Opinion issued January 15, 2015
In The
Court of Appeals For The
First District of Texas ———————————— NO. 01-13-00711-CV ——————————— RONALD E. INGALLS, AS TRUSTEE OF THE ADVENT NETWORKS, INC. BANKRUPTCY ESTATE AND ON BEHALF OF ADVENT NETWORKS, INC., Appellant V. SOUTHERN UNION COMPANY D/B/A SOUTHERN UNION TECHNOLOGY PARTNERS, L.P., TOM KARAM, AND JOHN E. BRENNAN, Appellees
On Appeal from the 129th District Court Harris County, Texas Trial Court Case No. 2009-06063
MEMORANDUM OPINION
Plaintiff-appellant Ronald E. Ingalls, as trustee of the Advent Networks, Inc.
Bankruptcy Estate and on behalf of Advent Networks, Inc., sued defendants- appellees Southern Union Company d/b/a Southern Union Technology Partners,
L.P., Tom Karam, and John E. Brennan (collectively, “Southern Union
defendants”). The trial court granted summary judgment in favor of the Southern
Union defendants. We affirm.
BACKGROUND
Advent was a telecommunications equipment provider formed in 1999 that
developed, manufactured, and sold a patented networking platform to cable
operators and distributors. Those customers in turn use Advent’s product to
provide subscribers with high-bandwidth commercial service.
Southern Union was an investor in Advent from Advent’s 1999 inception
until Advent filed for bankruptcy in 2005. Southern Union owned 14% of
Advent’s stock and was also one of Advent’s creditors. Two of Southern Union’s
employees, Tom Karam and John E. Brennan, served on Advent’s seven-member
board of directors.
A. Plaintiff’s Claims Ingalls’s petition alleged that Southern Union “owned a large enough
interest in Advent to exercise de facto control over key parts of its business.”
Ingalls complained that the Southern Union defendants used that control to kill
potential venture capital financing that could have saved Advent from insolvency
in 2005. As described by Ingalls’s petition:
2 Although Advent generated revenue of approximately $1.5 million in 2004, its operations were still largely supported by outside venture capital and institutional investment. . . . Advent raised over $24 million in equity and over $22 million in debt through convertible promissory notes issued in 2002 through 2005. In 2004, Advent began negotiations with a syndicate of venture investors to raise another round of equity financing. This round was intended to fund operations for approximately 18 months until Advent’s sales would support operations. Specifically, in late 2004, Advent had a firm proposal from Gefinor Ventures to finance Advent’s Series D round of financing to the tune of $7,000,000.00. That round was essential for obtaining working capital and building out inventory for Advent to continue selling products.
After initially supporting the Gefinor proposal, Brennan advised of Southern Union’s intention to prevent the Gefinor financing from occurring, to the detriment of Advent. During the Board’s crucial vote on the issue on January 31, 2005, and in the face of otherwise unanimous support from the rest the Board, Brennan and Karam voted against the Gefinor financing proposal in the sole interest of Southern Union and to the detriment of Advent. Thereafter, they acted on Southern Union’s behalf to ensure that the financing would fail by refusing to agree to Gefinor’s proposed terms, explaining to the Board that approval would result in Southern Union owning a greater interest in Advent (at no additional cost to Southern Union, though) and, thus, it would have to publically report its investment in Advent, which it did not want to do. The Gefinor financing did not occur as a result of Southern Union’s de facto control and, as a result, Advent did not have the funds to acquire the necessary inventory to meet orders that had been placed for its products. As a result, Advent was forced to seek protection under Chapter 11. Ingalls’s petition alleged that Karam and Brennan owed a fiduciary duty of
loyalty to act in the best interest of Advent by virtue of their position as directors
of Advent. Ingalls’s petition also alleged that, “as the controlling shareholder of
3 Advent, Southern Union owed Advent a duty of loyalty and of due care.”1 Ingalls
made claims against each Southern Union defendant, alleging that they “breached
their fiduciary duties to [Advent] by exercising bad faith and killing Advent’s
Gefinor financing with the full knowledge of the harm to Advent,” and that the
breach “resulted in injury to Plaintiff and benefit to Defendants.” As a result,
Ingalls sought actual damages of at least $7,000,000 and exemplary damages.
B. Southern Union Company’s Motion for Summary Judgment
Southern Union filed a traditional motion for summary judgment, arguing
that, “[a]s a matter of law, Southern Union was not a controlling shareholder of
Advent and thus did not have a fiduciary duty to Advent.” Alternatively, Southern
Union argued that summary judgment was appropriate because, even if Southern
Union were considered a controlling shareholder of Advent, as a matter of law it
had no duty to forgo contractual rights it was afforded as a preferred shareholder
and noteholder, as it would have been required to do if the Gefinor deal had been
accepted.
C. John Brennan’s and Tom Karam’s Motions for Summary Judgment Brennan and Karam also filed a traditional motion for summary judgment,
arguing that “the undisputed facts establish that neither Brennan nor Karam took
1 Although Ingalls pleaded that Southern Union owed a duty of due care, his allegations and arguments focus only on alleged breaches of the duty of loyalty.
4 any action that caused damages to Advent.” They also contended that Ingalls’s
real argument is that the tentative financing proposal fell through because Southern
Union refused to support the restructuring, not because of something Brennan or
Karam did. They assert that, as a matter of law, they are not vicariously liable for
Southern Union’s actions. 2
D. The Trial Court’s Judgment
The trial court granted summary judgment in favor of all the Southern Union
defendants without specifying the grounds. Ingalls appealed, arguing in a single
issue that the “trial court erred by granting Appellees’ motions for summary
judgment.”
STANDARD OF REVIEW
We review a trial court’s summary judgment de novo. Travelers Ins. Co. v.
Joachim, 315 S.W.3d 860, 862 (Tex. 2010). If a trial court grants summary
judgment without specifying the grounds for granting the motion, we must uphold
the trial court’s judgment if any of the grounds are meritorious. Beverick v. Koch
Power, Inc., 186 S.W.3d 145, 148 (Tex. App.—Houston [1st Dist.] 2005, pet.
denied).
2 Brennan and Karam also filed a no-evidence motion for summary judgment, arguing that there was no evidence that (1) either of them received a personal benefit through the actions Ingalls’s petition complains of, or (2) either of them failed to act in good faith.
5 In a traditional summary judgment motion, the movant has the burden to
show that no genuine issue of material fact exists and that the trial court should
grant judgment as a matter of law. TEX. R. CIV. P. 166a(c); KPMG Peat Marwick v.
Harrison Cnty. Hous. Fin. Corp., 988 S.W.2d 746, 748 (Tex. 1999). A defendant
moving for traditional summary judgment must conclusively negate at least one
essential element of each of the plaintiff’s causes of action or conclusively
establish each element of an affirmative defense. Sci. Spectrum, Inc. v. Martinez,
941 S.W.2d 910, 911 (Tex. 1997).
SOUTHERN UNION
Southern Union argues that summary judgment in its favor on Ingalls’s
breach-of-fiduciary-duty claim was proper because (1) “Southern Union did not
owe any fiduciary duty to Advent as a matter of law because it was not a
controlling shareholder, where Southern Union held only 14% of the stock in
Advent and only two seats on the seven-member Advent board,” 3 and (2)
“Southern Union was entitled to act in its own self-interest regardless of whether it
was a controlling shareholder, where Southern Union, acting as a creditor of
3 Relatedly, Southern Union notes that Delaware law focuses on control of the board rather than control over some aspect of a transaction when assessing control. Given our disposition of this appeal, we need not, and do not, opine about whether—and under what circumstances—a minority shareholder can be considered controlling without control over the company’s board of directors.
6 Advent, relied on contractual provisions to refuse the modification of existing
financial agreements.”
A. Applicable Law
The parties agree that, under the internal affairs doctrine, Delaware law as
the state of Advent’s incorporation governs this dispute. See TEX. BUS. ORG. CODE
ANN. § 1.102 (West 2012); see also Pride Int’l., Inc. v. Bragg, 259 S.W.3d 839,
848 n.2 (Tex. App.—Houston [1st Dist.] 2008, no pet.) (“[R]ights and duties of
directors and stockholders in corporate matters are governed by the laws of the
state of incorporation.”). And they agree that a shareholder owes a fiduciary duty
if (1) it owns a majority of the company’s shares, or (2) exercises control over the
business affairs of the corporation. Ivanhoe Partners v. Newmont Mining Corp.,
535 A.2d 1334, 1344 (Del. 1987).
B. The Summary Judgment Evidence
Southern Union’s summary-judgment evidence reflects that Advent sought
financing from Gefinor Venture Partners as it ran out of capital. As Advent
acknowledged in its pleadings, Southern Union initially supported Advent’s
seeking funds from Gefinor. Indeed, minutes from Advent’s November 2004
Board of Directors meeting reflect that Gefinor and Southern Union were actively
negotiating to reach mutually acceptable terms.
7 Gefinor’s proposal provided for Gefinor to invest $2,000,000 in exchange
for Series D stock and for existing or new investors to contribute $5,000,000 in
additional capital in exchange for Series D stock. Southern Union had previously
secured Advent’s $4,000,000 line of credit with a certificate of deposit. Gefinor’s
proposal required Southern Union to pay $2,000,000 to retire half of that debt in
return for Series C-1 stock. The remaining $2,000,000 credit line balance would
be retired with funds from other investors. Southern Union would also receive
some liquidity preference in the event the company was liquidated.
Southern Union’s summary judgment evidence also established that, under
Gefinor’s proposal, the Series D stock received by Gefinor and other investors
would be superior to the Series C-1 stock Southern Union would receive. Gefinor
also requested that all convertible debt holders, including Southern Union, be
asked to waive the right to interest payments and warrants that were provided by
their financing agreements. Finally, the Gefinor transaction would require that
funds be allocated in a manner that essentially wiped out the value of some of the
company’s founders’ existing shares. 4
On January 31, 2005, Advent’s board voted on whether to sign Gefinor’s
term sheet containing these proposals. A majority of the board approved signing
the term sheet and continuing with the negotiations. Jack Brennan voted against
4 It is not clear from the record how this allocation would impact Southern Union, if at all.
8 the proposal. Brennan voted Tom Karam’s proxy the same way, resulting in a 7-5
vote by the board. At the same meeting, Brennan notified other members of the
board that Southern Union would not be agreeing to terms required by Gefinor.
In response to Southern Union’s traditional motion for summary judgment,
Ingalls proffered summary-judgment evidence about the control Southern Union
had over parts of Advent, including a requirement that Advent obtain Southern
Union’s consent before pursuing certain ventures. Advent’s CEO, Edward Perry,
testified in his deposition that although Southern Union’s representatives did not
make up a majority of Advent’s board members, he felt that Brennan had
significant control over decisions given Southern Union’s role as an investor. The
specific areas over which Perry testified that Southern Union exerted control were
leadership, sales, and financial. Perry testified to his understanding that Southern
Union had decided not to support Gefinor’s proposal if it required conversion of
debt to stock because Southern Union did not want to push its ownership
percentage in Advent to a higher level, which in turn would trigger certain public
disclosures. Finally, Perry testified that shareholders vote in blocks among the
share classes, meaning that Southern Union could have blocked the Gefinor deal if
it had gone to a shareholder vote.
Dennis Murphree, another Advent board member, testified that a Southern
Union representative told him that Gefinor’s low valuation of Advent made
9 accepting the Gefinor financing proposal unacceptable because it would require
Southern Union to write off the difference between the $82 million prior valuation
of Advent and Gefinor’s current $10 million valuation, which would result in a
stock market hit to Southern Union.
Finally, Advent proffered an expert affidavit opining that accepting terms of
the Gefinor deal would have been more economically advantageous to Southern
Union than letting Advent go bankrupt.
C. Analysis
It is undisputed that Southern Union did not own a majority of Advent’s
stock or control a majority of Advent’s board. It is also undisputed that Southern
Union possessed certain contract rights that it would be required to give up under
the Gefinor deal, and that the Gefinor deal required Southern Union to convert
some existing debt to stock, which Southern Union did not want to do.
Ingalls argued, in his appellant’s brief, that “sufficient evidence was
presented to show that Southern Union acted as a controlling shareholder and note-
holder of [Advent], thus giving rise to fiduciary duties.” Stated differently,
Ingalls’s position is that Southern Union’s rights, which it possessed as a
noteholder, gave it control over Advent such that Southern Union should be treated
as a controlling shareholder even though it owned less than a majority of the
company’s stock. In response, Southern Union argued that “Delaware law is clear
10 that contract rights, regardless of how much ‘control’ they impart, do not make the
holder of such rights a controlling shareholder, and do not impose fiduciary
duties.” Moreover, Southern Union contended Ingalls’s brief wholly ignored one
of Southern Union’s summary-judgment grounds, i.e., that even if Southern Union
were deemed to be a controlling shareholder, “Delaware law recognizes that
controlling shareholders may act in their own self-interest.” In his reply brief,
Ingalls acknowledges that “controlling shareholders are not required to act
altruistically towards minority shareholders, or to their own financial detriment,”
but argues that this rule is inapplicable because “[n]othing about the Gefinor
proposal would have placed Southern Union in a worse-off financial stance.”
We agree with Southern Union that, even if it were a controlling
shareholder, its refusing to forgo contract rights and refusing to convert debt to
stock as required by the Gefinor deal would not amount to a breach of fiduciary
duty as a matter of law. Accordingly, the trial court properly granted summary
judgment in Southern Union’s favor.
Delaware law does not “require that directors or controlling shareholders
sacrifice their own financial interest in the enterprise for the sake of the corporation
or its minority shareholders.” Jedwab v. MGM Grand Hotels, Inc., 509 A.2d 584,
598 (Del. Ch. 1986). In Odyssey Partners, L.P. v. Fleming Companies, Inc., the
11 Delaware Chancery Court recognized that controlling shareholders do not have a
duty of self-sacrifice:
Fleming’s refusal to waive its preemptive rights or to assume further financial obligations on behalf of ABCO without adequate compensation cannot seriously be thought to have been a breach of its fiduciary duties. As Chancellor Allen observed in Thorpe v. CERBCO, Del. Ch., C.A. No., Allen, C., 1993 WL 443406, *7, mem. op. at 14 (Oct. 29, 1993), “controlling shareholders, while not allowed to use their control over corporate property or processes to exploit the minority, are not required to act altruistically towards them.” 735 A.2d 386, 411 (Del. Ch. 1999); S. Muojo & Co. LLC v. Hallmark Entm’t Invs.
Co., No. 4729-CC, 2011 WL 863007, at *11 (Del. Ch. 2011) (holding that debt
holder and majority stockholder “did not have any legal obligation to continue to
waive Crown’s debt obligations, . . . defer payments or to make other financial
concessions for the sake of Crown, or its minority stockholders.”).
The only response Ingalls offers is the assertion that Southern Union’s
accepting the Gefinor deal would not be detrimental to Southern Union financially.
In support, he cites Advent’s own expert’s conclusion that agreeing to the Gefinor
deal would have been a better economic choice for Southern Union. Ingalls,
however, does not cite any authority for our engaging in such analysis. Given that
the parties do not dispute that Southern Union relied on its existing contractual
rights in refusing to accept concessions required by the Genfinor deal, the inquiry
ends. Because Southern Union’s refusing to forego contractual rights does not, as
12 a matter of law, amount to a breach of fiduciary duty under Delaware law, the trial
court properly granted summary judgment in Southern Union’s favor.
BRENNAN AND KARAM
Brennan and Karam argue that summary judgment was appropriate
because, as a matter of law, nothing Brennan or Karam did caused injury to
Advent. Ingalls responds that Brennan and Karam voted to benefit Southern
Union rather than Advent, which is a breach of their duty of loyalty. He further
contends that Delaware courts “loosen normally stringent requirements of
causation and damages” when a breach of loyalty is at issue. Thorpe v. CERBCO,
Inc., 676 A.2d 436, 445 (Del. 1996).
Directors are required to hold “an undivided and unselfish loyalty to the
corporation” and be free from “conflict between duty and self-interest.” Cede &
Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993). “Essentially, the duty of
loyalty mandates that the best interest of the corporation and its shareholders takes
precedence over any interest possessed by a director, officer or controlling
shareholder and not shared by the stockholders generally.” Id.
As he did in the trial court, Ingalls focuses here on the evidence he contends
establishes that Brennan and Karam were beholden to Southern Union and, thus,
had divided loyalties. We agree with Brennan and Karam, however, that Ingalls
has failed to articulate any action by Brennan or Karam that impacted, much less
13 harmed, Advent. Ingalls’s real complaint is that Southern Union refused to agree
to Gefinor’s terms for providing Advent additional financing. At the board level,
Brennan and Karam did vote against continued negotiation with Gefinor—a vote
aligned with Southern Union’s plans to reject the deal. But Brennan and Karam
were outvoted at the board level, and the majority of the board voted to continue
forward with negotiations. It was Southern Union, in its capacity as a creditor, that
had the ultimate power to accept or reject Gefinor’s terms. Ingalls has not
articulated any other action by Brennan and Karam that allegedly harmed Advent.
The trial court, thus, correctly granted summary judgment in Brennan’s and
Karam’s favor.
CONCLUSION
We overrule Ingalls’s sole issue and affirm the trial court’s judgment.
Sherry Radack Chief Justice
Panel consists of Chief Justice Radack and Justices Jennings and Keyes.