Opinion
X04HHDCV156057381S
12-11-2015
Longcap PNT, LLC, derivatively on behalf of Post-N-Track Corporation v. G. Allen DeGraw et al
UNPUBLISHED OPINION
MEMORANDUM OF DECISION RE DEFENDANTS' MOTIONS TO DISMISS (#115 and #117)
David M. Sheridan, J.
The defendants Post-N-Track Corporation (" PNT"), G. Allen DeGraw (" DeGraw") and Transactions Methods, Inc. (" TMI") have moved to dismiss the plaintiff's complaint based on subject matter jurisdiction. The defendants argue that the plaintiff LongCap PNT, LLC (" LongCap") lacks standing to pursue this action because it ceded control of this claim to PNT's Board of Directors, the Complaint fails to allege facts establishing plaintiff's standing with the particularity required under Delaware law, and the dismissal of this derivative lawsuit is in PNT's best interests.
I. FACTS
The parties have extensively briefed the factual background leading up to this derivative lawsuit and have provided extensive documentary support in the form of affidavits and exhibits. What follows is a brief overview of the facts and allegations relevant to the motions to dismiss.
Defendant PNT provides software and services related to the exchange of health care transactions and related information to entities in the health care field. Defendant DeGraw is the CEO of PNT. Defendant TMI is owned and controlled by defendant DeGraw, and provides clearinghouse services for processing provider submitted claims, which are then processed through various clearinghouses for transmittal to the correct payer. The plaintiff LongCap is a stockholder of PNT.
In April 2007, TMI interfered with negotiations and entered into an agreement with United Health Care which the plaintiff claims was usurpation of " a lucrative business opportunity for PNT." The plaintiff alleges that under the agreement TMI itself receives a portion of United Health Care fees, but the work performed to earn those fees is performed entirely by PNT. Thus, all of the revenue could and should be properly revenue of PNT, which would substantially increase the revenues and profits of PNT.
On October 7, 2014, the plaintiff demanded that the PNT board of directors take appropriate measures against the defendants McGraw and TMI to redress the expenditure of unnecessary funds in connection with this transaction, misappropriation of PNT's corporate opportunities by TMI, and wrongful allocation of expenses incurred by the PNT on behalf of TMI.
PNT's Board of Directors established a Special Investigative Committee (" SIC") to review the plaintiff's demand. The SIC undertook an independent investigation and determined that PNT exercised appropriate business judgment and that the pursuit of this lawsuit did not serve PNT's best interests. PNT's Board of Directors considered the SIC's Report and approved a resolution that accepted the SIC's Report and directed the board's Litigation Committee to cause PNT's counsel to pursue this motion to dismiss.
The plaintiff alleges that the SIC was subject to undue influence, exercised poor business judgment, and engaged in self-dealing. The plaintiff also alleges that SIC was not properly constituted, was not structured to ensure the exercise of good business judgment, and was not composed in a way that ensured objectivity and lack of influence. The plaintiff further alleges that the SIC declined to take appropriate steps to protect the interests of the shareholders, and failed to ascertain critical information needed to make an informed decision. The plaintiff's complaint asserts four causes of action: (a) breach of fiduciary duty against DeGraw; (b) aiding and abetting breach of fiduciary duty against TMI; (c) unjust enrichment against DeGraw and TMI; and (4) a violation of CUTPA against DeGraw
The defendant PNT filed a motion to dismiss challenging jurisdiction on the basis that the plaintiff failed to allege facts " with particularity" showing that the board's refusal of LongCap's demand was wrongful, as required by Delaware Chancery Court Rule 23.1, which controls here pursuant to section 33-727 of the Connecticut General Statutes. The defendants DeGraw and TMI filed a motion to dismiss asserting that the plaintiff is an inadequate shareholder representative under Delaware law because its interests are contrary to those of PNT's other shareholders. All defendants have adopted the others' arguments in support of the respective motions to dismiss. The issues were fully briefed and the parties were heard at argument on August 31, 2015.
II. CONTROLLING LAW
A. Motions to Dismiss--Generally
A motion to dismiss is the proper means to raise the issue of subject matter jurisdiction. Practice Book § 10-31(a). " A motion to dismiss . . . properly attacks the jurisdiction of the court, essentially asserting that the plaintiff cannot as a matter of law and fact state a cause of action that should be heard by the court." (Internal quotation marks omitted.) Cox v. Aiken, 278 Conn. 204, 210-11, 897 A.2d 71 (2006).
" The issue of standing implicates [the] court's subject matter jurisdiction . . . Standing is the legal right to set judicial machinery in motion. One cannot rightfully invoke the jurisdiction of the court unless he [or she] has, in an individual or representative capacity, some real interest in the cause of action, or a legal or equitable right, title or interest in the subject matter of the controversy . . . When standing is put in issue, the question is whether the person whose standing is challenged is a proper party to request an adjudication of the issue . . ." Manning v. Feltman, 149 Conn.App. 224, 231, 91 A.3d 466, 471 (2014). " If a party is found to lack standing, the court is without subject matter jurisdiction to determine the cause." Handsome, Inc. v. Planning & Zoning Comm'n of Town of Monroe, 317 Conn. 515, 550, 119 A.3d 541 (2015).
In determining a motion to dismiss, as a general rule, the court must take the facts to be those as alleged in the complaint, including those facts necessarily implied from the allegations, and construed in a manner most favorable to the plaintiff. Cuozzo v. Town of Orange, 315 Conn. 606, 615, 109 A.3d 903 (2015). Where a motion to dismiss is accompanied by supporting affidavits, the court may look to those and not conclusively presume the validity of the complaint's allegations, and a hearing on disputed factual issues may be required. Dorry v. Garden, 313 Conn. 516, 523, 98 A.3d 55 (2014); Practice Book § 10-31(a).
B. Choice of Law
General Statutes § 33-727 provides: " In any derivative proceeding in the right of a foreign corporation, the matters covered by [sections 33-720 to 33-727, dealing with derivative actions brought in Connecticut, ] shall be governed by the laws of the jurisdiction of incorporation of the foreign corporation . . ." In accordance with § 33-727, the court will apply Delaware law to the present derivative action, as PNT was incorporated in that state.
III. ANALYSIS
A. Court of Chancery Rule 23.1.
Under Court of Chancery Rule 23.1, a shareholder seeking to pursue a derivative claim on behalf of a corporation must allege with particularity either (1) the efforts made to obtain the action the plaintiff desires from the directors, and the reasons for the plaintiff's failure to obtain the action, or (2) the reasons why such efforts would be futile and should be excused. Where a plaintiff fails to plead with particularity that demand was not made because it would be futile, or that demand was properly made and wrongfully was refused, the complaint will be dismissed. Haber v. Bell, 465 A.2d 353, 357, 360 (Del.Ch. 1983).
Court of Chancery Rule 23.1(a) provides " In a derivative action brought by one or more shareholders or members to enforce a right of a corporation or of an unincorporated association, the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall allege that the plaintiff was a shareholder or member at the time of the transaction of which the plaintiff complains or that the plaintiff's share or membership thereafter devolved on the plaintiff by operation of law. The 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 the reasons for the plaintiff's failure to obtain the action or for not making the effort."
Rule 23.1 is not satisfied by conclusory statements or mere notice pleading . . . On the other hand, the pleader is not required to plead evidence. What the pleader must set forth are particularized factual statements that are essential to the claim.Brehm v. Eisner, 746 A.2d 244, 254-55 (Del. 2000).
The requirement of a demand for board action on a derivative claim is a recognition of the fundamental premise of Delaware corporate law: the business and affairs of a corporation are managed by or under the direction of its board of directors. 8 Del.C. § 141(a). In most cases, it is the board of directors who is empowered to decide whether a claim should be brought on behalf of the corporation. Lambrecht v. O'Neal, 3 A.3d 277, 282 (Del. 2010). The demand serves as notice to the board of directors, allowing the board to review the facts and make a determination in its business judgment whether or not the corporation should take remedial action. See Schick, Inc. v. Amalgamated Clothing & Textile Workers Union, 533 A.2d 1235, 1240 (Del.Ch. 1987).
B. The Business Judgment Rule
With regard to that decision, a presumption exists--known as the " business judgment rule" --that " in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled in part on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). " When a stockholder's derivative suit . . . challenges the propriety of a decision of the directors, the business judgment rule protects the directors from liability by a presumption that the decision is proper . . . In order to overcome this presumption and successfully assail the directors' decision, the derivative plaintiff must first show facts which, if true, would remove the directors' decision from the protection of the rule, such as self-dealing, lack of good faith, failure to exercise due care, or the like." (Citation omitted.) Maldonado v. Flynn, 413 A.2d 1251, 1255 (Del. 1980), rev'd on other grounds, Zapata v Maldonado, 430 A.2d 779 (Del. 1981).
In examining the board's decision to refuse a demand to assert a claim, the court is limited to an analysis of the board's good faith and the reasonableness of the board's investigation of the demand. See Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990); Levine v. Smith, 591 A.2d 194, 206 (Del. 1991), overruled in part on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
Upon receipt of a demand, a board must determine the best method to inform itself of the facts relating to the alleged wrongdoing and " the considerations, both legal and financial, bearing on a response to the demand." Rales v. Blasband, 634 A.2d 927, 935 (1993). Any factual investigation the board decides to undertake must be conducted in good faith. And while a board has the inherent authority to delegate its investigatory duties, the delegation itself is judged by a standard of reasonableness, and considered in the context of the business judgment rule. See Stepak v. Addison, 20 F.3d 398, 405 (11th Cir. 1994) (" When a board chooses to delegate its investigatory duties, it must do so reasonably").
After an impartial, reasonable and good faith investigation, the board must then weigh the alternatives available to it, " including the advisability of implementing internal corrective action and commencing legal proceedings." Rales v. Blasband, supra, 634 A.2d at 935. If a board refuses a stockholder demand, a stockholder has the right to pursue the claims at issue in the demand only if the stockholder can allege with particularity sufficient facts to create a reasonable doubt about the good faith and reasonableness of the board's investigation. Levine v. Smith, supra, 591 A.2d at 212; Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990); Gatz v. Ponsoldt , 2004 WL 3029868, at *5 (Del.Ch. Nov. 5, 2004).
In order to survive a motion to dismiss under Rule 23.1 in the demand-refused context, a plaintiff must point to a pleading of particularized facts which, taken as true, raise a reasonable doubt that the refusal was a valid exercise of business judgment. Where the plaintiff has made a demand, and thus conceded that he has no basis to contest the independence of a majority of the board, the only issue subject to challenge is the good faith and reasonableness of the board's investigation of its demand. Where a plaintiff has pled particularized facts which, taken as true, create a reasonable doubt that the board's investigation complied with its duty of loyalty--that is, was undertaken in good faith--or with its duty of care--that is, was not grossly negligent--he has rebutted the business judgment rule with respect to the board's refusal of his demand, and may proceed with the litigation; otherwise, under Rule 23.1, the derivative litigation must be dismissed.Ironworkers Dist. Council of Philadelphia & Vicinity Ret. & Pension Plan v. Andreotti, No. CV 9714-VCG, 2015 WL 2270673, at *25 (Del.Ch. May 8, 2015).
To show that the board's decision to reject the demand breached its duty of care, the plaintiff must allege facts showing that the SIC's investigation was grossly negligent, meaning that the SIC or the board acted with reckless indifference or engaged in conduct outside the bounds of reason. McPadden v. Sidhu, 964 A.2d 1262, 1274 (Del.Ch. 2008); Mt. Moriah Cemetery v. Moritz , 1991 WL 50149, at *4 (Del.Ch. Dec. 10, 1990). The Delaware Chancery Court has held that a stockholder's criticisms regarding the types of documents reviewed or the persons interviewed in connection with an investigation do not rise to the level of gross negligence, because those choices are ones on which reasonable minds may differ. Id., see also, Gatz v. Ponsoldt , 2004 WL 3029868, at *5 (Del.Ch. Nov. 5, 2004).
To show that the board's decision to reject the demand breached its duty of loyalty to the corporation, the plaintiff must allege facts showing that either the investigation or the decision based on that investigation was affected by duplicity or improper motive--such as a personal interest in the disputed transactions--or with indifference to the harm that will necessarily result to the corporation's best interest from the challenged decision. See, e.g., Sutherland v. Sutherland, 958 A.2d 235, 239 (Del.Ch. 2008); In re Goldman Sachs Grp., Inc. S'holder Litig. , 2011 WL 4826104, at *20 (Del.Ch. Oct. 12, 2011). In re Novell, Inc. S'holder Litig , 2014 WL 6686785, at *7 (Del.Ch. Nov. 25, 2014) (" An analysis of motives is also key to determining whether a fiduciary acted in bad faith . . . The analysis here centers on whether the Board acted upon some other motive than of advancing the corporation's best interests").
C. The Plaintiff's Facts in Support of Its Claim that the Board's Refusal of its Demand was Not a Valid Exercise of Business Judgment
The plaintiff alleges in paragraph 8 and 9 of its complaint that the SIC formed by the board: 1) was not adequately composed nor structured to ensure the exercise of good business judgment, objectivity and lack of influence by DeGraw; and 2) did not " ascertain critical information to be able to make an informed and well-reasoned business judgment." These conclusory allegations are insufficient to satisfy Rule 23.1 Specific recitations of fact are required. See Maldonado v. Flynn, supra, 1255 (Del. 1980).
In the context of this motion to dismiss and in order to meet its burden of showing that the board do not conduct a reasonable investigation, the plaintiff must bring forth facts showing that the SIC's investigation was grossly negligent, meaning that the SIC or the board acted with reckless indifference or engaged in conduct outside the bounds of reason. However, nothing offered by the plaintiff creates sufficient doubt about the reasonableness of the board's investigation. By contrast, the evidence proffered by the defendants demonstrates that the SIC reasonably investigated the various legal, financial, and practical considerations behind the Board's action, and rendered a thorough and comprehensive report detailing the results of its inquiry and conclusions drawn therefrom.
For example, it was logical for the SIC to conclude that by proceeding as it did, PNT maintained a relationship with its providers, including United Healthcare and preserved the revenues stream from CIGNA, its major customer, all at a time when the company was trying to achieve a " cash flow positive" bottom line. (See SIC Report, p. 8.) There was also a sound factual basis to justify the SIC's conclusion that the 50/50 revenue split in the PNT-TMI Shared Service Agreement was a reasonable arrangement, given PNT's experience with other subcontractors and the fact that alternative models, such as an 80/20 revenue split in favor of PNT would only have provided an insignificant incremental increase in revenue. (See SIC Report, p. 9.) The plaintiff has offered no reason to question these justifications as contrived or specious.
In a similar fashion, in order to meet its burden of showing that the board did not conduct its investigation in good faith, the plaintiff must bring forth facts showing that the SIC was not independent and impartial. The evidence proffered by the defendants (and not disputed by the plaintiff) established that the SIC sufficiently established independence and impartiality: Ms. Skinner was disinterested in the transactions at issue, had no material interest in PNT, lacked any connection to Defendant DeGraw, and had no stake in the outcome of the investigation. Nothing in the SIC's thorough and comprehensive investigation indicates self-interest, bias, arbitrariness or bad faith. The plaintiff has not brought forth any facts which create reasonable doubt as to whether the investigation was conducted in good faith.
Nonetheless, despite the lack of countervailing evidence to inform the court's analysis of the board's good faith and the reasonableness of the board's investigation of the demand, the plaintiff urges the court to use its discretion to conclude that the requisites of Rule 23.1 have been satisfied, since the plaintiff in this instance has alleged self-dealing and potential self-interest or bias on the part of the SIC, citing Thorpe v. CERBCO, Inc., 17 Del. J. Corp. L. 1284, 611 A.2d 5 (Del. Ct. of Chancery 1991), affirmed in part and reversed in part, Thorpe v. CERBCO, Inc., 676 A.2d 436 (1996).
The difficulty with this argument is that nothing in Thorpe can be seen to establish as a general proposition that allegations of self-interest and bias--unsupported by any particularized facts--would allow the court, in its discretion, to find that the requirements of Rule 23.1 have been satisfied. In Thorpe, unlike here, the peculiar circumstances surrounding the board action in that case led to little if any evidence being available to the plaintiff to support allegations that the special investigating committee acted on self-interest or bias. The facts of Thorpe are unique, and do not preclude the application of Rule 23.1 in cases such as the one presented here.
For the reasons stated, the court finds that the plaintiff has failed to satisfy its burden of showing that the PNT board's decision to reject the LongCap demand was not based upon a reasonable investigation or was not made in good faith. The actions of PNT, its board and the SIC are entitled to the protections of the business judgment rule as established by Delaware law. The defendant's motion to dismiss is therefore granted on that basis.
Having determined that the complaint should be dismissed because the plaintiff has not established with the required particularity its standing to commence and maintain this suit on behalf of the corporation, the court need not reach the defendants' alternate ground for dismissal, i.e. that the plaintiff is an inadequate shareholder representative under Delaware law because its interests are contrary to those of PNT's other shareholders.
IV. CONCLUSION
For the reasons stated, the action is dismissed.