Summary
In Felker, the district court applied the demand futility standard articulated in Werbowsky and found that demand was excused.
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Case No. 04-0372-CV-W-ODS.
February 11, 2005
ORDER (1) GRANTING DEFENDANTS' MOTION TO STAY ACTION, AND (2) DENYING DEFENDANTS' MOTION TO DISMISS
Pending are Defendants' Motion to Stay Action (Doc. # 21) and Defendants' Motion to Dismiss (Doc. # 33). For the following reasons, Defendants' Motion to Stay is granted, but Defendants' Motion to Dismiss is denied.
I. BACKGROUND
The above-captioned matter is a shareholder derivative action brought by Plaintiff Ken Felker for the benefit of Nominal Defendant NovaStar Financial, Inc. ("NovaStar") against Defendants W. Lance Anderson, Scott F. Hartman, Rodney E. Schwatken, Gregory T. Barmore, Art N. Burtscher and Edward W. Mehrer (officers or directors of NovaStar Financial, Inc.) for breaches of their fiduciary duties owed to NovaStar between October 29, 2003, and April 8, 2004. Defendants filed a Motion to Dismiss arguing that Plaintiff's derivative complaint should be dismissed (1) for failure to make a pre-suit demand or demonstrate demand futility, (2) because NovaStar's corporate charter and Maryland law preclude liability, and (3) because Plaintiff's allegations concerning duty to monitor cannot form the basis of a breach of care claim.
II. STANDARD
A motion to dismiss for failure to state a claim should be granted when it appears that "the plaintiff can prove no set of facts in support of his claim which would entitle him to relief."Davis v. Hall, 992 F.2d 151, 152 (8th Cir. 1993) (citingConley v. Gibson, 355 U.S. 41, 45-46 (1957)). In ruling on a motion to dismiss, the Court is required to view the facts alleged in the complaint in the light most favorable to the Plaintiff.
III. DISCUSSION
A. Demand Requirement
Before being allowed to proceed with a derivative action, "a shareholder must first make a good faith effort to have the corporation act directly and explain to the court why such an effort was not made or did not succeed." Werbowsky v. Collomb, 766 A.2d 123, 133 (Md. 2001). Plaintiff did not make a pre-suit demand; instead, he argues that the futility exception applies. The futility exception is "very limited" and shall only be applied in two instances: "(1) a demand, or dely in awaiting a response to a demand, would cause irreparable harm to the corporation, or (2) a majority of the directors are so personally and directly conflicted or committed to the decision in dispute that they cannot reasonably be expected to respond to a demand in good faith and within the ambit of the business judgment rule."Id. at 144.
It is undisputed that Maryland's law applies because NovaStar is incorporated there.
Rule 23.1 of the Federal Rules of Civil Procedure requires that a derivative action 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 reasons for the plaintiff's failure to obtain the action or for not making the effort." Fed.R.Civ.P. 23.1. In his Amended Complaint, Plaintiff claimed that a demand on the NovaStar Board of Directors would have been futile for the following reasons:
(a) A majority of the Directors of NovaStar, as detailed herein, participated in, approved and/or permitted the wrongs alleged herein to have occurred and participated in efforts to conceal or disguise those wrongs from NovaStar stockholders and investors and are, therefore, not disinterested parties and thus could not fairly and fully prosecute such a suit even if such suit was instituted by them;
(b) A majority of the Directors had a responsibility and obligation to assure that all press releases and filings of SEC reports, including all financial reports, were accurate and that all internal controls and other oversight procedures were in place that would have detected and prevented the false and misleading statements put out by the Company to the public that are further described in this Complaint;
(c) In order to bring this suit, a majority of the Directors of NovaStar would be forced to sue themselves and/or persons with whom they have extensive business and/or personal entanglements, which they will not do, thereby excusing demand;
(d) The acts complained of constitute violations of state law and the fiduciary duties owed to NovaStar's officers and directors and are incapable of ratification;
(e) The actions of the Directors has impaired the Board's ability to validly exercise its business judgment and rendered it incapable of reaching an independent decision as to whether to accept Plaintiff's demands;
(f) Defendants Hartman and Anderson are currently defendants in numerous securities class action lawsuits arising out of the wrongdoing alleged herein and a suit by them to remedy the wrongs alleged herein would likely expose them to liability in the securities class actions; thus they are hopelessly conflicted in making any supposedly independent determination as to whether to sue themselves and the other Defendant Directors;
(g) NovaStar has been and will continue to be exposed to significant losses due to the wrongdoing complained herein; yet, the Director Defendants have not filed any lawsuits against themselves or other who were responsible for that wrongful conduct, nor have they attempted to recover any part of the damages NovaStar suffered and will suffer thereby or any of the illegal profits received by the insider seller Defendants;
(h) If the Defendant Directors were to bring this derivative action against themselves, they would thereby expose their own negligence and misconduct which underlies allegations against the Company contained in the class action complaints for violations of federal securities laws. Such admissions would impair the Company's and their defense of the Class Actions and greatly increase the probability of their personal liability in the Class Actions in an amount likely to be in excess of any insurance coverage to the Director Defendants;
(i) The Director Defendants are believed to be covered by an insurance policy which covers the type of misconduct alleged herein, which policy would likely preclude coverage, if any, if the Director Defendants initiated action against any of the other Director Defendants named herein. Therefore, the NovaStar board, and any committee thereof, is effectively disabled from complying with any demand that would cause the Company to bring suit against the Defendants because to do so would result in the loss of their insurance coverage.
Pl.'s Am. Compl. ¶ 59.
The Maryland Court of Appeals has stated that it is not willing to excuse the failure to make a demand "simply because a majority of the directors approved or participated in some way in the challenged transaction or decision." Werbowsky, 766 at 143. In addition, generalized or speculative allegations that the directors are conflicted or controlled by conflicted persons would not excuse the failure to make a pre-suit demand. Id. Plaintiff does generally allege that Defendants approved or participated in the alleged wrongs; however, Plaintiff also particularly alleges, among other things, that Defendants permitted and/or approved of the dissemination of false or misleading press releases, they violated state law and the fiduciary duties owed to NovaStar, they have not sought to recover any part of the damages suffered by NovaStar, and they concealed information from the public. Thus, Plaintiff has met the particularity requirement of Rule 23.1 and has properly pled why a pre-suit demand would have been futile. Defendants' Motion to Dismiss is denied with regard to Plaintiff's failure to make a pre-suit demand or demonstrate demand futility. B. Corporate Charter
Second, Defendants argue that NovaStar's corporate charter and Maryland law preclude liability and, therefore, Plaintiff's Complaint should be dismissed. Specifically, NovaStar's charter states that "no director or officer of this Corporation shall be personally liable to the corporation or its stockholders for money damages." Maryland law permits a corporate charter to limit the liability of directors for money damages except when directors actually receive an improper benefit or engaged in active or deliberate dishonesty. Md. Code Ann. Cts. Jud. Proc. § 5-418.
Plaintiff alleges that most Defendants sold their stock at artificially inflated prices during the relevant period of time, reaping proceeds of at least $75,000 to more than $5 million, thereby receiving an improper benefit. Pl.'s Am. Compl. ¶¶ 45-49. Additionally, Plaintiff claims that Defendants acted dishonestly in concealing facts from the public concerning NovaStar's growth through branch office expansions and the actual existence of branch offices, and by overstating NovaStar's interest income and expense. Pl.'s Am. Compl. ¶¶ 3, 18, 25-30, 38-40. If these facts were proven, Plaintiff would be entitled to relief. Defendants' Motion to Dismiss is denied with regard to their argument that NovaStar's corporate charter and Maryland law preclude liability.
C. Duty to Monitor
Finally, Defendants argue that Plaintiff's allegations that Defendants failed to monitor the activities of NovaStar, thereby breaching their duty of care, should be dismissed. The applicable Maryland statute reads:
(a) A director shall perform his duties as a director, including his duties as a member of a committee of the board on which he serves:
(1) In good faith;
(2) In a manner he reasonably believes to be in the best interests of the corporation; and
(3) With the care that an ordinarily prudent person in a like position would use under similar circumstances.
(b) (1) In performing his duties, a director is entitled to rely on any information, opinion, report, or statement, including any financial statement or other financial data, prepared or presented by:
(i) An officer or employee of the corporation whom the director reasonably believes to be reliable and competent in the matters presented;
(ii) A lawyer, certified public accountant, or other person, as to a matter which the director reasonably believes to be within the person's professional or expert competence; or
(iii) A committee of the board on which the director does not serve, as to a matter within its designated authority, if the director reasonably believes the committee to merit confidence.
(2) A director is not acting in good faith if he has any knowledge concerning the matter in question which would cause such reliance to be unwarranted.
(c) A person who performs his duties in accordance with the standard provided in this section shall have the immunity from liability described under § 5-417 of the Courts and Judicial Proceedings Article.
Md. Code Ann. Corps. Ass'ns § 2-405.1.
Plaintiff has pled that Defendants actively participated in the wrongdoing and/or permitted such activity through gross negligence or willful inattention to the duties owed the corporation. Defendants were directly involved with the day-to-day operations of NovaStar and directly participated in its management. Pl.'s Am. Compl. ¶ 18. Plaintiff further alleged that Defendants "were involved in the drafting, producing reviewing, disseminating, approving, ratifying and/or recklessly permitting the dissemination of the false and misleading statements and information alleged herein." Pl.'s Am. Compl. ¶ 18. Additionally, Plaintiff claims that Defendants concealed information from the public and shareholders concerning NovaStar's growth. Pl.'s Am. Compl. ¶ 29. Reviewing these facts in the light most favorable to Plaintiff, the Court finds that if these facts were proven Plaintiff would be entitled to relief. Defendants' Motion to Dismiss is denied with regard to Plaintiff's concerning a duty to monitor.
IV. CONCLUSION
For the foregoing reasons, Defendants' Motion to Dismiss is denied. Without opposition from Plaintiff, Defendants' Motion to Stay is granted. The above-captioned matter is hereby stayed pending the resolution of the parallel class action (In re NovaStar Financial Securities Litigation, Case No. 04-0330-CV-ODS).IT IS SO ORDERED.