Friday, May 29, 2015

Molycorp Directors’ Failure to Predict Future Is Not Actionable

By Anne Sherry, J.D.

Private equity investors in Molycorp, Inc., and the directors they appointed, have been unburdened of claims that they breached their fiduciary duties in connection with a secondary offering that injured minority shareholders. The Delaware Court of Chancery dismissed the plaintiffs’ derivative complaint with prejudice, holding that it failed to allege that the investors did anything wrong in exercising their contractual rights or that the directors should have prevented the offering (In re Molycorp, Inc. Shareholder Derivative Litigation, May 27, 2015, Noble, J.).

Background. Molycorp produces and sells rare earth oxides. About a year after its disappointing IPO, Molycorp knew that a federal loan guarantee would not come through and that financing and joint venture opportunities were in danger. The private equity investor defendants—who, at the time, owned 44.1 percent of Molycorp stock—then exercised their contractual right to demand priority registration of their shares. Molycorp filed a registration statement, and the selling defendants received approximately $575 million in the resulting June 2011 secondary offering—allegedly saturating the market for Molycorp stock in the process. By September, after prices for rare earth elements had fallen sharply, Molycorp’s cash on hand was short of its operating budget by approximately $400 million. The company raised cash by selling stock at prices considerably lower than what the selling defendants had received in the June offering.

The derivative complaint alleged that the director defendants breached fiduciary duties by favoring the interests of the defendants over those of Molycorp, that the private equity investors aided and abetted those breaches and also breached their own fiduciary duties as a control group, and that the selling defendants were unjustly enriched. In their view, the board should have delayed the June offering to allow Molycorp to hold an offering first, or should have at least allocated a substantial portion of the June offering to Molycorp. Instead, the plaintiffs argue, the private equity investors closed Molycorp out of the equity markets at a time when the company desperately needed an equity infusion.

Lack of actionable conduct. Transactions between a controlling shareholder and the company are not per se invalid; to state a claim, a plaintiff must allege that the controller acted in an unfair manner. Furthermore, a director’s appointment by a powerful shareholder does not automatically render the director’s decision suspect, and it is not wrong for a director simply to buy or sell company shares. While there was no question that the selling defendants, and not Molycorp, benefited from the June offering, the pleadings did not support a finding of wrongdoing.

Critically, the complaint did not allege that the registration rights agreement was invalid, and there was no reason to believe that the private equity investors knew when the bubble in rare earth elements would burst. Therefore, it failed to state a claim against the private equity investors for breach of fiduciary duty. The investors bargained for certain rights before Molycorp’s IPO. Finding that the investors took advantage of Molycorp via fairly extracted, publicly disclosed contractual rights could discourage would-be investors from funding startups for fear that their investment value would not be preserved. Even if the investors controlled their board appointees, the plaintiffs would need to plead that the investors did something wrong to state a claim for breach of fiduciary duty.

Similarly, the director defendants could not be accountable simply for failing to conduct a company registration. The complaint did not establish a reason to take such an action. Nor did the plaintiffs establish that the directors breached their duties in failing to delay the private equity investors’ demand registration because of a detrimental condition. Most importantly, there were no allegations that the director defendants knew that the market would rise and fall as dramatically as it did, when it did. “A director is not liable for failing to predict the movement of stock prices, and a stockholder is generally allowed to sell her shares,” the court concluded.

Finally, the unjust enrichment claim was defeated because the registration rights agreement was not challenged as unfair or invalid.

The case is No. 7282-VCN.