Cypress Holdings, III, L.P. v. Sport-BLX, Inc.

Background

Cypress purchased 7,760 shares of Sport-BLX common stock for approximately $1 million. An agreement provided that, while Cypress held at least 2.5% of Sport-BLX’s stock, Hall and De Perio would vote their shares in favor of Cypress holding a seat on Sport-BLX’s board and would honor anti-dilution protections.

The Second Amended Complaint alleged that Hall and De Perio made false promises to induce Cypress’s investment and later caused Sport-BLX to use investor funds for other purposes, including operating expenses and office space rented from Clinton Group. The complaint also alleged that they changed Sport-BLX’s business plan, offered to buy Cypress’s shares at an undervalued price, transferred their controlling interest to GlassBridge, and caused Cypress to lose its board seat. It further alleged that affiliated entities diverted Sport-BLX’s intellectual property, goodwill, assets, business plan, and opportunities, including through the sale of Sport-BLX’s trading-platform code to S-BLX Securities.

Cypress asserted nineteen causes of action. Eleven were styled as direct claims seeking damages for Cypress, and eight were styled as derivative claims brought on behalf of Sport-BLX.

Direct and Derivative Claims

A direct claim is one for an injury suffered independently by a shareholder, with any recovery paid to that shareholder. A derivative claim is one based on injury to the corporation, with any recovery paid to the corporation. Applying Delaware law, the court asked who suffered the alleged harm and who would receive the benefit of any recovery.

The court held that the following claims were improperly labeled as direct and had to be brought derivatively on behalf of Sport-BLX: Count Six, unjust enrichment; Counts Nine and Ten, tortious interference; Count Fifteen, breach of fiduciary duty; and Count Nineteen, minority shareholder oppression. These claims alleged harm to Sport-BLX through lost money, opportunities, contracts, or assets.

The court held that Counts Two and Five contained both direct and derivative theories. The portions alleging harm from stripping Sport-BLX of money, assets, or business opportunities were derivative. The non-derivative portions concerned alleged interference with Cypress’s board seat or other separate contractual rights held by Cypress.

Conflict of Interest

Federal Rule of Civil Procedure 23.1 requires a shareholder bringing a derivative action to fairly and adequately represent similarly situated shareholders. The court found that Cypress had an impermissible conflict when its direct claims and derivative claims against the same defendants competed for the same limited pool of damages. Because Cypress could recover more through its direct claims than through claims benefiting all shareholders, the court concluded that Cypress had an incentive to favor its direct recovery.

The court therefore dismissed derivative claims in Counts Two, Five, Six, Seven, Twelve, Thirteen, Seventeen, Eighteen, and Nineteen against Hall, De Perio, and GlassBridge. It also dismissed Counts Fourteen, Fifteen, and Sixteen against Strauss, Ruchalski, Baez, and Johnson because those individuals were indemnified by Sport-BLX and the direct and derivative claims could draw from the same pool of corporate money.

The court did not dismiss the derivative claims against Clinton Group and S-BLX Securities in Counts Six, Seven, Nine, Ten, Eleven, and Twelve. It also did not dismiss the derivative corporate-waste claim in Count Eighteen against Ruchalski, Strauss, Baez, and Johnson, because Cypress asserted no direct claims against those defendants and the court determined that indemnification would not apply to that claim on the allegations presented. The court stated that it could later fashion a remedy, including dismissal, if a conflict arose or if a remaining direct claim needed to be recast as derivative.

Adequacy of Representation

The court rejected defendants’ broader argument that Cypress was an inadequate representative for every derivative claim. The surviving claims against Clinton Group, S-BLX Securities, Ruchalski, Strauss, Baez, and Johnson did not compete with direct claims against those defendants. The court also rejected arguments based on Cypress’s alleged lack of incentive, alleged vindictiveness, the absence of other minority shareholders as plaintiffs, and Cypress’s involvement in separate litigation with Sport-BLX.

Disposition

The motion to dismiss the derivative claims was GRANTED in part and DENIED in part. The direct claims against Hall, De Perio, and Sport-BLX in Counts One, Two, Three, Four, and Five survived, as did the direct claim against GlassBridge in Count Eight. The surviving derivative claims were those against S-BLX Securities and Clinton Group in Counts Six, Seven, Nine, Ten, Eleven, and Twelve, and the derivative claim against Baez, Johnson, Strauss, and Ruchalski in Count Eighteen.