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Brown v. Kellar

Court of Chancery of Delaware

December 21, 2018

ROBERT G. BROWN, Plaintiff,

          Date Submitted: December 19, 2018

          David J. Teklits and Elizabeth A. Mullin, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Attorneys for Plaintiff Robert G. Brown

          Michael F. Bonkowski, Nicholas J. Brannick, and Bradley P. Lehman, COLE SCHOTZ, P.C., Wilmington, Delaware; Attorneys for Defendants Lorrence T. Kellar, Christiaan M. Olivier, Arthur B. Drogue, Jack W. Partridge, and R. Eric McCarthey

          ZURN, Vice Chancellor.

         Plaintiff Robert G. Brown, a stockholder of SPAR Group, Inc. ("SGRP"), brought this dispute to determine the composition of SGRP's board of directors (the "Board") under 8 Del. C. § 225 (the "225 Action"). This opinion addresses (i) Brown's November 14, 2018, Motion for Summary Judgment (the "Motion for Summary Judgment"), [1] and (ii) SGRP's December 13, 2018, Motion to Supplement the Summary Judgment Record (the "Motion to Supplement").[2] The 225 Action is on a dual track with an earlier action by SGRP against majority stockholders Brown and William H. Bartels for declaratory judgment, conspiracy, and breach of fiduciary duties (the "Bylaw Action").[3] The Bylaw Action seeks injunctive relief to prevent the majority stockholders' alleged entrenchment. The actions are scheduled for consecutive expedited trials in January 2019, with a status quo order binding the parties in the interim. The parties are currently engaged in discovery.

         In the 225 Action, Brown seeks a determination that certain written consents he and Bartels delivered to the Board in July 2018 removed incumbent director Lorrence T. Kellar and replaced him with non-party Jeffrey Mayer. Brown's Motion for Summary Judgment asserts that the written consents were technically valid and effective upon delivery, and that, as a matter of law, the Court cannot expand its scope of review in the summary 225 Action to consider extraneous inequitable conduct alleged to void the written consents.

         The defendants in the 225 Action are all incumbent Board members (the "Director Defendants").[4] They contend Brown's Motion for Summary Judgment must be denied so that the Court can consider their defense rooted in Brown's and Bartels' alleged inequitable conduct. The Director Defendants also assert that the written consents are not yet effective because SGRP did not send the prompt notice to stockholders as required under 8 Del. C. § 228(e) and Rule 14c-2 of the Securities Exchange Act of 1934. Finally, the Director Defendants moved to supplement the summary judgment record with a May 2018 email from Brown that purportedly "conceded the point" that notice is impracticable.[5]

         The Motion to Supplement is granted, but the subject materials do not affect my analysis on the Motion for Summary Judgment, which is granted in part and denied in part without prejudice to any of Brown's claims. The 225 Action will proceed to trial. Section 225 actions are narrow, summary proceedings to determine the in rem status of board and officer seats. At the same time, the Court must review cognizable claims, including potential breaches of fiduciary duty, to the extent they bear on the proper composition of the disputed offices. The Director Defendants assert such claims and are entitled to develop them through trial. While I intend to determine the 225 Action with a tailored analysis befitting its summary nature and scope, I cannot wholly exclude, at this time and on an undeveloped record, the Director Defendants' defense that alleged breaches of fiduciary duty nullify the written consents and bear on the composition of the Board.

         As for the written consents, I find that they were technically effective under Section 228 upon their delivery on July 5, 2018, notwithstanding the Section 225 issues, referenced above, that will be addressed at trial. SGRP cannot nullify otherwise effective written consents by unilaterally withholding notice of those acts. Nor can SGRP justify withholding that notice by pointing to perceived conflicts between SEC Rules and Delaware law.

         I. BACKGROUND

         The 225 Action and the Bylaw Action involve a series of purported corporate acts from the summer of 2018. The parties dispute the impact of those acts on SGRP and the current composition of its Board. I draw the background below from the parties' complaints and the uncontested facts from the briefing.

         A. The Parties

         SGRP is a Delaware merchandising and marketing services company based out of New York and Michigan.[6] As of June 29, 2018, the members of SGRP's Board were Bartels, Peter W. Brown, Christiaan M. Olivier, Arthur B. Drogue, Jack W. Partridge, Kellar, and R. Eric McCarthey.[7] SGRP's governance committee determined that Drogue, Partridge, McCarthey, and Kellar are independent directors.[8]

         Brown, Bartels, and SGRP have a long history.[9] Brown has held various director and management positions in the company, including his most recent posts as Chairman of the Board and an officer, which he retired from on May 3, 2018.[10] Bartels has been Vice Chairman of the Board and an officer since 1999.[11] Brown and Bartels together own a majority of SGRP outstanding stock and it is undisputed that they, at least collectively, are controlling stockholders.[12]

         B. The Written Consents

         On June 29 and July 5, 2018, Brown and Bartels executed written consents that together purported to remove Kellar from the Board and elect non-party Mayer in his place (the "June 29 Consent" and "July 5 Consent," or together, the "Director Consents").[13] Also on July 5, the Board purported to adopt amended and restated bylaws (the "July Bylaws").[14] Section 3.11 of the July Bylaws imposed a requirement that "a majority of the members of the Board shall be independent directors," but also stated that:

Notwithstanding any provision of [the Bylaws] or any size of or limited on the number of Board members established in any resolution of the Board or its stockholders to the contrary, the Board size shall be automatically expanded to accommodate each additional independent director needed to satisfy this majority requirement.[15]

         Brown and Bartels delivered the July 5 Consent at approximately 11:26 a.m., before the Board met to approve the July Bylaws around 3:00 p.m.[16] Brown contends the Director Consents were effective upon delivery of the July 5 Consent.[17]

         On July 31, SGRP filed a preliminary information statement (the "Preliminary Statement") with the SEC to disclose the Director Consents. After a ten-day period to allow the SEC to approve or comment, SGRP allegedly would have delivered the Preliminary Statement to stockholders.[18] But, on August 6, Brown and Bartels each filed an amended Schedule 13D with the SEC, recognizing their status as a control group for certain purposes and outlining several proposed bylaw amendments that they intended to adopt by written consent.[19] The SGRP Parties assert that these filings rendered the Preliminary Statement inaccurate and that disclosing it to stockholders would therefore be improper.[20]

         On August 8, Brown and Bartels delivered a third written consent (the "August 8 Consent") purporting to enact the changes outlined in their August 6 SEC filings. These included amending the bylaws to provide for supermajority Board approval for certain actions, generally fix the size of the Board unless determined otherwise by the stockholders, require stockholder approval for virtually all future directors, and remove the July Bylaws' requirement of a majority of independent directors.[21] The parties agree that the August 8 Consent did not become effective, if it became effective at all, until a fourth written consent was delivered on September 18 (with the previous consents, the "Written Consents").[22]

         C. The Litigation

         SGRP brought the Bylaw Action on September 4 (as amended on September 21) to challenge aspects of the Written Consents, including through a declaratory judgment and claims for conspiracy and breaches of the duty of loyalty. Brown followed with the 225 Action on September 18, which seeks a ruling under Section 225 to settle the Board's true composition. Both parties sought expedition, which the Court granted on October 2.[23] This case was then assigned to me on October 4.

         In their second affirmative defense to Brown's Section 225 complaint, the Director Defendants assert:

As is more fully set forth in SGRP's Verified Amended Complaint [Transaction ID No. 62479682] in the [Bylaw Action], Plaintiffs purported removal of Mr. Kellar and appointment of Mr. Mayer to the Board of SGRP are part of a larger, grossly inequitable scheme by Plaintiff and his co-controlling shareholder to improperly divert SGRP's resources to their own purposes and for their sole benefit, in violation of their fiduciary duties to SGRP and to its minority shareholders. Regardless of whether Plaintiffs actions described in its Complaint in this action were properly taken if the Court looks to the By-Laws in isolation, such inequitable actions do not become permissible simply because they are legally possible.[24]

         In the Bylaw Action, SGRP seeks the following relief that is potentially relevant to the Director Defendants' pleadings in this action:

• A declaratory judgment that the August 8 Consent's bylaw amendments, and "[a]ny further action by [Brown and Bartels] to remove or attempt to remove any independent director," are void or voidable.[25]
• A ruling that Brown and Bartels owe fiduciary duties to SGRP and its minority stockholders and breached those duties "[b]y seeking to amend the By-Laws and entrench their control over SGRP so that they can divert Company resources to themselves[.]"[26]
• A ruling that Brown and Bartels conspired to "entrench their control over SGRP, strip the Board of its independence, misappropriate Company assets for their own personal benefit, and harm SGRP and its minority stockholders[.]"[27]
• Permanent injunctions severely limiting Brown's and Bartels' control over SGRP, including "enjoining [Brown and Bartels] from . . . removing or attempting to remove any independent director(s), [and] taking or attempting to take any other action to weaken or attempt to weaken the independence of SGRP's Board or any of its Committees[.]"[28]

         On November 14, Brown moved for summary judgment in the 225 Action. The parties briefed the motion, and, on December 11, I heard argument. Discovery is still ongoing.

         On December 13, the Director Defendants moved to supplement the summary judgment record to include a May 17, 2018, email from Brown in which he commented on the legal proceedings as described in a draft SGRP SEC filing. The parties briefed the Director Defendants' request and submitted the Motion to Supplement for decision on December 19.

         II. ANALYSIS

         Brown seeks summary judgment on the grounds that the Director Consents are technically valid and effective, and that the SGRP Parties' allegations of inequity are purely collateral to this Section 225 proceeding and cannot be considered as a matter of law. The Director Defendants oppose summary judgment on the grounds that Section 225 permits the Court to consider their defense of inequitable conduct by Brown and Bartels, and that the Director Consents are not effective because notice to the minority stockholders has not been given under Section 228(e) or Rule 14c-2 of the Securities Exchange Act of 1934.

         The parties focus on whether the Court may consider the alleged inequitable conduct in the abstract under Section 225, rather than whether that conduct has been proven and how it might apply to the Director Consents and the composition of the Board. Discovery in this action is ongoing and trial is scheduled to begin in just over a month. As a result, the Director Defendants continue to develop their defense of the 225 Action: that purportedly inequitable conduct by Brown and Bartels render the Director Consents voidable. The Director Defendants' defense is not sufficiently developed for a pre-trial merits ruling.

         "There is no 'right' to a summary judgment."[29] "Summary judgment is appropriate when the record shows that 'there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.'"[30] "The moving party bears the burden of establishing that there are no issues of material fact, and the court must review all evidence in the light most favorable to the non-moving party."[31] "The Court maintains the discretion to deny summary judgment if it decides that a more thorough development of the record would clarify the law or its application."[32]

         The Director Defendants acknowledged at argument that there are no material disputed facts.[33] Accordingly, the only questions presented on the Motion for Summary Judgment are whether Brown is entitled to judgment as a matter of law, and whether a more thorough development of the record would clarify the law or its application.

         Separately, and in the context of these expedited proceedings, I grant the Motion to Supplement.[34] Because I need not reach the question of why SGRP declined to notify stockholders of the Director Consents, the evidence from the Motion to Supplement does not inform my analysis.[35]

         A. Because The Director Defendants Have Asserted Inequitable Conduct Bearing On The Board's Composition, The 225 Action Will Continue To Trial.

         Brown asserts that summary judgment is appropriate because the Director Defendants' defense in the 225 Action that inequitable conduct by Brown and Bartels render the Director Consents voidable, however developed, cannot be cognizable under Section 225 as a matter of law. In particular, Brown rejects the Director Defendants' assertion that the seminal Schnell v. Chris-Craft Industries, Inc.[36] decision provides an additional equitable gloss on Section 225 that compels this Court to consider Brown's and Bartels' inequitable conduct as broadly pled in the 225 and Bylaw Actions. If Brown is right, the Director Consents' technical compliance with Section 228 is dispositive of the Board's composition.[37]

         The Delaware Supreme Court summarized the scope of Section 225 proceedings in Genger v. TR Investors, LLC:

A Section 225 proceeding is summary in character, and its scope is limited to determining those issues that pertain to the validity of actions to elect or remove a director or officer. "In determining what claims are cognizable in a [Section] 225 action, the most important question that must be answered is whether the claims, if meritorious, would help the court decide the proper composition of the corporation's board or management team." If not, then those claims "are said to be 'collateral' to the purpose of a [Section] 225 action and must be raised in a [separate] plenary action."[38]

Section 225 proceedings are in rem, "where the 'defendants' are before the court, not individually, but rather, as respondents being invited to litigate their claims to the res (here, the disputed corporate office) or forever be barred from doing so."[39] That in rem nature limits what the Court can decide under Section 225. For instance, this Court may adjudicate a "claim that a director-respondent does not validly hold corporate office because that director obtained the office through fraud, deceit, or breach of contract. . . . but only for the limited purpose of determining the corporation's de jure directors and officers."[40]

         Section 225's scope is narrow, but Brown incorrectly posits "that allegations of inequitable conduct should not and cannot be injected into a Section 225 action, particularly where it is undisputed that the corporate action was taken by a majority of stockholder votes."[41] Delaware courts reject the notion that "rigid, inflexible rules preclude this court from hearing anything but the narrowest arguments in Section 225 cases."[42] Instead, "the question [of] whether an issue is properly litigable in a Section 225 action turns . . . upon a determination of whether it is necessary to decide in order to determine the validity of the election or designation by which the defendant claims to hold office."[43] Issues beyond that are collateral to the narrow scope of a Section 225 proceeding and may not be considered.[44]

         1. Schnell Is Consistent With Section 225.

         The parties dispute how, if at all, Schnell informs the scope of inquiry under Section 225. In Schnell, the Delaware Supreme Court rejected a company's attempt to thwart dissident stockholders by changing the annual meeting date, holding "that inequitable action does not become permissible simply because it is legally possible."[45] Brown asserts that the narrow scope of Section 225 cannot include the broad principles in Schnell. His interpretation of Delaware law paints a restrictive view of the claims that may arise in this proceeding.[46]

         If Section 225 demanded only technical compliance with statutory consent requirements, then I would grant Brown's Motion. But this Court has applied Schnell's equitable principles in Section 225 actions. For instance, in Gassis v. Corkery, the Court considered whether the plaintiff director's removal was voidable under Section 225 as either an impermissible retaliation for the director exercising his Section 220 rights or breaches of fiduciary duty by the directors who removed the plaintiff from the board. Consistent with Genger, both issues related directly to the composition of the board.[47] Gassis serves as an example of this Court's ability to review appropriate claims of inequitable conduct within the boundaries of Section 225.[48]

         In light of Genger and other precedent, I reject Brown's cramped view of this action and conclude that existing law on Section 225 permits the adjudication of inequitable conduct, as encouraged by Schnell, so long as those issues are germane to determining the composition of the Board. Courts weighing claims under Section 225 must consider cognizable allegations of fraud, deceit, breach of contract, breach of fiduciary duty, [49] and other claims that "if meritorious, would help the court decide the proper composition of the corporation's board or management team."[50] As a result, the Court must review issues that could infect the composition of a company's "de jure directors and officers" under Section 225, notwithstanding formal compliance with the voting procedures and requirements for those offices.[51]

         Schnell empowers this Court to look at both technicalities and equities.[52]Section 225's jurisprudence, although narrower in scope, echoes that doctrine. I read Delaware's existing law on Section 225 to embody an appropriately tailored version of the foundational principle "that inequitable action does not become permissible simply because it is legally possible."[53]

         2. The Director Defendants' Defense May Be Cognizable Under Section 225.

         Brown moved for summary judgment on the theory that the Director Defendants' defense is fundamentally not cognizable as a matter of law under Section 225. Given the expedited nature of this action, the Director Defendants' defense continues to incubate in discovery.[54] In light of that timing and the contours of Section 225 that guide review in this matter, summary judgment turns on whether the Director Defendants have alleged as their defense sufficiently cognizable claims of inequitable conduct that may impact the composition of the Board.

         I conclude that Brown is not entitled to judgment as a matter of law because the Director Defendants asserted, at this early stage, a sufficiently cognizable equitable defense under Section 225.[55] Their affirmative defense alleges inequitable conduct that, once developed, may affect the Director Consents and Brown's requested Board composition.[56] The Director Defendants are entitled to develop and test those allegations at trial. They need not prove them further at this stage when discovery is still ongoing.

         The Motion is denied without prejudice to Brown's arguments on this issue. The 225 Action will proceed to trial immediately before the Bylaw Action.[57] The Court will determine the extent to which Brown's and Bartels' alleged inequitable conduct ...

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