Glenbrook Capital Ltd. Partnership v. Kuo

• Decision Date: 06 September 2007
• Docket Number: No. C07-02377 MJJ.,C07-02377 MJJ.
• Citation: 525 F.Supp.2d 1130
• Court: U.S. District Court — Northern District of California
• Parties: GLENBROOK CAPITAL LIMITED PARTNERSHIP, Plaintiff, v. Mali KUO, et al., Defendant.

525 F.Supp.2d 1130

GLENBROOK CAPITAL LIMITED PARTNERSHIP, Plaintiff, v. Mali KUO, et al., Defendant.

No. C07-02377 MJJ.

United States District Court, N.D. California.

September 6, 2007.

COPYRIGHT MATERIAL OMITTED

Marc W. Rappel, Latham & Watkins, Los Angeles, CA, Adrian James Sawyer, Kerr & Wagstaffe LLP, San Francisco, CA, for Plaintiff.

Robert Alan Spanner, Trial & Technology Law Group, Menlo Park, CA, for Defendant.

ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION TO DISMISS

MARTIN J. JENKINS, District Judge.

INTRODUCTION

Before the Court is Defendants Mali Kuo ("Kuo"), Douglas Watson ("Watson"), and Digital Video Systems, Inc.'s ("DVS") (collectively, "Defendants") Motion to Dismiss.¹ Plaintiffs Glenbrook Capital Limited Partnership ("Glenbrook") opposes the motion. For the following reasons, the Court GRANTS in part and DENIES in part Defendants' Motion to Dismiss.

FACTUAL BACKGROUND

The current shareholder action arises from Defendants' alleged act of selling substantially all of DVS's assets — consisting of DVS's entire stake in another company — without holding the necessary shareholder vote, and without sufficiently disclosing the sale or their intent to use the sales proceeds to satisfy the Chief Executive Officer's personal debts. The material allegations of the operative complaint, which are taken as true for purposes of the current motion, are as follows.

A. The Parties

Plaintiff Glenbrook is a limited partnership engaged in the investment business. (Compl. ¶ 2.) It holds a minority interest in DVS. (Id.)

DVS is a Delaware corporation with its principal place of business in Mountain View, California. (Id. ¶ 3.) DVS was founded in 1992 to develop components and products using newly-developed digital video technologies. (Defs.' RJN, Ex. 4.) DVS went public on May 14, 1996, in an initial public offering that raised $43.7 million. (Compl. ¶ 10.) DVS's shares were originally listed on the NASDAQ, but its shares now trade over-the-counter. (Id.) At the time the complaint was filed, DVS's shares traded at $0.14 per share. (Id. ¶ 46.)²

Defendant Kuo is the current Chairman and Chief Executive Officer ("CEO") of DVS. (Id. ¶ 4.) She has signed several of DVS's SEC filings, including the November 21, 2005 Form 10-Q, the December 12, 2005 Form 8-K, the December 30, 2005 Form 8-K, the March 24, 2006 Form 8-K, and the April 18, 2006 Form 8-K. (Id.) Kuo lives in Santa Clara County. (Id.)

Defendant Watson is the Chief Operating Officer of DVS and a director. (Id. ¶ 5.) Watson had previously served as DVS's Chief Financial Officer, before resigning on March 19, 2006. (Id. ¶ 45.) He maintains control over DVS's bank accounts. (Id.) Watson also lives in Santa Clara County. (Id.)

B. Kuo's Litigation Against DVS and Control of the Board

In June, 2002, DVS sued Kuo and other former officers and directors in Santa Clara County Superior Court for breach of fiduciary duty.³ (Compl. ¶ 14.) Kuo filed a cross-claim for unpaid compensation and for securities fraud. (Id.) On February 1, 2005, a jury found for Kuo, and on April 8, 2005, the court entered judgment against DVS for $3.42 million. (Id.)

On April 29, 2005, following the entry of judgment, DVS and Kuo settled. (Id. ¶ 14.) Under the settlement agreement, DVS issued 100,147 shares of Series D convertible preferred stock (the "Series D") to numerous persons and warrant to purchase 100,148 shares of common stock to one holder. (Id. ¶ 16.) DVS also entered into a consulting agreement that obligated DVS to issue 11,291 shares of the Series D to two persons. (Id.) Glenbrook alleges that the purported recipients of the Series D were Kuo's personal creditors, business partners or nominees. (Id.) In all, some 18 creditors of Kuo's received the 100,147 shares of Series D. (Id.) The Series D bore an 8% dividend, and each share of Series D was convertible into ten shares of DVS common stock. (Id.)

In addition to the Series D issuance, the April 29, 2005 settlement also obligated DVS's directors to elect a slate of Kuo's nominees to the DVS board. (Id. ¶ 18.) On May 24, 2005, the DVS Board elected Kuo and two of her nominees to the Board. (Id.) Kuo thereby gained effective control "of DVS, and was appointed CEO and Chair. (Id.) Since that election, all directors other than Kuo and Watson have resigned. (Id.)

Following the settlement, on May 18, 2005, DVS, Watson, and Kuo entered into a pledge agreement (the "Pledge Agreement"). (Id. ¶ 17.) Under the Pledge Agreement, Kuo and her purported creditors were to receive DVS shares, to be registered almost immediately. (Id.) If they did not receive the shares, Kuo and the creditors would have the right to foreclose on DVS's shares in DVSK. (Id.) The Pledge Agreement was not disclosed to DVS's investors, and only came to light in March 2007 during other litigation between Kuo and a third party. (Id. ¶ 22.)

C. Kuo Engineers the Sale of DVS's Shares in DVSK

Plaintiff has alleged that there was a plan for DVS to satisfy Kuo's creditors by registering the Series D shares, or the common stock into which it was convertible, so that Kuo's creditors could sell their shares on the public markets. (Id. ¶ 19.) The Series D registration, however, never occurred, because DVS never filed a Form 10-Q with approved financial statements and so was unable to register its shares. (Id. ¶ 20.) DVS was due to file its Form 10-Q for the first quarter of 2005 on May 17, 2005. (Id.) Instead, however, DVS filed a "Notification of Late Filing," which bought it an additional six days. (Id.) At or about this time, DVS's outside, auditors resigned. (Id.) On May 22, 2005, DVS filed its Form 10-Q without the auditors' consent. (Id.) Absent current financial information, DVS could not register any new shares, either the Series D or new common shares. (Id.)

Accordingly, Defendants had to find another way to satisfy Kuo's creditors, and so Defendants turned their attention to DVS's only asset — its shares in DVSK. (Id. ¶ 22.) On or about December 10, 2005, DVS entered into a two-page stock purchase agreement (the "SPA") with Korea Technology Investment Corp. ("KTIC") under which DVS would sell its entire stake in DVSK — substantially all its assets — for $12 million. (Id. ¶¶ 1, 23.) DVS did not retain an investment banker in connection with the sale, or make any public announcements of it, despite the fact that the SPA required DVS to sell its only remaining asset. (Id.) The transaction moved so quickly that. Kuo's personal attorney has called it a "fire sale." (Id. ¶ 26.) On December 29, 2005, the sale of the DVSK stock to KTIC closed. (Id. 25.)

Defendants did not disclose the planned sale of DVSK stock in any public filing prior to the date the SPA was signed. (Id. ¶ 23, 25.) Even though it was a sale of substantially all of DVS's assets, no shareholder vote was held and DVS did not transmit to its shareholders any information statement, as required by Section 14(c) of the Securities Exchange Act of 1934 and rules promulgated thereunder. (Id. ¶¶ 25, 42, 57.)

The sale was first disclosed in a December 12, 2005 Form 8-K, after the SPA had already been signed. (Id. ¶¶ 42, 51; Defs' RJN, Ex. 1 (Form 8-K signed December 12, 2005).) The December 12 Form 8-K claims that DVS obtained written consents for the transaction from the holders of a majority of its shares, but does not identify those holders or describe their interests in the sale. (Id. ¶ 42.) It also promised that DVS would seek shareholder ratification of the sale (Compl. ¶ 54; Defs'. RJN, Ex. 1), which, according to Plaintiffs, never happened.

The sale generated $12 million in proceeds for DVS. (Id. ¶ 24.) Defendants wasted no time in using the proceeds to pay Kuo's personal creditors. (Id. ¶ 27.) On December 30, 2005, DVS issued checks totaling $150,000 to Kuo's personal creditors. (Id.) On January 2, 2006, DVS issued another round of checks, totaling $788,000, (Id.) In the end, some $1.5 million was paid to Kuo's creditors by DVS. (Id.)

D. DVS Fails to File Required Reports with the SEC

As a publicly-traded company, DVS is required to file annual and quarterly re ports with the SEC on. Forms 10-K and 10-Q. See generally 15 U.S.C. § 78m. DVS's last such filing was its November 21, 2005 Form 10-Q. (Compl. ¶ 46.) Since that date, DVS has not filed either a Form 10-K or a Form 10-Q. (Id.) DVS has also failed to file any proxy materials, and has not held an annual meeting of stockholders since November 18, 2004. (Id. ¶ 46.) On April 17, 2006, DVS filed a Form 8-K with the SEC stating that it would be unable to file its annual report for the year 2005, claiming an inability to obtain all necessary financial data from DVSK. (Id. ¶ 43.) As a result of these failures to file, DVS's shareholders have literally no idea what happened to the $12 million that DVS did not spend paying Kuo's debts.

E. Procedural History

Plaintiff filed the Complaint action on May 2, 2007 asserting claims for: (1) Securities Fraud in violation of Section 10(b) and Rule 10b-5 against all Defendants; (2) failure to follow Proxy Disclosure Rules in violation of Section 14(c) of the 1934 Act and SEC Rule 14c-2 against all Defendants; (3) Breach of Fiduciary Duties in violation of the duty of loyalty against all Defendants; (4) Appointment of a Receiver pursuant to 8 Delaware Code § 226(a) (3) against DVS; (5) Appointment of a Receiver pursuant to 8 Delaware Code § 291 against' DVS; (6) Appointment of a Receiver or Custodian pursuant to Delaware common law against DVS; and (7) Compelling Annual Shareholder Meeting against DVS. (Id. ¶¶ 47-86.) Plaintiff seeks rescission of Defendants' sale of DVSK or for payment due, punitive damages, and an accounting of DVS's losses.

Defendants now seek an order dismissing each of Plaintiff's claims.

LEGAL STANDARD

A. Motion to Dismiss

A motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) tests the legal sufficiency of a claim. Navarro v. Block, 250...