Harff v. Kerkorian

• Decision Date: 23 July 1974
• Parties: Philip HARFF and Stephanie Harff, Plaintiffs, v. Kirk KERKORIAN et al., Defendants.
• Court: Court of Chancery of Delaware

Page 215

324 A.2d 215

Philip HARFF and Stephanie Harff, Plaintiffs, v. Kirk KERKORIAN et al., Defendants.

Court of Chancery of Delaware, New Castle County.

July 23, 1974.

Arthur G. Connolly, Jr., Connolly, bove & Lodge, Wilmington, Kreindler & Kreindler, New York City, for plaintiffs.

Henry N. Herndon, Jr., Eduard F. von Wettberg, III, Morris James, Hitchens & Williams, Wilmington, Terry N. Christensen, Wyman, Bautzer, Rothman & Kuchel, Beverly Hills, Cal., for defendant Metro-Goldwyn-Mayer, Inc.

E. Norman Veasey, Allen M. Terrell, Jr., Richards, Layton & Finger, Wilmington, for appearing individual defendants.

Opinion and Order on defendants' motion to dismiss both claims; dismissal granted as to derivative action; summary judgment entered for defendants as to class action.

QUILLEN, Chancellor:

This action is a combined derivative and class action challenging a singular corporate

act--the declaration and payment of a $1.75 per share dividend by Metro-Goldwyn-Mayer, Inc., in the late fall of 1973.

Plaintiffs are holders of 5% Convertible subordinated debentures due 1993 which were issued by Metro-Goldwyn-Mayer, Inc. (MGM), pursuant to an Indenture Agreement between MGM and The Chase Manhattan Bank (Trustee) dated July 1, 1968. On November 21, 1973, the Board of Directors of MGM declared a cash dividend, the first cash dividend since 1969, in the amount of $1.75 per share of common stock. Plaintiffs contend that the dividends were declared improvidently and for the financial benefit of defendant Kerkorian, a member of the Board of Directors as well as the controlling stockholder of MGM. Plaintiffs allege that the declaration of cash dividends (1) damaged MGM by depleting its capital, thereby endangering its future prospects and (2) damaged the debenture holders in that it impaired the value of the conversion feature and caused a decline in the market value of the debentures themselves.

On this basis, plaintiffs are simultaneously maintaining a derivative action on behalf of the corporation as well as a class action on behalf of all holders of MGM's convertible debentures, excluding the members of the Board of Directors. The defendants are the individual directors of MGM and the corporation itself. In connection with the derivative claim, plaintiffs seek to recover from the individual defendants, on behalf of the corporation, the amount of the cash dividends which was paid pursuant to the November 21 declaration and damages for the loss of the use of the funds which were appropriated to make the dividend payments. In addition, plaintiffs request that all damages which may be recovered on the derivative claim be placed in a constructive trust 'for the benefit of the class members.' With regard to the class action, plaintiffs seek to recover money damages for class members.

Defendants have moved to dismiss the derivative action on the ground that plaintiffs lack standing to maintain an action on behalf of MGM due to the fact that they are not stockholders. Defendants also seek dismissal of the class action on the following grounds: (1) plaintiffs cannot fairly and adequately protect the interests of the class which they are seeking to represent in light of the conflict of interests which arises out of the conflicting recoveries, i.e., damages on behalf of the corporation for the derivative claim as well as damages from the corporation on the class claim; (2) although plaintiffs' rights and remedies as holders of convertible debentures are governed by the Indenture Agreement pursuant to which the convertible debentures were issued, plaintiffs have failed to allege that the defendants have breached any of the terms of that Agreement and, therefore, plaintiffs have failed to state a cause of action; (3) the complaint fails to state a claim upon which relief may be granted in that it fails to allege that the conditions precedent to suit which are provided in the Indenture Agreement have been met; and (4) the 'no-recourse' provision in the Indenture Agreement releases the directors of MGM from all liability to the plaintiffs and is an absolute defense to actions by debenture holders against the directors of MGM. This is the Court's decision, following briefing and oral argument, on defendants' motion to dismiss. In regard to the class claim, affidavits having been filed, the motion will be considered as one for summary judgment.

I. STANDING TO MAINTAIN DERIVATIVE ACTIONS

Defendants first contend that plaintiffs do not have standing to sue derivatively as they are not stockholders of MGM within the meaning of 8 Del.C. § 327, the terms of which are set forth below. Plaintiffs, on the other hand, argue that the convertibility of their debentures into common stock of MGM provides them with the necessary standing to sue on behalf of MGM. Plaintiffs emphasize the fact that they are not suing on behalf of themselves but rather are seeking to enforce a claim which belongs to the corporation which management refused to assert. ¹

The only statutory provision in Delaware dealing with the derivative action is 8 Del.C., § 327, which provides as follows:

'In any derivative suit instituted by a stockholder of a corporation, . . . it shall be averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction of which he complains or that his stock thereafter devolved upon him by operation of law.'

Chancery Court Rule 23.1, Del.C.Ann., which sets forth the procedure for instituting a derivative action, contains similar language. ²

It is noted, as plaintiffs have asserted, that when read literally § 327 does not provide that only stockholders have standing to sue derivatively. ³ It must be recognized, however, that § 327 does not create the right to sue derivatively but rather restricts that right. Section 327 was enacted to eliminate strike suits and other abuses which developed along with the derivative suit. See Henn, Law of Corporations, § 358, 2nd Ed. (1970). The purpose behind its enactment in 1945 was to prevent what has been considered to be an evil, namely, the purchasing of shares in order to maintain a derivative action designed to attack a transaction which occurred prior to the purchase of stock. Rosenthal v. Burry Biscuit Corporation, 30 Del.Ch. 299, 309, 60 A.2d 106, 111 (Ch.1948). ⁴

The derivative action was developed by equity to enable stockholders to sue in the corporation's name where those in control of the corporation refused to assert a claim belonging to the corporation. The nature of the derivative suit is two-fold: first, it is the equivalent of a suit by the stockholders to compel the corporation to sue; and second, it is a suit by the corporation, asserted by the stockholders in its behalf, against those liable to it. Cantor v. Sachs, 18 Del.Ch. 359, 365, 162 A. 73, 76 (Ch.1932). Suits by stockholders alleging mismanagement on the part of the directors are of course included within the umbrella of a derivative action. Bokat v. Getty Oil Company, Del.Supr., 262 A.2d 246, 249 (1970).

But it has been generally accepted under Delaware law that only one who was a stockholder at the time of the transaction or one whose shares devolved upon him by operation of law may maintain a derivative action. Folk, The Delaware General Corporation Law, pp. 485--486. For purposes of a derivative action, an equitable owner is considered a stockholder. Rosenthal v. Burry Biscuit Corp., 30 Del.Ch 299, 313, 60 A.2d 106, 113 (Ch.1948); Brown v. Dolese, 38 Del.Ch. 471, 479, 154 A.2d 233, 239 (Ch.1959), aff'd sub nom. Dolese Bros. Co. v. Brown, 39 Del.Ch. 1, 157 A.2d 784 (Sup.Ct.1960); Saks v. Gamble, 35 Del.Ch. 378, 381, 118 A.2d 793, 794 (Ch.1955), aff'd sub nom, Gamble-Skogmo, Inc. v. Saks, 35 Del.Ch. 503, 506, 122 A.2d 120, 121 (Sup.Ct.1956); Kenrich Corporation v. Miller, 377 F.2d 312 (3rd Cir.1967). But Delaware law seems clear that stockholder status at the time of the transaction being attacked and throughout the litigation is essential. Levien v. Sinclair Oil Corporation, Del.Ch., 261 A.2d 911, 922 (1969), aff'd Sinclair Oil Corporation v. Levien, Del.Supr., 280 A.2d 717 (1971); Hutchison v. Bernhard, 43 Del.Ch. 139, 220 A.2d 782 (Ch.1965); Braasch v. Goldschmidt, 41 Del.Ch. 519, 199 A.2d 760 (Ch.1964); Newkirk v. W. J. Rainey, Inc., 31 Del.Ch. 433, 436, 76 A.2d 121, 123 (Ch.1950); Heit v. Tenneco, Inc., 319 F.Supp. 884, 886 (D.Del.1970).

The holder of an option to purchase stock is not an equitable stockholder of the corporation. Gamble v. Penn Valley Crude Oil Corp., 34 Del.Ch. 359, 364, 104 A.2d 257, 260 (Ch.1954). Debenture holders are not stockholders and their rights are determined by their contracts. Wolfensohn v. Madison Fund, Inc., Del.Supr., 253 A.2d 72, 75 (1969). A holder of a convertible bond 'does not become a stockholder, by his contract, in equity any more than at law.' Parkinson v. West End St. Ry. Co., 173 Mass. 446, 53 N.E. 891, 892 (1899), an opinion by Justice Holmes.

Plaintiffs conceded at oral argument that creditors generally are not entitled to sue derivatively. Nor does this case involve any statutorily recognized rights where debenture holders are deemed to be stockholders. Compare 8 Del.C., § 221. Nevertheless, plaintiffs contend that the convertibility feature of the debentures which they hold sets them apart from other creditors and gives them standing to maintain a derivative suit. Plaintiffs rely on Hoff v. Sprayregan, S.D.N.Y., 52 F.R.D. 243 (1971), wherein it was held that convertible debenture holders had standing to institute a derivative suit. In Hoff, the plaintiffs had alleged a violation of the Securities Exchange Act of 1934, which classifies convertible debentures within the definitional meaning of 'equity security.' 15 U.S.C.A. § 78c(a)(11). On the basis of this definitional section in the Federal Act, the District Court found that the convertible debenture holders were 'stockholders' for purposes of bringing...