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Western Investment, LLC v. Deutsche Multi-Market Income Trust

Superior Court of Massachusetts, Suffolk, Business Litigation Session

February 3, 2017

Western Investment, LLC
v.
Deutsche Multi-Market Income Trust et al. [1]

          Filed February 6, 2017

          MEMORANDUM AND ORDER ON DEFENDANTS' MOTION TO DISMISS

          Edward P. Leibensperger, Justice of the Superior Court.

         This case presents a paradoxical claim by a shareholder against the trustees of two companies for strictly adhering to the plain provisions of the companies' by-laws with respect to the election of board members. Plaintiff, Western Investment, LLC, alleges that the application by the trustees of a duly adopted by-law, in existence for seven years, was a breach of fiduciary duty. For the reasons described below, Western's complaint fails to state a valid claim. Defendants' motion to dismiss must be granted.

         BACKGROUND

         The following facts are taken from the complaint, supplemented by documents referred to in the complaint such as the declarations of trust and the by-laws of the two defendant companies.[2]

         Western is a long-time shareholder in two closed-end investment funds, defendants Deutsche Multi-Market Income Trust (" KMM") and Deutsche Strategic Income Trust (" KST"). Western purchased shares in KMM in 1997 and in KST in 2002. Western brings this action to challenge the action of the trustees of the trusts in connection with the September 30, 2016, vote of shareholders for the election of trustees.

         KMM and KST are organized as Massachusetts business trusts. They are governed by declarations of trust and by-laws that for all purposes relevant to this litigation are substantively identical. The eleven individual defendants are trustees of the two trusts. They constitute the board of trustees of both KMM and KST. The boards are divided into three classes of trustees. Each class is elected for a three-year term and the elections are staggered so that only one class of trustees is up for election per year. In 2016, four seats on the board were up for election.

         In the 2016 election, Western nominated a slate of four individuals to run against four incumbent members of the board. With respect to both KMM and KST, the Western nominees obtained more votes than the incumbent trustees. For the KMM election, in which 11.97 million, or 53.47% of the 22.39 million outstanding shares were present and voting, the Western nominees each obtained the vote of approximately 6.2 million shares, while the incumbents received the vote of approximately 5.2 million shares. For the KST election, in which 2.37 million, or 54.39% of the 4.35 million outstanding shares were present and voting, the Western nominees each obtained the vote of approximately 1.4 million shares, while the incumbents received the vote of approximately 845, 000 shares. Stated another way, the Western nominees received the vote of approximately 28% of the outstanding shares of KMM and approximately 32% of the outstanding shares of KST. Because, however, the number of votes cast for either the Western nominees or the incumbents did not constitute a majority of the total outstanding shares, the boards of both trusts determined that the election did not produce a winner of the contested seats. As a result, pursuant to a by-law requiring that an incumbent trustee remain in office until the election of a successor, the incumbent trustees, who lost the plurality vote, remain in office.

         In connection with the 2016 elections, Western notified the trustees that it intended to nominate candidates for the four seats up for election and to present a shareholder proposal recommending that the boards be declassified. The trusts and Western then conducted a proxy contest in which each side solicited proxies from shareholders. In the proxy materials, the shareholders were expressly informed that a majority of the shares outstanding and entitled to vote was required to elect a member of the board of trustees.

         The declarations of trust expressly authorize the trustees to adopt by-laws " not inconsistent with the Declarations" and to amend or repeal by-laws relating to the rights or powers of the shareholders. Declarations, Art. IV, § 2. In addition, the declarations state that " [ e ] xcept when a larger vote is required by any provisions of . . . the By-Laws, the vote of a majority of the Shares or Notes entitled to vote on a matter shall decide the matter and the vote of a plurality of the Shares or Notes entitled to vote shall elect a Trustee." Declarations, Art. V, § 3 (emphasis added). The declarations also provide that an incumbent trustee remains in office " until the election and qualification of his successor, if any, elected at such meeting . . ." Declarations, Art. IV, § 1(c).

         In 2009, the trustees adopted § 2.11 of the by-laws for each trust entitled " Majority Voting for the Election of Trustees." The section states, in full, that " A majority of the Shares outstanding and entitled to vote on the matter shall elect a Trustee. A Trustee may be but need not be a Shareholder." This is referred to by Western in its complaint as the " majority of outstanding" by-law. It is the application of this by-law to the 2016 election that Western alleges was a breach of fiduciary duty by the trustees.

         Western did not challenge the adoption of the majority of outstanding by-law when it was adopted in 2009 or, apparently, when it was applied in annual elections in 2010, 2011, 2012, 2013, 2014 and 2015. Western alleges, however, that 2016 was the first election of trustees that was contested. Western points out that in uncontested elections a rule of the New York Stock Exchange allows brokers to cast votes for their clients, such that obtaining a vote of the majority of outstanding is feasible to attain. But in a contested election, Western avers, brokers may not, pursuant to New York Stock Exchange rules, vote the shares of their clients. As a result, Western says a vote of the majority of outstanding in a contested election is " nearly impossible" to achieve because of the difficulty of obtaining proxies. Complaint, ¶ s 4, 32. Thus, Western claims that " [a]pplication of the 'majority of outstanding' bylaw to contested elections discriminates only against the election of shareholder nominees." Complaint, ¶ 31. Further, the application by the trustees of the majority of outstanding by-law to a contested election is alleged to be a " blatant and improper entrenchment." Complaint, ¶ 5.

         By letter dated September 27, 2016, Western communicated a demand to the boards. The letter demanded that the boards not apply the majority of outstanding by-law to the 2016 election and threatened that if the boards refused to comply with the demand then the individual trustees would be in breach of their fiduciary duties. The boards did not reply to the demand before the September 30, 2016, annual meeting. The annual meeting vote results were certified by the inspector of elections on October 4, 2016. The boards effectively rejected the demand by failing to seat the Western nominees. On October 5, 2016, Western commenced this action.

         Western's complaint asserts five counts. The principal claim (Count 1) is that the defendant trustees breached a fiduciary duty of loyalty to the trusts and to the shareholders by applying the majority of outstanding by-law. In Count 2, Western alleges that applying the by-law violates an implied duty of good faith and fair dealing inherent in the declarations and by-laws. Count 3 avers that the majority of outstanding by-law is " unconscionable as applied to a contested election for trustees." Complaint, ¶ 55. Count 4 asserts that the trustees' conduct is a violation " of the 40 Act." Complaint, ¶ 62. Count 5 does not assert a cause of action but, instead, requests injunctive relief by an order declaring that the majority of outstanding by-law " ...


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