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Rojas v. Ellison

Court of Chancery of Delaware

July 29, 2019

JUAN C. ROJAS, derivatively and on behalf of J.C. PENNEY COMPANY, INC., Plaintiff,
v.
MARVIN R. ELLISON, MYRON E. ULLMAN III, PAUL J. BROWN, COLLEEN BARRETT, THOMAS ENGIBOUS, AMANDA GINSBERG, B. CRAIG OWENS, LISA A. PAYNE, DEBORA A. PLUNKETT, LEONARD H. ROBERTS, STEPHEN SADOVE, JAVIER G. TERUEL, R. GERALD TURNER, and RONALD W. TYSOE, Defendants, and J.C. PENNEY COMPANY, INC., Nominal Defendant.

          Submitted Date: April 30, 2019

          Thomas A. Uebler and Jeremy J. Riley, MCCOLLOM D'EMILIO SMITH UEBLER LLC, Wilmington, Delaware; Melinda A. Nicholson, KAHN SWICK & FOTI, LLC, New Orleans, Louisiana; Roger A. Sachar, NEWMAN FERRARA LLP, New York, New York, Attorneys for Plaintiff Juan C. Rojas.

          William M. Lafferty, Susan W. Waesco, and Riley T. Svikhart, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Meryl L. Young, GIBSON, DUNN & CRUTCHER LLP, Irvine, California; Jason J. Mendro and Lissa M. Percopo, GIBSON, DUNN & CRUTCHER LLP, Washington, D.C., Attorneys for Defendants Marvin R. Ellison, Myron E. Ullman III, Paul J. Brown, Colleen Barrett, Thomas Engibous, Amanda Ginsberg, B. Craig Owens, Lisa A. Payne, Debora A. Plunkett, Leonard H. Roberts, Stephen Sadove, Javier G. Teruel, R. Gerald Turner, and Ronald W. Tysoe, and Nominal Defendant J.C. Penney Company, Inc.

          MEMORANDUM OPINION

          C. BOUCHARD, JUDGE.

         A stockholder of J.C. Penney Company, Inc. asserts in this derivative action that the company's directors breached their fiduciary duty of loyalty by consciously disregarding their responsibility to oversee J.C. Penney's compliance with California laws governing price-comparison advertising. Plaintiff's central allegation is that the directors ignored a red flag in the form of a settlement of a civil case known as the Spann action, pursuant to which J.C. Penney agreed to pay up to $50 million for the benefit of a state-wide class of California consumers and to implement certain improvements to its price comparison advertising policy and practices.

         According to plaintiff, J.C. Penney's board failed to ensure that the company abided by the terms of the Spann settlement. Plaintiff implies that, had the board done so, the company might have avoided further civil litigation over its pricing practices that was launched against the company less than three months after court approval of the Spann settlement.

         Defendants have moved to dismiss the complaint under Court of Chancery Rule 23.1 for failure to make a demand on the board before filing suit. The independence of J.C. Penney's directors is unquestioned and no contention has been made that any of them have divided loyalties because of a personal financial interest in any underlying transaction. Plaintiff argues only that at least nine of the eleven members of the board as it existed when this lawsuit was filed face a substantial likelihood of personal liability with respect to the oversight claims asserted in this case.

         The standard under Delaware law for imposing oversight liability on a director is an exacting one that requires evidence of bad faith, meaning that "the directors knew that they were not discharging their fiduciary obligations."[1] For the reasons explained below, I conclude after carefully reviewing the allegations of the complaint and the documents incorporated therein that plaintiff has failed to allege facts from which it reasonably may be inferred that any of the directors on the board when this action was filed consciously allowed J.C. Penney to violate any price-comparison advertising laws so as to demonstrate that they acted in bad faith.

         Plaintiff thus has failed to plead with particularity that these individuals face a substantial likelihood of liability for the claims asserted in this case. Accordingly, making a demand on the board would not have been futile and the complaint will be dismissed with prejudice.

         I. BACKGROUND

         Unless otherwise noted, the facts recited in this opinion are based on the allegations of the Verified Stockholder Derivative Complaint ("Complaint") and documents incorporated therein.[2] They include a number of documents produced to plaintiff in response to a demand for books and records plaintiff made under 8 Del. C. § 220.[3] Any additional facts are either not subject to reasonable dispute or are subject to judicial notice.

         A. The Parties

         Nominal defendant J.C. Penney Company, Inc. ("J.C. Penney" or the "Company") is a Delaware corporation with its principal place of business in Plano, Texas.[4] J.C. Penney engages in the business of selling merchandise and services to consumers through approximately 865 department stores in the United States and Puerto Rico and online through its website. Plaintiff Juan C. Rojas alleges that he has been a stockholder of J.C. Penney continuously since at least July 2013.

         The defendants consist of fourteen current or former members of the Company's board of directors (the "Board").[5] When the Complaint was filed, the Board had eleven members (the "Demand Board"), nine of who are named as defendants: Paul J. Brown, Amanda Ginsberg, B. Craig Owens, Lisa A. Payne, Debora A. Plunkett, Leonard H. Roberts, Javier G. Teruel, R. Gerald Turner, and Ronald W. Tysoe. The other two members of the Demand Board are Wonya Y. Lucas and Jill Soltau, who was appointed as the Company's new CEO effective October 15, 2018. Owens, Payne, Plunkett, Teruel, and Roberts currently serve on the Board's Audit Committee.

         The remaining five defendants are former directors of J.C. Penney: Colleen Barrett, Thomas Engibous, Stephen Sadove, Marvin R. Ellison, who served as J.C. Penney's CEO from July 2015 through May 2018, and Myron E. Ullman III, who served as CEO from December 2004 through December 2011 and April 2013 through July 2015. Sadove is a former member of the Board's Audit Committee.

         B. J.C. Penney's Early Use of Allegedly False Reference Pricing

         Like most retailers, J.C. Penney offers sales and promotions to market merchandise. An important concept in this case is "reference pricing." The price at which a product actually has been sold is known as the "reference price." That price provides a point of reference-or a baseline-from which to determine the percentage or amount of a discount when a retailer has a sale. To use a simple example, if the price at which a retailer actually sold a particular dress is $100 and the retailer put that dress on sale for $40, the reference price would be $100 and the percentage of the discount would be 60%.

         Rojas alleges that J.C. Penney began utilizing "false reference pricing" in 2011, and perhaps earlier. False reference pricing occurs when the "original price" for a product identified in an advertisement is higher than the price the product actually sold for, which makes the discount appear bigger and "plays on the psychology of the consumer's desire to strike a good bargain."[6] Using the dress example, if a retailer were to mark up the price of the dress to $120 (even though the retailer previously sold the dress for only $100) and then put that dress on sale for $40, the percentage of the discount using a false reference price would be about 67%.

         In January 2012, J.C. Penney's then-new CEO Ron Johnson allegedly "admitted that JCP had been engaging in (illegal) false reference pricing, disclosing that for years the Company has been slowly increasing prices, that the Company's purported regular retail prices had 'no integrity,' and that almost every single item sold by the Company was at a discounted rate."[7] Johnson further stated "during an analyst call that fewer than 1 in 500 units were ever sold at the advertised 'regular price.'"[8] In February 2012, J.C. Penney adopted a new strategy, called "Fair and Square Every Day" pricing, under which J.C. Penney "offered its products at everyday low pricing" and did not offer sales or discounts on products.[9] When Johnson left the Company for failing to "radically overhaul the department store chain," J.C. Penney allegedly returned to using false reference pricing.[10]

         C. The Spann Action

         In 2012, Cynthia Spann, a J.C. Penney customer, filed an action against J.C. Penney in the United States District Court for the Central District of California on behalf of a class of California consumers (the "Spann action"). As amended, the complaint asserted that J.C Penney had engaged in false reference pricing in violation of California consumer protection statutes, including Section 17501 of the California Business & Professions Code.[11] The Spann action concerned alleged false reference pricing "of JCP's private branded and exclusive branded apparel and accessories."[12] It did not involve any products J.C. Penney sold that also were sold at other retailers.

         In July 2014, J.C. Penney adopted the "Policy for Former Price Comparison Advertising" (the "2014 Pricing Policy"), which provided rules to avoid false reference pricing.[13] The 2014 Pricing Policy established as a "general rule" that:

The former price to which JCPenney refers in its price comparison advertising must be "the actual bona fide price" at which the article was "openly and actively offered for sale, for a reasonably substantial period of time, in the recent, regular course of business, honestly and in good faith."[14]

         This language was taken directly from the Federal Trade Commission's guidelines concerning former price comparisons.[15] The 2014 Pricing Policy also required that the "landing period"-the time when a product initially is sold-be "[a]t least 14 consecutive days before the first price break event" and that for "basic items" the price must be used at least "14 out of every rolling 90 days" and "70 days annually."[16]

         On July 20, 2015, the Board's Audit Committee discussed the Spann action.[17]The minutes of the meeting reflect that Janet Link, the Company's General Counsel, "reviewed . . . the status of the Spann pricing compliance class action lawsuit" and that "[a] discussion ensued during which Ms. Link responded to questions asked and comments made by the Committee members."[18]

         On September 10 and 11, 2015, the parties in the Spann action entered into a Memorandum of Settlement that "included continued oversight of the Company's pricing policies."[19] On September 17, 2015, the full Board of J.C. Penney discussed the Spann action at a regular meeting. The minutes of the meeting reflect that the General Counsel:

provided an update on the Company's pricing class action litigation in California, titled Spann v. J.C. Penney Corporation, Inc. She reviewed the history of the case as well as recent developments. A discussion ensued during which Ms. Link responded to questions asked and comments made by the directors.[20]

         On November 10, 2015, the parties in the Spann action filed their formal Settlement Agreement with the district court.[21] The next day, J.C. Penney issued a press release announcing the settlement, in which it stated that "[t]he settlement agreement also contemplates that JCPenney will implement and/or continue certain improvements to its price comparison advertising policies and practices, including periodic monitoring and training programs designed to ensure compliance with California's advertising laws."[22]

         In the Settlement Agreement, J.C. Penney agreed to pay up to $50 million for the benefit of a state-wide class of California consumers, with the amount for claimants (after the payment of attorneys' fees and related costs) to be payable in cash or store credits.[23] J.C. Penney also agreed that as of the date of the settlement it was not violating, and would not violate in the future, federal or California law, including California price-comparison advertising laws:

JCPenney agrees that its advertising and pricing practices as of the date of this Settlement Agreement, and continuing forward, will not violate Federal or California law, including California's specific price-comparison advertising statutes. Specifically, JCPenney agrees that any former price to which JCPenney refers in its price comparison advertising will be the actual, bona fide price at which the item was openly and actively offered for sale, for a reasonably substantial period of time, in the recent, regular course of business, honestly and in good faith. As a further direct result of this Litigation, JCPenney shall implement a compliance program, which will consist of periodic (no less than once a year) monitoring, training and auditing to ensure compliance with California's price comparison laws.[24]

         The Settlement Agreement contains mutual releases and further provides that "JCPenney expressly denies liability for the claims asserted and specifically denies and does not admit any of the pleaded facts not admitted in its pleadings in the Litigation."[25]

         On July 28, 2016, J.C. Penney filed with the district court a response to an objection to the proposed settlement in which it provided an update concerning its implementation of new pricing policies and procedures:

JCPenney . . . can represent that it has implemented a new price-comparison advertising policy in direct response to this litigation. This policy has remained in effect at all times since it was enacted, including since the date of the Settlement Agreement. Moreover, pursuant to this new policy, JCPenney has created a Promotional Pricing Governance Committee and has instituted regular training sessions. JCPenney has also created a new position, Director of Pricing Compliance, whose primary responsibility is to monitor and ensure compliance with the new pricing policy.[26]

         On September 30, 2016, the district court approved the proposed settlement of the Spann action.[27]

         D. The California Action

         On December 7, 2016, the Los Angeles City Attorney filed an action against J.C. Penney on behalf of the People of the State of California in California Superior Court (the "California Action"). As amended, the complaint asserts violations of California's consumer protection statutes.[28] As part of a coordinated effort, the City Attorney filed actions against three other national retailers (Macy's, Kohl's, and Sears) in the same court, asserting similar claims under the same statutes.[29]

         One of the claims in the California Action is governed by Section 17501 of the California Business & Professions Code. That statute provides that:

No price shall be advertised as a former price of any advertised thing, unless the alleged former price was the prevailing market price . . . within three months next immediately preceding the publication of the advertisement or unless the date when the alleged former price did prevail is clearly, exactly and conspicuously stated in the advertisement.[30]

         The Los Angeles City Attorney interpreted this provision to require that a product must be offered at the reference price "for a majority of the days on which it was offered during the preceding 90 days," i.e., for at least forty-six of those ninety days.[31]

         On July 5, 2018, the California Superior Court granted in part and denied in part demurrers each of the four retailers had filed to dismiss the claims asserted against them. With respect to the claims asserted under Section 17501 of the Business and Professions Code, the California Superior Court granted the retailers' motions, finding "on the facts alleged [that] the statute is unconstitutionally vague as applied to these Defendants."[32] With respect to the City Attorney's forty-six-day theory, the court explained:

The People's selection of a 46 day requirement is an arbitrary interpretation of section 17501, it is not supported by existing case law, and other enforcement authorities are not bound by that interpretation. Section 17501 provides no guidance for determining how long within a three month period, a price must "prevail" in order to excuse a retailer from the duty of "clearly, exactly and conspicuously" stating the date when the former price did prevail.[33]

         On April 16, 2019, the Court of Appeal of California reversed the dismissal of the Section 17501 claims, finding that the statute was not void for vagueness.[34]

         The Court of Appeal decision highlights an important difference between the Spann action and the California Action. As explained above, the Spann action only concerned J.C. Penney's sales of private branded and exclusive branded products. By contrast, the California Action concerns J.C. Penney's sale of products on its website, which includes non-exclusive products sold by other retailers.[35] With respect to non-exclusive goods, the Court of Appeal held that the "prevailing market price" for purposes of Section 17501 is based on what all retailers selling a particular item have charged and not just the price at which J.C. Penney had sold the item:

The theory in question thus differs from the Spann theory primarily with respect to the market or markets in which the prevailing market prices are to be determined. Under section 17501, . . . the market for each nonexclusive item advertised by a real party consists of all the retailers selling the "advertised item" to the consumers targeted by the real party's advertisement. In those markets, the real party's actual price for a nonexclusive item will not establish the item's prevailing market price.[36]

         The California Action is still ongoing.

         E. The Cavlovic Action

         On December 16, 2016, shortly after the California Action was filed, a J.C. Penney customer in Kansas filed a putative consumer class action in Kansas state court for violations of the Kansas Consumer Protection Act and unjust enrichment (the "Cavlovic Action").[37] Cavlovic's complaint "alleged that she fell victim to [a] pricing scheme when she paid $171.66 for a pair of earrings that were advertised as originally costing $524.98" even though J.C. Penney had never actually sold the earrings at this higher price.[38] After J.C. Penney unsuccessfully moved to dismiss the Cavlovic Action, it settled with Cavlovic on her individual claims only.[39]

         F. Additional Board Discussions About Pricing

         From late 2016 through June 2017, [40] the Board engaged in at least two additional discussion about pricing, [41] although the minutes of the meetings do not refer specifically to any of the lawsuits discussed above or whether J.C. Penney's pricing policy complies with applicable laws.

         On November 18, 2016, the Company's Chief Financial Officer (Ed Record) reviewed with the Board a slide presentation and engaged in a discussion of ways to "optimize pricing."[42] The minutes reflect that Record "discussed the science around pricing as well as the Company's desire to bring more analytical rigor to its pricing strategies."[43]

         On March 1, 2017, the Company's Vice President of Pricing (Prosun Niyogi) updated the Board on the Company's pricing initiatives.[44] The minutes state that he "reviewed the current state of the Company's pricing and promotional structure" and "then discussed the Company's pricing objectives and key opportunities as well as the potential impact to the Company from changes in the pricing process."[45]

         G. The 2017 Pricing Policy

         In May 2017, the Company adopted a new pricing policy (the "2017 Pricing Policy").[46] The 2017 Pricing Policy reiterates the "general rule" from the 2014 Pricing Policy, [47] but contains a number of modifications. For example, the 2017 Pricing Policy provides that if "a company-wide [Buy More, Save More] event occurs during an item's Landing Period, the item(s) will be included in the company- wide offer" and it expanded "the ability to use an enterprise-wide, store-wide, or web-based coupon[] . . . during an item's landing period."[48]

         As noted above, the Settlement Agreement in the Spann action obligated J.C. Penney to create a compliance program and, in June 2016, the Company represented to the district court that it "created a new position, Director of Pricing Compliance, whose primary responsibility is to monitor and ensure compliance with the new pricing policy."[49] The 2017 Pricing Policy reflects that, in addition to hiring a new Director of Pricing Compliance, the Company also had hired two Compliance Specialists.[50]

         H. Procedural History

         On October 19, 2018, Rojas filed the Complaint asserting two derivative claims. Count I asserts that each of the individual defendants breached their fiduciary duties by failing to engage in oversight with respect to the Company's compliance with California's consumer protection laws. Count II asserts that each of the six defendants who currently serve (Owens, Payne, Plunkett, Teruel, and Roberts) or previously served (Sadove) on the Audit Committee breached their fiduciary duties because they "consciously failed to monitor their information and reporting systems for compliance relating to the Company's product pricing."[51]

         On December 18, 2018, defendants moved to dismiss the Complaint solely under Court of Chancery Rule 23.1.[52]

         II. ANALYSIS

         "A basic principle of the General Corporation Law of the State of Delaware is that directors, rather than shareholders, manage the business and affairs of the corporation."[53] For this reason, the decision to bring or refrain from bringing a derivative claim on behalf of the corporation is the responsibility of the board of directors in the first instance.[54] This approach "is designed to give a corporation, on whose behalf a derivative suit is brought, the opportunity to rectify the alleged wrong without suit or to control any litigation brought for its benefit."[55]

         Under Court of Chancery Rule 23.1, a stockholder who wishes to assert a derivative claim on behalf of a corporation must "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."[56] Under the heightened pleading requirements of Rule 23.1, conclusory "allegations of fact or law not supported by the allegations of specific fact may not be taken as true."[57]

         There are two tests under Delaware law for determining whether making a demand on the corporation's board of directors to pursue a claim may be excused as futile: the Aronson test and the Rales test.[58] This court applies the first test, from Aronson v. Lewis, [59] when "a decision of the board of directors is being challenged in the derivative suit."[60] The second test, from Rales v. Blasband, [61] governs when "the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit," such as "where directors are sued derivatively because they have failed to do something."[62]

         All parties agree that the Rales test applies in this case because Rojas is not challenging a specific board action or decision, but rather an alleged lack of board oversight.[63] This means that demand can be excused only if "the particularized factual allegations . . . create a reasonable doubt that, as of 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."[64]

         Here, Rojas does not challenge the independence of any members of the Demand Board and does not contend that any of them have divided loyalties because of a personal financial interest in any underlying transaction. Rojas argues only that a majority of the Demand Board is interested because they are exposed to a substantial likelihood of personal liability. More specifically, Rojas argues that a reasonable doubt exists regarding whether the Demand Board could have considered, impartially and in good faith, whether to pursue the claims in the Complaint because at least nine of its eleven members face a substantial likelihood of liability for failing to exercise their oversight obligations under Caremark. It is black letter law that "the mere threat of personal liability" is insufficient to make this showing.[65]

         Chancellor Allen famously remarked in Caremark that to prove liability for failing to monitor corporate affairs is "possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment."[66] Consistent with that sentiment, our Supreme Court held in Stone v. Ritter that, to plead a substantial likelihood of liability under Caremark, a stockholder must allege particularized facts to show that either (1) "the directors utterly failed to implement any reporting or information system or controls" or that (2) "having implemented such a system or controls, [the directors] consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention."[67]

         Under either theory, the "imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations."[68] "The need to demonstrate scienter to establish liability under an oversight theory follows not only from Caremark itself, but from the existence of charter provisions exculpating directors from liability for breaches of the duty of care that have become ubiquitous in corporate America."[69]

         Rojas argues that a majority of the Demand Board faces a substantial likelihood of liability under both prongs of Caremark.[70] He further argues that a majority of the J.C. Penney Board is conflicted because of the ongoing nature of the California Action. The court concludes that each of these arguments is without merit for the reasons discussed below and that plaintiff has failed to establish that any member of the Demand Board faces a substantial likelihood of liability under Caremark or is conflicted based on the California Action.

         A. The Complaint Fails to Allege Facts Sufficient to Show that the Directors Are Exposed to a Substantial Likelihood of Liability for Utterly Failing to Implement a System of Controls

         Rojas makes a faint-hearted attempt to argue that the members of the Demand Board face a substantial likelihood of personal liability under the first prong of Caremark for "utterly failing" to implement any reporting or information system or controls with respect to the Company's advertising and pricing policies. Focusing on when the Spann action settled, Rojas asserted in his Complaint that "there is no evidence that any Board member sought to put in place any safeguards to ensure that the Company's advertising and pricing policies were in conformance with the Consumer Protection Laws."[71] When briefing this motion, however, Rojas effectively abandoned this position, conceding that: "There is no assertion that the reporting system put in place at the time of the Spann settlement is inadequate, or that the Board did not know it existed."[72]

         Earlier this year, in Marchand v. Barnhill, our Supreme Court expounded on the duties Delaware law imposes on directors to ensure that board-level ...


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