The Missouri Court of Appeals Hands Plaintiff a Significant Victory in ESSI

June 4, 2013

On June 4, 2013, the Missouri Court of Appeals in St. Louis issued a precedent-setting ruling when it revived a lawsuit accusing Engineered Support Systems, Inc.’s (“ESSI”) senior officers and directors of misleading investors in connection with ESSI’s January 2006 merger with DRS Technologies, Inc. (“DRS”). The court’s decision overturned key parts of a dismissal by Judge Joan L. Moriarty that had shut down the entire lawsuit in 2012. The appellate decision allows plaintiff Daniel B. Nickell to resume prosecuting a class action against several ESSI and DRS senior officers and directors.

The lawsuit had its genesis in the September 2005 agreement whereby DRS would acquire ESSI. After the merger closed, it was revealed that between 1996 and 2003 ESSI’s senior officers and directors were granted millions of dollars of backdated employee stock options in violation of ESSI’s stock option plans. Despite public representations that the stock options were issued “at the money,” the options were actually issued “in the money,” enabling the ESSI senior officers and directors to improperly divert financial benefits to themselves. Thus, the defendants were motivated to sell ESSI quickly in order to avoid liability for their misconduct associated with the backdating of stock options. And, as alleged, they did – the ESSI defendants agreed to accept a reduced purchase price from DRS in exchange for DRS’s assumption of liability relating to the backdating misconduct and other personal benefits, including: (1) having the backdated stock options accelerated and cashed out; (2) a continuation of benefits for at least one year; and (3) an officers’ liability insurance policy. To get the ESSI shareholders to approve the deal, defendants disseminated false registration statements and prospectuses that concealed the backdating misconduct and the fact that the ESSI defendants were to receive personal benefits from DRS in exchange for a reduced purchase price. The concealment of the ESSI defendants’ conduct induced plaintiff and the proposed class to vote to approve the merger and sell their ESSI stock at a reduced price.

Plaintiff alleged that this conduct violated Missouri state law because defendants: (1) breached their fiduciary duties of good faith, due care, loyalty, honesty, reasonable inquiry, oversight, and supervision by accepting improper personal benefits and failing to act in the best interests of ESSI shareholders to obtain the highest price possible in connection with the sale of ESSI; and (2) were unjustly enriched in that the class received less for their ESSI stock as a result of payments received by the ESSI defendants in exchange for their wrongful conduct. Judge Moriarty dismissed these claims, holding that they were derivative claims and failed to allege any facts giving shareholders standing to individually sue the ESSI defendants. Additionally, Judge Moriarty held that plaintiff failed to allege that defendants owed him a duty, and instead, that officers and directors of corporations only owe fiduciary duties to the corporation and the shareholders collectively, not to individual shareholders.

Following briefing and argument, the Court of Appeals vacated key parts of the lower court’s dismissal in an important published opinion. The Court of Appeals held that plaintiff has standing to bring individual claims. While noting that shareholders must normally bring a derivative action – a suit on behalf of the corporation conducted by the shareholders as the corporation’s representative – in order to file suit against an officer or director, the court held that “[i]ndividual actions are permitted, and provide the logical remedy, if the injury is to the shareholders themselves directly, and not to the corporation.” And, “importantly, [here] the alleged injury constitutes a harm individual to [plaintiff] Nickell and the purported class, distinct from any injury to the corporation, because the alleged injury was a reduced price received for their individual shares.” The Court of Appeals also held that the ESSI defendants owed Nickell and the proposed class fiduciary duties. Although “[t]he fiduciary relationship between a director or officer of a corporation and the shareholders is generally held to be between the directors or officers and the shareholders as a whole . . . that relationship will extend to the shareholders individually if the directors or officers violated rights individual to the shareholders that injured the shareholders directly.”

While the decision of the Missouri Court of Appeals is not binding on courts outside of its jurisdiction, the court’s considered analysis in this decision may prove to be influential. The case is now back with the trial court, where plaintiff’s serious backdating allegations will finally be addressed.

Darren J. Robbins, Mark Solomon, Robert R. Henssler, Jr. and Maureen E. Mueller are the Robbins Geller attorneys litigating the case.

Nickell v. Shanahan, No. ED99163, 2013 Mo. App. LEXIS 664 (Mo. Ct. App. June 4, 2013).

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