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SIXTH DIVISION

September 29, 2000

No. 1-99-3587

JUSTICE O'BRIEN delivered the opinion of the court:

Plaintiffs, three shareholders of Illinois Superconductor Corporation (ISC), appeal the circuitcourt's order dismissing their third-amended class action complaint against defendants, ISC andmembers of ISC's board of directors, for failure to state a cause of action. On appeal, plaintiffs argue thatthe circuit court erred in determining that plaintiffs should have brought their claims in a derivativeaction instead of a direct class action. We affirm.

The facts of this case, as derived from plaintiffs' third amended complaint, are as follows. ISCis a publicly traded Delaware corporation that develops and sells filters used in cellular telephone basestations. In early 1997, ISC needed additional funds to finance its operations. ISC unsuccessfullyattempted to raise funds through a public offering of stock. The offering was abandoned, leaving ISCin need of $15 million.

ISC subsequently received a proposal for financing from Brown, Simpson LLC (BrownSimpson), a fund advisory firm based in New York City. Brown Simpson proposed providing up to $15million by buying ISC preferred stock. This preferred stock would be convertible to ISC common stockat a price determined by a formula agreed upon by the parties. The financing would be made in steps,or " tranches," of up to $3 million each. On June 5, 1997, the ISC board approved the Brown Simpsonfinancing arrangement.

Brown Simpson's intent was to make money by "short selling" large amounts of ISC's commonstock. Short selling is accomplished by borrowing a stock and immediately selling the borrowed stockinto the market at the current market price. The stock borrowed by a short seller must be replaced sharefor share at some time in the future. The short seller's goal is to later purchase shares of the stock at alower price and use those cheaper shares to replace the borrowed stock. The short seller's profit is thedifference between the proceeds he received from selling the borrowed stock and his cost to purchase thereplacement stock.

Ordinarily, the short seller assumes the risk that the stock price will rise, thereby making itimpossible to subsequently purchase stock at a price lower than the price at which he sold the borrowedstock. Here, though, plaintiffs alleged that ISC eliminated this risk in two ways. First, ISC providedBrown Simpson with "material, non public, confidential information" (hereinafter, the confidentialinformation) about ISC's future business prospects which led Brown Simpson to believe that the marketprice of ISC stock would not likely rise. Second, ISC provided newly issued common stock to replacethe stock that Brown Simpson sold short, thereby eliminating the risk that Brown Simpson would driveup the market price of ISC common stock by buying large quantities of that stock on the open market.

Counts I and II of plaintiffs' third amended complaint alleged that Brown Simpson agreed tothe short-selling financing arrangement (hereinafter, the Brown Simpson financing arrangement) onlyafter defendants disclosed the confidential information to Brown Simpson and concealed thatinformation from plaintiffs. Plaintiffs pleaded that the Brown Simpson financing arrangementultimately caused a "precipitous decline" in the price of ISC's common stock.

Count III alleged that the board of directors breached their fiduciary duty of due care byapproving the Brown Simpson financing arrangement without first informing themselves that such anarrangement would depress the market price of the ISC common stock.

Counts IV and V alleged that the board of directors breached their fiduciary duty of due care byaccepting the second and third "tranches" of funding pursuant to the Brown Simpson financingarrangement without first informing themselves that such funding would depress the market price ofthe ISC common stock.

Count VI alleged that the board of directors breached their fiduciary duty of loyalty by failingto provide plaintiffs with information that would have allowed plaintiffs to take curative action prior tothe "precipitous decline" in the price of the ISC common stock.

Count VII alleged that the board of directors breached their fiduciary duty of loyalty by acceptingthe Brown Simpson financing arrangement even though they should have known that such anarrangement would depress the price of ISC common stock.

Counts VIII and IX alleged that the board of directors breached their fiduciary duty of loyaltyby accepting the second and third tranches of funding pursuant to the Brown Simpson financingarrangement, even though they should have known that such a financing arrangement would depressthe price of ISC common stock.

Count X alleged that defendants ISC and the ISC board of directors violated the IllinoisConsumer Fraud and Deceptive Business Practices Act (815 ILCS 505/1 et seq. (West 1996)) bydisclosing material, confidential information to Brown Simpson and concealing the same informationfrom plaintiffs, the result of which was to depress the price of ISC common stock.

Count XI alleged that ISC's acceptance of funds in connection with the Brown Simpsonfinancing arrangement constituted a breach of ISC's "contract" with plaintiffs.

Count XII alleged that the board of directors breached their fiduciary duty of candor by failingto disclose to plaintiffs information that would have enabled plaintiffs to take curative action prior to the"precipitous decline" in the price of ISC common stock.

Plaintiffs sought certification of the action as a class action. Plaintiffs defined the class as "[a]llpersons and entities who owned the fully paid and non-assessable common stock of [ISC] in the periodMay 15, 1997, through December 31, 1997 ('Class Period' ), and were injured as a result of the directordefendants' breaches of their fiduciary duties and/or [ISC's] violation of their stockholder rights."

The circuit court dismissed plaintiffs' third amended complaint pursuant to section 2-615 of theCode of Civil Procedure (735 ILCS 5/2-615 (West 1996)), finding that plaintiffs properly should havebrought their action as a derivative action instead of a direct class action. Plaintiffs filed this timelyappeal.

When ruling on a section 2-615 motion to dismiss, the court accepts as true all well-pleaded factsand all reasonable inferences therefrom. Green v. Chicago Tribune Co., 286 Ill. App. 3d 1, 4 (1996). The court should not dismiss a complaint unless it clearly appears that no set of facts could be provedunder the pleadings entitling plaintiff to relief. Green, 286 Ill. App. 3d at 4-5. In making such adetermination, the court interprets the allegations of the complaint in the light most favorable toplaintiff. Green, 286 Ill. App. 3d at 5. In reviewing orders on a motion to dismiss, the appellate courtapplies a de novo standard of review. Doe v. TCF Bank Illinois, FSB, 302 Ill. App. 3d 839, 841 (1999).

The issue of whether plaintiffs properly should have brought their claims in a derivative actioninstead of a direct class action is determined by application of the substantive law of Delaware since ISCis incorporated in that state. Spillyards v. Abboud, 278 Ill. App. 3d 663, 667 (1996).

Whether a cause of action is individual or derivative must be determined from the nature of thewrong alleged and the relief that could result if plaintiffs were to prevail. Kramer v. Western PacificIndustries, Inc., 546 A.2d 348, 352 (Del. 1988). In a derivative suit, the shareholder sues on behalf of thecorporation for harm done to it whereas, in a direct action, the shareholder brings suit individually oron behalf of the class of shareholders for injuries done to them in their individual capacities. Kramer,546 A.2d at 351. To have standing to sue individually, plaintiffs must allege an injury separate anddistinct from other shareholders, or a wrong involving a contractual right of a shareholder that existsindependently of any right of the corporation. Kramer, 546 A.2d at 351.

Here, plaintiffs argue that they have standing to sue individually because the majority of theirclaims are for breach of fiduciary duties that defendants owed directly to plaintiffs. Plaintiffs also arguethat they suffered injury (loss of stock value) as a result of defendants' breaches of duty, whereasdefendants sustained no injury but instead benefitted from their alleged wrongdoing. Plaintiffs arguethat an award of relief to plaintiffs would redress the alleged wrong, whereas an award of relief todefendants in a derivative suit would serve only to reward a "wrongdoer."

We disagree. The Delaware Supreme Court has stated:

"[A]ctions charging 'mismanagement which depress[] the value of stock [allege]a wrong to the corporation; i.e., the stockholders collectively, to be enforced bya derivative action.' [Citations.] Thus, where a plaintiff shareholder claims thatthe value of his stock will deteriorate and that the value of his proportionateshare of the stock will be decreased as a result of alleged directormismanagement, his cause of action is derivative in nature." Kramer, 546 A.2dat 353.

Here, the essence of plaintiffs' entire third amended complaint is that defendants engaged inmismanagement that caused plaintiffs' stock values to decrease. Specifically, plaintiffs allege thatdefendants engaged in mismanagement by agreeing to the Brown Simpson financing arrangement whileignoring or failing to first inform themselves as to the probable consequences thereof. Plaintiffs alsoallege that defendants engaged in mismanagement by disclosing material information to Brown Simpson(and concealing said information from plaintiffs), the result of which was to encourage Brown Simpsonto agree to the financing arrangement. Plaintiffs allege that defendants' mismanagement caused"precipitous decline" in the price of their stock. Accordingly, plaintiffs' complaint is derivative in nature.

Plaintiffs argue that they are only required to bring a derivative action in cases involvingcorporate waste. Plaintiffs argue that there is no allegation of corporate waste here, and therefore theiraction need not be brought derivatively. Plaintiffs are incorrect. Even though plaintiffs' claims are notlabeled with the "corporate waste" descriptor, plaintiffs' alleged injury rests on allegations that some formof corporate mismanagement lowered the value of plaintiffs' stock. The Delaware Supreme Court hasheld that such claims of shareholder injury are derivative in nature. See Kramer, 546 A.2d at 353.

Plaintiffs argue that count XI of their third amended complaint states a cause of action for breachof contract. In support, plaintiffs cite Barbieri v. Swing-N-Slide Corp., 1996 WL 255907 (Del. Ch.) andMoran v. Household International, Inc., 490 A.2d 1059 (1985), aff'd, 500 A.2d. 1346 (1985). In Barbieri,plaintiff alleged that the director defendants manipulated the circumstances surrounding a self-tenderoffer in order to create a market for defendants to sell their shares. The court held that theplaintiff/stockholders could bring a direct action in response to the unfair self-tender offer. Barbieri isinapposite, as no self-tender offer is alleged here.

In Moran, the court held that a shareholder may bring a direct action for breach of contract if thecontractual breach involves a wrong to the shareholder and not to the corporation. Here, the allegedbreach of contract involves ISC's mismanagement in accepting funds in connection with BrownSimpson's financing arrangement. As discussed, ISC's corporate mismanagement is a wrong to thecorporation; therefore, plaintiffs' breach of contract count is derivative in nature.

For the foregoing reasons, we affirm the circuit court. As a result of our disposition of this case,we need not address defendants' other arguments on appeal.

Affirmed.

CAMPBELL, P.J., and BUCKLEY, J., concur.