Weinberger v. American Composting Inc et al

Filing 26

OPINION AND ORDER that American Composting's motion to dismiss 8 16 is DENIED; Weinberger's motion for leave to amend her complaint 20 is DENIED AS MOOT. Signed by Chief Judge J. Leon Holmes on 4/9/12. (vjt)

IN THE UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF ARKANSAS
WESTERN DIVISION
RISA WEINBERGER, in her individual capacity,
and on behalf of herself and all similarly situated
shareholders of American Composting, Inc.
v.

PLAINTIFF

No. 4:11CV00848 JLH

AMERICAN COMPOSTING, INC.;
and JAMES WILLITS

DEFENDANTS

OPINION AND ORDER
Risa Weinberger brings this shareholder derivative suit on behalf of American Composting,
Inc., against James Willits, American Composting’s majority shareholder, alleging breach of fiduciary
duty, breach of contract, and conversion. Weinberger also brings an individual action against Willits,
alleging that Willits breached his fiduciary duty to her as a minority shareholder. American
Composting has moved to dismiss Weinberger’s shareholder derivative claims under Federal Rule of
Civil Procedure 12(b)(6) for failure to state a claim upon which relief may be granted. American
Composting argues that Weinberger has failed to allege with sufficient particularity that a pre-lawsuit
demand upon American Composting would have been futile. For the following reasons, the Court
denies the motion.
I.
In ruling on a motion to dismiss, the Court must accept as true all factual allegations in the
complaint and review the complaint to determine whether its allegations show that the pleader is
entitled to relief. Schaaf v. Residential Funding Corp., 517 F.3d 544, 549 (8th Cir. 2008). All
reasonable inferences from the complaint must be drawn in favor of the nonmoving party. CrumpleyPatterson v. Trinity Lutheran Hosp., 388 F.3d 588, 590 (8th Cir. 2004). The Court need not,

however, accept as true legal conclusions, even those stated as though they are factual allegations.
Ashcroft v. Iqbal, 556 U.S. 662, 129 S. Ct. 1937, 1949-50, 173 L. Ed. 2d 868 (2009).
II.
The following facts are taken from Weinberger’s amended complaint and the documents
attached or referenced therein. Document #14.1
American Composting is a domestic corporation organized under Arkansas law. Practically
speaking, American Composting has two shareholders, Willits and Weinberger. Willits owns
51 percent of American Composting’s outstanding shares, serves as the company president, and is
responsible for all aspects of the company’s management and operation.

Weinberger owns

24.5 percent of American Composting’s outstanding shares and controls another 24.5 percent in her
position as the sole trustee for her children. Weinberger has never held any managerial or other
position of responsibility or employment with American Composting.
After receiving American Composting’s tax returns and other financial documents in 2009 and
2010, Weinberger became concerned that Willits was mismanaging the company and using corporate
funds for his personal benefit. Weinberger requested various financial statements and other
information from Willits, who did not fully cooperate with the requests. Weinberger then called a
special American Composting shareholders’ meeting, which was held on July 1, 2010. At and after

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The Court, in its discretion, has excluded all information pertaining to events that happened
after the filing of Weinberger’s original complaint, as the information is not necessary to, and would
not alter, its decision. See McCall v. Scott, 239 F.3d 808, 815 (6th Cir. 2001) (evaluating demand
futility as of the date the first derivative claims were made). Cf. 7C Wright, Miller, & Kane, Federal
Practice and Procedure: Civil 3d § 1831, 118-19 (“[T]he court has discretion to allow outside
materials to be introduced or to hold a hearing on the issue whether the demand on the directors
should be excused . . . .”).
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the meeting, Weinberger requested that Willits provide certain corporate records. Some, but not all,
of the records were provided.
Weinberger submitted the various records that she did obtain to her accountant, who
discovered that multiple cash disbursements had been made from American Composting’s corporate
bank accounts for Willits’ benefit. The disbursements included payments to Willits’ ex-wife totaling
$283,068.48, and payments to the law firm that represented Willits in his divorce totaling
$145,789.26. The documents showed a “Loans to Shareholders” balance that increased from
$21,075 in 2004 to $444,642.68 by September 9, 2011. The only loan evidenced by a promissory
note was a loan in the amount of $37,000, and Willits was not repaying that loan according to the
terms of the note. The records demonstrated that only $2,500 had been repaid from the loans, and
that there were no specific repayment plans or collateral presented in return. Weinberger alleges that
these loans are shams and that Willits has used corporate funds for his personal benefit.
On August 30, 2011, Weinberger’s counsel sent a letter to Willits’ counsel with a draft
complaint detailing, among other things, potential shareholder derivative claims. While Willits
provided a substantial number of documents in response to the letter, and he cooperated regarding
various stock transfers in question, he did not provide any solution or relief as to the alleged misuse
of corporate funds. After the letter was received, Willits acknowledged through his counsel that the
corporate funds had been used for his divorce-related issues and stated that he intended to present
a repayment plan to American Composting’s board of directors.
Around November 4, 2011, Weinberger received a letter from Willits’ counsel giving notice
of a special American Composting shareholders’ meeting to be held on November 15, 2011. Willits
stated in the letter that issues to be considered at the meeting were amendment of American

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Composting’s articles and by-laws and election of directors. Specifically, the letter stated that Willits
would nominate David Steinmetz and Mark Perry to “fill the two empty positions of director.”
Willits added that the “intent of the expansion of the board of directors is to elect independent
members . . . who may immediately continue the investigation of allegations by a shareholder that the
Corporation has claims against the current director, James R. Willits, and to direct the operations of
the Corporation in the future.” Neither Steinmetz nor Perry was employed by American Composting,
although Weinberger believes that Perry has sold insurance products to American Composting. At
the November 15 meeting, Willits voted all his shares in favor of the amendments and two new
directors, guaranteeing their success, while Weinberger voted her shares against these actions. Perry
and Steinmetz were elected, and the amendments passed. According to Weinberger, the amendments:
(1) enabled the two new directors to be elected at a special meeting rather than an annual meeting;
and (2) allowed the corporation to take action without a meeting at all, and without Weinberger’s
consent, as had previously been required.
Two weeks later, at the end of November, Weinberger filed her original complaint with this
Court. In the complaint, Weinberger alleged that the actions taken at the November 15 meeting had
no legitimate business purpose, were not taken in good faith, and were purely an attempt to avoid the
lawsuit. Thus, she alleged, “since Willits is both the party accused of wrongdoing against the
corporation as well as the individual who completely controls the corporation, the requirement of a
pre-suit demand should be excused as futile . . . .”
On January 12, 2012, Weinberger filed her amended complaint in this action, alleging many
of the same claims and facts as the first complaint. Weinberger states in her amended complaint that
she “has made no demand on the board of directors of [American Composting] to pursue the claims

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asserted herein” because such a demand would be futile. To support her claim of demand futility,
Weinberger alleges as follows:
52. Given the timing of the noticed special meeting . . .Weinberger believes that the
actions taken . . . have no legitimate business purpose, were not taken in good faith,
and are instead measures taken by Willits to attempt to avoid this lawsuit and to avoid
liability for misappropriating corporate funds for his personal use and benefit;
53. Specifically, Weinberger believes that Willits installed Perry and Steinmetz for the
purpose of creating the facade of an “independent” board of directors in order to
overcome the futility exception to the demand requirement for derivative litigation,
as demand would clearly be excused as futile if there were no persons other than the
wrongdoer Willits who had at least official legal authority over the affairs of the
corporation;
54. Regardless, as majority shareholder Willits could at any time reverse any action
taken by Perry and Steinmetz by removing them from office under Ark. Code Ann.
§ 4-27-808, so they do not insulate the corporation from Willits’ complete control,
or create any buffer between Willits and any decision of [American Composting] as
to whether to pursue litigation against Willits;
55. Since Willits as controlling majority shareholder can ultimately dictate the course
of [American Composting] as to all of its affairs, including any decision it would make
as to Weinberger’s claims, any decision by Perry and Steinmetz not to pursue the
lawsuit would be tainted by the realities that they were unilaterally elected by the vote
of Willits, and that Willits had the power to dictate that result by removing them from
office and reversing their decision if they had decided otherwise;
56. Similarly, even if Perry and Steinmetz did vote to pursue Weinberger’s claims,
Willits could immediately remove them from office and reverse their decision;
57. In short, regardless of the appointment of Perry and Steinmetz or how
“independent” they would otherwise be, the wrongdoer Willits unilaterally elected
them to the board, and still ultimately has the unfettered ability to decide whether
[American Composting] will pursue Weinberger’s claims in litigation against himself;
Document #14, at 8-9.
It is over the legal sufficiency and particularity of this specific language, and Weinberger’s
allegations in general, that the present dispute lies. American Composting argues that Weinberger
has failed to allege sufficiently that a pre-lawsuit demand upon American Composting to take legal
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action would have been futile, as is required by Ark. Code Ann. § 4-27-740 and Federal Rule 23.1.
American Composting specifically contends that Weinberger does not allege with sufficient
particularity or facts why the American Composting board of directors is not disinterested or
independent. Weinberger argues the opposite: that her complaint sufficiently alleges her reasons for
not making a demand.
III.
The United States Supreme Court has held that questions concerning demand futility involve
substantive law, and are therefore governed by the law of the state of incorporation of the company
being sued. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108-09, 111 S. Ct. 1711, 1723,
114 L. Ed. 2d 152 (1991); Berry ex rel. Dillard’s, Inc., --- S.W.3d — , 2011 Ark. App. 242, 2011
WL 1144697, *5 (Ark. App. 2011) (citing Kamen and applying Delaware law to a shareholder
derivative suit involving a Delaware corporation); In re AFC Enters., Inc. Derivative Litig., 224
F.R.D. 515, 518 (N.D. Ga. 2004) (“Although the [Federal Rule 23.1] pleading requirement is a
matter of federal procedure, whether demand on the corporation would have been futile is a matter
of . . . state law.”). It is undisputed that American Composting was incorporated in Arkansas, so the
Court will apply Arkansas law, where possible.
The law encourages corporations to address problems internally. Thus, in general, a
shareholder cannot bring an action in his own name to enforce a corporation’s rights; rather, such an
action must be authorized by the board of directors and brought by the corporation itself. Red Bud
Realty Co. v. South, 153 Ark. 380, 241 S.W. 21, 27 (1922). If a shareholder makes a demand upon
the board of directors to prosecute alleged wrongs, however, and the demand is refused or ignored,
the shareholder may then bring a shareholder derivative suit to enforce the corporation’s rights.

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Berry, 2011 WL 1144697 at *6; see also Ono v. Itoyama, 884 F. Supp. 892, 899 (D.N.J. 1995). The
shareholder may only bring such a suit without making a demand if the demand would be futile. Ono,
884 F. Supp. at 899; see also Allright Mo., Inc. v. Billeter, 829 F.2d 631, 639 (8th Cir. 1987).
One consequence of the law’s encouragement of internal resolution of corporate problems
is that the pleading requirements in a shareholder derivative suit are generally far more demanding
than typical permissive notice pleading. See Berry, 2011 WL 1144697 at *8; McCall, 239 F.3d at 815
(both citing Brehm v. Eisner, 746 A. 2d 244, 254 (Del. 2000)). Arkansas requires a shareholder
derivative complaint to “allege with particularity the demand made, if any, to obtain action by the
board of directors and either that the demand was refused or ignored or why he did not make the
demand.” Ark. Code Ann. § 4-27-740(b).2 The primary Arkansas case explaining demand futility
pleading appears to be Morgan v. Robertson, a 1980 opinion from the Arkansas Court of Appeals,
271 Ark. 461, 609 S.W.2d 662 (Ark. App. 1980).3 Morgan stated that “there is no absolutely certain
test” for demand futility, as such questions are decided on a case-by-case basis and determined largely
by the particular circumstances. 271 Ark. at 467, 609 S.W.2d at 665 (citation omitted); see also
Vernars v. Young, 539 F.2d 966, 968 (3rd Cir. 1976) (“[T]he issue is an intensely factual one.”).
Morgan then quoted Red Bud Realty:
The law does not require a futile ceremony. Therefore, where a majority of the
directors are under the control of a majority of the stockholders, and an action is
2

Section 4-27-740(b) generally tracks Federal Rule 23.1(b), which requires a plaintiff to “state
with particularity: (A) any effort by the plaintiff to obtain the desired action from the directors or
comparable authority . . . and (B) the reasons for not obtaining the action or not making the effort.”
Notably, Arkansas Rule of Civil Procedure 23.1 is nearly identical to Federal Rule 23.1.
3

Morgan was decided seven years before the enactment of Ark. Code Ann. § 4-27-740(b),
so it obviously does not discuss the statute. As detailed in the previous footnote, however, § 4-27740(b) contains the same basic demand futility requirements as Arkansas Rule 23.1, which Morgan
expressly covered. The Court sees no reason to ignore Morgan, which is still valid law.
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brought against them by an innocent shareholder in his own name . . . it is not
necessary for him to allege and prove, as a condition precedent to the maintenance of
the action, that, before instituting the same, he protested to the board of directors
against their own mismanagement and appealed to them for redress. Such protest
would fall upon deaf ears, because a majority of the directors could not be expected
to authorize, or to institute, an action against themselves charging themselves with
fraud. If they should do such an anomalous thing, in the language of the Supreme
Court of Missouri, “the bad faith of their action would be so apparent that no court
would entertain the suit.”
271 Ark. at 467, 609 S.W.2d at 665 (quoting Red Bud Realty, 241 S.W. at 27). Morgan states that
demand should not be required where it is apparent that it would be useless because the directors
participated in the alleged wrongdoing, the alleged wrongdoers dominated or controlled the directors,
or the directors profited from the alleged wrongdoing. 271 Ark. at 467-68, 609 S.W.2d at 665
(citations omitted).
In the present case, Weinberger does not claim that Steinmetz and Perry participated in or
profited from the alleged wrongdoing—she only accuses Willits of doing so. Rather, she contends
that demand would be useless because Willits controls or dominates Steinmetz and Perry, who
constitute a majority of the board of directors.
Arkansas case law does not provide a detailed explanation of what constitutes domination or
control, so the Court will attempt to infer how Arkansas courts might view the issue. As American
Composting has pointed out, it is likely that Arkansas courts would look to Delaware law for
assistance.4 Thus, this Court will primarily look to Berry, where the Arkansas Court of Appeals

4

Several states have adopted statutory language nearly identical to Ark. Code Ann. § 4-27740(b). See, e.g., Ky. Rev. Stat. § 271B.7-400(2) (Kentucky); Ind. Code § 23-1-32-2 (Indiana);
Wash. Rev. Code 23B.07.400(2) (Washington). When interpreting these provisions, state courts
often rely heavily upon Delaware law. See Allied Ready Mix Co. ex rel. Mattingly v. Allen, 994
S.W.2d 4, 8 (Ky. App. 1998) (“Delaware cases are the leading cases in this subject area and have
been followed by other courts. This Court finds them persuasive in the case at bar.”); In re ITT
Derivative Litig. v. ITT Corp., 932 N.E.2d 664, 668 (Ind. 2010) (Indiana Supreme Court looks to
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discussed and applied Delaware shareholder derivative law to a Delaware corporation. Berry, 2011
WL 1144697. The Delaware Supreme Court has stated that the specific facts alleged must create a
reasonable doubt that a majority of the directors are independent. Berry, 2011 WL 1144697 at *7
(citing Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), overruled on other grounds by Brehm, 746
A.2d at 253).5 To demonstrate lack of independence, a plaintiff must allege, with particularity, factual
allegations from which a court can infer that the board members in question “are acting at the
direction of the allegedly dominating individual or entity.” Id. at *11 (quoting Heineman v. Datapoint
Corp., 611 A.2d 950, 955 (Del. 1992), overruled on other grounds by Brehm, 746 A.2d at 253).
Merely alleging “that directors are dominated and controlled does not raise, per se, a reasonable
doubt as to the board’s independence and thus will not suffice to meet the demand-futility standard.”
Id. at *10. A director is independent if he will act “based on the corporate merits of the subject
before the board rather than extraneous considerations or influences,” but he is not independent if he

Delaware law in derivative cases because Ind. Code § 23-1-32-2 and its official comments provide
only a “modest explanation”); In re F5 Networks, Inc., 207 P.3d 433, 434 (Wash. 2009)
(“Washington follows the Delaware demand futility standard . . . .”); see also Kamen v. Kemper Fin.
Servs., Inc., 939 F.2d 458, 461 (7th Cir. 1991) (“Delaware [is] today’s dominant corporate
jurisdiction . . . .”).
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In addition to independence, Delaware courts also require a plaintiff to plead specific facts
that would create a reasonable doubt that a majority of the directors are disinterested. Id. The
further explication of “disinterested” by the Delaware Supreme Court indicates that this analysis is
similar to Morgan’s first and third demand futility possibilities listed above (i.e. it has to do with
director participation, profit, and wrongdoing). See id. at *10. Thus, it would appear that Delaware
takes a stricter approach to demand futility than Arkansas: whereas Arkansas seemingly only requires
a lack of independence or interest to excuse demand, Delaware requires both. This is not unusual,
as a fellow district court once noted that “the decisions of various courts [on demand questions] fall
across a wide spectrum ranging from a ‘hard-boiled’ approach requiring strict proof of futility . . . to
a more lenient standard . . . .” Jordon v. Bowman Apple Prods. Co., 728 F. Supp. 409, 413 (W.D.
Va. 1990). Also, notably, American Composting agrees with this Court’s interpretation that
Arkansas law only requires a plaintiff to “create a reasonable doubt that Perry and Steinmetz are not
disinterested or independent.” Document #17, at 7.
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is “beholden” to an interested director or so under the interested director’s influence that his
discretion is sterilized. Rales v. Blasband, 634 A.2d 927, 936-37 (Del. 1993) (citations omitted).
Weinberger first alleges that Steinmetz and Perry are not independent because Willits, as the
controlling majority shareholder, elected them to office and can reverse any decision they make or
remove them from office at will. Certainly, as American Composting points out, this position of
power by itself is probably not enough to demonstrate a lack of independence on the part of other
directors. See Kaster v Modification Sys., Inc., 731 F.2d 1014, 1019-20 (2nd Cir. 1984) (“We are
thus unwilling to say that ownership of a majority of shares by the alleged wrongdoer automatically
makes a demand on the directors futile.”); Kaufman v. Belmont, 479 A.2d 282, 287 (Del. Ch. 1984)
(similar); Heineman, 611 A.2d at 955 (similar); Aronson, 473 A.2d at 816 (“[I]t is not enough to
charge that a director was nominated by or elected at the behest of those controlling the outcome of
a corporate election. That is the usual way a person becomes a corporate director. It is the care,
attention and sense of individual responsibility to the performance of one’s duties, not the method of
election, that generally touches on independence.”).
Nevertheless, Weinberger has also provided detailed factual allegations concerning the
surrounding circumstances of this case, allegations that create a reasonable doubt as to the
independence of Steinmetz and Perry. Accepting Weinberger’s allegations as true, not long after
Weinberger first notified Willits of her intent to file a shareholder derivative suit, Willits called a
special shareholder meeting with the stated purpose of expanding the board of directors—apparently
for the first time ever. At that same meeting, Willits would amend American Composting’s articles
and by-laws to allow such an expansion, while at the same time removing the requirement in the bylaws that action be taken only at a meeting unless Weinberger’s consent was obtained. Had Willits

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remained the only director, a demand would almost certainly have been futile on Weinberger’s part
because she would have needed to demand that the alleged wrongdoer prosecute the action against
himself. See Magale v. Fomby, 132 Ark. 289, 201 S.W. 278, 281 (1918) (“[If] the corporation is
under the control of the guilty parties . . . then the stockholder himself may bring suit in equity in his
own behalf . . . .”); Ono, 884 F. Supp. at 899 (demand unnecessary where alleged wrongdoer
controlled 50 percent of the board). Thus, adding two directors provided Willits with a colorable
possibility of avoiding a shareholder derivative suit—a possibility that did not previously exist. These
specific circumstances and the fact that Willits maintains the ultimate power over the board of
directors create a reasonable doubt as to whether Perry and Steinmetz are truly independent, or
whether they were selected as a subterfuge to avoid a shareholder derivative suit. See Jordon, 728
F. Supp. at 414 (demand futile where shareholder controlled 75 percent of company and other factors
existed, such as evidence that majority shareholder was “vehemently opposed to the plaintiff’s
position”). These additional factual pleadings distinguish the present situation from cases such as
Kaster, Kaufman, Heineman, and Aronson, where there were no allegations that the board
members—and, indeed, the board positions—in question were added by the majority shareholder in
response to the threat of a shareholder derivative suit. On the contrary, the Second Circuit in Kaster
stated that “the reaction of the majority shareholder to those who oppose him” is a factor to be
considered in analyzing control and demand futility. 731 F.2d at 1020. In Aronson, the court stated
that the method of election does not generally touch on independence, but the court there was
referring to the general, everyday-course-of-business selection of a director by a majority shareholder,
which is the “usual way a person becomes a corporate director.” 473 A.2d at 816. Here, the first-

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time-ever expansion of the board and selection of two directors was in response to the pressing
possibility of a shareholder derivative suit. As a fellow district court once noted:
[T]he court should not cajole itself into believing that the members of a Board of
Directors elected by the dominant and accused majority Stockholder, after
accusations of wrongdoing have been made, were selected for membership on the
Board to protect the interests of the minority stockholders and to assure a vigorous
prosecution of effective litigation against the offending majority.
deHaas v. Empire Petroleum Co., 286 F. Supp. 809, 814 (D. Colo. 1968) (quotation omitted)
(emphasis added)).
While Willits stated, in proposing the addition of Perry and Steinmetz, that his intent was to
bring in independent board members to continue the investigation into the allegations that the
corporation had claims against him, the Court need not credit that statement of intent in ruling on the
present motion. As noted above, the Court must draw all reasonable inferences from facts alleged
in the complaint in favor of Weinberger. A reasonable person easily could disbelieve Willits’ claim
that, when confronted with an allegation that he used corporate funds for personal expenses, he
decided to select two impartial, independent persons to serve on the board and make an independent
decision as to whether the allegations were true. Nowhere in American law is the accused, after being
accused, allowed to select the person who will decide whether he is guilty or whether to prosecute
the claim.6 Moreover, the argument does not explain why it was also necessary for Willits to alter
the by-laws to elect these directors at a special meeting and essentially to remove Weinberger

6

The nearest case is arbitration, in which both sides jointly select a neutral arbitrator or, if a
panel of three will be convened, both sides select one arbitrator and those two then select the third.
Here, one side of the intra corporate dispute was completely excluded from the process of selecting
the two new “independent members . . . who may immediately continue the investigation of . . .
Willits[.]”
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altogether from the American Composting decision-making process. These actions cast a shadow
on the proceedings at American Composting.
American Composting’s motion to dismiss is denied. Documents #8, #16. Weinberger’s
motion for leave to amend her complaint is denied as moot. Document #20.
IT IS SO ORDERED this 9th day of April, 2012.

J. LEON HOLMES
UNITED STATES DISTRICT JUDGE

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