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Merritt-Chapman & Scott Corp.

Supreme Court of Delaware · Civil Procedure

Civil ProcedureDerivative suitsPleadingSummary judgmentSequestrationsequestrationamendment of complaintnew cause of action

Facts

MCS shareholders filed a derivative suit in 1969 seeking return of compensation paid to certain officers and directors, including Louis Wolfson and Elkin Gerbert, based on criminal proceedings arising out of MCS's stock purchase program involving Joseph Kosow. Although the stock purchases allegedly generated profits for Kosow and increased the book value of remaining MCS shares, the complaint sought forfeiture of compensation rather than damages for Kosow's profits. After the original convictions were reversed and retrials occurred, the criminal matter ended with Gerbert's perjury conviction and Wolfson's nolo contendere plea to false filing of MCS's 1963 annual report. Plaintiffs later attempted to rely on the Kosow transactions and profits as a basis for liability, but the complaint had been commenced by sequestration and had not fairly alleged those matters as a claim.

Issue

Whether plaintiffs could, in a sequestration-based derivative action seeking forfeiture of compensation, rely on unpleaded Kosow-profit transactions or underlying conduct not fairly alleged in the complaint, and whether the remaining criminal convictions legally justified retroactive forfeiture of six years of compensation. More specifically, the court had to determine the scope of the original complaint and whether the convictions that ultimately remained were sufficient to support the forfeiture remedy sought.

Rule

In an action commenced by sequestration, once nonresident defendants appear in response to the original complaint, the complaint may not be amended to add a new cause of action not originally asserted. A complaint must fairly notify defendants of the basis of liability and damages sought; where a complaint for compensation forfeiture is fairly read as resting on criminal convictions rather than specifically pleaded underlying conduct, the plaintiff cannot later restructure the case around different transactions or damages. On the circumstances here, a single incident of derelict behavior reflected in limited convictions did not legally justify retroactive forfeiture of six years of compensation.

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Shareholders of Redwood Marine Holdings, a Delaware corporation, filed a derivative action in the Court of Chancery against two nonresident directors by sequestration in Wilmington. The complaint sought repayment of all salary and bonuses paid after the directors were convicted in federal court of filing false regulatory reports, and mentioned a side transaction in Miami only as background to the indictment. After the directors appeared, the shareholders moved to amend to demand recovery of $3 million in profits allegedly earned by an outside broker in that Miami transaction.

How should the court most likely rule on the motion to amend?

Explanation. In an action commenced by sequestration, once nonresident defendants appear, the complaint may not be amended to add a new cause of action not asserted in the original complaint. Here, the original pleading fairly sought compensation forfeiture based on convictions, not recovery of third-party profits. Mentioning the transaction as background does not fairly notify defendants of a separate profits claim. (Derived from Merritt-Chapman & Scott Corp. (n.d.).)