Rosenquist v Economou [2011] MHSC 2; 3 MILR 145 (5 October 2011)

IN THE SUPREME COURT
REPUBLIC OF THE MARSHALL ISLANDS

S. Ct. Case No. 2010-002
High Ct. Civil No. 2009-056

JOSEPH ROSENQUIST, derivatively on behalf of Nominal Defendant DRYSHIPS, INC.,
Plaintiffs-Appellant

-v-

GEORGE ECONOMOU, GEORGE DEMATHAS, CHRYSSOULA KANDYLIDIS (aka CHRYSSOULA KANDYLIDI or CHRYSOULA KANDYLIDIS), EVANGELOS MITILANAIOS (aka EVANGELOS MYTILINAIOS or EVANGELOS MYTILINAEOS), ANGELOS PAPOULIAS, and GEORGE XIRADAKIS
Defendants-Appellees

and

DRYSHIPS, INC.,
Nominal Defendant

APPEAL FROM THE HIGH COURT

OCTOBER 5, 2011

CADRA, C.J.
SEABRIGHT[1] and KURREN[2] Acting Associate Justices.

SUMMARY:

Plaintiff filed a shareholder derivative action alleging Defendants breached their fiduciary duty of good faith, committed waste by approving transactions that were not the product of good faith business judgment, and were unjustly enriched. Appellant did not make a demand on the board of directors to initiate litigation, asserting that it would be futile. The Supreme Court upheld the High Court's dismissal of Plaintiff's complaint, concluding that Plaintiff did not meet the two-part test to demonstrate futility sufficient to excuse his failure to make presuit demand on the board of directors.

DIGEST:

1. APPEAL AND ERROR – Review – Questions of Law – Dismissal of Complaint: The Court reviews dismissal of a complaint de novo.

2. APPEAL AND ERROR – Review – Questions of Law – Dismissal of Complaint: In reviewing complaints on a motion to dismiss, plaintiffs are entitled to all reasonable factual inferences that logically flow from the particularized facts alleged, but conclusory allegations are not considered. Inferences that are not objectively reasonable cannot be drawn in the plaintiff's favor.

3. CORPORATIONS – Shareholder Derivative Action: Under Marshall Islands law, a shareholder asserting claims derivatively on behalf of a corporation shall first make a demand on the board of directors to initiate the litigation. Where a shareholder plaintiff fails to make such a demand, he must allege "with particularity" the reasons why that demand would have been futile.

4. CORPORATIONS – Law Applicable: Marshall Islands law requires the courts to look to Delaware corporate law.

5. CORPORATIONS – Shareholder Derivative Action: Where a plaintiff fails to make a demand on the board of directors to initiate litigation, courts apply a two-part test, and must determine whether, under the particularized fact alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

6. CORPORATIONS – Shareholder Derivative Action: In determining whether presuit demand is excused, the court must accept as true the well pleaded factual allegations in the complaint, but the pleadings must set forth particularized factual statements that are essential to the claim.

7. CORPORATIONS – Shareholder Derivative Action: Futility, as required to excuse presuit demand, is gauged by the circumstances existing at the commencement of a derivative suit.

8. CORPORATIONS – Shareholder Derivative Action: "Disinterested" means that directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which evolves upon the corporation or all stockholders generally.

9. CORPORATIONS – Shareholder Derivative Action: A plaintiff must rebut the presumption of the business judgment rule that sophisticated business people with years of experience acted with independence. "Independence" means that a director's decision is based on the corporate merits of the subject before the board, rather than extraneous considerations or influences.

10. CORPORATIONS – Shareholder Derivative Action: A stockholder's control of a corporation does not excuse presuit demand on the board without particularized allegations of relationships between the directors and the controlling stockholder demonstrating that the directors are beholden to the stockholders. A plaintiff must allege particularized facts showing that the other directors would be more willing to risk their reputation than risk the relationship with the interested director.

11. CORPORATIONS – Shareholder Derivative Action: In order to establish a reasonable doubt that the challenged transactions were the product of a valid exercise of business judgment, as required to excuse presuit demand, a plaintiff must set forth particularized facts rebutting the presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. This presumption protects decisions unless they cannot be attributed to any rational business purpose, and imposes a high burden to overcome.

12. CORPORATIONS – Shareholder Derivative Action: The court will not second-guess business decisions. Rather than question the merits of Board decisions, courts question the informational component of the directors' decision-making process and the motivations or the good faith of those charged with making the decision.

13. CORPORATIONS – Shareholder Derivative Action: This Court will not second-guess the Board's decision unless that decision "cannot be 'attributed to any rational business purpose."

14. CORPORATIONS – Shareholder Derivative Action: The size and structure of executive compensation are inherently matters of business judgment.

15. CORPORATIONS – Shareholder Derivative Action: A transaction constitutes "waste" if it is an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration.

KURREN, ACTING ASSOCIATE JUSTICE:

INTRODUCTION
This is a shareholder derivative action brought by Plaintiff-Appellant Joseph Rosenquist, derivatively on behalf of Nominal Defendant DryShips, Inc. Plaintiff is a shareholder of DryShips and filed this lawsuit against the following current and former members of its Board of Directors ("Board"): Defendants-Appellees George Economou, Chryssoula Kandylidis (a/k/a Chryssoula Kandylidi or Chrysoula Kandylidis), George Demathas, Evangelos Mitilinaios (a/k/a Evengelos Mytilinaios or Evangelos Mytilinacos), George Xiradakis, and Angelos Papoulias (collectively, "Defendants"). Plaintiff alleges that Defendants breached their fiduciary duty of good faith, committed waste by approving transactions that were not the product of good faith business judgment, and were unjustly enriched at DryShips's expense.

Plaintiff did not make a demand on the DryShips Board before instituting this action against Defendants. In the Amended Complaint, Plaintiff asserted that any such demand would have been "futile and useless. . .because the Board is incapable of making an independent and disinterested decision to institute and vigorously prosecute this action." Absent a demand on the Board, Defendants moved the High Court of the Republic of the Marshall Islands to dismiss the Amended Complaint. The High Court agreed with Defendants and dismissed the Amended Complaint, concluding that it did "not contain particularized allegations that raise a reasonable doubt that at the time the lawsuit was filed a majority of the directors were disinterested and independent or that the challenged transactions were the product of a valid exercise of business judgment." Although Plaintiff was permitted to move for leave to amend the Amended Complaint, he chose to appeal the High Court's decision to this Court.

As discussed below, the Court AFFIRMS the dismissal of the Amended Complaint.

BACKGROUND
A. Factual Background
Plaintiff is a shareholder of DryShips, which is a corporation incorporated under the laws of the Republic of the Marshall Islands and headquartered in Athens, Greece. Defendant Economou founded DryShips in 2004 as a holding company engaged in the ocean transportation of dry bulk cargoes worldwide. DryShips's assets are managed by Cardiff Marine, Inc., an entity owned 70% by Economou and 30% by his sister, Defendant Kandylidis. Fabiana Services S.A. is a corporation owned by Economou, which "provides the services of the individuals who serve in the positions of chief executive and chief financial officer of the Company." Dry Ships's articles of incorporation contain an exculpation clause, which exempts directors from liability for breaches of the duty of care.

Defendant Economou has served as DryShips' s chairman of the Board, president, chief executive officer, interim chief financial officer and, at the times DryShips entered into the transactions at issue, he owned between 9.0% and 31.0% of DryShips common stock.

Defendant Kandylidis, Economou's sister, has served as a non-executive director of DryShips since March 5, 2008. Defendant Demathas served as a non-executive director since July 18, 2006 and was a member of the Audit, Compensation and Nomination Committees at all times relevant. Defendant Xiradakis has served as a non-executive director since 2006 and was a member of the same Committees at all times relevant. Defendant Papoulias served as a non-executive director from April 2005 until December 22, 2008. Defendant Mitilinaios has served as a non-executive director and was a member of the Audit Committee since December 22, 2008. At the time this action was commenced, the Board consisted of Economou, Kandylidis, Dernathas, Mitilinaios, and Xiradakis.[3]

In the Amended Complaint, Plaintiff alleges that Economou dominates and controls DryShips through his ownership of the company, his positions within the company, "anti-takeover provisions" of the company's articles and bylaws, and "director appointments and compensation." Plaintiff further alleges that Economou's control of DryShips "resulted in Board approval of transactions that appear to have been designed to benefit Economou, not DryShips." The transactions for which Plaintiff seeks relief in this case are: (1) the Primelead Transaction, (2) the July and October Agreements, and (3) Economou's compensation.

1. The Primelead Transaction
On October 3, 2008, DryShips entered into a share purchase agreement to acquire equity interests of DrillShips Holdings, which was controlled by clients of Cardiff, including Economou, in exchange for 25% of the equity of Primelead Shareholders Inc., which is a DryShips subsidiary ("the Primelead Divestment"). In connection with this transaction, DryShips "assumed installment payment obligations of $1.1 billion and debt obligations of $261.l million."

Nine months later on July 9, 2009, after the shipping industry suffered an economic downturn, DryShips "announced that 'it has entered into an agreement to acquire the remaining 25% of the total issued and outstanding capital stock of Primelead"' ("the Primelead Acquisition").[4] The Primelead Acquisition would cause "Primelead (to] become a wholly-owned subsidiary of [Dry 'Ships]." The Primelead Acquisition "resulted in [DryShips] paying to Economou a one-time $50.0 million cash payment, and issuing to Economou 33,955,224 shares of DryShips convertible preferred stock." "Economou' s 25% equity interest in Primelead that DryShips acquired in the Primelead Acquisition was worth approximately $122 million at the time of the transaction, and the Preferred Stock that Economou received in the Primelead Acquisition was worth approximately $185 million." The Amended Complaint alleges that, in sum, "DryShips paid Economou a total of approximately $235 million ($50 million in cash and $185 million in Preferred Stock) for equity worth only $122 million, an overpayment of approximately $113 million, or 93%."

2. The July and October Agreements
On July 3, 2008, DryShips entered into the July Agreement to purchase four Panamax bulk carriers for $400 million from companies beneficially owned by Economou. DryShips paid to the selling entities a cash deposit of $55 million or 13.75% of the purchase price, which is higher than the industry standard of 10%. Defendants Demathas, Kandylidis, Mitilinaios, and Xiradakis approved the July Agreement.

On October 6, 2008, Dryships entered into the October Agreement to purchase nine special-purpose companies that each owned one Capesize bulk carrier. The special purpose companies were each owned by Cardiff or undisclosed clients of Cardiff. DryShips agreed to pay "more than $689 million in newly-authorized DryShips stock, and to assume $216 million in debt and $262 million in remaining shipyard installments to complete construction of some of the dry bulk carriers."

As 2008 progressed, "the health of the shipping industry deteriorated" and "the daily average of charter rates . . . [fell] over 90% from May 2008 through October 2008 and over 70% in October 2008 alone." Consequently, the Board terminated the July and October Agreements.

As to the July Agreement, DryShips paid for an "option to purchase the very same dry bulk carriers on an en bloc basis at a fixed purchase price of $160 million. In exchange for this Option, DryShips paid $26.25 million per vessel, or $105 million." As for the October Agreement, upon termination, "DryShips granted to Economou warrants to purchase Company stock . . ., the intrinsic value of these warrants is approximately $82.5 million." DryShips also "granted to 'clients' of Cardiff . . . $6.5 million shares of Dryships stock worth approximately $68,185,000."

3. Economou's Compensation
On January 21, 2009, Demathas and Xiradakis, as members of the Compensation Committee, approved a $6.98 million bonus payable to Economou for services rendered during 2008. On the same day, the Compensation Committee "also approved an increase in the annual fee to Fabiana" by $597,000, which further increased Economou's annual compensation.

B. Procedural Background