Securities Regulation Daily Demand on oil & gas company not excused
Tuesday, December 3, 2019

Demand on oil & gas company not excused

By Mark S. Nelson, J.D.

Shareholders seeking to hold a company’s directors responsible for poor business results and an SEC investigation failed to show demand was excused.

Shareholders of Zion Oil & Gas, Inc., asserted that demand on the company’s board would be futile in light of allegations that the company misled investors about its business prospects and an SEC investigation. However, the court concluded that the complaint failed to make particularized allegations of wrongdoing that would rise to the level required to excuse demand. Moreover, the court said in a footnote that, even if demand was excused, the court would decline to exercise supplemental jurisdiction over the two state law claims because the shareholders’ federal claim was made primarily for the purpose of getting the case into federal court (Smith v. Carrillo, November 26, 2019, Andrews, R.).

Zion, formed in 2000, was authorized to explore for oil and gas in Israel. The company markets itself via televangelists and a direct share purpose program. In 2018, rumors began circulating on social media sites that the company was being investigated by the SEC. Zion twice denied the allegations prior to acknowledging an SEC investigation into the company’s practices several months later after it had received an SEC subpoena. Meanwhile, Zion filed a proxy statement with the SEC in which it urged shareholders to, among other things, reelect the company’s board.

The shareholders’ complaint alleged negligent misrepresentations under Exchange Act Section 14(a) plus breach of fiduciary duty and unjust enrichment under Delaware law. The complaint asserted numerous problems with Zion, including a lack of internal controls, misleading statements about the company’s business and legal compliance, and the company’s failure to make certain disclosures in its proxy statement.

The court recited the applicable Delaware principles under Aronson that could, if the pleadings are sufficient, lead a court to conclude that a company’s directors were not disinterested and independent (e.g., they faced a substantial likelihood of personal liability) or casts doubt on whether a particular transaction was the product of a valid business judgment (e.g. bad faith). Although the court separately analyzed the Zion shareholders’ Section 14(a), breach of fiduciary duty, and unjust enrichment claims, there were some common themes about why the pleadings for each of these claims were insufficient. The Zion shareholders also faced an uphill battel because Zion’s charter contained an exculpatory provision on director conduct.

The common thread tying the shareholders’ claims together, the court suggested, was the lack of particularized facts. With respect to breach of fiduciary duty, it was not enough for the shareholders to allege that half of Zion’s directors were also company employees, nor did the shareholders allege that Zion’s directors received benefits or detriments not shared by all stockholders. The Section 14(a) claims were similarly weak, the court concluded, because they did not provide any details of the several asserted omissions by Zion or explain how the shareholders sustained damages; as for demand excusal, the complaint failed to allege bad faith by Zion’s directors. With respect to unjust enrichment, the court likewise found the alleged facts wanted for particularity and summarily concluded that the inadequate pleadings regarding breach of fiduciary duty and Section 14(a) also undermined the shareholders’ unjust enrichment claim.

The case is No. 18-cv-01399.

Attorneys: : Brian E. Farnan (Farnan, LLP) for Keith Smith. Travis Steven Hunter (Richards, Layton & Finger, P.A.) for Victor G. Carrillo.

Companies: Zion Oil & Gas, Inc.

MainStory: TopStory CorporateGovernance CorpGovNews GCNNews FiduciaryDuties DelawareNews

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