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In re ITT Corporation Derivative Litigation

November 25, 2008

IN RE ITT CORPORATION DERIVATIVE LITIGATION


The opinion of the court was delivered by: cATHY Seibel, J.

MEMORANDUM DECISION AND ORDER

Before the Court is Nominal Defendant ITT Corporation's Motion for Reconsideration (Doc. 27) filed on April 24, 2008.

I. Background

Piven v. Loranger, 07-CV-2878 ("Piven"), a stockholder derivative action, was originally filed on April 10, 2007. It was consolidated with two similar actions -- Levy v. Loranger,07-CV-6339 ("Levy") and Reale v. Loranger, 07-CV-7358 ("Reale") -- pursuant to a stipulation entered into by all the Parties.*fn1 The Stipulation provided that the cases are consolidated for all purposes, that Plaintiffs would file a consolidated amended complaint or designate one of the filed complaints as the operative complaint, and that Defendants were not required to respond to any of the three original complaints. (Doc. 6.) Plaintiffs filed a Verified Consolidated Amended Complaint ("Complaint") on November 13, 2007. (Doc. 13.)

Plaintiffs bring thisderivative action on behalf and for the benefit of Nominal Defendant ITT Corporation ("ITT") against the ITT Board of Directors ("Board," "Directors" or "Director Defendants") for breach of their fiduciary duties and other violations of law.*fn2 (Compl. ¶ 1.) The case arises out of a criminal proceeding in which ITT pleaded guilty to federal felonies involving: 1) the willful export of defense articles, including night-vision equipment, without a license; and 2) the willful omission of statements of material fact in required arms export reports. (Id.) ITT agreed to pay over $100 million in criminal fines, penalties and forfeitures, and subjected itself to a deferred prosecution agreement. (Id.) Plaintiffs assert claims against the Director Defendants for breach of fiduciary duty and gross mismanagement. (Id. ¶¶ 137-49.)

Fed. R. Civ. P. 23.1 provides that a plaintiff bringing a derivative action must allege with particularity his or her efforts to obtain the desired action from the corporation's board of directors, or explain why such efforts were not made. In this case, Plaintiffs plead alternatively that the Board refused demand and that demand was excused because any efforts to obtain the desired action from the Board would have been futile. (Id. ¶ 37.) They allege that Plaintiff Reale demanded by letter dated April 12, 2007, that the Board commence a legal action, and that in the four months between the demand letter and the commencement of Plaintiff Reale's derivative suit, ITT took no action with respect to the demand. (Id. ¶ 38.) Plaintiffs further allege that Plaintiff Piven (now Plaintiff Wilkinson, see note 2 below) did not make demand on ITT because doing so would have been futile. (Id. ¶ 39.) Demand on the Board would have been futile, they assert, because each Director participated in the alleged wrongdoing or otherwise breached his or her oversight duties, and bringing this action directly would, in effect, require the Directors to sue themselves for conduct for which insurance would not indemnify them. (Id. ¶¶ 40-51.)

Nominal Defendant ITT filed a motion to dismiss pursuant to Fed. R. Civ. P. 23.1 on November 30, 2007. (Doc. 15.) ITT argued that the action should be dismissed because, after Plaintiff Reale made a demand on the Board, the Board created a Special Litigation Committee ("SLC"), which hired outside counsel to investigate the circumstances that formed the basis of the demand. ITT contended that by making demand, Plaintiffs as a matter of law conceded that the Board could independently evaluate a demand, and that, once a Special Litigation Committee has been established to investigate claims with the assistance of independent outside counsel, separate derivative litigation may not be pursued. In addition, Defendant ITT contended that demand was not excused because Plaintiffs failed to allege particularized facts creating a reasonable doubt as to each director's ability to properly exercise his or her business judgment in considering a demand. It argued that generalized claims of misconduct on the part of the Directors as a whole, without director-by-director analysis, does not satisfy the pleading standards for demand futility.*fn3

The motion was originally decided on April 10, 2008. (Doc. 26.) In determining whether to revisit it, this Court must apply the "strict" standard governing motions for reconsideration pursuant to S.D.N.Y. Local Civil Rule 6.3. Shrader v. CSX Transp., 70 F.3d 255, 257 (2d Cir. 1995). "[R]econsideration will generally be denied unless the moving party can point to controlling decisions or data that the court overlooked." Rafter v. Liddle, No. 07-CV-2282, 2008 U.S. App. LEXIS 17470, at *2 (2d Cir. Aug. 13, 2008) (citing Shrader, 70 F.3d at 257) (internal quotation marks omitted); see S.D.N.Y. Local Civ. R. 6.3. The overlooked matters must be such that they "might reasonably be expected to alter the conclusion reached by the court." Shrader, 70 F.3d at 257. Motions for reconsideration "are not vehicles for taking a second bite at the apple." Rafter, 2008 U.S. App. LEXIS 17470, at *2(quoting Sequa Corp. v. GBJ Corp., 156 F.3d 136, 144 (2d Cir. 1998)) (internal quotation marks omitted).

The Parties are in agreement that the legal standard set forth in Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993), controls the issue of demand futility. Under that standard, the relevant inquiry is "whether or not the particularized factual allegations . . . create a reasonable doubt that . . . the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand." (Defs.' Mem. Law in Supp. Mot. Dismiss 14; Pls.' Opp'n 19-20.) The motion should have been determined under that standard, which -- as discussed further below -- in turn requires an examination of whether a majority of the directors face a substantial likelihood of personal liability for disregarding their fiduciary obligations. In this case, that examination requires an analysis of the Directors' implementation of reporting or information systems and/or the individual Directors' knowledge of and response to misconduct at ITT. Accordingly, the motion for reconsideration is granted. See, e.g., J.G. Peta, Inc. v. Club Prot., Inc., No. 99-CV-616, 2001 U.S. Dist. LEXIS 1676, at *4, *8 (N.D.N.Y Jan. 24, 2001) (granting motion for reconsideration where court inadvertently failed to apply correct legal standard).

II. Discussion

Before the Court is Defendant ITT's Motion to Dismiss the Complaint pursuant to Fed. R. Civ. P. 23.1(b) (Doc. 15), filed on November 30, 2007. For the following reasons, the Motion is granted to the extent the Complaint relies on demand futility, although Plaintiffs may attempt to cure the defects in the Complaint by amendment.

A. Legal Standards

Fed. R. Civ. P. 23.1(b) requires a plaintiff bringing a derivative action to, among other things, "state with particularity: (A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and (B) the reasons for not obtaining the action or not making the effort." This Federal Rule is the procedural embodiment of the substantive principle of corporate law that directors are empowered to direct the management of the business and affairs of the corporation. See Rales, 634 A.2d at 932. Pursuant to Rule 23.1, derivative plaintiffs must plead specific factual allegations showing that demand is excused. Well-pleaded allegations are accepted as true, Halpert Enters. v. Harrison, 362 F. Supp. 2d 426, 430 (S.D.N.Y. 2005), and all reasonable inferences that flow logically from particularized facts alleged should be drawn in the plaintiff's favor, Wood v. Baum, 953 A.2d 136, 140 (Del. 2008). Conclusory allegations, however, are not considered. Halpert Enters., 362 F. Supp. 2d at 429-30.

Fed. R. Civ. P. 23.1 is a pleading rule that "creates a federal standard as to the specificity of facts alleged with regard to efforts made to urge a corporation's directors to bring the action in question." RCM Sec. Fund, Inc. v. Stanton, 928 F.2d 1318, 1330 (2d Cir. 1991). The adequacy of those efforts, however, is determined by state law. Id. The substantive law on demand is the law of the state of incorporation. Kamen v. Kemper Fin. Servs., 500 U.S. 90, 108-09 (1991). Because ITT is an Indiana corporation, Indiana law dictates under what circumstances demand is excused. Indiana courts, in turn, look to Delaware law when considering cases involving alleged breaches of fiduciary duties. See, e.g., G & N Aircraft, Inc. v. Boehm, 743 N.E.2d 227, 238 (Ind. 2001) (citing Delaware precedent for principles of corporate law).

The standard for determining demand futility in the absence of a director decision is set forth in Rales, 634 A.2d at 934. To excuse demand pursuant to Rales, "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." Id. A director will be deemed interested and incapable of exercising "his or her independent business judgment without being influenced by adverse personal consequences" when a "corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders." Id. at 936. That "demand on the board would be tantamount to asking the directors to sue themselves," and the "allegation that the Defendants' directors' and officers' liability policies have an . . . exclusion that precludes coverage . . .," are "insufficient to create a reasonable doubt as to disinterestedness." Kerneghan v. Franklin, No. 06-CV-1533, 2008 WL 4450268, at *7 (S.D.N.Y. Sept. 29, 2008). A director must face more than "a mere threat" of personal ...


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