Tenth Circuit Court of Appeals Upholds Motion to Dismiss ZAGG, Inc. Shareholders’ Derivative Suit Against Company Officers and Directors

In Pikk, et al. v. Pedersen, et al., No. 15-04001 2016 BL 196060, (10th Cir. Jun 20, 2016), ZAGG, Inc. shareholders (“Plaintiffs”) appealed the district court’s motion to dismiss their complaint against five of the company’s past and present officers and directors (“Defendants”), alleging breach of fiduciary duty to ZAGG. The court of appeals upheld the lower court’s dismissal based on the Plaintiffs’ failure to make demand on the ZAGG Board of Directors and the failure to adequately allege the futility of such a demand.

According to the allegations, defendant Pedersen resigned from his position as Chairman of the Board and CEO of ZAGG in August 2012. Defendants explained that forced sales of over two million ZAGG shares pledged by Pedersen to his margin account prompted the resignation. Neither ZAGG’s 10-K nor its proxy statement disclosed Pedersen’s pledge of the shares. Three days after the resignation, a press release announced defendant Larabee as the new Board Chair and defendant Hales as interim CEO, after which ZAGG stock fell 13% the following trading day. A month later, Pedersen signed a $910,000, one-year consulting agreement with ZAGG and four months later, ZAGG appointed Hales as permanent CEO.

In June 2013, Plaintiffs filed a complaint alleging Defendants executed a “secret succession plan” to appoint Hales as CEO and breached their fiduciary duty as directors and officers. Plaintiffs did not make a demand to the Board of Directors before filing suit and alleged it would have been futile to do so. Plaintiffs alleged the Director Defendants, constituting three of the six Board Members, would be materially affected by liability for violation of Exchange Act §14(a), 15 U.S.C. § 78n(a) in not disclosing shares pledged as security in proxy statements. Plaintiffs further alleged the same three Defendants lacked independence because they had personal and business relationships with Pedersen, the former CEO. 

Both parties agreed Nevada state law applied. Nevada recognizes a shareholder’s right to sue on behalf of the corporation after first making a demand before the board or asserting sufficient reason for belief that the board members would be materially affected by the suit or influenced by interested parties. Shoen v. SAC Holding Corp., 137 P.3d 1171, 1179 (Nev. 2006). Demand to a board with an even number of members is futile if at least half are compromised. Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1046 n.8 (Del. 2004).

The court determined Plaintiffs failed to prove Defendants knowingly violated their fiduciary duty through nondisclosure of the pledged shares, thus liability was unlikely. The court further determined Plaintiffs’ theory about Defendants’ “secret succession plan” was “far-fetched.”

The court also held the Plaintiffs’ futility claim was unfounded as the lack of independence allegation concerned only three of the six Board Members. The court determined one of these members had no relationships of a “bias-producing nature.” The court did not consider the allegations against the other two challenged Directors as the inadequacy of the allegations against one mooted the futility argument that at least half of the board was compromised.

As the Plaintiffs failed to support the allegation that a demand on the Board would have been futile, the court upheld the dismissal.

The primary materials for this case can be found on the DU Corporate Governance website.

Elaine Nolen