RCM Securities Fund, Inc. v. Stanton

Decision Date26 March 1991
Docket NumberNos. 1207,1211,1210,D,s. 1207
Citation928 F.2d 1318
Parties, Fed. Sec. L. Rep. P 95,867 RCM SECURITIES FUND, INC. and Max L. Heine, Plaintiffs-Appellants, Cross-Appellees, v. E. Douglas STANTON, and Harold B. Matles as Trustees, and Robert Conrod, Benjamin F. Litwin, Thomas A. Mudano, Kathleen Durante and Lawrence A. McCarthy as Members of the Administrative Committee of the M.H. Rhodes, Inc., Employee Stock Ownership Trust for the Non-Bargaining Unit Employee Group, Edward J. Doyle, Angelo B. Rucci, Morris F. Marks, Jr., Robert C. Hunt, Jr., Lawrence A. McCarthy, Anthony J. Campanelli, Sr., and Oliver W. Thompson as Directors of M.H. Rhodes, Inc., and M.H. Rhodes, Inc., June Rhodes and Mark M. Rhodes, as Co-Administrators of the Estate of Mark H. Rhodes, Jr., and John J. Coleman as Executor of the Estate of Louis C. Lerner, Defendants-Appellees, June Rhodes and Mark M. Rhodes, as Co-Administrators of the Estate of Mark H. Rhodes, Jr., Cross-Appellants. ockets 90-7047, 90-7087, 90-7157.
CourtU.S. Court of Appeals — Second Circuit

Sharon S. Tisher, Hartford, Conn. (Day, Berry & Howard, Hartford, Conn., of counsel), for plaintiffs-appellants, cross-appellees.

Andrew J. Levander, New York City (Adam B. Rowland, Shereff, Friedman, Hoffman & Goodman, New York City, of counsel), for defendants-appellees Edward J. Doyle, Angelo B. Rucci, Morris F. Marks, Jr., Lawrence A. McCarthy, Anthony J. Campanelli, Sr., Oliver W. Thompson, and M.H. Rhodes, Inc.

Donald R. Holtman, Hartford, Conn. (Katz & Seligman, Hartford, Conn., of counsel), for defendants-appellees, cross-appellants June Rhodes and Mark M. Rhodes, as Co-Administrators of the Estate of Mark H. Rhodes, Jr.

Richard C. Robinson, Hartford, Conn. (Sorokin, Sorokin, Gross, Hyde & Williams, P.C., Hartford, Conn., of counsel), for defendants-appellees E. Douglas Stanton and Harold B. Matles, as Trustees, and Robert Conrod, Benjamin F. Litwin, Thomas A. Mudano, Kathleen Durante and Lawrence A. McCarthy.

Robert L. Wyld, Hartford, Conn. (Shipman & Goodwin, Hartford, Conn., of counsel), for defendant-appellee John J. Coleman as Executor of the Estate of Louis C. Lerner.

Before KAUFMAN, FEINBERG and WINTER, Circuit Judges.

WINTER, Circuit Judge:

This appeal arises from a shareholder derivative action brought to challenge two integrated transactions that allegedly disposed of assets amounting to one-third of a Delaware corporation's net worth and that transferred control of the corporation to an employee stock ownership plan, control of which is concentrated in high-level management. The district court dismissed the complaint on the ground that plaintiffs had failed to explain adequately their failure to make a demand upon the corporation's board of directors under Fed.R.Civ.P. 23.1. We conclude that state law, here that of Delaware, governs the need for such a demand. Delaware law excuses the failure to make a demand when, inter alia, particularized allegations in the complaint raise a reasonable doubt as to whether the directors exercised proper business judgment. Because we conclude that the allegations in the instant complaint suffice to create such a reasonable doubt, we reverse on the appeal. We dismiss the cross-appeal by the co-administrators of the Rhodes estate asking us to dismiss the complaint against them for failure to state a claim for relief.

BACKGROUND

Our statement of facts is based upon the allegations of the amended complaint 1 and the affidavits and exhibits submitted by defendants. Defendant-appellee M.H. Rhodes, Inc. ("Company"), a publicly held Delaware corporation with corporate facilities in Connecticut, manufactures mechanical timing devices. Defendants-appellees Edward J. Doyle, Angelo B. Rucci, Morris F. Marks, Jr., Robert C. Hunt, Jr., Lawrence A. McCarthy, Anthony J. Campanelli In January 1983, the Company established a non-contributory employee stock ownership plan, with a related trust, for the benefit of non-bargaining-unit employees of the Company (collectively "ESOP" or "Plan"). During the relevant time period, defendants-appellees E. Douglas Stanton and Harold B. Matles (collectively "Trustees") were appointed by the Directors to serve as trustees of the ESOP. In addition, Stanton served as treasurer and Matles as vice-president of the Company. Defendants-appellees Robert Conrod, Benjamin F. Litwin, Thomas A. Mudano, Kathleen Durante, and Lawrence A. McCarthy were appointed by the Directors to serve as members of the administrative committee to manage the ESOP. McCarthy was both a member of the Committee and a Director.

Sr., and Oliver W. Thompson (collectively "Directors") composed the board of directors of the Company during all or part of 1985 and 1986. Doyle was president and McCarthy was secretary of the Company during this period. The other five were outside Directors.

The Company initially funded the ESOP with a contribution of $85,000 cash and 5000 shares of the Company's common stock from its treasury. In 1984, it contributed $55,000 cash and 5000 treasury shares to the ESOP. These contributions, amounting to $140,000 and 10,000 shares, were the only contributions made prior to the transactions challenged in this action. By the end of 1985, the ESOP had fifty-six participants.

The Plan provides that contributions and forfeitures of stock (by departing employees whose term of employment was insufficient to cause their interest to vest) are to be allocated annually to the participants' accounts, with half of such contributions and forfeitures apportioned pro rata and half apportioned according to the ratio of the individual compensation to total participant compensation. Participants may direct the Trustees to vote their allocated shares in accordance with their instructions, and the Trustees are to vote the unallocated shares in the same ratio as the voting of the allocated shares. The Trustees are to use the same voting procedures in the event of a tender or exchange offer for shares of the Company.

In June 1985, Mark H. Rhodes, Jr., the founder, president, chairman of the board, and principal shareholder of the Company, died. At the time of his death, he owned 96,461 shares, or 39.2 percent of the outstanding common stock. Defendants-appellees and cross-appellants June Rhodes and Mark M. Rhodes (collectively "Rhodes defendants") are co-administrators of the Rhodes estate. At some point during the relevant time period, Louis C. Lerner, an owner of 26,800 shares of the Company, also died. Defendant-appellee John J. Coleman is executor of Lerner's estate.

In the six months between Rhodes' death and December 1985, the Company and the Rhodes estate received several inquiries from firms interested in acquiring the Company, including formal offers from RSR Industries, Inc. and Commercial Equities Corporation. On October 7, 1985, the Rhodes defendants made a formal request for the list of shareholders, a signal of a possible proxy solicitation.

The Directors met on October 16, 1985. In preparation for the meeting, Director Doyle made handwritten notes in which he indicated that the ESOP was the "KEYSTONE" to "prevent 'UNFRIENDLY TAKEOVER.' " At the meeting, the Directors met with Timothy Largay, a lawyer for the Rhodes estate, who told them that the Rhodes estate shares were for sale and that the estate was negotiating with third parties. Largay told the Directors that the estate had received an oral offer of $30 per share, and that the Directors "should assume that [the offeror] will want to control the Company." At the meeting, Director Rucci indicated that it "might seriously jeopardize the financial position of the Company" to finance a purchase of the Rhodes shares at $30, and Director Marks indicated that a purchase of the shares at a premium might be illegal. On November 12, Largay informed the Directors that the estate regarded a bid by RSR of $28 per share as fair and that the estate was prepared The amended complaint further alleges that on November 12, Largay also told an attorney for the Company that the Rhodes estate would sell its shares to the Company or to the ESOP only if all outstanding shares were acquired at the same premium paid to the estate. On November 18, Largay reduced these demands and agreed to have the Rhodes estate go ahead with the sale at $28 per share if the Company either indemnified the estate against actions by other shareholders or purchased the Lerner estate's shares at a premium to forestall it from instituting such litigation. Largay is alleged to have cited to a representative of the Company legal authority that a purchase of a block of shares from a large shareholder at a premium in order to thwart a takeover was a breach of the Directors' fiduciary obligations and might expose the seller to liability as an aider or abettor. The Directors were advised of Largay's communications on November 12 and 19, respectively. A month later, the Directors agreed to the acquisition of the Lerner shares as suggested by Largay.

to cooperate with RSR in acquiring the Company, a fact perhaps underscored by the prior demand for a list of shareholders.

In December 1985, at the instigation of the Directors, the Trustees, and the Committee, the ESOP was amended to provide for loans to finance the purchase of shares of the Company. As of December 1, 1985, just prior to the transactions at issue, the ESOP held 24,182 shares of common stock, or 9.8 percent of the Company's outstanding shares of common stock. Shortly after the amendment, on December 19, 1985, the Directors authorized a loan of $2.55 million and a cash contribution of $175,000 to the ESOP, in order to permit the ESOP to purchase the shares held by the Rhodes estate. The Company financed the loan to the ESOP by borrowing $2.55 million from Connecticut National Bank, secured by a fifteen-year mortgage on the Company's corporate and manufacturing facilities in Connecticut. Also on ...

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