entity pursuant to state corporate law or whether Section 4617(b)(2)(A)(i) divested stockholders of that right.[37] The Pagliara court could not have resolved that question without interpreting Section 4617(b)(2)(A)(i). As such, the court's determination on this issue was essential to the judgment.

         Pagliara argues that the "pure legal question" exception to issue preclusion should apply to the issue of whether Section 4617(b)(2)(A)(i) transferred Fannie Mae stockholders' right to books and records to the conservator. Pagliara asserts that the Pagliara opinion was rejected by the subsequent U.S. Court of Appeals for the District of Columbia Circuit opinion in Perry Capital LLC v. Mnuchin, [38] altering the legal context. But Perry Capital considered a different issue. Perry Capital addressed the legal sufficiency of stockholder direct and derivative claims against Fannie Mae and Freddie Mac arising out of the Third Amendment.[39] The D.C. Circuit agreed with the lower court in Perry Capital and held that Section 4617(b)(2)(A)(i) of HERA transfers the stockholders' right to bring a derivative claim—but not a direct claim—to the FHFA in all cases, even if the FHFA has a conflict of interest.[40] Thus, the court held that the stockholders' derivative claims were properly dismissed.[41] Because Fannie Mae stockholders retain the right to bring direct claims and a Section 220 claim is a direct claim, Pagliara argues that he should be entitled to seek books and records. But the Eastern District of Virginia considered the derivative-versus-direct distinction in Pagliara and held that, while Pagliara still may enforce his rights through direct claims, he requires an underlying right in order to state a claim. The court held that Section 4617(b)(2)(A)(i) divested Fannie Mae and Freddie ...


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