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applying USACafes to directors of corporate general partner
Summary of this case from Feeley v. Nhaocg, LLCOpinion
C.A. No. 16511.
Submitted: April 6, 1999.
Decided: August 6, 1999.
Joseph A. Rosenthal of Rosenthal, Monhait, Gross Goddess, OF COUNSEL: Abbey, Gardy Squitieri, Attorneys for Plaintiffs.
Kenneth J. Nachbar of Morris, Nichols, Arsht Tunnell, Attorneys for Defendants.
MEMORANDUM OPINION
Defendants, the corporate general partner of the limited partnership and the corporate general partner's directors, move pursuant to Court of Chancery Rule 12(b)(6) to dismiss this class action brought by the Plaintiffs, limited partners of the limited partnership. The Complaint alleges that the Defendants engaged in unfair dealing with the Plaintiffs and breached the duty of loyalty they owed to the Plaintiffs by approving a coercive reorganization of the partnership. Specifically the Complaint alleges that the reorganization resulted from an unfair process, diluted the Plaintiffs' equity ownership of the outstanding limited partnership units and intentionally sought to freeze out virtually all of the Plaintiffs for unfair and inadequate consideration in order to benefit the Defendants. Because Plaintiffs' support for the Complaint's theory that the reorganization diluted their equity interests and intended to freeze them out are mere conclusory allegations that Plaintiffs appear to abandon in their Answering Brief, I dismiss the portion of Plaintiffs' claim based on that theory. Nevertheless, contrary to Defendants' contentions, the remainder of Plaintiffs' Complaint sufficiently pleads that the reorganization was a self-interested transaction that was the result of an unfair process that produced unfair terms. I, therefore, grant in part and deny in part Defendants' motion. Furthermore, I grant Plaintiffs 30 days to amend their Complaint, if they can consistently with the policy expressed in Court of Chancery Rule 11, to include certain facts present in their Answering Brief but absent from their Complaint which would support their claim that the reorganization unfairly impacted the Plaintiffs.
Background
The facts recited are as alleged in the Complaint and, for the terms of the reorganization underlying the Complaint, as set forth in the Complaint and Information Statement/Prospectus dated June 8, 1998 disseminated in connection with the reorganization. It is appropriate in this instance for me to consider the Information Statement/Prospectus to set forth the terms of the reorganization because I conclude that the Information Statement/Prospectus is integral to Plaintiffs' claim and is incorporated into the Complaint. See Vanderbilt Income and Growth Assoc., L.L.C. v. Arvida/JMB Managers, Inc., Del. Supr., 691 A.2d 609, 613 (1996) (citing In re Santa Fe Pac. Corp. Shareholder Litig., Del. Supr., 669 A.2d 59, 70 (1995). The Plaintiffs rely on it in their Complaint as the source of facts surrounding the reorganization and also rely on it extensively in their Answering Brief. I also note that the Plaintiffs did not object to the Defendants' use of the Information Statement/Prospectus in this motion.
Boston Celtics Limited Partnership ("BCLP") is a Delaware limited partnership created in 1986. Up until BCLP's June 30, 1998 reorganization (the "Reorganization"), BCLP owned, among other assets, 99% of Celtics Limited Partnership, which, in turn, owns and operates the Boston Celtics professional basketball team. BCLP's units were sold to the public. Before the Reorganization, Plaintiffs were the direct owners of BCLP limited partnership units ("BCLP Units").
Defendant Celtics, Inc. (the "General Partner") is a corporation that serves as BCLP's sole general partner. The General Partner owns a 1% interest in BCLP. Defendants Paul Gaston, Don Gaston (Paul Gaston's father) and Paula Gaston (Paul Gaston's mother) along with certain related parties (the Gastons and these related parties referred to as "Gaston Affiliates") wholly own and control the General Partner. Gaston Affiliates own approximately 47.8% of the outstanding BCLP Units.
The General Partner's directors are designated by the General Partner's shareholders. BCLP limited partners have no vote in their election. Defendant Paul Gaston is the chairman of the board of the General Partner. Defendants Don Gaston, Paula Gaston, Leithead and Marsh serve as the General Partner's other directors. The General Partner's directors and officers perform all BCLP management functions and carry out BCLP's activities.
At the time BCLP was created and its Units were sold to the public, BCLP's income was not taxed at the partnership level. In December of 1987, Congress passed the Revenue Act of 1987 which provided, among other things, that certain existing publicly traded limited partnerships would be taxed as corporations for federal income tax purposes beginning in their first taxable year after December 31, 1997. Thus, absent some restructuring, BCLP would become taxable as a corporation for its tax year beginning July 1, 1998.
On April 18, 1998, BCLP announced the Reorganization. By the time BCLP first presented the Reorganization to the Plaintiffs in the June 8, 1998 Information Statement/Prospectus (the "Prospectus"), the General Partner and the owners of 50.1% of the outstanding BCLP Units had approved the Reorganization. Gaston Affiliates and Stephen C. Schram, a former executive officer of BCLP, were the owners of the 50.1% BCLP Units that had already approved the Reorganization. The Plaintiffs' approval of the Reorganization, therefore, was not necessary nor was it requested. Furthermore, under Delaware law, the Plaintiffs had no dissenters' rights or appraisal rights in connection with the Reorganization.
The Reorganization resulted in the formation of Boston Celtics Limited Partnership II ("BCLP II"), a publicly traded Delaware limited partnership that is subject to corporate-level taxation, and Castle Creek Partners, L.P., a Delaware limited partnership that is a private entity not subject to corporate level taxation. Pursuant to the Reorganization, BCLP distributed to holders of BCLP Units, at each holder's option, either (i) $20 in principal amount of Subordinated Debentures and $1 in cash for each BCLP Unit held of record, or (ii) one unit in Castle Creek for each 100 BCLP Units held of record. Following that distribution, BCLP became a subsidiary of BCLP II through a merger, in which (a) holders of BCLP Units that received Subordinated Debentures and cash in the distribution received one BCLP II Unit for each BCLP Unit held of record upon which Subordinated Debentures and cash were distributed and (b) holders of BCLP Units who received Castle Creek Units in the distribution retained their Castle Creek Units, but the BCLP Units with respect to which Castle Creek Units were distributed were canceled. BCLP's assets are now owned directly or indirectly by BCLP II and Castle Creek in exact proportion to the number of BCLP Units electing to receive, in the distribution, a distribution of Subordinated Debentures and cash compared to those electing to receive a distribution of Castle Creek Units.
In other words, if holders of"X%" of BCLP's Units elected to covert their Units into Units of Castle Creek, Castle Creek became the owner of"X%" of BCLP's assets. The balance of BCLP's assets are owned by BCLP, which became a subsidiary of BCLP II.
Since no fractional Castle Creek Units were to be issued under the Reorganization and since Castle Creek Units would be distributed only in exchange for blocks of 100 BCLP Units, holders of fractional blocks, i.e. blocks of fewer than 100 BCLP Units, were unable to receive Castle Creek Units for those BCLP Units, and were compelled to receive BCLP II Units, Subordinated Debt and cash.
Pursuant to the Castle Creek Partnership Agreement, the Castle Creek general partner has the right to effect one or more reverse splits of Castle Creek Units during the period ending on the first anniversary of the date on which the Reorganization is consummated. The Castle Creek general partner can effect the reverse split only for the purpose of reducing the number of holders of Castle Creek Units in order for Castle Creek to remain exempt from regulation under the Investment Company Act. Any such reverse split must be effected at the "Split Price" set forth in the Prospectus and, presumably, the Castle Creek Partnership Agreement. In the event that any reverse split is effected, however, holders of Castle Creek Units will be given the opportunity to purchase, at the Split Price, a sufficient number of Castle Creek Units to enable each holder to remain a holder of Castle Creek Units after the reverse split is effected.
The Split Price is equal to the greater of(i) the average of the high and low prices of BCLP Units as reported on the NYSE on the five trading days immediately preceding April 17, 1998 (the date on which the Reorganization was announced) and (ii) the sum of(x) the average of the high and low prices of the BCLP II Units as reported on the NYSE on the five trading days immediately preceding the date on which the reverse split is announced and (y) average of the high and low prices of the Subordinated Debentures as reported on the NYSE on the five trading days immediately preceding the date on which the reverse split is announced.
After the Reorganization, Gaston Affiliates owned all of the stock of the General Partner and all of the stock of the general partners of both BCLP II and Castle Creek. The general partners of BCLP II and Castle Creek have the right to collect management fees from the respective limited partnerships. Defendants Paul Gaston, Don Gaston and Paula Gaston serve on the boards of each of the general partners of the new partnerships. Gaston Affiliates owns a substantial majority of the outstanding Castle Creek Units and virtually none of the BCLP II Units.
The Parties' Contentions
Plaintiffs claim that the Reorganization was a self-interested transaction that benefited the Defendants and therefore is subject to the "entire fairness standard." Plaintiffs further claim that the Defendants breached their duty of loyalty that they owed the Plaintiffs by approving the Reorganization, which they claim was the result of an unfair process that produced unfair terms.
Defendants move to dismiss the claims pursuant to Rule 12 (b)(6) for failure to state a claim. Defendants argue that Plaintiffs' primary allegations, that the Reorganization diluted Plaintiffs' equity interests and was designed to freeze them out of the partnership, are merely conclusory. Defendants further argue that Plaintiffs' allegations of self-dealing fail to state a claim because they fail to allege facts that support the theory that the terms of the Reorganization were unfair to them.
Discussion
A. Legal Standard
The appropriate standard on a motion to dismiss pursuant to Court of Chancery Rule 12(b)(6) for failure to state a claim is rigorous. A complaint will be dismissed only if "it appears to a reasonable degree of certainty the plaintiff would not be entitled to relief under any set of facts which could be proved in support of his claim." This Court assumes the truth of all well-pleaded facts in the complaint and draws all reasonable inferences from those facts in the light most favorable to the plaintiff. Mere conclusory allegations, however, will not be accepted as true.
Rosan v. Chicago Milwaukee Corp., Del. Ch., C.A. No. 10526, mem. op. at 1, Chandler, V.C. (Feb. 6, 1990).
James River-Pennington, Inc. v. CRSS Capital, Inc., Del. Ch., C.A. No. 13870, mem. op. at 10, Steele, V.C. (Mar. 6, 1995) (citing Rabkin v. Philip A. Hunt Chiemical Corp., Del. Supr., 498 A.2d 1099, 1104 (1985)); In re USA Cafes, L.P. Litig., Del. Ch., 600 A.2d 43, 47 (1991).
Id. at 9-10 (citing Grobow v. Perot, Del. Supr., 539 A.2d 180, 187 n. 6 (1998)).
Id. at 10.
B. The General Law
It is well settled that, unless limited by the limited partnership agreement, the general partner of a Delaware limited partnership and the directors of a corporate General Partner who control the partnership, like the directors of a Delaware corporation, have the fiduciary duty to manage the partnership in the partnership's interests and the interests of the limited partners. As this Court said in Boxer v. Husky Oil Co., "the fiduciary duty of fair dealing by a general partner to a limited partner is no less than that owed by a director to a shareholder. The form of the enterprise does not diminish the duty of fair dealing by those in control of the investments." As a result, Delaware law requires the general partners of limited partnerships to exercise due care and to act in the best interest of the partnership and the limited partners. On the other hand, the business judgement rule generally protects the actions of general partners, affording them a presumption that they acted on an informed basis and in the honest belief that they acted in the best interest of the partnership and the limited partners.
Sonet v. Timber Co., Del. Ch., 722 A.2d 319, 322-23 (1998) (citing, Boxer v. Husky Oil Co., Del. Ch., 429 A.2d 995, 997 (1981)).
In re USA Cafes, L.P. Litigation, Del. Ch., 600 A.2d 43, 48-50 (1991).
429 A.2d at 997 (quoting Miller v. Schweickart, S.D.N.Y., 405 F. Supp. 366 (1975)).
See Nebenzahl v. Miller, Del. Ch., C.A. No. 13206, mem. op. at 5-6, Steele, V.C. (Aug., 29, 1996) (stating, "Delaware law requires directors to exercise due care in carrying out their fiduciary duties and to act in the best interest of the shareholders and the corporation.") (citing Cede Co. v. Technicolor, Inc., Del. Supr., 634 A.2d 345, 360 (1993)).
See Dean v. Dick, Del. Ch., C.A. No. 16566, mem op. at 8-14, Chandler, C. (June 10, 1999) (applying business judgement rule to general partner's conduct); See also Seaford Funding, L.P. v. MM Associates II, L.P., Del. Ch., 672 A.2d 66, 70 (1995).
See Nebenzahl, C.A. No. 13206 at 6 (stating, "[t]he business judgement rule generally protects the actions of directors, affording them the presumption directors act on an informed basis and in the honest belief they acted in the best interest of the corporation.") (citing Aronson v. Lewis, Del. Supr., 473 A.2d 805, 812 (1984)).
A plaintiff has the burden of rebutting the business judgement rule's presumption. A plaintiff can rebut the presumption by sufficiently pleading that the general partner appeared on both sides of a transaction or derived a personal benefit from a transaction in the sense of self-dealing. In the context of a challenge to the fairness of certain transactions, such as the cash-out merger of minority limited partners by a majority limited partner, it also is necessary for the plaintiff to allege specific items of misconduct that demonstrate unfairness, in order to survive a motion to dismiss. If the plaintiff meets this burden, the burden shifts to the defendant general partner to prove the "entire fairness" of the challenged transaction. "Under the entire fairness standard of judicial review, the defendant [general partner] must establish to the court's satisfaction that the transaction was the product of both fair dealing and fair price."
Id.
See Seaford Funding, L.P. 672 A.2d at 70 (stating, "[g]eneral partners may not claim the protection of the business judgement rule when appearing on both sides of the transaction or when deriving a personal benefit in the sense of self-dealing.") (citing Aronson v. Lewis, Del. Supr., 473 A.2d 805, 812 (1984)).
See Rabkin v. Philip A. Hunt Chemical Corp., Del. Supr., 498 A.2d 1099, 1105 (1985) (stating, in the context of a corporate cash-out merger, that "a plaintiff's mere allegation of "unfair dealing," without more, cannot survive a motion to dismiss. . . ." (citations omitted)); See also Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 703 (1983) (affirming Chancellor's conclusion "that the plaintiff in a suit challenging a cash-out merger must allege specific acts of fraud, misrepresentation, or other items of misconduct to demonstrate the unfairness of the merger terms to the minority.")
Nebenzahl, C.A. No. 13206 at 6 (citing Cede Co., 634 A.2d at 361).
Id.
C. The Complaint States a Claim
For the following reasons, I conclude (i) that Plaintiffs' allegations that the Reorganization diluted their equity interests in the partnership and intended to "freeze" them out of the partnership are merely conclusory allegations, and (ii) that the Plaintiffs' Complaint, nevertheless, sufficiently pleads its claim that the Defendants' plan unfairly impacted the Plaintiffs.
1. Plaintiffs Sufficiently Plead that the Defendant Directors Owed Plaintiffs Fiduciary Duties
In their Complaint Plaintiffs claim that the directors of the General Partner owe BCLP's limited partners fiduciary duties. In support of this claim, Plaintiffs allege that the directors of the General Partner perform all BCLP management functions and carry out the activities of BCLP. Plaintiffs, therefore, sufficiently plead that the directors of the General Partner owed Plaintiffs fiduciary duties.
2. Plaintiffs Sufficiently Plead that the Reorganization Was a Self-Interested Transaction and Rebut the Presumption of the Business Judgement Rule
See In re USA Cafes, L.P. Litigation, 600 A.2d 48 — 50.
Plaintiffs in their Complaint allege that (i) Gaston Affiliates, who constitute three of the General Partner's five directors, wholly owned and controlled the General Partner; (ii) that Gaston Affiliates owned a total of 47.8% of the outstanding BCLP Units; (iii) after the Reorganization, Gaston Affiliates would own a substantial majority of the outstanding Castle Creek Units; (iv) the option to receive Castle Creek Units in the distribution as opposed to the Subordinated Debentures and cash was an option only available to BCLP Unitholders that owned at least 100 BCLP Units; and (v) unlike BCLP II which is taxed as a corporation, Castle Creek will be subject to "pass through" tax treatment and that BCLP II's general partner, which is wholly owned by Gaston Affiliates, will have the authority to collect management fees from BCLP II. On the basis of these allegations, I conclude that Plaintiffs have sufficiently pleaded that the Reorganization was a self-interested transaction. As a result of the Reorganization, three of the General Partner's five directors and certain related parties (the Gaston Affiliates) became substantial majority owners of a privately held partnership not subject to corporate tax (Castle Creek) and free from regulation under the Investment Company Act, as opposed to the owners of 47.8% of the outstanding units of a publicly traded partnership subject to corporate tax (BCLP). Defendants, therefore, are not entitled to the presumption of the business judgement rule.
3. Plaintiffs Sufficiently Plead that the Reorganization Was the Result of an "Unfair Process"
It could be argued that the Reorganization's structure and effect are sufficiently analogous to a cash-out merger to require Plaintiffs to plead specific items that demonstrate the unfairness of the Reorganization in order to survive this motion to dismiss. Since, as I will explain, Plaintiffs in fact sufficiently plead that the Reorganization was the result of an unfair process and resulted in unfair terms, it is unnecessary for me to decide whether that pleading requirement must be met in order for the Complaint to survive this motion to dismiss.
Plaintiffs allege the process by which the terms of the Reorganization were determined was unfair because (i) Defendant Paul Gaston proposed the Reorganization and the General Partner determined the Reorganization's terms; (ii) the General Partner had admitted conflicts of interest in determining the terms of the Reorganization; (iii) the Plaintiffs were bound to the Reorganization through the written consents, and, therefore, had no opportunity to vote on the Reorganization; (iv) no independent party represented the Plaintiffs' interests in negotiation of the Reorganization; (v) the General Partner made a determination — without the benefit of any special committee or any financial advisor or any fairness opinion and despite its conceded conflicts of interest — that the Reorganization was fair to the BCLP Unitholders; and (vi) the sole basis for this determination was that the Reorganization provides for the allocation of BCLP's net assets to each of BCLP II and Castle Creek in the same proportions as Units of those partnerships were distributed to the original BCLP unitholders. In their Answering Brief, the Plaintiffs add that, as admitted in the Prospectus, the Defendants did not consider any of the benefits that would accrue to them or their affihates from the Reorganization when determining the Reorganization to be fair. I conclude that these factual allegations, considered together, are sufficient to support Plaintiffs' pleading that the "process" leading up to the Reorganization was unfair.
4. Plaintiffs Sufficiently Plead that the Terms of the Reorganization Were Unfair
In the Complaint, Plaintiffs seem to allege that the Reorganization's terms were unfair because (i) holders of less than 100 BCLP Units could not opt for Castle Creek Units; (ii) BCLP II's general partner and Castle Creek's general partner, both of whom are controlled by Gaston Affiliates, will have the authority to collect management fees whereas the General Partner did not have the authority to collect management fees from BCLP; (iii) BCLP II will be subject to corporate tax whereas Castle Creek will continue to enjoy "pass through" tax treatment; (iv) the Reorganization diluted the equity interests of BCLP unitholders by converting a substantial portion of their equity interest into subordinated debt; and (v) the Reorganization's ultimate purpose is to freeze out or otherwise eliminate the equity interests of Plaintiffs for unfair and inadequate consideration that fails to reflect the very substantial increase in the value of the Boston Celtics franchise over the past decade. In their Answering Brief, Plaintiffs also argue that the terms of the Reorganization are unfair because the Reorganization has left BCLP with an increased level of debt and associated risks, and because BCLP II, as a publicly traded partnership, will incur reporting costs that Castle Creek will not incur.
The gravamen of Plaintiffs' Complaint appeared to be the allegations that the Reorganization diluted their equity interests in BCLP and had the ultimate purpose of freezing them out of the partnerships for unfair and inadequate consideration. These allegations, however, are mere conclusory allegations unsupported by any factual allegations in the Complaint. The Complaint fails to allege how the Reorganization dilutes the Plaintiffs' equity interests. The only allegation that could support Plaintiffs' freeze out theory is the allegation that Castle Creek's general partner has the right to effect one or more reverse splits of Castle Creek Units for the sole purpose of reducing the number of holders of Castle Creek Units in order for Castle Creek to remain exempt from regulation under the Investment Company Act. The Complaint, however, fails to allege or set forth facts from which I could draw the inference that the Split Price at which the Castle Creek general partner would effect the reverse split is unfair or to address the fact that the Castle Creek Unitholders who would be subject to this reverse split opted for Castle Creek Units with notice of the possibility of a reverse split. Furthermore, in their Answering Brief, Plaintiffs fail to mention these allegations in support of their claims and even state that following the Reorganization, "BCLP's assets (mainly indirect ownership of the Boston Celtics basketball team), are owned directly or indirectly by BCLP II and Castle Creek in the same proportion that Units of BCLP II and Castle Creek were distributed to former unitholders of BCLP." This statement itself contradicts Plaintiffs' allegation that the Reorganization diluted their equity interest and was designed to freeze them out at an unfair price. I, therefore, dismiss the portions of the Complaint based on the alleged dilution of Plaintiffs' equity interests and the Reorganization's alleged purpose to freeze out the Plaintiffs.
Nevertheless, I conclude that Plaintiffs have pleaded facts sufficient to support their allegation that the terms of the Reorganization were unfair. Of particular significance is the allegation in the Complaint that the Reorganization provides BCLP II's general partner, which is wholly owned and controlled by Gaston Affiliates, with the right to collect management fees from BCLP II whereas the General Partner did not have the right to collect these fees from BCLP. Defendants fail to respond to this allegation or attempt to explain why this is a fair term of the Reorganization. I, therefore, conclude that Plaintiffs have in their Complaint sufficiently pleaded that the terms of the Reorganization were unfair to the Plaintiffs.
Furthermore, while not pleaded in their Complaint, in their Answering Brief Plaintiffs point to the fact that BCLP, which now is wholly owned by BCLP II, incurred substantial debt in order to consummate the Reorganization. Defendants respond by explaining that the debt the Plaintiffs refer to is the debt associated with the Subordinated Debentures, which debt is owed to the Plaintiffs, and debt that BCLP incurred in allocating the proportionate share of its assets to Castle Creek. It is the latter debt that is of most concern to me. Regardless of the fact that the Prospectus states that BCLP incurred this debt in order to avoid adverse tax consequences, the fact remains that BCLP incurred $30 million worth of debt to fund a Reorganization in which the only persons who appear to benefit are the Defendants and BCLP unit holders who were able to opt for Castle Creek Units. At this point in the proceedings, an allegation regarding this $30 million in debt incurred by BCLP in order to consummate the Reorganization would support a claim that the Reorganization was unfair to the Plaintiffs. I, therefore, grant Plaintiffs 30 days to amend their Complaint to include this allegation regarding the unfairness of the Reorganization's terms.
Two remaining issues are worth noting. First, Plaintiffs' allegations that BCLP II, unlike Castle Creek, is subject to corporate tax and reporting costs as a result of its status as a publicly traded partnership do not support a claim that the terms of the Reorganization were unfair. In the absence of the Reorganization, BCLP would have been subject to these same taxes and reporting costs and, therefore, they do not result from the Reorganization.
Second, Defendants attempt to undermine Plaintiffs' claim that the terms of the Reorganization were unfair by attacking the validity of Plaintiffs' allegation that only owners of at least 100 BCLP Units could opt to receive Castle Creek Units in the distribution. Defendants argue that holders of fewer than 100 BCLP Units had the ability to "round up" to a 100 unit holding, in which case they could elect either alternative. On the basis of the use of the term "round up" in other portions of their briefs, I understand Defendants' argument to be that owners of fewer than 100 BCLP Units could purchase enough BCLP Units so that they owned 100 Units and then elect either alternative. This argument is unpersuasive. The Prospectus states that
[d]istributions of Castle Creek [Units] will be effected only with respect to "blocks" of 100 BCLP Units; no fractional Castle Creek [Units] will be issued. As a result, holders of fewer that 100 BCLP Units will be unable to receive Castle Creek [Units], and will be compelled to receive BCLP II Units, Subordinated Debentures and cash.
The Defendants point me to no reference or suggestion in the Prospectus, and I was unable to find one, regarding this "round up" right. Furthermore, this round up right, if it exists, does not cure the unfairness associated with granting only BCLP Unitholders who own at least 100 BCLP Units the right to opt for Castle Creek Units when the other option consists of unfair terms. In order for the terms of the Reorganization to be fair, the Reorganization must be fair to all BCLP Unitholders given their status at the time it is announced, without requiring them to make a further investment in BCLP.
Conclusion
For the reasons stated above, I grant in part and deny in part Defendants' motion to dismiss. I also grant Plaintiffs 30 days to amend their Complaint, if they can appropriately do so.
IT IS SO ORDERED.
_________________________ Vice Chancellor