Blasband v. Rales
| Decision Date | 31 July 1992 |
| Docket Number | No. 91-3633,91-3633 |
| Citation | 971 F.2d 1034 |
| Parties | Fed. Sec. L. Rep. P 96,918, 23 Fed.R.Serv.3d 560 Alfred BLASBAND v. Steven M. RALES; Mitchell P. Rales; John Doe 1-10; Danaher Corporation, Alfred Blasband, derivatively on behalf of Danaher Corporation, Appellant. |
| Court | U.S. Court of Appeals — Third Circuit |
Stephen A. Whinston (argued), Arthur Stock, Berger & Montague, P.C., Philadelphia, Pa., Mark Minuti, Saul, Ewing, Remick & Saul, Wilmington, Del., for appellant.
Stephen P. Lamb (argued), Robert A. Glen, Robert E. Zimet, Joseph Guglielmelli, Skadden, Arps, Slate, Meagher & Flom, Wilmington, Del., for appellees Stephen M. Rales and Mitchell P. Rales.
David C. McBride, Young, Conaway, Stargatt & Taylor, Wilmington, Del., for appellee Danaher Corp.
Before GREENBERG and SCIRICA, Circuit Judges, and DEBEVOISE, District Judge *.
I.
Alfred Blasband appeals from a district court order of August 15, 1991, dismissing his complaint pursuant to Fed.R.Civ.P. 12(b)(6) and Fed.R.Civ.P. 23.1 in this shareholder derivative suit. This appeal raises difficult issues regarding shareholder standing and demand futility in derivative actions brought under Delaware law. In view of the procedural posture of the case, we will accept Blasband's allegations in our disposition of the appeal.
Blasband is a former shareholder of Easco Hand Tools, Inc. On September 1, 1988, while Blasband was an Easco shareholder, Easco initiated a public offering of $100 million of 12.875% Senior Subordinated Notes (the "Note Offering"). In the prospectus for the Note Offering, Easco disclosed that the proceeds would be used for repayment of outstanding indebtedness, general corporate purposes, and expansion of Easco's business through internal growth and acquisitions. The prospectus further stated that "[p]ending such uses, the Company will invest the balance of the net proceeds from this offering in government and other marketable securities which are expected to yield a lower rate of return than the rate of interest borne by the Notes."
After the Note Offering was completed, Easco invested at least $61.9 million of the proceeds in high-yield, highly speculative debt securities, commonly known as junk bonds. In its Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1988, Easco disclosed these investments as "temporar[y] invest[ments] in marketable securities and cash equivalents." One year later, in its 1989 Annual Report and 10-K, Easco disclosed that it still held these investments In February 1990, Easco entered into a merger agreement with the nominal defendant Danaher Corporation and Combo Acquisition Corporation, a wholly owned subsidiary of Danaher, providing for Easco shareholders to receive .4175 shares of Danaher common stock for each of their shares of Easco common stock. The merger was consummated in June 1990 with Easco surviving as a wholly owned subsidiary of Danaher. Consequently, Blasband's 1,100 shares of Easco were converted into 458 shares of Danaher. 1
but that "[d]uring 1989, the market for these securities became volatile and some market values declined significantly." Explaining that "[g]reater risk is generally associated with these high-yield securities, for which a thinly traded market exists and for which market quotations are not always available[,]" Easco stated that it had reduced the carrying value of its portfolio by $14 million and that it would probably suffer further losses if the remaining issues were sold. Easco disclosed an additional $1 million loss in its March 31, 1990 Form 10-Q filed with the SEC
Prior to the merger, Mitchell P. Rales was Chairman of Easco's board of directors and owned approximately 25% of Easco's common stock. His brother, Steven M. Rales, was a director of Easco and owned 27% of its stock. Mitchell Rales is also President and a director of Danaher, and Steven Rales is Chairman of the board of directors of Danaher. Together the brothers own 44% of Danaher's common stock. Beginning sometime in the mid-1980's, the Rales brothers retained Drexel Burnham Lambert Incorporated to assist in the Rales' corporate acquisition strategy. Through junk bond financing arranged by Drexel, the Rales brothers expanded Danaher by acquiring Western Pacific Corporation and Chicago Pneumatic Corporation. In 1988 the Rales brothers hired Drexel in connection with an ultimately unsuccessful $2.5 billion bid to acquire another company. In addition, Drexel assisted the Rales brothers in acquiring an interest in Easco in 1986 by partially providing the financing. 2 Furthermore, Drexel was selected as the sole underwriter for the Note Offering.
The junk bond investment of the proceeds of the Note Offering did not go unnoticed for, on October 25, 1990, Blasband's counsel sent a letter to the boards of directors of Easco and Danaher setting forth the discrepancy between the proposed use of the proceeds in the prospectus for the Note Offering and Easco's financial statements disclosing the actual investments in junk bonds. The letter requested additional information to explain, inter alia: (1) why the junk bond portfolio had lost $14 million in one year; (2) what securities Easco had purchased and sold between September 1, 1988, and December 31, 1989, and at what prices and through which brokerage house; (3) which Easco officers and directors approved or selected the purchases and sales; and (4) why Easco used the proceeds of the Note Offering in a manner contrary to that described in the prospectus. Counsel for Blasband stated that, although much of this information "could be obtained through a formal demand for inspection of the Company's books and records, we believe that it is in our mutual interest to proceed on a less formal basis."
Counsel for Danaher and Easco responded in a letter dated December 17, 1990, that "it would be inappropriate at this time to provide" the requested information. Further, counsel stated that "Easco fully and fairly complied with the requirements of the federal securities laws and regulations in disclosing all material information concerning the Note Offering and the subsequent use of the proceeds of that offering to its shareholders in its public financing." Additionally, counsel stated that compliance with the request "would impose a substantial burden on our clients ... [and] would be time-consuming and highly disruptive Unsatisfied with this response, Blasband filed this derivative action in the United States District Court for the District of Delaware on behalf of Danaher on March 25, 1991. The essence of Blasband's claim is that the Rales brothers violated their fiduciary duties owed to Easco by investing proceeds of the Note Offering in highly speculative junk bonds as consideration for their business dealings with Drexel and not for a legitimate corporate purpose. Blasband named the Rales brothers and ten "John Does" who were officers and directors of Easco at the time of the Note Offering as defendants. Danaher was joined as a nominal defendant. Blasband has not specifically identified the John Doe defendants and thus the Rales brothers remain the only actual defendants and we therefore refer to them as the appellees.
of the day-to-day management of the business...."
Prior to discovery, the appellees moved to dismiss the complaint pursuant to Rules 12(b)(6) and 23.1 on the grounds that Blasband had not made an appropriate demand on the directors of Danaher to take action and did not establish demand excusal. 3 Furthermore, the appellees contended that Blasband lacked standing to bring this action.
The district court granted the appellees' motion. Applying Delaware law, the district court held that demand excusal should be measured with regard to the Danaher board, and that Blasband did not adequately plead that demand would have been futile. Additionally, the court agreed with the appellees that Blasband lacked standing as a result of the merger. Accordingly, on August 15, 1991, the court dismissed the complaint with prejudice. Blasband on behalf of Danaher Corp. v. Rales, 772 F.Supp. 850 (D.Del.1991). Blasband filed a timely notice of appeal on September 12, 1991.
We agree with the district court that Blasband has not adequately established that he is excused from making a proper demand. However we also believe, contrary to the district court, that Blasband does have standing to maintain this derivative action, and we therefore hold that Blasband should be given the opportunity to move to amend the complaint to allege additional facts establishing that a proper demand would have been futile. Accordingly, we will vacate the order of August 15, 1991, and will remand the case for further proceedings. 4
II.
Blasband argues that our review is plenary to the extent that the district court granted the motion to dismiss pursuant to Rule 12(b)(6). See Scattergood v. Perelman, 945 F.2d 618, 621 (3d Cir.1991). The appellees, on the other hand, assert that the district court exercised its discretion in dismissing this action pursuant to Rule 23.1, and accordingly we may reverse only if we find an abuse of discretion. In fact, the district court's order recited that it granted the motion to dismiss under both Rules 12(b)(6) and 23.1. However, the district court's label is not binding on us. Rather, we must look to the course of the proceedings in the district court and the basis for its decision to determine the standard of review. Melo v. Hafer, 912 F.2d 628, 633 (3d Cir.1990), aff'd, --- U.S. ----, 112 S.Ct. 358, 116 L.Ed.2d 301 (1991); Rose v. Bartle, 871 F.2d 331, 340 (3d Cir.1989).
Rule 23.1 requires the plaintiff in a derivative action to allege that he or she was a shareholder at the time of the challenged transaction, and to set forth "with particularity the efforts, if any, made by the plaintiff to...
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