Opinion
Civil No. 3:03-CV-0841-H, (Consolidated with Civil Action No. 3:03-CV-0869-H)
January 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 September 30, 2003; Nominal Defendant i2 Technologies, Inc., and Defendants Sanjiv S. Sidhu, William M. Beecher, and David C. Becker's Motion to Dismiss, filed September 30, 2003; Defendant Gregory A. Brady's Motion to Dismiss, filed September 30, 2003; Plaintiffs' Response, filed October 31, 2003; Defendants' Cash, Crandall and Jordan's Reply, filed November 26, 2003; Nominal Defendant i2 Technologies, Inc., and Defendants Sidhu, Beecher, and Becker's Reply, filed November 26, 2003; Plaintiff's Supplemental Memorandum, filed December 18, 2003; and Defendants Cash, Crandall, and Jordan's Response to Plaintiff's Supplemental Memorandum, filed December 30, 2003. Also before the Court is Nominal Defendant i2 Technologies, Inc., and Defendants Sidhu, Beecher, and Becker's Request for Judicial Notice, filed September 30, 2003. Defendants seek dismissal of Plaintiffs' 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.
I. BACKGROUND
This is a shareholder derivative suit filed by Alan Spector and Thomas C. Olson, Jr., on behalf of nominal defendant i2 Technologies, Inc.("i2"). Plaintiffs filed a Consolidated Shareholder Derivative Complaint ("Complaint") on July 24, 2003, which alleges the Board of Directors and certain executive officers breached their fiduciary duties and violated common law from March 31, 1999 to the present ("Relevant Period"), and seeks remedies for these alleged breaches and violations and for remedies pursuant to the Sarbanes-Oxley Act of 2002. (Compl. at 2). Plaintiffs are, and were during the Relevant Period, shareholders. (Compl. at 4). Defendants are, or were at the time the complaint was filed, directors and/or officers of i2.
Thomas C. Olson, Jr.'s case was originally filed as Olson v. Sidhu, Civil Action Number 3:03-CV-0869-H, but was consolidated under the instant caption by Court Order on June 23, 2003.
Specifically, Plaintiffs allege that the named individual defendants, Sanjiv S. Sidhu, Gregory A. Brady, William M. Beecher, David C. Becker, Harvey B. Cash, Robert L. Crandall, and Michael H. Jordan, "caused [i2] to improperly recognize revenue in violation of Generally Accepted Accounting Principals ("GAAP") and to falsely publicize the integration capabilities and performance of its software product TradeMatrix." (Compl. at 2). Plaintiffs' 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 stock price. (Compl. at 32).
All Defendants, including nominal defendant i2, move to dismiss Plaintiffs' complaint. Defendants argue that Plaintiffs 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 Plaintiffs' action is barred by i2's Certificate of Incorporation; that Plaintiffs' product-related action is barred by res judicata; 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 Plaintiffs lack standing to sue derivatively because they 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 requirement of Federal Rule of Civil Procedure 23.1 and Delaware law 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.ClV.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, or to show why demand is excused "because the directors are incapable of making an impartial decision regarding such litigation." Id. at 932.
In the instant case, both sides agree that the test articulated by the Delaware Supreme Court in Rales is the appropriate test to use in determining whether demand in this case is excused as futile. ( See Def. Cash, Crandall and Jordan's Mot. at 5; Pl.'s Mot. at 9). 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." Rales, 634 A.2d at 934 n. 9. In the instant case, the Court must consider 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." Id. 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.
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 7). Both sides agree 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; Pl.'s Mot. at 10). 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. 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 their influence that their discretion would be sterilized." Id.
In the instant case, Plaintiffs offer eight reasons why the Board is "incapable of making an independent and disinterested decision to institute and vigorously prosecute this action." (Compl. at 38). Plaintiffs argue 1) that each of the individual Defendants "participated in, approved or recklessly disregarded the wrongs complained of in the complaint; 2) that Defendants Sidhu and Brady are not disinterested or independent because they are officers of the company, have personally engaged in the wrongful actions, have personally benefitted from such wrongful actions, and are named as defendants in the securities fraud class actions; 3) that Defendants Sidhu, Brady, Cash, Crandall, and Jordan approved and signed the allegedly false and misleading Annual Reports and so are not disinterested or independent; 4) that Defendants Sidhu, Brady, Cash, Crandall, and Jordan received but dismissed credible information regarding the violations of GAAP and abdicated their role in investigating those claims; 5) that the directors would be required to sue themselves and/or their fellow directors "who are their friends and with whom they have entangling alliances and interlocking business relationships, interests, and dependencies"; 6) that the directors have not taken any action to seek redress for the wrongdoing alleged in the Complaint, although they knew of it, that the Board approved filing a motion to dismiss the Scheiner class action, and that the Board is dominated and controlled by Sidhu and Brady; 7) that Defendants Sidhu and Brady have not offered to reimburse i2 for their bonuses and incentive-based compensation or to turn over their profits from the alleged insider trading; 8) that the Board's insurance coverage has an "insured vs. insured" exclusion clause, so the directors will not sue the officers or directors because then they would not be covered by their insurance. (Compl. at 38-41).
Defendants argue that Plaintiffs' assertions as to why demand is excused fall into four basic categories: 1) that the directors face potential liability on Plaintiffs' claims; 2) that the Board is dominated and controlled by Defendants Sidhu and Brady, who face potential liability; 3) that the Board has so far failed to take action by either filing suit against the wrongdoers, voluntarily returning the monies sought in the instant case, or by endorsing the filing of the motion to dismiss in the fraud class action; and 4) that the insurance clause precludes coverage if the directors filed against themselves or the officers. ( See Def. Cash, Crandall, and Jordan's Mot. at 8). The Court agrees with Defendants' characterization of Plaintiffs' arguments and will use these characterization in addressing 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, Plaintiffs assert that the outside Directors were interested because they faced potential liability on the wrongs Plaintiffs allege in the Complaint. However, Plaintiffs have alleged no particularized facts that raise their 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. This is not sufficient to conclude that the majority of the Board is interested.
2. Domination and Control of the Board
"To establish a lack of independence, [Plaintiffs] must show that the [outside] directors are `beholden' to [Sidhu and Brady] or so under their influence that their discretion would be sterilized." Rales, 634 A.2d at 936. Plaintiffs 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, Plaintiffs allege that Defendants Sidhu and Brady, insiders, dominate and control the Board such that the outside Directors are not independent. However, Plaintiffs offer nothing more than the bare assertion that the directors have "entangling alliances and interlocking business relationships, interests, and dependencies." (Compl. at 39). Plaintiffs allege no specific facts in support of this assertion, and therefore, 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 futile." Aronson, 473 A.2d at 817.
3. Board's Failure to Take Action
Plaintiffs also argue that demand is futile because the Board has not taken action to stop the allegedly wrongful action, nor has the Board taken action to seek recompense for the allegedly wrongful action. (Compl. at 40). This allegation is 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 excuse demand.
Plaintiffs also assert that demand is futile because Sidhu and Brady have not volunteered to reimburse i2 for their profits from the alleged insider trading and the Board has not sought reimbursement from them. (Compl. at 40-41). The inquiry for the Court remains whether such allegations create a reasonable doubt that the Board cannot act independently or disinterestedly. See Guttman v. Huang, 823 A.2d 492, 502 (Del.Ch. 2003). "[I]t is unwise to formulate a common law rule that makes a director `interested' whenever a derivative plaintiff cursorily alleges that he made sales of company stock in the market at a time when he possessed material, non-public information." Id. Plaintiffs here, however, have not even alleged that the outside Directors participated in the alleged insider trading. ( See Compl. at 40). The argument, therefore, must be that the outside Directors are not independent from Sidhu, the insider Director accused of insider trading. As discussed above, however, Plaintiffs have alleged no particularized facts to support their assertion that the Board lacked independence. Therefore, the mere allegation of insider trading by one insider Director is not sufficient to excuse demand on the entire Board.
4. "Insured vs. Insured" Exclusion Clause
Plaintiffs' final argument is that demand should be excused because i2's directors' and officers' liability insurance coverage contains an "insured vs. insured" exclusion clause, thus preventing the Board from suing itself because then they would lose their liability coverage. (Compl. at 41). Many courts have found the mere existence of this clause, without more, to be insufficient to excuse demand. See Matter of Prudential Ins. Co. Litigation, 659 A.2d 961, 973 (N.J. Super Ct. Ch. Div. 1995) (citing cases from the Delaware Court of Chancery, the Southern District of New York, and the Eleventh Circuit holding that the existence of an insured vs. insured exclusion clause is insufficient to excuse demand, explaining that it would eviscerate the demand requirement in almost all cases). The Court finds no reason to view Plaintiffs' argument as anything more than an argument that the Directors would be forced to sue themselves, and, as discussed above, this argument fails to excuse demand in the instant case.
III. CONCLUSION
The Court concludes that Plaintiffs have not created a reasonable doubt that the board is "capable of acting free from personal financial interest and improper extraneous influences," and have 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 Plaintiffs 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 Plaintiffs' Complaint is DISMISSED pursuant to Fed.R.Civ.P. 12(b)(6).
SO ORDERED.