Kanter v. Barella

Opinions of the United
2007 Decisions States Court of Appeals
for the Third Circuit
5-25-2007
Kanter v. Barella
Precedential or Non-Precedential: Precedential
Docket No. 05-5398
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PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 05-5398
RHODA KANTER, on behalf of herself and
derivatively on behalf of MEDQUIST
v.
HANS M. BARELLA;
BELINDA W. CHEW; WILLIAM E. CURRAN;
STEPHEN H. RUSCKOWSKI;
A. FRED RUTTENBERG, ESQ. ;
RICHARD H. STOWE; JOHN H. UNDERWOOD;
SCOTT M. WEISENHOFF; ERIK J. WESTERINK;
JAN H.M. HOMMEN;
KONINKLIJKE PHILIPS ELECTRONICS N.V.;
MEDQUIST INC. a New Jersey Corporation
Rhoda Kanter,
Appellant
On Appeal from the United States District Court
for the District of New Jersey
D.C. Civil Action No. 04-cv-05542
(Honorable Jerome B. Simandle)
Argued March 1, 2007
Before: SCIRICA, Chief Judge,
McKEE and NOONAN*, Circuit Judges.
(Filed: May 25, 2007)
DEBORAH R. GROSS, ESQUIRE (ARGUED)
TINA MOUKOULIS, ESQUIRE
Law Offices of Bernard M. Gross
The Wanamaker Building
100 Penn Square East, Suite 450
Philadelphia, Pennsylvania 19107
Attorneys for Appellant
*
The Honorable John T. Noonan, Jr., United States Circuit
Judge for the Ninth Judicial Circuit, sitting by designation.
2
BRIAN T. FRAWLEY, ESQUIRE (ARGUED)
Sullivan & Cromwell
125 Broad Street
New York, New York 10004
MICHAEL R. GRIFFINGER, ESQUIRE
LAN HOANG, ESQUIRE
TIMOTHY S. SUSANIN, ESQUIRE
Gibbons, P.C.
One Gateway Center
Newark, New Jersey 07102-5310
Attorneys for Appellees,
Hans M. Barella, Belinda W. Chew
William E. Curran, Stephen H. Rusckowski
Scott M. Weisenhoff, Erik J. Westerink
Jan H.M. Hommen, Koninklijke Philips Electronics N.V.
RANDALL W. BODNER, ESQUIRE (ARGUED)
Ropes & Gray
One International Place
Boston, Massachusetts 02110-2624
JEFFREY W. LORELL, ESQUIRE
Saiber, Schlesinger, Satz & Goldstein
One Gateway Center, Suite 1300
Newark, New Jersey 07102-5311
Attorneys for Appellees, A. Fred Ruttenberg,
Richard H. Stowe, John H. Underwood
3
NEAL R. MARDER, ESQUIRE (ARGUED)
GAIL J. STANDISH, ESQUIRE
PETER E. PERKOWSKI, ESQUIRE
Winston & Strawn
333 South Grand Avenue, 38th Floor
Los Angeles, California 90071
MARC J. GROSS, ESQUIRE
Greenbaum, Rowe, Smith & Davis
75 Livingston Avenue
Roseland, New Jersey 07068
Attorneys for Appellee, Medquist Inc.
OPINION OF THE COURT
SCIRICA, Chief Judge.
At issue in this shareholders’ derivative action for breach
of fiduciary duty is whether plaintiff properly pleaded demand
futility under Fed. R. Civ. P. 23.1. The District Court dismissed
under Fed. R. Civ. P. 12(b)(6). We will affirm.
I.
Rhoda Kanter, a shareholder of MedQuist, Inc., a New
Jersey corporation, brought a shareholders’ derivative suit
against MedQuist, ten individuals identified as members of
4
MedQuist’s board of directors, and Koninklijke Philips
Electronics N.V. (which owned 71 percent of MedQuist’s
unrestricted stock) for breach of fiduciary duty.1
MedQuist provides health information services and
medical transcription services, such as the transcription of
doctors’ voice-recorded dictation of medical reports for
inclusion in patient files. According to the complaint, MedQuist
bills clients for transcription services on a cost per line basis.
“Line” is defined as an “AAMT line,” which contains 65
characters, including any letter, number, symbol or function key
necessary for the final appearance, such as space bar, carriage
return, underscore, bold, and any characters contained in the
macro, header or footer.2 To calculate the number of lines, the
characters are totaled and divided by 65.
The complaint alleges MedQuist systematically inflated
its character counts by counting a single character as multiple
characters, which resulted in artificially high bills for
1
The MedQuist directors named in the suit are: Hans M.
Barella, Belinda W. Chew, William E. Curran, Stephen H.
Rusckowski, A. Fred Ruttenberg, Esq., Richard A. Stowe, John
H. Underwood, Scott M. Weisenhoff, Erik J. Westerink, and Jan
H.M. Hommen.
2
The AAMT line unit of measure is based on a standard
measure initially developed by the American Association for
Medical Transcription.
5
MedQuist’s customers. In March 2004, MedQuist announced
it would delay its annual filings with the Securities and
Exchange Commission pending completion of an independent
outside review of the company’s billing practices. Kanter
contends this review was undertaken in response to allegations
by one of MedQuist’s employees of improper billing practices.
The key findings of the independent review were released in
July 2004, allegedly revealing an unlawful billing scheme.
MedQuist’s board of directors responded to the findings by
taking unspecified “disciplinary action” against five MedQuist
employees. In October 2004, MedQuist issued a press release
stating that its financial filings and statements for the two prior
years should no longer be relied upon.3 In November 2004,
Kanter filed this shareholders’ derivative suit alleging
defendants violated their fiduciary duties to the company by (1)
failing to adequately ensure accurate and lawful billing
practices, (2) failing to prevent the artificial inflation of billing
3
A release dated Nov. 2, 2004, posted on MedQuist’s Web
site notes that the board announced on Oct. 29, 2004 that the
company’s financial statements for 2002 and 2003 “and all
earnings releases and similar communications relating to such
periods, should no longer be relied upon.” Press Release,
MedQuist, MedQuist Board Issues Statement on 2002–2004
Financials (Nov. 2, 2004), available at
http://www.corporate-ir.net/ireye/ir_site.zhtml?ticker=MEDQ
&script=412&layout=-6&item_id=639255 (last visited May 24,
2007).
6
figures, and (3) failing to accurately report the company’s true
financial condition in its published financial statements. Kanter
made no demand on the board of directors before filing suit.
All defendants filed Fed. R. Civ. P. 12(b)(6) motions to
dismiss. In her brief opposing the motions to dismiss, Kanter
requested leave to amend her complaint. Following oral
argument, the District Court determined the proposed
amendment would be futile, denied Kanter’s motion, and
granted defendants’ motions to dismiss with prejudice. The
District Court held Kanter had failed to make demand of the
board of directors, and had failed to plead facts with sufficient
particularity to merit excuse of the demand requirement of Fed.
R. Civ. P. 23.1. After denial of Kanter’s motion for
reconsideration, this appeal followed.
On appeal, Kanter contends the District Court erred by
applying improper legal standards in granting the motion to
dismiss and denying her request to amend her complaint.
II.
The District Court had jurisdiction over this case under
28 U.S.C. § 1332. We have appellate jurisdiction under 28
U.S.C. § 1291.
We review a district court’s ruling on demand futility
under Fed. R. Civ. P. 23.1 for abuse of discretion. Garber v.
Lego, 11 F.3d 1197, 1200 (3d Cir. 1993); Blasband v. Rales, 971
F.2d 1034, 1040 (3d Cir. 1992). We review denial of leave to
amend a complaint for abuse of discretion. In re Burlington
7
Coat Factory Sec. Litig., 114 F.3d 1410, 1434 (3d Cir. 1997).
III.
The central issue in this appeal is whether Kanter should
have been excused from the ordinary requirement that she make
a demand on the board of directors before filing a shareholders’
derivative action in the name of the corporation. We hold the
District Court did not abuse its discretion in granting the
motions to dismiss because Kanter’s pleading lacked the factual
particularity required to excuse demand. The Federal Rules of
Civil Procedure provide that a complaint “shall contain (1) a
short and plain statement of the grounds upon which the court’s
jurisdiction depends . . . (2) a short and plain statement of the
claim showing that the pleader is entitled to relief, and (3) a
demand for judgment for the relief the pleader seeks.” Fed. R.
Civ. P. 8(a).4 Notice pleading requires a plaintiff to provide the
opponent with fair notice of a claim and the grounds on which
that claim is based.
But there are three notable exceptions to notice pleading
that mandate a heightened standard requiring that facts be
pleaded with particularity: (1) pleading fraud, Fed. R. Civ. P.
4
The fundamental function of a federal pleading is “to inform
the opposing party and the court of the nature of the claims and
defenses being asserted by the pleader and, in the case of an
affirmative pleading, the relief being demanded.” 5 Charles
Alan Wright & Arthur R. Miller, Federal Practice and
Procedure § 1182 (3d ed. 2004).
8
9(b), the “who, what, when, where, and how” of the events at
issue, Burlington Coat Factory, 114 F.3d at 1422 (citation
omitted); (2) pleading scienter under the Private Securities
Litigation Reform Act of 1985, 15 U.S.C. § 78j(b), foreclosing
“boilerplate and conclusory allegations,” In re Rockefeller Ctr.
Props., Inc. Secs. Litig., 311 F.3d 198, 216 (3d Cir. 2002)
(citation omitted); and (3) pleading demand futility in
shareholder derivative suits under Fed. R. Civ. P. 23.1.5 Rule
23.1 requires a plaintiff to plead with particularity either the
efforts made to spur directors to take the action sought, and why
these efforts were unsuccessful, or the reasons why no effort
5
Under Fed. R. Civ. P. 23.1, a shareholder may file a
derivative suit against the board of directors to claim
enforcement of a right of the corporation where the corporation
has failed to assert that right. Rule 23.1 contains specific
requirements for plaintiffs’ pleadings in derivative suits. First,
the plaintiff must allege ownership of shares, or subsequent
ownership by operation of law, at the time of the challenged
transaction. Second, the plaintiff must plead that the federal
courts have jurisdiction to hear the action. Third, and of
particular relevance to this case, Rule 23.1 requires plaintiffs to
“allege with particularity the efforts, if any, made by the
plaintiff to obtain the action the plaintiff desires from the
directors or comparable authority . . ., and the reasons for the
plaintiff’s failure to obtain the action or for not making the
effort.” Fed. R. Civ. P. 23.1.
9
was made to demand action from the board. Where a plaintiff
has made no demand on the board, a court may excuse the rule’s
requirement if it determines that demand would have been futile.
But a plaintiff is obliged to plead, with particularity, facts that
establish demand futility. Fed. R. Civ. P. 23.1.
The purpose of Rule 23.1’s demand requirement is to
“affor[d] the directors an opportunity to exercise their
reasonable business judgment and waive a legal right vested in
the corporation in the belief that its best interests will be
promoted by not insisting on such right.” Kamen v. Kemper
Fin. Servs., Inc., 500 U.S. 90, 96 (1991) (internal quotation
marks omitted). The Court has noted the “demand requirement”
of Rule 23.1 relates to the “adequacy of the shareholder
representative’s pleadings,” and does not itself necessarily
require demand. Id. at 96. Furthermore, “the function of the
demand doctrine in delimiting the respective powers of the
individual shareholder and of the directors to control corporate
litigation clearly is a matter of ‘substance,’ not ‘procedure.’” Id.
at 96–97. Thus, federal courts hearing shareholders’ derivative
actions involving state law claims apply the federal procedural
requirement of particularized pleading, but apply state
substantive law to determine whether the facts demonstrate
demand would have been futile and can be excused. Id. at 98-
99.
IV.
At issue is whether Kanter’s pleading contained
sufficiently particularized facts under New Jersey’s substantive
10
standards for determining that demand of the MedQuist board
would have been futile.
The New Jersey Supreme Court in In re PSE&G
Shareholder Litigation, 801 A.2d 295 (N.J. 2002), set forth the
standard for analyzing shareholders’ derivative suits under its
own procedural rule, New Jersey Rule of Court 4:32-3.6
Drawing guidance from two Delaware cases,7 Aronson v. Lewis,
473 A.2d 805 (Del. 1984) and Brehm v. Eisner, 746 A.2d 244
(Del. 2000), the New Jersey Supreme Court articulated New
Jersey’s two-pronged standard for shareholder plaintiffs to
6
New Jersey Rule of Court 4:32-3, states in part:
The complaint shall also set forth with
particularity the efforts of the plaintiff to secure
from the managing directors or trustees and, if
necessary, from the shareholders such action as is
desired, and the reasons for the failure to obtain
such action or the reasons for not making such
effort.
N.J. R. 4:32-3 (formerly designated as R. 4:32-5).
7
The PSE&G court noted this issue was a matter of first
impression, but focused its analysis on the decision of the
Chancery Division of the New Jersey Superior Court in In re
Prudential Insurance Co. Derivative Litigation, 659 A.2d 961
(N.J. Super. Court 1995). The Prudential court, in the absence
of relevant New Jersey precedent, relied heavily on the
decisional law of Delaware.
11
withstand a motion to dismiss for failure to make a demand.
The Court stated:
[T]hey must plead with particularity 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. If either
prong is satisfied, demand will be excused under
[Rule 4:32-3].
PSE&G, 801 A.2d at 310. See also, Aronson, 473 A.2d at 814;
Brehm, 746 A.2d at 256.
In an earlier case, the Chancery Division of the New
Jersey Superior Court applied the Aronson two-prong approach
in In re Prudential Ins. Co. Derivative Litig., 659 A.2d 961 (N.J.
Super. Court 1995). The Prudential court found that the first
prong was not satisfied in that case because plaintiffs had made
“mere ‘conclusory allegations’” about the directors lack of
independence and disinterestedness. PSE&G, 801 A.2d at 309
(quoting Prudential, 659 A.2d at 971). The court noted the
pleading did not differentiate among the directors and set forth
no facts showing that defendants had actual knowledge of the
alleged wrongdoing. The court also rejected the suggestion that
demand was futile because directors would have to sue
themselves, calling this a “bootstrap argument” that, if accepted,
would “weaken the managerial power of directors.” Id.
The Prudential court also found the second prong was
12
not satisfied because the allegations involved inaction by the
board. This, the court reasoned, made it “impossible to perform
the essential inquiry contemplated by Aronson, whether the
directors have acted in conformity with the business judgment
rule in approving the challenged transaction.” Id. at 309
(quoting Prudential, 659 A.2d at 975) (internal quotation marks
omitted); Rales v. Blasband, 634 A.2d 927, 933 (Del. 1993).
Thus, when the complaint asserts inaction by the board, as here,
courts will not excuse demand “in the absence of allegations
demonstrating why the board is incapable of considering a
demand.”8 Prudential, 659 A.2d at 975; Rales, 634 A.2d at 934.
In reviewing a grant of a motion to dismiss, federal courts
“are required to accept as true all allegations in the complaint
and all reasonable inferences that can be drawn therefrom, and
view them in the light most favorable to the plaintiff.” Evancho
8
Rales offered this further guidance on determining demand
futility:
“[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. If the
derivative plaintiff satisfies this burden, then
demand will be excused as futile.
Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993).
13
v. Fisher, 423 F.3d 347, 350 (3d Cir. 2005). “However, a court
need not credit either ‘bald assertions’ or ‘legal conclusions’ in
a complaint when deciding a motion to dismiss.” Id. at 351.9
Kanter’s pleadings fail to create reasonable doubt about the
directors’ independence and disinterestedness or their valid
exercise of business judgment.
A.
Because the New Jersey Supreme Court in PSE&G
sought guidance from Delaware’s decisional law, we will do the
same here. To be independent, “‘a director’s decision is based
on the corporate merits of the subject before the board rather
than extraneous considerations or influences.’” Rales, 634
A.2d, at 936 (quoting Aronson, 473 A.2d at 816). Impartiality
and objectivity are the primary concerns. “Directorial interest
exists whenever divided loyalties are present, or where the
director stands to receive a personal financial benefit from the
transaction not equally shared by the shareholders.” Blasband
v. Rales, 971 F.2d 1034, 1048 (3d Cir. 1992) (citing Aronson,
473 A.2d at 812). A director who is beholden to an interested
director or “so under [another’s] influence that [his] discretion
9
New Jersey’s procedural standard similarly provides that
“‘[p]laintiffs are entitled to all reasonable factual inferences that
logically flow from the particularized facts alleged, but
conclusory allegations are not considered as expressly pleaded
facts or factual inferences.’” PSE&G, 801 A.2d at 312 (quoting
Brehm, 746 A.2d at 255); accord, Prudential, 659 A.2d at 971.
14
would be sterilized” would lack independence. Rales, 634 A.2d
at 936.
Kanter contends Philips controlled the board because it
owned 71 percent of MedQuist’s common stock, a fact she says
strengthens the inference that the directors nominated by Philips
can exert considerable influence over other directors. She
contends that seven directors were either current or former
employees of Philips and so were not independent of Philips
because they were beholden to it for continued employment,
salary and benefits. Thus, she contends a majority of the board
could not reasonably be expected to consider Kanter’s demand
impartially because a majority was controlled by Philips.10
10
Kanter’s complaint alleges the board of directors was
composed of ten persons, six of whom were nominated by
Philips. Defendants insist that the actual composition of the
board was six persons, with three Philips-nominated directors
and three independent directors. The other four persons sued by
Kanter, defendants add, no longer served on the board of
directors at the time the complaint was filed. On appeal,
defendants maintain that Kanter conceded to the District Court
she was aware of this prior to filing her complaint because she
had reviewed the list of directors posted on MedQuist’s Web
site.
Trial transcripts recite that Kanter acknowledged she was
aware of the discrepancy between the list of directors on file for
2003 with the SEC, and the list of directors MedQuist
maintained on its Web site. Kanter told the District Court she
15
But ownership of a majority stake in MedQuist alone
does not necessarily demonstrate a lack of ability to act with the
company’s best interests in mind. Conversely, that Philips
owned such a significant stake in MedQuist may suggest that its
interests were aligned with those of other stockholders or that it
would benefit from the company’s success. McGowan v. Ferro,
859 A.2d 1012, 1029 (Del. Ch. Ct. 2004); see Kaster v.
Modification Sys. Inc., 731 F.2d 1014, 1019 (2d Cir. 1984) (in
derivative action, the bare fact of 71% ownership by an alleged
wrongdoer was insufficient to excuse demand). The Aronson
court noted that a director’s nomination or election at the behest
of a controlling shareholder is not enough to show a lack of
independence because that “is the usual way a person becomes
named all ten persons as defendants out of an abundance of
caution because she did not know which list was correct.
Here, she contends the actual board membership was a
factual issue that should not have been decided on a motion to
dismiss. But Kanter mischaracterizes the District Court opinion,
which makes no factual determination about the board’s size or
composition, but rather found unavailing Kanter’s assertion that
board members could not be independent simply because Philips
controlled 71 percent of MedQuist’s common stock.
Kanter also contends MedQuist’s failure to update its
directorship list with the SEC supports an inference that the
board consciously disregarded its responsibilities. But this alone
cannot create reasonable doubt about the directors’
independence or disinterestedness.
16
a corporate director.” Aronson, 473 A.2d at 816. The focus
should be on the director’s “care, attention and sense of
individual responsibility to the performance of one’s duties, not
the method of election, that generally touches on independence.”
Id.
Despite Kanter’s assertions of misfeasance or non-
feasance, the only board actions cited in her complaint—those
detailing the board of directors’ response when it was informed
of the allegedly improper billing scheme—suggest that the
board reacted appropriately. The board hired two outside
firms—law firm Debevoise & Plimpton LLP and accounting
firm PricewaterhouseCoopers, LLP—to conduct an independent
investigation. Following results of this investigation, the board
disciplined several employees; and it notified shareholders and
the general public of inaccuracies in its financial reports for the
relevant periods. The complaint fails to create a reasonable
doubt that the MedQuist board lacked independence as a result
of Philips’ ownership of a majority stake in MedQuist.
Kanter also contends that defendant A. Fred Ruttenberg,
a partner at the law firm Blank Rome Comisky & McCauley
LLP11 and an outside MedQuist director, was not independent
because his firm had acted as outside counsel to MedQuist. She
asserts Ruttenberg was beholden to Philips to maintain the
business relationship between his firm and MedQuist.
The Court of Appeals for the Sixth Circuit found no
11
The firm has since shortened its name to Blank Rome LLP.
17
automatic inference of bias or control on the part of a director
who had himself given legal assistance to the company as
outside counsel.12 In re Gen. Tire & Rubber Co. Sec. Litig., 726
F.2d 1075, 1084 (6th Cir. 1984). We agree. Kanter has failed
to create a reasonable doubt of Ruttenberg’s independence on
this ground.13
B.
12
Other courts have noted that where a complaint fails to
allege the amount of fees received by a director’s law firm or
fails to show that the director’s compensation from the firm was
tied to work he helped bring in from the company, it “fails to
allege the materiality of these factors to [the director].”
Guttman v. Huang, 823 A.2d 492, 503 (Del. Ch. 2003). The
Delaware Chancery Court has also suggested that receipt of
“substantial” fees by the law firm of a director could create
reasonable doubt as to that director’s independence, but that this
inference was not automatic. In re Ply Gem Indus., Inc.,
S’holders Litig., 2001 WL 755133 at *8–9 (Del. Ch. 2001)
(where a partner at a small law firm brought nearly $1 million
in revenues from a single client in one year to the firm, he “may
be sufficiently beholden to, or at least significantly influenced
by, that client as to affect the independence of his judgment”).
13
Kanter makes no specific claims at all about the other two
outside directors, either about how they are controlled or how
they acted inappropriately.
18
Kanter also fails to create a reasonable doubt as to the
directors’ disinterestedness. As noted, “[d]irectorial interest
exists when divided loyalties are present, or where the director
stands to receive a personal financial gain from the transaction
not equally shared by the shareholders.” Prudential, 659 A.2d
at 971; Aronson, 473 A.2d at 812. “A director is not to be
viewed as being ‘interested’ merely because he or she may have
approved the challenged transaction or because a shareholder
alleges that the directors would be reluctant to sue a fellow
corporate decision-maker.” PSE&G, 801 A.2d at 314;
Prudential, 659 A.2d at 971. “A plaintiff may not bootstrap
allegations of futility merely by alleging that the directors
participated in the challenged transaction or that they would be
reluctant to sue themselves.” Prudential, 659 A.2d at 971.
As the District Court noted, the complaint does not place
specific blame on any director, nor does it assert they had
knowledge of the alleged billing practice or that they benefitted
from the use of this practice. In Prudential, the court was faced
with similarly unspecific pleadings about director interest. It
wrote:
The amended complaint does not single out,
among current or past directors, which directors
participated in the alleged wrongdoing, which
directors “control” the board and which are, in
turn, “controlled.” No individual directors or
group of directors are set apart; in fact, many
allegations do not differentiate among the
19
directors and the other defendants. Nor does the
amended complaint plead any facts showing that
past directors had actual knowledge of the alleged
wrongdoings at the time they were committed.
Id., at 971.
Here the complaint fails to allege specific actions by any
of the defendants, nor does it assert knowledge of alleged
wrongdoings. The District Court found these conclusory
allegations insufficient to satisfy the heightened pleading
requirements of Rule 23.1. We agree.
Kanter’s pleadings are non-specific, and fail to
differentiate between directors other than to assert all the
Philips-nominated directors were controlled by Philips and that
Ruttenberg was beholden to Philips for law firm business. With
the exception of Ruttenberg, no specific director is alleged to
have any interest in the alleged scheme that would differ from
the shareholders’. And in Ruttenberg’s case, as noted, that
allegation is attenuated.
The bare allegation that a board is interested because its
members would be reluctant to sue themselves has been
considered and rejected. See Prudential, 659 A.2d at 972;
Aronson, 473 A.2d at 816. Kanter has not pled sufficiently
particularized facts to show director interest or lack of
independence
C.
20
Kanter has also failed to create a reasonable doubt that
the board exercised valid business judgment in the challenged
transaction, thus failing to satisfy the second prong of the
analysis adopted by the New Jersey Supreme Court in PSE&G.
Aronson and Prudential noted the difficulty of
overcoming the valid business judgment presumption in
situations where the allegations involved inaction by a board.
Aronson, 473 A.2d at 813; Prudential, 659 A.2d at 974–75. As
noted, the PSE&G Court held that where inaction is the heart of
the allegation, the plaintiff bears the burden of demonstrating a
reasonable doubt as to the validity of the business judgment
presumption.
Kanter challenges broad inaction by the board. The only
actions pleaded—the actions taken by the board after learning
of the alleged improper billing scheme—cut against her
argument rather than bolster it. Her pleaded facts do not suggest
incompetence or misfeasance that might call into question the
board’s business judgment.
The board’s actions included an independent
investigation by Debevoise & Plimpton and
PricewaterhouseCoopers, a public statement that the company’s
financial filings and statements during the relevant period
should not be relied on, and the discipline of several employees.
These appear to be precisely the types of actions an independent
board exercising valid business judgment should take when
made aware of a serious problem. By themselves they do not
create reasonable doubt as to the validity of its judgment.
21
Kanter does not plead facts showing that the board or
Philips were involved in the scheme, that they conceived it or
covered it up, or that they acted improperly once made aware of
it. The absence of such facts in her pleading—and the presence
of facts that undercut her contention—defeats her argument that
demand of the board would have been futile. Kanter has failed
to satisfy the second prong of the PSE&G test.
1.
The District Court also rejected Kanter’s attempt to paint
her claim as fitting under In re Caremark International, Inc.
Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). The
District Court noted that Kanter’s claims were “empty of the
kind of fact pleading that is critical to a Caremark claim,” which
would have to show the directors were conscious of the fact they
were not doing their jobs. See Guttman v. Huang, 823 A.2d
492 (Del. Ch. 2003). Such pleading should have alleged the
lack of an audit committee, or the existence of an audit
committee whose work was patently inadequate or that
functioned with clear notice of serious accounting irregularities,
the District Court noted.
We agree. Kanter has failed to plead there were any red
flags that should have alerted the directors to the problems.
Rather, she pleaded the opposite, that MedQuist had a
functioning audit committee that appears to have been
functioning and meeting properly, and that the board’s actions
when it learned of the problem were responsive and appropriate.
22
V.
Kanter also appeals the denial of her motion for leave to
amend her complaint. Fed. R. Civ. P. 15(a) provides that leave
to amend a complaint shall be freely given when justice so
requires. Generally, a plaintiff will be given the opportunity to
amend her complaint when there is an asserted defense of failure
to state a claim. Shane v. Fauver, 213 F.3d 113 (3d. Cir. 2000);
6 Charles Alan Wright & Arthur R. Miller, Federal Practice
and Procedure § 1473 (2d ed. 1990). We review for abuse of
discretion, and there is none where pleading deficiencies would
not have been remedied by proposed amendments. In re Adams
Golf, Inc. Sec. Litig., 381 F.3d 267, 280 (3d. Cir 2004). Where
an amended pleading would be futile, that alone is sufficient
ground to deny leave to amend. See Burlington Coat Factory,
114 F.3d at 1434–35; Lake v. Arnold, 232 F.3d 360, 373 (3d Cir.
2000).
After oral argument, the District Court denied Kanter’s
motion for leave to amend. A review of the transcript
demonstrates that Kanter offered no new facts demonstrating
demand futility.14
14
The only new facts offered were that three class action
lawsuits had been filed against MedQuist, suits which Kanter
posited would help her plead with greater specificity. However,
these complaints had been filed some months prior to Kanter’s
original complaint, and Kanter failed to identify what facts, if
any, from those cases would help her case.
23
The District Court did not abuse its discretion in denying
leave to amend the complaint.15
VI.
For these reasons, we will affirm the judgment of the
District Court.
15
Kanter also contends the District Court should have applied
a reasonable doubt standard in its analysis of whether
MedQuist’s exculpatory provision shielded the directors.
New Jersey allows a corporation to include an
exculpatory provision for its directors and officers in its charter.
Such provisions, however, cannot exculpate directors and
officers from “any breach of duty based upon an act or omission
(a) in breach of such person’s duty of loyalty to the corporation
or its shareholders, (b) not in good faith or involving a violation
of law or (c) resulting in receipt by such person of an improper
personal benefit.” N.J. Stat. Ann. § 14A:2-7 (West 2006).
The District Court here applied the standard that where
the charter provision is consistent with the state statute, the
provision provides significant protection for directors, and the
plaintiff must show a “substantial likelihood” of success in
proving that one of the three exceptions to the exculpatory
provision was met. Guttman, 823 A.2d at 501.
Whether the standard is “reasonable doubt” or
“substantial likelihood,” Kanter’s pleading fails under either
test.
24