Arnold v. McClendon et al
Filing
32
ORDER denying 25 Motion to Dismiss. Signed by Honorable Timothy D. DeGiusti on 9/28/2012. (mb)
IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF OKLAHOMA
M. LEE ARNOLD, Derivatively on Behalf of )
CHESAPEAKE ENERGY CORPORATION, )
)
Plaintiff,
)
)
vs.
)
)
AUBREY K. McCLENDON, et al.,
)
)
Defendants.
)
No. CIV-11-986-D
ORDER
Before the Court is the motion to dismiss [Doc. No. 25] of Defendant Chesapeake Energy
Corporation (“Chesapeake”). Chesapeake seeks dismissal pursuant to Fed. R. Civ. P. 12(b)(1) and
(6), arguing Plaintiff M. Lee Arnold (“Mr. Arnold”) lacks standing to pursue this shareholder
derivative action on behalf of Chesapeake Energy Corporation (“Chesapeake”), and has failed to
allege facts sufficient to support the essential elements of a shareholder derivative claim. Mr.
Arnold has responded, and Chesapeake filed a reply.
I. Background:
Mr. Arnold, a Chesapeake shareholder, brought this action to assert derivative claims based
on alleged violations of the federal securities laws in connection with Chesapeake’s July 2008 stock
offering. He alleges that the registration statement and related materials in connection with that
offering have material omissions. Mr. Arnold does not dispute that his claims in this lawsuit are
essentially the same as those asserted in a class action suit pending in this Court, United Food and
Commercial Workers’ Union v. Chesapeake Energy, et al., CIV-09-1114-D (the “Class Action”).
Prior to the September 6, 2011 filing of this lawsuit, another Chesapeake shareholder brought
a derivative action against the Chesapeake board of directors (the “Directors”), alleging breaches
of fiduciary duty based on the same claims asserted in the Class Action. That action, Lutzker v.
Chesapeake Energy Corp., et al., CJ-09-2329, is pending in the District Court of Oklahoma County.
However, the parties voluntarily stayed that case pending the outcome of the Class Action.1
In its motion, Chesapeake argues Mr. Arnold lacks standing to pursue the instant litigation
because he cannot show the Directors refused his request that they pursue the litigation on behalf
of the corporation.
II. Standards governing the sufficiency of allegations in a shareholder derivative action:
Chesapeake seeks dismissal pursuant to both Fed. R. Civ. P. 12(b)(1) and 12(b)(6). Its Rule
12(b)(1) argument seeking dismissal for lack of subject matter jurisdiction is based on the contention
that Mr. Arnold lacks standing to pursue this action. As a general rule, the “‘proper procedural
route’ for standing challenges is a motion under rule 12(b)(1).” Kautz v. Sugarman, 2011 WL
1330676, at *3 (S.D.N.Y. Mar. 31, 2011 (unpublished opinion) (quoting Alliance for Environmental
Renewal, Inc. v. Pyramid Crossgates, 436 F.3d 82, 89 n. 6 (2d Cir. 2006)). Where standing is
challenged in a shareholder derivative action, however, the “case law is unclear” as to whether the
issue is analyzed under Rule 12(b)(1) or 12(b)(6). Winn v. Schafer, 499 F. Supp. 2d 390, 395
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Chesapeake notes that two other shareholders separately filed derivative actions in the District Court
of Oklahoma County. In those lawsuits, In re Chesapeake Shareholder Litigation, No. CJ-09-3983, and
Louisiana Municipal Police Employees’ Union v. Chesapeake, No. CJ-09-2870, the plaintiffs assert breaches
of fiduciary duty and related claims based on the 2008 employment compensation paid to Defendant Aubrey
K. McClendon. On November 1, 2011, these state cases were stayed pursuant to an order preliminarily
approving a settlement of both cases. Mr. Arnold has also filed another derivative action, Case No. CIV-11985-M, which alleges, inter alia, a breach of fiduciary duty in connection with Defendant McClendon’s 2008
employment compensation. In a December 23, 2011 Order [Doc. No. 39], Mr. Arnold’s lawsuit was
consolidated with another shareholder derivative action also based on Mr. McClendon’s 2008 compensation,
Clem v. Aubrey K. McClendon, et al., CIV–11-997-M. By Order of March 14, 2012 [Doc. No. 43], Judge
Vicki Miles-LaGrange granted the parties’ joint motion to stay the consolidated proceedings pending the
resolution by the Oklahoma Supreme Court of an appeal of the District Court’s approval of the settlement
in the two state court cases. The stay of the consolidated actions remains in effect as of the date of this Order.
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(S.D.N.Y. 2007). Although the Tenth Circuit Court of Appeals has not expressly addressed this
issue, most courts appear to conclude the issue of standing in a shareholder derivative action “can
be raised on either a Rule 12(b)(1) or a Rule 12(b)(6) motion.” San Diego County Employees
Retirement Ass’n v. Maounis, 749 F. Supp. 2d 104, 125 n. 6 (S.D.N.Y. 2010) (citations omitted).
Defendants challenging standing often raise the issue in the manner utilized by Chesapeake in this
case, and assert both Rule 12(b)(1) and 12(b)(6) motions. Id.; Winn, 499 F. Supp. 2d at 395.
However, the courts generally analyze the sufficiency of the allegations according to Rule 12(b)(6)
and Rule 23.1 rather than Rule 12(b)(1). See In Re Textron, Inc., 811 F. Supp. 2d 564, 571 (D. R.I.
2011); Oakland County Employees’ Retirement System v. Massaro, 772 F. Supp. 2d 973, 976 (N.D.
Ill. 2011); San Diego County, 749 F. Supp. 2d at 125 n. 6; Richelson v. Yost, 738 F. Supp. 2d 589,
595 (E.D. Pa. 2010).
Having reviewed the relevant decisions as well as the parties’ briefs in this case, the Court
concludes that the instant motion should be analyzed according to the standards applicable to Rule
12(b)(6) and Rule 23.1.
A. Standards governing Rule 12(b)(6) motions:
To avoid dismissal pursuant to Rule 12(b)(6), a complaint “must contain enough factual
allegations ‘to state a claim to relief that is plausible on its face.” Bell Atlantic Corp. v. Twombly,
550 U.S. 544, 570 (2007); Robbins v. Oklahoma, 519 F. 3d 1242, 1247 (10th Cir. 2008); VanZandt
v. Oklahoma Dept. of Human Services, 276 F. App’x 843, 846 (10th Cir. 2008) (unpublished
opinion). To state a plausible claim, “the Plaintiff has the burden to frame a ‘complaint with enough
factual matter (taken as true) to suggest’ that he or she is entitled to relief.” VanZandt, 276 F. App’x
at 846 (quoting Robbins, 519 F. 3d at 1247.) “Factual allegations must be enough to raise a right
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to relief above the speculative level.” Twombly, 550 U. S. at 555. Thus, plaintiffs must allege
sufficient facts to “nudge[ ] their claims across the line from conceivable to plausible.” Id. at 570.
B. Standards governing application of Rule 23.1:
Assessing the sufficiency of the allegations in a shareholder derivative complaint also
requires application of the pleading requirements of Fed. R. Civ. P. 23.1. “Shareholder derivative
suits must satisfy both the general pleading standards of Rule 12(b)(6) and the particular
requirements set forth in Rule 23.1.” Kautz v. Sugarman, 2011 WL 1330676, at *3 (S.D.N.Y. Mar.
31, 2011) (unpublished opinion) (citing Halebian v. Berv, 590 F.3d 195, 204 (2d Cir.2009)). Rule
23.1 prescribes the pleading requirements for a shareholder derivative claim. Fed. R. Civ. P.
23.1(b). In addition to requiring a verified complaint, the Rule dictates that certain allegations must
be included. Accordingly, the Complaint must:
1) allege that the plaintiff was a shareholder or member at the time of the transaction
complained of, or that the plaintiff's share or membership later devolved on it by
operation of law;
(2) allege that the action is not a collusive one to confer jurisdiction that the court
would otherwise lack; and
(3) 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.
Fed. R. Civ. P. 23.1(b)(1)-(3).
“[U]nder Federal Rule of Civil Procedure 23.1, a plaintiff bringing a shareholders’ derivative
suit must state with particularity that the plaintiff has made a demand on the board of directors to
take the requested action or the reasons for not making the demand. Fed.R.Civ.P. 23.1(b).” In re
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American International Group, Inc. Derivative Litigation, 700 F. Supp. 2d 419, 430 (S.D.N.Y. 2010)
“ Rule 23.1 is not satisfied by conclusory statements or mere notice pleading.” Brehm v. Eisner, 746
A.2d 244, 254 (Del.2000). “‘Because Rule 23.1 requires that plaintiffs make particularized
allegations, it imposes a pleading standard higher than the normal standard applicable to the analysis
of a pleading challenged under Rule 12(b)(6).’” In re American International, 700 F. Supp. 2d at
430 (quoting Kernaghan v. Franklin, 2008 WL 4450268, at *3 (S.D.N.Y. Sept. 29, 2008)); see also
In re Adolor Corp. Derivative Litigation, 2009 WL 1325738, at *5 (E.D. Pa. 2009) (unpublished
opinion) (Rule 23.1 “imposes a heightened pleading standard for shareholder derivative suits”).
III. Application:
In its motion, Chesapeake acknowledges the Complaint satisfies Rule 23.1 to the extent it
is properly verified, sufficiently alleges Mr. Arnold is a Chesapeake shareholder, and alleges the
absence of collusion to confer jurisdiction. Chesapeake argues, however, that the Complaint is
deficient because it fails to state with particularity that Mr. Arnold made a demand upon the
Chesapeake Directors prior to filing suit, and the Directors refused to initiate the litigation he
demanded. Chesapeake further argues that Mr. Arnold’s allegations and the exhibits attached to,
and incorporated by reference in, the Complaint show the Directors did not refuse his demand to
pursue litigation on behalf of the corporation. Chesapeake contends the exhibits show the Directors
informed Mr. Arnold that, because his proposed claims are the same as those asserted in the Class
Action, they would determine whether to pursue a lawsuit after certain matters were adjudicated in
the Class Action. Mr. Arnold argues the Directors’ response is equivalent to a refusal to pursue the
litigation, thus satisfying the demand prerequisite to a derivative action.
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A derivative action “is a litigation device that enables shareholders to sue on behalf of the
corporation where those in control of the company refuse or fail to assert a claim belonging to it.”
Alabama By-Products Corp. v. Cede & Co., 657 A.2d 254, 264-65 (Del. 1995) (citing Aronson v.
Lewis, 473 A.2d 805, 811 (Del. Super. 1984), overruled sub nom. on other grounds, Brehm v.
Eisner, 746 A.2d 244, 253 (Del. 2000)).2 There are two aspects to a derivative action: (1) an effort
by the shareholders against the corporation to compel it to sue; and (2) the underlying claim by the
corporation, asserted by shareholders on its behalf, against those who caused the corporation legal
injury. Aronson, 473 A.2d at 811.
Because a plaintiff in a derivative action is asserting a claim on behalf of the corporation,
he must establish “standing to maintain a derivative shareholder’s suit” on the corporation’s behalf.
Alabama By-Products, 657 A. 2d at 265. To do so, he must first make a demand on the
corporation’s directors to bring the suit at issue, and he must show that the directors refused his
demand. The demand requirement “affords the directors an opportunity to exercise their reasonable
business judgment” to determine whether the best interests of the corporation are served by the
directors’ pursuit of the litigation or by foregoing their right to sue and allowing a derivative action
to be pursued. Daily Income Fund v. Fox, 464 U.S. 523, 532-33 (1984).
“Until the board is
afforded such a reasonable opportunity to respond, a shareholder making the demand has no
standing to commence derivative litigation on the corporation’s behalf.” Abbey v. Computer &
Communications Technology Corp., 457 A. 2d 368, 371 (Del. Ch. 1983); Nussbacher v. Continental
2
The parties agree that Oklahoma courts consider decisions of the Delaware courts persuasive
authority on issues related to the construction of the Oklahoma General Corporation Act because it is based
on Delaware’s Corporations Act. See Beard v. Love, 173 P.3d 796, 802 (Okla. Civ. App. 2007).
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Illinois Bank & Trust Co., 518 F.2d 873 (7th Cir.1975), cert. denied, 42 U.S. 928 (1976); Mills v.
Esmark, Inc., 91 F.R.D. 70 (N.D. Ill.1981); Siegal v. Merrick, 84 F.R.D. 106 (S.D.N.Y.1979)).
“The demand requirements of Rule 23.1 are predicated on the application of the business
judgment rule in the context of a board’s exercise of its managerial power over a derivative claim.”
In re Price/Costco Shareholder Litigation, 1995 WL 786631, at *3 (W.D. Wash. Oct. 30, 1995)
(unpublished opinion) (citing Levine v. Smith, 591 A.2d 194, 205 (Del. 1991)). “The business
judgment rule is ‘a presumption that in making a business decision, not involving self-interest, 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.’” Id. (quoting Spiegel v. Buntrock, 571 A.2d
767, 774 (Del. 1990)). “If a board’s decision can be attributed to any rational business purpose, a
court will not substitute its judgment for that of the board.” In re Price/Costco, 1995 WL 786631,
at* 3 (citing Levine, 591 A.2d at 207).
In this case, Mr. Arnold alleges that he made demand on the Chesapeake Directors and that
they refused to take action. Complaint at ¶¶ 105; 126-131. In support of this allegation, he attaches
to the Complaint correspondence between his attorney and the Directors.3 Complaint, Exs. 1-10.
Exhibit 1 is a March 20, 2009 letter from Mr. Arnold’s attorney making demand that the Directors
file suit on behalf of the corporation to assert the claims raised in the February 26, 2009 class action
lawsuit based on alleged material omissions in the July 2008 stock offering. Exhibit 2 is an undated
3
Because the exhibits are expressly referenced and incorporated in the Complaint and constitute an
integral part of Mr. Arnold’s allegations, they may be considered in the Court’s ruling on the motion without
the need to convert it to a motion for summary judgment. Alvarado v. KOB-TV, L.L.C. 493 F.3d 1210,
1215-1216 (10th Cir.2007). GFF Corp. v. Associated Wholesale Grocers, 130 F.3d 1381, 1384 (10th
Cir.1997).
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letter from Jennifer M. Grigsby, Senior Vice President, Treasure and Corporate Secretary of
Chesapeake. Ms. Grigsby acknowledges receipt of Mr. Arnold’s March 20 letter and advises it has
been transmitted to the Directors for consideration.
Exhibit 3 to the Complaint is a July 24, 2009 letter from Mr. Arnold’s attorney to Ms.
Grigsby in which he acknowledges receipt of her letter, but states the Directors have not responded
to his demand. In addition, Mr. Arnold’s attorney asserts a new demand upon the Directors that they
initiate litigation regarding Mr. McClendon’s 2008 compensation increase and related matters.
Ms. Grigsby’s August 11, 2009 response is submitted as Exhibit 4. She acknowledges
receipt of the July 24 letter and advises that the Directors considered Mr. Arnold’s first demand at
their June meeting. She states that the Directors decided at that time to postpone a decision on Mr.
Arnold’s demand until receipt of a ruling in the pending motion to dismiss the Class Action suit.
Exhibit 5 to the Complaint is a November 14, 2009 letter from Ms. Grigsby to Mr. Arnold’s
attorney in which she notes the Class Action suit had been transferred from the Southern District of
New York to this Court, and reiterates the Directors’ determination to defer a decision on Mr.
Arnold’s demand for litigation until receipt of a ruling on the motion to dismiss the Class Action.
She also advises the Directors considered Mr. Arnold’s subsequent demand for litigation regarding
Mr. McClendon’s 2008 compensation and states they also decided to defer a decision on that
demand. Ms. Grigsby notes that the Directors are aware of the statute of limitations with regard to
these issues, and states that, if necessary, tolling agreements will be provided.
In the December 2, 2009 letter submitted as Exhibit 6, Mr. Arnold’s attorney replied to Ms.
Grigsby, acknowledging receipt of her August and November letters. He reiterated Mr. Arnold’s
initial demand for litigation, expressed disagreement with the Directors’ view that they should defer
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action until a ruling on the pending motion to dismiss the Class Action, and stated his view that the
Directors’ position of “neutrality” could be seen as tacit approval of Mr. Arnold’s right to pursue
a derivative action. He also asked for detail regarding the possibility of tolling agreements.
Exhibit 7 to the Complaint is Ms. Grigsby’s April 15, 2010 letter advising the motion to
dismiss the Class Action case had been denied, but indicating the Directors anticipated an appeal
of that ruling, and decided to await an appellate decision before considering pursuit of litigation.
Exhibit 8 is a September 15, 2010 letter to Ms. Grigsby from Mr. Arnold’s attorney in which
he noted the denial of the motion to dismiss the Class Action lawsuit, and requested a “prompt
response” from the directors to Mr. Arnold’s initial demand request. Counsel sought a decision by
September 24, 2010.
Ms. Grigsby’s September 15 response is submitted as Exhibit 9. She states counsel’s request
has been forwarded to the Directors for consideration at their September 23, 2010 meeting. Exhibit
10 to the Complaint is an October 13, 2010 letter from Ms. Grigsby to Mr. Arnold’s attorney
advising the Directors voted at their September 23 meeting to defer action on Mr. Arnold’s demand
pending the resolution of the Class Action lawsuit. Ms. Grigsby also states there are no current
statute of limitations issues, and no need to consider tolling agreements at that time.
In the Complaint, Mr. Arnold alleges facts summarizing the foregoing communications.
Complaint ¶¶ 105-117. He also alleges that it appears the Directors did not conduct an investigation
of the allegations he detailed in his demand letter, despite the passage of 29 months prior to the filing
of the Complaint. Id. at ¶¶ 123-124; 131.
Mr. Arnold alleges in detail that the Directors’ response to his initial demand constitute a
tacit refusal to pursue the litigation he requested. He alleges in detail contentions that the Directors’
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failure to take action constitutes approval of his intent to pursue litigation on behalf of Chesapeake
or a waiver of its right to pursue the litigation. Complaint at ¶¶ 130-132.
The Court concludes that Mr. Arnold’s detailed allegations are sufficient to satisfy the
particularized pleading requirements of Rule 23.1 with regard to his demand that the Directors
initiate litigation to assert the claims he enumerates in the Complaint. In its motion, Chesapeake
argues that the Directors’ response to Mr. Arnold’s demand constitute a reasonable response and
exercise of the business judgment rule, which must be accepted by the Court in deference to the
corporation’s right to manage its own affairs. See, e.g., Levine, 591 A. 2d at 205. Chesapeake then
argues that, as a result, its response to Mr. Arnold cannot be construed as a refusal to pursue the
litigation he demanded. Mr. Arnold responds that a corporate board of directors’ failure to timely
respond or its delayed response can be construed as a refusal.
Both parties cite decisions which appear to support these contrary arguments. The Court’s
initial focus must be whether Mr. Arnold’s Complaint satisfies the applicable pleading standards.
The Court concludes that it does. Regarding the application of the business judgment rule, having
reviewed the relevant decisions, the Court concludes that the sufficiency of Chesapeake’s response
to Mr. Arnold’s demand constitutes a factual question which cannot properly be resolved in a motion
to dismiss. While Chesapeake is correct in its explanation of the business judgment rule, the
application of the rule in this case does not necessarily dictate dismissal of the Complaint. The
question raised is whether the Directors’ actions in response to Mr. Arnold’s letter amount to a
refusal of his demand. The Court finds that his allegations are sufficient to create a factual dispute
regarding that issue. While the Court may ultimately conclude that the Directors’ response is
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sufficient and this action cannot be pursued derivatively, it cannot make that determination on the
basis of the pleadings before it at this time.
IV. Conclusion:
For the foregoing reasons, the motion to dismiss [Doc. No. 25] is DENIED. Chesapeake is
directed to file its answer to the Complaint within the time period prescribed by the Federal Rules
of Civil Procedure.
IT IS SO ORDERED this 28th day of September, 2012.
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