Breakaway Solutions, Inc. v. Morgan Stanley & Co. Inc., C.A. No. 19522 (DE 8/27/2004)
| Decision Date | 27 August 2004 |
| Docket Number | C.A. No. 19522. |
| Parties | <I>Breakaway Solutions, Inc.</I> <I>v.</I> <I>Morgan Stanley & Co. Inc., et al.</I> |
| Court | United States State Supreme Court of Delaware |
Dear Counsel:
Plaintiff Breakaway Solutions, Inc. ("Breakaway") is a bankrupt publicly held, internet-related corporation. Defendants Morgan Stanley & Co. Inc., Lehman Brothers, Inc., and Deutsche Bank Securities, Inc. (collectively the "Defendants" or the "Underwriters") are among this nation's leading underwriters of Initial Public Offerings ("IPOs"). Breakaway brought this purported class action on behalf of the technology companies that hired the Defendants as underwriters for their IPOs in the late 1990's and into 2000, and saw the price of their stock increase dramatically in a short period of time following their IPOs. Breakaway alleges that the Defendants allocated the newly issued stock to favored clients who then shared with the Defendants a portion of the profits realized from the large increase in stock price following the IPO. Breakaway has set forth five causes of action under state law: breach of contract, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, unjust enrichment, and indemnification. The Defendants have moved to dismiss the Complaint1 under Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief can be granted.
This dispute grew out of the stock market boom of the late 1990's and the technology stocks which fueled it. More specifically, this boom was spearheaded by companies which, seeking capital for their new businesses, engaged in an IPO. Those companies retained underwriters who used their expertise to evaluate the corporation, to determine the number of shares to offer and the offering price of those shares, and to distribute the shares to the public in order that the shares might be subsequently traded by the public.
The relationship between underwriters and the issuer is established by the underwriting agreement. Among other things, the underwriting agreements obligate the underwriters to acquire the IPO securities from the issuers at a fixed price and then to resell the securities to the public in accordance with the terms set forth therein. Moreover, the agreements typically provide for indemnification and contribution in the event a claim or liability results from the issuance of the shares.
The underwriters derive the compensation for their services from the spread between the fixed, discounted price at which they acquire the securities from the issuer and the public offering price at which they resell the securities to investors. This agreed upon spread is customarily 7% of the total IPO proceeds.
Amid the stock market boom, reports began to surface regarding two interrelated practices allegedly engaged in by underwriters, such as the Defendants. The first of these practices, known as "underpricing," involved efforts of the underwrites to set the price of the IPO stock lower than its true value. The second alleged practice was that the underwriters would profit from this underpricing by allocating IPO securities to favored clients in exchange for payments ("kickbacks") or other consideration from those clients pursuant to side agreements. These payments were in addition to the fees received by the underwriters by way of the underwriting spread.
Breakaway, an internet company, provided technical, operational, management, and other services to electronic and other businesses. Breakaway's shares were initially offered to the public on or about October 6, 1999, in accordance with an underwriting agreement (the "Agreement") with the Defendants, dated October 5, 1999. Breakaway alleges that the terms of the Agreement, to which Breakaway agreed in reliance upon the Defendants' expertise, were as follows: Breakaway sold 3,000,000 shares of its common stock to the Defendants and other members of the underwriting syndicate for $13.02 per share, or $39,060,000 total. The underwriters were to sell the shares to the public at $14 per share; their 7% spread amounted to $0.98 per share. Subsequently, the Defendants and the other members of the syndicate exercised their "over-allotment" option in the Agreement to acquire a contractual maximum of 450,000 addition shares from Breakaway, also at $13.02 per share, for $5,859,000. As a result, Breakaway's IPO generated gross proceeds of $48.3 million, or approximately $44.9 million to Breakaway net of the underwriting fee.
Breakaway's stock price soared the day it began trading, rising as high as $71.00 per share from the initial $14.00 and closing at $42.25, more than triple the offering price. Breakaway alleges that, at these trading prices, it "left money on the table" in an amount between $196 million ($71.00 per share times 3,450,000 shares minus $48 million raised by the IPO) and $97 million ($42.25 per share times 3,450,000 shares minus $48 million). Breakaway was not alone in experiencing this rapid growth, and the tripling of its IPO price was far from the most extreme example of such rapid escalation.2
The Complaint focuses on side agreements between the Defendants and their favored clients or the "kickbacks" (as characterized by Breakaway) which the Defendants received in relation to the underpriced IPO shares described above. These side agreements frequently took the form of allowing the Defendants to share directly in the profits of clients who quickly sold (or "flipped") the particular IPO stock to other investors in the after-market; increased or excessive trading commissions paid by the favored clients in connection with the IPO stock or other securities transactions; and other similar arrangements. If the client declined to compensate the Defendants with at least part of its profits, the client would be denied future allocations of similarly underpriced IPO shares.
These allocation and compensation practices, according to Breakaway, permitted the Defendants to obtain millions of dollars in compensation from IPOs in addition to their contracted 7% underwriting fee. Moreover, this additional compensation frequently exceeded — Breakaway alleges that it often dwarfed — the underwriting fee that the Defendants contractually agreed to charge.
In its Complaint, Breakaway alleges that the offending conduct sustains five causes of action based on state law.3 The first is a "standard" breach of contract claim. Breakaway claims that the Defendants' IPO allocation and profit sharing concerning the underpriced shares breached the Agreement. Specifically, Breakaway contends that express contract terms related to pricing and compensation were breached by the Defendants' receiving more compensation than that allowed by the Agreement and that, by selling to favored clients, the IPO was not a "public" one. Second, Breakaway contends that the Defendants breached the implied covenant of good faith and fair dealing through the selective sale of the IPO shares because the "spirit and intent" of the Agreement were violated as consideration was diverted away from Breakaway and into the Defendants' own pockets. Third, Breakaway claims that the Defendants were its fiduciaries and they breached their fiduciary duties through the challenged practices. Fourth, Breakaway asks for indemnification or contribution for federal securities actions that have been brought against it and those similarly situated and which arose out of their IPOs. Finally, Breakaway brings a claim for unjust enrichment and restitution, asserting that the Defendants should be required to surrender their excessive compensation since it would be inequitable for them to retain it.
The Defendants have moved to dismiss the Complaint. Their primary argument is that Breakaway's claims are preempted by the Securities Litigation Uniform Standards Act of 1998 ("SLUSA").4 They argue that, although Breakaway does not affirmatively allege fraud, the substance of its claims, all premised on state law, is based on fraud, especially the focus on underpricing and kickbacks, thus bringing its claims within the grasp of SLUSA. They also allege that Breakaway has failed, as a matter of law, to state claims for breach of contract, breach of the duty of good faith and fair dealing, breach of fiduciary duty, and unjust enrichment, and that the indemnification claim is not ripe for judicial review.
Breakaway, not surprisingly, disputes these contentions.
Under Court of Chancery Rule 12(b)(6), the Court is bound to consider only the allegations of the complaint and any documents that are considered integral to it.5 In deciding the motion, the Court must assume the truthfulness of all well-pled facts in the complaint and view those facts, as well as all inferences that may be drawn reasonably from them, in the light most favorable to Breakaway.6 However, conclusory allegations, unsupported by the facts in the complaint, will not be taken as true.7 No motion under Rule 12(b)(6) may be granted unless it appears with reasonable certainty that the plaintiff would not be entitled to relief under any set of facts which could be proven at trial to support a cause of action.8
Congress enacted the Private Securities Litigation Reform Act9 (the "PSLRA") in 1995 in response to what it perceived to be frivolous private securities lawsuits that were damaging the market.10 The PSLRA imposed more stringent procedural and substantive requirements for private securities actions in the federal courts as a way to deter meritless suits.11 To avoid these...
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