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Mehta v. Mobile Posse, Inc.

Court of Chancery of Delaware

May 8, 2019

ANURAG MEHTA, Plaintiff,
v.
MOBILE POSSE, INC., a Delaware corporation, JONATHAN JACKSON, STEVEN J. MURRAY, CHRISTOPHER H. HOLDEN, JOHN L. DAVIESandTHOMAS D. ROBERTS, Defendants.

          Date Submitted: February 7, 2019

          Marcus E. Montejo, John G. Day, PRICKETT, JONES & ELLIOTT, P.A., Wilmington, Delaware; Counsel for Plaintiff Anurag Mehta.

          Rafael X. Zahralddin, Jonathan M. Stemerman, ELLIOTT GREENLEAF, P.C., Wilmington, Delaware; Counsel for Defendants Mobile Posse, Inc., Johnathan Jackson, Steven J. Murray, Christopher H. Holden, John L. Davies, and Thomas D. Roberts.

          MEMORANDUM OPINION

          McCORMICK, V.C.

         The plaintiff was a common stockholder of Mobile Posse, Inc. Mobile Posse's management completed a buy-out of the company in the spring of 2018. Directors appointed by the preferred stockholders negotiated the merger; the preferred stockholders approved the merger by written consent. The merger consideration was below the preferred stockholders' combined liquidation preference, so the common stockholders received no consideration. Before this litigation, the common stockholders also received little information regarding the merger.

         In completing the merger, Mobile Posse and its board had to satisfy basic requirements imposed by Delaware law. For example, Section 262 of the Delaware General Corporation Law ("DGCL") required that the company inform stockholders of their appraisal rights within ten days of the consummation the merger. Section 228 of the DGCL required that the company, when acting through written stockholder consent, promptly notify the stockholders who did not consent. Section 251 of the DGCL required that the merger agreement state the terms and conditions of the merger, including the cash stockholders would receive in exchange for their shares.

         The complaint in this case reads like a law school exam designed to test a student's knowledge of these and other basic legal requirements for consummating the merger. The defendants, Mobile Posse and its board, would not have done well on that exam. The defendants failed to notify stockholders of their appraisal rights within the timeframe set by Section 262. They forgot to send prompt notice of the written stockholder consents as required by Section 228. They neglected to include the amount of cash the preferred stockholders would receive for their shares on the face of the merger agreement or documents it incorporates as required by Section 251. The complaint alleges counts under each of these three statutory provisions and further asserts three additional counts. The additional counts claim that: the stockholder consents did not have a ratifying effect under Section 144 of the DGCL; the director defendants breached the fiduciary duty of disclosure; and the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair.

         Through this litigation, the defendants became aware of many of their mistakes. They attempted to correct some by disseminating a supplemental notice. That supplement attached a document discussing some other state's appraisal laws.

         Although the defendants candidly admit to having neglected many of their obligations in connection with the merger and related transactions, they have moved for judgment on the pleadings. They argue that they are entitled to judgment on the pleadings because the violations were remedied by the supplemental notice or caused no harm. They also contend that one of the plaintiff's claims relies on an outdated version of Section 228. On the last point only, the defendants are entitled to judgment on the pleadings. This decision denies rest of the defendants' motion.

         I. FACTUAL BACKGROUND

         The facts are drawn from the complaint and the documents it incorporates. The defendants urge the Court to also consider facts contained in documents, such as the supplemental notice, that they attach to their answer.

         "There appears to be a split in authority . . . regarding [whether courts can consider] documents attached to the answer but not referenced in or attached to the complaint."[1] The weight of authority, and the only Delaware decision addressing the issue, favors considering attachments to the answer, at least for limited purposes.[2] Most decisions addressing this issue are based on Federal Rule of Civil Procedure 10(c), which provides that "[a] copy of a written instrument that is an exhibit to a pleading is a part of the pleading for all purposes."[3] This Court's rules contain nearly identical language.[4] Because "[d]ecisions interpreting the Federal Rules of Civil Procedure are usually of great persuasive weight in the construction of parallel Delaware rules, "[5] the Court will consider the exhibits attached to the defendants' answer. Still, because all inferences from the pled facts must be made in a light most favorable to the non-moving party, the Court does not rely on those exhibits that contradict the complaint's well-pled facts.[6]

         A. Mobile Posse's Business and Board

         Defendant Johnathan Jackson founded Mobile Posse (or the "Company") in 2005. The Company provides mobile advertising and customer-relationship-management solutions on mobile devices. Its main software product is pre-installed on mobile devices, and that software and related services provide content and advertising on those devices. The Company's platform reaches seven operating systems and nearly twenty million active consumers. The Company's business model is risky; the Company has only one customer and that customer could terminate its contract for convenience. If that customer terminated the contract, or simply did not renew it, "the Company would most likely need to liquidate its assets."[7]

         The Company raised over $25 million in capital through six series of preferred stock (Series A, A-1, B, B-1, B-2, and C). The preferred stock entitled holders to liquidation preferences and voting rights, such as the right to approve a sale of the Company. The waterfall of proceeds provided a liquidation preference of 100% of the amount invested by the junior preferred stockholders, and 125% for the senior series of preferred stock. Dividends of eight percent a year also accrued first to senior preferred stock, and then to junior holders, adding "in excess of $2, 000, 000 to these liquidation preferences on an annual basis."[8] As of April 3, 2018, the accrued dividends totaled $17, 003, 591 and liquidation preferences totaled approximately $44, 678, 801.[9]

         Mobile Posse's Board of Directors comprised Jackson and persons affiliated with the preferred stockholders: John L. Davies, Christopher H. Holden, Steven J. Murray, and Thomas D. Roberts. These directors and their affiliates held most or all of the Company's outstanding preferred stock and a majority of the Company's outstanding voting power.

         B. The Company's Sale Efforts

         Beginning in December 2014, the board began to explore a sale of the Company. The Company engaged Headwaters BD LLC to conduct the sale process. Headwaters contacted approximately 120 potential strategic buyers. In December 2016, Mobile Posse executed a letter of intent to sell to a strategic buyer for approximately $45, 000, 000, with another $17, 000, 000 as part of a potential earn-out. Common stockholders would have received none of the $45, 000, 000 closing payment, though they could have potentially received $0.38 per share through the earn-out. That buyer eventually walked away from the deal "in the Spring of 2017 due to concern that the Corporation only had one customer."[10]

         In June 2017, the Company engaged a new investment banker, Canaccord Genuity. Canaccord contacted approximately 170 potential strategic and financial buyers, but received only one expression of interest. That potential financial buyer "submitted an indication of interest in September 2017 to acquire the Corporation for an enterprise value between $31, 000, 000 and $37, 000, 000, subject to due diligence."[11] Mobile Posse went forward with due diligence, although the offer would not have satisfied the Corporation's preferred stock. This buyer too backed out during due diligence "because of similar concerns that the Corporation's business depended on a single customer."[12]

         C. The Merger

         In January 2018, in the wake of the Company's two failed processes, management members offered to purchase the Company for $33, 100, 000 in cash and $1, 000, 000 in rollover equity. Also, the Company had instituted a management carve-out plan "that called for up to 16% of the proceeds from a Change in Control event . . . to be paid to certain executives and management of the Corporation."[13]Under the carve-out, management would receive $5, 900, 000.[14] The Board countered at $35, 500, 000 cash, up to $1, 000, 000 in rollover equity, and management forfeiting its rights to a carve-out payment.

         The Board formed a special committee of directors who would not be receiving rollover equity. After several weeks of negotiations, the parties agreed to terms of a merger (the "Merger"). Under the Merger, the purchasers would pay $33, 800, 000, including $1, 000, 000 in rollover equity.[15] Management would receive no carve-out of Merger proceeds. And senior preferred stockholders forewent a portion of their liquidation preference to enable lower classes of preferred stock to receive consideration.

         Common stockholders would receive nothing because the purchase price was less than the preferred stockholders' $44 million liquidation preference.[16] Defendants sought the written consent of preferred stockholders, but did not provide the consent solicitation and information statement to Mobile Posse's twenty common stockholders.

         D. The 280G Solicitation

         Certain payments due to Jackson and Chief Financial Officer Stephen Sincavage upon consummation of the Merger exceeded 2.99 times their base amount in recent years. Under Section 280G of the Internal Revenue Code, those payments were "parachute payments" that Mobile Posse could not deduct, and on which the recipients would pay an excise tax. Mobile Posse could avoid this outcome under Section 280G by obtaining the approval of 75% of the holders of all outstanding stock. Around March 28, 2018, the Company issued a solicitation seeking stockholder consents pursuant to Section 280G (the "280G Solicitation").[17]

         Plaintiff Anurag Mehta ("Plaintiff") is a former employee of Mobile Posse who owned 240, 000 shares of Mobile Posse common stock. He received the 280G Solicitation. The solicitation mentioned, but did not describe, the Merger. That mention was the first time Plaintiff learned of the Merger. The 280G Solicitation stated that the executing stockholder adopted and approved the resolution "effective as of March 28, 2018."[18] Stockholders approved the 280G Solicitation. On April 2, the Company's preferred stockholders approved the Merger by written consent.

         E. The Initial Notice

         After receiving the Section 280G Solicitation, Plaintiff attempted to obtain more information about the Merger. The Company did not respond to Plaintiff's inquiry until April 19 when it emailed him a notice and the stockholder merger resolution (the "Initial Notice").[19] The Initial Notice said that stockholders had consented to and that the Company had consummated the Merger. The Initial Notice did not contain any information about what consideration any stockholders, common or preferred, would receive. The Company did attach the Merger Agreement, which referenced a payment schedule (the "Payment Schedule"). But the Payment Schedule was not included. The Initial Notice was also light on details about appraisal rights, telling stockholders that if they did not vote for the Merger they may obtain the fair value of their shares. It did not attach the appraisal statute, although on its face it purported to do so. It did not inform the stockholders of any procedures for asserting their appraisal rights.

          F. The Litigation and Supplemental Notice

         Plaintiff commenced this litigation on May 18, 2018. His claims alerted the Company to multiple deficiencies in the Initial Notice. In response to the complaint, the Company issued a supplemental notice on June 19, 2018 (the "Supplemental Notice"). The Supplemental Notice contained ten separate documents, attached to the Amended Answer as Exhibits 1 through 10. It disclosed information including the availability of appraisal rights, the rights of preferred stockholders, the Payment Schedule, and the background of the sales process that led to the Merger.

         Defendants answered and asserted affirmative defenses on July 11, 2018. Defendants filed an amended answer attaching numerous exhibits, including the Supplemental Notice, on October 5, 2018. Defendants contemporaneously moved for judgment on the pleadings. After briefing, the Court heard oral argument on February 7, 2019.

         II. LEGAL ANALYSIS

         The Complaint asserts six causes of action. Count I alleges that Defendants violated 8 Del. C. § 262 by failing to provide statutorily required information concerning appraisal rights. Count II alleges that the 280G Solicitation violated 8 Del. C. § 228 by failing to disclose material facts necessary for stockholders to decide whether to execute the written consents. Count III alleges that the Initial Notice does not give rise to the safe harbor protections of 8 Del. C. § 144, and violated the "prompt" notice requirements of 8 Del. C. § 228. Count IV alleges that Defendants violated 8 Del. C. § 251 by failing because the Merger Agreement fails to state the consideration paid to stockholders. Count V alleges that the director defendants breached the fiduciary duty of disclosure by failing to meet the statutory requirements of 8 Del. C. §§ 228 and 262. Count VI alleges that the director defendants breached their fiduciary duty of loyalty by engaging in a self-dealing transaction that was not entirely fair.

         Defendants moved for judgment on the pleadings on each of the six Counts. In deciding a motion for judgment on the pleadings under Court of Chancery Rule 12(c) the Court "accord[s] plaintiffs opposing a Rule 12(c) motion the same benefits as a plaintiff defending a motion under Rule 12(b)(6)."[20] This means the Court "view[s] the facts pleaded and the inferences drawn from such facts in a light most favorable to the non-moving party. The Court must take the well-pleaded facts alleged in the complaint as admitted."[21]

         "A motion for judgment on the pleadings may be granted only when no material issue of fact exists and the movant is entitled to judgment as a matter of law."[22] Because "the standards for motions under both Rule 12(b)(6) and Rule 12(c) are almost identical"[23] a motion for judgment on the pleadings can only be granted against a plaintiff if she "could not recover under any reasonably conceivable set of circumstances susceptible of proof."[24]

         A. Count I: Appraisal Disclosures

         Section 262(d)(2) requires that "within 10 days [of the merger the surviving corporation] shall notify each of the holders of any class or series of stock . . . who are entitled to appraisal rights of the approval of the merger . . . and that appraisal rights are available for" their shares.[25] The notice "shall include" a copy of Section 262.[26]

         Defendants admit that twenty minority stockholders did not receive notice of their appraisal rights within the period specified by Section 262.[27] Defendants argue, however, that the Supplemental Notice constituted a "replicated remedy" resetting the clock, permitting the common stockholders to exercise their appraisal rights, and entitling Defendants to judgment in their favor on Count I.[28]

         Defendants' replicated remedy theory comes from Berger v. Pubco Corp.[29]In that case, the Court found that disclosures regarding a short-form merger provided inadequate detail and attached an outdated version of the appraisal statute.[30] On appeal, the Supreme Court discussed "[i]n the abstract," four theoretical "remedial alternatives" for addressing deficient disclosures concerning stockholder appraisal rights.[31] One of the remedial alternatives involved a "'replicated appraisal' proceeding that would duplicate the precise sequence of events and requirements of the appraisal statute."[32] No one advocated for this relief, and the Supreme Court did not award it. Indeed, the Supreme Court was critical of its own theoretical brainchild. The Court described a "replicated appraisal remedy" as suboptimal for many reasons, including that it would give fiduciaries "little incentive to observe their disclosure duty in future cases, since the cost of the remedy [] would be negligible."[33] Defendants cite no decision that blesses this replicated remedy as an appropriate fix to an improper notice under Section 262. That is no surprise, because "fairness requires that the corporation be held to the same strict standard of compliance with the appraisal statute as the minority shareholders."[34]

         Even if a replicated appraisal remedy was a legally viable option, the Company's attempt to invoke it fails. The Supplemental Notice itself (Exhibit 1 to the Amended Answer) contained correct information, but it attached a document (Exhibit 3 to the Amended Answer) that contained incorrect information. The document as a whole, therefore, contained incorrect and internally inconsistent instructions. Two glaring errors are particularly problematic.

         First, Section 262 requires that a stockholder assert appraisal rights "within 20 days after the date of mailing" of the appraisal notice.[35] The Supplemental Notice attached a copy of the statute, and the cover letter to the Supplemental Notice correctly stated the Company's intent to permit each stockholder the option of exercising appraisal rights "within 20 days of the mailing of this notice."[36] The March 28, 2018 notice, which was attached to the Supplemental Notice, stated that the Company would set "a date by which [it] must receive the demand for payment (which date may not be fewer than 30 nor more than 60 days after the Dissenters' Notice is delivered)."[37] The thirty-to-sixty day window is not Delaware law.[38] Had stockholders complied with that deadline, they would have missed the twenty-day "replicated" period for submitting their demand.

         Second, the March 28, 2018 notice told stockholders the wrong procedures for enforcing their appraisal rights. The process described in that document starts with an "Offer of Payment," which obligated the surviving corporation "to pay to each dissenting shareholder . . . the amount the Company estimates to be the fair value of the shares, plus accrued interest from the effective date of the Merger."[39] After making that offer, and providing other information, [40] the dissenting stockholder could accept the offer or within 30 days provide "his or her own estimate of the fair value for the dissenting holder's shares and the interest due, and may demand payment of such holder's estimate."[41] If after this back and forth process the demands for appraisal "remain[ed] unsettled, the Company must commence a nonjury equity valuation proceeding in the [Court of Chancery, Wilmington, Delaware], within 60 days after receiving the payment demand and must petition the court to determine the fair value of the shares and accrued interest."[42] The Company would then "make all dissenting stockholders whose demands remain unsettled parties to the proceeding and to serve a copy of the petition upon each of them."[43]If the Company "does not commence the proceeding within those 60 days . . . the Company [would] pay each dissenting stockholder whose demand remains unsettled the amount demanded."[44]

         None of this is Delaware law or procedure. Section 262 does not describe this process.[45] Section 262 tells stockholders they can "commence an appraisal proceeding by filing a petition in the Court of Chancery . . . [w]ithin 120 days after the effective date of the" deal.[46] There is no required back and forth, offer of payment from the corporation, or period where the stockholders sit back and wait for the corporation to start the proceeding, which if it never does, they will be paid their demand. Mobile Posse informed its stockholders of incorrect procedures.

         "The purpose of the requirement that a copy of the appraisal statute be included in the Notice is to enable shareholders to make an informed decision whether to accept the merger consideration or to seek appraisal."[47] Plaintiff has pled it is reasonably conceivable that a corporation does not satisfy Section 262 by attaching a correct copy of the statute but then telling stockholders information and procedures that contradict the statute.

         B. Count II: The 280G Solicitation

         Count II asserts that the 280G Solicitation violated 8 Del. C. § 228 by including a pre-printed effective date and by failing to disclose material facts to the stockholders.

         1. Section 228 Form Dating Issues

         The 280G Solicitation, which Plaintiff attached to his Complaint, states that the signing stockholder "hereby adopt[s] and approve[s] the following recitals and by written consent, effective as of March 28, 2018."[48] Based on H-M Wexford LLC v. Encorp, Inc., [49] Plaintiff argues "stockholder consents cannot be form dated but rather must bear the date of the stockholder's signature."[50]

         H-M Wexford interpreted language in Section 228 removed by amendment. Before the amendment, Section 228 required that "[e]very written consent shall bear the date of signature of each stockholder or member who signs the consent."[51] The mandatory use of "shall" meant that the "pre-printed date" on the consents were insufficient, and each signer needed to date their consent.[52] The August 2017 amendment struck the "shall bear the date of signature" language relevant to the H-M Wexford.[53] The synopsis to the bill confirms: "Section 228 is amended to provide that a consent need not bear the date of signature of the stockholder or member signing the consent."[54] Plaintiff is thus wrong that the consents must bear the date of signature. Defendants are entitled to judgment on the pleadings on this issue.[55]

          2. Section 228 Disclosure Violations

         Plaintiff argues that Defendants did not disclose all material information required by 8 Del. C. § 228 for stockholders to decide whether to execute the 280G Solicitation.

         This Court has allowed stockholders to state a claim under 8 Del. C. § 228 based on the failure to disclose information, [56] although Section 228 "contains no disclosure requirements other than that the written consents be in writing, set forth the action to be taken, and be signed by the holders of the stock."[57] This is because "actions under Section 228 require strict compliance to avoid mischief and disorder in corporate actions."[58]

         The 280G Solicitation asked stockholders to approve executive compensation related to the Merger. One of the resolutions even states that "the undersigned Stockholders acknowledge and agree that this Action by Written Consent is entirely separate from the vote to approve the Merger . . . ."[59] The 280 Solicitation, however, fails to provide any information concerning the Merger, including the fact that the common stockholders would receive no consideration. Compounding this problem, Defendants concede they did not provide the consent solicitation related to the Merger to the common stockholders.[60] This meant that the common stockholders first learned of the Merger by reading the 280G Solicitation.[61]

         This type of incomplete disclosure resembles those of two other decisions involving written consents, Calesa Associates, L.P. v. American Capital, Ltd., [62] and Carsanaro v. Bloodhound Technologies, Inc.[63] In both cases, the written consents omitted important information referenced on the face of the consent. In Calesa, the documents the stockholders were asked to sign were incomplete, missing attachments, or in draft form.[64] In Carsanaro, several of the incorporated exhibits were missing in their entirety.[65] By asking stockholders to approve of parachute payments in connection with the Merger, but providing them no information about the Merger, Defendants similarly erred. Defendants are not entitled to judgment on Count II.

         C. Count III: The Initial Notice

         Count III alleges that Defendants are not entitled to the protections of 8 Del. C. § 144(a)(2) because the Initial Notice failed to disclose material facts. Count III also alleges that Defendants violated 8 Del. C. § 228 by failing to provide prompt notice of the action by written consent.

         1. Section ...


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