Lowinger et al v. Oberhelman et al

Filing 39

ORDER entered by Judge Sara Darrow on March 31, 2017. The Board's decision to defer its investigation is protected by the business judgment rule and Plaintiffs' complaint is therefore premature. Defendants' #22 Motion to Dismiss is GRANTED. Plaintiffs' Complaint is DISMISSED WITHOUT PREJUDICE and WITH LEAVE TO REFILE. If Plaintiffs choose to file an amended complaint, they are directed to do so by April 28, 2017. Defendants' #25 Motion for Leave to File a Reply in Support of the Motion to Dismiss is GRANTED. Plaintiff's #28 Motion for Leave to File a Sur-Reply is GRANTED. Plaintiffs' #35 Motion to Strike Defendants' Supplemental Brief is GRANTED. (RS1, ilcd)

E-FILED

Friday, 31 March, 2017 04:15:13 PM
Clerk, U.S. District Court, ILCD
UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF ILLINOIS
PEORIA DIVISION
ROBERT LOWINGER and ISSEK
FUCHS, derivatively on behalf of
CATERPILLAR, INC.,
Plaintiff,
Case No. 1:15-cv-01109-SLD-JEH

v.
DOUGLAS R. OBERHELMAN,
EDWARD J. RAPP, STEVEN H.
WUNNING, and LUIS DELEON
Defendants
CATERPILLAR, INC., a Delaware
Corporation,
Nominal Defendant.
ORDER

Before the Court are Defendants’ Motion to Dismiss, ECF No. 22, Defendants’ Motion
for Leave to File a Reply in Support of Motion to Dismiss, ECF No. 25, Plaintiffs’ Motion for
Leave to File Sur-Reply Brief Instanter, ECF No. 28, and Plaintiffs’ Motion to Strike Brief and,
Alternatively, for Leave to File Proposed Response to Defendants’ Supplemental Filing, ECF
No. 35. For the following reasons, the motions are GRANTED.
BACKGROUND1

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At the motion to dismiss stage of litigation, a district court must assume the truth of the complaint’s well-pleaded
factual allegations, though not its legal conclusions. Munson v. Gaetz, 673 F.3d 630, 632 (7th Cir. 2012). Besides
the complaint itself, a motion to dismiss may be based on “documents attached to the complaint, documents that are
critical to the complaint and referred to in it, and information that is subject to proper judicial notice,” along with
additional facts set forth in the plaintiff’s brief opposing dismissal, so long as those facts “are consistent with the
pleadings.” Geinosky v. City of Chicago, 675 F.3d 743, 745 n.1 (7th Cir. 2012). Accordingly, the facts set forth
below are stated as favorably to Plaintiffs as permitted by the amended complaint and the other materials just

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Caterpillar (or “Company”), a publicly traded Delaware corporation with its principal
executive offices located in Peoria, Illinois, is a manufacturer of construction and mining
equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric
locomotives.
The operative pleading in this case names Caterpillar as nominal defendant, in addition to
four Individual Defendants: Douglas R. Oberhelman, Edward J. Rapp, Steven H. Wunning, and
Luis de Leon.
The Acquisition & Demand Futility Suits
On November 10, 2011, Caterpillar issued a joint press release with ERA publicizing its
pre-conditional voluntary offer for the purchase of Zhengzhou Siwei Mechanical & Electrical
Manufacturing Co., Ltd. (“Siwei”), a manufacturer of hydraulic mining roof supports that was a
wholly owned subsidiary of ERA Mining Machinery, Ltd (“ERA”), a Chinese mining equipment
company.
In June 2012, Caterpillar completed the tender offer to acquire ERA and Siwei. In
November 2012, Caterpillar announced that it had identified discrepancies between the inventory
recorded in Siwei’s accounting records and its actual physical inventory during an inventory
check at Siwei’s facilities, and was launching an internal investigation into Siwei. On January
18, 2013, Caterpillar issued a press release announcing that this internal investigation into Siwei
had uncovered “deliberate, multi-year, coordinated accounting misconduct concealed at Siwei”
designed to overstate the profitability of Siwei’s business. Specifically, Caterpillar’s internal
investigation identified inappropriate accounting practices involving improper cost allocation

mentioned, with all reasonable inferences drawn in Plaintiffs’ favor. See Westmoreland Cnty. Emp. Ret. Sys. v.
Parkinson, 727 F.3d 719, 729 (7th Cir. 2012).

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that resulted in overstated profit, as well as improper revenue recognition practices involving
early and, at times, unsupported revenue recognition. As a result of this misconduct, Caterpillar
reported a non-cash goodwill impairment charge of $580 million in the fourth quarter of 2012.
Oberhelman participated in a conference call on January 28, 2013, in which he stated “I
recognize the decision to acquire Siwei happened on my watch and the buck stops at my desk. I
am accountable for that acquisition.” Between January and March 2013, several financial news
outlets published pieces reporting that there were pre-acquisition “red flags” that the Caterpillar
Board should have taken into consideration. The Caterpillar Board, during its investigation of
the accounting practices at Siwei, characterized the situation as one in which it had been
“deliberately misled” by Siwei managers.
On March 6, 2013, the first of four shareholder derivative suits alleging demand futility
was filed in the Central District of Illinois. All four suits were consolidated by the Court on
March 31, 2014. The Court dismissed the Consolidated Complaint on September 28, 2015. An
Amended Consolidated Complaint was filed November 12, 2015, and again dismissed for failure
to plead demand futility on September 29, 2016, on the basis that plaintiffs failed to raise a
reasonable doubt that the Directors were disinterested and independent or that the challenged
transaction was otherwise the product of a valid exercise of business judgment. In the meantime,
the Court denied Defendants’ motion to stay this case on March 28, 2016. ECF No. 21.
The Demand Process
On June 25, 2014, Plaintiffs sent a demand letter (“Demand”) to the Caterpillar Board to
demand an investigation into the Acquisition and specifically any potential claims of breach of
fiduciary duty by Oberhelman, Wunning, Rapp, and de Leon.

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After volleying information requests about Plaintiffs’ shareholder status throughout July
and August 2014, Sidley Austin sent a letter on Board’s behalf, dated August 29, 2014, stating
the Board’s decision not to pursue the investigation while the other suits were pending in the
Central District of Illinois. The letter stated that “because the Company is expending time and
resources to defend against the Derivative Litigation plaintiffs’ contention that demand on the
Board is futile, the Board believes that it is appropriate first to litigate that contention before
addressing the demands in your letter.” August 29, 2014 Demand Response, Compl. Ex. F, ECF
No. 3-8.
Plaintiffs’ counsel responded on September 30, 2014, indicating that it disagreed with the
Board’s decision to delay investigation, and that it would consider the Board’s failure to
promptly investigate as an effective refusal of the Demand. Sept. 30, 2014 Pl.’s Letter Board’s
attorney, Compl. Ex. G, ECF No. 1-9. Plaintiffs expressed concerns that the Board’s delay
would lead to an inability to make claims within certain statutes of limitations. Id.
Around November 13, 2014, Plaintiffs’ counsel held a teleconference with Caterpillar’s
counsel at Sidley Austin, during which Plaintiffs expressed concerns about the applicable statute
of limitations. Defendants’ counsel refused to enter into a tolling agreement and offered to
provide legal analysis regarding the tolling of the statute of limitations, which they had not done
by the time of the filing of the complaint, despite follow-up requests from Plaintiffs’ counsel.
On March 17, 2015, Plaintiffs filed the present action alleging the individual Defendants
breached their fiduciary duties to Caterpillar. In August 2015, Defendants filed a motion to stay
the case, ECF No. 21, which was denied on March 28, 2016. The Motion to Dismiss was filed
on June 15, 2016.
DISCUSSION

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Defendants argue that their consideration of Plaintiffs’ demand was not refused, but only
subject to “deferred consideration” due to the pending Consolidated Litigation. Mot. Dismiss 2.
Further, Defendants argue, Plaintiffs have not presented particularized facts showing that the
decision to delay or refuse the demand was wrongful. Mem. Supp. Mot. Dismiss 13. Plaintiffs
assert that the Board’s response was not timely because the Board’s inaction threatened to run up
against the three-year statute of limitations within which a suit for breach of fiduciary duty may
be brought under Delaware law. Opp. Mot. Dismiss 5. Plaintiffs also argue that the Court may
not consider the materials submitted by Defendants subsequent to the filing of the complaint to
show that it acted in accordance with the business judgment rule. Id. at 12–13. Defendants
move to dismiss the complaint as prematurely filed. Mem. Supp. Mot. Dismiss 10, ECF No. 23.
Plaintiffs argue that they did not file prematurely, because the Board’s delay in investigating, in
addition to its refusal to enter into tolling agreements, threatened to result in making the suit
untimely. Mem. Opp. 5. Plaintiffs made the Demand in June 2014 and filed suit in March 2015.
I.

Legal Standard on a Refused or Delayed Demand in Shareholder Derivative Suit
The derivative suit is a tool by which a shareholder seeks to enforce the corporation’s

right against its own directors’ “misfeasance and malfeasance.” Kamen v. Kemper Fin. Servs.,
Inc., 500 U.S. 90, 95 (1991). Because “‘the basic principle of corporate governance that the
decisions of a corporation—including the decision to initiate litigation—should be made by the
board of directors or the majority of shareholders,’ most jurisdictions require a pre-suit demand
be made of the corporation’s board of directors.” In re Abbott Labs. Derivative S’holders Litig.,
325 F.3d 795, 803 (7th Cir. 2003) (quoting Kamen, 500 U.S. at 101). Under Delaware law,
which the parties agree applies here, a shareholder may only bring suit (1) where the shareholder
“has demanded that the directors pursue the corporate claim and they have wrongfully refused to

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do so” or (2) “where demand is excused because the directors are incapable of making an
impartial decision regarding such litigation.” In re Discover Fin. Servs. Derivative Litig., No. 12
C 6436, 2015 WL 1399282, at *3 (N.D. Ill. Mar. 23, 2015) (quoting Rales v. Blasband, 634 A.2d
927, 932 (Del. 1993)).
When shareholders make a demand upon the board of directors, the shareholders “tacitly
concede[] the independence of a majority of the board to respond.” Levine v. Smith, 591 A.2d
194, 212 (Del. 1991) overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
Upon receipt of the demand, a board “must investigate” the alleged wrongdoing and decide on a
course of action. Maccoumber v. Austin, No. 03 C 9405, 2004 WL 1745751, at *3 (N.D. Ill.
Aug. 2, 2004). Because Delaware law strongly presumes that directors are the managers of
corporate affairs, shareholder plaintiffs must also ensure that, before initiating their own suit,
they “have afforded the board sufficient time to investigate the allegations and decide whether to
bring suit or reject the demand.” Piven v. Ryan, No. 05 CV 4619, 2006 WL 756043, at *2 (N.D.
Ill. Mar. 23, 2006). “There can be no precise rule as to how much time a Board must be given to
respond to a demand. Indeed, the question in premature filing cases is . . . whether the time
between demand and filing of suit was sufficient to permit the Board of Directors to discharge its
duty to consider the demand.” Allison on Behalf of Gen. Motors Corp. v. Gen. Motors Corp.,
604 F. Supp. 1106, 1117 (D. Del. 1985). A reasonable response time hinges on the “complexity
of the technological, quantitative, and legal issues raised by the demand.” Maccoumber, 2004
WL 1745751, at *4 (quoting Allison, 604 F. Supp. at, 1117–18).
A board’s failure to issue a formal response to the demand may constitute an implicit
refusal. See e.g., Ironworkers Dist. Council of Philadelphia & Vicinity Ret. & Pension Plan v.
Andreotti, No. CV 9714-VCG, 2015 WL 2270673, at *23 (Del. Ch. May 8, 2015), aff’d sub nom.

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Ironworkers Dist. Council of Philadelphia v. Andreotti, 132 A.3d 748 (Del. 2016). Once a board
has taken some action in response—but has not made a formal decision—and plaintiffs proceed
to file suit, the suit may proceed if the plaintiff raises “a reasonable doubt that the board’s lack of
response is consistent with its fiduciary duties.” Rich ex. rel. Fuqi Intern., Inc. v. Yu Kwai
Chong, 66 A.3d 963, 976–77 (Del. Ch. 2013). “Where the board considers a demand, and
determines that pursuit of the litigation demanded is not in the corporate interest, the stockholder
thereafter lacks standing to bring the litigation derivatively, unless the board’s refusal is
wrongful[.]” Ironworkers Dist. Council of Philadelphia & Vicinity Ret. & Pension Plan v.
Andreotti, No. CV 9714-VCG, 2015 WL 2270673, at *25 (Del. Ch. May 8, 2015).
When shareholders file suit, they must state with particularity “any effort by the plaintiff
to obtain the desired action from the directors or comparable authority,” Fed. R. Civ. P.
23.1(b)(3)(A), and that the board’s refusal of its demand “itself is in breach of the directors’
fiduciary duties,” Ironworker Dist. Council, 2015 WL 2270673, *25.
Where a plaintiff has pled particularized facts which, taken as true, create a reasonable
doubt that the board’s investigation complied with its duty of loyalty—that is, was
undertaken in good faith—or with its duty of care—that is, was not grossly negligent—he
has rebutted the business judgment rule with respect to the board's refusal of his demand,
and may proceed with the litigation; otherwise, under Rule 23.1, the derivative litigation
must be dismissed.
Id. A court may reasonably infer a breach of the duty of care when a board issues a decision
without sufficient information due to a failure “either to investigate the demand at all or in
pursuing such an inadequate investigation, in light of the seriousness of the demand.” Id. at 26.
A shareholder can allege bad faith by pleading facts showing a board decision was “so
inexplicable that a court may reasonably infer that the directors must have been acting for a
purpose unaligned with the best interest of the corporation.” Id.
B.

Constructive Refusal or Deferred Consideration
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Plaintiffs assert the Board’s decision amounts to a tacit refusal of the demand that is
outside the protection of the business judgment rule. Opp. Mot. Dismiss 5–9. Defendants argue
the Board’s decision was a deferral, not a rejection, and the complaint should be dismissed as
premature. Mem. Supp. Mot. Dismiss 9–13. The Court must decide whether the complaint
alleges the Board’s actions constitute a constructive refusal of Plaintiff’s demand or a decision to
defer consideration of the demand until after the parallel consolidated demand futility case was
resolved.2 The Court must then decide whether the Board’s decision is protected by the business
judgment rule. If it is not protected by the business judgment rule, the suit proceeds. If it is
protected by the business judgment rule, the suit should be dismissed.
Defendants ask the Court to follow the lead of MacCoumber and Piven v. Ryan, No. 05–
cv–4619, 2006 WL 756043, at *3–4 (N.D. Ill. Mar. 23, 2006). In MacCoumber, a shareholder
demanded an investigation into behavior prompting a $600 million fine. The Board deferred
consideration of the demand until a later time because it was busy spending time and money on
previously filed demand-futile derivative suits making the same claims. MacCoumber, 2004 WL
1745751, *2. The shareholder waited about a month and then filed suit alleging wrongful refusal
of demand. The district court decided that the board’s promise, to investigate promptly once the
futility issue was decided, was reasonable given that the resolution of that case would eliminate
or trigger the board’s investigation. The court dismissed the derivative suit, with leave to refile,
pending the state court’s determination of the demand futility issue in an earlier-filed derivative
action. MacCoumber, 2004 WL 1745751, at *5–6. The facts and outcome of Piven v. Ryan,
2006 WL 756043, at *3–4 are similar.
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Defendant asserts the fact that the demand was only deferred and not rejected justifies dismissal without
consideration of whether it was a decision protected by the business judgment rule. Mem. Supp. Mot. Dismiss 13.
MacCoumber and Piven did not explicitly reference the rule in regard to the decision to defer, but both courts
pronounced the decisions reasonable before dismissing the suits. MacCoumber, 2004 WL 1745751, *6; Piven, 2006
WL 7456043, *4.

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In contrast, Defendants offer Rich ex rel. Fuqi Intern., Inc. v. Yu Kwai Chong, 66 A.3d
963, 976 (De. Ch. 2013). In Rich, stockholders made a demand in June 2012. Id. at 969. In
October 2010, the board created a committee to investigate the demand’s allegations. A separate
audit committee eventually began investigating accounting problems. By January 2012, the
Board had quit paying the audit committees’ analysts. The committee never finished its audit
and the board never responded to the demand in writing. Id. at 969, 972. The court concluded
that the board abandoned its investigation despite being aware of some corporate
mismanagement. Under those circumstances, the court found the allegations sufficient to raise a
reasonable doubt that the board acted in good faith and refused to apply the protections of the
business judgment rule. Id. at 979. “[W]here the board has not responded to a demand, the
plaintiff satisfies [23.1], and may proceed, upon raising a reasonable doubt that the board’s lack
of a response is consistent with its fiduciary duties.” Id. at 976.
Here, the Board responded to the June 25, 2014 demand on August 29, 2014, advising the
Plaintiffs that the Derivative Litigation had previously been filed and that its resolution would
directly affect the Board’s response to the Plaintiffs’ demand, the Board intended to conserve
resources by waiting until after the Derivative Litigation was resolved before investigating
Plaintiffs’ allegations. August 29, 2014 Demand Response. The Board’s decision here looks
very similar to the boards’ decisions in both MacCoumber and Piven—deferring rather than
tacitly refusing, like the Board in Rich. The Court finds the Board acted—it did not ignore
Plaintiffs’ Demand. Its Response, which was drafted after ascertaining that the Plaintiffs were
indeed shareholders, indicated that it had reviewed the Demand, and alerted Plaintiffs to the
already commenced litigation raising the same claims but in a demand excused posture. It relays
a decision to defer further inquiry into the Demand’s allegations because since “the Derivative

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Litigation will necessarily address the issue of whether a demand is required, the Board has
determined that it would not be a prudent expenditure of time and resources for it to conduct
additional inquiry into the allegations raised in your letter.” Demand Response. It supports its
decision by referring to MacCoumber and Piven. It indicates future activity because it promises
to “monitor the progress of the Derivative Litigation and . . . consider your letter at a later point
in time, as circumstances warrant.” Id. at 2. The Court finds the Board’s letter was a deferral,
not a rejection, of Plaintiffs’ Demand.
C.

Business Judgment Rule

The Court must then assess whether the Board’s decision to defer is protected by the
business judgment rule. Defendants assert its decision was protected because the Complaint
does not include any facts from which the Court could infer the Board’s decision was made in
bad faith or that the Board was uninformed when it issued its Demand Response. Mem. Supp.
Mot. Dismiss 14. Plaintiffs’ only basis for arguing the Board’s decision was not protected by the
business judgment rule is Plaintiffs’ allegations that the Board did not act in good faith when it
delayed considering the Demand and “potentially compromised any claims to the extent that they
would need to be asserted within the applicable limitations period.” Compl. ¶ 67. Defendants
additionally refused to enter a statute of limitations tolling agreement. Id. ¶ 68.
Plaintiffs claim the breach of fiduciary duty claim is subject to Delaware’s three-year
statute of limitations period for breach of fiduciary duty claims. See, e.g., Ausikaitis v. Kiani,
962 F. Supp. 2d 661, 673 (D. Del. 2013) (“[P]ursuant to 10 Del. C. § 8106, claims for breach of
fiduciary duty . . . are subject to a three-year statute of limitations.”). The Acquisition was
completed on June 6, 2012, Compl. ¶¶ 1 and 36, which Plaintiffs allege makes June 6, 2015 the

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potential and likely deadline for filing any claim. Opp. Mot. Dismiss 5, 8–9. The complaint was
filed on March 17, 2015.
To support their claim that Defendants’ deferred response constitutes bad faith, Plaintiffs
cite Witchko v. Schorsch, No. 15 CIV. 6043 (AKH), 2016 WL 3887289, at *4 (S.D.N.Y. June 9,
2016). In Witchko, the court denied the defendant’s motion to dismiss for lack of derivative
standing and found the demand refusal, which, in part, proposed postponing suit, lacked
evidence of independent and good faith consideration of the merits. The court questioned the
continued viability of postponing suit because at oral argument the attorneys seemed unaware of
when the statute of limitations would run. The court expressed concern that while the board’s
decision to wait “to bring the claims might be a sound business judgment, a failure to enter into
some sort of stipulation to extend the time frame for such a claim during the pendency of the
related litigation and government investigation, could be an abdication of that judgment.” Id. at
*4 & n.1. The statute of limitations was set to run within 6 months of oral argument. Id.
Defendants dispute Delaware’s three-year statute of limitations applies here. Under
Illinois choice-of-law rules, Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496 (1941),
Plaintiffs’ derivate claim for breach of fiduciary duty is governed by Delaware substantive law
and Illinois procedural law. Reply 1–2, ECF No. 26 (citing Bagdon v. Bridgestone/Firestone,
Inc., 916 F.2d 379, 383 (7th Cir. 1990)). Statute of limitations are procedural, Belleville Toyota,
Inc. v. Toyota Motor Sales, U.S.A., Inc., 770 N.E.2d 177, 194 (Ill. 2002), and the Illinois statute
of limitations for breach of fiduciary duty is five years. 735 ILCS 5/13-205; Travelers Cas. &
Sur. Co. v. Bowman, 893 N.E.2d 583, 587 (Ill. 2008). Defendants properly distinguish Plaintiffs’
cases; in Ausikaitis, the parties agreed the Delaware statute of limitations applied, and in Niki, the
parties’ contractual choice of Delaware law was not contested.

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The Court agrees with Defendants’ assessment of the proper statute of limitations in this
case, but is not required to so rule because no one argues Plaintiffs missed the deadline. Instead,
Plaintiffs argue that knowing the three-year statute of limitations applied, the Board’s decision to
defer investigating the demand until after the Court decided whether demand was required was
too risky, placed recovery in jeopardy, and could only have been made in bad faith. Similarly
indefensible was its decision to not enter into a tolling agreement. However, Plaintiffs have not
alleged the Board shared its understanding that a three-year statute of limitations applied in this
case. Therefore, no inference of bad faith can be drawn from Plaintiffs’ vague allegations that
the Board’s decision to defer and not enter into tolling agreements was in bad faith. Defendants
have professed here that the deadline for filing was actually five years from the date Caterpillar
became aware of certain discrepancies in inventory—November 2017. Reply 1. Caterpillar’s
response to Plaintiffs’ Demand was conveyed by letter on August 29, 2014, 38 months before the
proposed deadline. The Board’s decision to defer its investigation to await a ruling in the
demand futility case does not indicate bad faith.
CONCLUSION
The Board’s decision to defer its investigation is protected by the business judgment rule
and Plaintiffs’ complaint is therefore premature. Defendants’ Motion to Dismiss, ECF No. 22, is
GRANTED. Plaintiffs’ Complaint is DISMISSED WITHOUT PREJUDICE and WITH LEAVE
TO REFILE. If Plaintiffs choose to file an amended complaint, they are directed to do so by
April 28, 2017. Defendants’ Motion for Leave to File a Reply in Support of the Motion to
Dismiss, ECF No. 25, is GRANTED. Plaintiff’s Motion for Leave to File a Sur-Reply, ECF No.
28, is GRANTED. Plaintiffs’ Motion to Strike Defendants’ Supplemental Brief, ECF No. 35, is
GRANTED.

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Entered March 31, 2017.
s/ Sara Darrow
SARA DARROW
UNITED STATES DISTRICT JUDGE

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