Wollman v. Hospitality Investors Trust, Inc.

Background

Stuart Wollman, an Hospitality Investors Trust, Inc. (HIT) shareholder, brought a direct shareholder action against HIT, its external managers—the AR Companies—and several officers and directors. The complaint asserted one count of common-law fraud and sought relief including rescission of Wollman’s stock-purchase transaction. He also proposed suing on behalf of similarly situated HIT stockholders.

Wollman alleged three fraud theories. First, he claimed that part of a disclosed 4% property-management fee was actually an undisclosed underwriting commission paid in connection with HIT’s public offering. Second, he claimed that HIT failed to disclose a Massachusetts securities regulator’s investigation of the dealer-manager for the offering, which allegedly contributed to a liquidity crisis and the loss of approximately $40 million in earnest-money deposits. Third, he claimed that HIT used a fictitious estimated net asset value of $21.48 per share when it paid dividends in stock, causing him to receive shares at an inflated price.

The defendants moved to dismiss under Federal Rule of Civil Procedure 12(b)(1), which concerns federal subject-matter jurisdiction, and Rule 12(b)(6), which concerns whether a complaint states a legally sufficient claim.

Subject-Matter Jurisdiction

Wollman relied on the Class Action Fairness Act, which generally requires at least 100 proposed class members, minimal diversity between the parties, and more than $5 million in controversy. The defendants argued that the proposed class was so obviously unable to meet the class-certification requirements that Wollman’s assertion of jurisdiction was frivolous.

The court rejected that argument. It assumed, without definitively deciding, that an obviously noncertifiable class could defeat jurisdiction in a Class Action Fairness Act case. But it held that the proposed nationwide fraud class was not so clearly unsustainable at this stage. The court therefore held that the defendants had not overcome Wollman’s assertion of federal subject-matter jurisdiction.

Shareholder Standing

Applying Maryland law to the question whether the claims were direct or derivative, the court explained that a shareholder may sue directly only for an injury distinct from harm to the corporation. A decline in the value of the shareholder’s stock ordinarily reflects corporate harm and must be pursued derivatively, on behalf of the corporation. The court also considered whether the requested relief would benefit the individual shareholder or the corporation.

The court held that Wollman could assert his first theory directly, although the issue appeared to be a novel question of Maryland law. His theory was that he would not have bought HIT stock had he known about the alleged undisclosed commission. The court viewed that as an alleged fraudulent inducement of his personal purchase, rather than merely a decline in the value of HIT caused by excessive fees. Wollman’s request for rescission—returning the value of his original investment—also supported treating the claim as direct.

The court held that the investigation theory was derivative because the complaint alleged that the investigation caused HIT to lose value, which in turn reduced the value of Wollman’s investment. Wollman did not allege a distinct injury separate from HIT’s alleged losses.

The court held that the third theory was direct because the alleged injury was that Wollman personally overpaid for shares based on an inflated net asset value. That injury and the requested relief were alleged to belong to Wollman rather than HIT.

Failure to State a Claim

The court applied New York law to the common-law fraud claim. Fraud required a false material statement or omission, knowledge of its falsity, an intent to induce reliance, justifiable reliance, and injury. Because the claim sounded in fraud, Federal Rule of Civil Procedure 9(b) also required the complaint to identify the alleged fraud with particularity and to plead facts supporting a strong inference of fraudulent intent.

The court held that the fraudulent-inducement theory was based only on conclusory assertions. The Special Litigation Committee report’s findings that the management-fee arrangement was a “deal term” favoring AR Capital and that the Property Manager had not performed required services did not support an inference that the disclosed management fee was actually an undisclosed underwriting commission. The court stated that Wollman could not convert an allegedly excessive disclosed management fee into an undisclosed underwriting commission merely by renaming it.

The investigation theory also failed. Wollman did not allege that the defendants knew about the investigation or knew that Massachusetts would imminently file a complaint. He did not allege that the investigation would have been material to his investment decision, that he was unaware of information about the investigation, or that the defendants had a duty to disclose the investigation. The theory also remained derivative under the court’s standing analysis.

The net-asset-value theory failed because the alleged later declines in HIT’s share value did not support an inference that the earlier estimate was false. The court stated that a bad investment, without more, did not suggest fraud. The complaint also failed to plead a strong inference that the defendants acted with fraudulent intent. The court found that the defendants’ positions, ownership interests, and general corporate motives were insufficient.

Leave to Amend and Disposition

The court denied leave to amend because amendment would be futile. At oral argument, Wollman identified no additional facts from the Special Litigation Committee report that could support his fraud theories, even though he had reviewed that report. The court found no reason to believe that he could supply the missing allegations.

The court granted the defendants’ motions to dismiss. It dismissed the complaint with prejudice, directed the Clerk to close all open motions, and directed the Clerk to close the case.