OPINION AND ORDER DENYING DEFENDANTS' MOTION TO DISMISS
ALVIN K. HELLERSTEIN, District Judge.
This derivative shareholder action is brought by Plaintiffs to assert claims on behalf of Eagle Bulk Shipping Inc. ("Eagle"), a Republic of the Marshall Islands corporation engaged primarily in the ocean transport of bulk cargoes. The essence of Plaintiffs' allegations is that since 2007 Eagle has been operated by its Directors and executive officers primarily to benefit its Directors and executive officers, and not for the benefit of the corporation and its shareholders. On September 7, 2011, Defendants moved to dismiss Plaintiffs' Complaint. At the conclusion of oral argument, and by my Summary Order of November 22, 2011, I denied Defendants' motion. This opinion provides a fuller explanation of my decision.
I. Plaintiffs' Complaint
Plaintiffs bring suit against current members of Eagle's Board of Directors, one former Director, and certain Eagle executive officers: Sophocles Zoullas (Chief Executive Officer and Director), Alexis Zoullas (Director), Alan Ginsburg (Chief Financial Officer), Douglas Haensel (Director), Jon Tomasson (Director), Joseph Cianciolo (Director), David Hiley (Director), Thomas Winmill (Director), and Forrest Wylie (former Director) (together, "Defendants"). Compl. ¶¶ 4-12. Plaintiff's allegations focus on decisions by Eagle's Board regarding: (1) director compensation; (2) executive officer compensation; and (3) Delphin Shipping LLC ("Delphin"), an alleged competitor.
Plaintiffs allege that following a 2007 change in Eagle's ownership, Eagle's Board restructured the manner in which the Directors were compensated. Compl. ¶¶ 28-31. In addition to receiving a fixed salary as well as options and dividend equivalent payments as was the previous practice, Directors began to receive compensation for each Board or committee meeting attended, resulting in significantly increased and excessive compensation. Compl. ¶¶ 31-32. Plaintiffs allege that the restructured compensation scheme violated Eagle's Bylaws, which provide that Directors can be compensated on the basis of meetings attended or by a fixed salary. Compl. ¶ 32. Plaintiffs further allege that in 2008, 2009 and 2010, Eagle's director compensation decisions were made by a committee of Eagle's Board, rather than the Board itself, in violation of Section 57 of the Marshall Islands Business Corporations Act. Compl. ¶ 33.
Plaintiffs allege that in 2008, 2009 and 2010, Eagle's director compensation "reached levels that were generally three to four times the compensation paid in 2006 and in some cases were up to ten times as much," despite no change in director responsibilities and duties. Compl. ¶¶ 29-37. For example, Plaintiffs allege that the Board met 20 times in 2010 as compared with six times in 2006, and that after meeting one time in 2006, the Compensation Committee met 30 times in 2008, 40 times in 2009 and 24 times in 2010. Compl. ¶ 37-41. Plaintiffs allege that in 2007, no non-employee director received compensation in excess of $117,000 and that in 2009 and 2010 certain non-employee directors received compensation in excess of $475,000. Compl. ¶¶ 30-36, 54. Plaintiffs further allege that Eagle's spending on director compensation during this period was far in excess of its alleged competitors. Compl. ¶¶ 41, 53-54, 58-59. For example, Plaintiffs allege that Eagle's 2010 director compensation was nearly four times that of Genco Shipping & Trading Limited ("Genco"), an alleged competitor also incorporated in the Marshall Islands that is alleged to be nearly five times as profitable and have 25% more vessels in operation than Eagle. Compl. ¶¶ 41, 53-54.
Plaintiffs allege that "[h]and in hand with the extraordinary rise in director compensation came skyrocketing executive compensation awards, bearing no relationship to Company performance, which was at its worst during this same period." Compl. ¶ 38. Plaintiffs allege that Eagle did not benchmark its executive officer compensation to comparable companies (and misstated its reasons for failing to do so), nor did it "use[ ] key financial measurements to inform compensation decision." Compl. ¶¶ 41, 52, 60. Plaintiffs allege, for example, that Sophocles Zoullas received $35,788,323 in compensation in 2008, $8,582,112 in 2009, and $8,347,867 in 2010. Compl. ¶¶ 42-44. In addition to this compensation, Plaintiffs allege that Sophocles Zoullas' 2008 employment contract was unreasonable (and in stark contrast to his 2005 employment agreement) in granting Zoullas the unilateral right to quit at will without penalty while imposing punitive costs on Eagle should Zoullas be terminated. Compl. ¶¶ 61-67.
Plaintiffs allege that for 2008-2010, Eagle's total executive officer compensation was approximately $65.8 million and Eagle's total director compensation was approximately $6.4 million, together more than half of Eagle's combined net income of approximately $121.8 million. Compl. ¶ 51. Plaintiffs allege that in 2010 Eagle paid cash compensation to its directors and executive officers equivalent to 45.5% of its net income, while competitors paid between 6.2% and 1.4%. Comp. ¶ 59. Plaintiffs further allege that Eagle's director and executive officer compensation during this period was sharply out of line with its performance and its stock's performance. Compl. ¶¶ 53-60, 68-76. Plaintiffs allege a decline in stock price of 90%, multiple defaults to Eagle's primary lender and an uncertain future as a going concern. Compl. ¶¶ 68-76.
Plaintiffs also allege that the relationship Eagle has negotiated between itself and Delphin is contrary to Eagle's interests. Plaintiffs allege that Eagle's Directors have permitted Sophocles Zoullas to form, and serve as non-executive chairman of, Delphin and that Eagle has entered into an agreement (the "Management Agreement") with Delphin that requires Eagle to provide all commercial and technical supervisory management services for Delphin's ships but does not provide Eagle with reasonable compensation in return. Compl. ¶¶ 77-85.
Plaintiffs allege the existence of a quid pro quo arrangement that causally links the Eagle Board's decisions regarding its own compensation with its decisions regarding executive officer compensation and Delphin. Plaintiffs allege that "[b]eginning in 2008, management and directors had a quid pro quo arrangement, in which the directors paid management excessive sums at the direction of Sophocles Zoullas, and the directors similarly awarded themselves dramatic pay increases, both by charging excessive rates and by holding an excessive number of meetings. Through this quid pro quo arrangement, the officers did not object to the dramatically increasing directors fees, because in return they were paid excessive compensation, and vice versa." Compl. ¶ 39. Plaintiffs further allege that "the board's decision to allow Sophocles Zoullas to participate in Delphin and use Company resources in that pursuit was part of a quid pro quo arrangement. Pursuant to this quid pro quo exchange, the board permitted Sophocles Zoullas to enrich himself at the expense of the Company, so that the executive officers would not object when the directors took excessive and escalating amounts from the Company for themselves." Compl. ¶ 115.
Plaintiffs bring claims for breach of fiduciary duty with respect to director compensation, executive officer compensation, and the Management Agreement and the Board's permitting Sophocles Zoullas to participate in Delphin. Compl. ¶¶ 122-144. Plaintiffs bring their action derivatively, without demand upon the Eagle Board since, as Plaintiffs allege, "the board participated in, approved, and/or permitted the wrongs alleged . . . and is not disinterested and lacks sufficient independence to exercise business judgment." Compl. ¶ 102.
II. Defendants' Motion to Dismiss
Defendants have moved to dismiss Plaintiffs' Complaint. Defendants argue that Plaintiffs' claims regarding executive compensation and Delphin are precluded pursuant to Fed. R. Civ. P. 23.1 by Plaintiffs' failure to plead demand futility with particularity. Furthermore, Defendants argue that Plaintiffs' claims regarding director compensation must be dismissed pursuant to Fed. R. Civ. P. 12(b)(6) for failure to state a claim upon which relief can be granted.
A. Demand Futility
A derivative action "place[s] in the hands of the individual shareholder a means to protect the interests of the corporation from the misfeasance and malfeasance of faithless directors and managers. To prevent abuse of this remedy, however, equity courts established as a precondition for the suit that the shareholder demonstrate that the corporation itself had refused to proceed after suitable demand, unless excused by extraordinary conditions."
While Fed. R. Civ. P. 23.1 is "a rule of pleading that creates a federal standard,"
Delaware courts have found certain factual allegations sufficient to infer a causal link between directors' enrichment and their indifference to corporate waste, raising reasonable doubt as to the disinterestedness of the directors' decisions and making the required demand futile. In
Inferring a causal link between director self-compensation decisions and other director decisions requires viewing the director self-compensation decisions and the other director decisions as an interrelated set of transactions. In the demand futility context, "[i]n deciding whether to consider a sequence of transactions separately or collectively, the Court reviews the circumstances surrounding the challenged transactions, as alleged by the particularized facts of the complaint, to decide whether it can be reasonably inferred that those transactions constituted a single, self-interested scheme."
Here it is a reasonable inference from the particularized facts of Plaintiffs' Complaint that the Directors' self-compensation decisions and the Directors' decisions regarding executive officer compensation and Delphin should be considered together for purposes of determining demand futility. Taken as a whole, the particularized facts of Plaintiffs' Complaint do not require but nonetheless permit the inference that the decisions of Eagle's Board at issue were part of a scheme, enabled either by the exchange of mutual indifference or a more explicit agreement, between the Directors and executive officers, pursuant to which each took what it could from Eagle. This theory makes sense of the series of action and inactions by Defendants alleged by Plaintiffs, including striking increases in compensation that bore no relation to performance or industry norms, were enacted in violation of Eagle's Bylaws and Marshall Islands law, and have endangered Eagle's continuing viability. Considering the Directors' decisions together and given the particularized factual allegations in Plaintiffs' Complaint, the quid pro quo arrangement alleged by Plaintiffs is a reasonable inference and creates a reasonable doubt as to the disinterestedness of a majority of the Directors with respect to their decisions regarding executive compensation and Delphin. Thus, pursuant to
Defendants contend that Plaintiffs must prove quid pro quo independently and not as an inference from instances of challenged business transactions. Defendants argue that the two prongs of
B. Failure to State a Claim
Defendants argue that Plaintiffs fail to state a claim for breach of fiduciary duty regarding the establishment of allegedly excessive director compensation. To survive a Fed. R. Civ. P. 12(b)(6) motion to dismiss, a claim must be "plausible on its face" when the court accepts as true all of the complaint's factual allegations.
Plaintiffs argue that the sufficiency of their claim should be determined under Delaware law, while Defendants argue that Delaware's director compensation statute conflicts with Marshall Islands law and thus New York law should be applied.
With respect to director compensation, the New York Court of Appeals has held:
Under this standard, Plaintiffs' particularized factual allegations regarding director compensation suffice to survive Defendants' motion to dismiss for failure to state a claim. Defendants have alleged compensation rates excessive on their face and other facts which call into question whether the compensation was fair to the corporation when approved, the good faith of the directors setting those rates, or that the decision to set the compensation could not have been a product of valid business judgment. Similarly, Plaintiffs' particularized factual allegations regarding director compensation suffice to survive Defendants' motion to dismiss for failure to state a claim under Delaware law. "Like any other interested transaction, directoral self-compensation decisions lie outside the business judgment rule's presumptive protection, so that, where properly challenged, the receipt of self-determined benefits is subject to an affirmative showing that the compensation arrangements are fair to the corporation."
For the reasons stated above, and as provided by my Summary Order of November 22, 2011, Defendants' motion to dismiss is denied.