Erickson v. Jernigan Capital, Inc.

Background

Lead Plaintiff John R. Erickson brought a proposed class action under Sections 14(a) and 20(a) of the Securities Exchange Act of 1934. He sued Jernigan Capital, Inc. (JCAP) and members of its board of directors, alleging that they issued materially false or misleading proxy disclosures to obtain shareholder approval for a going-private transaction at an unfairly low price.

JCAP was a publicly traded real estate investment trust focused on self-storage. NexPoint Advisors, L.P. acquired all of JCAP’s publicly traded stock, and the transaction resulted in a privately held entity called NexPoint Storage Partners. JCAP shareholders approved the acquisition at $17.30 per share on October 26, 2020, and the transaction closed on November 6, 2020.

The proxy materials stated that a principal reason for the proposed acquisition was the limited interest that other self-storage real estate investment trusts would likely have in acquiring JCAP’s portfolio. Erickson alleged that JCAP did not disclose before the shareholder vote that Extra Space Storage, a leading self-storage real estate investment trust, was participating through a $300 million investment. That investment represented about one-third of the transaction’s approximately $900 million value. In exchange, Extra Space received the right to acquire and operate JCAP’s portfolio and one of three board seats in the surviving company. JCAP disclosed the Extra Space deal for the first time on November 9, 2020.

Claims and motion to dismiss

The defendants moved to dismiss the amended complaint for failure to state a claim. On a motion to dismiss, the court generally accepts the complaint’s factual allegations as true and asks whether they plausibly show that the plaintiff may be entitled to relief. Securities claims also must identify the allegedly misleading statements or omissions and explain why they were misleading with particularity.

For a Section 14(a) claim involving a proxy statement, Erickson had to plausibly allege a material misrepresentation or omission, loss causation, and that the proxy solicitation was an essential link in carrying out the transaction. Loss causation means a causal connection between the alleged misleading disclosure and the plaintiff’s economic loss. A Section 20(a) claim requires an underlying violation, control of the primary violator, and meaningful participation in the alleged wrongdoing.

Court’s analysis

The court held that Erickson adequately alleged a material omission. In the court’s view, the allegation that JCAP disclosed limited interest from other self-storage real estate investment trusts while omitting Extra Space’s $300 million investment plausibly suggested that the proxy materials described a materially different transaction from the one that was carried out. A reasonable shareholder could have considered Extra Space’s investment important when deciding whether to approve the sale at $17.30 per share.

The defendants argued that the Extra Space deal was still undeveloped when shareholders voted and therefore did not have to be disclosed. The court rejected that argument at the pleading stage. It explained that a prospective transaction or negotiation may need to be disclosed if it is material, based on factors such as its size and the likelihood that it will occur. Because the $300 million deal closed less than two weeks after the vote, the court said Erickson was entitled to the reasonable inference that the deal was not merely undeveloped on the voting date.

The defendants also argued that Extra Space might not have invested without NexPoint’s acquisition, so the investment did not affect what JCAP shareholders needed to know. The court rejected that reasoning, concluding that once JCAP stated that other self-storage real estate investment trusts had limited interest in the portfolio, omitting Extra Space’s substantial interest could be misleading even if the investment depended on NexPoint’s acquisition.

The court also held that Erickson adequately pleaded loss causation. The amended complaint alleged that the misleading proxy materials induced shareholders to approve the transaction and that the $17.30-per-share price was inadequate because the Extra Space deal indicated that JCAP’s shares were worth more. The court characterized the alleged loss as the higher price shareholders would have demanded if they had known about Extra Space’s investment. It noted that Erickson might have difficulty proving damages later, but found the allegations sufficient at the motion-to-dismiss stage.

Disposition

The court denied the defendants’ motion to dismiss the amended complaint. It rejected the defendants’ arguments that Erickson failed to state a Section 14(a) claim and therefore also rejected their only stated argument against the Section 20(a) claim. The court directed the parties to file a joint letter and proposed case-management plan, including a proposed schedule for briefing on the lead plaintiff’s motion for class certification.