Kuberski v. Lime Energy Co. et al

Filing 67

Memorandum Opinion and Order Signed by the Honorable Harry D. Leinenweber on 3/25/2014:Civil case terminated. Mailed notice(wp, )

IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
RICHARD KUBERSKI and ERIC L.
LAWTON, Derivatively, and on
Behalf of Nominal Defendant
LIME ENERGY CO.,
Plaintiff
s,
v.

Case No. 12 C 7993

JOHN O’ROURKE, JEFFREY
MISTARZ, DAVID ASPLUND,
GREGORY BARNUM, CHRISTOPHER
CAPPS, WILLIAM CAREY, JR.,
JOSEPH DESMOND, STEPHEN
GLICK, PRADEEP KAPADIA,
RICHARD KIPHART, DANIEL PARKE
and DAVID VALENTINE,

(Consolidated with
Case No. 13 C 1708)
Hon. Harry D. Leinenweber

Defendant
s,
and
LIME ENERGY CO., a Delaware
Corporation,
Nominal
Defendant.

MEMORANDUM OPINION AND ORDER
This

is

a

shareholder

derivative

action

in

which

Plaintiffs Richard Kuberski (“Kuberski”) and Eric L. Lawton
(“Lawton”), shareholders of Defendant Lime Energy Co. (“Lime”),
seek to sue the members of the Board of Directors, certain
former directors, and one officer on behalf of Lime.

I.

LEGAL STANDARD

Under a derivative suit a shareholder seeks to enforce a
right that belongs to the corporation.

A basis principle of

corporate governance is to place the decision to initiate
litigation

in

the

hands

of

the

board

of

directors.

Accordingly, Federal Rule of Civil Procedure 23.1 requires a
plaintiff bringing a shareholder derivative action to state
with particularity “any effort by the plaintiff to obtain th
desired action from the directors or comparable authority [and]
the reasons for . . . not making the effort.”

Whether the

content of the statement of particularity suffices to permit
the shareholders to proceed with the litigation, however,
depends on state substantive law.

Robert F. Booth Trust v.

Crowley, 687 F.3d 314, 316-17 (7th Cir. 2012). Because Lime is
incorporated in Delaware, Delaware law determines whether the
plaintiffs may litigate derivatively on Lime’s behalf, since
they made no demand on the Lime Board to bring a suit.
Under Delaware law, plaintiffs like Kuberski and Lawton
must make a pre-suit demand of the board of directors, unless
“under the particularized facts alleged, a reasonable doubt is
created

that

(1)

the

directors

are

disinterested

and

independent [or](2) the challenged transaction was otherwise
the product of a valid exercise of business judgment.” Aronson
v. Lewis, 473 A.2d 805 (Del. 1984).

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The test is disjunctive,

i.e., if either prong is satisfied, demand is excused.

Brehm

v. Eisner, 746 A.2d 244, 256 (Del. 2000).
In order to establish the first prong, Plaintiffs must
plead with particularity, facts that show that the Board that
would be addressing the demand can impartially consider its
merits without being influenced by improper considerations,
such as an entitlement to receive a personal financial benefit
from the challenged conduct which is not equally shared by the
stockholders.
The second prong involves the Business Judgment Rule which
rule establishes “a presumption that in making a business
decision the directors of a corporation acted on an informed
basis, in good faith, and in the honest belief that the action
taken was in the best interests of the company.
acknowledgment of

the

managerial

prerogatives

It is an

of Delaware

directors. Gantler v. Stephens, 965 A.2d 695, 705 (Del. 2009).
A plaintiff must plead sufficient facts with particularity to
rebut that presumption, which it can do by showing a director
breached the fiduciary duty of loyalty and fails to act in good
faith.
II.

BACKGROUND

Lime is a Delaware corporation that provides clean energy
solutions to various entities and commercial businesses.

At

the time the initial Complaints in this case were filed, Lime’s

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Board

was

composed

of

six

directors:

David

Asplund

(“Asplund”), Lime’s Executive Chairman and former CEO, John
O’Rourke (“O’Rourke”), Lime’s current CEO, and four outside
directors,

Gregory

Barnum

(“Capps”),

Stephen

Glick

(“Barnum”),
(“Glick”),

Christopher

and

Richard

Capps
Kiphart

(“Kiphart”). Although Asplund resigned from the Board on March
6, 2013 and has since passed away, under Delaware law, the
question of demand futility focuses on the board’s composition
at the time plaintiff’s claims were first brought.

Harris v.

Carter, 582 A.2d 222, 228-29 (Del. Ch. 1990).
The alleged misreporting of revenue over a two-year period
was announced by a Lime Company press release issued on July
17, 2012.

The specific periods encompassed the company’s

consolidated financial statements on Form 10-K for the periods
ending December 31, 2010 and December 31, 2012 and quarterly
report on Form 10-Q for the period ending March 31, 2012.

The

statement further stated that the Board’s Audit Committee made
the determination based on the results of a partial internal
review conducted by the Company’s management.

The statement

said that the improprieties may have included the recording of
non-existent revenue and the recording of revenue earlier that
was appropriate.
On December 27, 2012, the Company issued another press
release announcing an expansion of the internal review to

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include the years ending on December 31, 2008, and December 31,
2009.

On January 14, 2013, Lime issued another press release

advising that it had received a determination letter from the
NASDAQ’s Listing Qualification Department, that Lime was non
complaint with NASDAQ’s listing rules and was in danger of
being delisted, although at the time of the Complaint it
continued to be listed.
Damages alleged to have been incurred by Lime include
expenditure of significant sums of money for legal fees, the
loss of reputation and good will, incurring accountant and
investigator fees with respect to the internal investigation,
and

loss

of

revenues

restatements.

and

profits

due

to

any

subsequent

Compl. ¶ 215.

As to Defendants Asplund and O’Rourke, the former and the
current CEO, the allegations are that as a result of their
offices, they lack independence.
“ultimately

responsible

for

Further, as such they were

the

Company’s

operation,

the

compilation of financial statements, and internal controls.”
Thus, “they either participated in or were recklessly unaware
of the fraudulent scheme to inflate the Company’s earnings and
revenue figures, which was intended to make the Company appear
more profitable and attractive to investors.”
211.

Compl. ¶¶ 209-

Further, they are alleged to be Defendants in related

securities fraud class actions.

Compl. ¶ 213.

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As to Defendant Kiphart, who was Chairman of the Board
from 2006 until 2011, and again after May 29, 2012, he is
alleged, similar to Asplund and O”Rourke, to have either
participated in or was recklessly unaware of the fraudulent
schemes.

Compl. ¶¶ 214, 215.

He is further alleged to

dominate and control other board members because he was the
largest shareholder (holding more than 40% of Lime’s common
stock) and because he personally provided substantial financing
and liquidity to the company by entering into a revolving
credit note with the company, his agreement to issue letters of
credit on the company’s behalf, and by providing a $2 million
revolving bridge loan.

Compl. ¶ 216.

As to Defendants, Barnum and Capps, they are alleged to
have

participated

directly

in

the

schemes

membership on the Board Audit committee.

through

their

Thus, according to

the Complaint, they reviewed and approved the false financial
statement and as members they had “heightened responsibilities
for ensuring the reliability of the financial reporting and
compliance with applicable laws and regulations.”

In addition

to reviewing and approving the financial results of the Lime
business operations, they signed the annual reports for Lime on
Form 10-K for each of the relevant years.

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Compl. ¶¶ 217-220.

Somewhat redundantly the Complaint also charges all of the
directors with violating the Lime’s Code of Ethics, with
reviewing and approving the various Form 10-Ks, for making with
“either knowing or recklessly making improper statement in the
company’s

press

releases

and

SEC

filings”

concerning

the

company’s financial results and business operations, and by
failing “to insure that the Company had an adequate system of
internal

and

financial

controls

in

place

to

dissemination of improper public disclosures.”

prevent

the

Compl. ¶¶ 224,

225).
Further, many of the board members had previous business
relations

with

one

another

previously acquired by Lime.
farther-in-law

of

Capps

and

through

companies

Compl. ¶ 227.
Valentine,

that

were

Kiphart is the

and

all

of

the

Defendants have made capital investments into the company. Id.
Finally, the demand is alleged to have been futile because
the Board

“has

so restricted

the

scope

of

the

[internal

investigation] as to render it incomplete and ineffective.”
Compl. ¶ 228.
III.

DISCUSSION

Where a board consists, as here, with six members, if
plaintiffs can establish that three are not disinterested and
not independent, then demand is considered futile because there
would not be a majority of independent directors. Beneville v.

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York, 769 A.2d 80, 85-86 (Del. Ch. 2999).

In this context

“disinterested” means that directors can neither appear on both
sides of a transaction nor expect to derive any personal
financial benefit from it in the sense of self-dealing, as
opposed to a benefit which devolves upon the corporation or all
stockholders generally.
(Del. 1984).

Aronson v. Lewis, 473 A.2d 805, 812

“Independence” means that a director’s decision

is “based on the corporate merits of the subject before the
board rather than extraneous considerations of influences,”
such as where a director is “dominated and controlled” by
someone who is interested.

Id., at 816; Brehm v. Eisner, 746

A.2d 244 at 257. However, if there is no “interested” director
in

the

transaction,

there

is

no

need

to

consider

the

independence of the remaining directors.
Plaintiffs raise a number of arguments attempting to
demonstrate that some or all of the directors were interested
in

the

matter

before

the

board

and

therefore

lacked

independence. Most of the arguments center around Kiphart. It
is alleged in the Complaint that Kiphart, who owns more than
40% of Lime’s stock and was the former and is the current board
chairman, is obviously “interested.”

He is further alleged to

control both Asplund and O’Rourke who, it is alleged, owe their
jobs to Kiphart.

And as pointed out above, both Capps and

Valentine are Kiphart’s sons-in-law.

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Thus, the argument for

lack of

independence

are

in

the

main based

on

Kiphart’s

relation with Lime as the owner of more than 40% of the stock,
and consequently his relationship with the remaining board
members. However, for Plaintiffs to make a case that the board
was not independent they must plead facts to demonstrate that
Kiphart, and through him the other board members, had an
interest in the misstatements of revenue, to the effect that he
or they received some benefit from the misstatements that was
not available to the other shareholders. In re Walt Disney Co.
Derivative Litigation, 731 A.2d 342, 355 (Del Ch. 1998).
In the Disney case, the plaintiffs in attempting to
justify their failure to make a demand on the Disney Board of
Directors, alleged that Disney Chairman Michael Eisner was
interested in the matter before the board and because he
controlled 12 of the 15 members of the Board.

The matter

before the board to which Eisner was allegedly interested, over
which the plaintiffs sought to sue on behalf of Disney, was an
alleged overly lucrative employment agreement that the Board
voted to give Michael Ovitz to induce him to serve as Disney’s
President.

The Delaware Court held that the plaintiffs failed

to allege facts with sufficient particularity to establish that
Eisner had an interest in the Ovitz contract.

In so finding

the court took a practical view of the allegations.
plaintiffs

had

argued

that

it

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was

to

Eisner’s

The

financial

advantage to offer Ovitz a lucrative contract because, in
addition to a long-time personal relationship he had with
Ovitz, providing a lucrative compensation package to Ovitz
established a high baseline which would make it easier for
Eisner to negotiate increased compensation for himself.

The

court rejected this argument by noting that at that time Eisner
owned several million options to purchase Disney stock as well
as several million shares, and approval of Ovitz’ expensive
contract could, if thought to be excessive, could impact
negatively on the value of Eisner stock and options.
Similarly, in this case, misstating revenue in order to
increase stock prices would not be in the best interest of the
largest shareholder such as Kiphart who did not sell his
shares. Had he utilized the opportunity to unload his stock at
the higher price, which plaintiffs do not allege, a case of
interest could, of course, be made.

Misstating revenue is

somewhat similar to a Ponzi scheme in that the increased income
on the front end will eventually turn up as reduced income at
the back end.

Consequently, a shareholder such as Kiphart

stood to, and presumably did, take a bath as a result of the
sharp drop in share price.

Compl. ¶¶ 189, 194.

In addition,

according to the Complaint, Kiphart was on the hook for letters
of credit of up to $300,000.00.

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Plaintiffs also argue that O’Rourke and Asplund, current
and former CEO’s, Kiphart, as Chairman of the Board, and Barnum
and Capps, as Audit Committee members face a substantial
likelihood of liability due to their positions and thus could
not be expected to vote to sue themselves.

However the

allegations of the Complaint to not rise above the “must have
known” or “were recklessly unaware” of the alleged wrongdoing.
Oversight liability under Delaware law
establish.

is very difficult to

This is because directors are not subject to

personal liability for employee failures unless they act or
fail to act in bad faith, which means that “the directors were
conscious of the fact that they were not doing their job.

In

re Citigroup Inc. Shareholders Litigation, 964 A.2d 106, 123
(Del Ch. 2009).

If

hindsight is the only basis for inference

of bad faith, it is not enough.

Higginbotham v. Baxter

Intern., Inc., 495 F.3d 753, 759 (7th Cir. 2007).

Examples of

allegations that might suffice to establish board liability
would be (1) that the directors had received reports that the
revenues were being improperly recorded and did nothing about;
(2) that senior management was possibly engaged in insider
trading

by

selling

shares

in

unusual

quantities

to

take

advantage of the high price of the stock and to make sure the
sales occurred before the stock tanked, see, In re Cendant
Corp. Derivative Action Litigation, 189 F.R.D. 117, 129 (D.N.J.

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1999); or (3) that they had failed to establish any procedure
for monitoring employee actions.
allegations pled.
some

sort

of

Here there are no such

However, there is pled that the Board had

internal

review

procedure

because

the

misstatement of revenue was detected through an internal review
brought about by management.
There are no specific allegations that any member of the
Board had any prior knowledge of the alleged misstatements and
no allegations that any board member had participated in making
the misstatements in any way, other than by publishing them.
This

is

not

such

egregious

conduct

that

would

face

a

substantial likelihood of liability due to their failure to
prevent the misrepresentations.

Seminaris v. Landa, 6612 A.2d

1350, 1354-5 (Del Ch. 1995).
Plaintiffs make a number of additions arguments as to why
the Board faces liability.

For example, the Complaint alleges

the existence of a code of ethics that allegedly was violated
but fails to allege any specific way that the Defendants
violated it.

The Complaint also alleges that certain of the

Defendants, Asplund and O’Rourke, were named in a parallel
securities litigation.

Compl. ¶ 213.

But Delaware law holds

that being named a defendant in such parallel securities
litigation does not provide an independent base for showing a
substantial likelihood of liability.

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Sherman v. Ryan, 911

N.E.2d 378, 391 (Ill. App. 1st Dist. 2009).

There are other

allegations pled, but none rise to the level that would excuse
failure to demand.
IV.

CONCLUSION

For the reasons stated herein, Plaintiffs having failed to
make a demand on the Lime Board of Directors that it initiate
a derivative action and having failed to establish that such a
demand would have been futile, the Defendants’ Motion to
Dismiss is granted.

The Plaintiffs having been given multiple

chances previously to amend the Complaint, the Motion to
Dismiss is granted with prejudice.

IT IS SO ORDERED.

Harry D. Leinenweber, Judge
United
States
District
Court
Date: 3/25/2014

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