In re Huron Consulting Group , 2012 IL App (1st) 103519 ( 2012 )

ILLINOIS OFFICIAL REPORTS
Appellate Court
In re Huron Consulting Group, Inc., 2012 IL App (1st) 103519Appellate Court In re HURON CONSULTING GROUP, INC., SHAREHOLDER
Caption DERIVATIVE LITIGATION (Brian Hacias, Plaintiff-Appellant, v.
Huron Consulting Group, Inc., a Delaware Corporation; George E.
Massaro, Dubose Ausley, James D. Edwards, H. Eugene Lockhart, John
S. Moody, and John F. McCartney, In their Capacity as Members of the
Board of Directors; Gary Holdren, Gary Burge, and Wayne Lipski,
Individually; and PricewaterhouseCoopers, LLP, Defendants-Appellees).
District & No. First District, Second Division
Docket No. 1-10-3519
Filed March 27, 2012
Held Plaintiff’s shareholder derivative action alleging breach of fiduciary duty,
(Note: This syllabus unjust enrichment, gross mismanagement and waste of corporate assets
constitutes no part of arising from accounting irregularities and financial losses over a period
the opinion of the court of several years was properly dismissed on the ground that plaintiff failed
but has been prepared to adequately plead demand futility as required under the applicable law,
by the Reporter of regardless of his contention that making a demand on the board of
Decisions for the directors to bring the action would have been futile.
convenience of the
reader.)
Decision Under Appeal from the Circuit Court of Cook County, No. 09-CH-30826; the
Review Hon. Martin S. Agran, Judge, presiding.
Judgment Affirmed.
Counsel on Robert B. Weiser, Brett D. Stecker, Jeffrey J. Ciarlanto, and Joseph M.
Appeal Profy, all of Weiser Law Firm, P.C., of Wayne, Pennsylvania, and
Mathew T. Hurst, of Susman Heffner & Hurst LLP, of Chicago, for
appellant.
Thomas P. Cimino, Jr., and Jeanah Park, both of Vedder Price, P.C., of
Chicago, for appellee Gary Holdren.
Walter C. Carlson, David A. Gordon, and Nilofer Umar, all of Sidley
Austin LLP, of Chicago, for appellee Gary Burge.
Charles F. Smith and Gretchen M. Wolf, both of Skadden, Arps, Slate,
Meagher & Flom LLP, of Chicago, for appellee Wayne Lipski.
Emily Nicklin, John F. Hartmann, Timothy A. Duffy, and Jennifer
Cowen, all of Kirkland & Ellis LLP, of Chicago, for appellee
PricewaterhouseCoopers, LLP.
Richard W. Clary and Rachel G. Skaistis, both of Cravath, Swaine &
Moore LLP, of New York, New York, and Richard J. Prendergast and
Michael T. Layden, both of Richard J. Prendergast, Ltd., of Chicago, for
other appellees.
Panel JUSTICE CONNORS delivered the judgment of the court, with opinion.
Presiding Justice Quinn and Justice Harris concurred in the judgment and
opinion.
OPINION
¶1 Plaintiff Brian Hacias filed this consolidated shareholder derivative lawsuit on behalf of
Huron Consulting Group. He asserted several claims of breach of fiduciary duty, unjust
enrichment, gross mismanagement, and waste of corporate assets against Huron, the
members of its board of directors, and three former executives arising out of accounting
irregularities and financial losses sustained over the course of several years. He also asserted
breach of contract and professional negligence claims against Huron’s independent auditor.
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Plaintiff also alleged that he did not make a demand on the board of directors to bring this
lawsuit on Huron’s behalf, as he was required to do under applicable law, because such a
demand would be futile. The circuit court dismissed his complaint for failing to adequately
plead demand futility. Plaintiff now appeals, alleging that the circuit court erred in
considering extrinsic evidence when evaluating the sufficiency of the allegations in his
complaint. Additionally, he claims that the circuit court erroneously denied his motion for
leave to amend the complaint. For the following reasons, we affirm.
¶2 I. BACKGROUND
¶3 Plaintiff is a shareholder of Huron Consulting Group, a Delaware corporation.
Defendants include several Huron executives employed at the time that the alleged
wrongdoing occurred in this case (executive defendants). Gary Holdren was Huron’s chief
executive officer, chairman, and president. Wayne Lipski was Huron’s chief accounting
officer. Gary Burge was Huron’s vice president, treasurer, and chief financial officer.
Plaintiff also named members of the board of directors as defendants, including George
Massaro, Dubose Ausley, James Edwards, H. Eugene Lockhart, John Moody, and John
McCartney (director defendants). Huron is also a nominal defendant in this action.
Additionally, plaintiff named PricewaterhouseCoopers, Huron’s independent auditor, as a
defendant in this case.
¶4 Huron provides accounting, financial, and corporate transaction services in various
industries. Huron experienced rapid growth between October 2004 and July 2009, primarily
due to its aggressive strategy of acquiring other accounting and consulting firms. In an effort
to retain the employees of the consulting firms it acquired, it allocated to the owners of the
acquired firms, the so-called “selling shareholders,” millions of dollars to distribute to their
employees as financial incentives to keep them employed with Huron after the acquisition.
¶5 Providing such bonuses to future employees is common practice and the “Generally
Accepted Accounting Principles” (GAAP) instruct that such retention payments must be
accounted for as compensation expenses. As such, the expenses would offset Huron’s
earnings. However, between 2006 and early 2009, Huron accounted for the incentive
payments as “goodwill,” which did not offset earnings and had the effect of artificially
increasing Huron’s earnings per share. Plaintiff alleges that by “materially understat[ing its]
publicly reported expenses,” Huron “deceiv[ed] Wall Street analysts and other financial
market participants concerning Huron’s true financial performance” between 2006 and early
2009.
¶6 On July 31, 2009, Huron publicly acknowledged that it improperly accounted for the
incentive payments between 2006 and early 2009 and admitted that it “materially misstated”
its financial results. Huron announced that it would have to restate its financial results for
those years. Huron’s restatement of earnings revealed that it overstated its income by a total
of $57 million. Consequently, plaintiff alleged, instead of meeting or exceeding analysts’
expectations during that period, Huron would have missed its expectations every quarter.
Huron also announced that the Securities and Exchange Commission (SEC) and the United
States Attorney’s Office (USAO) for the Northern District of Illinois opened inquiries into
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Huron’s practices.
¶7 Huron also announced that three of its executives had resigned as a consequence of these
accounting issues. Holdren resigned as chairman and chief executive officer, Lipski resigned
as Huron’s chief accounting officer, and Burge resigned as vice president, treasurer, and chief
financial officer. However, Huron announced that Burge would continue to serve as treasurer
until the end of 2009.
¶8 After making these announcements, plaintiff alleged, Huron’s stock dropped by more
than 69%, representing a marketing capitalization loss of over $650 million. Plaintiff alleged
that notwithstanding Huron’s financial issues, the members of the board of directors earned
an average of $330,438 in annual salary. That amount was “higher than the average director
compensation awarded at 16 of the top 20 Fortune 500 companies.”
¶9 As a result of the accounting errors and resulting financial losses, plaintiff filed this 10-
count derivative complaint. Plaintiff asserted three counts of breach of fiduciary duty against
the directors and the executives. He alleged a separate breach of fiduciary duty claim against
the directors alone. Plaintiff also asserted claims for unjust enrichment, abuse of control,
gross mismanagement, and waste of corporate assets against the directors and executives.
Plaintiff also asserted professional negligence and breach of contract claims against
PricewaterhouseCoopers.
¶ 10 Because this is a shareholder derivative suit, plaintiff was required by Delaware Chancery
Court Rule 23.1 (Del. Ch. Ct. R. 23.1) to either plead that he made a demand on the board
of directors to bring this lawsuit on behalf of Huron or state with particularity why making
such a demand would have been futile. Plaintiff did not make a demand but, rather, pleaded
demand futility. Generally, he asserted that the directors were incapable of evaluating the
demand claim in a disinterested and independent manner that protects the best interests of
the corporation. The detailed allegations of plaintiff’s demand futility claims will be
discussed in our analysis below.
¶ 11 Huron and the director defendants (hereinafter, collectively referred to as defendants)
filed a combined motion to dismiss plaintiff’s complaint under section 2-619.1 of the Code
of Civil Procedure (Code) (735 ILCS 5/2-619.1 (West 2008)). They sought dismissal of the
complaint under sections 2-619(a)(2) and 2-619(a)(9) of the Code (735 ILCS 5/2-619(a)(2),
(a)(9) (West 2008)), arguing that plaintiff lacked standing to bring the claim on Huron’s
behalf because he had not established that making a demand on Hurons directors would have
been futile.1 They also sought dismissal under section 2-615 of the Code based on plaintiff’s
failure to state a claim for relief with respect to the 10 derivative claims. 735 ILCS 5/2-615
(West 2008).
1
On appeal, the executive defendants adopted the arguments made by Huron and the director
defendants as to demand futility, which arguments are based on the latter’s motion to dismiss.
Although PricewaterhouseCoopers challenges plaintiff’s demand futility differently based on its
position as a third party, we need not address that argument or any of plaintiff’s substantive claims
if we decide as a threshold matter that plaintiff lacks authority to bring claims on Huron’s behalf,
against itself or a third party, because he has not adequately pleaded demand futility.
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¶ 12 In support of their section 2-619(a) motion, defendants attached the “Declaration of J.
Wesley Earnhardt,” who is “an associate at Cravath, Swaine & Moore LLP and counsel to
defendant Huron Consulting Group, Inc.” Earnhardt attached 14 documents to the
“declaration,” which he described as “true and correct” copies of those documents. Among
those documents were certain public filings of defendant Huron, FTI Consulting, Inc., and
CRA International, Inc., filed under the Securities Exchange Act of 1934 (15 U.S.C. § 78a
(2010)); a “letter sent by Robert B. Weiser, Esq. and Joseph Gentile, Esq. to Richard
Prendergast, Esq. on September 29, 2009”; a “letter sent by Francis P. Barron, Esq. to Robert
B. Weiser, Esq. and Joseph Gentile, Esq. on October 1, 2009”; a memorandum of law in
support of defendants’ motion to stay a cause of action pending in federal court; a copy of
a consolidated derivative complaint filed in that federal action on January 15, 2010; and a
copy of the minute order denying the motion to stay.
¶ 13 The circuit court granted defendants’ motion to dismiss with prejudice “for failure to
satisfy Delaware law.” In analyzing each of plaintiff’s demand futility allegations, the court
relied upon the documents contained in the Earnhardt declaration. The court concluded that
plaintiff failed to establish that demand was excused and, therefore, he could not “obtain
relief on any of the claims raised” in the complaint. This appeal followed.
¶ 14 II. ANALYSIS
¶ 15 A. Derivative Suit
¶ 16 A shareholder derivative suit permits an individual shareholder to bring suit “ ‘to enforce
a corporate cause of action against officers, directors, and third parties.’ ” (Emphasis in
original.) Kamen v. Kemper Financial Services, Inc., 500 U.S. 90, 95 (1991) (quoting Ross
v. Bernhard, 396 U.S. 531, 534 (1970)). It was intended as a vehicle to allow shareholders
to protect a corporation’s interests from “ ‘faithless directors and managers.’ ” Kamen, 500
U.S. at 95 (quoting Cohen v. Beneficial Loan Corp., 337 U.S. 541, 548 (1949)). However,
to preserve the balance of control, the shareholder must first demonstrate as a precondition
to bringing suit that he made a demand on the corporation to pursue the action and that the
demand had been refused or that the demand was “ ‘excused by extraordinary conditions.’ ”
Kamen, 500 U.S. at 96 (quoting Ross, 396 U.S. at 534).
¶ 17 The demand requirement is not merely a matter of procedure. Kamen, 500 U.S. at 96-97.
Rather, it is a substantive determination as to who has the power to control corporate
litigation; in essence, it reallocates the governing powers within the corporation. Kamen, 500
U.S. at 101. Because corporations are “creatures of state law” and state law is the “font of
corporate directors’ powers,” the substantive law of the state of incorporation applies in
determining whether the shareholder has adequately established that he has satisfied the
demand requirement to proceed with the litigation on the corporation’s behalf. (Internal
quotation marks omitted.) Kamen, 500 U.S. at 98-99.
¶ 18 Here, the parties agree that because Huron is incorporated in Delaware, the demand
requirement is governed by Delaware Chancery Rule 23.1 (Del. Ch. Ct. R. 23.1). Rule 23.1
provides:
“The complaint shall also allege with particularity the efforts, if any, made by the
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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.” Del. Ch. Ct. R. 23.1(a).
The derivative plaintiff is required to make a demand on the board of directors to address the
alleged wrongdoing on the corporation’s behalf. The directors must be allowed to “rectify
an alleged wrong without litigation, and to control any litigation which does arise.” (Internal
quotation marks omitted.) Braddock v. Zimmerman, 906 A.2d 776, 784 (Del. 2006).
Alternatively, the plaintiff must sufficiently allege with particularity that the demand
requirement is excused because it would be futile. Generally, the demand requirement will
be deemed futile where the derivative plaintiff establishes that there is reason to doubt the
board’s ability to evaluate the demand in a disinterested and independent manner. Braddock,
906 A.2d at 784.
¶ 19 B. Res Judicata
¶ 20 As an initial matter, defendants submit that we should affirm dismissal of plaintiff’s
derivative suit because it is barred by res judicata. Defendants claim that while this matter
was pending on appeal, the United States District Court for the Northern District of Illinois
dismissed the same claims of demand futility asserted by other derivative plaintiffs against
these defendants in Oakland County Employees’ Retirement System v. Massaro, 772 F. Supp.
2d 973 (N.D. Ill. 2011). Therefore, they argue, the district court’s ruling bars “this action.”
Plaintiff contends that under Delaware law, which he claims is applicable here, a dismissal
for failure to adequately plead demand futility must be made without prejudice and,
therefore, it is nonfinal for res judicata purposes, citing West Coast Management & Capital,
LLC v. Carrier Access Corp., 914 A.2d 636, 645 n.32 (Del. Ch. 2006), for support.
¶ 21 The parties’ arguments raise several novel legal issues. For example, we are not
convinced that this matter should be analyzed under the doctrine of res judicata as opposed
to the doctrine of collateral estoppel. See West Coast Management, 914 A.2d at 642-43(discussing the trend among federal courts to apply collateral estoppel when evaluating
demand futility claims brought by subsequent derivative plaintiffs because the corporation,
as the true party in interest, retains the right to pursue the underlying lawsuit). Additionally,
although this case was filed in Illinois and is allegedly precluded by a prior decision rendered
by a federal district court sitting in Illinois, plaintiff contends that we should apply
Delaware’s preclusion law because it is part of the substantive analysis of a Rule 23.1
pleading. But see Allianz Insurance Co. v. Guidant Corp., 387 Ill. App. 3d 1008, 1022
(2008) (explaining that there are conflicting decisions in Illinois as to whether the law of the
forum state or the law of the rendering jurisdiction applies in determining the preclusive
effect of a prior judgment); see also Du Page Forklift Service, Inc. v. Material Handling
Services, Inc., 195 Ill. 2d 71, 77-78 (2001) (tacitly applying the preclusion law of the forum
state). However, we need not resolve these issues here because under the preclusion law of
any of these jurisdictions, Massaro has no preclusive effect on the claims alleged in
plaintiff’s derivative suit.
¶ 22 Res judicata and collateral estoppel are equitable doctrines designed to promote judicial
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economy and encourage reliance on adjudication. Allen v. McCurry, 449 U.S. 90, 94 (1980);
Ballweg v. City of Springfield, 114 Ill. 2d 107, 113 (1986). Res judicata, or claim preclusion,
refers to the preclusive effect that a final judgment has to foreclose relitigation of claims that
were, or could have been, raised in an earlier suit between parties or their privies. Migra v.
Warren City School District Board of Education, 465 U.S. 75, 77 n.1 (1984); River Park,
Inc. v. City of Highland Park, 184 Ill. 2d 290, 302 (1998). Collateral estoppel, or issue
preclusion, prevents relitigation of issues of law or fact that have previously been litigated
and decided in an action involving the same parties or their privies. Migra, 465 U.S. at 77
n.1; Du Page Forklift Service, 195 Ill. 2d at 77.
¶ 23 The assumption underlying both of these doctrines is that the judgment alleged to have
a preclusive effect must have been rendered before the judgment in the case in which
preclusion is asserted. Allianz, 387 Ill. App. 3d at 1025-26 (citing Freeman United Coal
Mining Co. v. Office of Workers’ Compensation Program, 20 F.3d 289, 294 (7th Cir. 1994)).
To hold otherwise would work to undo a valid judicial opinion and elevate one court’s
holding above another’s. Such a result would impinge on the principles of comity and full
faith and credit upon which these doctrines rest. See Marrese v. American Academy of
Orthopaedic Surgeons, 470 U.S. 373, 380 (1985); Allianz, 387 Ill. App. 3d at 1021.
¶ 24 In this case, the circuit court entered its judgment on plaintiff’s demand futility claim on
October 25, 2010. However, the federal district court did not issue its final judgment in
Massaro until March 22, 2011. Thus, the Massaro decision cannot have a preclusive effect
on the circuit court’s judgment because Massaro was issued after that judgment and,
therefore, would not prevent relitigation of previously adjudicated matters. On the contrary,
the circuit court’s decision in the case below may have had a preclusive effect on the district
court’s judgment.
¶ 25 We also note parenthetically that section 2-619(a)(3) of the Code permits dismissal of
a claim where there is another action pending between the same parties for the same cause.
735 ILCS 5/2-619(a)(3) (West 2008). In the past, litigants have successfully asserted section
2-619(a)(3) as a basis for dismissal in similar situations, as was done by the corporate
defendant in Schnitzer v. O’Connor, 274 Ill. App. 3d 314 (1995), which defendants relied
upon in this case to support their res judicata argument. Nevertheless, it does not appear that
defendants advanced section 2-619(a)(3) as a basis for dismissal.
¶ 26 Regardless, neither res judicata nor collateral estoppel applies where the allegedly
preclusive judgment was issued after the order in the case below. Applying either doctrine
here would undo the order of the circuit court, which is a result not contemplated by the
doctrine. See Allianz, 387 Ill. App. 3d at 1025-26 (citing Freeman United, 20 F.3d at 294).
Therefore, Massaro has no preclusive effect to bar plaintiff’s demand futility claim in the
case below.
¶ 27 C. Motion to Dismiss
¶ 28 Generally, plaintiff’s argument on appeal challenges the circuit court’s reliance on
extrinsic evidence attached to defendants’ motion to dismiss to determine whether he made
sufficient allegations of demand futility. Plaintiff’s counsel acknowledged at oral argument
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that Illinois procedural law governs in this case, but nevertheless argued that plaintiff is only
required to adequately plead, not prove, that demand is futile under Delaware law. He claims
that the circuit court erred in relying on the contents of the Earnhardt declaration, attached
to defendants’ motion, to determine whether his pleading was sufficient.
¶ 29 Defendants filed their motion to dismiss under section 2-619(a)(2) of the Code of Civil
Procedure.2 735 ILCS 5/2-619(a)(2) (West 2010). Section 2-619(a)(2) provides:
“Defendant may *** file a motion for dismissal of the action *** upon any of the
following grounds. If the grounds do not appear on the face of the pleading attacked the
motion shall be supported by affidavit:
***
(2) That the plaintiff does not have legal capacity to sue ***.”
Based on the legal propositions set forth in Kamen, defendants argued that plaintiff is not
entitled to bring a derivative suit on Huron’s behalf because he failed to adequately plead
demand futility under Rule 23.1. Therefore, defendants argued, plaintiff lacked legal capacity
to sue and his derivative complaint should be dismissed on that basis.
¶ 30 Pursuant to the plain language of section 2-619(a), a defendant is entitled to submit an
affidavit in support of a motion to dismiss if the grounds for dismissal do not appear on the
face of the complaint. Although the Earnhardt “declaration” is of questionable validity to
serve as an affidavit given its failure to comply with Illinois Supreme Court Rule 191 (eff.
July 1, 2002)–in light of Earnhardt’s failure to provide sworn or certified copies of any of the
documents submitted and his incompetence to provide foundation for the attorney letters at
least (see Evergreen Oak Electrical Supply & Sales Co. v. First Chicago Bank of
Ravenswood, 276 Ill. App. 3d 317, 319-20 (1995))–plaintiff did not move to strike it. Thus,
from a procedural perspective, the court did not err in considering the materials contained
in the “declaration” while evaluating the section 2-619 motion.
¶ 31 Nevertheless, the circuit court erred in dismissing plaintiff’s complaint for lack of
standing under that section. A motion for involuntary dismissal under section 2-619 “admits
the legal sufficiency of the plaintiff’s complaint, but asserts an affirmative defense or other
matter that avoids or defeats the plaintiff’s claim.” Barber v. American Airlines, Inc., 241 Ill.
2d 450, 455 (2011). Here, defendants argued that plaintiff lacked standing because he failed
to adequately plead demand futility. That is, defendants’ challenge to standing was based
solely on the sufficiency of plaintiff’s allegations of demand futility. However, by moving
for dismissal under section 2-619, defendants necessarily admitted the legal sufficiency of
plaintiff’s complaint, as defendants’ counsel acknowledged at oral argument. Therefore,
defendants’ argument fails and their motion to dismiss under section 2-619 should have been
denied.
2
Defendants also nominally assert dismissal under section 2-619(a)(9), based on an
“affirmative matter avoiding the legal effect of or defeating the claim.” 735 ILCS 5/2-619(a)(9)
(West 2010). However, defendants made no specific arguments identifying an affirmative matter as
a basis for dismissal under that section.
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¶ 32 A review of the relevant case law supports this concept. In Brehm v. Eisner, the Delaware
Supreme Court articulated the legal framework to be applied to Rule 23.1 demand futility
claims. Brehm v. Eisner, 746 A.2d 244, 254 (Del. 2000). It held that when evaluating such
claims, a court is “merely reading the English language of a pleading and applying to that
pleading statutes, case law[,] and Rule 23.1 requirements. To that extent, [the] scope of
review is analogous to that accorded a ruling under [Delaware Chancery Court] Rule 12(b)(6)
[governing motions to dismiss for ‘failure to state a claim upon which relief may be
granted].’ ” Brehm, 746 A.2d at 254. Similarly, under Illinois procedural law, a section 2-615
motion to dismiss attacks the legal sufficiency of the complaint, assessing “ ‘whether the
allegations of the complaint *** are sufficient to establish a cause of action upon which relief
may be granted.’ ” Green v. Rogers, 234 Ill. 2d 478, 491 (2009) (quoting Vitro v. Mihelcic,
209 Ill. 2d 76, 81 (2004)). Although there may be situations in which a section 2-619 motion
to dismiss is the proper vehicle to challenge a derivative suit that includes a demand futility
claim, under these circumstances, defendants should have sought dismissal under section 2-
615 of the Code. See, e.g., Sherman v. Ryan, 392 Ill. App. 3d 712, 721 (2009) (affirming
dismissal of a derivative suit under section 2-615 where plaintiff failed to adequately plead
demand futility).
¶ 33 Indeed, plaintiff has argued in this court and in the court below that his complaint should
be reviewed under the section 2-615 standard and that his allegations be evaluated without
consideration of extrinsic evidence, specifically, the Earnhardt declaration. In light of the fact
that we review a motion to dismiss de novo, whether it is brought under section 2-615 or
section 2-619, and considering that plaintiff bears the burden of establishing that his
complaint sufficiently alleges demand futility under Rule 23.1 (Beam ex rel. Martha Stewart
Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1048-49 (Del. 2004)), we will review the
adequacy of plaintiff’s demand futility claim under the standards of section 2-615. See In re
Marriage of Siegel, 271 Ill. App. 3d 540, 544 (1995). In any event, we may affirm the circuit
court’s decision on any basis supported by the record. Studt v. Sherman Health Systems, 2011
IL 108182, ¶ 48.
¶ 34 D. Demand Futility
¶ 35 When reviewing a motion to dismiss for failure to state a claim, we accept as true all
well-pleaded factual allegations in the complaint and construe all reasonable inferences
therefrom in favor of the plaintiff. Sherman, 392 Ill. App. 3d at 722. However, we need not
consider mere conclusions of law or fact unsupported by specific factual allegations.
Sherman, 392 Ill. App. 3d at 722. Furthermore, demand futility allegations must be stated
“with particularity,” elevating the pleading requirements under Rule 23.1 beyond that which
is required to survive an ordinary challenge under section 2-615 or its equivalent. Malpiede
v. Townson, 780 A.2d 1075, 1083 (Del. 2001).
¶ 36 Demand futility claims are analyzed under one of two legal standards. The Aronson
standard applies where the challenged action forming the basis of the derivative lawsuit
involves specific business decisions of the directors and the exercise of their business
judgment. Rales v. Blasband, 634 A.2d 927, 933 (Del. 1993); Aronson v. Lewis, 473 A.2d
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805, 812 (Del. 1984), overruled on other grounds, Brehm, 746 A.2d at 254. Under the
Aronson standard, “demand will be excused if the derivative complaint pleads particularized
facts creating a reasonable doubt that (1) the directors are disinterested and independent or
(2) the challenged transaction was otherwise the product of a valid exercise of business
judgment.” (Internal quotation marks omitted.) Braddock, 906 A.2d at 784.
¶ 37 On the other hand, where the subject of the derivative suit does not attack an affirmative
decision of the board, the Aronson standard does not apply. Braddock, 906 A.2d at 784. That
is, “[w]here there is no conscious decision by directors to act or refrain from acting, the
business judgment rule has no application,” making it “impossible to perform the essential
inquiry contemplated by Aronson.” Rales, 634 A.2d at 933. In such cases, demand is excused
only where “the particularized factual allegations create a reasonable doubt that, [at] the time
the complaint was filed, the board of directors could have properly exercised its independent
and disinterested business judgment in responding to a demand.” Braddock, 906 A.2d at 785(listing the three situations in which the Rales standard applies) (citing Rales, 634 A.2d at
934).
¶ 38 Plaintiff’s complaint alleges that making a demand on the board would have been futile
for four reasons. Three of the asserted reasons challenge the directors’ ability to consider a
demand in a disinterested and independent manner, which implicates the Rales standard. The
remaining claim implicates the Aronson standard. We will analyze each claim in turn.
¶ 39 1. Rales Claims
¶ 40 To determine whether the board of directors could have impartially considered a demand
at the time it was presented, as the Rales standard requires, we look to the nature of the
decision faced by the directors in evaluating a shareholder demand. Rales, 634 A.2d at 935.
Addressing a demand is a two-step process: first, the directors must inform themselves of the
relevant legal and financial facts implicated by the challenged action; and second, they must
weigh the alternatives available for resolving the issues, including “implementing internal
corrective action and commencing legal proceedings.” Rales, 634 A.2d at 935. The directors
must be able to act independently of “personal financial interest and improper extraneous
influences.” Rales, 634 A.2d at 935.
¶ 41 a. Director Compensation
¶ 42 Plaintiff first alleges that “a majority of the directors lack independence from each other
and/or other interested directors.” Because they receive “materially higher” director fees as
compared to directors at other corporations, there is “cause to doubt the[ir] independence”
in “considering a demand to commence and vigorously prosecute this action.” Again, the
plaintiff must plead with particularity that there is reason to doubt that a majority of the
directors could evaluate a demand using their “independent and disinterested business
judgment.” Braddock, 906 A.2d at 785.
¶ 43 Director independence examines a director’s ability to make an impartial decision
notwithstanding the fact that he is presumed disinterested. Rales, 634 A.2d at 936. That is,
independence questions whether “ ‘a director’s decision is based on the corporate merits of
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the subject before the board rather than extraneous considerations or influences.’ ” Rales, 634
A.2d at 936 (quoting Aronson, 473 A.2d at 816). To demonstrate lack of independence, a
plaintiff must show that a majority of directors are “beholden” to an interested director or “so
under [his] influence that [the directors’] discretion would be sterilized.” Rales, 634 A.2d at
936 (citing Aronson, 473 A.2d at 815). The allegation of influence may be based on
“ ‘financial ties, familial affinity, a particularly close or intimate personal or business affinity
or *** evidence that in the past the relationship caused the director to act non-independently
vis-à-vis an interested director.’ ” Sherman, 392 Ill. App. 3d at 725 (quoting Beam, 845 A.2d
at 1051).
¶ 44 Here, plaintiff cannot establish that the majority of directors lack independence because
he has not demonstrated–or even alleged–which of the directors they are beholden to or how
those directors may be “interested.” An “interested” director is one who “receive[s] a
personal financial benefit from a transaction that is not equally shared by the stockholders.”
Rales, 634 A.2d at 936. In Rales, the court concluded that there was reason to doubt that two
directors of a corporation, Sherman and Ehrlich, could evaluate a demand claim
independently because they were beholden to two other directors, the Rales brothers, who
were “interested” in whether the board brought suit pursuant to a shareholder demand. Rales,
634 A.2d at 936. The Rales brothers were sufficiently alleged to have invested corporate
funds in such a way that benefitted themselves. Rales, 634 A.2d at 936 (citing Blasband v.
Rales, 971 F.2d 1034, 1052 (3d Cir. 1992)).
¶ 45 The plaintiff in Rales sufficiently alleged that Sherman and Ehrlich were “beholden” to
the Rales brothers. Rales, 634 A.2d at 936. Sherman earned $1 million per year as the chief
executive officer of a company and the Rales brothers served as that company’s chairman
of the board and chairman of the board’s executive committee, which positions “place[d]
them in a position to exert considerable influence over Sherman.” Rales, 634 A.2d at 937.
Similarly, the Rales brothers owned the majority of stock in a company for which Ehrlich
and his two brothers served as high-level executives and wielded substantial influence over
the Ehrlich brothers. Rales, 634 A.2d at 937. The court found that Sherman and Ehrlich both
had personal financial stakes in maintaining their employment and the Rales brothers had
substantial influence over their ability to remain employed. That was sufficient to allege that
Sherman and Ehrlich were beholden to the Rales brothers such that they could not
independently evaluate a demand futility claim that implicated the Rales brothers. Rales, 634
A.2d at 936-37.
¶ 46 However, plaintiff has not done the same in this case. He asserted that a majority of the
directors lacked independence from each other, but did not assert or demonstrate that any one
of them was “interested” as that term is defined by the Delaware Supreme Court. His
allegations that individual directors lacked independence is merely a comparison of the fees
Huron paid its directors and fees awarded to directors of other Fortune 500 companies he
selected. He then concludes that “[b]ecause of the sheer size of the atypical director fees”
awarded to each director in this case, “there is reason to doubt [their] independence from
other directors, rendering [them] incapable of impartially considering a demand to commence
and vigorously prosecute this action.” Plaintiff cannot survive dismissal based on such
conclusory statements. See Sherman, 392 Ill. App. 3d at 722. More importantly, plaintiff
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failed to allege that any director has used his influence to pressure the others to do his
bidding to further his personal interests, as the test for “independence” requires under Rales.
Therefore, plaintiff has not alleged with particularity that demand should be excused as futile
because the directors lacked independence.
¶ 47 b. Director Oversight Liability
¶ 48 Plaintiff also alleges that defendants McCartney, Edwards, and Ausley, who were
members of the board’s audit committee, face a “substantial likelihood of liability” for
breaching their fiduciary duties in “allow[ing] *** false and misleading statements to be
disseminated in [Huron’s] SEC filings *** and, otherwise, fail[ing] to ensure that adequate
internal controls were in place regarding the serious accounting issues and deficiencies.”
Additionally, plaintiff alleges that defendants Moody, Ausley, Lockhart, and McCartney,
who were members of the board’s compensation committee, face a “substantial likelihood
of liability” for breach of their fiduciary duties in permitting the compensation problems at
the acquired companies to go “unnoticed and uninvestigated.” He alleged that the
compensation committee is responsible for “review[ing] matters of general compensation
and conduct[ing] investigations (and retain[ing] independent counsel and/or advisors) into
matters within [its] purview.”
¶ 49 Although plaintiff does not specifically state it, these claims of “director oversight
liability” attack the directors’ ability to evaluate a demand claim in a disinterested manner.
Rales, 634 A.2d at 936 (stating that “[d]irectorial interest also exists where a corporate
decision will have a materially detrimental impact on a director, but not on the corporation
[or] stockholders”). Where such director oversight liability is alleged, the plaintiff must
establish that (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). Under either scenario, the “imposition of liability requires a showing that the directors
knew that they were not discharging their fiduciary obligations.” Stone, 911 A.2d at 370. A
breach of fiduciary duty exists only where the “directors fail to act in the face of a known
duty to act, thereby demonstrating a conscious disregard for their responsibilities.” Stone, 911
A.2d at 370.
¶ 50 Reading plaintiff’s allegations generously, they resemble the allegations made in In re
Caremark International Inc. Derivative Litigation, 698 A.2d 959, 967 (Del. Ch. 1996),
where the plaintiff alleged that the defendants “allowed a situation to develop and continue
which exposed the corporation to enormous legal liability and that in doing so they violated
a duty to be active monitors of corporate performance,” bringing it within the second theory
of director oversight liability. Caremark, 698 A.2d at 967; see also Stone, 911 A.2d at 370.
This so-called Caremark claim has been referred to as “possibly the most difficult theory in
corporation law upon which a plaintiff might hope to win a judgment” because it attempts
to hold directors personally liable for the bad acts of its employees. (Internal quotation marks
omitted.) Stone, 911 A.2d at 372 (quoting Caremark, 698 A.2d at 967-68); Sherman, 392 Ill.
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App. 3d at 727.
¶ 51 To establish this type of claim, plaintiff would have to allege with particularity that there
was “ ‘a sustained or systematic failure of the board to exercise oversight–such as an utter
failure to attempt to assure a reasonable information and reporting system exists–[which]
establish[es] the lack of good faith that is a necessary condition to liability.’ ” Stone, 911
A.2d at 372 (quoting Caremark, 698 A.2d at 971). Here, according to plaintiff’s own
complaint, the board of directors created the audit committee whose charter required it to
“[r]eview[ ] the adequacy and effectiveness of [Huron’s] accounting and internal control
policies and procedures on a regular basis” and “[r]eview[ ] with management *** reports
determining the accounting treatment for payments to be made by [Huron] on an initial and
ongoing basis in connection with acquisitions,” among other things.
¶ 52 In this case, as in Stone, plaintiff seeks “to equate a bad outcome with bad faith.” Stone,
911 A.2d at 373. The reality is that plaintiff acknowledged that the directors had a reasonable
information and reporting system in place. Although the reporting system may have failed
in this case, without more, that cannot subject the directors to personal liability for failures
by Huron’s “senior management” to report the improper accounting of retention payments.
See Stone, 911 A.2d at 372. Plaintiff has alleged no “red flags” demonstrating that the audit
committee defendants knew that Huron’s “internal controls were inadequate, that these
inadequacies would result in illegal activity, and that the board chose to do nothing about
problems it allegedly knew existed.” (Internal quotation marks omitted.) Stone, 911 A.2d at
370. Therefore, plaintiff has failed to establish that demand futility is based on director
oversight liability.
¶ 53 Nor did plaintiff allege any such red flags with respect to the compensation committee
defendants. He alleged that those defendants were obligated to review general compensation
issues. Although plaintiff alleged that those defendants “permitted” the retention payments
“to go unnoticed and uninvestigated,” he never alleged that they knew that their oversight
process was inadequate, that the failure of oversight would result in illegal activity, or that
they simply chose to ignore any such problems. Thus, plaintiff also cannot establish demand
futility through this director oversight liability claim.
¶ 54 Generally, our conclusions here are based on the allegations identified in plaintiff’s
complaint as “Demand Futility Allegations.” To the extent that plaintiff may rely on other
allegations in his 229-paragraph complaint to imply that a majority of the director defendants
knowingly abdicated their fiduciary duties, those allegations are insufficient to establish
demand futility. Plaintiff’s allegations of various wrongdoing implicate the actions of the
“Individual Defendants,” whom he described as including the six director defendants as well
as the three executive defendants. However, plaintiff is required to show that the “directors
are potentially personally liable for the failure of non-director [Huron] employees” to
properly account for the retention payments. (Emphases in original.) Stone, 911 A.2d at 372.
Plaintiff’s general allegations of bad faith by any one of those nine “Individual Defendants”
cannot be used to impute specific knowledge of wrongdoing to a majority of the director
defendants in order to satisfy the demand futility test. For example, plaintiff alleged that
according to the audit committee’s report, the “Individual Defendants” knew that retention
payments had been made and improperly accounted for. However, the report specifically
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states that “senior management” knew of these problems. The managers’ knowledge cannot
then be imputed to the director defendants for the purpose of establishing their potential
personal liability.
¶ 55 c. Authorization of an Internal Investigation
¶ 56 Plaintiff’s last Rales claim alleges that all of the directors are “interested” because they
face a “substantial likelihood of liability in connection with the audit committee’s purported
‘internal investigation’ and the restatement of Huron’s financial results.” Consequently, he
alleges, the board has shown “hostility” to a derivative suit. Additionally, he asserts that the
audit committee “could not possibly have performed an ‘independent’ investigation, because
*** [its members] have been charged with investigating their own conduct.”
¶ 57 Initially, we note that plaintiff has failed to identify the basis of personal liability that
results from the directors’ “connection with the [a]udit [c]ommittee’s purported ‘internal
investigation’ and the restatement of Huron’s financial results.” As such, he has failed to
adequately plead how, specifically, the directors would have favored their personal interests
in avoiding liability while evaluating the demand claim.
¶ 58 The remaining allegation–that the audit committee defendants cannot be disinterested
when investigating their own conduct–was rejected by the Delaware Supreme Court in
Aronson as a “bootstrap” argument. Aronson, 473 A.2d at 818. There, it said, “a bare claim
of this sort raises no legally cognizable issue under Delaware corporate law.” Aronson, 473
A.2d at 818. Therefore, plaintiff also has not established demand futility based on director
oversight liability in this context.
¶ 59 2. Aronson Claim
¶ 60 Plaintiff also alleged that all of the directors are “interested” because they “engaged in
conduct which is not protected by the business judgment rule” by retaining defendant Burge
as treasurer of Huron for five months after his employment was terminated in July 2009. He
alleges that Burge’s salary for those months amounted to “bestowing gifts on him, which was
a waste of corporate assets.” He claims that this decision by the directors is not protected by
the business judgment rule.
¶ 61 Plaintiff’s allegations challenge a specific business decision of the directors and are
analyzed under the Aronson standard. See Rales, 634 A.2d at 933. As stated above, demand
is excused under the Aronson standard where the complaint pleads “particularized facts
creating a reasonable doubt that (1) the directors are disinterested and independent or (2) the
challenged transaction was otherwise the product of a valid exercise of business judgment.”
(Internal quotation marks omitted.) Braddock, 906 A.2d at 784.
¶ 62 The business judgment rule cloaks directors with the presumption that in making
business decisions on behalf of the corporation, they do so on an informed basis, in good
faith, and in the honest belief that their actions are in the corporation’s best interest. Grobow
v. Perot, 539 A.2d 180, 187 (Del. 1988) (citing Aronson, 473 A.2d at 812), overruled on
other grounds, Brehm, 746 A.2d at 254. Where a derivative plaintiff fails to rebut this
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presumption with well-pleaded facts, the plaintiff must allege some other facts to raise a
reasonable doubt that the challenged transaction was the product of a valid exercise of
business judgment. Grobow, 539 A.2d at 187. Here, as in Grobow, plaintiff did not allege
the traditional claims of fraud, bad faith, or self-dealing in rebuttal. Grobow, 539 A.2d at
187. Thus, plaintiff must allege some other set of facts to refute the presumption that the
directors “exercised sound business judgment in the honest belief” that retaining Burge as
treasurer of Huron “was in the best interest of the company.” (Internal quotation marks
omitted.) Grobow, 539 A.2d at 187.
¶ 63 Under the first prong of Aronson, plaintiff must adequately plead that the directors had
a personal interest in retaining Burge or that they were beholden to him in a way that showed
they lacked independence. Plaintiff alleges neither that the directors received a personal
financial benefit by retaining Burge as treasurer nor that they would be personally
detrimentally impacted in a way not equally shared by the stockholders by not retaining him.
See Rales, 634 A.2d at 936 (citing Aronson, 473 A.2d at 812). Nor does he allege that the
directors were beholden to Burge in any way. Rather, plaintiff alleges that the directors
“bestow[ed] gifts” upon Burge by retaining him in a paid position for an additional five
months after terminating his employment, which was a waste of corporate assets.
¶ 64 In that case, plaintiff has the burden of showing through particularized pleading that an
“exchange *** is so one[-]sided that no business person of ordinary, sound judgment could
conclude that the corporation has received adequate consideration.” (Internal quotation marks
omitted.) In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106, 137 (Del.
Ch. 2009); see also Grobow, 539 A.2d at 189 (citing Saxe v. Brady, 184 A.2d 602, 610 (Del.
Ch. 1962)). Plaintiff’s complaint contains no such allegations. For example, he does not
allege that Burge failed to perform any duties as treasurer despite receiving a salary, nor does
he allege that the salary Burge received was exorbitant for the services provided. He merely
alleged that “despite concluding that it was appropriate to replace him, the Board nonetheless
agreed to permit Burge to continue to serve” as treasurer and that his continued employment
was a “gift.” A court is particularly ill-suited for determining whether payments for services
are reasonable or excessive because the value of the services is a matter of judgment on the
part of the person paying for them. Saxe, 184 A.2d at 610. However, we can surmise that at
least one reasonable benefit of retaining Burge for an additional five months would be having
someone familiar with the position perform those duties until a suitable replacement was
found and having him assist in the transition to a new treasurer. Therefore, plaintiff has not
established a claim for corporate waste to overcome the presumption of good faith and, thus,
has not established demand futility. See Citigroup, 964 A.2d at 137.
¶ 65 For the foregoing reasons, plaintiff has not met his burden of pleading with particularity
that demand was futile. Accordingly, his complaint was properly dismissed.
¶ 66 E. Leave to Amend the Complaint
¶ 67 Finally, plaintiff argues that the circuit court erred in denying his “requested leave to
replead in the event that [it] was inclined to grant any portions” of the motion to dismiss. He
argues on appeal that he “contemplated” adding certain particularized allegations had he been
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allowed to amend the complaint.
¶ 68 Our review of the record reveals that plaintiff never made a proper motion to the court
to amend his complaint and, thus, there was nothing for the circuit court to act on. Plaintiff
cites to a footnote contained in the “Conclusion” section of his response to the motion to
dismiss. The footnote states, “[i]f the court is inclined to grant any portion of Defendants’
Motions, Plaintiffs respectfully request 45 days leave to replead,” citing Alpha School Bus
Co. v. Wagner, 391 Ill. App. 3d 722, 748 (2009), in support. That is not a proper motion for
leave to amend. We review a court’s ruling on a motion for leave to amend a complaint for
an abuse of discretion. Alpha School Bus, 391 Ill. App. 3d at 748-49. In order for the circuit
court to exercise its discretion in deciding on the motion, it must review the proposed
amended pleading to determine whether it would cure the defect in the pleadings, whether
it was timely, whether it prejudiced the opposing party, and whether there were previous
opportunities to amend. Alpha School Bus, 391 Ill. App. 3d at 748-49 (citing Loyola
Academy v. S&S Roof Maintenance, Inc., 146 Ill. 2d 263, 273-74 (1992)). Here, the circuit
court had not yet granted defendants’ motion to dismiss when plaintiff submitted its response
to that motion. Thus, plaintiff’s footnote in that response could not have served as a proper
motion for leave to amend, which must contain an argument for permitting amendment
pursuant to the above factors and include a copy of the proposed amended pleading. Alpha
School Bus, 391 Ill. App. 3d at 749; see also 3 Richard A. Michael & Michael J. Kaufman,
Illinois Practice §§ 26:1, 26:3 (2d ed. 2011) (“[a] reviewing court will not consider any
alleged error in denying a motion for leave to amend unless the proposed amendment has
been submitted to the trial court and made part of the record”). The circuit court did not
abuse its discretion in denying plaintiff’s motion because, among other things, plaintiff never
made a proper motion.
¶ 69 III. CONCLUSION
¶ 70 For all of the foregoing reasons, we hold that plaintiff failed to adequately allege
particularized facts establishing that demand on the directors would have been futile under
Delaware Chancery Court Rule 23.1. Additionally, plaintiff failed to make a proper motion
for leave to amend. Thus, his claim that the court erroneously denied his motion fails.
¶ 71 Affirmed.
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