Xyngular v. Schneckl

Filing 185

MEMORANDUM DECISION AND ORDER granting 133 SEALED MOTION to Dismiss Derivative Claims. Mr. Schenkel's eleventh through fifteenth causes of action are dismissed with prejudice. Signed by Judge Robert J. Shelby on 1/8/15 (alt)

IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF UTAH, CENTRAL DIVISION

XYNGULAR CORPORATION, a Delaware
corporation,
MEMORANDUM
DECISION AND ORDER
Plaintiff,
v.

Case No. 2:12-cv-00876-RJS

MARC SCHENKEL, an individual,

Judge Robert J. Shelby

Defendant.

Before the court is a motion to dismiss shareholder derivative claims. Plaintiff Marc
Schenkel brought the claims on behalf of Xyngular Corporation against members of its board of
directors. This motion is part of a broader lawsuit involving Mr. Schenkel, Xyngular, members
of Xyngular’s board, and a number of third-party defendants. Xyngular moves to dismiss Mr.
Schenkel’s derivative claims. For the reasons stated below, the court grants Xyngular’s motion.
BACKGROUND
Mr. Schenkel is a cofounder and shareholder of Xyngular, a network marketing company
that distributes health supplements. The company was incorporated in Delaware in 2009. Mr.
Schenkel was also a member of the board of directors, along with Rudy Revak, Mary Julich, and
Steve Kole. Shortly after Xyngular’s formation, Mr. Schenkel’s business relationship with the
other board members began to deteriorate and the parties resorted to litigation. Part of that
litigation includes derivative claims Mr. Schenkel brought on behalf of Xyngular. Below, the
court summarizes the facts relevant to those claims.

1

I. Mr. Schenkel’s Demand Letter
In September 2011, Mr. Schenkel sent a demand letter to Xyngular in which he
demanded that the board investigate and pursue claims against Mr. Revak, Mr. Kole, and Ms.
Julich for “misappropriation of corporate assets, corporate waste, self-dealing, and usurpation of
corporate opportunities.” Mr. Schenkel alleged in the demand letter that


the board of director’s use of Global Venture Management Services, LLC (GVMS) to
provide IT services and other administrative support was improper because a conflict of
interest existed and GVMS provided substandard service;



Mr. Revak, Mr. Kole, and Ms. Julich improperly authorized bonuses to GVMS
employees, including themselves;



Mr. Revak, Ms. Julich, and Mr. Kole improperly created and operated a company named
Nouvara that competed with Xyngular;



Mr. Revak, Ms. Julich, and Mr. Kole transferred “stock in Xyngular to shareholders of
GVMS without apparent consideration”;



Mr. Jensen, the vice-president of GVMS, was permitted to take control of the
management of Xyngular without approval from the board; and



Mr. Jensen acted contrary to Xyngular’s interest by hiring GVMS to provide IT services
despite the conflict of interest created by Mr. Jensen’s employment at GVMS.

II. Xyngular’s Response to the Demand Letter
Days after receiving the demand letter, Xyngular responded to Mr. Schenkel by stating
that the board “disagrees with [Mr. Schenkel’s] claims of self-dealing, mismanagement and
retaliatory behavior and believes it has acted, and continues to act, in the best interests of its
shareholders.” The letter further denied any allegations that the commercial relationship

2

between Xyngular and GVMS was inappropriate. Xyngular also stated that it was “willing to
confirm this conclusion through a form of independent review.” To conduct the independent
review, Xyngular planned to add to its board “at least two individuals with significant experience
in the networking marketing industry who have no ownership or business interest” in Xyngular
or GVMS. These new board members would investigate Mr. Schenkel’s letter and determine
whether the board should pursue derivative claims.
In September 2012, Xyngular filed this suit, seeking a declaratory judgment that Mr.
Schenkel had breached his obligations to the company. Xyngular then further responded to Mr.
Schenkel’s demand letter in October 2012, stating that the company appointed three new
independent board members (Jim Northrop, Dan Murphy, and Russ Fletcher) to investigate the
matter. The letter generally addressed Mr. Schenkel’s allegations by stating that


the bonuses paid to GVMS were for important services and that additional payments
were in the best interest of the company to ensure continuation of the services;



the creation of Nouvara was meant to improve efficiency by utilizing a centralized
management company;



there was no transfer of Xyngular stock to members of GVMS other than the stock issued
to Mr. Revak, Ms. Julich, and Mr. Kole when Xyngular was formed;



Mr. Jensen provides consulting and management services for Xyngular but “does not
control [the company] and has no authority to take action on . . . matters other than as
directed by the officers and Directors of Xyngular”; and



GVMS provides satisfactory IT services and Mr. Fletcher, a board member and IT expert,
selected GVMS to provide such services.

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In sum, the new board members investigated the allegations in Mr. Schenkel’s demand
letter and decided against pursuing derivative claims.
III. Mr. Schenkel’s Claims
Mr. Schenkel responded to Xyngular’s Complaint by filing counterclaims and third-party
claims against Xyngular directors. Mr. Schenkel also brought derivative claims on behalf of
Xyngular. These claims, numbered eleven through fifteen in Mr. Schenkel’s Complaint, include
breach of contract, breach of covenant of good faith and fair dealing, promissory estoppel, unjust
enrichment, and breach of fiduciary duty. Mr. Schenkel filed his Complaint after the Xyngular
board had informed him that it declined to pursue derivative claims.
In his Complaint, Mr. Schenkel makes several allegations about the adequacy of the
Xyngular board’s investigation of his demand letter. In relevant part, Mr. Schenkel makes the
following allegations:


the purported new board members tasked with investigating the demand letter were not
independent;1



the results of the investigation were predetermined by Global Venture Partners, a
company owned by Mr. Revak, Mr. Julich, Mr. Kole, and Mr. Jensen;2



the new board members failed to reasonably investigate the demand letter;3 and



the board’s response to the demand letter contained false and misleading statements.4

1

Third-Party Complaint (Dkt. 80), at ¶¶ 65-73.
Id. at ¶ 75.
3
Id. at ¶ 118.
4
Id. at ¶ 98.
2

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ANALYSIS
I. Standard of Review
Federal Rule of Civil Procedure 23.1 requires a shareholder derivative complaint to “state
with particularity any effort by the plaintiff to obtain the desired action from the directors or
comparable authority” and “the reasons for not obtaining the action or not making the effort.”5
The Tenth Circuit has held that the satisfaction of Rule 23.1 is a matter of federal law. But the
law of the state of incorporation, in this case Delaware, is an appropriate source of federal
common law for suits involving Rule 23.1.6
Delaware courts have clarified that under Rule 23.1, a plaintiff wishing to bring a claim
for a wrongful refusal of demand “must allege with particularity facts raising a reasonable doubt
that the corporate action being questioned was properly the product of business judgment.”7
When considering a motion to dismiss, the court “must accept all the well-pleaded allegations of
the complaint as true and must construe them in the light most favorable to the plaintiff.”8
II. Presuit Demand and Board Independence
The board of directors decides whether to pursue claims on behalf of the corporation.9
Shareholders can cause the corporation to bring claims if they “(1) make a pre-suit demand by
presenting the allegations to the corporation’s directors, requesting that they bring suit, and
showing that they wrongfully refused to do so, or (2) plead facts showing that demand upon the
board would have been futile.”10 Here, Mr. Schenkel made a presuit demand when he sent his
demand letter to the Xyngular board.
5

Fed. R. Civ. P. 23.1(b)(3)(A)-(B).
Cadle v. Hicks, 272 F. App’x. 676, 678 (10th Cir. 2008) (citing Kamen v. Kempter Fin. Servs., Inc., 500 U.S. 90,
96, 108 (1991)).
7
Brehm v. Eisner, 746 A.2d 244, 254-55 (Del. 2000).
8
Cressman v. Thompson, 719 F.3d 1139, 1152-53 (10th Cir. 2013).
9
In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106, 120 (Del. Ch. 2009).
10
Id.
6

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The parties dispute two issues: (1) whether Mr. Schenkel conceded the independence of
the board when he made his demand and (2) whether the complaint alleges sufficient facts that
the board wrongfully refused to bring the derivative claims. The court considers these issues in
turn.
A. The Board’s Independence
Mr. Schenkel contends that the Xyngular board is not independent and that he did not
concede its independence by making a presuit demand. To support this contention, Mr. Schenkel
makes three arguments: (1) he did not concede the independence of the new board members
because he did not know their identities when he sent the demand letter; (2) the board conceded
its lack of independence when it appointed new board members to investigate the allegations;
and (3) Xyngular waived its defense by failing to raise it at an earlier stage of the litigation.
(1) Independence of the New Board Members
It is well established under Delaware law that a shareholder who makes a demand on a
board before filing suit “tacitly concedes the independence of a majority of the board to
respond.”11 At the very least, Mr. Schenkel conceded the independence of the existing Xyngular
board members. Mr. Schenkel urges the court to draw the line there. He argues that he did not
concede the independence of the new board members assigned to investigate his demand letter
because he did not yet know their identities.
Mr. Schenkel then contends that the new board members lacked independence based on
their preexisting friendships and business relationships with the original board members. But
Mr. Schenkel conceded the independence of the original board members when he made a presuit

11

See, e.g., Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990); FLI Deep Marine LLC v. McKim, 2009 WL
1204363, at * 3 (Del. Ch. Mar. 24, 2009).

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demand. Accordingly, the original board members were independent and therefore could not
destroy the new board members’ independence.
(2) The Board’s Alleged Concession of Its Lack of Independence
Mr. Schenkel next argues that the board conceded its lack of independence by delegating
the investigation of his allegations to new board members. Generally, the traditional business
judgment rule applies when a board delegates authority to investigate a demand letter to a special
litigation committee.12 Courts solely consider “the good faith and the reasonableness of the
committee’s investigation.”13 Here, however, Mr. Schenkel cites Abbey v. Computer and
Communication Technology Corp.14 to argue that the board conceded its lack of independence
and became “disabled from exercising business judgment.”15 In other words, Mr. Schenkel
contends that the business judgment rule does not apply.
In Abbey, the board formed a special litigation committee and delegated the power to not
only investigate the shareholder’s demand letter, but to also make all decisions on the potential
lawsuit.16 The shareholder then brought suit, arguing the demand was excused.17 The board (not
the special litigation committee) then moved to dismiss.18
The Delaware Supreme Court found that “by divesting itself of any power to make a
decision on the pending suit, and by adding a new and independent director and by designating
him as a Special Litigation Committee of one with the final and absolute authority to make the
decision on behalf of the corporation, the incumbent board of directors, in effect, conceded that

12

Spiegel, 571 A.2d at 778.
Id.
14
457 A.2d 368 (Del. Ch. 1983).
15
Allison on Behalf of Gen. Motors Corp. v. Gen. Motors Corp., 604 F. Supp. 1106, 1121 n.16 (D. Del. 1985) aff’d,
782 F.2d 1026 (3d Cir. 1985).
16
Id. at 371-75.
17
Id.
18
Id.
13

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the circumstances alleged in the complaint justified the initiation of the suit by the plaintiff.”19
Thus, despite the presuit demand letter, the court allowed the shareholder to question the
independence of the board as if the complaint were filed without a demand.
But Abbey is limited. The Delaware Supreme Court has warned that the case does not
“stand for the proposition that a board of directors, ipso facto, waives its right to challenge a
shareholder plaintiff’s allegation that demand is excused by the act of appointing a special
litigation committee and delegating to that committee the authority to act on the demand.”20
Rather, Abbey “specifically recognizes the right of a board of directors to appoint committees to
address derivative litigation, without automatically subjecting the committee’s decision to”
judicial scrutiny into whether the board is independent.21
Unlike Abbey, the Xyngular board never fully divested itself of its decision-making
power in this lawsuit.22 It only tasked the new board members to investigate Mr. Schenkel’s
claims. And the new board members did just that: they investigated the demand letter and
concluded that the board should not pursue derivative claims. In short, Abbey does not apply and
the board did not concede its lack of independence.
(3) Waiver
Lastly, Mr. Schenkel argues that Xyngular waived its demand defense by raising it nine
months after filing the suit. But that is incorrect. Mr. Schenkel filed the derivative claims on
October 22, 2012. On November 30, 2012, as part of Xyngular’s timely Answer to Mr.

19

Id. at 373.
Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990).
21
Id.
22
Abbey v. Computer and Commc’n Tech. Corp., 457 A.2d 368, 374 (Del. Ch. 1983). (“[If the board] had merely
appointed a committee to investigate the allegations and to report back to the board for whatever action the board
might choose to take on the merits of the charges, it would be one thing. In such a case the board would not be
surrendering the ultimate decision on the worthiness of the alleged cause of action to a committee of independent
directors.”)
20

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Schenkel’s counterclaim, Xyngular asserted the business judgment rule as a defense.23 Xyngular
also stated that it believed that Mr. Schenkel’s derivative claims were barred for failure to
comply with Rule 23.1.24 Accordingly, the court finds that Xyngular did not waive its demand
defense.
B. Wrongful Refusal
Even when a shareholder makes a presuit demand, he can still bring derivative claims if
he can show that the board wrongfully refused to bring the claims.25 The court now examines
Mr. Schenkel’s Complaint to determine whether he alleged sufficient facts to show that Xyngular
wrongfully refused to bring the derivative claims.
(1) Business Judgment Rule
When a shareholder makes a presuit demand and that demand is refused, the court
reviews the board’s decision under the business judgment rule.26 At the outset, Mr. Schenkel
argues that the new board members were not independent, and thus their decision is not protected
by the business judgment rule. But, at least under Delaware law, Mr. Schenkel’s presuit demand
operates as a concession that the board was independent, including the new board members. The
court thus examines Mr. Schenkel’s claims of wrongful refusal under the 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. Absent an abuse of discretion, that
judgment will be respected by the courts. The burden is on the party challenging the decision to

23

Answer to Counterclaim (Dkt. 21), at 16, ¶ 9.
Id. at 16, ¶ 10.
25
In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106, 120 (Del. Ch. 2009).
26
See, e.g., Levine v. Smith, 591 A.2d 194, 212 (Del. 1991); Zapata Corp. v. Maldonado, 430 A.2d 779, 784 n.10
(Del. 1981).
24

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establish facts rebutting the presumption.”27 Consequently, “once the shareholder makes the
demand on the board . . . the Court’s only inquiry is into the board’s good faith and the
reasonableness of the investigation.”28 The “business judgment rule may be rebutted in those
rare cases where the decision under attack is so far beyond the bounds of reasonable judgment
that it seems essentially inexplicable on any ground other than bad faith. The decision must be
egregious, lack any rational business purpose, constitute a gross abuse of discretion, or be so
thoroughly defective that it carries a badge of fraud.”29 With this standard in mind, the court
examines Mr. Schenkel’s Complaint to determine whether it alleges that the board wrongfully
refused to pursue the derivative claims.
(2) Mr. Schenkel’s Allegations
The board’s investigation was predetermined by Global Venture Partners: Mr. Schenkel
argues that the new board members’ investigation was predetermined. He first points the court
to the allegation that “[w]hile Mr. Murphy and Mr. Fletcher were attempting to improperly
enrich themselves with their new business partners, Mr. Schenkel received no response from the
board regarding their purported investigation into his demand letter.”30 This appears to lead to
the conclusion that the new board members were not independent and thus their investigation
was predetermined. Again, Mr. Schenkel’s presuit demand operates as a concession: the new
board members were independent.
Next, Mr. Schenkel states that the new board members appeared to communicate about
the demand letter only six days before they sent their final response outlining the findings of the

27

Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
Charal Inv. Co., Inc. v. Rockefeller, 1995 WL 684869, at *2 (Del. Ch. Nov. 7, 1995).
29
Alidina v. Internet.com Corp., 2002 WL 31584292, at *4 (Del. Ch. Oct. 3, 2002) (internal quotations omitted)
(quoting Parnes v. Bally Entm’t Corp., 722 A.2d 1243, 1246 (Del.1999) and In re J.P. Stevens & Co., 542 A.2d 770,
780–81 & n.5 (Del.Ch.1988)).
30
Third-Party Complaint (Dkt. 80), at ¶ 74.
28

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investigation. To support this argument, Mr. Schenkel points to an email sent from Mr.
Northrop’s office to Mr. Murphy and Mr. Fletcher on October 2, 2012 that stated, “Jim
[Northrop] would like to have a call today to discuss the proposed letter to Marc Schenkel.”31
Mr. Schenkel appears to argue that, given the short amount of time between the correspondence
and the response, the investigation was predetermined. But the email does not suggest that the
Xyngular board only began to discuss the response on October 2, 2012. It merely states that Mr.
Northrop wished to speak with the other new board members about the letter.
Lastly, Mr. Schenkel alleges that Global Venture Partners (a company owned by Mr.
Revak, Ms. Julich, Mr. Kole, and Mr. Jensen) forced Xyngular to file the lawsuit.32 This leads to
the inference that the investigation was predetermined because Xyngular had already decided to
file suit before the board responded to the demand letter. But this also leads to another inference:
the board believed it was in the company’s best interest to sue Mr. Schenkel and the new board
members, after conducting an investigation, believed that Mr. Schenkel’s claims were meritless.
In the end, Mr. Schenkel’s allegations that the investigation was predetermined are insufficient to
overcome the high bar of the business judgment rule.
The new board members failed to reasonably investigate the claims: Mr. Schenkel next
argues that the board members failed to reasonably investigate the demand.33 Under the business
judgment rule, “when a board refuses a demand, the only issues to be examined are the good
faith and the reasonableness of the investigation.”34 Further, “there is obviously no prescribed
procedure that a board must follow” in investigating a claim35 and “[c]orporate directors
normally have only limited available time to deliberate, and a determination of what matter will
31

Opp. to Xyngular’s Motion to Dismiss (Dkt. 144-22).
Third-Party Complaint (Dkt. 80), at ¶ 75.
33
Id. at ¶ 118.
34
Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990).
35
Levine v. Smith, 591 A.2d 194, 214 (Del. 1991).
32

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(and will not) be considered must necessarily fall within the board’s discretion.”36
Mr. Schenkel’s contention rests on several allegations. First, Mr. Schenkel alleges that
board members did not talk with Xyngular’s COO Mr. Oliver about the IT issues in the demand
letter and relied on GVMS to justify its own fees rather than do an independent evaluation. But
the investigating board members were not required to speak with Mr. Oliver or make an
independent evaluation of the GVMS fees. The response letter specifically addresses these
issues, stating, “We spent a significant amount of time evaluating your claims about deficient IT
support for Xyngular and the costs for providing proper support.”37 The new board members
concluded that the IT support was satisfactory and that the fees paid to GVMS were in the best
interests of Xyngular.
Second, Mr. Schenkel argues that Xyngular failed to investigate whether Symmetry
misappropriated Xyngular’s top selling product, Xyng.38 But the demand letter does not mention
Xyng and only mentions Symmetry in passing. What’s more, the determination of what is and
what is not investigated falls within the board’s discretion.
Third, Mr. Schenkel appears to allege that Mr. Murphy’s involvement with Uppercase
Living results in interestedness on the part of the board.39 As stated previously, Mr. Schenkel’s
presuit demand operated as a concession that the board was independent, including Mr. Murphy.
The response to the demand letter contains false and misleading information: Lastly, Mr.
Schenkel argues that the response to the demand letter contained false and misleading
information.40 The response letter stated, “There has been no transfer of Xyngular stock to
members of GVMS, other than what was issued to Revak, Kole and Julich at the beginning of
36

Id.
Motion to Dismiss (Dkt. 62-2).
38
Third-Party Complaint (Dkt. 80), at ¶ 117.
39
Id. at ¶ 71.
40
Id. at ¶ 110.
37

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Xyngular’s existence.”41 Mr. Schenkel argues that he defined GVMS as both GVMS and
Symmetry Corporation and that the evidence strongly supports the allegation that there was
transfer of stock to Symmetry. Yet, it is unclear that Mr. Schenkel’s demand letter referred to
both GVMS and Symmetry when it stated, “We also question the transfer of certain stock in
Xyngular to shareholders of GVMS without apparent consideration.” Xyngular appears to have
responded to this concern in good faith based on a reasonable interpretation of the demand letter.
In sum, corporate directors have limited time and ample discretion. Here, Mr. Schenkel’s
allegations do not overcome the presumption of good faith. Perhaps the board’s investigation
could have been more thorough or effective. Perhaps Xyngular could have made better business
decisions. But these are not the questions the court considers under the business judgment rule.
Mr. Schenkel has not alleged egregious actions that rebut the presumption of deference to
corporate directors’ business judgment.
CONCLUSION
For these reasons, the court GRANTS Xyngular’s Motion to Dismiss Derivative Claims
and DISMISSES WITH PREJUDICE Mr. Schenkel’s eleventh through fifteenth causes of
action.
SO ORDERED this 8th day of January, 2015.

BY THE COURT:

_________________________
ROBERT J. SHELBY
United States District Judge

41

Motion to Dismiss (Dkt. 62-2).

13