Hildene Opportunities Master Fund, Ltd. et al v. Holata Micco LLC et al
Filing
51
MEMORANDUM Opinion and Order. Signed by the Honorable Manish S. Shah on 3/12/2019: Defendants' motion to dismiss 37 is granted in part, denied in part. Hildene can pursue its constructive fraudulent transfer claim against Holata Micco, but its other claims are dismissed without prejudice. [For further detail see attached order.] A status hearing is set for 4/5/19 at 9:30 a.m. Notices mailed. (psm, )
UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
HILDENE OPPORTUNITIES MASTER
FUND, LTD., et al.,
Plaintiffs,
No. 18 CV 1758
Judge Manish S. Shah
v.
HOLATA MICCO, LLC, et al.,
Defendants.
MEMORANDUM OPINION AND ORDER
Plaintiffs Hildene Opportunities Master Fund and Hildene Opportunities
Master Fund II hold debt securities issued by Leaders Group, a bank holding
company. Leaders Group, now insolvent, has defaulted on the interest payments it
owes to the trust. Hildene claims that Leaders Group’s directors executed a plan to
benefit its insiders and evade Leaders Group’s obligations to its creditors, first by
diluting Leaders Group’s own shares in the bank and then by facilitating an
unreasonable foreclosure sale of the shares to Holata Micco, a secured creditor
controlled by Leaders Group insiders. Hildene sued Holata Micco and Leaders
Group’s directors over the dilution and foreclosure. Defendants move to dismiss the
complaint. For the reasons explained below, the motion is granted in part, denied in
part.
I.
Legal Standards
A complaint must contain factual allegations that plausibly suggest a right to
relief. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). I accept the facts alleged in the
complaint as true and draw reasonable inferences from those facts in Hildene’s favor,
but I do not accept as true the complaint’s legal conclusions. Id. at 678–79. I consider
the complaint, exhibits attached to the complaint, and, if they are central to the
claims, documents referenced by the complaint. Tobey v. Chibucos, 890 F.3d 634, 648
(7th Cir. 2018).
Hildene’s allegations of fraud or mistake must be stated with particularity.
Fed. R. Civ. P. 9(b). Plaintiffs must describe “the who, what, when, where, and how”
of the fraud, though precisely how much information is required for each of those
descriptions varies depending on the facts of a case. Webb v. Frawley, 906 F.3d 569,
576 (7th Cir. 2018). Plaintiffs are required to conduct their own careful pretrial
investigations to “inject[ ] precision and some measure of substantiation into their
allegations of fraud.” United States ex rel. Berkowitz v. Automation Aids, Inc., 896
F.3d 834, 840 (7th Cir. 2018) (citation omitted).
II.
Facts
Leaders Group is a privately held bank holding company that once owned all
of the equity in Leaders Bank. [6] ¶¶ 3, 13.1 In 2004, Leaders Group set up a trust to
issue trust preferred securities, or TruPS. [6] ¶ 2. TruPS are a way bank holding
companies can raise capital. [6] ¶ 30. Instead of the company issuing shares to
investors directly, it opens a trust, and the trust buys debentures, or junior
subordinated notes, issued by the company. Investors buy shares of the trust—the
Bracketed numbers refer to entries on the district court docket. Page numbers are taken
from the CM/ECF header at the top of filings. Facts are taken from the amended complaint,
[6].
1
2
TruPS—and the terms of the TruPS mirror the terms of the debentures. As the bank
holding company makes payments to the trust on the notes, the trust passes funds
along to the TruPS investors in the form of dividends. See In re BankAtlantic
Bancorp, Inc. Litig., 39 A.3d 824, 827 (Del. Ch. 2012) (explaining the TruPS
structure). The benefit of this structure is that the bank holding company can treat
the TruPS as debt for tax purposes (allowing it to deduct payments to the trust as
interest payments) but as equity for regulatory capital requirements. [6] ¶ 31. Here,
Leaders Group entered into an indenture with U.S. Bank National Association, the
trustee of the TruPS trust, and issued about $5.1 million of debentures. [6] ¶¶ 2, 33.
The trust issued 5,000 TruPS to investors, with a liquidation amount of $1,000 each,
pursuant to the Declaration of Trust. [1] ¶ 34. Hildene owns all of the TruPS. [6] ¶ 35.
Under the indenture, Leaders Group was allowed to defer its quarterly interest
payments for up to 20 consecutive quarters, but all of those deferred payments had
to be paid at the end of the deferral period, along with accrued interest. [6] ¶ 32.
Leaders Group owned one million shares in Leaders Bank, which represented
all of the bank’s issued shares and substantially all of Leaders Group’s assets. [6]
¶¶ 36–37. In 2008, Leaders Group assigned all these shares to Cole Taylor Bank as
security. [6] ¶ 37. Some time later, Leaders Bank issued new shares to the Kelly
family. [6] ¶¶ 38–39. These new shares diluted Leaders Group’s ownership (without
any payment in return) and resulted in the Kelly family owning 63% of the bank’s
equity. [6] ¶¶ 3, 38–39. The trustee (the holder of the debentures) was not given notice
of the new share issuance, and Leaders Group continued to certify that it was in
3
compliance with the indenture. [6] ¶¶ 40, 42. In 2015, insiders of Leaders Group
incorporated Holata Micco. [6] ¶ 50. One month after its incorporation, Holata Micco
acquired the debt (and the accompanying liens on the bank shares) that Cole Taylor
Bank held against Leaders Group. [6] ¶ 51. Shortly after the acquisition, Leaders
Group failed to pay interest on the debentures, and it exceeded the interest deferral
allowances under the indenture. The trustee declared an event of default. [6] ¶¶ 45–
47. Holata Micco knew of Leaders Group’s deadline to pay the deferred interest. [6]
¶ 52.
In the summer of 2017, Holata Micco instituted a “friendly” foreclosure of its
liens on the bank shares. [6] ¶ 54. No one hired investment bankers, and Leaders
Group did not consult restructuring experts about bankruptcy. [6] ¶ 67. Instead,
Leaders Group allowed Holata Micco to go forward with the foreclosure sale. [6] ¶ 68.
Holata Micco sent notice of the sale to U.S. Bank’s corporate address, but the notice
did not say that it was being sent to U.S. Bank because it is the indenture trustee. [6]
¶ 55. The notice said that Holata Micco was foreclosing on a note of about $8.4 million
and provided the date for an auction. [6] ¶¶ 55–56. Holata Micco did not hire anyone
to manage the sale and relied instead on publishing notice in the Chicago Tribune’s
Sunday edition for three weeks (one of which fell on the Fourth of July weekend). [6]
¶¶ 59–60. The notice appeared on the fourth page of the “auction mart” section in
small font, and it included onerous terms and conditions of the proposed sale. [6]
¶¶ 59–60, 62. Ultimately, Holata Micco was the only party present at the public sale
of Leaders Group’s bank shares, and its credit bid of $6 million was accepted. [6] ¶ 63.
4
Holata Micco’s winning bid was less than Leaders Bank’s tangible common equity of
about $26 million. [6] ¶ 65. Because Leaders Group owed Holata Micco more than the
$6 million credit bid amount, there were no leftover sale proceeds with which to pay
unsecured creditors like Hildene. [6] ¶ 64. Holata Micco did not assume the TruPS
obligations. [6] ¶ 70.
In December 2017, with Leaders Group’s default on the indenture having gone
uncured, the trustee provided it notice of acceleration, and the full amount of the
TruPS has been due since then. [6] ¶ 48. Leaders Group has not made any payments
toward its obligation, which, together with accrued interest, amounted to about $6.6
million as of February 2018. [6] ¶ 49. In March 2018, Hildene directed the trustee to
bring suit to enforce its rights under the indenture and allow Hildene to bring its own
suit directly. [6] ¶ 74. The trustee responded by giving Hildene permission to institute
an action immediately. [6] ¶ 75.
III.
Analysis
Hildene brings six claims related to the dilution of Leaders Group’s ownership
of the bank and the foreclosure sale of the bank shares to Holata Micco. The dilutionrelated claims are a fraudulent transfer claim against the Kellys and a claim against
all of Leaders Group’s directors for fraudulently concealing a breach of fiduciary duty.
The foreclosure-related claims are a breach of fiduciary duty claim against all of the
directors and claims against Holata Micco for aiding and abetting the breach,
receiving a fraudulent transfer, and conducting a commercially unreasonable sale in
violation of the UCC. Defendants move to dismiss all the claims.
5
A.
Contractual Bars
Defendants argue that certain of the indenture’s provisions bar Hildene’s
claims. New York law governs interpretation of the indenture. [37-1] § 14.5. See also
Kardolrac Indus. Corp. v. Wang Labs., Inc., 135 Ill.App.3d 919, 921 (1st Dist. 1985).
1.
No Recourse Provision
Section 13.1 of the indenture provides that no recourse “for the payment of the
principal of or premium, if any, or interest on any Debenture, or for any claim based
thereon or otherwise in respect thereof, and no recourse under or upon any obligation,
covenant or agreement of the Company in this Indenture … or because of the creation
of any indebtedness represented thereby” can be had against Leaders Group’s
directors or stockholders. [37-1] at 47. Courts applying New York law have found
similarly worded no-recourse provisions to bar only contract claims. See LaSalle Nat.
Bank v. Perelman, 141 F.Supp.2d 451, 459–62 (D. Del. 2001). And the New York
Court of Appeals has said of a similar provision “that it did not and could not cover
the future fraudulent acts of the directors.” Small v. Sullivan, 245 N.Y. 343, 356–57
(1927). See also Bankers Tr. Co. v. Hale & Kilburn Corp., 84 F.2d 401, 405 (2d Cir.
1936).
Most of Hildene’s claims are not based on defendants’ obligations under or
breaches of the indenture. Hildene’s claim for the directors’ breach of fiduciary duty,
for example, is based on the directors failing to take necessary actions when Leaders
Group was insolvent and instead allowing the foreclosure sale to go through. No part
of that claim hinges on any obligations that the directors had under the indenture.
The same is true of the other claims, including those against Holata Micco.
6
Defendants argue that these claims amount to artfully pleaded contract claims for
breach of the indenture, pointing in part to Hildene’s statement that it was injured
by Leaders Group’s inability to repay the TruPS and its representation in a status
report that it seeks damages that include interest and principal amounts under the
indenture. But Hildene’s theory of calculating its damages is not a statement of its
theory of liability. Breach of the indenture is not part of most of Hildene’s claims, and
those claims are not barred by the no-recourse provision.
The fraudulent concealment claim is different. It is a contract claim. The
misrepresentations at issue are the no-default certificates that Leaders Group issued
to the trust as required by the indenture, despite allegedly breaching the indenture
by allowing the dilution to occur. This is a “breach-of-contract allegation[ ] dressed up
in the language of fraud.” Greenberger v. GEICO Gen. Ins. Co., 631 F.3d 392, 395 (7th
Cir. 2011). Because the no-recourse provision bars claims for breaches of the
indenture against the directors, the fraudulent concealment claim is dismissed.
2.
No Action Provision
Section 5.4 of the indenture provides that “[n]o holder of any Debenture shall
have any right to institute any suit, action or proceeding for any remedy hereunder,”
unless certain steps—like providing written notice to the trustee of an event of default
and waiting 60 days after notice is issued—are taken. [37-1] at 29. The parties dispute
whether this provision applies to Hildene. As Hildene points out, it is not the “holder
of any Debenture.” The trust holds all the debentures. [49] at 4. Defendants argue
that though Hildene itself does not hold a debenture, it “purport[s] to stand in the
shoes of the Trust,” [50] at 6, though they provide no citation for that characterization
7
of Hildene’s claims. Hildene alleges that it is a creditor of Leaders Group, [6] ¶ 106,
not that it is standing in the trustee’s shoes. As a creditor, Hildene can bring
derivative claims on Leaders Group’s behalf and bring fraudulent transfer claims
directly.
Because Hildene alleges that it is a creditor and does not hold a debenture, the
no-action provision does not apply to its claims. Even if the no-action clause did apply
to Hildene, it would not bar the type of claims that it asserts here. Like the norecourse provision, the no-action clause would only bar claims arising from the
indenture. See Howe v. Bank of New York Mellon, 783 F.Supp.2d 466, 473–74
(S.D.N.Y. 2011).2
Hildene argues that it is authorized to bring suit under § 14.11 of the
indenture, which allows TruPS holders to “institute legal proceedings directly against
the Company” to enforce the trustee’s rights under the indenture when the trustee
does not do so itself. [37-1] at 49. I agree with defendants that § 14.11 does not
authorize Hildene’s claims because they are not against Leaders Group, and I would
add that Hildene is not seeking to enforce the trustee’s rights under the indenture.
But because I find that Hildene’s alleged status as a creditor allows it to bring its
claims, it need not resort to § 14.11.
Hildene also argued that even if § 5.4’s procedural requirements applied to it, the trustee
waived those requirements. But I am not convinced that the trustee can unilaterally waive
compliance with them. See Fed. Hous. Fin. Agency v. UBS Real Estate Securities, Inc., No.
651282/12, 2016 WL 4039321, at *3 (N.Y. Sup. Ct. 2016).
2
8
3.
Right to Sell
Section 15.8 provides that senior secured creditors can sell collateral at any
time “without the consent of or notice to the Trustee or the Security holders.” [37-1]
at 53. Defendants argue that this provision expressly permitted the foreclosure sale,
and Hildene’s claims should therefore be dismissed. But, as Hildene explains, “the
crux of the Complaint is not that the sale of the Bank Shares occurred, but rather,
that it was done in a manner in furtherance of tortious conduct and that was not
commercially reasonable.” [39] at 15. This further underscores why Hildene’s claims
are more than recast contract claims.
B.
Derivative or Direct Claims?
Hildene contends that its breach of fiduciary duty claim against the directors
and its UCC claim against Holata Micco are brought derivatively on behalf of Leaders
Group and that the others are direct claims brought on its own behalf. Defendants
argue that they are all direct claims, while noting that Hildene “purportedly bring[s]
every cause of action on behalf of the Trustee.” [44] at 3.
Derivative actions are often brought by shareholders, who bring claims “on
behalf of a corporation to seek relief for injuries done to that corporation, where the
corporation either cannot or will not assert its own rights.” Davis v. Dyson, 387
Ill.App.3d 676, 682 (1st Dist. 2008). When a corporation is insolvent, its creditors are
also allowed to bring derivative claims on its behalf. Caulfield v. Packer Grp., Inc.,
2016 IL App (1st) 151558, ¶ 42, 56 N.E.3d 509, 519 (1st Dist. 2016). “[D]erivative
claims always and only belong to the corporation on whose behalf they are brought,
and any damages awarded in a derivative suit flow exclusively and directly to the
9
corporation, not to the nominal plaintiffs.” Stevens v. McGuireWoods LLP, 2015 IL
118652, ¶ 15, 43 N.E.3d 923, 928 (2015) (emphasis in original). In Illinois, “[w]hether
an action is derivative or direct … requires a strict focus on the nature of the alleged
injury, i.e., whether it is to the corporation or to the individual shareholder that injury
has been done.” Sterling Radio Stations, Inc. v. Weinstine, 328 Ill.App.3d 58, 62 (1st
Dist. 2002). Put another way, the question is whether “the ‘gravamen’ of the pleadings
states injury to the plaintiff upon an individual claim as distinguished from an injury
which indirectly affects the shareholders or affects them as a whole.” Zokoych v.
Spalding, 36 Ill.App.3d 654, 663 (1st Dist. 1976).3
Defendants argue that because all the claims complain of actions “‘designed to
harm Leaders Group’s creditors’—not Leaders Group,” the claims are all direct in
nature. [37] at 15. But Hildene’s claims stem from the dilution and foreclosure sale,
events that indirectly injured Hildene because they decreased the value of Leaders
Group. Any harm to Hildene is shared equally by other stakeholders in the company.
For that reason, Hildene’s breach of fiduciary duty claim, the claim against Holata
Micco for aiding and abetting the breach (even though Hildene labels that claim a
direct one), and the UCC claim4 are derivative. Though the fraudulent transfer claims
Though these cases refer to shareholders, Hildene does not argue that the standard differs
for claims brought by creditors.
3
The UCC claim—brought derivatively against Holata Micco on behalf of Leaders Group—
contains confusing allegations that it “seeks to remedy wrongdoing committed by the
Individual Defendants” and that the “individual defendants” conducted the sale. [6] ¶¶ 115,
120. But the complaint’s other allegations demonstrate that it was Holata Micco that
conducted the sale in a manner that harmed Leaders Group, [6] ¶¶ 55, 59, 69, so I accept
Hildene’s characterization of the claim as a derivative one against Holata Micco.
4
10
are also based on harm to Leaders Group that indirectly affected Hildene, the
fraudulent transfer statute expressly gives creditors the ability to bring suit for their
injuries, see 740 ILCS 160/8, so Hildene may pursue them directly.5
Defendants point out that in its derivative claims, Hildene seems to seek
damages on its own behalf. Hildene does allege that it was damaged. See [6] ¶ 96. But
the nature of the injury is derivative, so it is still a derivative claim, and any recovery
belongs to Leaders Group. See Stevens, 2015 IL 118652, ¶ 15, 43 N.E.3d at 928.
C.
Direct Claims – Fraudulent Transfer
Hildene’s only direct claims are its fraudulent transfer claims. A fraudulent
transfer can occur when the debtor makes the transfer “with actual intent to hinder,
delay, or defraud any creditor of the debtor.” 740 ILCS 160/5(a)(1). The parties did
not discuss the factors that the statute offers to determine whether the debtor made
the transfer with the requisite intent. 740 ILCS 160/5(b).6 The requisite intent can
also be implied when the transfer is made “without receiving a reasonably equivalent
Hildene characterized its fraudulent concealment claim against the directors (barred by the
no-recourse provision discussed above) as a derivative claim brought on behalf of Leaders
Group, but the allegations are that “Leaders Group fraudulently concealed the fraudulent
transfer from the Trustee.” [6] ¶ 143. The alleged injury was inflicted on the trustee, not
Leaders Group, so Hildene could not bring it on Leaders Group’s behalf.
5
The factors to consider are whether: “(1) the transfer or obligation was to an insider; (2) the
debtor retained possession or control of the property transferred after the transfer; (3) the
transfer or obligation was disclosed or concealed; (4) before the transfer was made or
obligation was incurred, the debtor had been sued or threatened with suit; (5) the transfer
was of substantially all the debtor’s assets; (6) the debtor absconded; (7) the debtor removed
or concealed assets; (8) the value of the consideration received by the debtor was reasonably
equivalent to the value of the asset transferred or the amount of the obligation incurred; (9)
the debtor was insolvent or became insolvent shortly after the transfer was made or the
obligation was incurred; (10) the transfer occurred shortly before or shortly after a
substantial debt was incurred; and (11) the debtor transferred the essential assets of the
business to a lienor who transferred the assets to an insider of the debtor.” 740 ILCS 160/5(b).
6
11
value in exchange for the transfer or obligation and the debtor was insolvent at that
time or the debtor became insolvent as a result of the transfer or obligation.” 740
ILCS 160/6(a). Rule 9(b)’s heightened pleading standard applies to both kinds of
fraudulent transfer claims. See Gen. Elec. Capital Corp. v. Lease Resolution Corp.,
128 F.3d 1074, 1079 (7th Cir. 1997) (applying Rule 9(b) to constructive fraudulent
transfer claim).
1.
Dilution
Hildene brings a fraudulent transfer claim against the Kellys based on the
dilution, but Hildene has not alleged that Leaders Group (the debtor) made any
transfer with respect to the dilution. As defendants argue, the complaint alleges that
Leaders Bank, not Leaders Group, issued the shares to the Kellys. [6] ¶ 129. Even if
I were persuaded that Leaders Group could be held accountable for the bank’s
transfer if it caused it, see DZ Bank AG Deutsche Zentral-Genossenschaft Bank v.
Meyer, 869 F.3d 839, 843 (9th Cir. 2017), the complaint gives me nothing from which
to infer that Leaders Group caused the transfer other than the mere fact that it was
the sole shareholder of the bank. That is not sufficient. See id. at 841 (stating that
the debtor “caused” his solely-owned company to transfer assets).
Defendants also argue that Hildene did not provide enough detail in its
allegation that Leaders Group was insolvent at “all relevant times.” [6] ¶ 80. This
argument is well taken with respect to the dilution, since the complaint only generally
alleges that the dilution happened “[s]ome time after 2008.” [6] ¶ 38. So though the
complaint alleges that Leaders Group was insolvent when the dilution occurred, [6]
12
¶ 133, there is no concrete indication of when that was. Rule 9(b) requires more for
an allegation of timing.
For these reasons, the dilution-based fraudulent transfer claim against the
Kellys is dismissed.
2.
Foreclosure
Hildene brings both kinds of fraudulent transfer claims against Holata Micco
for the foreclosure sale. Defendants argue that Hildene has not sufficiently alleged
Leaders Group’s intent to defraud for a claim under 740 ILCS 160/5(a)(1). Some of
the statutory considerations weigh in favor of an inference of intent—the transfer
was made to an insider (Holata Micco), the sale was made after the indenture trustee
declared an event of default, the transfer was of most of Leaders Group’s assets, and
the consideration it received is alleged to be short of the shares’ fair value. But the
statutory factors are “merely considerations” and are not dispositive. Lindholm v.
Holtz, 221 Ill.App.3d 330, 334 (2nd Dist. 1991).
The complaint’s factual allegations about the foreclosure do not give rise to an
inference of fraudulent intent on Leaders Group’s part. Though the transfer was to
an insider, the complaint does not allege that the majority of directors were interested
in the transaction or beholden to the insiders. The transfer occurred through the
foreclosure on a lien, and the complaint does not allege that the lien was not valid,
that Holata Micco did not legally acquire the lien, or that its foreclosure was not
justified. Put together, the complaint alleges that Leaders Group—controlled by a
disinterested and independent board—defaulted on a secured loan, Holata Micco
enforced its legal right to foreclose on the security, and Leaders Group allowed the
13
foreclosure to occur. Though Hildene alleges that the foreclosure was conducted in a
commercially unreasonable manner, it alleges that Holata Micco conducted the sale.
See [6] ¶¶ 55, 57, 59, 69; [39] at 10. That Leaders Group “did nothing other than to
look the other way” during the foreclosure, [6] ¶ 68, does not give rise to an inference
of fraudulent intent by the debtor. Even if the Leaders Group insiders who controlled
Holata Micco harbored a devious intent to cheat Leaders Group’s creditors and
acquire its assets for themselves at an unfairly low price, that intent cannot be
imputed to Leaders Group, which was controlled by directors who were disinterested
and independent from Holata Micco.
The complaint alleges that “Leaders Group and Holata Micco failed to comply
with the notice procedures in the Trust Agreement in order to prevent [Hildene] from
participating in the sale,” [6] ¶ 111, but defendants point out that the indenture does
not require senior creditors to provide notice to the trustee or TruPS investors before
foreclosing on their security, [37-1] § 15.8, and Hildene does not cite a provision
requiring Leaders Group to notify Hildene of the foreclosure. The complaint also
alleges that “Leaders Group was well aware of the successor clause and sought to
structure the Bank Shares sale to avoid having to comply with the TruPS
indentures,” [6] ¶ 111, but that allegation is a conclusory one. Hildene has not stated
a transfer with intent to defraud claim.
Proof of fraudulent intent is not required to establish constructive fraud. A.G.
Cullen Const., Inc. v. Burnham Partners, LLC, 2015 IL App (1st) 122538, ¶ 27, 29
N.E.3d 579, 586 (1st Dist. 2015). The complaint adequately alleges that the
14
foreclosure auction was scheduled for July 19, 2017, and at that time Leaders Group
was insolvent—a sufficiently particular allegation of the timing of insolvency. [6]
¶¶ 55, 108. Though defendants argue that “a person gives a reasonably equivalent
value if the person acquires an interest of the debtor in an asset pursuant to a
regularly conducted, noncollusive foreclosure sale,” 740 ILCS 160/4(b), Hildene
alleges that the bank share foreclosure was not “regularly conducted” but rather
commercially unreasonable. The complaint alleges that Holata Micco’s credit bid of
$6 million was “substantially less than the fair market value of the Bank Shares,
based on Leaders Bank’s approximately $26,000,000 in tangible common equity and
other factors.” [6] ¶ 65. The bank’s tangible common equity at least makes it plausible
that the credit bid was below the value of the shares. And though it seems doubtful
that Hildene, an unsecured creditor, would have recovered anything even if the
foreclosure had been conducted more favorably to creditors, it is at least plausible
that a sale commensurate with the bank’s value could have generated something for
Hildene—it has alleged damages.
D.
Derivative Claims
1.
Demand Futility
Derivative actions have a demand requirement that obligates the plaintiff to
demonstrate that the entity whose rights she seeks to enforce rejected the
opportunity to bring suit after receiving suitable demand. See Kamen v. Kemper Fin.
Servs., Inc., 500 U.S. 90, 95–96 (1991). “The purpose of the demand requirement is to
afford the directors an opportunity to exercise their reasonable business judgment
and waive a legal right vested in the corporation in the belief that its best interests
15
will be promoted by not insisting on such right.” Id. at 96 (cleaned up). Its function is
to “delimit[ ] the respective powers of the individual shareholder and of the directors
to control corporate litigation.” Id.
Federal Rule of Civil Procedure 23.1 requires plaintiffs in derivative actions to
“state with particularity (A) any effort by the plaintiff to obtain the desired action
from the directors or comparable authority and, if necessary, from the shareholders
or members; and (B) the reasons for not obtaining the action or not making the effort.”
“[A]lthough federal law governs the degree of detail that the plaintiff must furnish
when it gives its ‘reasons for not obtaining the action or not making the effort,’ state
law will determine whether those reasons are sufficient.” Westmoreland Cty.
Employee Ret. Sys. v. Parkinson, 727 F.3d 719, 722 (7th Cir. 2013) (citation omitted).
Because Leaders Group is an Illinois corporation, Illinois law governs whether
demand is excused, and Illinois follows Delaware law on the issue. See In re Abbott
Labs. Derivative Shareholders Litig., 325 F.3d 795, 803 (7th Cir. 2003); Spillyards v.
Abboud, 278 Ill.App.3d 663, 675 (1st Dist. 1996).
Hildene argues that the demand requirement does not apply to it because it is
a creditor, not a shareholder. Hildene points out that Rule 23.1 says it applies “when
one or more shareholders or members of a corporation” bring a derivative action.
Nevertheless, demand futility is a substantive—not a procedural—requirement, so
whether it applies to creditors is a matter of state law. Westmoreland, 727 F.3d at
722. Some non-binding cases assume that demand futility applies to creditorderivative suits. See In re Hartford Court Dev., Inc., No. 17 BK 01356, 2018 WL
16
604540, at *2 (Bankr. N.D. Ill. Jan. 25, 2018); In re First Capital Holdings Corp., 146
B.R. 7, 13 (Bankr. C.D. Cal. 1992).
Hildene offers no reason why the demand requirement should not apply to
creditors who bring derivative actions, which are equitable in nature. Shareholders
are permitted to enforce a corporation’s rights because “they are the ultimate
beneficiaries of the corporation’s growth and increased value.” N. Am. Catholic Educ.
Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007). But when a
corporation is insolvent, “its creditors take the place of the shareholders as the
residual beneficiaries of any increase in value.” Id. The incentives of shareholders
and creditors are the same, id. at 102, so the same safeguards should apply. The
policies behind the demand requirement for shareholders apply with equal force to
creditors—directors are charged with managing a corporation’s affairs and the
decision to litigate belongs in their hands, absent special circumstances. For that
reason, the demand requirement applies to derivative actions brought by creditors.
See Prod. Res. Grp., L.L.C. v. NCT Grp., Inc., 863 A.2d 772, 795–96 (Del. Ch. 2004)
(providing arguments for and against applying the demand requirement to creditors,
without deciding the issue).
Hildene argues that demand should be excused as futile. One argument it
raises is that demand is futile because Hildene contacted John Gleason, one of
Leaders Group’s directors and its CEO, and he said Leaders Group disputes Hildene’s
allegations and refused to provide information. [6] ¶ 86. This argument reflects a
misunderstanding of demand futility. See Blasband on Behalf of Danaher Corp. v.
17
Rales, 772 F.Supp. 850, 856 (D. Del. 1991), vacated on other grounds, 971 F.2d 1034
(3d Cir. 1992) (“The test, as articulated by the Delaware courts, is not whether it
appears unlikely on the evidence that the board will respond affirmatively to the
demand … Rather, the question is whether directors have the legal capacity to
consider the demand disinterestedly.” (citation omitted)). Demand is futile when
particularized factual allegations create a reasonable doubt 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, 814
(Del. 1984).7 The demand-futility “analysis is fact-intensive and proceeds director-bydirector and transaction-by-transaction.” Khanna v. McMinn, No. CIV.A. 20545-NC,
2006 WL 1388744, at *14 (Del. Ch. May 9, 2006).
a. Disinterested and Independent Directors
A disinterested director “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.”
Aronson, 473 A.2d at 812. With respect to the dilution of Leaders Group’s bank
shares, the complaint alleges that two of Leaders Group’s twelve directors have the
last name Kelly (the same name as the family that received the newly issued shares),
Both parties apply the Aronson test, so I assume Hildene’s claims are based on the directors’
actions or conscious inaction, not actions that they were not aware they should take.
Otherwise, the test articulated in Rales v. Blasband, 634 A.2d 927, 933–34 (Del. 1993), which
applies to circumstances “where the subject of the derivative suit is not a business decision
of the board,” would apply. See Abbott, 325 F.3d at 806.
7
18
but that is not a majority of the directors.8 With respect to the foreclosure of the bank
shares, the complaint alleges that two of Leaders Group’s twelve directors are
principals of Holata Micco who stood to gain from the sale—also not a majority. So
the majority of directors were disinterested in both transactions.
An independent director is one whose “decision is based on the corporate merits
of the subject before the board rather than extraneous considerations or influences.”
Id. at 816. Hildene argues that “Directors of Leaders Group are related (i.e.,
siblings),” pointing to allegations about the two Kelly directors and the two Gleason
directors, which still leaves the majority of directors independent. Hildene also
asserts that the directors “are beholden to one another through a myriad of family
and business relationships related to Leaders Group and Holata Micco” and that the
Kelly family holds influence over Leaders Group. [39] at 19. Neither of those
assertions are found in the complaint, nor are they supported by factual allegations.
See Aronson, 473 A.2d at 815. Though Hildene asks me to take judicial notice of the
Leaders Group organizational chart as proof of the Kelly family’s influence over the
directors, it establishes only that the Kelly family is a minority shareholder of
Leaders Group and does nothing to suggest that any of the directors are beholden to
the family.9
I dismissed Hildene’s only derivative claim relating to the dilution transaction—the
fraudulent concealment claim—above, on other grounds. But for the sake of completeness, I
will address demand futility with respect to the dilution anyway.
8
Hildene cited to a link that does not lead to the organizational chart. From the title that it
gave,
I
assume
it
meant
to
refer
to
the
one
available
at
https://www.chicagofed.org/~/media/others/banking/financial-institution-reports/fr-y-6-pdffiles/2016/l/leaders-group-inc-2856014-2016.pdf.
9
19
Because Hildene has not alleged a reasonable doubt that the majority of
directors were disinterested and independent, it must rely on Aronson’s second test
for demand futility.
b. Business Judgment Rule
The business judgment rule “is 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.”
Aronson, 473 A.2d at 812. However, the business judgment rule does not protect
directors against allegations of “bad faith, fraud, illegality or gross overreaching.”
Stamp v. Touche Ross & Co., 263 Ill.App.3d 1010, 1016 (1st Dist. 1993). “The totality
of the complaint’s allegations need only support a reasonable doubt of business
judgment protection, not ‘a judicial finding that the directors’ actions are not
protected by the business judgment rule.’” Abbott, 325 F.3d at 809 (citation omitted)).
Hildene states that the directors did not exercise due care, but there is nothing
in the complaint to suggest that the directors’ actions are attributed to a lack of care,
diligence, or skill. Instead, Hildene alleges that the directors’ actions were done in
bad faith. “If due care is exercised … then the business judgment rule is applicable to
preclude director liability for erroneous judgments absent conduct involving fraud,
illegality or conflict of interest.” Stamp, 263 Ill.App.3d at 1016. In other words, the
business judgment rule applies unless the directors breached their fiduciary duty of
loyalty.
The fiduciary duty of loyalty requires directors “to administer the corporate
affairs for the common benefit of all the stockholders and exercise their best care,
20
skill and judgment in the management of the corporate business solely in the interest
of the corporation.” Id. at 1015 (citation omitted) (emphasis in original). “[T]he
intentional dereliction of duty or the conscious disregard for one’s responsibilities
[constitutes] bad faith conduct, which results in a breach of the duty of loyalty.”
Westmoreland, 727 F.3d at 726 (quoting McPadden v. Sidhu, 964 A.2d 1262, 1274
(Del.Ch.2008)). See also In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 67 (Del.
2006) (director acts in bad faith when she intentionally acts with a purpose other
than protecting the best interests of the corporation, intends to violate the law, or
intentionally fails to act in the face of a known duty to do so). Because the majority
of directors did not have a conflict of interest, the question here is whether the
complaint’s allegations adequately accuse them of acting in bad faith.
Hildene has not alleged facts to make a bad-faith claim plausible for the
dilution of shares. As I explained above, Hildene did not allege that the directors took
any action or inaction with respect to the dilution, but even if the directors caused
the dilution, the allegations do not suggest bad faith. The majority of the directors
were disinterested and independent, and plaintiffs’ factual allegations do not give rise
to an inference that any of them were intentionally shirking known duties or had in
mind an interest other than the corporation’s. The only dilution-related allegation
that Hildene points to as demonstrating bad faith is that the directors “did not permit
Leaders Group to market the equity in the Bank.” [6] ¶ 41. It is unaccompanied by
any allegation that the directors knew they had an obligation to market the equity or
21
facts from which to infer that they did not market the equity because they were
motivated by something other than Leaders Group’s interests.
Nor has Hildene alleged a plausible claim for bad faith in the foreclosure sale.
Again, there are no allegations that the directors knew of any obligations that they
intentionally ignored or to suggest that the directors intended to do anything illegal
or with a nefarious purpose. Hildene cites to the allegation that the directors “took
no action for years to try to maximize the value of its assets,” [6] ¶ 54, but that quite
general allegation does not suggest that the directors knew they had an obligation to
take any particular action. And the other allegations Hildene relies on are things the
directors “could have” done—like filed for bankruptcy, hired an investment banker,
or other unknown “[a]lternatives.” [6] ¶¶ 6, 66. If the directors intentionally flouted
a known obligation to take those actions or if their inaction is attributed to an
impermissible purpose, then the business judgment rule would not protect them, but
otherwise, the business judgment rule does not allow Hildene to substitute its
judgment for that of the directors.
Hildene has not established either Aronson test, so its failure to meet the
demand requirement is not excused, and the derivative claims are dismissed.
2.
Merits
Though I need not reach them, I briefly address some of the merits arguments
regarding the derivative claims. Defendants argue that the business judgment rule
defeats Hildene’s breach of fiduciary claim as a matter of law. Though Hildene does
not argue it, the business judgment rule may be an affirmative defense that a
complaint generally need not anticipate. See Fed. Deposit Ins. Corp. v. Giancola, No.
22
13 C 3230, 2014 WL 1056643, at *3 (N.D. Ill. Mar. 19, 2014). Anyway, dismissal would
be appropriate for the same reasons that demand is not excused as futile—the
complaint’s allegations of the directors’ choices are unaccompanied by facts showing
that those choices were made in bad faith. As for the aiding and abetting claim,
Holata Micco cannot be liable for aiding and abetting a breach of fiduciary duty that
did not occur, so that claim’s fate is tied to the unsuccessful breach of fiduciary duty
claim.
Defendants also challenge Hildene’s claim that the foreclosure sale violated
the UCC. The UCC requires that “[e]very aspect of a disposition of collateral,
including the method, manner, time, place, and other terms, must be commercially
reasonable.” 810 ILCS 5/9-610(b). A sale is conducted in a commercially reasonable
manner if it is made “(1) in the usual manner on any recognized market; (2) at the
price current in any recognized market at the time of the disposition; or (3) otherwise
in conformity with reasonable commercial practices among dealers in the type of
property that was the subject of the disposition.” 810 ILCS 5/9-627(b). Defendants
argue that Hildene only relies on the allegedly insufficient price to support its claim,
but Hildene alleges that the advertisements used to publicize the foreclosure sale
were a commercially unreasonable method of selling bank equity. See [6] ¶ 119
(“Bank equity is not typically sold through newspaper advertisements.”). Contrary to
defendants’ assertion, that newspaper ads are not the normal commercial practice for
selling bank equity is not a conclusion, it is a fact accepted as true at this stage. That
23
makes it plausible that the sale was commercially unreasonable, but this derivative
claim is dismissed for the reasons discussed above.
IV.
Conclusion
Defendants’ motion to dismiss [37] is granted in part, denied in part. Hildene
can pursue its constructive fraudulent transfer claim against Holata Micco, but its
other claims are dismissed without prejudice.10
ENTER:
___________________________
Manish S. Shah
United States District Judge
Date: March 12, 2019
“District courts routinely do not terminate a case at the same time that they grant a
defendant’s motion to dismiss; rather, they generally dismiss the plaintiff’s complaint
without prejudice and give the plaintiff at least one opportunity to amend her complaint.”
Foster v. DeLuca, 545 F.3d 582, 584 (7th Cir. 2008).
10
24
Disclaimer: Justia Dockets & Filings provides public litigation records from the federal appellate and district courts. These filings and docket sheets should not be considered findings of fact or liability, nor do they necessarily reflect the view of Justia.
Why Is My Information Online?