Two different judges in the same Massachusetts state court dismissed two separate class actions – each brought against an adviser to a group of closed-end funds, certain of the adviser’s affiliates and the funds’ board by holders of the funds’ common shares (and each case involving a different adviser, closed-end fund group and board), holding that those claims must be brought derivatively on the funds’ behalf rather than as direct class actions.
In both cases, the plaintiffs complained about the decision by the funds’ board in 2008 to redeem some of the funds’ auction rate preferred stock (“ARPS”). The complaints alleged that the ARPS represented favorable financing for the funds because, among other things, the interest rates and other costs were favorable and the financing did not have a set term that would expire, but rather was “perpetual.” When the market for ARPS froze in 2008, the funds had to pay a penalty rate that was much higher than the rate the funds had been paying to the ARPS shareholders up to that point. The funds therefore redeemed some of the ARPS and replaced them with other forms of debt financing. According to the plaintiffs, this replacement of the ARPS with debt financing increased the funds’ costs and reduced the total assets of the funds. The plaintiffs also complained that the defendants caused the funds to pay the full issue price when they re-acquired the ARPS, which price exceeded their market value.
The plaintiffs asserted three claims: (1) breach of fiduciary duty by the funds’ trustees; (2) aiding and abetting breach of fiduciary duty by the funds’ adviser and affiliates; and (3) unjust enrichment by the adviser and affiliates through their receipt of fees from the debt financing that replaced the ARPS.
In one action, Delaware law applied. The court held that the plaintiff’s claims on behalf of a class of the fund’s common shareholders arising from the fund’s redemption of its preferred shares allege that the fund overpaid for those redemptions, resulting in lower returns to the common shareholders, which involve an alleged injury to the fund. The plaintiff also failed to explain how the redemptions, which decreased the number of preferred shares, could have decreased the common shareholders’ voting power. Because the plaintiff did not allege an injury to shareholders which is distinct from the injury to the fund, the court held that the plaintiff could not bring the claims directly. Beckham v. Keith, Jr., No. 10-3574-BLS2 (Mass. Super. Ct. Suffolk Cty., June 14, 2011).
In the other action, Massachusetts law applied. The court held that the plaintiff has “misread a fine distinction in the law” because “[a]lleging that the common shareholders have suffered harm distinct form that of the ARPS holders does not demonstrate the propriety of a direct action” under Massachusetts law, which “requires injury separate and distinct from the Funds.” Here, plaintiff’s alleged injury regarding the decision to change the Funds’ financing from ARPS to the replacement debt financing “is the depletion of the Funds’ assets, leaving the Funds with less cash to distribute to the common shareholders,” and therefore the common shareholders suffered injury only derivatively in proportion to their pro rata share of the Funds’ assets.” The court noted that the plaintiff “cannot escape the plain language of his well-pleaded complaints” which allege that the replacement borrowing “was more costly for the Fund.” Accordingly, “any recovery must go to the Fund, not directly to the common shareholders.” The court pointed out that the plaintiff “has an ample opportunity to pursue vindication of the Funds’ rights within the bounds of the procedural rules, including a derivative action following a rejected demand on the Board.” Manuszak v. Esty, No. 10-3456-BLS1 and Manuszak v. Esty, No. 10‑3457-BLS1 (Mass. Super. Ct., Suffolk Cty., June 20, 2011).
Goodwin Procter LLP represented the independent trustees in the Manuszak proceeding.