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Reith v. Lichtenstein

Court of Chancery of Delaware

June 28, 2019

DONALD REITH, individually and on behalf of all others similarly situated, Plaintiff,
v.
WARREN G. LICHTENSTEIN, GLEN M. KASSAN, WILLIAM T. FEJES, JR., JACK L. HOWARD, JEFFREY J. FENTON, PHILIP E. LENGYEL, JEFFREY S. WALD, STEEL PARTNERS HOLDINGS L.P., STEEL PARTNERS, LTD., SPH GROUP HOLDINGS LLC, HANDY & HARMAN LTD., and WHX CS CORP., Defendants, and STEEL CONNECT, INC., a Delaware Corporation, Nominal Defendant.

          Date Submitted: March 15, 2019

          Andrew S. Dupre and Alexandra M. Joyce, MCCARTER & ENGLISH, LLP, Wilmington, Delaware; Eduard Korsinksy, Amy Miller, William J. Fields, and Samir Shukurov, LEVI & KORSINSKY, LLP, New York, New York; Attorneys for Plaintiff Donald Reith.

          John M. Seaman, ABRAMS & BAYLISS LLP, Wilmington, Delaware; Thomas J. Fleming, Adrienne Ward, and Kerrin T. Klein, OLSHAN FROME WOLOSKY LLP, New York, New York; Attorneys for Defendants Warren G. Lichtenstein, Jack L. Howard, Glen M. Kassan, William T. Fejes, Jr., Steel Partners Holdings L.P., Steel Partners, Ltd., SPH Group Holdings LLC, Handy & Harman Ltd., and WHX CS Corp.

          Gregory V. Varallo, Matthew D. Perri, and Sarah T. Andrade, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Attorneys for Defendants Jeffrey J. Fenton, Philip E. Lengyel, and Jeffrey S. Wald.

          MEMORANDUM OPINION

          ZURN, VICE CHANCELLOR.

         Steel Connect, Inc. acquired another company in December 2017. A Steel Connect stockholder plaintiff sees wrongdoing in part of the deal financing, in which Steel Connect sold preferred stock to Steel Partners Holdings, L.P. ("Steel Holdings"). Steel Holdings already held over a third of Steel Connect's stock, owned the entity responsible for managing Steel Connect, and was affiliated with management and several board members. The newly issued preferred stock pushed Steel Holdings' stock ownership to nearly half. Steel Holdings' component of the financing was considered and approved by a special committee of independent board members, and by the board.

         That special committee, and the compensation committee, also recommended equity grants to Steel Connect's executive chairman and two individuals who joined the board the same day Steel Holdings' financing was approved. All three individuals are affiliated with Steel Holdings. Adding these new equity grants to Steel Holdings' existing stock, and the preferred stock it bought, gave Steel Holdings and its affiliates majority control of Steel Connect. Issuing the grants required amending the company's incentive award plan, which in turn required an informed stockholder vote.

         The plaintiff views Steel Holdings as a controlling stockholder who owed and breached fiduciary duties by causing Steel Connect to issue Steel Holdings preferred stock, and the equity grants, on the cheap. He claims the directors breached their fiduciary duties in approving the transaction with Steel Holdings and the equity grants, and by making faulty disclosures in seeking stockholder approval for amending the incentive award plan. On the defendants' motion to dismiss, it appears that Steel Holdings is a controlling stockholder, that the plaintiff's claims are derivative, and that demand for bringing those claims is excused. The stockholder's breach of fiduciary duty claims against these individuals and entities survive the motion to dismiss. I conclude the stockholder has failed to allege the members of the special committee committed a non-exculpated breach of fiduciary duty in approving the preferred stock transaction, but has pled a non-exculpated breach of fiduciary duty for approving the equity grants.

         I. BACKGROUND

         I draw the facts from the allegations in, and documents incorporated by reference or integral to, the Complaint and judicially noticeable facts available in public Securities and Exchange Commission filings.[1] Additionally, plaintiff Donald Reith ("Plaintiff") received books and records from the Company that he used in drafting the Complaint, which are also properly considered on a motion to dismiss.[2]

         A. Steel Holdings Acquires Company Stock, Appoints Directors To The Company's Board, And Influences The Selection Of New Company Executives.

         Defendant Steel Holdings is a Delaware limited partnership and a publicly traded holding company. In 2011, Steel Holdings[3] started acquiring stock in ModusLink Global Solutions, Inc., later renamed Steel Connect, Inc. ("the Company"), which is a Delaware corporation. Steel Holdings owned 14.9% of the Company's outstanding shares by September 28, 2012. In February 2013, Steel Holdings entered into a settlement agreement with the Company that permitted Steel Holdings to appoint directors and purchase additional shares.[4] As part of that agreement, the Company nominated two Steel Holdings designees for election to its board (defendants Glen M. Kassan and Warren G. Lichtenstein) and agreed that if Lichtenstein were elected, he would serve as chairman; two incumbent directors also retired and were replaced by other new directors. If certain conditions were met, including the election of Steel Holdings' nominees to the board, Steel Holdings would purchase stock and warrants in a private placement. In March 2013, Kassan and Lichtenstein were elected to the board. Accordingly, pursuant to the settlement agreement, the Company sold shares and warrants to Steel Holdings that increased its ownership to 29.9%. From 2013 through 2016, Steel Holdings purchased more Company stock. As of December 14, 2016, Steel Holdings owned 20, 440, 133 shares of the Company's stock, constituting approximately 35.62% of the Company's outstanding shares.

         Lichtenstein is connected to Steel Holdings and its affiliates in a number of ways. He is Executive Chairman of SHGP, which is the general partner of Steel Holdings. He is also CEO of Steel Partners and Chairman of HNH.

         Kassan served as the Company's Chief Administrative Officer from May 2014 until January 2015 and has been the board's Vice Chairman since May 2014. He has been associated with Steel Partners LLC, a subsidiary of Steel Holdings, since August 1999. He served as HNH's CEO from October 2005 through December 2012 and on the HNH board until May 2015. He was also an officer and director of SL Industries until its acquisition by HNH in June 2016. Additionally, his principal occupation was "serving as an employee of Steel Services, Ltd." ("Steel Services"), which is a subsidiary of Steel Holdings.[5]

         Defendants Jeffrey J. Fenton and Jeffrey S. Wald were already on the Company's board when Kassan and Lichtenstein became directors. Fenton and Wald have no connection to Steel Holdings, and the Company considers them independent directors.

         On December 18, 2013, non-party Anthony Bergamo was appointed to the board. "Mr. Bergamo's nomination was recommended by Mr. Lichtenstein, the Company's Chairman of the Board."[6] Although Bergamo was also a director of Steel Holdings, he was classified as an independent director under NASDAQ rules.[7]Bergamo served as a director until his death on September 29, 2017.

         Finally, Philip E. Lengyel joined the board in May 2014. Like Fenton and Wald, Lengyel was not affiliated with Steel Holdings, and the Company considers him independent. Bergamo, Fenton, Kassan, Lengyel, Lichtenstein, and Wald were the six members of the Company's board as of August 2017.

         Steel Holdings is also involved in managing the Company. On December 31, 2014, an indirect wholly owned subsidiary of Steel Holdings, SP Corporate Services LLC ("SP Corporate"), entered into a Management Services Agreement with the Company.[8] SP Corporate provided management services from January 1, 2015 through March 10, 2016.[9] That day, the Management Services Agreement was amended and SPH Services, Inc., the parent of SP Corporate and an affiliate of Steel Holdings, took over.[10] SP Corporate and Steel Partners LLC then merged into SPH Services, Inc., with SPH Services, Inc. surviving.[11] SPH Services, Inc. has since changed its name to Steel Services Ltd. Lichtenstein was the CEO of SP Corporate Services, and is now the CEO of Steel Services.[12]

         Under the management agreement, Steel Services provides "(1) services related to corporate treasury functions and financing matters; (2) services to support M&A functions[;] and (3) services related to advising the Company on risk management, governance and compliance generally, assisting with public company reporting requirements, advising on investigations and litigation, and advising on major business transactions."[13] "During the year ended July 31, 2017, pursuant to the Management Services Agreement, the Company paid a fixed monthly fee of $175, 000 in consideration for the services and incremental costs as incurred."[14] This fee was reduced on September 1, 2017, to $95, 641 per month.[15]

         Steel Holdings affiliates replaced Company management in 2016. Lichtenstein served as the Company's interim CEO from March 28 through June 17, 2016, when he became Executive Chairman. That day, the Company made two additional personnel changes. First, James R. Henderson replaced Lichtenstein as CEO of the Company, and also became President. From March 23 to June 16, 2016, Henderson had served as CEO of the Company's principal operating subsidiary. Henderson's relationship with Steel Holdings goes back to 1999. "He was associated with [Steel] Partners LLC and its affiliates from August 1999 until 2011."[16] He was a director of SL Industries from January 2002 to March 2010. In the early- to mid-2000's, he was a director, CEO, President, COO, and Vice President of Operations at different times for Steel Holdings' predecessor, WebFinancial Corporation.[17] That included serving as CEO of WebBank, a wholly owned subsidiary of Steel Holdings.

         Second, the Company hired Louis J. Belardi to serve as Executive Vice President, CFO, and Secretary. Belardi joined the Company from SL Industries, where he had spent approximately the previous twelve years as CFO, Secretary, Treasurer, and Corporate Controller at different times. He replaced Joseph B. Sherk, a Steel Services employee who had served as the Company's Principal Financial Officer, Principal Accounting Officer, and Corporate Controller under the Management Services Agreement from January 1, 2015, through June 27, 2016.[18] In June 2016, when Belardi joined, Sherk went back to working for the Company in a different role.[19]

         B. The Company Finances The IWCO Acquisition With Funding From Steel Holdings, Adds New Directors, And Awards Them Equity Grants.

         Plaintiff alleges that in the summer of 2017, Steel Holdings started exploring ways to utilize the Company's net operating loss carryforwards ("NOLs").[20] NOLs can offset income, reducing the taxes a company pays.[21] But because the Company was not profitable, it could not utilize its NOLs. Acquiring another entity that generated profits would allow the Company to unlock the value of the NOLs.

         In August 2017, the Company agreed to acquire all outstanding shares of IWCO, a Delaware corporation that provides data-driven marketing solutions. IWCO had consistently generated profits that would allow the Company to take advantage of its NOLs. Plaintiff alleges that Steel Holdings saw the deal as an opportunity to extract economic benefits and seize majority control of the Company without a stockholder vote, and did so through the structure of the deal financing.

         The Company's board met on September 8 and discussed financing for the deal. Henderson and Belardi also attended the meeting, along with outside counsel and Defendant Jack L. Howard. At the time, Howard was affiliated with Steel Holdings, but not the Company. The expected deal value was $475.6 million. The board considered a structure that would include financing from affiliates of Cerberus Business Finance LLC, and $83.7 million in cash from the Company in turn financed partially through a "bridge loan" from Steel Holdings. The board resolved to form a special committee of independent directors ("the Special Committee") to consider Steel Holdings' financing, and appointed Wald, Lengyel and Fenton (together the "Special Committee Defendants"), with Wald as chair, to the Special Committee. The board approved payment of a $25, 000 fee to each member of the Special Committee, half payable immediately and half upon closing of the transaction. The Special Committee met for the first time the same day, and minutes reflect that Steel Holdings could "invest up to $35 million in the Company through the purchase of a to-be-established series of the company's convertible preferred stock."[22]

         On September 25, the Special Committee met and retained legal and financial advisors.[23] On November 15, the Special Committee met with its financial advisor.[24]The Special Committee reviewed a proposed $35 million capital raise through the issuance of convertible preferred stock ("Preferred Stock").[25]

         On December 15, the board met and (1) approved the IWCO acquisition and its funding, (2) added two new members to the board, and (3) awarded equity grants to those new directors and Lichtenstein. The order in which these actions were taken, and which directors approved each act, is disputed. Plaintiff alleged that all seven directors approved the deal and equity grants. The Company disclosed that "[t]he preferred stock transaction was approved by a special committee consisting of independent directors of ModusLink who are not affiliated with Steel Partners."[26]At argument, the defendants clarified that the full board approved the deal and equity grants after the Special Committee had approved them.[27] It is not clear whether that version of the full board included the two new directors, and the Company did not include the relevant board minutes in its books and records production to Plaintiff.

         Be that as it may, some version of the board approved the deal, and the transaction closed. Under the final terms of the Preferred Stock, the Company created and sold $35, 000, 000 worth (35, 000 shares at $1, 000 a share) of Series C Convertible Preferred Stock to SPH, a subsidiary of Steel Holdings. The initial conversion price was $1.96 a share, which represented a 31.5% premium over the December 15, 2017 closing price, of $1.49 per share. The Preferred Stock carried voting rights equal to the number of common shares at the $1.96 conversion price, equaling approximately 11.14% of the Company's voting power. As a result, Steel Holdings' voting power increased from 35.62% to 46.76%. The day the deal was announced, the Company's stock closed at $2.18 per share.

         As to the new directors, the Company disclosed that the Nominating Committee[28] of the board had recommended, and the board approved, increasing the board to seven seats and electing Howard and William T. Fejes to those seats.[29]Howard is President of Steel Holdings and Steel Holdings GP, and also a director of Steel Holdings GP. Howard is also HNH's Principal Executive Officer and Vice Chairman of its board. Fejes has served as President of non-party Steel Services, an indirect wholly owned subsidiary of Steel Holdings, since October 2017. He has also served as an executive at HNH and at SL Industries, Inc., a subsidiary of HNH. Finally, the Company further disclosed that the Compensation Committee and Special Committee also recommended, and the board approved, equity grants of 5.5 million shares to Lichtenstein (3.3 million), Howard (1.65 million) and Fejes (550, 000) (the "Equity Grants"). Fejes and Howard received these grants for "current and future services to the Company."[30] At argument, their counsel described their role as "de facto investment bankers" for the Company, as "[t]hey found the IWCO merger opportunity, went out there and rounded up the financing, did the negotiating and the like."[31]

         Four million shares of the Equity Grants were to vest immediately, and the balance (1, 500, 000) would vest upon the Company's stock price closing at $2.00, $2.25 and $2.50 for five consecutive days. 1, 050, 000 of the shares were also subject to stockholder approval due to limits set by the Company's Incentive Award Plan adopted in 2010 (the "2010 Plan"). Based on the $2.19 closing price of the Company's stock on December 18, 2017, the Equity Grants to Lichtenstein, Howard, and Fejes were worth approximately $7.2 million, $3.6 million, and $1.2 million, respectively. The Equity Grants gave Steel Holdings' affiliates more than 5% of additional voting power. Through the Equity Grants and Preferred Stock combined, Steel Holdings and its affiliates increased their beneficial ownership from approximately 35.62% to approximately 52.3%.

         C. The Company Seeks Stockholder Approval To Amend Its Compensation Plan.

         The Company asked stockholders to approve amendments to the 2010 Plan. The 2010 Plan provided for the grant of various awards, including stock options, restricted stock, and stock appreciation rights. One type of award is a "Full Value Award." Section 2.26 of the Plan defines "Full Value Award" as "any Award other than (i) an Option, (ii) a Stock Appreciation Right or (iii) any other Award for which the Holder pays the intrinsic value existing as of the date of grant (whether directly or by forgoing a right to receive a payment from the Company or any Affiliate)."[32]

         Section 3.1 of the Plan limits the number of Full Value Awards. The parties disagree how it does so. The language is as follows:

(a) Subject to Section 13.2 and Section 3.1(b), the aggregate number of Shares which may be issued or transferred pursuant to Awards under the Plan is (i) 5, 000, 000 plus (ii) any Shares which are subject to awards under the Prior Plans which after the Effective Date are forfeited or lapse unexercised or are settled in cash and are not issued under the Prior Plans; provided, that subject to Section 13.2 and, with respect to Full Value Awards that terminate, expire or lapse or for which shares of Common Stock are tendered or withheld, Section 3.1(b) the aggregate number of shares of Common stock which may be issued or transferred pursuant to Full Value Awards under the Plan is 3, 000, 000. No more than 5, 000, 000 Shares may be issued upon the exercise of Incentive Stock Options. After the Effective Date, no awards may be granted under any Prior Plan, however, any awards under any Prior Plan that are outstanding as of the Effective Date shall continue to be subject to the terms and conditions of such Prior Plan.[33]

         In the Company's Schedule 14A Proxy Statement filed on December 8, 2010 (the "2010 Proxy"), the Company stated that the maximum number of Full Value Awards that could be issued was three million shares: "The Plan provides that no more than 3, 000, 000 shares will be granted as 'full value awards', such as restricted stock, restricted stock units, deferred stock, performance awards, or stock payments where the participant does not pay the intrinsic value for such award."[34]

         On March 19, 2018, the Company filed its 2017 Proxy. Therein, the Company sought stockholder approval to amend the 2010 Plan to allow for 1, 050, 000 of the 5, 500, 000 million in Equity Grants. The proposed amendments (i) increased the number of shares available for issuance from five million to eleven million, and (ii) eliminated the limit on the number of "Full Value Awards" that could be issued under the 2010 Plan (the "Plan Amendment").

         In describing the 2010 Plan's terms, the 2017 Proxy did not disclose the limit on Full Value Awards or that the 2010 Proxy described that limit as being set at three million. The 2017 Proxy stated the limit applied not to all Full Value Awards, but only to those issued under the Company's compensation plans prior to the 2010 Plan that were forfeited, lapsed, or settled in cash after the 2010 Plan's effective date, which were recycled for use under the 2010 Plan (the "Recycled Awards"). The board also did not disclose why the Plan Amendment was necessary to effectuate the Equity Grants. The 2017 Proxy told stockholders about the 1, 050, 000 shares that were subject to the Plan Amendment, but did not reiterate the previously disclosed details of all of the Equity Grants.

         D. Litigation Ensues.

         On January 23, 2018, Plaintiff sent the Company a demand pursuant to 8 Del. C. § 220 for books and records concerning the issuance of the Preferred Stock and the Equity Grants (the "Challenged Transactions"). After agreeing to a confidentiality agreement that provided that the Company's production would be deemed incorporated in a subsequent complaint, Plaintiff received documents. Plaintiff then filed his six-count complaint on April 13, 2018. In short, Plaintiff alleges that (1) the Challenged Transactions were a pretext for allowing Steel Holdings to gain majority voting control for inadequate consideration, and (2) the Director Defendants misled stockholders in seeking their approval for the Equity Grants. Accordingly, Plaintiff argues the individual directors breached their fiduciary duties in approving and disclosing the Challenged Transactions, and violating the 2010 Plan through the Equity Awards (Counts I (direct) and II (derivative)); that the Entity Defendants aided and abetted those breaches (Counts III (direct) and IV (derivative)); that Steel Holdings as the Company's controlling stockholder breached its fiduciary duties (Count V); and that the recipients of the Preferred Stock and Equity Grants were unjustly enriched (Count VI).

         On June 8, 2018, the defendants moved to dismiss under Court of Chancery Rule 12(b)(6) and Rule 23.1. The parties briefed the motions, and I heard oral argument on March 5, 2019. Of their own volition, the parties submitted supplemental letters on March 8 and 15.

         II. ANALYSIS

         The defendants' motions to dismiss under Rules 12(b)(6) and 23.1 and is made more complex by the fact that the board went through several iterations. The Steel Holdings Defendants provided the following chart summarizing the composition of the board during the relevant periods:

August 2017

December 15, 2017[35]

Present

Lichtenstein (Chair)

Lichtenstein (Chair)

Lichtenstein (Chair)

Kassan

Kassan

Kassan

Wald

Wald

Wald

Fenton

Fenton

Fenton

Lengyel

Lengyel

Lengyel

Bergamo (to Sept. 29, 2017)

Howard
Fejes

         I first address whether Steel Holdings was a controlling stockholder at the time of the Challenged Transactions. That analysis informs whether Plaintiff's claims are dual, not just derivative, and whether Plaintiff's claims are reviewed under the business judgment rule or entire fairness. After concluding Steel Holdings is a controller and Plaintiff's claims are derivative, I turn to whether demand is excused. Finding that it is, I turn to whether the members of the Special Committee are exculpated. I then consider Plaintiff's claims for aiding and abetting. Finally, under Rule 12(b)(6), I consider whether Plaintiff has adequately pled his derivative breach of fiduciary duty, unjust enrichment, and disclosure claims.

         A. Standard of Review

         Rules 12(b)(6) and 23.1 place different pleading burdens on the parties. "Rule 23.1 places a heightened burden on Plaintiff to plead demand futility by meeting 'stringent requirements of factual particularity that differ substantially from the permissive notice pleadings'" of Rules 8 and 12(b)(6).[36] "Because the standard under Rule 12(b)(6) is less stringent than that under Rule 23.1, a complaint that survives a motion to dismiss pursuant to Rule 23.1 will also survive a 12(b)(6) motion to dismiss, assuming that it otherwise contains sufficient facts to state a cognizable claim."[37]

         Under the reasonable conceivability standard of Rule 12(b)(6), I must "accept all well-pleaded factual allegations in the Complaint as true, accept even vague allegations in the Complaint as 'well-pleaded' if they provide the defendant notice of the claim, draw all reasonable inferences in favor of the plaintiff, and deny the motion unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof."[38] And "[a]lthough there is a heightened burden under Rule 23.1 to plead particularized facts, when a motion to dismiss for failure to make a demand is made, all reasonable inferences from the pled facts must nonetheless be drawn in favor of the plaintiff in determining whether the plaintiff has met its burden under Aronson."[39]

         B. Steel Holdings Is A Controlling Stockholder.

         The allegation that a transaction involves a controlling stockholder on both sides is a serious one because it imposes fiduciary duties on the controlling stockholder and potentially strips directors of the protection of the deferential business judgment rule. "If the plaintiff rebuts the business judgment presumption, the Court applies the entire fairness standard of review to the challenged action and places the burden on the directors to prove that the action was entirely fair."[40] This usually precludes granting a motion to dismiss.[41]

         "In 1994, in the seminal case of Kahn v. Lynch Communications Systems, Inc.[], the Delaware Supreme Court described two scenarios in which a stockholder could be found a controller under Delaware law: where the stockholder (1) owns more than 50% of the voting power of a corporation or (2) owns less than 50% of the voting power of the corporation but 'exercises control over the business affairs of the corporation.'"[42] A plaintiff may plead that a minority stockholder exercises control over the business affairs of the corporation even if only "with regard to the particular transaction that is being challenged."[43] Before the Challenged Transactions, Steel Holdings owned 35.62% of the Company's shares, so the parties appropriately focus on the second scenario.

         The "'actual control' test requires the court to undertake an analysis of whether, despite owning a minority of shares, the alleged controller wields 'such formidable voting and managerial power that, as a practical matter, it is no differently situated than if it had majority voting control.'"[44] "Making this showing is no easy task, as the minority blockholder's power must be so potent that it triggers the traditional Lynch concern that independent directors' free exercise of judgment has been compromised."[45] "[T]he scatter-plot nature of the [Court's previous] holdings highlights the importance and fact-intensive nature of the actual control factor."[46] But at bottom, the plaintiff must show only that it is reasonably conceivable the minority stockholder is a controller.[47]

         Finally, a note about timing. This Court has not often had to identify the precise moment when a stockholder assumed or wielded control, or decide whether a change in board composition caused a controller to lose control. In this case, the parties select a time that helps their arguments when taking Bergamo's September 29, 2017 passing into account. Defendants argue the relevant time is when the Special Committee approved the Challenged Transactions on December 15.[48]Plaintiff argues Steel Holdings was a controller throughout all relevant time periods, but suggests that if the Court must select one time to evaluate the transaction, that moment should be September 8, 2017, when the Special Committee was created.[49]

         The Delaware Supreme Court's recent decision in Olenik v. Lodzinski[50] provides guidance. There, in deciding whether a majority stockholder who fell below 50% ownership during the negotiating period remained a controlling stockholder, the Supreme Court concluded the analysis should focus on when "substantive economic negotiations took place that fixed the field of play for the eventual transaction price."[51] Here, the key economic negotiations started at least in early September, when the board created the Special Committee and started negotiating the terms of the Preferred Stock. Still, because context matters, this opinion analyzes Steel Holdings' influence throughout the relevant period, including how it changed over time.

         1. Steel Holdings Controlled The Company As Of August 2017.

         Plaintiff focuses on three aspects of Steel Holdings' influence over the Company. The first is its stock ownership of 35.62%. The second is Steel Holdings' ability to appoint Company directors. The third is its control over the Company's management. Steel Holdings replaced the Company's management with alleged affiliates in June 2016, and the Company paid an affiliated entity significant funds every month under the Management Services Agreement. Together, these sources of influence make it reasonably conceivable Steel Holdings was a controlling stockholder entering August 2017.

         First, the 35.62% stake in the Company is not enough on its own, [52] but it is "a large enough block of stock to be the dominant force in any contested election."[53]Indeed, Steel Holdings used its stock purchases to secure a settlement agreement that allowed it to purchase additional shares and obtain clout over the board: in early 2013 it replaced two of the five incumbents, and increased the board to seven by adding Lichtenstein and Kassan. Later that year, Lichtenstein successfully recommended that Bergamo, also a director at Steel Holdings, join the board. Defendants concede Lichtenstein is not independent of Steel Holdings. Plaintiff has alleged extensive connections between Kassan and Steel Holdings that, for reasons explained below in the context of demand futility, also impair his ability to act independently of Steel Holdings.

         Lastly, the parties dispute Bergamo's independence.[54] That is not the question that informs whether Steel Holdings is a controlling stockholder.[55] "Lack of independence focuses on the director, and whether she has a conflict in the exercise of her duty on behalf of her corporation. Consideration of controller status focuses on the alleged controller, and whether it effectively controls the board of directors so that it also controls disposition of the interests of the unaffiliated stockholders."[56]In considering Steel Holdings' control at the Company, what matters is its ability to control who joined the board. The Company's disclosure on this point is clear: "Mr. Bergamo's nomination was recommended by Mr. Lichtenstein, the Company's Chairman of the Board."[57]

         Finally, Steel Holdings increasingly influenced management. It signed the Management Services Agreement whereby the Company paid a Steel Holdings affiliate to provide services. And the Company's top executives were also Steel Holdings affiliates: Lichtenstein acted as interim CEO until Henderson and Balardi, who also have connections to Steel Holdings, took the executive positions of CEO and CFO in 2016. In the period before the IWCO transaction, Howard and Fejes acted as "de facto investment bankers" for the Company, as "[t]hey found the IWCO merger opportunity, went out there and rounded up the financing, did the negotiating and the like."[58] This hands-on work further supports the conclusion that Steel Holdings had "day-to-day managerial supremacy" over the Company as of August 2017.[59]

         The gestalt of Steel Holdings' stock ownership, influence over the board, and influence over management makes it reasonably conceivable that it exercised control over the Company's business affairs entering August 2017, when the Company began negotiating the IWCO acquisition, such that it owed fiduciary duties.

         2. Steel Holdings Appears To Exercise Control Leading Up To The Challenged Transactions And Over Their Approval.

         On September 8, 2017, the board met to consider the deal to acquire IWCO and its financing, and appointed the Special Committee to review Steel Holdings' financing component. On September 29, as the Company was moving forward with the transaction, Bergamo passed away. Thus, as of September 29, three of the Company's five directors were independent and unaffiliated with Steel Holdings. Based only on that fact, especially in light of Plaintiff's insistence that Bergamo was not independent from Steel Holdings, Steel Holdings' influence would appear to decrease leading up to the approval of the Challenged Transactions. But other data points show the opposite.

         First, Steel Holdings affiliates were involved in the IWCO transaction. Howard, a Steel Holdings affiliate and eventual board nominee, attended the September 8 board meeting. At that time, Howard had no position at the Company. His only connection was to Steel Holdings. The minutes from that meeting show the board only discussed two topics: (1) whether the board should appoint a Special Committee, and (2) management's update as to ongoing Company operations.[60]

         Second, the Company gave Howard and Fejes stock options worth $3.6 million and $1.2 million when they joined the board in December 2017 for "current and future services to the Company, "[61] apparently in the form of facilitating the IWCO transaction as described above. The fact that the Company compensated two Steel Holdings individuals for arranging the IWCO transaction supports the conclusion that Steel Holdings controlled that transaction.

         Finally, Fejes and Howard joined the board on the same day the board approved the IWCO transaction. As when Lichtenstein, Kassan, and Bergamo joined the board, the December additions indicate Steel Holdings had control over who joined the board.[62] Whether Fejes and Howard joined the board before or after it approved the Challenged Transactions, and whether they participated in the vote, remain to be seen. According to the Steel Holdings Defendants' briefing, the Special Committee approved the Challenged Transactions "at a time when the independents were a majority (three of five) of the board."[63] At argument, the Steel Holdings Defendants clarified that the full board approved the Challenged Transactions after the Special Committee had approved them.[64] Plaintiff alleges all seven board members, including Fejes and Howard, approved the Challenged Transactions.[65]Plaintiff also points out that under the 2010 Plan, awards such as the Equity Grants could only be given to employees, consultants, or non-employee directors, so Fejes and Howard must have been directors on the day the transactions were approved to receive their grants. Thus, it is reasonably conceivable that Fejes and Howard were on the version of the board that approved the Challenged Transactions.[66] Under those facts, and as further discussed below in the context of demand futility, a majority of the directors were not disinterested and independent when the board approved the Challenged Transactions.

         Thus, even if control is analyzed as of December 2017, when the board approved the Challenged Transactions, it is reasonably conceivable that Steel Holdings was a controlling stockholder, and that it exercised actual control over the Company for purposes of the IWCO acquisition.

         C. Plaintiffs Claims Are Solely Derivative, And The Gentile Exception Does Not Apply.

         Plaintiff alleges both direct (Counts I, III, V) and derivative claims (Counts II, IV, VI) asserting the board and Entity Defendants breached their fiduciary duties in approving the Challenged Transactions.[67] Tooley v. Donaldson, Lufkin & Jenrette, Inc. governs whether a claim is direct or derivative.[68] The inquiry "must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?"[69] "[A] court should look to the nature of the wrong and to whom the relief should go."[70] "Where all of a corporation's stockholders are harmed and would recover pro rata in proportion with their ownership of the corporation's stock solely because they are stockholders, then the claim is derivative in nature."[71] By contrast, a stockholder pleads a direct claim if he "demonstrate[s] that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation."[72]

         Appropriately, Plaintiff does not argue his claims are direct under Tooley. "In the typical corporate overpayment case, a claim against the corporation's fiduciaries for redress is regarded as exclusively derivative, irrespective of whether the currency or form of overpayment is cash or the corporation's stock."[73] In such situations, "any dilution in value of the corporation's stock is merely the unavoidable result (from an accounting standpoint) of the reduction in the value of the entire corporate entity, of which each share of equity represents an equal fraction."[74]

         Plaintiff instead argues "[t]he Preferred Stock and Equity Grants fall squarely within the unique circumstances that give rise to dual-natured claims espoused by the Delaware Supreme Court in" Gentile v. Rossette.[75] In Gentile, our Supreme Court stated that there "is at least one transactional paradigm-a species of corporate overpayment claim-that Delaware case law recognizes as being both derivative and direct in character."[76] Claims are treated as "both derivative and direct" if:

(1) a stockholder having majority or effective control causes the corporation to issue "excessive" shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding shares owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders.[77]

         In El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, the Supreme Court indicated that Gentile should be applied cautiously, and "decline[d] the invitation to further expand the universe of claims that can be asserted" dually.[78] Chief Justice Strine concurred and went further, describing Gentile as "difficult to reconcile with traditional doctrine" and viewing the Supreme Court's refusal "to extend Gentile to the alternative entity arena" as "implicitly recogniz[ing] that Gentile undercuts the clarity and coherence that Tooley brought to the determination of what claims are derivative."[79]

         Since El Paso, this Court has handled Gentile claims carefully.[80] One of those decisions, Klein v. H.I.G. Capital, L.L.C., guides the analysis in this case.[81] Klein also dealt with the issuance of preferred stock. The alleged controlling stockholder there purchased $310 million worth of Series A preferred stock from the corporation.[82] "[T]he gravamen of the Complaint [was] that [the alleged controller] paid less than fair value to the Company to acquire the Preferred Stock."[83] That claim was "a classic form of an 'overpayment' claim" because it challenged "the fairness of the consideration paid for the Preferred Stock given its terms."[84]

         Chancellor Bouchard concluded Gentile did not apply to the issuance of the preferred stock, "particularly in light of the Supreme Court's recent El Paso decision."[85] Even though the preferred stock "would have resulted in a dilution of the minority stockholders' voting power," "the critical point" was that the minority stockholders were not diluted in the same way as those in Gentile "because they retained the same percentage of the Company's shares of common stock after the Preferred Stock was issued as they had before."[86] The harm came not from dilution, but from the "issuance of a different type of security (the Preferred Stock) whose terms allegedly should have commanded a higher price than was paid."[87] "The benefit of any recovery to remedy this alleged harm logically would go to the Company rather than any specific stockholder(s) and thus the underlying legal theory is plainly derivative in nature."[88]

         In this case, the allegations about the Preferred Stock are nearly identical and so warrant the same conclusion as Klein. Because Gentile does not apply here, Plaintiff's claims concerning the Preferred Stock are properly analyzed as derivative.

         The same is true for the approval of the Equity Grants. It is not clear that the Grants even satisfy the first prong of Gentile because there is no exchange of shares for assets of the controlling stockholder that have a lesser value. The Equity Grants were for "current and future services to the Company."[89] Lawsuits challenging such "excessive payments of corporate funds" are also traditionally derivative, [90] as under Tooley any loss was experienced by, and any recovery would go to, the corporation.[91] The claim is derivative, and in light of El Paso, I will not extend Gentile to the Equity Grants. Plaintiff's direct claims of breach of fiduciary duty in Counts I and V are dismissed.

         D. Demand Is Excused.

         "A cardinal precept of the General Corporation Law of the State of Delaware is that directors, rather than shareholders, manage the business and affairs of the corporation."[92] This applies to "[t]he decision whether to initiate or pursue a lawsuit on behalf of the corporation."[93] "Recognizing, however, that directors and officers of a corporation may not hold themselves accountable to the corporation for their own wrongdoing, courts of equity have created an ingenious device to police the activities of corporate fiduciaries: the shareholder's derivative suit."[94] Because a derivative action "impinges on the managerial freedom of directors" to control that litigation, the Court conducts a threshold inquiry to determine whether the derivative action is appropriate.[95] "Accordingly, in order to cause the corporation to pursue litigation, a [stockholder] must either (1) make a pre-suit demand by presenting the allegations to the corporation's directors, requesting that they bring suit, and showing that they wrongfully refused to do so, or (2) plead facts showing that demand upon the board would have been futile."[96]

         The demand requirement "insure[s] that a stockholder exhausts his intracorporate remedies, "[97] "provide[s] a safeguard against strike suits, "[98] and "assure[s] that the stockholder affords the corporation the opportunity to address an alleged wrong without litigation and to control any litigation which does occur."[99]"[T]he demand requirement and the strict requirements of factual particularity under Rule 23.1 'exist to preserve the primacy of board decisionmaking regarding legal claims belonging to the corporation.'"[100] Any attempt to plead demand futility "must comply with stringent requirements of factual particularity" required by Rule 23.1, which are "not satisfied by conclusory statements or mere notice pleading."[101]

         Plaintiff did not make a demand before bringing his derivative claims (Counts II, IV, and VI), and alleges doing so would have been futile. "Under Delaware law, depending on the factual scenario, there are two different tests for determining whether demand may be excused: the Aronson test and the Rales test."[102] This Court has discussed the differences between those tests (or lack thereof) at length in other decisions.[103] Here, the parties agree Aronson applies.[104] "Under the familiar Aronson test, to show demand futility, plaintiffs must provide particularized factual allegations that raise a reasonable doubt that '(1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.'"[105]

         "[D]emand futility analysis is conducted on a claim-by-claim basis."[106] I turn first to Plaintiff's claim that the board breached their fiduciary duties in approving the Preferred Stock, and then to the Equity Grants.

         1. Demand Is Excused Concerning The Preferred Stock.

         Plaintiff focused his arguments that demand is excused on the disinterestedness and independence of the board.[107] "At the pleading stage, a lack of independence turns on 'whether the plaintiffs have pled facts from which the director's ability to act impartially on a matter important to the interested party can be doubted because that director may feel either subject to the interested party's dominion or beholden to that interested party.'"[108] "Independence is a fact-specific determination made in the context of a particular case. The court must make that determination by answering the inquiries: independent from whom and independent for what purpose?"[109] Here, the inquiry is whether each director is independent from Steel Holdings for the purpose of evaluating a demand relating to the Preferred Stock.

         Defendants have conceded that Lichtenstein, Howard, and Fejes were not independent and disinterested with respect to either the Preferred Stock or the Equity Grants.[110] This gives Plaintiff three of the four directors he must compromise to show demand would have been futile.

         Fenton, Lengyel, and Wald are the three members of the Special Committee. Plaintiff asserts only a conclusory challenge to their independence and disinterestedness. Plaintiff alleges that "they face a substantial likelihood of liability for having improperly approved" the Challenged Transactions.[111] But "the fact that a director previously approved a challenged transaction is one of many factors that 'standing alone' or 'without more' will not call into question a director's ability to consider a demand."[112] Nor is it enough that the members of the Special Committee received a $25, 000 fee for their services. Plaintiff has not shown that was a material amount.[113] Plaintiff has not raised a reasonable doubt about these directors' independence.

         That leaves Kassan, the seventh and final director, as the director that will tip the scales for demand futility. Kassan's connections to Steel Holdings, apart from his roles at the Company, date back to 1999 and are set forth in the following chart.

Steel Holdings Affiliate

Position(s)

Steel Services

Employee

Current

HNH

CEO

Oct. 2005 - Dec. 2012

Vice Chairman of Board of Directors

Oct. 2005 - May 2015

Member of Board of Directors

July 2005 - May 2015

SL Industries

Member of Board of Directors

Jan. 2002 - June 2016

President

Feb. 2002 - Aug. 2005

Chairman of Board of Directors

May 2008 - June 2016

Interim CEO

June 14-29, 2010

Interim CFO

June 14 - Aug. 30, 2010

Web Financial Corporation (predecessor to Steel Holdings)

Vice President

June 2000 - Apr. 2007

CFO

June 2000 - Apr. 2007

Secretary

June 2000 - Apr. 2007

         At the Company, Kassan was one of the first directors Steel Holdings nominated to the board in 2013 under the settlement agreement. He became Vice Chairman of the Company's board in May 2014, and served as Chief Administrative Officer between May 2014 and January 2015. He is considered "a member of the Section 13(d) group"[114] along with Lichtenstein, Howard, and Fejes, HNH, and numerous other Steel Holdings affiliates.[115] The Company has disclosed that he is "affiliated with Steel Holdings, "[116] and warned he may face conflicts of interest with Steel Holdings.[117] He was not an independent director under NASDAQ rules. As of December 2017, Kassan's "principal occupation" was "serving as an employee of Steel Services, Ltd., a subsidiary of Steel Holdings." [118]

         The parties dispute Kassan's recent history with Steel Holdings. Plaintiff's Complaint alleges Kassan's recent roles to be only his seat on the board, his role with SL Industries that ended in June 2016, and his continued employment by Steel Services. At argument, defendants argued Kassan was "semiretired," that his connections to Steel Holdings varied in duration but generally ended in 2016, and that Plaintiff did not allege "he is someone who is now drawing significant amounts of his livelihood from" Steel Holdings.[119] This led to competing letters after argument.[120] Plaintiff points out that the Schedule 13D filed on March 7, 2019, reiterated the previously disclosed facts that Kassan is "an employee of a subsidiary of Steel Holdings" and that his "principal occupation" was still "serving as an employee of Steel Services, Ltd., a subsidiary of Steel Holdings."[121] The Steel Holdings Defendants responded that Kassan left "full-time employment in 2015" and since that time

his responsibilities at Steel Services, Ltd., have involved responding to requests from the companies with which he had served in the past, and providing information and insights drawing on his experience. He is paid the minimum necessary to enable him to participate in Steel Services' medical plan: $23, 659.92 gross pay in 2018.[122]

         This information was not in the record or the Company's public filings.

         For purposes of defendants' motion to dismiss, even under Rule 23.1, Plaintiff is entitled to all reasonable inferences from facts that are pled or subject to judicial notice. On those facts, Plaintiff has sufficiently alleged that Kassan would not be disinterested and independent in evaluating a demand concerning the Preferred Stock. As listed above, Kassan has had numerous roles, including roles such as CEO, President, and CFO that warrant significant compensation, for four entities within the Steel Holdings family. According to public disclosures, as of both December 2017 and March 2019, his "principal occupation" was working for Steel Services, which is the Steel Holdings affiliate that provides the Company services under the Management Services Agreement.

         The Preferred Stock increased Steel Holdings' ownership in the Company. The nature and number of roles Kassan has had with Steel Holdings and its affiliates, and the length of his service, create a reasonable doubt as to his independence for evaluating whether to pursue claims related to the Preferred Stock. As a result, the scales tip in Plaintiff's favor. Demand was futile, and so excused, for the claims challenging the issuance of the Preferred Stock.

         2. Demand Is Excused Concerning The Equity Grants.

         To Plaintiff, the Equity Grants are both unfair and a violation of the 2010 Plan. Like the Preferred Stock, the Equity Grants were given to Steel Holdings affiliates. The Equity Grants, together with the Preferred Stock, gave Steel Holdings and its affiliates majority voting control of the Company. Under the first prong of Aronson, demand for Plaintiff's claim that the board breached their fiduciary duties in approving the Equity Grants is excused. For the reasons stated above, four of the seven members of the board (Fejes, Howard, Kassan, and Lichtenstein) cannot impartially consider whether to pursue claims relating to the Equity Grants.

         Another aspect of Plaintiff's claim concerning the Equity Grants implicates the second prong of Aronson. Plaintiff alleges the Director Defendants breached their fiduciary duties by approving and/or accepting the Equity Grants in knowing violation of the 2010 Plan. He cites Pfeiffer v. Leedle[123] and Sanders v. Wang[124] to argue the decision to award the Equity Grants in violation of the 2010 Plan was not the product of a valid exercise of business judgment. "The business judgment standard is not appropriate, and demand will be excused . . . when a plaintiff pleads particularized facts that indicate that the board knowingly or deliberately failed to adhere to the terms of a stock incentive plan."[125] "One way that a plaintiff can allege sufficiently a knowing and deliberate failure on the part of a board is by demonstrating that the alleged action was a clear and unambiguous violation of the company's stock incentive plan."[126] Defendants contend Plaintiff has not shown that the board violated an unambiguous provision, or that the violation was knowing or deliberate.

         Plaintiff believes the Equity Grants violated the 2010 Plan because they exceeded the number of Full Value Awards the 2010 Plan permitted. The issue turns on an interpretation of Section 3.1 of the 2010 Plan. For ...


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