Kohls v. Kenetech

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~3 . I , .,4;r (I . IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE IN AND FOR NEW CASTLE COUNTY ROBERT 1,. KOHLS and LOUISE A. KO HLS) Plaintiffs, V. > Civil A&ion No. 17763-NC KENETECH CORPORATION and MARK D. ) LERDAL, ANGUS M. DUTHIE, ) GERALD R. ALDERSON and CHARLES ) CHRISTENSON, > Defendants. -.. 1. :, ) -:.~ MEMORANDUM OPINION Submitted: April 20, 2000 Decided: July 26, 2000 Edward M. McNally, Esquire and John T. Meli, Jr., Esquire, of MORRIS, JAMES, HITCHENS & WILLIAMS LLP, Wilminton, Delaware, Attorneys for Plaintiffs. Charles F. Richards, Jr., Esquire, Raymond J. DiCamillo, Esquire and Thad J. Bra.cegirdle, Esquire, of RICHARDS, LAYTON & FINGER, Wilmington, Delaware, Attorneys for Defendants. LA MB, Vice Chancellor I . INTRODUCTION IPlaintiffs bring this purported class action on behalf of all holders as of May 13, 1998, of K.eneteNzh 8 !4 % Preferred Redeemable Increased Dividend Equity ,Securities ( PRIDES j. Plaintiffs first claim rests entirely on their contract rights, as plaintiffs say they seek[] to litigate whether [Kenetech] was windjng up when it carried out a program of selling off all its assets, paying all :(ts debl:s, firing its emplo:yees and going out of any operating business. If so, plaintif fs say that they ha d a right under the PRIDES Certificate of Designations I:O receive $1,012.50 per share (or $20.25 per depositary share unit), plus accrued and unpaid preferred dividends, as a special distribution. Second, ,plaintiffs allege that the Kenetech directors were under a fiduci.ary duty to protect the rig.hts of preferred stockholders while the company was near insolvency by ensuring that the special distribution was paid to them. For the reasons set forth below, I conclude that pl,sintiffs fail to state a claim upon which relief can be granted. Kenetech PRIDES were Imarketed by selling depositary share units representing a 1150 interest in a PRIDES share. 1 II. FACTUAL BACKGROUND The nucleus of operative facts at issue here is the same as in Quadrangle Offshore (Cayman) .LLC v. Kenetech Co~p.~ In that case, the court held a trial involving virtually the same facts and legal claims and ruled in the defendants favor. The reader is also referred to the memorandum opinion in a companion action, Kohls v. Dutl~ie.~ The basic facts are as follows. In May 1994, Keneteclh sold 102,942 shares of PRIDES. Under the Kenetech Certificate of Designations, the PRIDES were conve:rtible into .Kenetech common stock at the option of the holder within three years and were subject to mandatory conversion into such shares (if not sooner redeemed) on the fourth anniversary of the:ir issuance, May 14, 1998. The Certificate also providled for the payment of a preferential distribution to PRIDES holders in the event of a liquidation, dissolution, or winding up of the corporation. Specifically, the Certificate slated: In the event of any voluntary or involuntary liquidation, Idissolution, or winding up of the corporation . . the holders of outstanding share of I?.RIDES are entitled to receive the sum of $1,012.50 per shares, plus an amount equal to any accrued and unpaid Preferred Dividends thereon, out of the assets of the Del. Ch., C.A. No. 16362, Steele, V.C. (Oct. 21, 1998) (denying defendants motion to dismiss) ( Quadrangle I ) and Del. Ch., C.A. No. 16362, Steele, V.C. (Oct. 13, 1999) (post-trial opinion granting judgment for defendants) ( Quadrangle I[ ), nfs d, Del. Supr., 751 A.2d 8 78 (2000) (ORDER). 3 Del. Ch., C.A. No. 17 762, Lamb, V.C. (Jul. 26, 2000). 2 Corporation available for distribution to stockholders, before any distribution is made to Iholders of [common] stock. While the Certificate specifically provided that a sale of assets would not constitu.te a winding up, liquidation or dissolution, the Certificate did not otherwise define or differentiate these terms. Eleginning in 1995, Kenetech s business deteriorated significantly. The board of directors began selling off most of its assets and operations. In June 1.996, Kenetech defaulted on approximately $99 million worth of its senior s;ecured notes. Kenetech structured a plan to sell its remaining significant asset, a 50% stake in a power plant project in Puerto Rico called EcoElectrica. The board estimated that it could obtain $126 - $146 million for its interest at that time. Although Kenetech. s creditors had the power to force the company into bankruptcy, they agreed to give Kenetech time to obtain certain regulatory approvals and financing for lbe EcoElectrica project. If Kenetech could satisfy I.hose contingencies., the selling price for its interest in the project could increase Idramatically, making comple1.e satisfaction of the company s debt more likely. In 1996 and 1997, Kenetech moved ahead with asset sales and reducing rhe sta.ff. By 1997, Kenetech had fired most of its workers and stopped pursuing all new business ventures,. The contemplated sale of EcoElectrica, however, met with substantial delays, although it is alleged that by early 1998, the Kenetech directors knew that EcoE,lectrica rnight be sold for a net amount in excess of that owed on the senior notes, thus leaving some ability to pay all or a part of the dispute~d preferential distribution and, perhaps, some value to the equity. At no time before May 14, 1998, did Kenetech declare or pay the $1,012.50 disputed preferential distribution to the holders of PRIDES. Instead, on that date, Kenerech purported to mandatorily convert the PRIDES into common stock, at the rate of one share of PRIDES for 50 shares of common rjtock. In July 1998, Kenetech received an offer to purchase its EcoElectrica interest for over $237 million, and the transaction later closed for $252 million. The complaint alleges that tht: net proceeds of this sale were sufficient to eliminate Kenetech s capital deficit, pay the accrued PRIDES dividend and pay substantially all of the dispulcd preferential distribution. III. THEPARTIES CONTENTIONS [n this action, plaintiffs first argue that before their PRIDES were mandatorily converted, Keneitech engaged in a winding up within the meaning of that term in the IKene tech] Certificate of Designations. As a result, each holder of a share of PRIDES was entitled to payment of $1,102.50 per share, The conversion ratio equals one share of common stock for each depositary share unit. Although not alleged in the complaint, the Kenetech common shares were, at this time, trading at a nominal price. 4 plus accrued dividends. 5 Plaintiffs second claim is that [b]y at least October ;!4, 1996, the Director Defendants had a fiduciary duty to protect the interests of the holders of the PIRIDE,S because [Kenetech] was in the vicinity of insolvency. 6 Thus, by failing to ensure that the PRIDES preferential distribution would be triggere d before the mandatory conversion into nearly worthkss shares of Kenetech common stock, [tJhe Director Defendants failed to act in good faith to protect the interests of the PRIDES and to deal fairly with the PRIDES and this failure constituted a breach of Defendants fiduciary duty to the PRIDES [holders]. . Pointing to Vice Chancellor Steele s post-trial Opinion in Quadrangle 11, which has now been affirmed by the Delaware Supreme Court and is discussed in greater detail below, defendants assert that this matter has already been decideId and there is no point in relitigating the same issues. Defendants assert that either the doctrme of res judicatu or collateral estoppel bars plaintiffs from assertiug their claims. Alternatively, defendants contend that plaintiffs fail to state a claim upon which relief can be granted j camp. q 42. Id. 1145. Id. 749. 8 Quadrangle Ofshore (Cnyman) LLC v. Kenetech Corp., Del. Ch., C.A. No. 16362, Steele, V.C. (Oct. 13, 1999), ujj ?i. Del. Supr., 751 A.2d 878 (2000) (ORDER). 5 IV. ANALYSIS The standard on a .motion to dismiss under Court of Chancery Rule 1.2(b)(6) is well known. The motion will be granted if it appears with reasonable certainty that the plaintiff could not prevail on any set of facts that can be inferred from lhe pleading. However, the plaintiff is entitled to all reasonable inferences thal. can be drawn from the complaint. lo A. Does Res Judiicuta: or Collateral Estoppel Apply? Defendants assert that .res judicata and collateral estoppel provide a basis to bar .the present suit. As was said in Foltz v. Pullman, Inc. :I1 There are, however, significant differences between the two doctrines. Under the doctrine of res judicata, a judgment in a prior suit involving the ;same parties, or persons in privity with them, bars a second suit on the same cause of action. Under the doctrine of collateral estoppel, on the other hand, a judgment in a prior suit does not operate to bar a subsequent cause of action but rather Iprecludes the relitigation of a factual issue which was litigated and decided in the prior suit between the same parties or persons in Iprivity with them.12 The plaintiff in F&z, ,a product liability action, had. previously lost her claim for worker s compensation, which was brought against her deceased Path Cormunicutions Corp., Del. Supr., 672 A.2d 35, 38 (1996) (citing In re LGACafes, L.P. Litig., Del. Ch. 600 A.2d 43, 47 (1991); Rabkin v. Philip A. Hunt Chem Corp., Del. Supr., 498 A.2d 1099, 1104 (1985)). Solonzo~z v. Id. (citing Irr re iJ.5:ACaJes, 600 A.2d at 47) Del. Super.. 319 A.2d 38 (1974) Id. at 40. 6 husband s former employer. The Industrial Accident Board concluded that the plaintiff had failed to show that her husband s death was due to conditions at his workpl.ace. The defendants in Foltz argued that the Board s d.etermination was either res judicatu or collateral estoppel as against the plaintiff. The court held that res judicata could not apply because the Foltz defendants were neither parties to the worker s compensation action nor were in privity with the former employer. l4 But the court did allow the use of collateral Iestoppel defensively because tthe plaintiff should not be allowed to relitigate a factual issue that was already decided in a prior suit in which she had a full and fair opportunity to present her case. H While Foltz suggests that Delaware does not require mutuality to apply collateral estoppel, it in no way allows a victorious defendant to assert that other plaintiffs, not parties to the prior action, are barred from relitigating facts found in that litigation. Rather, the law is clear that the party invoking the Id. I Id. j id. at 41-42 I6 See also, Columbia Gas. Co. v. Playtex FP, Inc., Del. Supr., 584 A.2d 1214, 1217 (199 1) ( Delaware, like many other jurisdictions, has abandoned the requirement of mutuality as a prerequisite to the assertion of collateral estoppel. ). 7 doctrine as a defense must show that the party against whom collateral estoppel is asserted was a previousr party. The Kohls were concededly not parties to the Quadrangle action. Defendants do, however, claim that a finding of privity between the Kohls and the plai:ntiffs in Quadrangle is consistent with long-standing Delaware law that courts of this state may conclusively adjudicate the rights incident to stock of a Delaware corporation without. the necessity of having all holders of that stock before the Court. T:hey also cite to State v. Maclzin, a criminal law case in which the Superior Court held that the fact that prosecuting parties were different would not bar the application of collateral estoppel, for the proposition that Delaware has significantly relaxed the privity requirement. In this regard, defendants argue that if the interests of ;s party were adequately represented in a prior litigation, a finding of privity is appropriate. They then discuss the extent to which the Quadrangle plaintiffs litigated their .-_- --- Id. at 1217; see also Cklysler Carp v. New Castle County, Del. Super., 464 A.2d 75, 130 (1983) ( [wlhen an issue of fact which was necessary to the outcome of a valid prior judgment has been fully litigated, it may not be reargued by a party to that prior proceeding. >emphas: IS added)). I8 Quudrungle 1 1 was an individual, not a class, action, and defendants chose not to znove to certify a plaintiff class, as they might have done. See Ct. Ch. R. 23; Wright, Miller & Kane, Federal Practice and Frocedure: Civil 2d 51785, n. 1. ) Del. Super., 642 A.2d 1235, 1239 (1993). Def. Op. Br. at 19 (citing Division of Child Support Enforcement ex rel. Veney v. Campbell, Del. Super., 1989 WL. 122950, at *3, (Oct. 18, 1989) (holding that the Division of Child Support Enforcement could not relitigate a prior paternity determination). 8 case (bringing two motions for a temporary restraining order, securing an expedited trial, conducting a lour day trial on the merits, etc.) and conclude that the present plaintiffs cannot. iseriously dispute that Quadrangle adequately represented their interests. in the Quadrangle action. While defendants positions might carry the day in different circumstances, their arguments are largely irrelevant to a preclusion analysis. .4 perscm who is not a party tlo an action is not bound by the judgment in that action, with the following exceptions: First, in a representative action, the non-party can be bound tlo the judgment. 23 Second, where a non-party has a specijk type of pre-exidzg legal relationship with a named party, such as bailor and bailee, predecessor and successor or indemnitor and indemnitee, the nonparty can be bound. 24 If neither of the above exceptions exist, the non-party may nevertheless be bound by vime of some conduct that falls short of becoming a party but which justly should result in his being denied opportunity to relitigate the ma.tters previously in issue. j x For example, defendants argument about adequate representation would be relevant if Qund,~rzgle had been a class a&ion. 2? See, e.g., Restatement (Second) of Judgments 5 62 (1982) (hereinafter Judgments ). Id. s 62 cmt. a; see nlsc.~ id. $0 41-42. Id. 0 62 cmt. a. j id. 9 Haphazard use of the term privity can lead to improper findings of preclusion. This is so because the term, except in reference to specific legal relationships, is so amorphous that it often operates as a conclusion rather than an explanation. * In the preclusion analysis, even a legal relationship such as husbarrd and wife does not [alone] justify imposing preclusion. on one of them on the basis of a judgment affecting the other. Rather, preclusion can properly be imposed when the claimant s conduct induces the opposing party reasonably to suppose tha.t the litigation will firmly stabilize the latter s legal Iobligations. 27 13eing fellow stockholders is plainly not the type of legal relationship that fits the second exception listeNd above. An individual stockholder is not, solely because of potentially aligned interests, presumed to act in the place of (and with the power to bind) the ot!her stockholders. Also, the defendants do not claim that the Kohls knew about or actually did anything in connection with the prior litigation. Thus, defendants cannot assert that some affirmative conduct caused them to refrain from taking action. to bind the present plaintiffs, or, for that matter, the other PRIDES holders, to that action. Id. cm. c. ICI. (emphasis added) 10 Defendants only remaining argument is that by virtue of Quadrangle s aggress;ive litigation approach, the other PRIDES holders are bound. This claim fails because it does not matter that Quadrangle would have been an adequate representative, had it been appointed to such role. A representative party must be granted such authority, either by the represented party itself (in accordance with agency principles) or, in the class action context, by the court.28 It is equally well-settled that a properly named class representative s failure to provide adequate notice tlo the purported class with respect to the action (or to :adequately represent the mterests of the class) will render any subsequent judgment non-binding upon the class. I thus find it self-evident that if a litigant never seeks to and iis never compelled to act in a representative capacity, the class of people that theoretically could have been represented by that litigant is in no way precluded from asserting their own claims in a subsequent proceeding.30 See Ct. Ch. R. 23 Ii) See Judgments $ 4:! cmt. b. ( Where such notice requirements, whether imposed by statute (or order of court, havl: not been substantiually complied with, the investiture of the representative is defective and the judgment for that reason is not binding on the persons putatively represented. ). Judgments uses the following example: A person brings a purported class action but the representational allegations are struck in a pre-trial proceeding. The Restatement makes clear that those people who should have been part of the class are not precluded by issues determined in the first action. Judgments § 42, illus. 5. 11 Thus, I conclude that the Kohk are not precluded from litigating any and all claims or issues that were or could have been raised by Quadrangle.31 1%. IDo the Plaintiffs State a Claim Upon Which Relief Can be Granted? While neither res judiazta nor collateral estoppel operates to preclude the Kohls litigation of this action or its essentially factual underpinnings, the complaint is nevertheless subject to dismissal. This is so because the Kohls fail to distinguish their claims,, either factually or legally, from those adjudicated by Vice Chancellor Steele in Quadrangle II. Normal respect for the principle of :mre decisis and ap:plicaf.on of the general standard for deciding a motion under IRule 12(b)(6) require thal: I d&miss this complaint. In other words, although plaintiffs are not literally bound by the judgment in Quadrangle II, the,y must still state a viable cause of action. Plaintiffs must ldifferentiate the facts and/or legal theories of their case from valid and binding precedents. If, for exam:ple., they sought to litigate about an entirely different provision of the PRIDES contracts, they presumably could do so despite the fact that the plaintiff in Quadmngle would be barred from doing so by res judicata. One can easily understand why corporate defendants would not want the rule Kenetec:.h now urges. For example, if Quadrangle proceeded individually, no other PRIDES holders filed actions, and the courl rendered a final decision in plaintiffs favor after the statute of limit~2tions period expired, the other PRIDES holders could not join in the recovery by asserting that Quadrangle was implicitly acting as a class representative. 12 However, the plaintiffs in this case can only proceed if their claims are distinguishable from those actiudicated in Quadrangle II. In that regard, they say that Qmadmzgle ZZ focused on two things: (i) whether the plaintiffs right to the preferential distribution was triggered by a Kenetech liquidation and (ii) whether Kenetech breached the implied covenant of good faith and fair dealing by delaying in its efforts to sell EcoElectrica until after the mandatory conversion date. Plaintiffs argue tha.t although they: understand and agree that the Court should not permit them to rebtigate the issue of ,whether [Kenetech] was in liquidation, plaintiffs have a right to be heard on their claim that [Kenetech] was winding up and that the [Kenetech] directors breached their fiduciary duty to the PRIDES holders, a duty that arose because of [Kenetech s] closeness to insolvency. Neither of these claims were made in the tQundmngle litigation3 I do not agree that Vice Chancellor Steele s opinion should be read so narrowly. Instead, hi.s decision in Quadrangle ZZ addresses the exact contract language upon which plaintiffs rest their claims, and, not surprisingly, considers the precise facts averred by plaintiffs.33 Why should plaintiffs be able to :I2 Pl. Ans. Br. at 10. x Plaintiffs argue thal because Vice Chancellor Steele denied the defendants motion to dismiss in Quadrangle I, I must do the same in this case. I disagree. Uniess the facts alleged by plaintiffs or inferences reasonably drawn therefrom can be distinguished from the factual findings, made by Vice Chancellor Steele after trial, I am not required to deny the motion. In other words, I must dismiss this complaint unless there is some reasonable prospect that my ultimate: factual findings will (differ from those found in a similar case. Plaintiffs efforts to differentiate the cases rest solely on different legal arguments, not on factual distinctions. 13 prosecute this case any further, when even if all they allege is true, Quadrangle 27 requires that they lose? 34 Vice Chancellor Steele made numerous rulings that would apply with full force to this case. For example, he considered and rejected the notion that the Kenete~ch directors owed fiduciary duties to the PRIDES holders in relation to ihe contract terms of those securities. In that regard, he stated: As demonstrated in the liquidation analysis prepared for the board s October 24, 1996 board meeting, the effect of bankruptcy at that point would be to nullify the value of Kenetech s common stock. Thus, it was in the best interests of Kenetech s common shareholders to placate the Senior Note holders. Kenetech convinced the note holders committee to refrain from filing an involuntary bankruptcy petition and sought to maximize the sale price of EcoElectrica in order to satisfy the notes and (possibly) retain some value for the common shareholders. Those actions were reasonable in light of Kenetech s situation and comported >kvith the board s j?duciary duties towards its common shareholders. 35 The court then considered whether Delaware recognizes any special duty of a fiduciary nature to PRIDES holders, distinct from duties to common stockholders: It is oft noted that a preferred shareholder s rights are those specified in -the certificate of designation, but existing precedent also supports the proposition that in sofar as their interests are harmonious, preferredl shareholders share with common . I note that, for the sake of clarity and fairness to plaintiffs, I view Quadrangle II as if it relatm to not only a different plaintiff, but also to a different defendant Quadrangle II at 20 (emphasis added) 14 shareholders the right to demand loyalty and care from the fiduciaries entrusted with managing the corporation. 3 \/ice Chancellor Steele recognized, however, that [thee PRIDES rihareholders right to a liquidation preference places them in an economically antagonistic relationship with the common. Therefore, to the extent that the PRIDES shareholders enjoy liquidation rights preferential to those of the Kenetech common shareholders, those rights must be spelled out in the Certificate. r37 Ihis analysis of the scope of a director s fiduciary obligations to preferred stockholders is well-reasoned and carefully grounded in valid precedent. While Vice Chancellor Steele eventually focused his analysis on whether the conduct of the Kenetech board comported with the implied covenant of good faith and fair dealing., it is clear that he addressed the question of fiduciary duty and held that the boa:rd did not violate any such obligation. For these reasons, plaintiffs second claim, which rests on the existence of a fiduciary obligation to protect the rights of preferred stockholders when the company is near insolvency, cannot survive this motion. Plaintiffs argument that they should now be able to litigate over whether Kenetech was winding up rather than liquidating meets the same fate. j6 Id at 21 (emphasis added) (citations omitted). Id. at 2 l-22. 15 Although plaintiffs are correct that the Opinion does not reflect that Quadrangle specifically argued that Kenetech was involved in a winding up, as opposed to a liquidation or a diss~olution, Vice Chancellor Steele made clear that his view of liquidation. would encompass a winding up. Indeed, the court expressly stated that ]t]he parties focus exclusively on the terrn liquidation and I: perceive no reason why the outcome would be any different if they litigated over the meaning of dissolution or winding up. 38 Similarly, after discussing the four elements of liquidation recognized by Chancellor Brown in RothscMd Int l Corp. v. Liggett Carp Inc. ,39 Vice Chancellor Steele stated that [tlhe circumstances of this case suggest a modifiicarion of the Chancellor s definition of liquidation to add an additional 8elemer&, namely, otherwise winding up business affairs. 40 In support of that proposnion., the court cited then-Vice Chancellor Chandler s statement in Rosan v. Chicago Milwaukee Corp. that a central characteristic of a liquidation was a winchg up of the corporation s affairs . I j8 Id. at n. 18. I9 Del. Ch., 463 A.2d 642, 646 (1983), uff d, Del. Supr., 474 A.2d 133 (1984). The four elements are (1) selling off assets, (2) paying off creditors, (3) distributing remaining proceeds and (4) abandoning the corporate form. lo Quudrangle II at 24-25. Del. Ch., CA. No. 10526, mem. op. at 9, Chandler, V.C. (Feb. 6, 1990). 16 In the circumstances, il. is clear that in Quadrangle ZZ, this court conside:red all of the arguments here advanced and held contrary to plaintiffs position. That opinion has no,w been affirmed by the Supreme Court and conclusiively represents the law of this state. Allowing the parties to litigate about settled issues is an affront to both Courts. V. CONCLUSION I[n sum, I agree with plaintiffs that they are not barred by res judicata or collateral estoppel from litigating the claims asserted. Nevertheless, their complaint, read in accordance with the normal standard applied in the case of a motion to dismiss under Flule 12(b)(6), fails to state a claim upon which relief may be granted. 17

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