Shareholder Derivative Action Dismissed Because Plaintiff Failed To Make A Demand on the Board of Directors

IN RE HURON CONSULTING GROUP, INC. v. HURON CONSULTING GROUP, INC., Ill: Appellate Court, 1st Dist., 2nd Div. 2012 - Google Scholar:


This case arises under Delaware law.  Plaintiff, Brian Hacias, brought a derivative action purportedly on behalf of Huron Consulting against its directors.  Because the corporation was a Delaware corporation, Delaware law applies.


A derivative action is a lawsuit brought by a shareholder on behalf of the corporation against an alleged corporate wrongdoer.  The shareholder is attempting to stand in the shoes of the corporation.


Under Delaware law, the plaintiff shareholder who brings a derivative action must make a demand on the board of directors or allege what is known as demand futility.  In plain English, the plaintiff must tell the Board of Directors about the alleged wrongdoing and tell the Board to pursue it.


In some circumstances, demand is excused.  This usually occurs where the directors are not disinterested, such as where the directors are themselves the alleged wrongdoers.  Delaware law allows the plaintiff to allege that the directors could not be expected to sue themselves for wrongdoing.


Under the Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) 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 a product of a valid exercise of business judgment."  The Aronson standard applies to specific decisions of the Board of Directors.


Where the Board of Directors did not make a decision regarding the issues in the lawsuit, another standard applies.  Under Delaware law, "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.'" (quoting Braddock v. Zimmerman, 906 A.2d 776 (Del. 2006).


Here the court found that the plaintiff had not adequately alleged demand futility under either test and dismissed the case.  In essence, plaintiff failed to allege that any one of the directors was "interested."  Instead, according to the court, plaintiff made conclusory allegations which were insufficient to state a claim.


The Appellate Court affirmed the dismissal of the Complaint.


Edward X. Clinton, Jr.

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Manufacturer's Fraud Claim Against Walgreens Dismissed Under Rule 9(b)

IMAGENETIX, INC. v. Walgreen Co., Dist. Court, ND Illinois 2012 - Google Scholar:

The plaintiff is a manufacturing company that sold goods to Walgreens.  Plaintiff participated in a Walgreens coupon program under which those who purchased its product would receive a coupon.  After the program ended Walgreens sent Plaintiff an invoice for rebates totaling $640,000.

Plaintiff claimed that Walgreens engaged in fraud by charging it for rebates that were not valid.

Federal Rule of Civil Procedure 9(b) requires a heightened state of pleading for fraud claims.  The court explained:

"Allegations of fraud are subject to a heightened pleading requirement. Rule 9(b) requires that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." The heightened pleading therefore requires a complaint alleging fraud to contain more substance to survive a motion to dismiss as compared to a Rule 12(b)(6) motion based on another cause of action. See Ackerman v. Nw. Mutual Life Ins. Co., 172 F.3d 467, 469 (7th Cir. 1999) (stating that Rule 9(b) forces "the plaintiff to do more than the usual investigation before filing his complaint"). A satisfactory fraud pleading must include "the who, what, when, where, and how: the first paragraph of any newspaper story." DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990)."

As the court noted, the plaintiff claimed that it grew suspicious of Walgreens' rebate claim.  Therefore, according to the Court there was no reliance and no fraud.  The Court explained as follows:

"The motion to dismiss the fraud claim is granted. To prove common law fraud, Plaintiff must plead the following elements: (1) a false statement of material fact; (2) defendant's knowledge that the statement was false; (3) defendant's intent that the statement induce the plaintiff to act; (4) plaintiff's reliance upon the truth of the statement; and (5) plaintiff's damages resulting from reliance on the statement. Tricontinental Indus. v. PricewaterhouseCoopers, LLP, 475 F.3d 824, 841 (7th Cir. 2007) (citing Connick v. Suzuki Motor Co., Ltd., 675 N.E.2d 584, 591 (Ill. 1996)). As described above, the elements must be described with particularity.

The first, second, and third elements here are well-pled. Plaintiff has provided sufficient specifics about what statements were false: namely, the billing statements from Walgreens to Plaintiff. These statements, according to Plaintiff, essentially inflated the redemption rate in order to prompt Plaintiff to overpay for the Register Rewards and Easy Saver programs. The second and third elements can be pled generally under Rule 9(b), and the complaint quite clearly alleges knowledge of the falsity and intent to induce.

Where the complaint falls flat is on reliance and damages. I take reliance first. As to the Register Rewards program, Paragraphs 14 and 15 illustrate the point. Paragraph 14 reads as follows:

Following the week of the promotion, Walgreens represented to Imagenetix that it issued approximately 54,000 Register Rewards coupons related to the purchase of Celadrin and that 52,039 of those coupons were redeemed by customers. The redemption rate of over 95 percent was excessively high, especially considering the relatively short expiration period (i.e., two weeks) for each Register Rewards coupon. Walgreens billed Imagenetix $533,000 for coupons purportedly redeemed, plus $188,000 for scan down charges and a co-op charge related to the Register Rewards program.

It is this representation by Walgreens that Imagenetix claims was false. Even if true, however, Paragraph 15 not only fails to specify reliance, it comes close to pleading Plaintiff out of court on that element:

Because of the extremely high redemption rate for its Register Rewards promotion, Imagenetix audited the program. Imagenetix analyzed the purportedly redeemed coupons that were sent to Imagenetix by Walgreens' coupon processor, NCH Marketing Services, Inc. ("NCH"). Each Register Rewards coupon has a fourteen-digit code with the store number, lane number, and the date and time the coupon was printed. Imagenetix's audit revealed wide-spread fraud by Walgreens.

The most likely interpretation of this paragraph is that Imagenetix was suspicious of Walgreens' alleged misrepresentation, and sought to check out Walgreens' claims for reimbursement. If so, Plaintiff did not rely on Walgreens' representations — false or otherwise — and thus could not prove common law fraud.^[1]

But I must interpret the complaint in Plaintiff's favor and there is one interpretation that could save Plaintiff's case. This interpretation is that Plaintiff in fact paid Walgreens the full amount Walgreens had fraudulently demanded, and audited the program shortly after. If that is what Plaintiff is trying to say, then reliance may be present and the fraud complaint might plausibly be plead. I note that this interpretation only saves Plaintiff from a "with prejudice" dismissal.^[2]The claim of fraud is dismissed because the fourth element is not plead with sufficient particularity, but Plaintiff may attempt to amend the complaint to more clearly and specifically plead the reliance element.

The fifth element, damages from the reliance, is also far too vague to meet the strictures of Rule 9. Regarding the alleged damages, the complaint says two things. First, in Paragraph 23, regarding the Easy Saver program, the complaint says: "[o]n information and belief, Walgreens charged Imagenetix an amount in excess of the payments received by consumers." This statement is problematic for two reasons. One, it is vague as to whether Walgreens simply presented a bill or whether Imagenetix actually paid the bill. If only the former, then Imagenetix did not rely on the statements and was not damaged. If the latter, more particularity is required. This is because allegations made "on information and belief" are inappropriate in the fraud context, unless the relevant facts are not accessible to the plaintiff and the plaintiff provides grounds for his suspicions. Pirelli Armstrong Tire Corp. Retiree Med. Benefits Tr. v. Walgreen Co., 631 F.3d 436, 442-43 (7th Cir. 2011). The exception to the general rule does not apply here, because any payments Plaintiff has made would obviously be known to them.

The second statement regarding damages is as follows: "[a]s a result of Walgreens' misconduct related to the Register Rewards, Easy Saver, and other programs, Imagenetix and other manufacturers have overpaid Walgreens." It is entirely unclear what Plaintiff paid, when it paid, and under which of the programs. Rule 9 commands that Plaintiff provide more detail about how much it paid and when it paid those amounts pursuant to which programs. Plaintiff must also show in its pleading how its reliance on Walgreens' false statements led to the payments.

The fraud allegations are dismissed for failure to plead sufficient particularities under Rule 9. For the reasons stated above, the dismissal is without prejudice."

The court gave Imaginetix leave to amend the complaint.

Comment: Obviously, the lesson here is that under the new pleading standards set forth in recent U.S. Supreme Court decisions. plaintiffs must provide much more detail than previously.  The old days of federal notice pleading are long gone.  Fact pleading, which has long been the practice in the state courts, is now slowly becoming the accepted federal practice.

Edward X. Clinton, Jr.

www.clintonlaw.net

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