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City of Tamarac Firefighters' Pension Trust Fund v. Corvi

Court of Chancery of Delaware

February 12, 2019

CITY OF TAMARAC FIREFIGHTERS' PENSION TRUST FUND, Plaintiff,
v.
CAROLYN CORVI, JANE C. GARVEY, BARNEY HARFORD, TODD M. INSLER, WALTER ISAACSON, JAMES A.C. KENNEDY III, OSCAR MUNOZ, ROBERT A. MILTON, WILLIAM R. NUTI, SITO PANTOJA, EDWARD M. PHILIP, EDWARD L. SHAPIRO, LAURENCE E. SIMMONS, JEFFERY A. SMISEK, DAVID J. VITALE, and JAMES M. WHITEHURST, Defendants, and UNITED CONTINENTAL HOLDINGS, INC., a Delaware Corporation, Nominal Defendant.

          Date Submitted: November 14, 2018

          Carmella P. Keener, Jessica Zeldin, ROSENTHAL, MONHAIT & GODDESS, P.A. Wilmington, Delaware; Gustavo F. Bruckner, POMERANTZ LLP, New York, New York; Attorneys for Plaintiff City of Tamarac Firefighters' Pension and Trust Fund.

          Gregory P. Williams, Robert L. Burns, Anthony M. Calvano, RICHARDS LAYTON & FINGER, P.A., Wilmington, Delaware; Craig C. Martin, Matt D. Basil, Howard S. Suskin, JENNER & BLOCK LLP, Chicago, Illinois; Attorneys for Defendants Carolyn Corvi, Jane C. Garvey, Barney Harford, Todd M. Insler, Walter Isaacson, James A.C. Kennedy III, Oscar Munoz, Robert A. Milton, William R. Nuti, Sito Pantoja, Edward M. Philip, Edward L. Shapiro, Laurence E. Simmons, David J. Vitale, and James M. Whitehurst.

          Arthur G. Connolly, Ryan P. Newell, Kyle Evans Gay, Shaun Michael Kelly, CONNOLLY GALLAGHER, Wilmington, Delaware; Royal B. Martin, William G. Sullivan, Giel Stein, CLARK HILL, PLC, Chicago, Illinois; Attorneys for Defendant Jeffery A. Smisek.

          David E. Ross, R. Garrett Rice, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Attorney for Nominal Defendant United Continental Holdings, Inc.

          MEMORANDUM OPINION

          McCORMICK, V.C.

         In 2011, then-chairman of the Port Authority of New York and New Jersey, David Samson, wanted to "fly friendly skies" direct from Newark, New Jersey to Columbia, South Carolina, where he owned a vacation home. Samson proposed to Jeffery A. Smisek, then-chief executive officer of United Continental Holdings, Inc. ("United"), that Smisek re-institute a Newark-to-Columbia route, which historically operated at a loss. Smisek agreed, but in exchange for Samson's approval of development projects at United Airline's regional hub. The flights took off, at least for a time. In 2014, a federal investigation into an unrelated Port Authority scandal uncovered facts concerning Samson's "chairman's flight." Multiple federal investigations of United ensued.

         In the midst of the federal investigations, Smisek and United entered into a separation agreement that provided Smisek with approximately $37 million in benefits. A special committee of outside directors advised by outside counsel negotiated and approved the separation agreement.

         A stockholder made two litigation demands asking the United board to claw back the separation compensation or rescind the separation agreement. The board rejected both demands, and the stockholder filed this derivative suit. The defendants have moved to dismiss the complaint.

         When a plaintiff makes a pre-suit litigation demand, the plaintiff's complaint can only survive a motion to dismiss under Court of Chancery Rule 23.1 by pleading that the directors wrongfully refused the demand. In this case, the complaint fails to plead particularized facts raising a reasonable doubt that the defendants acted with due care and in good faith in rejecting the demand.

         This case presents one twist on the usual demand-refusal analysis. By making a pre-suit litigation demand, a plaintiff "tacitly concedes" that the board is disinterested and independent for purposes of responding to the demand.[1] In this case, the board did not consider the demand. The board instead delegated the issue to a special committee. The plaintiff argues that the board was grossly negligent in delegating the issue to the special committee because its members were incapable of acting disinterestedly and independently on the demand. The defendants respond that the Court may not consider the alleged conflicts because the tacit concession extends to the members of the special committee.

         Extending the tacit concession to the members of the special committee conflicts with the Delaware Supreme Court's decision in Scattered Corp. v. Chicago Stock Exchange, Inc.[2] This decision thus evaluates the plaintiff's allegations of conflicts at the committee level to determine whether the board acted with gross negligence when delegating the issue to the special committee. The defendants prevail nevertheless, because the complaint does not allege disabling conflicts with sufficient particularity.

         The plaintiff also asserts a waste claim against the director defendants and an unjust enrichment claim against Smisek. The act of making a pre-suit litigation demand bars a plaintiff from pursuing derivative litigation involving subject matter of the demand, regardless of the legal theory, unless the plaintiff can show wrongful refusal. Because the plaintiff's waste and unjust enrichment claims arise from the subject matter of the demand, they too are subject to the demand refusal analysis.

         I. FACTUAL BACKGROUND

         The background facts are drawn from the particularized allegations of the Verified Amended Stockholder Derivative Complaint (the "Amended Complaint") and documents incorporated therein. The decision also considers the correspondence refusing the plaintiff's litigation demands.[3]

         A. The Federal Investigations

         Nominal Defendant United is a publicly traded airline holding company that owns and operates United Airlines.[4]

         In September 2011, Samson was chairman of the Port Authority of New York and New Jersey. Smisek was United's CEO. Over dinner in Manhattan, Samson asked Smisek to revive United Airlines' discontinued Newark-to-Columbia route, which would ease Samson's commute to his South Carolina vacation home.[5] After Smisek agreed to reinstate the route, the Port Authority approved United's projects at Newark International Airport.[6] United operated the Newark-to-Columbia route twice a week for nineteen months. It generated losses for United of approximately $945, 000.[7]

         A federal investigation into an unrelated 2013 Port Authority scandal uncovered the interactions between Smisek and Samson. Multiple federal agencies responded by commencing investigations.

         On January 22, 2015, and February 17, 2015, United received grand jury subpoenas from the Office of the United States Attorney for the District of New Jersey (the "U.S. Attorney's Office").[8] On September 9, 2015, United received a subpoena from the Securities Exchange Commission ("SEC") covering similar topics. United also received information requests from the General Services Administration and the Office of Inspector General for the Port Authority.

         B. The Special Committee

         On March 2, 2015, United's Board of Directors (the "Board") established a special committee of nine independent and disinterested directors (the "Special Committee").[9] The Board resolution broadly empowered the Special Committee to oversee United's response to the federal subpoenas and manage United's internal investigation into any potential misconduct.[10] The resolution "gave the Special Committee the authority to act on behalf of the Board and to enter into any agreement with federal, state, and local authorities."[11]

         The Special Committee retained Jenner & Block LLP ("Jenner") to provide counsel concerning both United's subpoena responses and the Special Committee's investigation.[12]

         C. The Separation Agreements

         On September 8, 2015, the Special Committee approved a separation agreement between United and Smisek.[13] Pursuant to the separation agreement, Smisek received benefits contemplated in his employment agreement, including a separation payment of $4, 875, 000, accrued stock and awards, flight benefits, and lifetime airport parking spots.[14] The Amended Complaint values the benefits conferred by the separation agreement at approximately $37 million.[15] The Special Committee also approved separation agreements with two other United executives (with Smisek's separation agreement, the "Separation Agreements").[16]

         The Separation Agreements permit United to claw back separation benefits if the executive fails to cooperate with the defense or investigation of certain claims, or if the executive pleads guilty to or is convicted of a felony arising from his tenure at United (the "Clawback Provisions").[17]

         D. The Fall-Out from the Federal Investigations

         On July 13, 2016, United entered into a non-prosecution agreement with the U.S. Attorney's Office.[18] Under the non-prosecution agreement, United agreed to pay a $2, 250, 000 fine and take other remedial steps.[19]

         The next day, Samson agreed to plead guilty to bribery for using his official authority to pressure United into restoring the Newark-to-Columbia route for his personal benefit.[20] Samson was sentenced to one year of home confinement and four years of probation.[21] He was also ordered to pay a fine of $100, 000.[22]

         On December 2, 2016, the SEC accepted United's Offer of Settlement, in which United agreed it had committed books and records and internal controls violations under SEC regulations. The settlement required United to pay a penalty of $2, 400, 000.[23]

         E. The Initial Demand

         Plaintiff City of Tamarac Firefighters' Pension Trust Fund ("Plaintiff") alleges that it held United common stock at all relevant times.[24]

         With information gathered by using 8 Del. C. § 220, [25] Plaintiff sent a litigation demand to the Board on October 7, 2016 (the "Initial Demand").[26] The Initial Demand requested that United claw back compensation from Smisek and the other two United executives.[27] It further requested that United modify its clawback policies and future employment agreements to include provisions "granting the Board discretion to recoup compensation whenever the Board determines misconduct, willful or otherwise, has occurred."[28]

         Although Plaintiff addressed its Initial Demand to the Board, the Board delegated consideration of the Initial Demand to the Special Committee. Before the Initial Demand, the Board replaced four of the nine original Special Committee members and added a tenth member.[29] Five of the ten committee members considering the Initial Demand, therefore, had also negotiated and approved the Separation Agreements. The Special Committee sought advice from its existing counsel, Jenner, in responding to the Initial Demand.

         The Special Committee rejected the Initial Demand in a letter from Jenner dated March 24, 2017.[30] The letter explained in detail the nature of the Special Committee's investigation:

[T]o date, we have collected materials from approximately 50 custodians, and we reviewed approximately 7.5 million pages of materials. In addition to our substantial document collection and review, we conducted approximately 240 witness interviews of both former and current Company employees. In addition, we have met in person with the various government agencies on numerous occasions . . . .[31]

         The letter reported that the Special Committee met on March 14, 2017, to consider the Initial Demand and that its members unanimously decided to decline to take action in response to the demand.[32]

         Because the circumstances under which United could exercise its clawback rights under the Separation Agreements had not occurred, the letter stated: "Should any of the circumstances described in the [Clawback Provisions] arise, the Special Committee may consider suitable action at that time."[33]

         The letter also rejected Plaintiff's demand that United modify its clawback policies and claw back any compensation paid to any executive involved in certain actions, explaining that such a modification "is inconsistent with prevailing industry practice."[34] The letter observed that "[s]imilarly-situated companies do not confer upon their boards" the level of discretion sought by the Initial Demand, and such a modification "would make it difficult for United to recruit and retain top talent[.]"[35]

         The letter further explained: "Among the Special Committee's considerations were the concern of disruption to or distraction from the business, the efficacy of the requested action, and the actions United has already taken on its own initiative as a result of its investigation and in response to these events and government resolutions."[36]

         F. The Supplemental Demand

         Plaintiff commenced this litigation on May 4, 2017.[37] Plaintiff named as defendants Smisek and each of the fifteen directors who served on the Board at the time Plaintiff commenced litigation (collectively, the "Director Defendants" and with Smisek, "Defendants").[38]

         After Defendants moved to dismiss the initial complaint, Plaintiff sent another demand letter on September 15, 2017 (the "Supplemental Demand").[39] Like the Initial Demand, Plaintiff addressed the Supplemental Demand to the Board. The Supplemental Demand repeated the prior list of demands and added a request that the Board institute legal action to rescind Smisek's separation agreement.[40]

         After receiving the Supplemental Demand, the Special Committee formed a subcommittee comprising five of its members who were not on the Special Committee (or the Board) when the Separation Agreements were approved.[41] The Subcommittee did not retain new counsel; it received advice from Jenner concerning the Supplemental Demand.[42]

         The Subcommittee met on December 20, 2017, and unanimously declined to take any action in response to the Supplemental Demand.[43] Jenner explained in a letter to Plaintiff dated December 31, 2017, that the Subcommittee considered "the findings and outcomes of the internal and government investigations, the likelihood that United could successfully rescind or otherwise reverse the [S]eparation [A]greements, concern of disruption to or distraction from the business, and the other actions United took as a result of its investigation and in response to these events and government resolutions."[44] The letter further stated that if the conditions for invoking the Clawback Provisions arose, "the Special Committee or Subcommittee, as appropriate, may consider suitable action."[45]

         Plaintiff filed the Amended Complaint on February 12, 2018.[46] Defendants renewed their motions to dismiss.[47] The parties presented oral arguments to the Court on November 14, 2018.[48]

         II. LEGAL ANALYSIS

         Defendants have moved to dismiss the Amended Complaint, which has three Counts: Count I for breach of fiduciary duties, Count II for waste, and Count III for unjust enrichment. Each Count is derivative in nature and thus subject to Court of Chancery Rule 23.1.[49]

         A. Count I: Wrongful Demand Refusal

         Rule 23.1 derives from the bedrock principle that directors, rather than stockholders, manage the business and affairs of the corporation.[50] Their authority includes decisions to pursue or refrain from pursuing litigation on behalf of the corporation.[51] As part of this board-centric model, Rule 23.1 requires that a stockholder wishing to bring a derivative action first demand that the board of directors take action.[52] If a plaintiff chooses not to make a demand, the stockholder must plead with particularity why it would have been futile to present the matter to the board.[53]

         Of the two potential routes presented by Rule 23.1-pleading demand excusal with particularity or making a pre-suit demand-the former is a steep road, but the latter is "steeper yet."[54] By making a pre-suit demand, a stockholder "tacitly concedes" the disinterest and independence of the board to respond.[55] The board's decision to refuse the demand, therefore, is subject to the business judgment rule. After making a pre-litigation demand, a stockholder plaintiff may not pursue claims challenging the subject matter of the demand; the stockholder is limited to a claim that the board wrongfully refused the demand.[56] This limitation applies to all derivative claims arising from the subject matter of the demand, even legal theories not expressly identified by the stockholder or considered by the board.[57]

         Having made a pre-suit demand, Plaintiff is on the "steeper road." Accordingly, to survive a motion to dismiss, Plaintiff must plead with particularity facts sufficient to "create a reasonable doubt" that the demand refusal was a valid exercise of the board's business judgment.[58] In Spiegel, the Delaware Supreme Court focused the demand-refusal analysis on two issues: "the good faith and reasonableness of [the board's] investigation."[59] Under this framework, Plaintiff "'must allege particularized facts that raise a reasonable doubt that (1) the board's decision to deny the demand was consistent with its duty of care to act on an informed basis, that is, was not grossly negligent; or (2) the board acted in good faith, consistent with its duty of loyalty.'"[60] The two prongs of Spiegel-gross negligence and bad faith-are disjunctive, and Plaintiff can survive dismissal by meeting the test under either prong.

         1. The Amended Complaint fails to plead particularized facts creating a reasonable doubt that the directors acted with due care.

         As its chief argument under the first prong of Spiegel, Plaintiff contends that the Special Committee and Subcommittee members were conflicted with respect to the litigation demands. Thus, they say, the Board acted with gross negligence in relying on the Special Committee and Subcommittee to respond to the litigation demands.[61] In response, Defendants argue that the tacit concession automatically extends to board committees, and therefore the Court may not consider whether the committee members were conflicted with respect to the demand.[62]

         Defendants rely on Spiegel, in which the board formed a committee to respond to the plaintiff's pre-suit litigation demand.[63] The stockholder argued that the board conceded conflicts by forming the committee.[64] The Delaware Supreme Court rejected this argument, stating:

The same standard of judicial review is applicable when a board delegates authority to respond to a demand to a special litigation committee. The issues are solely the good faith and reasonableness of its investigation.[65]

         Based on the facts of Spiegel and the above-quoted language, Defendants conclude that Spiegel limits the Court's demand-refusal analysis to the good faith and reasonableness of the committee's investigation.[66] Put differently, Defendants say that Spiegel precludes the Court from analyzing conflicts at the committee level in a demand-refusal analysis.

         Defendants' interpretation of Spiegel is reasonable, but it fails to consider two subsequent Delaware Supreme Court ...


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