DCG & T ex rel. Battaglia/Ira v. Knight

• Decision Date: 18 December 2014
• Docket Number: Civil Case No. 3:14–cv–067–JAG.
• Citation: 68 F.Supp.3d 579
• Court: U.S. District Court — Eastern District of Virginia
• Parties: DCG & T, for the use and benefit of Jack BATTAGLIA/IRA, et al., Plaintiffs, v. Glade M. KNIGHT, et al., Defendants.

68 F.Supp.3d 579

DCG & T, for the use and benefit of Jack BATTAGLIA/IRA, et al., Plaintiffs

v.Glade M. KNIGHT, et al., Defendants.

Civil Case No. 3:14–cv–067–JAG.

United States District Court, E.D. Virginia, Richmond Division.

Signed Dec. 18, 2014.

Jeffrey Hamilton Geiger, Sands Anderson PC, Richmond, VA, Olimpio Lee Squitieri, Squitieri & Fearon LLP, New York, NY, Daniel Robert Lapinski, Kevin Peter Roddy, Wilentz, Goldman & Spitzer, P.A., Woodbridge, NJ, for Plaintiffs.

Jennifer Farer, Charles William McIntyre, Jr., McGuireWoods LLP, Washington, DC, Elizabeth Flannagan Edwards, Jeffrey Dean McMahan, Jr., McGuireWoods LLP, Richmond, VA, for Defendants.

MEMORANDUM OPINION

JOHN A. GIBNEY, JR., District Judge.

Three Virginia corporations that shared overlapping directors and managers merged into one corporation in March 2014. The shareholders of one of those corporations brought this suit against its directors and managers, complaining that the merger was the result of a flawed, conflicted, and ill-considered decision-making process and that the merger diluted the value of their shares. The shareholders ask the Court to find that the directors and managers breached their fiduciary duties to the corporation and shareholders and to undo the merger. The directors and managers filed this motion to dismiss under Federal Rule of Civil Procedure 12(b)(6).

In their amended complaint, the plaintiffs (collectively, “DCG & T”) allege several putative class and derivative claims arising from the merger of three Richmond-based real estate investment trusts (“REITs”): Apple REIT Nine, Inc. (“A9”), Apple REIT Eight, Inc. (“A8”), and Apple REIT Seven, Inc. (“A7”). After shareholder approval from each entity, A8 and A7 merged into A9.¹ DCG & T, which held shares of A9 at the time of the merger, alleges that A9's directors and officers violated Virginia corporate law when they breached their fiduciary duties to the company, engaged in a conflicted or affiliated transaction, and distributed proxy materials that contained material omissions or falsehoods.

DCG & T brings four counts, asserting both putative class and derivative claims and seeking both money damages and rescission of the merger. Count I alleges a direct class claim against the A9 Directors for breaches of the duty of loyalty and care. Count II alleges the same breach as a derivative action on behalf of A9 against the Directors. Count III alleges a direct class claim against the A9 Directors and Managers for breaches of the duty of loyalty and candor. Finally, Count IV alleges both direct and derivative claims in an effort to undo the merger as a violation of Virginia corporate law forbidding conflicted and affiliated transactions.

Counts I and III fail because Virginia requires that claims for fiduciary breaches be brought as derivative claims, not direct claims. Count II states a plausible claim for fiduciary breach. The Directors' arguments that they are immune from liability by virtue of the statutory business judgment rule and A9's articles of incorporation cannot defeat DCG & T's claims at this stage. Count IV states a derivative claim for a conflicted transaction, but only that. The amended complaint lacks sufficient facts to support the allegation of an affiliated transaction. Additionally, a plaintiff must bring a conflicted transaction claim as a derivative claim, not a direct claim. Accordingly, the Court grants the motion with respect to Count I, Count III, and Count IV's affiliated transaction and direct conflicted transaction claims. The Court denies the motion with respect to Count II and Count IV's derivative conflicted transaction claim.

I. MATERIAL FACTS

REITs are business entities that invest shareholders' money in the purchase and operation of revenue-generating properties. A9 was one of several REITs operated by defendant Glade Knight, who acted as CEO and Chairman of A9, A8, and A7, collectively known as the Apple REITs. Glade Knight also owns, either directly or indirectly, the companies hired by the Apple REITs to provide management, operation, and advice for the Apple REITs' properties. Prior to the merger, defendants Justin Knight, David McKenney, Kristian Gathright, and Bryan Perry comprised the executive management of the Apple REITs, including A9 (collectively, “the Managers”). This consolidation of manpower bled into the Apple REITs' director structures, too: before the merger each director sat on multiple Apple REIT boards. As relevant here, each of the A9 directors, defendants Michael Waters, Robert Wily, James Barden, Bruce Matson, and Glade Knight (collectively, “the Directors” or “the Board”), were directors of either A8 or A7, or, in Knight's case, both; Knight, Waters, and Matson also sat on A7's board, and Knight, Wily, and Barden also sat on A8's board.

As early as 2011, the boards of the Apple REITs each began exploring consolidation into a single REIT. By mid–2013, A7, A8, and A9 each met with legal counsel and financial advisers to coordinate a proposed merger. Because each Apple REIT had directors who served as a director of one of the others, the boards created non-overlapping special committees consisting of two directors. A9's Special Committee consisted of Matson and Waters. Each Apple REIT also hired separate legal counsel and financial advisors to advise on the merger. A9 hired Hogan Lovells and Citigroup, respectively. After Hogan Lovells reviewed the proposed merger agreement and Citigroup determined that the merger terms would be fair to A9, the Special Committee recommended that the Board approve the proposed merger. The proposed terms established an exchange ratio whereby A7 shareholders' shares would be converted to A9 common shares on a 1:1 ratio and A8 shareholders' shares would be converted to A9 common shares on a 1:0.85 ratio.²

On August 6, 2013, the Board approved the transaction, and forwarded it for shareholder approval. Because of the overlap among Apple REIT directors, the Board made no formal recommendation to its shareholders with respect to the merger, except to state that the Board found the transaction advisable and in A9's best interests.

The A9 mailed a 600–page proxy statement to shareholders on or about January 23, 2014, and followed that with a supplement on February 19, 2014. When voting closed on February 27, 2014, the requisite number of shareholders from each Apple REIT voted in favor of the merger, which became effective on March 1, 2014. A7 and A8 became wholly owned subsidiaries of A9. A9 then changed its name to Apple Hospitality.

Before the merger, on December 16, 2013, A9 shareholders DCG & T and Jack Battaglia (collectively, “DCG & T”) made written demand on the Board to abort the merger or adjust the exchange ratios to be more favorable to A9. The Board did not respond. DCG & T filed its first complaint on January 31, 2014, and sought a temporary restraining order and preliminary injunction to enjoin the merger on February 10, 2014. DCG & T withdrew that request on February 18, 2014, and subsequently filed its amended complaint on March 24, 2014.

The amended complaint alleges claims against the director defendants, the management defendants, ten unnamed individuals, and A9. This matter was reassigned to the undersigned on August 8, 2014.

II. DISCUSSION³

DCG & T brings four counts against the defendants, each alleging state law claims.⁴ Count I alleges a class claim against the Directors for breach of the fiduciary duties of loyalty and care. Count II alleges a derivative claim on behalf of A9 for the same breach. Count III alleges a class claim against both the Directors and Managers for breach of the fiduciary duties of loyalty and candor. Count IV alleges both a class claim and derivative claim in order to set aside the merger as a conflicted or affiliated transaction.

1. Counts I and III Must Be Brought as Derivative Actions

A shareholder derivative suit is an equitable action that deputizes shareholders to protect themselves “from the designing schemes and wiles of insiders who are willing to betray their company's interests in order to enrich themselves.” Simmons v. Miller, 261 Va. 561, 573, 544 S.E.2d 666, 674 (2001) (quoting Surowitz v. Hilton Hotels Corp., 383 U.S. 363, 371, 86 S.Ct. 845, 15 L.Ed.2d 807 (1966) ). Virginia follows the majority rule that “suits for breach of fiduciary duty against officers and directors must be brought derivatively on behalf of the corporation and not as individual shareholder claims.” Id. at 576, 544 S.E.2d at 675. Virginia limits fiduciary breach claims to derivative actions, in part, because the limitation prevents a deluge of lawsuits, reassures corporate creditors that damages recovered from the action will be returned to corporate coffers, ensures that all shareholders benefit equally, yet still “compensates the injured shareholder by increasing the value of his shares.” Id. at 574, 544 S.E.2d at 674. A class action differs significantly from a derivative suit, because a class action asserts a direct claim on behalf of class members who have suffered harm, not on behalf of the corporation.

DCG & T argues that shareholders may pursue direct actions for breaches of fiduciary duty when the shareholders allege “individual injuries, rather than injuries to the corporate entity.” Pls.' Supp. Brief 5. DCG & T correctly notes that the Supreme Court of Virginia characterized the derivative-claim rule in Simmons as follows: “an action for injuries to a corporation cannot be maintained by a shareholder on an individual basis and must be brought derivatively.” Simmons, 261 Va. at 574, 544 S.E.2d at 674 (emphasis added).

According to DCG & T's reading of this language, the use of the phrase “for injuries to a corporation” means that if a director injured the shareholder individually rather than indirectly through the corporation, a shareholder may bring a direct action.

But Simmons means something entirely from the language DCG & T cherrypicks from the opinion. In S...