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ABRAMS v. KOETHER

May 29, 1991

BURTON R. ABRAMS, RICHARD N. ABRAMS, RODNEY A. ABRAMS AND BRIAN K. ABRAMS, PLAINTIFFS,
v.
PAUL O. KOETHER, NATALIE I. KOETHER, DAVID B. BLANCHARD, HENRY H. PORTER, JOHN GALUCHIE, JR., MYRON GELBACH, JR., MICHAEL WITTE, LLOYD KLATZKIN AND SHAMROCK ASSOCIATES, A LIMITED PARTNERSHIP, DEFENDANTS, V. TEXAS AMERICAN ENERGY CORPORATION, NOMINAL DEFENDANT.



The opinion of the court was delivered by: Lechner, District Judge.

    OPINION

This is a shareholder derivative action brought by shareholder plaintiffs Burton R. Abrams, Richard N. Abrams, Rodney A. Abrams and Brian K. Abrams (collectively, the "Plaintiffs") against defendants Paul O. Koether ("P. Koether"), Natalie I. Koether ("N. Koether"), David B. Blanchard ("Blanchard"), Henry H. Porter ("Porter"), John Galuchie, Jr. ("Galuchie"), Myron Gelbach, Jr. ("Gelbach"), Michael Witte ("Witte"), Lloyd Klatzkin ("Klatzkin"), current and former directors of Texas American Energy Corporation ("TAE"), Shamrock Associates, a Limited Partnership ("Shamrock") (collectively, the "Defendants") and nominal defendant TAE. Jurisdiction is based on diversity of citizenship pursuant to 28 U.S.C. § 1332.

The Defendants now move for summary judgment on the complaint on the ground that this complaint (the "1990 Complaint") fails to meet the pleading requirements of Fed.R.Civ.P. 23.1.*fn1 For the reasons which follow, partial summary judgment is granted and the 1990 Complaint is dismissed without prejudice under Fed.R.Civ.P. 23.1.

Facts

The Plaintiffs are Illinois residents who own shares of common stock of nominal defendant TAE. 1990 Complaint, ¶ 9. TAE is a Delaware corporation headquartered in Far Hills, New Jersey. 1990 Complaint, ¶ 10. It has over 7,000,000 shares of common stock outstanding which are publicly traded on NASDAQ. Id. Shamrock is a New Jersey limited partnership also headquartered in Far Hills, New Jersey. Id., ¶ 11. Shamrock owns approximately thirty-five percent of TAE's outstanding common stock. Id., ¶ 22.

The 1990 Complaint alleges that "[a]ll the [D]efendants are linked together by a host of familial, business and other ties . . .," and that they "are involved in a byzantine network of interlocking and overlapping business relationships." Id., ¶¶ 11, 23. Of especial importance for the purposes of this motion are the allegations as to dual allegiances by members of the TAE board of directors. It appears from the 1990 Complaint that the board underwent a change in composition in 1989. Therefore, the allegations as to dual allegiances are described first as to the members of the board as it existed in 1986, when the wrongdoing alleged in the 1990 Complaint was begun, and then as to members of the board as it existed in 1989 after the change in the board's membership.

In 1986, the TAE board consisted of P. Koether, Blanchard, Porter, Gelbach and Witte.*fn2 Of these five directors, four are alleged to have had dual allegiances to both TAE and Shamrock. The 1990 Complaint alleges P. Koether has been Chairman of the board of directors of TAE since 1986 and at all relevant times has been a general and limited partner of Shamrock. Id., ¶ 12.*fn3 The 1990 Complaint alleges Blanchard has been a director and officer of TAE since 1986 and at all relevant times has been a general partner of Shamrock. Id., ¶ 13. It alleges Gelbach was a director of TAE from 1986 to June 1989 and at all relevant times has been a general partner of Shamrock. Id., ¶ 14. In addition, it alleges that Porter was a director of TAE from 1986 through 1989 and is a limited partner of Shamrock. Id., ¶ 16. Witte, the fifth director on the board as it existed in 1986, is not alleged to have had any ties to Shamrock. However, he is alleged to have participated in the allegedly fraudulent 1986 takeover of TAE. See Id., ¶¶ 31-38; infra at 7-8.

It appears that in 1989, the TAE board of directors underwent a partial change in composition. In that year, Galuchie and Klatzkin were appointed to the board to replace Gelbach and Porter. Id., ¶¶ 15-17. Galuchie and Klatzkin are not alleged to have any ties to Shamrock. See id. However, Klatzkin is alleged to be a director and stockholder of Sun Equities Corp. ("Sun"). Id., ¶ 24.*fn4 Sun has a subsidiary named Edudata. Edudata owned one hundred percent of the shares of T.R. Winston ("TRW"), a retail brokerage firm. Id. In addition, Klatzkin is alleged to have owned a controlling interest in the American Physicians Service Group, Inc. ("APSGI") with P. Koether and "affiliate companies of the Defendants." Id., ¶ 27.*fn5 Klatzkin is alleged to have been on both sides of transactions between TAE and Sun and APSGI. See id., ¶¶ 78, 82; infra at 11-12. Galuchie is alleged to be employed by an "affiliate of a general partner of Shamrock." Id., ¶ 15. It is alleged that this affiliate received payment from TAE for services rendered by Galuchie. Id., ¶ 15. In addition, Galuchie is alleged to be both a director of Edudata and of TAE and to have been on both sides of a transaction by virtue of that fact. Id., ¶ 24.

The 1990 Complaint alleges that prior to the time the Defendants gained control of TAE, TAE consisted of two companies: its wholly-owned subsidiary Texas American Oil Corporation, a Texas-based oil and gas company incorporated in Delaware, and a regulated public utility, Western Kentucky Gas ("Western Kentucky"), which distributed and sold natural gas to more than 139,000 customers in western and central Kentucky. Id., ¶ 29. The 1990 Complaint alleges that TAE "had substantial operations and hundreds of employees." Id.

In 1986, defendants P. Koether, Blanchard, Galuchie, Gelbach, Porter, Witte and Shamrock, as well as Hecco Ventures ("Hecco"),*fn6 a California-based partnership which is not named as a defendant in the 1990 Complaint, allegedly mounted a successful hostile proxy fight for control of TAE under the rubric of the TAE Stockholders Protective Committee. Id., ¶ 32. As stated, Blanchard, P. Koether, Gelbach, Porter and Witte were elected in 1986 to TAE's board of directors. Id., ¶¶ 16, 38. N. Koether and her law firm became counsel to TAE. Id. The 1990 Complaint alleges that the Defendants now own a controlling interest in TAE through their respective ownership interests in Shamrock and their affiliates. Id., ¶ 22.

The 1990 Complaint alleges the Defendants engaged in misconduct in acquiring TAE and mismanaged TAE and engaged in self-dealing since acquiring control. It alleges that as a result, TAE was converted from "a valuable, regulated public utility into a corporate shell" with "virtually no operations and only six employees." Id., ¶¶ 3, 6. The 1990 Complaint alleges:

  Plaintiffs bring this action derivatively to
  enable and require TAE to recover from
  [D]efendants the damages TAE has sustained as a
  result of [D]efendants' and others' unlawful,
  pervasive and continuing plan, conspiracy or
  scheme to fraudulently seize control of TAE,
  convert its assets to cash and thereafter loot TAE
  for the benefit of defendants and their
  affiliates.

Id., ¶ 7.

The 1990 Complaint alleges the unlawful activity by the Defendants commenced with their allegedly fraudulent takeover of TAE. According to the 1990 Complaint, the Defendants disseminated false and misleading proxy materials to TAE's stockholders in connection with their hostile proxy fight for control of TAE. Id., ¶¶ 32-33. The 1990 Complaint lists the various ways in which the proxy materials were allegedly false or misleading and various material facts which were allegedly omitted. See id., ¶ 34.

In addition, the 1990 Complaint alleges various transactions the Defendants engaged in on behalf of TAE were wrongful and the product of self-dealing. It alleges that between October and December 1987, the Defendants caused TAE to sell Western Kentucky, TAE's primary asset, to their own financial benefit and to TAE's detriment. Id., ¶ 39. The 1990 Complaint alleges Western Kentucky was sold for approximately $61.5 million in cash, which was "more than sufficient to permit TAE to retire or restructure its approximately $13 million in bank debt." Id., ¶ 40. The Defendants allegedly solicited the consent of TAE shareholders for the sale of Western Kentucky through false and misleading proxy statements. The 1990 Complaint lists the ways in which the proxy statements were false or misleading. Id., ¶¶ 42-43.

The 1990 Complaint alleges that on 24 April 1987, the Defendants caused TAE to sell to Shamrock and Hecco 1,600,000 shares of TAE common stock for $1.25 per share when the stock was trading in the market at $1.44 per share. Id., ¶ 50. It is alleged that on 18 May 1988, the Defendants caused TAE to purchase 972,000 shares of its own stock from Hecco at $2.50 per share when the stock was trading in the market at approximately $1.62 per share. Id., ¶ 52.

Plaintiffs complain the Defendants forced TAE to participate in a "greenmail" transaction for the benefit of Shamrock and at the expense of TAE (the "Prime Transaction"). .The 1990 Complaint alleges that a group of the Defendants, including P. Koether, N. Koether, Blanchard, Gelbach and Shamrock, and others formulated a plan to gain control of a firm known as Prime Medical ("Prime"). Id., ¶ 53. By February 1987, this group owned seventeen percent of Prime's stock. Id. On 30 June 1987, Prime agreed to buy back 1,142,150 shares of its stock for $5.10 per share when the stock was then trading at $4.00 per share, allegedly to induce the Defendants to cease their efforts to gain control of Prime (the "Buyout"). Id., ¶¶ 54, 55. The transaction allegedly included the agreement that if the Buyout did not occur within a specified period of time, Shamrock would repurchase the shares from Prime at the same price, $5.10 per share. Prime's directors would then resign and be replaced by directors designated by the Defendants. Id., ¶ 56. N. Koether, Blanchard and Gelbach, general partners of Shamrock, allegedly personally guaranteed to Prime Shamrock's obligation to repurchase Prime's shares if the Buyout did not occur. Id., ¶ 57.

When the Buyout fell through, Prime allegedly exercised its right to require Shamrock to repurchase its shares. Id., ¶ 60. It is also alleged that Shamrock avoided incurring the cost of the repurchase, however, by forcing TAE to purchase 1.2 million Prime shares from Shamrock at $5.10 per share. Id., ¶ 63. Under this purchase agreement, TAE could "put" to Shamrock, or force Shamrock to buy back, the Prime shares between designated dates. Id., ¶ 71. The 1990 Complaint further alleges that on 24 October 1988, the Defendants caused TAE to enter into an agreement which gave the appearance that TAE was exercising the put. Id. It is contended that:

  In reality, however, instead of actually giving
  TAE's money back, [the D]efendants forced TAE to
  keep all of the Prime stock, and in fact, forced
  TAE to take even more Prime stock from Shamrock,
  the consideration for which was the purported
  termination of TAE's rights under the put of TAE's
  [Prime shares].

Id., ¶ 73 (emphasis in original).

Additional grievances include that the Defendants filed suit against Prime on 31 October 1988 for fraudulently and negligently overstating Prime's earnings in order to induce Shamrock to purchase Prime shares. Id., ¶ 69. The Plaintiffs complain that the "Defendants excluded TAE from any participation in [that] suit, despite the fact that TAE was the real party in interest." Id. In addition, the 1990 Complaint alleges the Defendants forced TAE to continue to acquire Prime stock. Id., ¶ 77. On 11 October 1989, the Defendants allegedly caused TAE to sell its shares of Prime stock to APSGI at a loss. Id., ¶¶ 27, 78. As stated, the 1990 Complaint alleges that at all relevant times, P. Koether and Blanchard were directors of APSGI and P. Koether and Klatzkin and affiliate companies of the Defendants owned a controlling interest in APSGI. Id., ¶ 27.

The 1990 Complaint alleges additional self-dealing by the Defendants by stating that on 12 September 1989 the Defendants caused TAE to acquire one hundred percent of the stock of TRW from its parent, Edudata, a subsidiary of Sun. Id., ¶¶ 82, 24.*fn7 As stated, P. Koether, N. Koether and Klatzkin are allegedly directors of Sun and Galuchie is allegedly a director of Edudata. Id., ¶ 24. In addition, the 1990 Complaint alleges TAE has paid N. Koether and the law firm with which she is affiliated approximately $2 million in legal fees incurred in "documenting, restructuring or implementing the self-dealing transactions described herein." Id., ¶ 83.

Plaintiffs contend it would be futile to demand action of TAE's directors in response to the grievances contained therein because:

  [a]t all times relevant hereto, TAE's Board of
  Directors has been dominated and controlled by
  self-interested director defendants. At no time
  relevant hereto has a majority of TAE's Board of
  Directors been disinterested with respect to the
  transactions complained of. . . . The transactions
  complained of herein were authorized by and
  ratified by the director defendants, who were at
  all times relevant hereto acting in their own
  self-interest and for their own fraudulent,
  self-dealing personal benefit.

Id., ¶ 91. Specifically, the 1990 Complaint states as the basis for its allegations of futility:

  (a) The Board of Directors of TAE has been, and
    is, comprised of a majority of directors who
    were and are directly and financially interested
    in the self-dealing transactions at issue;
  (b) The TAE Board is, and has been, dominated and
    controlled by one or more of defendants Koether,
    Blanchard, Gelbach, Galuchie, Porter, Witte*fn8
    and Klatzkin, who have or had a direct financial
    stake in the self-dealing transactions
    complained of. Board decisions on most of the
    matters complained of herein, or all of them,
    were unanimous;
  (c) To obtain relief for the wrongs alleged herein
    would require defendants to sue: (1) themselves,
    (ii) entities such as Shamrock in which they
    have a financial stake, or (iii) their families
    (such as Koether's wife Natalie), friends and
    business associates, which they will not do;
  (d) The defendants and TAE's Board have repeatedly
    and relentlessly acted in their own
    self-interest, as set forth herein, violating
    their duties of candor, loyalty and care, and
    there is no reason to suppose that they would
    now change their behavior;
  (e) The defendants enjoy in their capacities as
    directors of TAE a unique opportunity to enhance
    their own personal financial welfare which they
    are loath to relinquish or jeopardize; and
  (f) The transactions alleged herein are clearly
    not and could not possibly be the result of the
    exercise of reasonable business judgment.

Id., ¶ 92.

The Defendants move for summary judgment on the ground that the Plaintiffs have previously made demand for legal action on Defendants with respect to the grievances set forth in the 1990 Complaint, that the previous demand was refused by the TAE board of directors and that the instant lawsuit is therefore foreclosed under Delaware law, the state of TAE's incorporation.*fn9 In support of their motion, the Defendants submit a series of letters written between June 1988 and August 1989.

Contrary to the representation of the Defendants, the letters written between June and August 1988 are not demands for legal action by the TAE Board of Directors but requests for information. On 10 June 1988, Burton Abrams wrote a letter to Blanchard in which he complained of fees paid to N. Koether's law firm and of the Prime stock purchase. The letter closed by Blanchard requesting answers to a list of ten questions concerning the Prime stock purchase. See 10 June 1988 Abrams Letter to Blanchard. On 11 July 1988, Blanchard wrote a letter to Burton Abrams in which he defended the Prime stock purchase by stating it was structured such that TAE would reap any gain resulting from the purchase and Shamrock would absorb any loss. See 11 July 1988 Blanchard Letter to Abrams. On 29 July 1988, Burton Abrams wrote a second letter to Blanchard in which he characterized the 11 July 1988 letter as a "rehash of the literature embodied in [the] previous proxy releases" and in which he requested additional information concerning the "Matrix deal." 29 July 1988 Abrams Letter to Blanchard. On 2 August 1988, Blanchard wrote a letter to Burton Abrams in which he stated he believed he answered the questions posed by Burton Abrams and in which he offered to meet with him for further discussion. See 2 August 1988 Blanchard Letter to Abrams.

On 4 October 1988, Eldon L. Ham ("Ham"), the attorney for Burton Abrams and other TAE shareholders, wrote a letter to Blanchard on behalf of such shareholders in which he made a formal demand for action "against certain officers and directors of TAE who profited directly [or] indirectly from the Prime transactions." (the "4 October 1988 Demand"). See 4 October 1988 Ham Letter to Blanchard. The letter complained that the price paid by TAE for Prime stock, $5.10 per share, was not economically justified. Id. It further complained that the resulting loss was not mitigated by the put option, given that even if the put option ...


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