IN RE GAYLORD CONT. CORP. SHAREHOLDERS

• Decision Date: 10 August 1999
• Docket Number: Civil Action No. 14616.
• Citation: 747 A.2d 71
• Parties: In re GAYLORD CONTAINER CORPORATION SHAREHOLDERS LITIGATION.
• Court: Court of Chancery of Delaware

747 A.2d 71

In re GAYLORD CONTAINER CORPORATION SHAREHOLDERS LITIGATION.

Civil Action No. 14616.

Court of Chancery of Delaware, New Castle County.

Submitted: July 27, 1999.

Decided: August 10, 1999.

Joseph A. Rosenthal, Carmella P. Keener, of Rosenthal, Monhait, Gross & Goddess, Wilmington, DE; Steven G. Schulman, Edith M. Kallas, Cary L. Talbot, of Milberg Weiss Bershad Hynes & Lerach, New York City, and Stephen Ramos, of Berger & Montague, Philadelphia, PA, of counsel, for Plaintiffs.

William O. LaMotte III, Karen Jacobs Louden, S. Mark Hurd, of Morris, Nichols, Arsht & Tunnell, Wilmington, DE; Thomas O. Kuhns, Timothy A. Duffy, of Kirkland & Ellis, Chicago, IL, of counsel, for Individual Defendants.

Lewis H. Lazarus, of Morris, James, Hitchens & Williams, for Nominal Defendant Gaylord Container Corporation.

OPINION

STRINE, Vice Chancellor.

Nearly four years into this purported class action, this court confronts the question of whether a class should be certified.¹ The answer to that question turns on whether the plaintiffs' Unocal claims allege special injury, justifying a characterization of them as stating individual, as well as derivative, claims. In this opinion, I conclude that the complaint does state individual claims and therefore that class certification is appropriate.

I.

The facts necessary to resolve this motion are drawn from the complaint.

Defendant Gaylord Container Corporation ("Gaylord") manufactures and distributes prosaic items such as corrugated containers and grocery bags, without which America's consumerist economy would function quite cumbersomely. Before 1995, Gaylord's certificate of incorporation provided for two classes of common stock: Class A and Class B. When the two classes voted together, each Class A share was entitled to one vote and each Class B share was entitled to ten votes.

As of the beginning of 1995, Gaylord's founder, Chairman, and Chief Executive Officer, defendant Marvin A. Pomerantz, owned over 85% of the Class B stock, giving him 62% of the company's total voting power. Other Gaylord directors and officers held another 12% of the company's total voting power. As a result, Gaylord management wielded firm control over the company. Collectively, I will refer to Pomerantz and the other management holders as the "Management Holders" and their combined stockholdings as the "Management Block."

In the late 1980's, Gaylord, like many businesses, began to suffer from the adverse effects of a recession. By 1991, Gaylord was unable to meet its debt obligations. As a result, it embarked on a pre-packaged financial restructuring pursuant to Chapter 11 of the federal Bankruptcy Code. The restructuring was consummated in September 1992.

As part of the restructuring, Gaylord was required to issue significant equity in the form of warrants and common stock to its creditors. Compl. ¶ 15. Most important, Gaylord was required to agree to a potential restructuring of its Class A and Class B common stock. The potential restructuring provided that if Gaylord's Class A stock did not reach and maintain a prescribed trading price then the outstanding Class B stock would automatically become Class A stock on July 31, 1995. The effect of such an occurrence would be to reduce the Management Holders' total voting strength from 74% to 20%.

As a result, Gaylord stockholder votes would no longer be controlled by the Management Holders.

By 1995, Gaylord's performance had improved substantially. Yet, its stock price had not reached the level sufficient to ensure that the Class B stock would not be eliminated. In late spring and early summer 1995, the Gaylord board of directors (the "Board") realized that the Management Holders would soon lose voting control of the company. According to the complaint, the Board therefore developed a strategy designed to maintain the Management Holders' continued control of the company.

The strategy began with the Board's adoption of a shareholder rights plan (the "Rights Plan," a.k.a., "poison pill") on June 15, 1995. Suffice it to say, the Rights Plan made it economically impractical for any possible acquiror to obtain control of Gaylord without the Board's approval.

The strategy was furthered by the Board's July 7, 1995 decision to call a stockholder meeting for July 21, 1995. The date of the meeting was significant, because it enabled the Management Holders — who were due to lose voting control on July 31, 1995 — to control the outcome of the vote.

The meeting was called for the purpose of voting on proposed charter and bylaw amendments (the "Amendments") providing that:

All stockholder action be taken at a meeting of the stockholders and not by written consent;

Stockholder meetings be called only by the Chairman or the Board;

A two-thirds vote is required to amend the bylaws and the provisions of the charter amended by the Amendments (the "Supermajority Amendment"); and

Section 203 of the Delaware General Corporation Law, 8 Del. C. § 203, shall govern the company, thus preventing the merger of the company with a stockholder owning less than 85% of the company's stock absent Board approval.

Compl. ¶ 27.

The complaint alleges that the Rights Plan and the Amendments were adopted for the purpose of entrenching Pomerantz and his fellow Management Holders in their offices. Taken together, the Rights Plan and the Amendments constitute a formidable barrier to any potential acquiror not favored by the Management Holders. As a result of the Rights Plan and the Amendments, such an acquiror faces the following barriers:

The Rights Plan, which is redeemable only by Board action;

The need to acquire 85% of the company's stock not held by the Management Holders or to obtain Board approval for any merger as a result of the Amendment making 8 Del. C. § 203 applicable to the company An inability to utilize a consent solicitation to replace the Board and thereby reduce the problems created by the Rights Plan and § 203;

An inability to conduct a proxy fight except at the annual meeting or a time agreed to by the Board; and

An inability to repeal any of the Amendments except by obtaining an overwhelming majority of the shares not held by the Management Holders.

II.

On December 19, 1996, this court, per Vice Chancellor Balick, denied the defendants' motion to dismiss the complaint for failure to state a claim and, as to the derivative claims, for failure to make a demand. In re Gaylord Container Corp. Shareholders Litig., Del. Ch., Consol. C.A. No. 14616, mem. op., 1996 WL 752356, Balick, V.C. (Dec. 19, 1996).

As to the defendants' Rule 12(b)(6) motion, Vice Chancellor Balick held that the complaint stated a claim that the Rights Plan and the Amendments, taken in combination, constituted an unreasonable set of defensive measures adopted for an improper purpose. In this regard, he noted that:

While the rights plan is in effect, it seems economically unlikely that any party would acquire more than 15% of Gaylord['s] stock, let alone a majority. Considering normal voting behavior, it would be practically impossible for stockholders to reach the supermajority required to remove the charter and bylaw amendments while the board continued to have at least the 20% voting power that it held when the dual-class structure expired. While the [A]mendments are in effect, stockholders who oppose the board's position on an offer could only wait until the next regular meeting to pursue a proxy contest or, if the chairman or board refuses to call a special meeting, file an action claiming breach of fiduciary duty. Of course, timing is likely to be crucial to anyone interested in acquiring control of a company.

In re Gaylord Container Corp., mem. op. at 7.

As such, Vice Chancellor Balick held that the defendants bear the burden under Unocal Corp. v. Mesa Petroleum Co., Del. Supr., 493 A.2d 946 (1985), to demonstrate the reasonableness of these measures. In such circumstances, the "proper course" was "to deny the motion to dismiss, permit the plaintiffs to pursue discovery, and give the defendants an opportunity to satisfy the enhanced scrutiny standard. The court will then have a better basis to determine whether the board took proper precautions to protect stockholders from coercive takeover tactics or, as the plaintiffs claim, acted primarily to keep control." In re Gaylord Container Corp., mem. op. at 8-9.

With regard to the defendants' Rule 23.1 motion, Vice Chancellor Balick held that demand was excused since "the board's adoption of the shareholder rights plan is subject to enhanced scrutiny and the circumstances alleged in the complaint create an inference of improper purpose." Id. at 9 (citing Moran v. Household Int'l, Inc., Del. Ch., 490 A.2d 1059, 1071, aff'd, Del. Supr., 500 A.2d 1346 (1985); Wells Fargo & Co. v. First Interstate Bancorp, Del. Ch., C.A. No. 14696, mem. op. at 18, 1996 WL 32169, Allen, C. (Jan. 18, 1996)).

III.

In the complaint, the plaintiffs seek certification on behalf of a class (the "Proposed Class") of all non-defendant Gaylord stockholders who "are being specially injured and deprived of the opportunity to maximize the value of their Gaylord shares by the wrongful acts of the [defendants]... and whose franchise rights and voting control have been impaired by the [defendants'] unlawful actions."² Compl. ¶ 43. The plaintiffs seek rescission of the Rights Plan and the Amendments, as well as monetary damages on behalf of the Proposed Class.

Although it is the plaintiffs' burden to demonstrate that the Proposed Class should be certified, the reality is that the defendants concede that most of the necessary prerequisites to class certification exist. Therefore, this opinion will only address the primary reason the defendants believe justifies denial of class certification. This reason is that the complaint allegedly states only derivative and not class claims, and therefore class certification would essentially be futile.³

A.

The...