Flynn v. Miller Energy Resources, Inc. et al (TV1)

Filing 45

MEMORANDUM AND OPINION as set forth in following order.Signed by District Judge Thomas A Varlan on 9/21/12. Associated Cases: 3:11-cv-00422, 3:11-cv-00412(ABF)

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF TENNESSEE
AT KNOXVILLE
PATRICK P. LUKAS, derivatively on behalf
of MILLER ENERGY RESOURCES, INC.,

)
)
)
Plaintiff,
)
)
v.
)
)
MERRILL A. MCPEAK, SCOTT M. BORUFF, )
DELOY MILLER, JONATHAN S. GROSS,
)
HERMAN GETTELFINGER, DAVID HALL,
)
CHARLES M. STIVERS, DON A. TURKLESON, )
and DAVID VOYTICKY,
)
)
Defendants,
)
)
and
)
)
MILLER ENERGY RESOURCES, INC.,
)
)
Nominal Defendant.
)

No.:

3:11-CV-422 (Lead Case)1
(VARLAN/SHIRLEY)

MEMORANDUM OPINION
This consolidated civil action is before the Court on the defendants’ Motion to
Dismiss [Doc. 12].2 Pursuant to Fed. R. Civ. P. 12(b)(6) and 23.1, the defendants seek the
dismissal of this case primarily based on the argument that plaintiff failed to make a demand

1

Pursuant to the Order of the Court on June 26, 2012 [Doc. 36], this case was consolidated
with Flynn v. Miller Energy Resources, et al., No. 3:11-CV-412, and the instant case was designated
as the lead case.
2

A Motion to Dismiss [Doc. 14] was also filed in case number 3:11-CV-412 prior to
consolidation. Because the claims and arguments presented in that case are virtually
indistinguishable from those in the lead case, this opinion and accompanying order will serve as a
ruling on that motion as well.

on Miller Energy’s Board of Directors to investigate and, if appropriate, pursue an action on
Miller Energy’s behalf prior to bringing this lawsuit as required by Rule 23.1 and Tenn. Code
Ann. § 48-17-401. The plaintiff has responded to the motion [Doc. 29] and the defendants
have replied [Doc. 30]. The matter is ripe for determination.
After careful consideration and for the reasons set forth herein, the Court will
GRANT the motion to dismiss.
I.

Background3
A.

The Parties

Lead plaintiff Patrick P. Lukas is a current shareholder of defendant Miller Energy
Resources, Inc. (“Miller Energy” or the “Company”) and has continuously held Miller
Energy stock at all relevant times [Doc. 1 ¶ 15]. Defendant Miller Energy is a Tennessee
corporation engaged in the exploration, production, and drilling of oil and natural gas
resources in the United States [Id. ¶¶ 1, 16]. The nine individual defendants are Miller
Energy’s current directors [Id. ¶¶ 17–25]. Four of the individual defendants also serve as
Miller Energy officers: Scott Boruff is Chief Executive Officer; Deloy Miller is Chief
Operating Officer; David Voyticky is President and interim Chief Financial Officer; and
David Hall is the Chief Executive Officer of Cook Inlet Energy, a subsidiary of Miller
Energy [Id. ¶¶ 18–19, 22, 25; Doc. 12 at p. 2]. The remaining five individual defendants –

3

For the purposes of a motion to dismiss, the Court takes plaintiff’s factual allegations as
true. See Erickson v. Pardus, 551 U.S. 89, 94 (2007) (noting that, “when ruling on a defendant’s
motion to dismiss, a judge must accept as true all the factual allegations contained in the complaint”
(citations omitted)).
2

General Merrill A. McPeak, Don A. Turkleson, Jonathan S. Gross, Charles M. Stivers, and
Herman Gettelfinger – are directors from outside the Company [Doc. 1 ¶¶ 17, 20–21, 23–24].
B.

The Valuation of the Company’s Assets

On December 16, 2009, the Company announced that it had acquired in a bankruptcy
proceeding certain oil and gas assets in Alaska, valued at $325 million, for a total cost of
$2.25 million [Id. ¶¶ 2, 30]. The facilities would be operated through the Company’s whollyowned subsidiary, Cook Inlet Energy, LLC [Id. ¶ 30]. Over time, Miller Energy announced
the increased value of these assets to over $400 million in March 2010 [Id. ¶ 31–34], over
$800 million in May 2010 [Id. ¶ 39], and over $1.2 billion in August 2010 [Id. ¶ 41]. The
announced valuation of the Alaskan assets was positively reflected in the Company’s
financial reports and increased stock price [Id. ¶ 2].
On December 23, 2010, the Company entered into an amended employment
agreement with defendant Boruff which provided for a substantial increase in compensation
and options to purchase shares of Miller Energy stock [Id. ¶ 44–45]. The agreement was
recommended by the Compensation Committee (consisting of defendants McPeak, Stivers,
and Gettlefinger) and approved by the Board in recognition for the Company’s financial
performance [Id. ¶¶ 28, 46].
On July 28, 2011, a website called TheStreetSweeper published a report stating the
Company’s Alaska assets, valued at $350 million on the books, were actually worth $25
million to $30 million and offset by $40 million worth of liabilities [Id. ¶ 51]. While Miller
Energy disputes the accuracy of this report and questions the motives of its authors, the
3

plaintiff alleges and the Company acknowledges that the Company’s stock price did decline
following the posting of this report [Id. ¶¶ 4, 52].
C.

The SEC Filings

On July 29, 2011, Miller Energy filed its Annual Report on Form 10-K with the
Securities and Exchange Commission (“SEC”) for its fiscal year ending April 30, 2011 [Id.
¶¶ 5, 53–54]. The Annual Report contained a statement by KPMG, the Company’s auditor,
stating that the Company’s financial statements fairly presented the Company’s financial
position as of April 30, 2011 [Id. ¶ 54]. The Annual Report also included an Exhibit 23,
which contained KPMG’s signed consent to the use of its report by Miller Energy [Id.]. The
Annual Report further stated that the Company’s Audit Committee (consisting of defendants
McPeak, Stivers, Gross, and Voyticky) determined that certain financial statements could no
longer be relied upon as a result of errors in those financial statements and they would be
restated [Id. ¶ 55].
On August 1, 2011, Miller Energy filed a Form 8-K with the SEC stating that the
Annual Report, filed on July 29, 2011, and its financial statements were filed prior to KPMG
completing its review and without KPMG’s consent to use their report and should not be
relied upon [Id. ¶ 56]. The Form 8-K also stated that the Company expected to file an
amended Annual Report “as soon as possible” with revised financial statements [Id.]. These
disclosures resulted in a decline in Miller Energy’s stock price [Id.].

4

On August 9, 2011, the Company filed Amendment No. 1 to the Annual Report with
the SEC which identified its Annual Report as deficient, removed the audit report and
consent report of KPMG, and corrected certain “computational errors” in the financial
statements included in the Annual Report [Id. ¶ 58]. The Amendment No. 1 also stated that
the Company expected to file another amended Annual Report containing audited financial
statements as soon as “(1) the Audit Committee of our Board of Directors completes its
review of the events which led to the filing of the 2011 10-K prior to the completion of
KPMG’s review of our 2011 10-K and the issuance of its audit report, and (2) KPMG LLP
has completed its review of our fiscal year 2011 financial statements and issues its report
thereon.” The Amendment No. 1 further stated that the Audit Committee had engaged
Andrews Kurth LLP as special independent legal counsel to conduct a review of the filing
[Id.].
On August 29, 2011, the Company filed an amended Annual Report on Form 10-K
with the SEC which, according to the plaintiffs, described some of the losses the Company
had already incurred and would continue to incur as a result of “the materially false and
misleading statements caused to be issued by the Defendants” [Id. ¶ 59]. The Amended
Annual Report states that the restatement of the Company’s historical financial statements
“may have a material adverse effect on our business and stock price” and the erroneously
filed 10-K “will adversely impact our ability to raise additional capital” [Id. ¶¶ 60–61].
Additionally, the Amended Annual Report advises that the Company may be subject to
regulatory actions surrounding the filing of the Annual Report which could result in
5

increased legal fees and fines [Id. ¶ 62]. Plaintiff claims that, as a result of these actions, “the
price of the Company’s stock still has not recovered” [Id. ¶ 64].
D.

Plaintiff’s Claims

Plaintiff claims that the defendants, because of their positions of control and authority
as directors and/or officers of Miller Energy, “were able to and did, directly and/or indirectly,
exercise control over the wrongful acts” alleged [Id. ¶ 68]. Plaintiff alleges that the
defendants’ conduct was a “knowing and culpable violation of their obligations as directors
of Miller, the absence of good faith on their part, and a knowing or willful disregard for their
duties to the Company and its shareholders and a breach of their fiduciary duty of loyalty,
good faith, oversight, and diligence in management and administration of its affairs that the
Defendants were aware posed a risk of serious injury to the Company” [Id. ¶ 72]. Plaintiff
further alleges that the defendants “completely abdicated their oversight duties to the
Company by failing to implement internal procedures and controls necessary to prevent the
wrongdoing alleged” [Id. ¶ 77].
Plaintiff asserts the following claims, organized as “counts,” against the defendants:
(I) breach of fiduciary duty and disseminating materially false and misleading information;
(II) breach of fiduciary duties for failing to properly oversee and manage the company; (III)
unjust enrichment; (IV) abuse of control; (V) gross mismanagement; and (VI) waste of
corporate assets4 [Id. ¶¶83–111].

4

Count VI is mislabeled in the Complaint as the second Count V.
6

E.

The Demand Allegations

This action was filed on August 31, 2011. Plaintiff admits that he has not made any
demand on the Board to institute this action “because such a demand would be a futile,
wasteful and useless act” [Id. ¶ 75]. Plaintiff further alleges he did not make a demand on
the Board “because the wrongful acts complained of herein evidence a pattern of conduct
showing a wholesale abandonment of their fiduciary duties, including the duty to exercise
oversight, due care, and diligence” [Id. ¶ 78]. Plaintiff contends the acts complained of
“demonstrate a pattern of misconduct, were not, nor could they have been, the product of a
valid or good faith exercise of business judgment” [Id. ¶ 79]. Plaintiff alleges that demand
is excused because “every member of the Board permitted false and misleading statements
to be made in SEC filings, thereby abdicating their fiduciary duties to the Company, and
severely damaging the Company. Therefore, every member of the Board faces a substantial
likelihood of liability for their breaches of fiduciary duties, unjust enrichment, and other
violations of state law” [Id. ¶ 80]. Plaintiff alleges demand is excused because:
defendants issued a series of materially false and/or misleading
statements in which they failed to disclose, among other things: (1) that
the value of the oil and gas assets in Alaska acquired by the Company
was substantially less than that reported by the Company; (2) that the
net income reported as a direct result of the acquisition of the Alaskan
assets was overstated; (3) that the Company failed to properly classify
royalty expense; (4) that the Company did not properly record
depletion, depreciation and amortization expenses related to leasehold
costs, wells and equipment, fixed assets and asset retirement
obligations; (5) that the Company failed to properly calculate and
record sufficient compensation expense on equity rewards; (6) that the
Company did not properly calculate the liability for Miller’s derivative
securities; (7) that the Company failed to properly record income taxes;
7

(8) that the Company’s financial statements and results were overstated,
and in violation of GAAP5; (9) that the Company lacked adequate
internal and financial controls; and (10) as a result of the foregoing, the
Company’s financial performance, business and operations were far
worse than Defendants disclosed.
[Id. ¶ 81.] Finally, plaintiff alleges that demand is excused as to defendants McPeak, Stivers,
Gross, and Voyticky because “each served as members of the Audit Committee and breached
their fiduciary duties of due care, loyalty, and good faith, because the Audit Committee . .
. allowed or permitted false and misleading statements to be disseminated in the Company’s
press releases and other disclosures and failed to ensure that adequate internal controls were
in place” [Id. ¶82].
II.

Analysis
A.

Standard of Review

Federal Rule of Civil Procedure 8(a)(2) sets out a liberal pleading standard, Smith v.
City of Salem, 378 F.3d 566, 576 n.1 (6th Cir. 2004), requiring only “‘a short and plain
statement of the claim showing that the pleader is entitled to relief,’ in order to ‘give the
[opposing party] fair notice of what the . . . claim is and the grounds upon which it rests,’”
Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (quoting Conley v. Gibson, 355 U.S.
41, 47 (1957)). Detailed factual allegations are not required, but a party’s “obligation to
provide the ‘grounds’ of his ‘entitle[ment] to relief’ requires more than labels and
conclusions.” Twombly, 550 U.S. at 555. “[A] formulaic recitation of the elements of a

5

“GAAP” is an acronym for Generally Accepted Accounting Principles.
8

cause of action will not do,” nor will “an unadorned, the-defendant-unlawfully-harmed-me
accusation.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009).
In deciding a Rule 12(b)(6) motion to dismiss, a court must construe the complaint in
the light most favorable to the plaintiff, accept all factual allegations as true, draw all
reasonable inferences in favor of the plaintiff, and determine whether the complaint contains
“enough facts to state a claim to relief that is plausible on its face.” Twombly, 550 U.S. at
570; Directv, Inc. v. Treesh, 487 F.3d 471, 476 (6th Cir. 2007) (citation omitted). “A claim
has facial plausibility when the plaintiff pleads factual content that allows the court to draw
the reasonable inference that the defendant is liable for the misconduct alleged.” Iqbal, 556
U.S. at 678. “Determining whether a complaint states a plausible claim for relief will
[ultimately] . . . be a context-specific task that requires th[is Court] to draw on its judicial
experience and common sense.” Id. at 679.
B.

Demand Futility

Both Fed. R. Civ. P. 23.1 and Tenn. Code Ann. § 48-17-401(b) impose certain
requirements in shareholder derivative actions. Specifically, section 48-17-401(b) requires
that a derivative complaint “allege with particularity the demand made, if any, to obtain
action by the board of directors and either that the demand was refused or ignored or why the
person did not make the demand.” Similarly, Rule 23.1(b)(3) requires a derivative complaint
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.” Thus, a
9

shareholder must first make a written demand on the corporation’s directors requesting them
to prosecute the suit or to take other suitable corrective action. Lewis ex rel. Citizens Sav.
Bank & Trust Co. v. Boyd, 838 S.W.2d 215, 221 (Tenn. Ct. App. 1992). The demand
requirement recognizes 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. Kamen v. Kemper Finan. Servs., Inc., 500 U.S. 90,
101 (1991). As noted above, plaintiff admits that he did not make a pre-filing demand upon
the Board, but claims that such a demand would be “a futile, wasteful and useless act” [Doc.
1 ¶ 75].
Most states, including Tennessee, recognize an exception to the general demand rule
and permit a shareholder to proceed with an independent suit without making a demand when
the shareholder can demonstrate that doing so would be futile. Lewis, 838 S.W.2d at 222.
Defendants’ primary argument in support of the motion to dismiss is that the plaintiff has not
pled with sufficient particularity the reasons for failing to make a pre-suit demand. The bulk
of the parties’ pleadings debate the appropriate legal test for determining demand futility,
with both parties acknowledging that Tennessee law must govern whether plaintiff was
excused from making a demand because Miller Energy is a Tennessee corporation. See
Kamen, 500 U.S. at 108–09 (“a court that is entertaining a derivative action . . . must apply
the demand futility exception as it is defined by the law of the State of incorporation”);
McCall v. Scott, 239 F.3d 808, 815 (6th Cir. 2001) (“whether the failure to make a demand
is excused must be determined under the substantive law of the state of incorporation”).
10

Defendants rely on Lewis ex rel. Citizens Sav. Bank & Trust Co. v. Boyd, 838 S.W.2d
215, 221 (Tenn. Ct. App. 1992), which states the general proposition that “courts have
excused the demand requirement when the corporation’s officers and directors will
themselves be defendants or when the officers and directors are in collusion with those who
have injured the corporation.” Notably, the Lewis decision cites to Deaderick v. Wilson, 67
Tenn. 108, 131 (1874), a case relied upon by the plaintiff, in support of this general
proposition. However, the Lewis decision then expounds upon the general proposition
regarding demand excused cases as follows:
In demand excused cases, the grounds for the shareholder’s claim are
(1) that the board is interested and not independent and (2) that the
challenged transaction is not protected by the business judgment rule.
Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984). Thus, demand
excused cases require an examination of the corporate decision-makers’
interest and independence, Levine v. Smith, 591 A.2d at 212, as well as
the good faith and reasonableness of its investigation.
Lewis, 838 S.W.2d at 222.6 Defendants argue that Lewis, via the Aronson decision, sets forth
the standard for demand excused cases in Tennessee. Thus, defendants argue that plaintiff
must demonstrate with particularity that a majority of Miller Energy’s nine directors are (1)
not disinterested or (2) not independent and the complaint fails to do so [Id. at p. 12].
The plaintiff objects to this characterization of the demand futility standard in
Tennessee and contends that the general rule is as stated in Deaderick, that demand will be

6

Levine v. Smith is found at 591 A.2d 194 (Del. 1991). Both Aronson and Levine were
overruled on other grounds by Brehm v. Eisner, 746 A.2d 244, 254 (Del. 2000), regarding the
appropriate standard of appellate review.
11

excused as futile where the corporation’s officers and directors are defendants in the action
or are in collusion with the defendants, and no more [Doc. 29 at p. 12]. Plaintiff cites several
other Tennessee cases in support of this position, including Wallace v. Lincoln Sav. Bank,
15 S.W. 448, 449 (Tenn. 1891) (a derivative suit may proceed “where the corporation is
disabled from suing, as where the managing agents of the corporation (its officers and
directors) are themselves to be the defendants”); Peeler v. Luther, 135 S.W.2d 926, 928
(Tenn. 1940) (demand “need not be made where the corporation is under the control of the
wrongdoers or of persons who are necessary parties defendant”); and Akin v. Mackie, 310
S.W.2d 164, 168 (Tenn. 1958) (same). In short, the plaintiff urges the Court to conclude that
demand is excused because all nine of the Board members are named as defendants and to
reject the further analysis of Lewis requiring examination whether the directors exercised
disinterested and independent business judgment.
Defendants respond that demand should be not excused merely because all the
members of the Board are named as defendants as suggested by Deaderick; otherwise,
plaintiffs could easily circumvent the demand requirement by naming all members of the
Board as defendants [Doc. 12 at p. 12; Doc. 30 at p. 3]. Defendants cite to a number of cases
from other jurisdictions in support of this proposition, but have not provided any authority
from Tennessee courts on this point, nor is the undersigned aware of any.
Although plaintiff argues that the Lewis decision did not expressly adopt the Aronson
test, it appears that the test for demand futility is that as stated above by Lewis and has been
recited and followed by both state and federal courts. See McCarthy v. Middle Tenn. Elec.
12

Membership Corp., 466 F.3d 399, 410 (6th Cir. 2006); Lay v. Burley Stabilization Corp.,
2010 WL 2639931 at *4 (E.D. Tenn. June 28, 2010); DuVall v. Ecoquest Int’l, Inc., 2007 WL
2811052 at *2 (E.D. Mo. Sept. 24, 2007); Humphreys v. Plant Maint. Servs., Inc., 1999 WL
553715 at *6 (Tenn. Ct. App. July 30, 1999). However characterized, Lewis appears to state
the test for demand futility in Tennessee and this Court is bound to follow it. See Hayes v.
Equitable Energy Resources Co., 266 F.3d 560, 566 (6th Cir. 2001) (“A federal court sitting
in diversity applies the substantive law of the state in which it sits”). Thus, this Court must
determine whether the complaint has alleged with particularity (1) that the Board is interested
and not independent and (2) that the challenged transaction is not protected by the business
judgment rule.7 Lewis, 838 S.W.2d at 222.
1.

Interest

A director is considered interested in a decision made by the board “where he or she
will receive a personal financial benefit from a transaction that is not equally shared by the
stockholders.” Rales, 634 A.2d at 936. “Directorial interest also exists where a corporate
decision will have a materially detrimental impact on a director, but not on the corporation
and the stockholders.” Id. Citing Rales, defendants contend that the complaint contains no
allegations that the directors are unable to base their decisions on the corporate merits of the
7

Defendants also contend that because plaintiff appears to be challenging the Board’s failure
to act, rather than challenging an affirmative decision by the Board, only the first prong of the
Aronson analysis applies and the issue is “whether or not the particularized factual allegations of a
derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed,
the board of directors could have properly exercised its independent and disinterested business
judgment” [Doc. 12 at p. 11, citing Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993)]. In light of
the subsequent analysis, the Court need not resolve this issue.
13

subject before the Board rather than extraneous considerations or influences [Doc. 12 at p.
12; Rales, 634 A.2d at 936]. Defendants also claim the complaint does not allege that, as a
result of the challenged decisions, any director received a personal financial benefit not
equally shared by the stockholders [Id.].
Plaintiff contends that each defendant “personally participated in the misconduct
alleged in the Complaint” and were directors during the time period the Company
“disseminated false and misleading disclosure materials” [Doc. 29 at p. 16, citing Doc. 1 ¶
76]. Plaintiff further alleges that the defendants “completely abdicated their oversight duties
to the Company by failing to implement internal procedures and controls necessary to
prevent the wrongdoing” [Id., citing Doc. 1 ¶ 77]. Plaintiff claims that the defendants
“caused and permitted to be filed disclosure materials” containing the following
misrepresentations: (1) that the value of the oil and gas assets in Alaska acquired by the
Company was substantially less than that reported by the Company; (2) that the net income
reported as a direct result of the acquisition of the Alaskan assets was overstated; (3) that the
Company failed to properly classify royalty expense; (4) that the Company did not properly
record depletion, depreciation and amortization expenses related to leasehold costs, wells and
equipment, fixed assets and asset retirement obligations; (5) that the Company failed to
properly calculate and record sufficient compensation expense on equity rewards; (6) that the
Company did not properly calculate the liability for Miller’s derivative securities; (7) that the
Company failed to properly record income taxes; (8) that the Company’s financial statements
and results were overstated, and in violation of GAAP; (9) that the Company lacked adequate
14

internal and financial controls; and (10) as a result of the foregoing, the Company’s financial
performance, business and operations were far worse than Defendants disclosed [Doc. 29 at
p. 17, citing Doc. 1 ¶¶ 50, 81]. Plaintiff points out that the Audit Committee, consisting of
defendants McPeak, Stivers, Gross, and Voyticky, “were in the best position to control the
Company’s financial disclosures” [Doc. 29 at p. 17, citing Doc. 1 ¶ 82]. Plaintiff finally
contends that defendant Boruff “reaped windfall compensation awards that stemmed from
the meteoric rise of [the] Company’s stock price that was, in turn, predicated on the false
disclosures” [Id., citing Doc. 1 ¶ 28].
A careful review of the Complaint, however, reveals that the plaintiff has failed to
plead with particularity facts showing that a majority of the Board will be materially affected
in a manner not shared by the corporation or the stockholders. See, e.g., In re Ferro Corp.
Derivative Litig., 511 F.3d 611, 618 (6th Cir. 2008) (“Broad, generalized and conditional
statements . . . do not constitute facts pleaded with particularity”) (quoting In re Xcel Energy,
Inc., 222 F.R.D. 603, 607 (D. Minn. 2004)). Indeed, the vast majority of the allegations are
recitations from the Company’s various press releases and/or financial statements, such as
“the Company announced,” “the Company issued a press release,” or “the Company filed its
Quarterly Report” [See, e.g., Doc. 1 at ¶¶ 30–32]. These allegations do not contain any facts
showing that any individual defendant did or failed to do anything, much less that any
defendant will be materially affected in a manner not shared by the corporation or the
stockholders. Quoting from the Annual Report, the plaintiff alleges that “the Audit
Committee determined that certain of the Company’s financial statements . . . could no
15

longer be relied upon as a result of errors in those financial statements” [Id. at ¶ 55].
Similarly, quoting from the Form 8-K filed on August 1, 2011, the plaintiff again alleges that
the “Audit Committee determined that the Company’s consolidated balance sheet at April
30, 2011, and the Company’s consolidated statements of operations, stockholder’s equity and
cash flows for the year then ended, as well as the report of KPMG dated July 29, 2011 on
such statements . . . should not be relied upon” [Id. at ¶ 56]. Even interpreting these
allegations as against the individual members of the Audit Committee, they do not show
actions or inactions in which the Committee members would be materially affected in a
manner not shared by the corporation and the stockholders. Indeed, it seems entirely
plausible that the defendants, the Company, and the stockholders suffered as a result of these
events.
Within the section of the Complaint described as “derivative and demand allegations,”
the plaintiff alleges that defendants “completely abdicated their oversight duties to the
Company by failing to implement internal procedures and controls necessary to prevent the
wrongdoing” and “the wrongful acts complained of herein evidence a pattern of conduct
showing a wholesale abandonment of their fiduciary duties, including the duty to exercise
oversight, due care, and diligence” [Doc. 1 ¶¶ 77–78]. These conclusory allegations of a
failure to act or failure to oversee are often referred to as a Caremark violation described as
follows:
[A] director’s obligation includes a duty to attempt in good faith to
assure that a corporate information and reporting system, which the
board concludes is adequate, exists, and that failure to do so under
16

some circumstances may, in theory at least, render a director liable for
losses caused by non-compliance with applicable legal standards.
In re Caremark Int’l, Inc. Derivative Litig., 698 A.2d 959, 970 (Del. Ch. 1996). The
Caremark court described this theory as “possibly the most difficult theory in corporation
law upon which a plaintiff might hope to win a judgment.” Id. at 967. To succeed on such
a claim, a plaintiff must establish “a sustained or systematic failure of the board to exercise
oversight – such as an utter failure to attempt to assure a reasonable information and
reporting system exists.” Id. at 971. Thus, a plaintiff can only overcome the demand
requirement with “well-pleaded facts to suggest a reasonable inference that a majority of the
directors consciously disregarded their duties over an extended period of time.” Kenney v.
Koenig, 426 F. Supp. 2d 1175, 1182 (D. Colo. 2006) (quoting David B. Shaev Profit Sharing
Account v. Armstrong, 2006 WL 391931 at *1 (Del. Ch., Feb. 13, 2006)).
The plaintiff’s claims are replete with general averments of culpability and lengthy
quotes from press releases and financial reports. The complaint lacks allegations of specific
failures of the directors or the Audit Committee beyond the conclusory allegation that they
“allowed or permitted false and misleading statements to be made” [Doc. 1 at ¶ 80]. Plaintiff
alleges only that the defendants were Board members8 during the period when the accounting
improprieties occurred. “That is not enough.” Kenney, 426 F. Supp. 2d at 1183. The

8

As defendants point out, not all of the individual defendants were members of the Board
during the entire period of the events alleged. Defendants Gross, McPeak, and Voyticky joined the
Board in April 2010 [Doc. 1 ¶¶ 17, 20, 25], and defendant Turkleson joined the Board in January
2011 [Id. ¶ 24]. Thus, these defendants could not have “allowed or permitted” false and misleading
statements to be issued prior to joining the Board.
17

complaint contains no specific factual allegations of the role played, if any, by members of
the Audit Committee in preparing or approving the financial reports or which specific
oversight duties were neglected. The complaint contains no specific factual allegations of
improprieties discovered and ignored or covered up. See In re Ferro Corp. Derivative Litig.,
511 F.3d at 621 (“Plaintiffs failed to allege ‘any particular facts whatsoever to establish what
roles, if any, the individual defendants had in causing and/or covering up the accounting
irregularities’”). The Company’s eventual recognition that its internal controls were
ineffective does not necessarily equate to “a sustained or systematic failure of the board to
exercise oversight.” In re Caremark Int’l Inc. Derivative Litig., 698 A.2d at 971. Instead,
the Board’s recognition of the deficiencies and subsequent action suggest the opposite
inference. Further, “if mere recognition by the board that controls were previously
ineffective or inadequate were sufficient to establish a substantial likelihood of liability,
demand would be excused in practically every case involving a restatement of financials.”
Kenney, 426 F. Supp. 2d at 1183 (quoting Shields ex rel. Sundstrand Corp. v. Erickson, 710
F. Supp. 686, 691 (N.D. Ill. 1989)); In re Ferro Corp. Derivative Litig., 511 F.3d at 621
(“bald charges of mere failure to take corrective action are . . . inadequate to demonstrate
futility”) (quoting Lewis v. Graves, 701 F.2d 245, 249 (2nd Cir. 1983)). The plaintiff’s
failure to plead particularized facts establishing that a majority of the directors consciously
disregarded their duties over an extended period of time dooms his ability to establish a
Caremark violation and thus establish that the directors were interested.

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Therefore, for the reasons discussed above, the Court finds that the plaintiff has failed
to allege particularized facts showing that a majority of the Board would not be disinterested
under Rales, 634 A.2d at 930. The Court next examines whether a majority of the Board
lacked independence.
2.

Independence

“Independence means that a director’s decision is based on the corporate merits of the
subject before the board rather than extraneous considerations or influences.” Aronson, 473
A.2d at 816; Kenney, 426 F. Supp.2d at 1185. To establish lack of independence, the
plaintiff must show that the directors are “beholden to” or “so under their influence” of the
extraneous influences that their discretion would be sterilized. Rales, 634 A.2d at 936 (citing
Aronson, 473 A.2d at 815). “A party alleging domination and control of a company’s board
of directors bears the burden of proving such control by a showing a lack of independence
on a part of a majority of the directors.” Kenney, 426 F. Supp. 2d at 1185 (quoting Telxon
Corp. v. Meyerson, 802 A.2d 257, 264 (Del. 2002)). “A director may be controlled by
another person if that person has ‘the direct or indirect unilateral power to decide whether
the director continues to receive a benefit upon which the director is so dependent or is of
such subjective material importance that its threatened loss might create a reason to question
whether the director is able to consider’ the merits of the demand objectively.” Id.
Defendants argue that the complaint does not contain any allegations which demonstrate a
lack of director independence [Doc. 12 at p. 12]. The undersigned agrees.

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While plaintiff, in relying on the Deaderick formula for demand futility, suggests that
the defendants engaged in collusive activity [Doc. 29 at pp. 12–13], the complaint contains
no allegations of collusion among the defendants or anyone else. There are no allegations
that any individual or group of directors has exercised undue influence over the other
directors or the Board as a whole. There are no allegations that any individual or group of
directors is beholden to any other individual or group of directors. In short, plaintiff has
failed to allege any facts sufficient to support a claim of control or “succumbing to influences
which convert an otherwise valid business decision into a faithless act,” Aronson, 473 A.2d
at 816, and the Court has found none.
The Court notes that the complaint takes particular aim at defendants McPeak and
Boruff. Plaintiff alleges that General McPeak is “[c]hief among the perpetrators,” the
Company’s Lead Director, and a member of the Company’s Audit Committee and
Compensation Committee [Doc. 1 at ¶¶ 11, 28]. Several paragraphs of the complaint are
devoted to the suggestion that General McPeak’s reputation and experience as a director
were overstated (e.g., “McPeak is in the business of selling his reputation”) [Doc. 1 at ¶¶ 11,
17, 36–38]. The complaint also contains general allegations of actions taken by the
Compensation Committee or the Audit Committee, described as “with defendant McPeak as
its chairman” or “under the direction of McPeak” [Id. at ¶¶ 46, 66]. However, the only
individual allegation against General McPeak is that he “completely absconded his fiduciary
duties and oversight responsibilities” [Id. at ¶¶ 11, 36]. This is not a particularized allegation
of fact; it is a conclusion. There are no allegations that General McPeak exerted undue
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influence over any other directors, that other directors were “beholden to” him, or that he
engaged in any collusive activity. Even assuming such allegations could be read into the
complaint and General McPeak was not independent, he does not constitute a majority of the
Board.
The complaint contains numerous allegations regarding defendant Boruff’s increased
compensation. In short, the complaint alleges that defendant Boruff received a significant
compensation increase as a result of the Company’s purported financial performance, which
was undeserved [Id. at ¶¶ 10, 45–46, 49, 95]. However, there are no allegations that
defendant Boruff exercised control over any other directors or that any directors were
“beholden to” him. Indeed, there are no allegations of any specific act or omission of any
kind by defendant Boruff, only that his compensation was overstated in light of the
Company’s “real” financial performance. Perhaps it could be inferred that defendant Boruff
was “beholden to” or controlled by the members of the Compensation Committee who
approved his increased compensation and therefore further inferred that defendant Boruff
was not independent. However, that is not what the Complaint says. Even assuming such
inferences could (or should) be read into the Complaint and defendant Boruff was not
independent, he does not constitute a majority of the Board.
Thus, for the reasons set forth above, the Court finds that the plaintiff has failed to
plead particularized facts showing that a majority of the defendants were not independent.
Because plaintiff has not shown that a majority of the directors are disinterested or not
independent, plaintiff cannot satisfy the first prong of the demand excused test. Lewis, 838
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S.W.2d at 222. Further, inasmuch as the demand excused test is presented in Aronson and
Lewis in the conjunctive (“and”), the plaintiff must satisfy both prongs in order to excuse the
failure to make a pre-suit demand on the Board. The plaintiff’s inability to meet the first
prong of the test necessarily means the plaintiff cannot show that his failure to make a presuit demand on the Board should be excused. Because plaintiff has failed to allege specific
facts to demonstrate demand futility, the Court finds that plaintiff has failed to adequately
plead that his failure to make a prelitigation demand should be excused as required by Tenn.
Code Ann. § 48-17-401(b) and Fed. R. Civ. P. 23.1(b).
In light of the Court’s conclusion on the demand requirement, the Court finds it
unnecessary to address the defendants’ alternate arguments as to whether the complaint states
a valid cause of action against them.
III.

Conclusion
For the reasons set forth above, the Court finds that the plaintiff has not adequately

pled specific facts demonstrating that his failure to make a pre-suit demand on Miller
Energy’s Board of Directors should be excused. Accordingly, the defendants’ motion to
dismiss [Doc. 12] will be GRANTED and this case will be dismissed. An appropriate order
will be entered.
ORDER ACCORDINGLY.

s/ Thomas A. Varlan
UNITED STATES DISTRICT JUDGE

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