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In re ITT Corp. Derivative Litigation

September 8, 2009


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


Before the Court are (1) Nominal Defendant ITT Corporation's Motion to Dismiss the Third Amended Verified Consolidated Complaint ("Third Amended Complaint") filed on March 17, 2009, (Doc. 41); (2) the Motion of Raymond W. LeBoeuf, Frank T. MacInnis, Linda S. Sanford, Markos I. Tambakeras, Steven R. Loranger, Curtis J. Crawford, Christina A. Gold, Ralph F. Hake, and John J. Hamre ("Director Defendants") to Dismiss the Third Amended Complaint, filed on March 17, 2009, (Doc. 58); and (3) the Special Litigation Committee's Motion to Terminate this Action, filed on March 17, 2009, (Doc. 46).

I. Background

On November 13, 2007, Plaintiffs filed a Verified Consolidated Amended Complaint ("Complaint") in 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.*fn1 (Doc. 13.) 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. (Compl. ¶ 1.) 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.)

Rule 23.1 of the Federal Rules of Civil Procedure ("Rule 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 the Complaint, Plaintiffs pleaded 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 alleged 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, the Board took no action with respect to the demand. (Id. ¶ 38.) Plaintiffs further alleged that Plaintiff Piven did not make a demand on ITT because doing so would have been futile. (Id. ¶ 39.) Demand on the Board would have been futile, they argue, 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 the Complaint pursuant to Rule 23.1 on November 30, 2007. (Doc. 15.) That Motion was denied on April 10, 2008. (Doc. 26.) On April 24, 2008, ITT filed a Motion for Reconsideration. (Doc. 27.) On October 28, 2008, Plaintiffs filed, with the Court's permission, a Second Consolidated Verified Amended Complaint ("Second Amended Complaint") for the sole purpose of curing a jurisdictional defect. (Doc. 37.) Plaintiffs in their Second Amended Complaint dropped Plaintiff Piven as a party and added Plaintiff Wilkinson who, like Plaintiff Piven, did not make a demand on the Board before commencing a derivative action on the basis that such a demand would have been futile. The substantive allegations were unchanged. By Memorandum Decision and Order filed November 25, 2008, this Court granted ITT's Motion for Reconsideration. (Doc. 40.) Upon reconsideration, this Court granted ITT's Motion to Dismiss to the extent that the Second Amended Complaint relied on demand futility. The Court found that Plaintiffs failed to make specific allegations regarding each individual director's substantial likelihood of liability for willfully or recklessly breaching his or her fiduciary duties, in that Plaintiffs did not allege with sufficient particularity that Defendants failed to implement reporting or information systems or controls or that, having implemented such controls, the Directors consciously failed to monitor or oversee their operations. This Court, however, gave Plaintiffs leave to attempt to cure the defects in the Second Amended Complaint by amendment.

Plaintiffs filed a Third Amended Complaint on December 23, 2008. (Doc. 41.) Nominal Defendant ITT again moved to dismiss the Third Amended Complaint with prejudice pursuant to Rule 23.1. (Doc. 43.) In addition, the Special Litigation Committee of the Board of Directors of ITT Corporation (the "SLC") filed a Motion to Terminate this action pursuant to Rule 23.1 and Indiana Business Corporation Law Section 23-1-32-4. (Doc. 46.) Relying on ITT's Motion to Dismiss and the SLC's Motion to Terminate this Action, the Director Defendants also filed a Motion to Dismiss the Third Amended Complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. (Doc. 58.)

II. Discussion

A. ITT and Director Defendants' Motions to Dismiss

1. Legal Standards

Rule 23.1(b)(3) of the Federal Rules of Civil Procedure 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 v. Blasband, 634 A.2d 927, 932 (Del. 1993). 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. Inc., 500 U.S. 90, 108-09 (1991). Because ITT is an Indiana corporation, Indiana law dictates the circumstances under which 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 "where the subject of the derivative suit is not a business decision of the board" 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 director-Defendants 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." Kernaghan v. Franklin, No. 06-CV-1533, 2008 U.S. Dist. LEXIS 75447, at *22-23 (S.D.N.Y. Sept. 29, 2008) (internal quotation marks omitted); accord King v. Baldino, No. 08-CV-54, 2009 U.S. Dist. LEXIS 76132, at *30-31 (D. Del. Aug. 26, 2009) ("Were demand to be found futile merely because directors would be suing themselves . . . the demand requirement of Rule 23.1 would be eviscerated." (internal quotation marks omitted) (alteration in original)). A director must face more than a "mere threat" of personal liability to be considered interested and incapable of exercising his or her business judgment in considering a demand. Rales, 634 A.2d at 936. To be deemed interested, a director must face "a substantial likelihood" of personal liability. Id. (internal quotation marks omitted).

Claims for breach of fiduciary duty premised on director oversight are analyzed according to the standards set forth in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). This theory of director liability is "possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment." Id. at 967. The "necessary conditions predicate for director oversight liability" are: (1) "the directors utterly failed to implement any reporting or information system or controls;" or (2) "having implemented such a system or controls, consciously failed to monitor or oversee its operations[,] thus disabling themselves from being informed of risks or problems requiring their attention." Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006); accord Caremark, 698 A.2d at 971. "In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations," Stone, 911 A.2d at 370, and therefore, acted in "bad faith," Desimone v. Barrows, 924 A.2d 908, 935 (Del. Ch. 2007) ("a scienter-based standard applies to claims in the delicate monitoring context").

In sum, to excuse demand pursuant to Rule 23.1, Plaintiff Wilkinson must raise a reasonable doubt that the Board could have exercised independent and disinterested judgment in addressing a demand, by alleging particularized facts to show that a majority of the Directors face a "substantial likelihood" of personal liability for knowingly not discharging their fiduciary duties through bad-faith failures of oversight -- either the failure to implement any reporting or ...

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