Opinion
Civ. No. 00-5113 (DRD).
April 15, 2002
William Pinilis, Esq., PinilisHalpern, LLP, Morristown, NJ, Steven E. Cauley, Esq., Scott E. Poynter, Esq., J. Allen Carney, Esq., Cauley Geller Bowman Coates, LLP, Little Rock, AR, Attorneys for Plaintiff, Errol McDonald.
John J. Francis, Jr., Esq., Drinker Biddle Shanley LLP, Florham Park, NJ, Jonathan J. Lerner, Esq., Christopher P. Malloy, Esq., Skadden, Arps, Slate, Meagher Flom, LLP, New York, NY, Attorneys for Officer Defendants, Michael R. Bonsignore, Giannantonio Ferrari, Donald J. Redlinger, Robert D. Johnson, Richard F. Wallman, Peter M. Kreindler and James T. Porter.
John J. Francis, Jr., Esq., Drinker Biddle Shanley LLP, Florham Park, NJ, Roy L. Reardon, Esq., Michael Chepiga, Esq., Edward D. Hassi, Esq., Simpson Thacher Bartlett, New York, NY, Attorneys for Outside Director Defendants, Hans W. Bechrer, Gordon M. Bethune, Jaime Chico Pardo, Ann M. Fudge, James J. Howard, Bruce Karatz, Russell E. Palmer, Ivan G. Seidenberg, Andrew C. Sigler, Marshall N. Carter, Robert P. Luciano, John R. Stafford and Michael W. Wright.
OPINION
This matter comes before the Court on the motion of the defendants Hans W. Bechrer, Gordon M. Bethune, Jaime Chico Pardo, Ann M. Fudge, James J. Howard, Bruce Karatz, Russell E. Palmer, Ivan G. Seidenberg, Andrew C. Sigler, Marshall N. Carter, Robert P. Luciano, John R. Stafford and Michael W. Wright (collectively, the "Outside Director Defendants" or "Outside Directors") to dismiss the Plaintiff's Amended Verified Derivative Complaint (the "Complaint") pursuant to Federal Rules of Civil Procedure 23.1 and 12(b)(6). The Outside Director Defendants are independent, non-management or "outside" directors of Honeywell International, Inc. In addition, Defendants Michael R. Bonsignore, Giannantonio Ferrari, Donald J. Redlinger, Robert D. Johnson, Richard F. Wallman, Peter M. Kreindler and James T. Porter (collectively, the "Officer Defendants") and Honeywell International, Inc. have joined in the Outside Defendants' motion to dismiss. For the reasons that follow, the Complaint is dismissed as to all parties.
During oral argument, Plaintiff's counsel agreed to dismiss the Complaint against Defendants Redlinger, Johnson, Kreindler, and Porter. They had been dismissed from the related Securities Class Action case on the ground that the complaint inadequately alleged scienter with respect to them. Consequently, this decision affects only Defendants Bonsignore, Ferrari and Wallman.
Background
The facts of this case has been set forth in greater detail in a published opinion, In re Honeywell International, Inc. Securities Litigation, 182 F. Supp.2d 414 (D.N.J. 2002) (the "Securities Class Action"). For the sake of brevity, only the facts relevant to the motion at hand will be set forth in this opinion.
Honeywell International, Inc., a Delaware corporation with its principal place of business in Morristown, New Jersey, was formed on December 1, 1999, when Honeywell Inc. and AlliedSignal Inc. merged. The surviving entity-"Honeywell"-is a "huge 120,000 employee, $20 billion revenue per year worldwide conglomerate providing aerospace products and services, control technologies for buildings, homes and industry, specialty chemicals, fibers and plastics and electronics and advanced materials." Compl. ¶ 19.
In the six months following the merger, various officers of Honeywell, including CEO Michael Bonsignore, President and COO Giannatonio Ferrari, and Senior Vice-President and CFO Richard F. Wallman, held certain meetings and conference calls with analysts from Wall Street investment banking and brokerage firms, money and portfolio managers, institutional investors and large Honeywell shareholders to discuss the Company's performance and its future prospects. Compl. ¶¶ 23-28. These discussions centered on management's projections of future performance, including projections of anticipated earnings per share ("EPS") and predictions of savings anticipated from the merger. Id. None of the Outside Director Defendants is alleged to have been involved in these discussions.
During this time, Honeywell also issued press releases reporting its quarterly results for the 4th quarter of 1999 and the 1st quarter of 2000, and Honeywell management held conference calls with analysts and investors to discuss those results.Compl. ¶¶ 24-26. Honeywell met its EPS projections in each of those two quarters. Id. Honeywell also made periodic reports as required to the SEC. On February 23, 2000, Honeywell filed its annual report on Form 10-K for 1999. Id. ¶¶ 45-46.
Between June 2 and June 19, 2000, the price of Honeywell stock dropped from $59-1/8 to $40-3/4. Compl. ¶ 68. On June 19, Honeywell announced that it would not achieve its second quarter earnings per share forecast. In the days following the June 19 announcement, Honeywell's share price continued to fall. Id.
On July 10, 2000, Honeywell's Chairman and CEO, Michael Bonsignore, spoke at an investor conference about some of the issues that Honeywell had identified as contributing to the Company's inability to meet its earlier forecast. Mr. Bonsignore explained that a number of Honeywell's business segments had fallen short of expectations and detailed the problems in each of those businesses. Compl. ¶ 72.
Following the decline in Honeywell's share price, several class actions were filed in this District alleging federal securities laws violations. Id. ¶ 2. These class actions were consolidated into the Securities Class Action, In re Honeywell Inc. Secs. Litig., No. 99-2231 (DRD). On or about October 17, 2000, plaintiff Errol McDonald, alleging that he owns an unspecified number of shares of Honeywell stock, commenced this derivative action against all fourteen of the then members of the Honeywell board of directors, as well as five present Honeywell officers and one former officer. Of the fourteen directors named in this suit, only Bonsignore, Honeywell's CEO, was an officer of Honeywell; the remaining thirteen were outside directors. Id. ¶ 5(a)-(t). Eight of the thirteen Outside Directors had previously served on the board of directors of AlliedSignal. Id. ¶ 19.
This derivative action names as defendants the same Honeywell officers who were sued as defendants in the Securities Class Action. None of the thirteen Outside Directors sued here is a defendant in the Securities Class Action. In addition, plaintiff's claims in this case arise from the same core facts alleged in the Securities Class Action Complaint, which emphasizes insider sales of stock that occurred ahead of public disclosure of Honeywell's failure to meet its earnings projections. None of the Outside Directors engaged in such sales.
Plaintiff did not make a pre-suit demand on the Board of Directors. Instead, he alleges that the demand requirement was excused because it would have been futile. Id. ¶ 17.
This court has jurisdiction over the case pursuant to 28 U.S.C. § 1332 because complete diversity of citizenship exists between the Plaintiff and each Defendant. The jurisdictional minimum amount of damages of § 1332 is also satisfied.
Analysis
The Outside Director Defendants contend that the Complaint should be dismissed because (i) Plaintiff failed to make pre-suit demand as required by Delaware corporate law; (ii) Plaintiff has failed to demonstrate that pre-suit demand is excused because it is futile; and (iii) Honeywell's Certificate of Incorporation shields the Outside Directors from liability for the cause of action asserted by Plaintiff. The Officer Defendants and Honeywell International, Inc. join in the Outside Directors' motion as it relates to Plaintiff's failure to make a pre-suit demand and failure to adequately demonstrate that pre-suit demand is excused.The demand requirement is set forth in Federal Rule of Civil Procedure 23.1, which provides in relevant part as follows:
The [derivative] complaint shall also 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.
In interpreting the demand requirement, federal courts look to the substantive law of the state of incorporation. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 96 (1991). Rule 23.1 represents a departure from the usual notice pleading requirements of the Federal Rules of Civil Procedure and requires that claims of demand futility be alleged with particularity.See Tabas v. Mullane, 608 F. Supp. 759, 766 (D.N.J. 1985). I. Whether Pre-Suit Demand Is Excused.
A derivative lawsuit allows an individual shareholder to bring a suit to "enforce a corporate cause of action against officers, directors, and third parties." Ross v. Bernhard, 396 U.S. 531, 534 (1970). Rule 23.1 requires that a derivative complaint "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 reason for the plaintiff's failure to obtain the action or for not making the effort." The Supreme Court in Kamen v. Kemper Financial Services, Inc., 500 U.S. 90, 95 (1991), wrote that Rule 23.1 "does not create a demand requirement of any particular dimension." Instead, "the substantive requirements of demand are a matter of state law."Blasband v. Rales, 971 F.2d 1034, 1047 (3d Cir. 1992). Because Honeywell is a Delaware corporation, Delaware law governs the substantive requirements of Plaintiff's claims, including the demand requirement.
Delaware courts permit a shareholder to bring a derivative suit where those in control of the corporation refuse to assert a claim belonging to it, see Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984), overruled by Brehm v. Eisner, 746 A.2d 244(Del. 2000); Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984),overruled by Brehm v. Eisner, 746 A.2d 244(Del. 2000). However, "a cardinal precept of the General Corporation Law of the State of Delaware is that the directors, rather than shareholders, manage the business and affairs of the corporation." Levine v. Smith, 591 A.2d 194, 200 (Del. 1991); Pogostin, 480 A.2d at 624. The decision to bring a lawsuit or to refrain from litigating a claim on behalf of the corporation is a decision concerning the management of the corporation and consequently is the responsibility of the directors. Levine, 591 A.2d at 200. Accordingly, because a derivative action impinges on the managerial freedom of directors, the demand requirement "exists at the threshold, first to insure that a stockholder exhausts his intracorporate remedies, and then to provide a safeguard against strike suits." Aronson, 473 A.2d at 811-12. Therefore, the demand requirement is not a mere formality, but is instead an important aspect of Delaware's substantive law. See Blasband, 971 F.2d at 1048; Levine, 591 A.2d at 207.
According to the Delaware Supreme Court, "[t]he test of demand futility is a two-fold test," the prongs of which are disjunctive. Brehm v. Eisner, 746 A.2d 244, 256 (Del. 2000). Therefore, if either prong is satisfied, demand is excused. The first prong of the test is "whether, under the particularized facts alleged, a reasonable doubt is created that . . . the directors are disinterested and independent." Id. (citingAronson, 473 A.2d at 814, 816. The second prong is whether the pleading creates a reasonable doubt that "the challenged transaction was otherwise the product of a valid exercise of business judgment." Id. (citing Aronson, 473 A.2d at 814). However, in cases where the plaintiff does not challenge a specific business transaction that the directors authorized, the second prong of the Aronson inquiry-whether the challenged transaction was otherwise the product of a valid exercise of business judgment-has no application. See Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993).
In the instant case, Plaintiff has not sought to challenge any particular transaction. Instead, the Complaint merely alleges that the defendants breached their fiduciary duties owed to Honeywell and its shareholders, failed to disseminate promptly accurate and truthful information with respect to Honeywell's operations, financial conditions and earnings, aided and abetted illegal insider sales of stock, and knowingly violated federal and state securities laws. See Compl. ¶¶ 76-79. To excuse his statutory and procedural obligations to make a pre-suit demand upon the Board of Directors as futile, Plaintiff must allege facts with particularity that a majority of the Board of Directors were tainted by interest, lacked independence or acted in a manner that was not in Honeywell's best interest. See Rales, 634 A.2d at 934 ("Thus, a court must determine whether or not 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.").
Plaintiff's interpretation of Rales to allow review under the second prong of the Aronson test is simply wrong. Even the passage of Rales quoted by Plaintiff explicitly instructs other courts that the two-part Aronson demand futility test is inapplicable in situations where "the subject of the derivative suit is not a business decision of the board." Here, there is no allegation in the Complaint which suggests that the Honeywell Board made a decision to act or refrain from acting which could be classified as a business decision. Instead, it appears that the Outside Directors merely fulfilled their duties as directors.
Because it is clear that Bonsignore is an interested director, the relevant inquiry is whether a majority of the Outside Directors were either interested or lacked independence.
A. Interest
A director is considered interested if he or she will receive or has received a personal financial benefit from a transaction that is not equally shared by the stockholders. Rales, 634 A.2d at 936; Aronson, 473 A.2d at 812; Pogostin, 480 A.2d at 624. Directorial interest also exists where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders. In such circumstances, a director cannot be expected to exercise his or her independent business judgment without being influenced by the adverse personal consequences resulting from the decision. See Rales, 634 A.2d at 936. Normally, however, the "mere threat of personal liability for approving a questioned transaction standing alone, is insufficient to challenge either the independence or disinterestedness of directors. . . ." See Aronson, 473 A.2d at 815. Consequently, when the plaintiff claims that the directors are disabled by the risk of liability, the claim must be pleaded with sufficient particularity to permit the court to conclude that there is a substantial likelihood of liability on the part of the directors. See In re Baxter Intern. Inc. Shareholders Litig., 654 A.2d 1268, 1270 (Del.Ch. 1995). In the present situation, the risk of Outside Director liability seems slight in view of the fact that none of them were named as defendants in the Securities Class Action and by the fact that four of the Officer Defendants were dismissed from that action for failure of the Complaint to sufficiently allege scienter as to them. It is unlikely, a fortiori, that scienter could be alleged against the Outside Directors.
Plaintiff advances four reasons why the Outside Directors are so conflicted between their individual interests and the interests of Honeywell that they cannot be disinterested. See Compl. ¶ 17.
First, Plaintiff alleges that because a number of directors were previously directors of AlliedSignal, they possessed a greater awareness of Honeywell's integration problems and thus must have been aware that statements they "approved" about the successful integration of the two companies were false.See Compl. ¶ 17(a)(6). However, the Complaint does not set forth any particular or detailed information about how the directors became aware of the integration problems, which integration problems they became aware of, or even what statements they "approved." These allegations do not support an inference that the Outside Directors were interested.
Second, the Complaint alleges that because the Outside Directors authorized and signed Honeywell's 1999 Annual Report, which was filed on Form 10-K with the Securities and Exchange Commission, the directors would be unwilling to admit to any false or misleading statements or omissions in the Annual Report because such an admission would subject them liability under the securities laws. See Compl. ¶ 17(a)(3), 17(e). Generally, the "mere threat of personal liability" is insufficient to challenge either the independence or disinterestedness of directors, see Aronson, 473 A.2d at 815, without additional particularized allegations which would lead to a conclusion that there is a substantial likelihood of liability on the part of the directors,see Baxter, 654 A.2d at 1270. Here, Plaintiff has not alleged specific wrong-doing other than that the Outside Directors signed a Form 10-K which contained false or misleading statements. This sort of allegation is insufficient to create a reasonable doubt as to the disinterestedness of the Outside Directors. There are no allegations as to what was false and misleading and as to the Outside Directors' knowledge of false and misleading material. Generally, the potential of liability against a director arising solely from signing a misleading registration statement or 10-K does not make an outside director interested. See Seminaris v. Landa, 662 A.2d 1350, 1354 (Del.Ch. 1995).
Third, the Complaint alleges that the Officer Defendants have all sold shares of Honeywell stock and that the Outside Directors aided and abetted these sales by allowing them and breached their fiduciary duties to Honeywell by refusing to take action against these inside sellers on behalf of Honeywell. However, the Complaint does not explain how the Outside Directors have benefitted financially from these insider sales, nor does the Complaint address the fact that on a motion to dismiss the Securities Class Action, the court dismissed claims all but three of the officers accused of selling Honeywell stock while allegedly in possession of non-public information. See Honeywell, 182 F. Supp.2d at 429.
Fourth, Plaintiff alleges that the Outside Directors are incapable of evaluating a demand because they would be forced to expose their own wrongdoing and to sue themselves. See Compl. ¶¶ 17(b)-(e). Apparently, Plaintiff relies on the case In re Cendant Corp. Derivative Action Litig., 189 F.R.D. 117 (D.N.J. 1999), in support of his claims. In Cendant, the district court held that a majority of the board was sufficiently interested to excuse the failure to make a pre-suit demand. Cendant, however, is clearly distinguishable from the instant case. In Cendant, the court found the complaint presented allegations that: (i) all 16 of the director defendants were also defendants in other pending class action suits and faced personal liability; (ii) eight of the directors received special compensation packages or the grant of significant fees; (iii) ten of the directors sold shares while in possession of material adverse information; and (iv) the directors signed, approved and published false statements through which they received personal benefits. In contrast, here, (i) none of the Outside Directors is named in the Securities Class Action; (ii) none of the Outside Directors received special compensation packages (or any other form of remuneration related to Plaintiff's allegations); (iii) none of the Outside Directors is alleged to have sold shares; and (iv) although several of the Outside Directors signed the 1999 Form 10-K, they are not alleged to have profited as a result or known of any false information. In addition, Cendant is an instance, unlike the present case, where the company itself had already publicly admitted to having committed a wide-range of financial and accounting fraud. The differences between Cendant and the instant case are significant. Analysis of the disinterestedness of directors is fact-intensive, see Brehm, 746 A.2d at 255;Aronson, 473 A.2d at 808, and thus the Cendant court's ruling does not support Plaintiff's position. B. Independence
Independence means that "a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences." Aronson, 473 A.2d at 816. It is not enough to plead that one or more of the directors may have been interested or dominated; Plaintiff must show that a majority of the board was incapable of exercising business judgment. See Levine, 591 A.2d at 205, Pogosotin, 480 A.2d at 623. Therefore, to establish lack of independence, Plaintiff must demonstrate that a majority the directors are "beholden" to Bonsignore (the only interested director on the Board) or so under his influence that their discretion would be sterilized.Id. at 815, Levine, 591 A.2d at 205.
As evidence of the Outside Directors' lack of independence, Plaintiff cites Bonsignore's alleged dominance of Honeywell's Board of Directors. As evidence of Bonsignore's dominance over the Board, Plaintiff relies on an instance where Bonsignore "was able to convince the Board to recommend against a proposal that would have significantly limited his personal income", i.e., a shareholder proposal to cap the CEO's compensation as a multiple of the lowest paid worker of Honeywell. Compl. ¶ 17(a)(2). However, decisions regarding executive compensation are within the purview of a company's board of directors. Consequently, when "an independent and informed board, acting in good faith, determines that the services of a particular individual warrant large amounts of money, whether in the form of current salary or severance provisions, the board has made a business judgment." Grimes v. Donald, 673 A.2d 1207, 1215 (Del. 1996); see also Del. Code Ann. tit. 8, § 141(a) ("The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors. . . ."). Furthermore, "that judgment normally will receive the protection of the business judgment rule unless the facts show that such amounts, compared with the services to be received in exchange, constitute waste or could not otherwise be the product of a valid exercise of business judgment." Grimes, 673 A.2d at 1215. Because Plaintiff has not plead facts suggesting that the Board of Directors, in rejecting the shareholder proposal, acted contrary to their business judgment, the Board's decision to reject the shareholder proposal regarding executive compensation was wholly legitimate and does not evidence any domination by Bonsignore. Accordingly, none of the allegations in Plaintiff's Complaint creates any doubt as to the Outside Directors' independence.
Because Plaintiff has failed to create a reasonable doubt as to the disinterestedness or independence of the Outside Directors, he has failed to satisfy the test to excuse demand set forth inAronson and Rales. Consequently, the failure to make a pre-suit demand upon Honeywell's Board of Directors is fatal to the further prosecution of this lawsuit.
In oral argument, Plaintiff's counsel requested the opportunity to refile his Complaint if I dismissed the Complaint pursuant to Rule 12(b)(6). Because there is no reason why Plaintiff would not have pled all of the facts leading to his allegation that pre-suit demand would be unnecessary and futile, and because Plaintiff has not specified any such facts at argument or otherwise, his Complaint will be dismissed without leave to amend.
II. Whether Plaintiff's Breach of Fiduciary Duty Claim Against the Outside Directors Is Barred by Honeywell's Certificate of Incorporation
In their motion to dismiss, the Outside Defendants argue that the Complaint should be dismissed as to them because Honeywell's certificate of incorporation absolves them from personal liability to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability "(i) for any breach of the Director's duty of loyalty to the corporation or its stockholders, (ii) for any acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law, (iii) under section 174 of the General Corporation Law, or (iv) for any transaction from which the director derived an improper benefit." Because the Complaint will be dismissed because the Plaintiff failed to make pre-suit demand upon Honeywell's Board of Directors and because the Plaintiff has failed to demonstrate that pre-suit demand would be futile, it is unnecessary to address the second ground for dismissal.
Conclusion
The Outside Director Defendants' motion to dismiss the Plaintiff's claim for failure to state a cause of action is granted. The Officer Defendants' and Honeywell's motion to join in the Outside Director Defendants' motion to dismiss is also granted.
An order implementing this decision will be entered.