Summary
finding ancillary jurisdiction of the federal court exists over state law claims brought by a court-appointed receiver
Summary of this case from U.S. Sec. & Exch. Comm'n v. HaabOpinion
Case No. 1:03-cv-01165-DFH-VSS.
September 30, 2004
ENTRY ON DEFENDANTS' MOTIONS TO DISMISS
In the case of Securities and Exchange Commission v. Church Extension of the Church of God, Inc., No. 1:02-cv-1118, this court appointed plaintiff Jeff J. Marwil conservator and receiver for Church Extension of the Church of God, Inc. ("CEG") and United Management Services, Inc. ("UMS"). CEG is a financial arm of the Church of God, headquartered in Anderson, Indiana. UMS is a subsidiary of CEG that managed real estate and businesses for CEG. The SEC alleged in its civil enforcement action that CEG was insolvent and had raised millions of dollars unlawfully by making false statements to prospective purchasers of investment notes, the vast majority of which were sold to members of the Church of God.
Acting as conservator and receiver, plaintiff Marwil has sued defendants James Perry Grubbs and Shearon Louis Jackson, former presidents of CEG and UMS respectively, as well as former CEG directors Shirley B. Cathie, Michael D. Curry, Mary Jean Daniels, Fred Davey, John R. Davis, Derrol Dawkins, Carolyn Gallender, Hector G. Gonzalez, Brian G. Krushel, Gregory D. Kendall, Alvin R. Oldham, Catarina Perez-Scrivner, Terry S. Pol, Doyle D. Rahjes, Richard W. Shockey, Isadore Small III, Paul VanNorman, Linda Wilbraham, Kenneth C. Wilson, and Gail Zimmerman. Marwil alleges that the defendants breached their fiduciary duties to CEG under Indiana state law.
To the extent plaintiff Marwil is attempting to assert a claim on behalf of noteholders, that claim is dismissed. For reasons set forth in this court's decision in a related case, Marwil does not have standing to assert claims on behalf of individual noteholders but may do so on behalf of the receivership entity, CEG. Marwil v. Farah, 2003 WL 23095657 (S.D. Ind. Dec. 11, 2003).
The claims here arise from CEG's sales of approximately $85 million in investment notes to church members over several years. CEG has not been able to make timely interest payments to investors as required by the notes. CEG and UMS reached a settlement with the SEC when the SEC filed its action in July 2002. Pursuant to that settlement, and under supervision by this court and Marwil, CEG has undertaken a plan to liquidate its assets to meet as many obligations to creditors as possible, including its obligations to the noteholders. The present case is a part of those efforts.
The defendants have filed motions to dismiss the Complaint under both Federal Rule of Civil Procedure 12(b)(1) for lack of subject matter jurisdiction and Rule 12(b)(6) for failure to state a claim upon which relief can be granted. For the reasons explained below, defendants' motions are denied.
The Applicable Standards — Rules 12(b)(1) and 12(b)(6)
Plaintiff Marwill invokes federal subject matter jurisdiction based on his appointment by this court as receiver for CEG and UMS, and on the SEC civil enforcement action. Defendants challenge jurisdiction claiming that Marwil lacks standing, and that the SEC action is not a valid basis for supplemental jurisdiction over the state law claims at issue. Defendants have limited their motions to dismiss to the pleadings, without offering any evidentiary material beyond the court's own files. Where a motion to dismiss under 12(b)(1) is based solely on the pleadings, a district court must accept as true all material allegations of the complaint, drawing all reasonable inferences in the plaintiff's favor. Lee v. City of Chicago, 330 F.3d 456, 468 (7th Cir. 2003), citing Retired Chicago Police Association v. City of Chicago, 76 F.3d 856, 862 (7th Cir. 1996). Plaintiff Marwil, as the party invoking federal jurisdiction, bears the burden of establishing the required elements of standing. Lee v. City of Chicago, 330 F.3d at 468, citing Lujan v. Defenders of Wildlife, 504 U.S. 555, 561 (1992).
In ruling on a motion to dismiss under Rule 12(b)(6) for failure to state a claim upon which relief can be granted, the court must assume as true all well-pleaded facts set forth in the complaint, construing the allegations liberally and drawing all inferences in light most favorable to the plaintiff. Forseth v. Village of Sussex, 199 F.3d 363, 368 (7th Cir. 2000). Under the liberal notice pleading standard in federal civil actions, the plaintiff is entitled to the benefit not only of his allegations but of any other facts he might assert that are not inconsistent with his allegations. Thus, in responding to a motion for judgment on the pleadings, a plaintiff may posit facts in his brief and, so long as they are not inconsistent with his complaint, the court must assume they are true for purposes of deciding the motion. See, e.g., Trevino v. Union Pacific Railroad Co., 916 F.2d 1230, 1239 (7th Cir. 1990) (reversing dismissal). In fact, a plaintiff whose case has been dismissed can even include new facts in his appellate brief that show dismissal was not warranted. Chavez v. Illinois State Police, 251 F.3d 612, 650 (7th Cir. 2001); see also Thomas v. Guardsmark, Inc., ___ F.3d ___, 2004 WL 1908357, 2 (7th Cir. Aug. 27, 2004) (in opposing motion to dismiss, plaintiff could submit non-evidentiary materials to illustrate a set of facts consistent with the allegations in the complaint). Defendants are entitled to dismissal only where "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Chaney v. Suburban Bus Division, 52 F.3d 623, 626-27 (7th Cir. 1995). Nevertheless, a plaintiff may still plead himself out of court if the complaint includes particulars that show he cannot possibly be entitled to the relief he seeks. Warzon v. Drew, 60 F.3d 1234, 1239 (7th Cir. 1995), citing Thomas v. Farley, 31 F.3d 557, 558-59 (7th Cir. 1994).
The Complaint's Allegations
For the purpose of deciding these motions, the court accepts the following allegations contained in the Complaint as true. CEG is an Indiana not-for-profit corporation established to raise funds for the Church of God, a church with over 2,000 affiliated congregations and over 230,000 members nationwide. CEG was established in the 1920s to help the Church of God extend its mission and its congregations by, for example, lending money to local congregations to build and renovate churches. From 1996 to April 2002, CEG raised millions of dollars by selling investment notes, mostly to church members. The notes were sold in connection with Offering Circulars containing detailed information about CEG and its finances and operations. CEG represented to investors that the funds from these notes would be used primarily to make interest-bearing loans to local churches. In 2002, CEG owed approximately $85 million to note holders.
Marwil alleges that instead of making loans to churches, the majority of the note proceeds were used to pay debts owed to prior CEG investors and to fund disastrous "bargain sale" transactions. Bargain sale transactions can be a lawful and prudent mechanism allowing a charitable organization to recognize income from non-cash contributions. In a typical and legitimate bargain sale, a seller sells property to the charitable organization for less than full value. For accounting purposes, the charity records the difference between the sale price and market value as income. The seller, in turn, can treat the difference between the market value and sale price as a charitable contribution for income tax purposes. The determination of market value is obviously critical to the tax and accounting legitimacy of the transaction.
Marwil alleges that defendants engaged in a series of high-risk bargain sale transactions from 1996 through early 2002 using inflated appraisals and other devices to exaggerate the value of the properties acquired. He alleges that those transactions resulted in CEG recognizing more than $24 million in phantom income during those years. This phantom income, according to Marwil, allowed CEG to claim that it was solvent when it was insolvent, and therefore to deceive prospective investors into buying still more notes. In reality, CEG was experiencing substantial losses, and most of its reported income was the artifical product of the bargain sale transactions.
In a jury trial in the SEC enforcement action in July 2004, a jury found both Grubbs and Jackson liable for fraud and negligence under federal securities laws arising from the same course of events at issue in this case. Post-verdict motions remain pending in that action, and the court has not yet entered final judgment in that case.
The Complaint alleges that these bargain sale transactions were negotiated and authorized by defendant Grubbs, president of CEG, and defendant Jackson, president of UMS, a CEG-controlled corporation responsible for managing CEG's subsidiary corporations and real estate holdings. The Complaint alleges that the director defendants also approved these transactions.
In July 2002, the SEC filed its civil enforcement action under federal securities laws against CEG, UMS, Grubbs and Jackson. On July 31, 2002, this court appointed Marwil to serve as conservator of CEG and UMS. The court approved an order agreed upon by the SEC, CEG and UMS (though not by Grubbs and Jackson). The court ordered Marwil to try to "ensure that the Investors are made whole with respect to the funds they invested with Defendant Church Extension." Final Judgment and Order of Permanent Injunction and Other Equitable Relief, at 4 ("Final Judgment Order"). In a later order issued January 31, 2003, the court approved the note holder repayment plan and, citing 28 U.S.C. §§ 754, 959, and 1651, Federal Rule of Civil Procedure 66, Local Rule 66.1, and the court's inherent powers, granted Marwil powers of receivership. See Order (A) Approving Plan For Noteholder Repayment by CEG and UMS, and (B) Granting Related Relief ("Plan Order"). On August 12, 2003, acting as conservator and receiver for CEG, Marwil brought the present action.
The detailed complaint alleges that the officers (Grubbs and Jackson) and the directors breached their fiduciary duties to CEG by recklessly undertaking and approving bargain sale transactions, and by continuing to issue notes that CEG could not reasonably expect to repay. The complaint alleges that the defendants knew that CEG's reserves were perilously low, that the transactions offered no hope of significant cash flow or profits, and that the transactions would further diminish CEG's ability to pay its creditors, ultimately resulting in CEG's insolvency and liquidation.
Discussion
I. Subject Matter JurisdictionA. Standing
1. Marwil as Receiver
Defendants all argue that Marwil lacks standing because he was not actually appointed a receiver by this court and that even if he was, CEG was not truly in receivership. The court disagrees on both points.
On July 31, 2002, this court granted the SEC's motion for permanent injunction and other equitable relief, which included appointing Marwil as conservator. The court stated as follows in its Final Judgment Order:
It is further ordered, adjudged, and decreed that, by consent of Plaintiff [SEC] and Defendants Church Extension and United Management, Jeff J. Marwil, of the law firm of Jenner Block, is hereby appointed by this Court to serve as Conservator. The Conservator's mandate is to protect the interests of the approximate[ly] 7,000 investors who invested and/or reinvested in Defendant Church Extension's investment note program from in or about 1996 through at least April 2002 ("Investors"). To the extent possible, the Conservator shall ensure that the Investors are made whole with respect to the funds they invested with Defendant Church Extension.
Final Judgment Order at 4. At that time, the court did not authorize Marwil to bring lawsuits on behalf of CEG or UMS. However, in the Plan Order dated January 31, 2003, the court approved a plan agreed upon among the SEC, CEG, and UMS, and further authorized as follows:
To enable the Conservator to institute and prosecute Causes of Action not asserted by CEG . . . and/or defend actions at law or equity in the courts of the United States and any state thereof arising out of or relating to Causes of Action, and to assist the Conservator in carrying out his mandate set forth in Section V of this Court's [Final Judgment Order], the Court, pursuant to 28 U.S.C. §§ 754, 959, and 1651, Federal Rule of Civil Procedure 66, Southern District of Indiana Local Civil Rule 66.1, and this Court's inherent powers, hereby CONFERS upon the Conservator powers of receivership for the purposes set forth in this paragraph. For such purposes, the Conservator may refer to himself, as appropriate, as the "Receiver of CE and UMS."
Plan Order at 2.
The attached Plan for Noteholder Repayment agreed to by the SEC, CEG, and UMS described the Conservator's powers as follows:
The Conservator, however, does not presently have all of the statutory and common law powers of a federal equity receiver, including the clearly defined authority to institute legal proceedings on behalf of CEG and/or the Investors. To fully carry out his mandate of protecting the interests of the Investors and ultimately making them whole, it may become necessary for the Conservator to institute and prosecute Causes of Action. . . . Accordingly, to enable the Conservator to institute and prosecute Causes of Action not asserted by CEG, to assert Causes of Action on behalf of Noteholders and other Claimholders, and/or defend actions at law or equity in the courts of the United States arising out of or relating to Causes of Action, and to assist the Conservator in carrying out his mandate . . . the Conservator shall have the powers of receivership for the purpose of instituting and prosecuting Causes of Action.
Plan at 10-11.
The language from the Final Judgment Order, Plan Order and Plan shows that the settling parties to the SEC action and the court intended that Marwil have many of the powers of a receiver for CEG and UMS. It also shows that, with the consent of CEG and UMS, the court gave Marwil power to institute lawsuits on behalf of CEG and UMS.
Defendants contend that neither state nor federal law recognizes the type of receiver status granted by this court. They argue essentially that because the court did not grant Marwil all the powers a court might grant a receiver, he is not authorized to exercise the more limited powers that the court intended to give him with the consent of CEG and UMS. This all-or-nothing argument is not persuasive. The terms of Marwil's appointment reflect a compromise among the interested parties to accommodate the unusual character of CEG and UMS and the vital role they play (or should play) in the affairs of the Church of God. While seeking to maximize the liquidation value of the insolvent CEG, the parties and the court intended also to preserve some goodwill between the Church of God and CEG and church members. The hope has been that church members would continue to financially support the expansion of the church through the new entity, now known as Church Builders Plus, set up under the court's Plan Order.
Defendants also argue that since CEG has not been dissolved, it cannot be in receivership. This argument is contrary to Indiana law. See Hasselman v. Japanese Development Co., 27 N.E. 318, 320 (Ind.App. 1891) ("An insolvent corporation in the hands of a trustee or receiver, maintains its existence . . . as far as may be necessary to fully wind up its affairs."). Marwil is therefore receiver for CEG and UMS, the receivership entities and has authority from the court and from the CEG board to pursue the claim against these defendants.
2. Marwil is suing on behalf of the receivership entities
A second prong of the officer defendants' standing argument is that even if Marwil is a receiver, he is a receiver for CEG, thus any standing he has is limited solely to claims that belong to CEG. They contend that Marwil is attempting to assert claims that rightfully belong to the noteholders. Specifically, they argue that CEG did not suffer a loss and actually benefitted from monies received from the noteholders, so there is no harm to CEG to support a claim. The argument misses the point. The essence of plaintiff's claims is that CEG was in no position to undertake the several bargain sale transactions authorized by the officer defendants and ratified by the director defendants. And contrary to the stated purpose of the investment notes, Marwil alleges, CEG improperly used the proceeds from investment notes to repay earlier investors rather than to fund new church loans. As a result of these actions, CEG has been ordered to liquidate its assets and will be forced to dissolve upon completion of the repayment plan to investors. Marwil alleges that the defendants undertook reckless transactions that created the illusion of solvency and effectively enabled CEG and UMS to descend even deeper into insolvency to proceed unchecked. These allegations are sufficient to support a claim that CEG itself was injured by defendants' activities. See Scholes v. Lehmann, 56 F.3d 750, 754 (7th Cir. 1995); Schacht v. Brown, 711 F.2d 1343, 1347-48 (7th Cir. 1983) (conduct that exacerbates corporations insolvency and artificially prolongs its life may harm corporation and be actionable on behalf of corporation). Corporations are distinct legal entities with rights of their own; a receiver suing on behalf of a corporation is asserting those rights. Marwil has properly asserted claims that the defendants caused harm to the receivership entities. For all of the foregoing reasons, Marwill has standing in this action.
The difficulties are in the details. Paragraph 25 of the Complaint states that the court has "ancillary jurisdiction over third-party actions brought by the Receiver on behalf of creditors of the receivership." (emphasis added). That statement recognizes practical realities: any recovery in this action would benefit the creditors of the insolvent entities. Nevertheless, Marwil is suing as receiver for alleged breaches of duties owed to CEG and UMS, the receivership entities. Notwithstanding the practical realities, he is not suing as a legal representative of creditors. Additionally, the language of the Plan and Plan Order appears to grant Marwil power to act on behalf of noteholders. However, as explained, the language in the agreed Plan and Plan Order, both negotiated among counsel in the SEC action, contemplates that creditors are entitled to benefit from any action that Marwil may bring as receiver on behalf of CEG and UMS. Indeed, such a benefit was expected by the parties. For the reasons explained by this court in Marwil v. Farah, 2003 WL 23095657, 5-6 (S.D. Ind. Dec. 11, 2003), neither the court nor the parties by agreement could confer on Marwil the power to assert causes of action belonging directly to the noteholders. The court is today issuing orders to amend the Plan to comply with the terms of the court's order in Marwil v. Farah.
B. Supplemental Jurisdiction
The defendants argue that this court does not have subject matter jurisdiction over the state law claims asserted in the Complaint because the claims do not arise under federal law and diversity of citizenship is not complete. Marwil relies on 28 U.S.C. § 1367, which authorizes supplemental jurisdiction over claims where original jurisdiction exists in federal court and the state law issues are so related to the original action that they actually "form part of the same case or controversy" as the original action.
Marwil correctly relies on Tcherepnin v. Franz, 485 F.2d 1251 (7th Cir. 1973), to support jurisdiction in this case. Tcherepnin was a case arising under the federal securities laws. In the underlying action, shareholders and depositors of a savings and loan association sued in federal court for allegedly fraudulent solicitations of deposits and investments. The district court ultimately appointed receivers and instructed them "that all claims of the Association were to be litigated in this court as ancillary to the case in chief." Tcherepnin v. Franz, 316 F. Supp. 714, 716 (N.D. Ill. 1970). Acting on behalf of the savings and loan association, the receivers subsequently filed state law claims in the district court, including breach of fiduciary duty claims, against officers and employees of the savings and loan association. The defendants challenged the district court's subject matter jurisdiction over those claims. The Seventh Circuit upheld the district court's ancillary jurisdiction over the state law claims based on its jurisdiction over the original action in federal court that resulted in the appointment of a receiver. The Seventh Circuit explained: "The ancillary jurisdiction of federal courts over actions incident to a receivership established by a federal court has long been recognized. So long as an action commenced by a court appointed receiver seeks `to accomplish the ends sought and directed by the suit in which the appointment was made, such action or suit is regarded as ancillary so far as the jurisdiction of the . . . court of the United States is concerned.'" 485 F.2d at 1255-56, quoting Pope v. Louisville, New Albany Chicago Railroad Co., 173 U.S. 573, 577 (1899) (internal citations omitted).
This action falls squarely within the reasoning of Tcherepnin. Marwil's appointment was made under the express mandate to "protect the interests of the . . . investors who invested in Defendant Church Extension's investment note program [and to] ensure that the Investors are made whole with respect to the funds they invested." Final Judgment Order at 4. The present action, though brought on behalf of CEG, aims in part toward eventual distribution of recovered funds to CEG's creditors, including the noteholders. It therefore unquestionably "seeks to accomplish the ends sought and directed by the suit in which the appointment was made."
Moreover, the court's exercise of jurisdiction here is authorized by 28 U.S.C. § 1367, which codified older practices and doctrines of ancillary jurisdiction. The action resulting in Marwil's appointment as receiver was brought by the SEC against CEG, UMS, and defendants Grubbs and Jackson in federal court under federal law. This court has original jurisdiction over that action under 28 U.S.C. §§ 1331, 1337, and 1345. The claims Marwil is asserting against these defendants are in substance cross-claims (against co-defendants Grubbs and Jackson) and third-party claims (against the former directors) supplemental to the SEC action. When the underlying action arises under federal law, such claims are within the district court's supplemental jurisdiction without regard to the citizenship of the parties so long as such claims are "so related to claims in the action within such original jurisdiction that they form part of the same case or controversy under Article III of the United States Constitution." 28 U.S.C. § 1367(a). These claims plainly are part of the of same case or controversy as the underlying SEC action. Marwil's claims against the former officers and directors are based on precisely the same course of conduct and the same transactions that were the basis for the SEC action. The SEC action is still on this court's active docket; the court continues to supervise the conservatorship and receivership; and judgment has not yet been entered on the SEC claims against defendants Grubbs and Jackson. Notwithstanding their differing docket numbers, the present action and the SEC action are properly deemed the same case under Article III, and the court sees no reason they should not be consolidated under Rule 42(a) of the Federal Rules of Civil Procedure. If any parties in either action object to such consolidation, they shall file a written objection no later than October 18, 2004. (A copy of this entry shall be docketed in the SEC enforcement action.)
For the foregoing reasons, the court finds that it has subject matter jurisdiction over this action, and defendants' motions to dismiss for lack of subject matter jurisdiction are denied.
II. Rule 12(b)(6) — Fiduciary Duty
All of the defendants argue that plaintiff has failed to plead a claim of breach of fiduciary duty upon which relief could be granted. The arguments do not warrant dismissal under Rule 12(b)(6).
A. Breach of Fiduciary Duty
First, the officer defendants contend that the Complaint should be dismissed because it does not allege "self-dealing, usurpation of a corporate opportunity or any other recognized category of breach of fiduciary duty." Off. Def. Br. at 9. Rule 8(a) of the Federal Rules of Civil Procedure requires a short and plain statement of the claim. The claim in this case is for breach of fiduciary duty, and the claim is laid bare for defendants to see in the Complaint. Self-dealing and usurpation — commonly regarded as violations of the duty of loyalty — do not define the entire universe of fiduciary breach any more than loyalty defines the universe of fiduciary duty. There was no need for the plaintiff to allege theories that he had no intention of pursuing. Plaintiff alleges that the defendant officers knew or should have known that the property appraisals for the bargain sale transactions were unreasonably high, that CEG could not afford to issue more notes to investors or to pay existing investors, and that continuing to issue notes would hurt the company. These allegations are sufficient at the Rule 12(b)(6) state to state a claim for breach of the officers' fiduciary duty of care.
The officer defendants also assert that the Complaint fails because it "obliterates" the distinction between the duties of corporate officers and those of directors. The point is not persuasive. Both corporate directors and corporate officers owe fiduciary duties to the corporation. See Biberstine v. New York Blower Co., 625 N.E.2d 1308, 1318 (Ind.App. 1993); Griffin v. Carmel Bank Trust Co., 510 N.E.2d 178, 182 (Ind.App. 1987) ("[D]irectors and officers of a corporation act in a fiduciary capacity, and their acts must be for the benefit of the corporation."); Yerke v. Batman, 176 Ind. App. 672, 376 N.E.2d 1211, 1214 (Ind.App. 1978) ("[C]oncerning matters affecting the general well being of the corporation, the officers and directors are fiduciaries to the corporation."). These duties include a duty of care. While the duties of directors are statutory, "the personal liability of corporate officers . . . is determined by common law rules of agency." Winkler v. V.G. Reed Sons, Inc., 638 N.E.2d 1228, 1231 (Ind. 1994) (internal citations omitted); see also Ind. Code § 23-1-36-2, official comments (declining to codify standards of conduct for officers and leaving common law agency and contract principles as "the source of the duty of care owed to a corporation by an officer.") (emphasis added); Medtech Corp. v. Indiana Insurance Co., 555 N.E.2d 844, 850 (Ind.App. 1990) ("If an agent does not act in good faith or with due care, he may be held liable to his principal for losses sustained.") (emphasis added). Any distinction between the duties of officers and those of directors is immaterial at this stage of the litigation.
The Officer defendants point to a "flaw in the plaintiff's chronology," as a basis for dismissal, as least as to defendant Jackson. Off. Def. Br. at 10. The Complaint states that defendant Jackson was an officer of CEG only "until 1997," yet lists August 1998 as "the first transaction subject to this suit." Cplt. ¶¶ 4, 44. After that time, however, Jackson was an officer of UMS, which was controlled by CEG. Marwil may pursue the case on the theory that Jackson owed fiduciary duties to both UMS and what was, for practical purposes, its corporate parent.
Finally on this point, the officer defendants were found by a jury to be liable of fraud. Although that verdict remains subject to challenge, the verdict is at least an indication that Marwil may be able to prove a set of facts consistent with the allegations of fiduciary breach in the Complaint. The Complaint sufficiently alleges that both director and officer defendants breached their fiduciary duties.
B. Business Judgment Rule
Turning finally to the substance of Marwil's breach of fiduciary duty claim, the defendants contend that Marwil's allegations do not state a claim because he has alleged only conduct that is protected by the business judgment rule. This argument is also not persuasive.
Indiana's business judgment rule protects directors against personal liability for many decisions they make as directors:
(a) A director shall, based on facts then known to the director, discharge the duties as a director . . .:
(1) In good faith;
(2) With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
(3) In a manner the director reasonably believes to be in the best interests of the corporation.
. . .
(c) A director is not acting in good faith if the director has knowledge concerning the matter in question that makes reliance otherwise permitted by subsection (b) unwarranted.
. . .
(e) A director is not liable for any action taken as a director, or any failure to take any action, unless:
(1) The director has breached or failed to perform the duties of the director's office in compliance with this section; and
(2) The breach or failure to perform constitutes willful misconduct or recklessness.
The quoted statute applies to directors of not-for-profit corporations. It closely tracks the provision for directors of for-profit corporations in Ind. Code § 23-1-35-1.
In general, the protection against liability provided by the business judgment rule extends to officers as well as to directors. See Ralph A. Peeples, The Use and Misuse of the Business Judgment Rule in the Close Corporation, 60 Notre Dame L.Rev. 456 (1985); H. Henn J. Alexander, Laws of Corporations 663 (3d ed. 1983); see also Bane v. Ferguson, 890 F.2d 11, 14 (7th Cir. 1989) (Illinois business judgment rule would shield corporation's directors and officers from liability). However, as noted above, Indiana law treats officers and directors differently and expressly avoids establishing statutory standards of conduct for officers of for-profit corporations. The statute applicable to officers of not-for-profit corporations, Ind. Code § 23-17-14-2, closely tracks the for-profit statute, so the same legislative intent seems to apply to such officers. This might be an arguable point, but for purposes of Rule 12(b)(6), the officer defendants cannot invoke the business judgement rule as a basis for dismissal.
As for the director defendants, Indiana's version of the business judgment rule is "a strongly pro-management version of the business judgment rule." GN Aircraft, Inc. v. Boehm, 743 N.E.2d 227, 238 (Ind. 2001). A director has a duty under the law to act in good faith, with ordinary care under the circumstances, and in a manner the director believes to be in the best interests of the corporation. Ind. Code § 23-1-35-1(a). Individual director liability requires proof that a director not only breached a duty of good faith or ordinary care, but that the breach constituted "willful misconduct or recklessness." Ind. Code § 23-1-35-1(e) (for-profit corporations); GN Aircraft, 743 N.E.2d at 238; Shepard v. Meridian Insurance Group, Inc., 137 F. Supp. 2d 1096,1103 (S.D. Ind. 2001). The official study commission comment on Indiana's business judgment rule statute states that director liability for damages requires proof of, "at a minimum, conscious disregard of or indifference to the consequences of a risky act." Ind. Code § 23-1-35-1(e).
The Supreme Court of Indiana has recognized the Commission's commentary as authoritative. Fleming v. International Pizza Supply Corp., 676 N.E.2d 1051, 1054 n. 5 (Ind. 1997). The commentary to subsection (e) further explains:
Subsection (e)'s liability standard is a conscious response to the serious problems that have arisen in recent years due to the increasing amount of litigation against directors, the increasing expense of defending such claims, and the increasing cost (and decreasing availability and scope) of director and officer liability insurance. These developments have in turn made it increasingly difficult for corporations to persuade qualified individuals to serve on boards of directors. Narrowing the bases for imposition of personal liability on directors was recommended by the Commission, and adopted by the General Assembly, as a crucial part of Indiana's efforts to reverse that trend. Subsection (e) reflects the public policy of Indiana that personal liability should be imposed on directors only in limited circumstances, and should be construed in furtherance of that objective.
While this protection is extensive, it is not absolute. "The business judgment rule protects directors from liability only if their decisions were informed ones." Brane v. Roth, 590 N.E.2d 587, 591-92 (Ind.App. 1992). Directors are also obliged to act in good faith. Id. at 590. In deciding the director defendants' motion to dismiss under Rule 12(b)(6), therefore, the court must assume that plaintiff Marwill would be able to prove that the defendant directors, as alleged, willfully or recklessly breached their duties in ratifying the bargain sale transactions at issue in this case. Marwil alleges that the CEG directors breached their fiduciary duty by ratifying transactions that they knew or should have known CEG was financially incapable of sustaining. Although the business judgment rule may make it difficult for Marwil to prove these claims, they are certainly sufficient to survive a Rule 12(b)(6) motion to dismiss. Marwil's allegations regarding the directors' approval of the bargain sale transactions are the sort of allegations that could sustain a breach of fiduciary claim if supported with evidence that the directors deliberately chose that course of action knowing that CEG was not financially strong enough to meet its obligations. Such evidence also could convince a trier of fact that the directors did not act in the best interests of the corporation or were indifferent to the interests of the corporation. The court cannot say at this stage that there is no possible set of facts consistent with the allegations in Marwil's complaint that would permit him to prove a breach of fiduciary duty by the director defendants. As the Supreme Court explained recently: "Rule 8(a) establishes a pleading standard without regard to whether a claim will succeed on the merits. `Indeed it may appear on the face of the pleadings that a recovery is very remote and unlikely but that is not the test.'" Swierkiewicz v. Sorema N.A., 534 U.S. 506, 515 (2002), quoting Scheuer v. Rhodes, 416 U.S. 232, 236 (1974).
Defendants also argue that the Indiana business judgment rule allowed them to rely on professional recommendations concerning the challenged transactions. Specifically, they argue that they properly relied on the recommendations of professional appraisers, accountants, and attorneys before engaging in the transactions. Although the statute protects such reliance, generally speaking that protection is subject to the limitation that a director was reasonably familiar with the recommendations made. See Hanson Trust PLC v. ML SCM Acquisition, Inc., 781 F.2d 264, 275 (2d Cir. 1986) ("while directors are protected to the extent that their actions evidence their business judgment, such protection assumes that courts must not reflexively decline to consider the content of their `judgment' and the extent of the information on which it is based."). Therefore, the court must assume at this stage in the proceedings, taking as true all of the facts alleged in the Complaint, that the directors could not have reasonably believed that the appraisals were reliable.
The court denies defendants' motions to dismiss the breach of fiduciary duty claims. Drawing all reasonable inferences in plaintiff's favor, the allegations state a claim upon which relief could be granted.
C. Allegations of "Scheme" and Ponzi Scheme
Finally, defendants Grubbs and Jackson argue that because the Complaint alleges a "scheme," plaintiff must plead the claims with particularity under Federal Rule of Civil Procedure 9(b). These defendants contend that the Complaint is not specific enough to sustain a claim for a "scheme" under Rule 9(b)'s heightened pleading standard. This argument is without merit. Defendants have not cited and the court did not find any statutory law or case authority for the proposition that a complaint's mere use of the word "scheme" invokes the Rule 9(b) particularity requirement. In this case, the only claims at issue are claims for breach of fiduciary duty. They are not claims for fraud. Fraud is not even an element of the breach of fiduciary duty claim. It is inapposite that plaintiff used the word "scheme" in the Complaint to describe the conduct that supports his claim. The term "fraud" is not used in the Complaint.
As noted, however, in the SEC enforcement action a jury found Grubbs and Jackson liable for securities fraud stemming from this series of transactions and the issuance of investment notes.
Defendants also argue that plaintiff has not sufficiently stated a claim for relief based on alleged "Ponzi schemes." All that is required at this stage in the proceedings is that plaintiff's Complaint is sufficient to put defendants on notice as to what the claim is. Plaintiff is not required at this point to show he will succeed on his claim. To survive a motion to dismiss, plaintiff need only allege facts consistent with a Ponzi scheme as a means by which defendants breached their fiduciary duties to the corporation. Plaintiff claims, and indeed defendants admit, that proceeds from newer investors were used to repay earlier investors to keep CEG afloat. Plaintiff alleges that this use of funds was contrary to the offering circulars. These allegations are sufficient.
D. Additional Issues
Defendants Grubbs and Jackson submit that they were not personally responsible for issuing the investments notes to investors. However, Marwil may well be able to come forward with evidence showing that Grubbs and Jackson were deeply involved in the issuance of those notes and the deceptive information provided to prospective investors, and that they structured the challenged bargain sale transactions to ensure that CEG's financial statements showed positive but phantom income. Defendants Grubbs and Jackson owed fiduciary duties to CEG and can be held liable for breaches of those duties where they cause harm to the corporation. See Griffin v. Carmel Bank Trust Co., 510 N.E.2d at 182. A basic tenet of corporations law is that officers and directors may be liable to investor shareholders for wrongdoing that harmed investor shareholders in derivative suits, Daly v. Showers, 8 N.E.2d 139, 104 Ind. App. 480 (1937), and to the corporation itself for actions that harmed the corporation, Shelby Engineering Co. v. Action Steel Supply, Inc., 707 N.E.2d 1026 (Ind.App. 1999). Defendants' motion to dismiss on that basis is denied.
Finally, the director defendants argue that plaintiff's complaint was "voluminous." This would not be a promising basis for dismissing a complaint, even if defendants had made the argument in their opening brief. See Davis v. Ruby Foods, Inc., 269 F.3d 818, 820 (7th Cir. 2001) (reversing dismissal on this basis, and noting that district judges have "better things to do with their time" than act as editors screening complaints for brevity and focus).
Conclusion
For the reasons stated above, defendants' motions to dismiss are denied. Plaintiff was properly appointed receiver and was granted the power to pursue causes of action in this court on behalf of CEG. Plaintiff has also sufficiently constructed his complaint to put defendants on notice that plaintiff's claim is for a breach of fiduciary duty.
So ordered.