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Klein v. H.I.G. Capital, L.L.C.

Court of Chancery of Delaware

December 19, 2018

MELVYN KLEIN, Plaintiff,
v.
H.I.G. CAPITAL, L.L.C.; H.I.G. SURGERY CENTERS, LLC; H.I.G. BAYSIDE DEBT & LBO FUND II; BCPE SEMINOLE HOLDINGS LP; BAIN CAPITAL INVESTORS, LLC; BAIN CAPITAL PRIVATE EQUITY, LP; MICHAEL DOYLE; MATTHEW LOZOW; ADAM FEINSTEIN; TERESA DELUCA; and BRENT TURNER, Defendants, and SURGERY PARTNERS, INC., Nominal Defendant.

          Date Submitted: September 13, 2018

          Kurt M. Heyman and Melissa N. Donimirski, HEYMAN ENERIO GATTUSO & HIRZEL LLP, Wilmington, Delaware; Jason M. Leviton and Joel A. Fleming, BLOCK & LEVITON LLP, Boston, Massachusetts, Attorneys for Plaintiff.

          Stephen C. Norman and Jaclyn C. Levy, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; David B. Hennes, Martin J. Crisp, and Paul S. Kellogg, ROPES & GRAY LLP, New York, New York, Attorneys for Nominal Defendant Surgery Partners, Inc. and Defendant Michael Doyle.

          Elena C. Norman and Benjamin M. Potts, YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware, Attorneys for Defendants H.I.G. Bayside Debt & LBO Fund II, H.I.G. Capital, LLC, and H.I.G. Surgery Centers, LLC.

          David E. Ross and S. Michael Sirkin, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Yosef J. Riemer, P.C., Devora W. Allon, and Alexandra Strang, KIRKLAND & ELLIS LLP, New York, New York, Attorneys for Defendants Bain Capital Investors, LLC, Bain Capital Private Equity, LP, and BCPE Seminole Holdings LP.

          MEMORANDUM OPINION

          BOUCHARD, C.

         In May 2017, Surgery Partners, Inc. and its controlling stockholder (HIG) simultaneously entered into three interrelated transactions. First, Surgery Partners agreed to purchase National Surgical Healthcare from a third party. Second, HIG agreed to sell its 54% common stock stake in Surgery Partners to an affiliate of Bain Capital Private Equity, LP for a per-share price that reflected a premium over the market price at the time. Third, Surgery Partners agreed to issue to Bain shares of a newly created class of Series A preferred stock that voted with its common stock, paid a 10% dividend, and contained other allegedly attractive terms, including a conversion feature that already was "near" or "in" the money.

         Critically, each of the three transactions was conditioned on the others. This meant that the sale of HIG's control position to Bain would not happen unless Bain was satisfied with the terms of the Series A preferred stock. This created a dynamic whereby HIG allegedly was incentivized to provide Bain favorable terms on the Series A preferred stock in order to maximize the price at which HIG could liquidate and exit its investment in Surgery Partners.

         In December 2017, a few months after the three transactions closed, a stockholder plaintiff (Melvyn Klein) filed this action challenging the fairness of the Series A preferred stock issuance to Bain. His complaint focuses on the incentives HIG and Bain had to "scratch each other's back" and criticizes the process surrounding the deal negotiations, including that (i) Bain used the same counsel and accounting advisor as Surgery Partners during the negotiations, (ii) Surgery Partners did not utilize a special committee to exclude HIG's representative on the board from negotiations concerning the Series A preferred stock despite the conflict HIG faced with respect to selling its control position to Bain, (iii) no stockholder other than HIG had any say in approving any of the transactions, and (iv) Surgery Partners' financial advisor did not provide a fairness opinion concerning the consideration paid for the Series A preferred stock and stood to benefit from the transactions by providing financing for Surgery Partners' acquisition of National Surgical Healthcare in addition to receiving an advisory fee on the deal.

         Klein's complaint asserts eight claims. Four of them are pled as direct claims and the other four are pled as derivative claims. The legal theories underlying each of the direct claims mirror the derivative claims. Defendants have moved to dismiss all of the claims under Court of Chancery Rule 23.1 for failure to make a demand on Surgery Partners' board before filing suit and under Court of Chancery Rule 12(b)(6) for failure to state a claim for relief. For the reasons explained below, the court concludes that six of the claims must be dismissed but that the other two will survive.

         Three subsidiary conclusions drive this result. First, the court rejects plaintiff's contention that his admittedly derivative claims fall within the paradigm our Supreme Court recognized in Gentile v. Rossette[1] for asserting claims "dually" as both direct and derivative claims, thus all of the direct claims must be dismissed. Second, plaintiff has pled sufficient particularized facts to raise a reasonable doubt about the independence and disinterestedness of a majority of the directors on Surgery Partners' board when the complaint was filed, thus plaintiff is excused for failing to make a demand on the board. Third, the complaint states derivative claims for (i) breach of fiduciary duty against HIG as Surgery Partners' controlling stockholder on the theory that it received a unique benefit and was conflicted in connection with the transactions, thereby presumptively triggering entire fairness review of the Series A preferred stock transaction, and (ii) aiding and abetting a breach of fiduciary duty against Bain. The reasoning for these conclusions follows.

         I. BACKGROUND

         The facts recited herein are based on facts pled in the Verified Class Action and Derivative Complaint (the "Complaint") and documents incorporated therein.[2]Any additional facts are either not subject to reasonable dispute or are subject to judicial notice.

         A. The Parties

         Nominal Defendant Surgery Partners, Inc. ("Surgery Partners" or the "Company") is a Delaware corporation headquartered in Nashville, Tennessee that provides surgical services across twenty-nine states. The Company is publicly listed, and its shares trade on NASDAQ. Plaintiff Melvyn Klein alleges he has been a stockholder of the Company since at least October 1, 2015.[3]

         Defendant H.I.G. Capital, LLC, a Delaware limited liability company, is a private investment management firm that focuses on private equity, venture capital, debit/credit, real estate, and public equity investments. Defendants H.I.G. Surgery Centers, LLC and H.I.G. Bayside Debt & LBO Fund II are Delaware entities affiliated with and managed by H.I.G. Capital, LLC. For simplicity, these three entities will be referred to collectively as "HIG." HIG owned 54.2% of the Company's outstanding common stock as of April 17, 2017.[4]

         Defendant Bain Capital Private Equity, LP, a Delaware limited partnership, is an investment advisory firm focused on advising on private equity investments, including leveraged acquisitions and recapitalizations, investments in growth companies, turnarounds, and traditional buyouts. The Complaint names as defendants two other entities affiliated with Bain Capital Private Equity, LP: BCPE Seminole Holdings LP and Bain Capital Investors, LLC. For simplicity, these three entities will be referred to collectively as "Bain."

         The individual defendants (the "Director Defendants") consist of the five members of the Company's board of directors (the "Board") when the three transactions described below were entered into on May 9, 2017: Teresa DeLuca, Michael Doyle, Adam Feinstein, Matthew Lozow, and Brent Turner.[5] Doyle has been a director of Surgery Partners since August 2012 and served as its Chief Executive Officer from April 2015 through September 7, 2017.[6] He continued to serve on the Board after stepping down as CEO.[7] Turner has served as a director of Surgery Partners since December 2015 and as the President of Acadia Healthcare Company since 2011.[8] Lozow is a Managing Director of H.I.G. Capital and was a director of Surgery Partners from April 2015 through August 31, 2017.[9] Feinstein and DeLuca have been directors of Surgery Partners since August 2015 and September 2016, respectively.[10]

         B. Approval of the Transactions

         On May 3, 2007, Christopher Laitala, a former Managing Director of H.I.G. Capital and the Chairman of the Board of Surgery Partners at the time, "abruptly" resigned from the Board.[11] Less than one week later, on May 9, the Board-then consisting of Doyle, Lozow, Feinstein, DeLuca, and Turner-approved and the Company simultaneously entered into three transactions (the "Transactions").[12]

         In the first transaction, Surgery Partners agreed to acquire National Surgical Healthcare from a third party (Irving Place Capital) for approximately $760 million (the "NSH Acquisition").[13] In the second transaction, HIG agreed to sell all of its common shares of Surgery Partners to Bain at a price of $19 per share in cash for a total purchase price of approximately $502.7 million (the "HIG Share Sale").[14] In the third transaction, Surgery Partners agreed to issue and sell to Bain 310, 000 shares of a newly created class of Series A preferred stock of the Company (the "Preferred Stock") at a price of $1, 000 per share, for a total price of $310 million (the "Bain Share Issuance").[15]

         The Transactions were interrelated and dependent on each other. Specifically, the NSH Acquisition was conditioned on the completion of both the Bain Share Issuance and the HIG Share Sale, and the HIG Share Sale was conditioned on the Bain Share Issuance.[16]

         The Preferred Stock accrues dividends at a rate of 10%, compounding quarterly, and is convertible into common stock at a price of $19 per share.[17] The Preferred Stock is senior to the Company's common stock and its holders vote with the common stockholders together as a single class.[18] As long as Bain retains 50% of the shares of the Preferred Stock issued in the Bain Share Issuance, its affirmative vote is required before the Company can pay dividends other than dividends on the Preferred Stock; enter into a recapitalization, share exchange, or merger; increase its indebtedness; or modify any provision of the Company's organizational documents that would adversely affect the powers of the Preferred Stock, among other things.[19]The Preferred Stock, together with the common stock Bain acquired from HIG, represents approximately 66% of the voting power of all classes of capital stock of the Company.[20]

         According to the Complaint, the implied call option provided by the convertible feature of the Preferred Stock already was "near the money/in the money" when the Transactions were announced.[21] On May 9, 2017, the date the Board approved the Transactions, shares of Surgery Partners closed at $18.20 per share.[22] The next day, when the Transactions were announced, the shares closed at $20.95 per share.[23] The Complaint alleges that the dividend rate on the Preferred Stock was "extraordinarily favorable," as the Company had issued $400 million of senior unsecured notes in March 2016 with an interest rate of 8.875%.[24]

         No special committee was appointed to negotiate or approve the Transactions.[25] The Company's public filings state that all three Transactions were approved by the Board, without mentioning that any of the five directors on the Board at that time had abstained from voting.[26] Despite this lack of public disclosure, HIG and the Director Defendants contend-and plaintiff does not object to the court considering for purposes of the pending motions-that one of the directors who was affiliated with HIG (Lozow) abstained from voting on the Transactions.[27] The public stockholders were not asked to vote on the Transactions, which HIG approved by written consent as the Company's majority stockholder.[28]

         The Complaint alleges that various firms that provided advice on the Transactions had conflicts of interest. Ropes & Gray LLP, which was Bain's longtime counsel, advised both Surgery Partners and Bain on the Transactions.[29]Allegedly in recognition of this conflict, Bain also engaged Kirkland & Ellis LLP as its counsel.[30] PwC LLP represented both Bain and Surgery Partners as an accounting advisor with respect to the Transactions.[31] Jefferies LLC served as the Company's exclusive financial advisor, but it did not issue a fairness opinion and stood to benefit from the Transactions by providing financing for the NSH Acquisition and earning fees for arranging a $1.29 billion senior credit term loan and a $75 million revolving credit facility.[32]

         C. Events after the Transactions Were Approved

         During a May 10, 2017 earnings call, an analyst expressed puzzlement over the Company's decision to finance the NSH Acquisition through the Bain Share Issuance rather than issuing common stock, asking:

did you guys contemplate issuing equity, just straight out equity? Or did Irving-did the buyers not want equity? Or was it just because of the competitive nature that you had to pay cash? I'm just curious, again, going back to the deleveraging or the opportunity that arose that could have led to a deleveraging.[33]

         Doyle provided a "rambling response," stating, in relevant part, that:

the competitive nature of the transaction and the certainty of outcome from our perspective and from the other side's perspective or-again, there's a lot of things that come into play, and it was a pretty complicated process with, as you take a look at us bringing in a new long-term partner in Bain Capital Private Equity, replacing H.I.G., putting in a preferred and acquiring a company.[34]

         The Transactions closed on August 31, 2017. Upon the closing, Lozow resigned from the Board and two Managing Directors of Bain were elected as directors: Christopher Gordon and T. Devin O'Reilly.[35] After the closing, Bain held approximately 65.7% of the Company's outstanding voting stock, and publicly described itself as "the controlling stockholder of [Surgery Partners]."[36]

         On September 7, 2017, the Company announced that Doyle would be stepping down as CEO, but would remain on the Board.[37] Doyle and the Company entered into a consulting services agreement under which Doyle consulted for six months in exchange for a total fee of $275, 000.[38] Doyle also entered into a severance agreement under which he received, among other things, his salary through the date of his resignation, $550, 000 in cash severance to be paid over a twelve month period, a pro-rata portion of the bonus he would have earned in 2017, and COBRA premiums for a year.[39]

         Clifford Adlerz replaced Doyle as CEO of Surgery Partners on September 7, 2017.[40] Adlerz, who previously provided consulting services to Bain, became a member of the Board on October 30, 2017.[41]

         II. PROCEDURAL HISTORY

         On December 4, 2017, Klein filed this action.[42] The Complaint contains eight claims. Counts I-IV are pled as direct claims and Counts V-VIII are pled as derivative claims. The legal theories underlying each of the four direct claims mirror each of the four derivative claims.

         Counts I and V assert claims for breach of fiduciary duty against the Director Defendants for "entering into the Transactions without ensuring that the Bain Capital Share Issuance was entirely fair."[43] Counts II and VI assert claims for breach of fiduciary duty against Bain and HIG as an alleged control group "[a]t the time the Transactions were agreed to" for "entering into the Bain Capital Share Issuance, a conflicted transaction that was not entirely fair."[44] Counts III and VII assert, in the alternative to the breach of fiduciary duty claims asserted against HIG in Counts II and VI, respectively, claims for breach of fiduciary duty against HIG as "the sole controlling stockholder" for "causing the Company to enter into the Bain Capital Share Issuance, a conflicted transaction that was not entirely fair."[45] Counts IV and VIII assert, in the alternative to the breach of fiduciary duty claims asserted against Bain in Counts II and VI, respectively, that Bain aided and abetted breaches of fiduciary duty by HIG and the Director Defendants.[46]

         On March 5, 2018, defendants filed their opening briefs in support of motions they had filed several months earlier to dismiss the Complaint under Court of Chancery Rules 12(b)(6) and 23.1. On April 17, 2018, plaintiff voluntarily dismissed DeLuca and Feinstein from this action without prejudice.[47] On September 17, 2018, a few days after oral argument on the pending motions, the court entered an order approving a stipulation the parties had filed to dismiss Lozow and Turner from this action with prejudice only as to the plaintiff in this action.[48]

         III. ANALYSIS

         The standard for deciding a motion to dismiss under Court of Chancery Rule 12(b)(6) is well-settled:

(i) all well-pleaded factual allegations are accepted as true; (ii) even vague allegations are "well-pleaded" if they give the opposing party notice of the claim; (iii) the Court must draw all reasonable inferences in favor of the non-moving party; and [iv] dismissal is inappropriate unless the plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof.[49]

         Under Court of Chancery Rule 23.1, a derivative claim will be dismissed for lack of standing unless plaintiffs either "(1) make a pre-suit demand by presenting the allegations to the corporation's directors, requesting that they bring suit, and showing that they wrongfully refused to do so, or (2) plead facts showing that demand upon the board would have been futile."[50]

         As the above recitation of his claims demonstrates, Klein does not challenge the NSH Acquisition, which involved the Company's acquisition of a healthcare business from a third party. Nor does he directly challenge the HIG Share Sale, in the sense of seeking any relief concerning the transfer to Bain of HIG's majority ownership of common stock in Surgery Partners. Rather, the Complaint focuses on the Bain Share Issuance.[51] More specifically, the gravamen of the Complaint is that Bain paid less than fair value to the Company to acquire the Preferred Stock and that HIG "had a strong economic motivation to make the terms of the Bain Capital Share Issuance appealing to Bain Capital because Bain Capital would, rationally, be willing to pay more for HIG's common stock as the terms of the Bain Capital Share Issuance became more favorable."[52]

         The following analysis of the eight claims in the Complaint proceeds in three parts. The court begins by determining whether Counts I-IV properly can be brought as direct claims, or whether they are purely derivative claims. The court next considers whether demand would be futile with respect to the derivative claims (Counts V-VIII) and then, after finding that demand would be futile in this case, analyzes defendants' arguments for dismissal under Rule 12(b)(6) for failure to state a claim for relief.

         A. Counts I-IV of the Complaint Must Be Dismissed Because They Cannot Be Brought as Direct Claims.

         To determine whether a claim is direct or derivative, the court must consider "(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?"[53] "In the typical corporate overpayment case, a claim against the corporation's fiduciaries for redress is regarded as exclusively derivative, irrespective of whether the currency or form of overpayment is cash or the corporation's stock."[54] This is because "any dilution in value of the corporation's stock is merely the unavoidable result . . . of the reduction in the value of the entire corporate entity, of which each share of equity represents an equal fraction."[55]

         Klein's claims are a classic form of an "overpayment" claim. He disputes the fairness of the consideration paid for the Preferred Stock given its terms, in particular its dividend rate and the implied call option value of its conversion feature. The Complaint alleges, for example, that "the Preferred Stock had significant option value because the conversion price was already lower than the trading price. Yet Bain Capital also got an extraordinarily favorable dividend rate of 10%."[56] Such claims are quintessentially derivative.[57] Indeed, Klein does not contend that his claims are not derivative, [58] he just argues that they also can be brought as direct claims under the "transactional paradigm" recognized in Gentile v. Rosette.[59]

         In Gentile, our Supreme Court recognized "a species of corporate overpayment claim" that can be both direct and derivative in nature:

A breach of fiduciary duty claim having this dual character arises where: (1) a stockholder having majority or effective control causes the corporation to issue "excessive" shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding shares owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders. Because the means used to achieve that result is an overpayment (or "over-issuance") of shares to the controlling stockholder, the corporation is harmed and has a claim to compel the restoration of the value of the overpayment. That claim, by definition, is derivative.
But, the public (or minority) stockholders also have a separate, and direct, claim arising out of that same transaction. Because the shares representing the "overpayment" embody both economic value and voting power, the end result of this type of transaction is an improper transfer-or expropriation-of economic value and voting power from the public shareholders to the majority or controlling stockholder. For that reason, the harm resulting from the overpayment is not confined to an equal dilution of the economic value and voting power of each of the corporation's outstanding shares. A separate harm also results: an extraction from the public shareholders, and a redistribution to the controlling shareholder, of a portion of the economic value and voting power embodied in the minority interest. As a consequence, the public shareholders are harmed, uniquely and individually, to the same extent that the controlling shareholder is (correspondingly) benefited.[60]

         In short, the harm Gentile seeks to remedy arises "when a controlling stockholder, with sufficient power to manipulate the corporate processes, engineers a dilutive transaction whereby that stockholder receives an exclusive benefit of increased equity ownership and voting power for inadequate consideration."[61]

         Significantly, our Supreme Court recently construed the Gentile doctrine narrowly in El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff.[62] In that case, a limited partner argued that its claim, which alleged overpayments by the partnership to the controlling general partner, fell within the Gentile framework because the overpayments diluted the minority limited partners' economic interests but concededly were "not coupled with any voting rights dilution."[63] The Supreme Court refused to apply Gentile in that circumstance, explaining:

Gentile concerned a controlling shareholder and transactions that resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder. [Plaintiff's] claim does not satisfy the unique circumstances presented by the Gentile species of corporate overpayment claims.[64]

         The Court further explained, "[w]e decline the invitation to further expand the universe of claims that can be asserted 'dually' to hold here that the extraction of solely economic value from the minority by a controlling stockholder constitutes direct injury."[65] To do so, the Court reasoned, "would deviate from the Tooley framework and largely swallow the rule that claims of corporate overpayment are derivative."[66] In a concurrence, Chief Justice Strine went further and suggested that Gentile should be overruled, at least in certain respects.[67]

         The Supreme Court's ruling in El Paso was not made lightly. To the contrary, the ruling resulted in the reversal of a $171 million judgment for damages because it ensured that plaintiff's standing to maintain a derivative claim was extinguished when the limited partnership was acquired in a merger "after the trial was completed and before any judicial ruling on the merits" in what the high court described as a "troubling case."[68]

         In the wake of El Paso, this court has exercised caution in applying the Gentile framework, commenting in one case that "[w]hether Gentile is still good law is debatable"[69] and finding in another that "Gentile must be limited to its facts."[70]"Whatever the ultimate fate of the Gentile paradigm may be, the current state of the law for the doctrine to apply is that (i) there must be a controlling stockholder or control group; and (ii) the challenged transaction must result 'in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder.'"[71]

         Defendants make a number of arguments against the application of Gentile in this case, one of which focuses on the structural reality that HIG's ownership interest or voting power was not increased through issuance of the Preferred Stock to Bain and that Bain "was not a stockholder-much less a controlling stockholder-of the Company prior to the Preferred Share Issuance."[72] In other words, according to defendants, Gentile should not apply here because there was no expropriation of either voting power or economic value by the controlling stockholder (HIG) that was in place when the Transactions were approved.

         Relying on Gatz v. Ponsoldt, [73] Klein responds that the court should consider the substance of the Transactions irrespective of their form. In Gatz, our Supreme Court applied Gentile to hold that minority stockholders of Regency Affiliates, Inc. could bring direct claims against its directors, its prior controlling stockholder, and its new majority stockholder where "the direct beneficiary of any alleged expropriation of . . . voting power and economic value" arising from a recapitalization was a third party that owned no Regency stock before the recapitalization.[74] The Supreme Court reasoned that "[l]ooking through the form of the transaction to its substance, it becomes apparent that the Recapitalization is properly analyzed as two separate transactions that [the controlling stockholder], by creative timing and coordination, caused simultaneously to be rolled into one."[75]The first transaction "was a [Gentile] expropriation of voting power and economic value from the public shareholders by and to the controlling shareholder" and the second "was a transfer of the benefits of that expropriation by the controlling shareholder to the third party."[76] Plaintiff argues that, similar to Gatz, the substance of the deal challenged in this case is that HIG expropriated voting power and economic value from the Company's minority stockholders that it transferred to Bain as part of a series of interrelated Transactions.

         Even if the court were to ignore the form of the Transactions here and treat Bain as if it were the Company's controlling stockholder before it acquired the Preferred Stock, Klein's claims nevertheless would not fit within the Gentile framework in my view, particularly in light of the Supreme Court's recent El Paso decision. As previously mentioned, that decision expresses caution in applying Gentile so as not to "expand the universe of claims that can be asserted 'dually'" and makes clear that, to trigger Gentile, there must be a transfer of "both economic value and voting power from the minority stockholders to the controlling stockholder."[77]

         Here, if one assumes for the sake of argument that the Transactions were sequenced so that Bain acquired HIG's common shares of Surgery Partners before it acquired the Preferred Stock, there would not have been a transfer of economic value of the nature contemplated in the Gentile line of cases. To be sure, this hypothetical scenario would have resulted in a dilution of the minority stockholders' voting power. This is because the Preferred Stock votes with the common as a single class and the net effect of the Bain Share Issuance in the hypothetical is that Bain's voting power would have increased from approximately 54% to approximately 66% of all classes of the Company's capital stock, thereby diluting the voting power of the minority stockholders commensurately.

         But, and this is the critical point, the minority stockholders would not have been diluted similarly in this scenario as an economic matter because they retained the same percentage of the Company's shares of common stock after the Preferred Stock was issued as they had before. Thus, there would not have been the type of transfer of economic value normally contemplated in a Gentile claim: a "dilutive stock issuance to a controlling stockholder."[78] Indeed, all else being equal, the minority stockholders' aggregate percentage of the Company's common stock would not be reduced until such time, if ever, that the Preferred Stock is converted into common stock-an event that is not alleged to have occurred.[79]

         In this case, unlike in Gentile, the economic harm that allegedly occurred came not from the issuance of shares of stock to a controller that resulted in an expropriation of economic value from the minority stockholders by diluting their aggregate ownership percentage, but from the issuance of a different type of security (the Preferred Stock) whose terms allegedly should have commanded a higher price than was paid. As noted above, the core grievance in the Complaint is that Bain "got an extraordinarily favorable dividend rate of 10%" even though "the Preferred Stock had significant option value because the conversion price was already lower than the trading price."[80] In other words, the Complaint pleads that Bain paid the Company too little for the Preferred Stock given its favorable terms. The benefit of any recovery to remedy this alleged harm logically would go to the Company rather than any specific stockholder(s) and thus the underlying legal theory is plainly derivative in nature.[81]

         In sum, the Gentile framework does not fit the facts pled in this case. In keeping with our Supreme Court's recent teachings, therefore, I decline to expand that doctrine's reach to treat Counts I-IV of the Complaint as dual claims in order to avoid further erosion of the Tooley framework for distinguishing between direct and derivative claims.[82] Accordingly, Counts I-IV must be dismissed. The court turns next to consider whether Klein has pled facts showing that making a demand on the Board would have been futile with respect to his parallel derivative claims.

         B. Klein Has Adequately Pled Demand Futility for his Derivative Claims.

         "Making a pre-suit demand is futile when the directors upon whom the demand would be made 'are incapable of making an impartial decision regarding such litigation.'"[83] Klein did not make a demand on the Board, so he must allege with particularity that his failure to do so should be excused.[84] "In this analysis, I accept as true [Klein's] particularized allegations of fact and draw all reasonable inferences that logically flow from those allegations in [Klein's] favor."[85]

         Delaware law has two tests for determining whether demand is excused: the test articulated in Aronson v. Lewis[86] and the test articulated in Rales v. Blasband.[87] The Aronson test applies when "a decision of the board of directors is being challenged in the derivative suit."[88] The Rales test, in contrast, applies when "the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit."[89] Rales identified three examples of scenarios where this could arise:

(1) where a business decision was made by the board of a company, but a majority of the directors making the decision have been replaced; (2) where the subject of the derivative suit is not a business decision of the board; and (3) where . . . the decision being challenged was made by the board of a different corporation.[90]

         In this case, both parties agree that Aronson applies. This is the correct test because Klein is challenging a board action-the Board's approval of the Transactions-and four out of five of the directors on the Board at that time (Doyle, Feinstein, Turner, and DeLuca) comprised four out of seven members of the Board when this action was filed (the "Demand Board").

         Under Aronson, "to show demand futility, [Klein] must provide particularized factual allegations that raise 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."[91] Under the first prong:

Disinterested means that directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which devolves upon the corporation or all stockholders generally. Independence means that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.[92]

         With respect to the second prong, this court has explained that the plaintiff must "plead particularized facts sufficient to raise (1) a reason to doubt that the action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the decision."[93]

         The Demand Board consisted of the following seven members: Adlerz, DeLuca, Doyle, Feinstein, Gordon, O'Reilly, and Turner.[94] Thus, to establish demand futility under Aronson, Klein must impugn the ability of at least half (i.e., four) of the Demand Board directors to have considered a demand impartially.[95]

         Klein concedes that DeLuca and Feinstein were disinterested and independent.[96] Defendants do not argue that Adlerz, Gordon, and O'Reilly were independent, [97] and the Complaint's allegations raise a reasonable doubt about their independence. This is because, when the Complaint was filed, Gordon and O'Reilly were Managing Directors of Bain and Adlerz was the CEO of Surgery Partners.[98]Thus, the result here turns on the sufficiency of the allegations concerning one of the remaining two directors: Doyle and Turner. If Klein has alleged particularized facts to raise a reasonable doubt that either one was not disinterested or independent when this action was filed, then demand would be excused. In my opinion, Klein has done so with respect to Doyle.[99]

         When the Complaint was filed in December 2017, Doyle, who had been the Company's CEO less than three months earlier, was in the middle of a six-month consulting services agreement with the Company that paid him $275, 000 or approximately $45, 833 per month.[100] This amount was more, on a monthly basis, than Doyle's base salary as Surgery Partners' CEO for 2016, which was $450, 000 per year or approximately $37, 500 per month.[101]

         This court has found that a "consulting agreement suggests a lack of independence" for purposes of examining demand futility.[102] In Orman v. Cullman, Chancellor Chandler found it "reasonable to infer that $75, 000 would be material" to the director in question and that he would be "beholden to the controlling shareholders for future renewals of his consulting contract."[103] Similarly here, it is reasonable to infer that a Bain-controlled Surgery Partners could have chosen to renew Doyle's consulting contract, impairing his ability to act independently of Bain.[104] This is especially true because the consulting agreement at issue paid Doyle more on a monthly basis than his former salary as CEO.[105]

         This inference is further supported by NASDAQ and NYSE rules providing, with certain exceptions not relevant here, that a person shall not be considered independent if that person received $120, 000 or more in consulting fees during any twelve-month period within the three preceding years.[106] It is true, as defendants point out, that exchange listing rules do "not operate as a surrogate for[] this Court's analysis of independence under Delaware law for demand futility purposes."[107] As Chief Justice Strine explained in Sandys v. Pincus, however, exchange rules are relevant for determining independence under Rule 23.1 and it would create "cognitive dissonance" for our jurisprudence to ignore them:

We agree with the Court of Chancery that the Delaware independence standard is context specific and does not perfectly marry with the standards of the stock exchange in all cases, but the criteria NASDAQ has articulated as bearing on independence are ...

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