Opinion
Civil No. 3:03-CV-1057-H
February 26, 2004
MEMORANDUM OPINION AND ORDER
Before the Court are Defendants Harvey B. Cash, Robert L. Crandall, and Michael H. Jordan's Motion to Dismiss, filed October 17, 2003; Nominal Defendant i2 Technologies, Inc., and Defendants Sanjiv S. Sidhu and William M. Beecher's Motion to Dismiss, filed October 17, 2003; Defendant Gregory A. Brady's Motion to Dismiss, filed October 17, 2003; Plaintiff's Response, filed November 24, 2003; Defendants' Cash, Crandall, and Jordan's Reply, filed December 19, 2003; Nominal Defendant i2 Technologies, Inc., and Defendants Sidhu, Brady, and Beecher's Reply, filed December 19, 2003; Plaintiff's Supplemental Authority, filed January 7, 2004; and Nominal Defendant i2 Techonologies, Inc., and Defendants Sidhu, Brady, and Beecher's Response to Plaintiff's Supplemental Authority, filed January 23, 2004. Also before the Court is Nominal Defendant i2 Technologies, Inc., and Defendants Sidhu and Beecher's Request for Judicial Notice, filed October 17, 2003. Defendants seek dismissal of Plaintiff's Consolidated Shareholder Derivative Complaint. Upon review of the pleadings, briefs, and relevant authorities, the Court is of the Opinion for the reasons stated below that Defendants' Motions to Dismiss should be GRANTED and Nominal Defendant i2 Technologies, Inc., and Defendants Sidhu and Beecher's Request for Judicial Notice should be DENIED as moot.
I. BACKGROUND
This is a shareholder derivative suit filed by Peter Kaltman on behalf of Nominal Defendant i2 Technologies, Inc. ("i2"). Plaintiff filed his Amended Derivative Complaint ("Complaint") on September 12, 2003, seeking to recover $556,281,110.00 in bonuses, equity-based compensation, and profits realized from the sale of i2 Technologies securities by Defendants Sidhu, Beecher, and Brady. (Compl. at 2). Plaintiff brings his claims pursuant to Section 304 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") and Delaware common law. (Id.). Plaintiff is, and was during the time the acts complained of occurred, a shareholder. (Compl. at 8). Defendants are, or were at the time the complaint was filed, directors and/or officers of i2. (Compl. at 8-13).
Plaintiff's complaint stems from a re-audit i2 performed in 2003 for financial years 1999, 2000, and 2001, which resulted in a restatement of i2's financial statements for those years and a loss in its stock price. (Compl. at 13-16, 18-24). Plaintiff alleges that the restatement was the result of "misconduct" on the part of Defendants, and, therefore, Defendants Sidhu, Beecher, and Brady must reimburse i2 for all bonuses and incentive-based compensation and for all profits earned on stock trades during 1999, 2000, and 2001. (Id. at 2-3). Plaintiff also makes claims against the three officer defendants, Sidhu, Beecher, and Brady, for insider trading. (Id. at 3). Plaintiff does not state a specific cause of action against the three director defendants, Cash, Crandall, and Jordan. (See generally, Compl.).
All Defendants, including Nominal Defendant i2, move to dismiss Plaintiff's complaint. Defendants argue that Plaintiff failed to establish demand futility pursuant to Federal Rule of Civil Procedure 23.1 and Delaware law; that the complaint does not meet the particularity requirements of Federal Rule of Civil Procedure 9(b); that Plaintiff's action is barred by i2's Certificate of Incorporation; and that the Sarbanes-Oxley Act claim fails as a matter of law. The Court will address these arguments below.
II. ANALYSIS
Defendants first argue that Plaintiff lacks standing to sue derivatively because he did not make demand on i2's Board of Directors. (Def. Cash, Crandall, and Jordan's Mot. at 2-3). Defendants argue that if demand is not made on the Board prior to filing a derivative suit, the complaint must comply with the requirements of Federal Rule of Civil Procedure 23.1 and Delaware law and plead with particularity the reasons demand is excused. ( Id.). In a derivative action, Rule 23.1 requires that the complaint "shall . . . allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for the plaintiff's failure to obtain the action or for not making the effort." FED.R.CIV.P. 23.1. Because i2 is a Delaware corporation, "the substantive corporation law of Delaware determines whether or not the demand requirements of FED.R.CIV.P. 23.1 have been satisfied." Rales v. Blasband, 634 A.2d 927, 932 n. 7 (Del. 1993). Delaware law requires a stockholder to make a demand on the Board of Directors to pursue the corporate claim "[b]ecause directors are empowered to manage, or direct the management of, the business and affairs of the corporation, 8 DEL.C. § 141(a)." Id. at 932.
In the instant case, Defendants argue that the test articulated by the Delaware Supreme Court in Rales v. Blasband, 634 A.2d 927 (Del. 1993), is the appropriate test to use in determining whether demand in this case is excused as fufile. Defendants argue the Rales test is appropriate because Plaintiff is not challenging a business decision made by the Board. (See Def. Cash, Crandall and Jordan's Mot. at 4). Rales requires the Court to determine whether "the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand." Rales, 634 A.2d at 934. To create a doubt that the board of directors could exercise its independent and disinterested business judgment, the Plaintiff would need to allege with particularity facts that create a reasonable doubt that the board is "capable of acting free from personal financial interest and improper extraneous influences." Id. at 935. The Rales test is employed where "directors are sued because they have failed to do something . . . demand should not be excused automatically in the absence of allegations demonstrating why the board is incapable of considering a demand." Id. at 934 n. 9.
Plaintiff argues that he is challenging a business decision of the Board, and thus, the Court should use the test developed in Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), to determine if demand is excused. (Pl.'s Mot. at 14). Aronson requires the Court to determine whether "under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." Aronson, 473 A.2d at 814. Therefore, the Court must make two inquiries, "one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof." Id. The basic difference between the Rales test and the Aronson test is the second inquiry the Court makes under the Aronson test that the Court does not make under the Rales test.
After examining the Complaint, the Court concludes that the Rales test is appropriate in the instant case because Plaintiff does not challenge any conscious business decision of the Board. The only action of the Board that Plaintiff challenges in the instant case is the failure of the Board to "pursue its remedies and seek disgorgement of those monies" made by Defendants Sidhu, Beecher, and Brady from allegedly trading on inside information and from receiving bonuses as a result of financial misconduct. (See Compl. at 24-29). The Rales test is appropriate where the allegation is that the Board failed to do something. See Rales, 634 A.2d at 924, n. 9.
The Court has considered Plaintiff's argument "that director conduct falls outside the protection of the business judgment rule if all of the alleged facts, if true, imply that the defendant directors knew they were making material decisions without adequate information and without adequate deliberation, and that they simply did not care if the decisions caused the corporation and its stockholders to suffer injury or loss. In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 289 (Del.Ch. 2003)." (Pl.'s Response at 14-15). The Court does not find that Plaintiff's Complaint alleges any facts that would imply that the Outside Directors acted without adequate information or deliberation. The Complaint is devoid of facts regarding how the directors made any decisions, and thus fails to show that the directors' conduct falls outside the protection of the business judgment rule. Therefore, the Court's decision in the instant case would be the same even if the Court analyzed whether demand is excused using the Aronson test.
In the instant case, therefore, the Court must consider whether "the particularized factual allegations of [the] derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand." Id. at 934. To create a doubt that the board of directors could exercise its independent and disinterested business judgment, the plaintiff needs to allege with particularity facts that create a reasonable doubt that the board is "capable of acting free from personal financial interest and improper extraneous influences." Id. at 935.
In the instant case, when the complaint was filed the Board of Directors of i2 consisted of Sanjiv S. Sidhu, Harvey B. Cash, Robert J. Crandall, and Michael H. Jordan. (See Def. Cash, Crandall, and Jordan's Mot. at 6-7). Defendants concede that Sidhu, as i2's President and Chief Executive Officer, is an insider and, thus, could arguably be considered interested. (See Def. Cash, Crandall, and Jordan's Mot. at 7). The remaining directors, Cash, Crandall, and Jordan, however, are outsiders, meaning they are not also officers of the company and so are not automatically considered interested or not independent. (See id.). Defendants argue that because the majority of the Board is comprised of outside directors, pre-suit demand would be excused if a majority of the Board meets the Rales test. (Id.). The Court agrees and will therefore only consider whether Plaintiffs' Complaint meets the test of disinterested and independent as to the three outside directors, Cash, Crandall, and Jordan.
"A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders," or "where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders." Rales, 634 A.2d at 936. "To establish lack of independence, [Plaintiff] must show that the directors are `beholden' to the [interested director] or so under [his] influence that their discretion would be sterilized." Id.
In the instant case, Plaintiff offers eight reasons why the Board is not independent or disinterested. (Compl. at 30-32). Plaintiff argues 1) that Defendant Sidhu cannot be reasonably expected to argue against his own interests by authorizing the company to seek reimbursement from him; 2) that Defendant Sidhu dominates the Board and owns approximately 27% of the company's outstanding shares; 3) that Defendants Crandall and Jordan are not disinterested because they were appointed to the Board, not elected, and that Defendants Cash, Crandall, and Jordan comprised the Audit Committee and would not sue themselves because of their potential liability for their business decisions regarding the investigations of accounting improprieties; 4) that all individual Defendants signed at least one Form 10-K or 10-Q that has since been restated; 5) that the directors cannot be expected to pursue these claims because one of the directors is also a defendant in a securities fraud class action; 6) that Defendants Sidhu and Brady have close ties, evidenced by their joint ownership of a yacht; 7) that the directors allowed the Officer Defendants to sell stock and to receive bonuses while there were allegations of financial impropriety pending; and, 8) that the Board has failed to act. (Compl. at 30-32).
Defendants argue that Plaintiffs' assertions as to why demand is excused fall into four basic categories: "1) [the Outside Directors] were complicit in the alleged wrongdoing; 2) [the Outside Directors] are dominated and controlled by other persons; 3) [the Outside Directors] would not pursue derivative claims because of parallel securities litigation; and 4) [the Outside Directors] have failed to take action." ( See Def. Cash, Crandall, and Jordan's Mot. at 8). The Court agrees with Defendants' characterization of Plaintiffs' arguments and will use these characterizations to address whether demand is excused.
1. The Directors' Potential Liability
The Delaware Supreme Court has explained that "the mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors." Rales, 634 A.2d at 936. Only when the potential for liability rises from a mere threat of personal liability to a substantial likelihood of personal liability will directors be considered interested. Id. See also Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984). In the instant case, Plaintiff asserts that the outside Directors were interested because they faced potential liability on the wrongs Plaintiff alleges in the Complaint. However, Plaintiff has alleged no particularized facts that raise his assertion from a mere threat to a substantial likelihood of personal liability. Plaintiff has pleaded no particularized facts which create a reasonable doubt that Defendants Cash, Crandall, or Jordan's actions were not valid exercises of business judgment. See Rales, 634 A.2d at 936. In fact, Plaintiff has not even stated a particular claim against the Outside Directors in his complaint or stated particular facts regarding the Outside Directors' actions on the Board. (See generally, Compl.). This is not sufficient to conclude that the majority of the Board is interested.
Plaintiff relies on McCall v. Scott, 239 F.3d 808 (6th Cir. 2001). Plaintiff argues that allegations of a breach of the duty of care will amount to a substantial likelihood of director liability for corporate losses where directors have "exhibited intentional ignorance of and willful blindness to red flags signaling fraudulent practices throughout the corporation."(Pl.'s Response at 16). The Court notes that the Sixth Circuit also cited with approval a case holding "that when director liability is predicated upon ignorance of liability creating activities only a sustained or systematic failure of the board to exercise oversight-such as an utter failure to attempt to assure a reasonable information and reporting system exists-will establish the lack of good faith that is a necessary condition to liability." McCall, 239 F.3d at 817 (citing In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959, 971 (Del.Ch. 1996)). In the instant case, the Court finds that the Complaint makes no allegations that would show that the Outside Directors "exhibited intentional ignorance of or willful blindness to red flags" or of a sustained failure to exercise oversight, such that the Outside Directors face a substantial likelihood of liability.
2. Domination and Control of the Board
"To establish a lack of independence, [Plaintiff] must show that the [outside] directors are `beholden' to [Sidhu] or so under [his] influence that their discretion would be sterilized." Rales, 634 A.2d at 936. Plaintiff must "allege particularized facts manifesting `a direction of corporate conduct in such a way as to comport with the wishes or interests of the corporation (or persons) doing the controlling." Aronson, 473 A.2d at 816. In the instant case, Plaintiff alleges that Defendant Sidhu dominates and controls the Board such that the Outside Directors are not independent. Plaintiff makes a conclusory statement that Sidhu dominates the Board and that he owns 27% of the company's shares. (Compl. at 30). Plaintiff also seems to argue that Defendants Crandall and Jordan lack independence because they were appointed to the Board, not elected. (Id.). Plaintiff also argues that Sidhu and Brady have close personal ties as evidenced by their joint ownership of a yacht. (Id.). None of Plaintiff's allegations are sufficient to excuse demand. The Delaware Supreme Court found a similar argument in Aronson to be insufficient to prove a lack of independence. See Aronson, 473 A.2d at 815-16. Plaintiff in the instant case has failed to "allege particularized facts manifesting a direction of corporate conduct in such a way as to comport with the wishes or interests of the corporation (or persons) doing the controlling." Id. at 816 (citations omitted). The Court cannot conclude "that the complaint factually particularizes any circumstances of control and domination to overcome the presumption of board independence, and thus render demand fufile." Aronson, 473 A.2d at 817.
The Court finds the last argument to be inapposite because Brady is not on the Board and his relationship with Sidhu is not relevant to the present inquiry. Additionally, there is no allegation that Brady dominates or controls any of the Outside Directors.
3. Parallel Securities Litigation
Plaintiff argues that the directors cannot be expected to pursue these claims because one of the directors is also a defendant in a securities fraud class action. (Compl. at 30). The only director to be named as a defendant in the securities fraud class action is Defendant Sidhu. See Scheiner v. Sidhu, et al, 3:01-CV-418-H, currently pending in this Court. Plaintiff argues that if the other directors were to pursue the derivative claims he alleges in his complaint, that this would be "an acknowledgment of the merits of the shareholders' claims." (Compl. at 30). Similar allegations have been held to be insufficient to create a reasonable doubt that directors are interested or not independent. See Seminaris v. Landa, 662 A.2d 1350, 1355 (Del.Ch. 1995). The Court finds Plaintiff's conclusory allegation insufficient to render demand fufile.
4. Board's Failure to Take Action
Plaintiff argues that demand is fufile because the Board has failed to take action to seek reimbursement of the profits, bonuses, and compensation. (Compl. at 31-32). The Court agrees with Defendants that Plaintiff has failed to allege with particularity what information the Outside Directors knew, who knew it, when they knew it, or how they "abdicated their investigation to management." (See Def. Cash, Crandall, and Jordan's Mot. at 15). This allegation is, therefore, insufficient to excuse demand. In an unpublished opinion, the Delaware Court of Chancery stated, "The mere fact that [the Board] has elected not to sue before the derivative action was filed should not of itself indicate `interestedness.'" Richarson v. Graves, C.A. No. 6617, 1983 WL 21109, *3 (Del.Ch. March 7, 1983). The Court of Chancery went on to explain that "it is the Board's inaction in most every case which is the raison d'etre from Rule 23.1." Id. In the instant case, the Court agrees that Plaintiffs' assertions are not indicative of interestedness. Plaintiffs assertions here are insufficient to create a reasonable doubt and thus excuse demand.
III. CONCLUSION
The Court concludes that Plaintiff has not created a reasonable doubt that the board is "capable of acting free from personal financial interest and improper extraneous influences," and has thus failed to demonstrate that demand is excused. Rales, 634 A.2d at 935. In light of this conclusion, the Court does not need to address Defendants' other arguments for why the case should be dismissed. Because Plaintiff did not make demand on the Board and failed to allege with particularity why demand was excused, as required pursuant to Federal Rule of Civil Procedure 23.1 and Delaware law, the Court GRANTS Defendants' Motions to Dismiss.
For the reasons stated above, Defendants' Motions to Dismiss are GRANTED and Plaintiff's Complaint is DISMISSED pursuant to Fed.R.Civ.P. 12(b)(6). Nominal Defendant i2 Technologies, Inc., and Defendants Sidhu and Beecher's Request for Judicial Notice is DENIED as moot.
SO ORDERED.