July 1, 2010
ALAN R. KAHN, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS-APPELLANTS,
STEPHEN H. RUSCKOWSKI, CLEMENT REVETTI, JR., GREGORY M. SEBASKY, SCOTT M. WEISENHOFF, MARK E. SCHWARZ, BRIAN O'DONOGHUE, WARREN E. PINCKERT II, EDWARD SIEGEL, MEDQUIST, INC. AND KONINKLIJKE PHILIPS ELECTRONICS N.V., DEFENDANTS-RESPONDENTS.
On appeal from the Superior Court of New Jersey, Chancery Division, Burlington County, Docket No. C-0007-08.
NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION
Argued September 24, 2009
Before Judges Skillman, Fuentes and Simonelli.
Plaintiff Alan R. Kahn appeals from the November 21, 2008 Chancery Division order granting defendants' motion to dismiss his amended complaint pursuant to Rule 4:6-2(e) for failure to state a claim upon which relief can be granted. We affirm in part, reverse in part and remand for further proceedings.
Plaintiff is a minority shareholder in defendant MedQuist, Inc. (MedQuist), a publicly-traded New Jersey corporation and "provider of medical transcription technology and services... [to] health systems, hospitals and large group medical practices throughout the United States."
Defendant Koninklijke Philips Electronics N.V. (Philips) owned approximately seventy percent, or over twenty-six million shares, of MedQuist's common stock. A "Governance Agreement" between Philips and MedQuist required, in part, that MedQuist's Board of Directors (Board) shall consist of eleven directors: MedQuist's Chief Executive Officer; a MedQuist Officer designated by MedQuist's Chief Executive Officer; six directors designated by Philips, "all of whom may be directors, officers, employees, [a]ffiliates or [a]ssociates of [Philips]" (Philips Directors); and three directors not affiliated with Philips (Independent Directors).
The Governance Agreement also established a "Supervisory Committee" whose responsibilities included "the general oversight, administration, amendment and enforcement... of any other agreements or arrangements between [MedQuist]... and [Philips]... which would be required" to be disclosed to the Securities and Exchange Commission (SEC). The Supervisory Committee had to include the Independent Directors.
In 2004, MedQuist became embroiled in a controversy involving client overbilling, which resulted in several lawsuits. Also, as a result of MedQuist's inability to timely file its 2003 Annual Report with the SEC, NASDAQ, the securities exchange listing the stock, de-listed MedQuist's common shares.
On July 6, 2007, Philips publicly announced that it viewed its MedQuist ownership interest as a non-core holding and was reviewing options with respect thereto. In view of this announcement, on July 11, 2007, MedQuist publicly announced that the Board had retained Bear, Stearns & Co., Inc. (Bear Stearns) to advise it on strategic alternatives for the company.
On November 2, 2007, Philips publicly announced its decision to sell its entire interest in MedQuist "if a satisfactory price and other acceptable terms can be realized." Philips also announced its intention to pursue a transaction in which MedQuist's other shareholders will be offered the same consideration as Philips, subject to any necessary approval of the [Board]. Accordingly, Philips intends to coordinate with MedQuist in conducting an auction for such sale with all interested potential purchasers. However, there can be no full assurance as to either the ultimate structure of any resulting transaction or whether any transaction will occur.
That same day, in light of Philips's decision to sell its MedQuist shares, MedQuist publicly announced its intent to evaluate whether a sale of the entire company was in MedQuist's and the minority shareholders' best interests.
A November 8, 2007 amendment to the Governance Agreement reduced the Board to seven members. The Board now consisted of four Philips Directors, defendants Stephen H. Rusckowski, Clement Revetti, Jr., Gregory M. Sebasky, and Scott M. Weisenhoff,*fn1 and three Independent Directors, N. John Simmons, Jr., Richard H. Stowe, and John H. Underwood. MedQuist appointed the Independent Directors to a "Special Committee," which it established to evaluate any proposals MedQuist received regarding the sale of the company, and to recommend to the Board whether to accept or reject those proposals.
On November 9, 2007, the Board publicly announced that the Independent Directors/Special Committee members had resigned due to a disagreement about their role "in the conduct of the [e]valuation [of the sale of MedQuist] and any resulting sale process resulting from the [e]valuation[.]" Shortly thereafter, the Board appointed defendants Mark E. Schwarz, Brian O'Donoghue and Warren E. Pinckert, II as Independent Directors/Special Committee members.
Plaintiff alleged that the sale of MedQuist was not in the minority shareholders' best interests. Accordingly, on January 22, 2008, he filed a complaint individually and on behalf of the minority shareholders*fn2 against the Philips Directors, Philips and MedQuist alleging breach of the fiduciary duties of good faith, fair dealing, loyalty and due care.
Thereafter, the Board received several proposals, which it submitted to Bear Stearns for review, including one from CBaySystems Holdings Ltd. (CBay). The CBay proposal contained two components:
[CBAY would] either acquire 100% of [MedQuist] at the same per share price and on substantially the same terms as offered to Philips or... acquire up to 100% of [MedQuist] in a merger transaction which offered the shareholders of [MedQuist] other than Philips the option to receive either the same consideration offered to Philips or to remain shareholders of [MedQuist]. [(Emphasis added).]
Plaintiff refers to the second component, which is at issue here, as the "Premium Option Proposal" because the price offered per share to Philips ($11) allegedly exceeded the then stock market price ($7.50) by forty-six percent.
On May 22, 2008, MedQuist publicly announced the Board's rejection of all proposals, including the CBay proposal. MedQuist stated that "[i]n light of the [Special Committee's] determination... that it could not favorably recommend any of the proposals received because the consideration offered was insufficient for a sale of [MedQuist] based, among other things, on information provided by [Bear Stearns], the [Board] decided not to proceed with any of the proposals received." MedQuist also announced Philips's agreement with CBay to sell its MedQuist shares for $11 per share.*fn3 Defendant Edward Siegel did not deliberate or vote on the matter because he had not yet been appointed to the Board.*fn4
Plaintiff filed an amended complaint on June 12, 2008, adding Schwarz, O'Donoghue, Pinckert and Siegel as defendants. He alleged generally that, except for Siegel, they breached their fiduciary duties of undivided loyalty, independence or due care by rejecting the Premium Option Proposal, thus "prevent[ing the minority] shareholders from deciding for themselves whether to accept the 46% premium for their shares or remain shareholders of MedQuist."
As to Schwartz and O'Donoghue, plaintiff alleged that because Schwarz is the sole general partner of an entity owning over two million MedQuist shares representing approximately 7.1% of MedQuist's total outstanding shares, and because O'Donoghue is a founder and managing member of an entity owning over five hundred thousand MedQuist shares representing approximately 1.5% of MedQuist's total outstanding shares, they rejected the Premium Option Proposal in order to protect their own positions by preventing other minority shareholders from electing to accept that proposal. According to plaintiff, Schwarz and O'Donoghue "faced the very real risk that a sufficiently large number of [minority] shareholders would [choose] to sell at the premium $11 per share price, such that CBay would own 90% or more of MedQuist[,]" entitling it to "effect a short form merger pursuant to [N.J.S.A.] 14A:10-7 and squeeze-out the minority interest and acquire 100% of... MedQuist without any shareholder approval[,]" or they "faced the prospects of an increasingly illiquid stake for their substantial holdings."
As to Rusckowski, Revetti, Sebasky, Weisenhoff and Siegel, plaintiff alleged that they were "beholden to Philips and [unable to] act with undivided loyalty to [the minority] shareholders." As to Philips, plaintiff alleged that it had financial incentives to swiftly complete the transaction with CBay, and that the Philips Directors were "aligned with Philips" in preventing any delay that acceptance of the Premium Option Proposal might pose.
As to Pinckert, who owned no MedQuist shares and had no financial stake in the matter, plaintiff alleged that he "sided with Schwarz and O'Donoghue and has likewise prevented shareholders from deciding for themselves whether to accept the Premium Option Proposal." He also cited Pinckert's "continued receipt of lucrative Board fees and other valuable perquisites" as the basis of self-interest. As to Siegel, plaintiff merely alleged that he "ratified the [Board's] decision [to reject the Premium Option Proposal] through his inaction."
Although alleging no specific breach of fiduciary duty by MedQuist and Philips, plaintiff joined Philips as a defendant, alleging that as the majority shareholder it owed a fiduciary duty to the minority shareholders, which it breached through the actions of the Philips Directors. Plaintiff joined MedQuist as a defendant because the injunctive relief he sought may entail a merger transaction to which it would be a necessary party.
Defendants filed a motion to dismiss pursuant to Rule 4:6-2(e) for failure to state a claim upon which relief can be granted contending, in part, that plaintiff's breach of fiduciary duty claim is derivative, and that plaintiff failed to plead either that he made a demand on the Board or that such a demand would have been futile, as required by Rule 4:32-3. Alternatively, defendants contended that plaintiff failed to allege facts supporting his breach of fiduciary duty claim, and that they are shielded from liability by an exculpatory clause in MedQuist's Amended and Restated Certificate of Incorporation, which limits the Board's personal liability for damages for breach of any fiduciary duty, and by the business judgment rule based on their reliance on Bear Stearns.
The trial judge granted the motion to dismiss, concluding that this is a derivative action because plaintiff failed to allege that he suffered either a "special injury" not suffered by all shareholders or a wrong involving his contractual rights as a shareholder. The judge noted that the Premium Option Proposal "was an opportunity that never materialized, such that no [minority] shareholder was allowed the option of accepting a financial premium for their shares or else to retain their ownership of same."
The judge also found that plaintiff failed to make a demand on the Board to bring suit on MedQuist's behalf or that the Board refused to do so, as required by Rule 4:32-3, and that plaintiff failed to allege facts justifying that any such demand, if made, would have been futile. Accordingly, the judge concluded that plaintiff could only proceed with a derivative action if he presented specific and compelling facts to rebut the presumption of the business judgment rule, which he found plaintiff failed to do. The judge stated that it is undisputed that the... Board assigned the task of reviewing the CBay [proposal], in its entirety, to the [Special] Committee, who in turn acted upon the advice of [Bear Stearns] to recommend that the [proposal] be rejected. Although there is always an opportunity for impropriety or self-dealing in a process as complex as this, [p]laintiff has failed to identify any such occurrence within the subject transactions. Instead, [p]laintiff has suggested hypothetical motivations that, at best, could indirectly benefit the individual [defendants]. By way of illustration, [p]laintiff does not plead particularized facts that would sustain a reasonable belief that Philips improperly influenced the Philips Directors to reject the CBay [proposal] in order to expedite its own negotiations. Therefore, the...
Board, in its entirety, is entitled to the presumption that it acted in the best interests of [MedQuist]. Once the CBay [proposal] was voted down, the Board had no continuing obligation to revive it or to facilitate that offer.
Finally, the judge concluded that plaintiff made no allegations regarding either a fiduciary duty owed by MedQuist to its shareholders or a breach of such duty. The judge did not address the exculpatory clause or the business judgment rule. This appeal followed.
Our review of a dismissal for failure to state a claim pursuant to Rule 4:6-2(e) is de novo, following the same standard as that of the trial court. Donato v. Moldow, 374 N.J. Super. 475, 483 (App. Div. 2005). "Thus, like the trial court, [we] must accept as true the facts alleged in the complaint, and credit all reasonable inferences of fact therefrom, to ascertain whether there is a claim upon which relief can be granted." Malik v. Ruttenburg, 389 N.J. Super. 489, 494 (App. Div. 2008).
In evaluating such a motion, "courts are cautioned to search the complaint 'in depth and with liberality to ascertain whether the fundament of a cause of action may be gleaned even from an obscure statement[,]'" Banco Popular No. America v. Gandi, 184 N.J. 161, 165 (2005) (quoting Printing Mart-Morristown v. Sharp Elecs Corp., 116 N.J. 739, 746 (1989)), particularly if further discovery is taken.'" Id. at. 183 (quoting Pressler, Current N.J. Court Rules, comment 4.1 on R. 4:6-2 (2005)). However, the complaint must state "the facts on which the claim is based," R. 4:5-2, rather than relying on conclusory allegations or the assertion that "essential facts that the court may find lacking can be dredged up in discovery." Printing Mart, supra, 116 N.J. at 768; R. 4:5-2.
Applying these standards, we conclude that the judge improperly found this to be a derivative action. "Under the [New Jersey Business Corporation Act, N.J.S.A. 14A:1-1 to 16-4], shareholders may not bring derivative actions except in compliance with statutory requirements and Rules of Court." Strasenburgh v. Straubmuller, 146 N.J. 527, 550 (1996) (citing N.J.S.A. 14A:11-7, R. 4:32-5). However, under the "special injury" exception, a shareholder may bring an individual action "'where there is a wrong suffered by [a] plaintiff that was not suffered by all stockholders generally or where the wrong involves a contractual right of the stockholders, such as the right to vote.'" Ibid. (quoting In re Tri-Star Pictures, Inc., 634 A.2d 319, 330 (Del. 1993)).
"To determine whether a complaint states a derivative or an individual cause of action, courts examine the nature of the wrongs alleged in the body of the complaint, not the plaintiff's designation or stated intention." Id. at 551. Breach of fiduciary duty claims against directors are "generally regarded as derivative claims unless the injury to shares is distinct." Id. at 552. "If the breach of duty causes a 'special injury,' shareholders may sue directly. For example, claims against directors for the selective dissemination of information to one group of shareholders over another are not derivative in nature because the unfair dealing unequally affects shareholders that were deprived of the information." Ibid.
Examining plaintiff's allegations, we are satisfied that he alleges a "special injury" not suffered by MedQuist or all of its shareholders. Although CBay proposed to acquire up to one hundred percent of MedQuist's shares at the price per share offered to Philips, it only offered the Premium Option Proposal to shareholders "other than Philips," namely, the minority shareholders. Accordingly, defendants' alleged wrongful conduct caused injury only to the minority shareholders, who were allegedly deprived of the opportunity to decide whether to keep or sell their shares at a price forty-six percent higher than the stock market price, and for that reason, this is not a derivative action.
The question then is whether the complaint should be dismissed on any of the alternative grounds defendants raise: that plaintiff failed to state a cause of action that they breached a fiduciary duty to the minority shareholders, or that they are shielded from liability by the exculpatory clause or the business judgment rule.
Plaintiff admits that MedQuist neither breached a fiduciary duty nor committed any wrongdoing. Plaintiff merely alleges that because the Premium Option Proposal was a merger transaction, MedQuist is a necessary party to effectuate a possible injunction directing Philips and the Philips Directors to purchase the minority shareholders' shares on the same terms as the Premium Option Proposal. Except to cite an unpublished opinion from another jurisdiction, plaintiff cites no legal authority for such relief. Accordingly, the trial judge properly dismissed this case as to MedQuist.
Although not specifically mentioned by the judge, this case must also be dismissed as to Siegel and Pinckert. As to Siegel, "no liability can be imposed upon a director of a company for acts committed and completed by his co-directors prior to his coming into office." Solimine v. Hollander, 128 N.J. Eq. 228, 234 (Ch. 1940). Siegal did not vote to reject the Premium Option Proposal, and plaintiff alleges no facts that Siegel knew about that proposal either before or after its rejection.
Plaintiff alleges no facts evidencing any wrongdoing by Pinckert or any benefit Pinckert received from the rejection of the Premium Option Proposal. In fact, plaintiff argues on this appeal that the individual defendants, except Pinckert, breached their duty of loyalty to the minority shareholders.
We reach a different conclusion as to Philips and the remaining individual defendants. As to Philips, "[i]n general, there is no fiduciary relationship among stockholders."
D'Arcangelo v. D'Arcangelo, 137 N.J. Eq. 63, 67 (Ch. 1945). However, a majority shareholder owes minority shareholders a fiduciary duty to act fairly. Casey v. Brennan, 344 N.J. Super. 83, 107-08 (App. Div. 2001), aff'd, 173 N.J. 177 (2002); Dermody v. Sticco, 191 N.J. Super. 192, 196 (Ch. Div. 1983); Berkowitz v. Power/Mate Corp., 135 N.J. Super. 36, 45 (Ch. Div. 1975). A majority shareholder cannot use its powers for its own personal advantage and to the detriment of the minority stockholders. Ibid.
As to the remaining individual defendants, there is no dispute that, as Board members, they had a fiduciary duty to MedQuist and the minority shareholders. Casey, supra, 344 N.J. Super. at 108. "In light of their status as fiduciaries our law demands of directors utmost fidelity in dealing with a corporation and its stockholders." Ibid. They too must act fairly and cannot use their powers for their own personal advantage and to the detriment of the minority stockholders. Ibid.
[C]orporate officers and directors who engage in self-dealing transactions have a heavy burden of showing that they have not violated their fiduciary obligations to the minority stockholders. At a minimum their conduct is subject to a searching inquiry to determine whether it conforms to accepted concepts of fairness and equity. [Berkowitz, supra, 135 N.J. Super. at 49.]
To establish a breach of fiduciary duty on the part of Philips and the remaining individual defendants, therefore, plaintiff had to allege such facts as would demonstrate some basis for invoking the fairness obligation.
Plaintiff has alleged that Philips and the Philips Directors breached their fiduciary duty by rejecting the Premium Option Proposal in order to advance Phillips's interest in receiving expeditious payment for its MedQuist shares. Plaintiff has alleged that Schwarz and O'Donoghue rejected the Premium Option Proposal in order to protect the large portion of MedQuist shares they controlled through entities they managed from a short form merger or from the reduction in liquidity of those shares in the market. Accepting all of these facts as true, and affording plaintiff all reasonable inferences therefrom, we are satisfied that plaintiff has made factual allegations that Philips and the remaining individual defendants breached their fiduciary duty to the minority shareholders sufficient to withstand a Rule 4:6-2(e) motion to dismiss.
Whether the business judgment rule shields the individual defendants from liability is not ordinarily decided on a Rule 4:6-2(e) motion. Plaintiff is entitled to discovery on this issue prior to a court's ruling on the rule's applicability. Likewise, applicability of the exculpatory clause cannot be determined at this juncture, as the clause excepts "damages for any breach of duty based upon an act or omission (a) in breach of [a] director's duty of loyalty to [MedQuist] or the shareholders of [MedQuist], or (b) not in good faith or involving a knowing violation of laws, or (c) resulting in the receipt by such directors of an improper personal benefit." Whether or not the exculpatory clause shields defendants from liability, therefore, must abide the completion of discovery.
Affirmed in part, reversed in part, and remanded for further proceedings. We do not retain jurisdiction.