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South Carolina
JUDICIAL DEPARTMENT
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2009-02-10-01
STATE OF SOUTH CAROLINA ) IN THE COURT OF COMMON PLEAS
COUNTY OF CHARLESTON ) NINTH JUDICIAL CIRCUIT
___________________________________ )  
  )  
THE ESTATE OF JACQUELIN K. )  
STEVENSON, by and through its Co- )  
Personal Representatives, Jacquelin S. )  
Bennett and Kathleen S. Turner, )  
Derivatively on Behalf of Nominal )  
Defendant FORCE PROTECTION, INC., )  
  )  

                                                                 Plaintiff,

)  
  )  
vs.
)  
  ) Civil Action No. 2008-CP-10-1735
FRANK KAVANAUGH, et al., )  
  )  
                                                           Defendants, )  
  )  
and
)  
  )  
FORCE PROTECTION, INC., )  
  )  
                                              Nominal Defendant. )  
____________________________________ )  
____________________________________    
BARBARA A. HUGHES, LUTHER F. )  
HUGHES, and CLAYTON REED, )  
Derivatively on Behalf of FORCE )  
PROTECTION, INC., )  
  )  
                                                                Plaintiffs, )  
  )  
vs.
)  
  )  
MICHAEL MOODY, et al. ) Civil Action No. 2008-CP-10-2444
  )  
                                                          Defendants, )  
  )  
and
)  
  )  
FORCE PROTECTION, INC., )  
  )  
                                              Nominal Defendant. )  
____________________________________ )  
     

ORDER GRANTING IN PART, AND DENYING IN PART DEFENDANT’S MOTION TO DISMISS

Background

A. The Parties

In this shareholder derivative action, the Defendants have filed a joint motion to dismiss Plaintiffs’ Verified Derivative Complaints on the grounds that the Plaintiffs lack standing to pursue the claims on behalf of the Company and have otherwise failed to plead claims for relief.

Force Protection is a publicly traded company headquartered in Ladson, Charleston County, South Carolina and incorporated in Nevada.  It manufactures and sells ballistic and blast-protected vehicles, and its primary customer is the U.S. Department of Defense. 

Plaintiff the Estate of Jacquelin K. Stevenson (“Stevenson”) is, as of the time of the filing of the Complaint, being probated in Charleston County. The Stevenson Complaint alleges, upon information and belief, that testator Jacquelin K. Stevenson purchased shares of Force Protection stock between May 3, 2006 and November 3, 2006, and that a trust that is part of the Estate purchased shares on or about May 23, 2007. Stevenson compl. ¶ 4.

Plaintiffs Barbara A. Hughes and Luther F. Hughes are residents of South Carolina, and co-Plaintiff Clayton Reed is a resident of Texas (collectively, these Plaintiffs are referred to as the “Hughes Plaintiffs”). Hughes compl. ¶¶ 19-20. The Hughes Plaintiffs allege that they owned Force Protection stock “during some or all of the Relevant Period”, defined as “January 2007 through the present”, although they do not allege the number of shares held or when they purchased these shares. Id. The Hughes Plaintiffs revealed in their brief in opposition to the Defendants’ motion to dismiss that Barbara Hughes has been a shareholder since January 16, 2007, Luther Hughes since February 6, 2007, and Clayton Reed since October 18, 2007. HughesBr. p. 16, n.9.1.

The Stevenson Complaint names as individual defendants the five current members of Force Protection’s board of directors -- Michael Moody, Jack Davis, Roger G. Thompson, Jr., John S. Day, and John S. Paxton, Sr. -- plus former directors and/or officers Frank Kavanaugh, Gordon McGilton, Raymond W. Pollard, Gale Aguilar, and Michael S. Durski. The Hughes Complaint names four of the five current members of Force Protection’s board of directors -- Michael Moody, Jack Davis, Roger G. Thompson, Jr., and John S. Day -- plus former director and officer R. Scott Ervin. The Hughes Complaint does not assert any claims against current director Paxton.

B. Plaintiffs’ Claims

Both Complaints bring similar causes of action for purported breaches of fiduciary duty premised on the Individual Defendants’ alleged failure to oversee the Company’s financial and operational controls.  In addition, the Hughes Plaintiffs allege that the Individual Defendants (1) failed to correct material weakness in the Company’s controls over financial reporting; (2) failed to prevent unspecified “self-dealing,” (3) failed to investigate allegedly improper sales of stock by two Defendants, Frank Kavanaugh and Gordon McGilton, and (4) were unjustly enriched by virtue of being compensated for their service to the Company. Id. ¶¶ 4, 67–70.  The Hughes Plaintiffs also allege that Kavanaugh and McGilton breached their fiduciary duties to Force Protection by selling their own personally held shares. Id. ¶¶ 67-70.  The Hughes Plaintiffs seek a declaration that the Individual Defendants have violated fiduciary duties to the Company, an award of damages allegedly sustained by the Company, imposition of a constructive trust on any profits obtained by Kavanaugh and McGilton in connection with alleged insider selling and “misappropriation of information,” an award of attorneys’ fees and litigation expenses, and other unspecified equitable relief. Id. ¶ 100.2

Stevenson alleges that the Individual Defendants “allowed and/or caused” Force Protection “to operate without adequate internal controls over its business operations, including its financial reporting systems” and to “issue materially false and misleading statements regarding the true nature of Force Protection’s business operation, internal controls, and financial results.” Stevenson complaint, ¶ 2.  Stevenson also alleges that two Individual Defendants sold stock while it was purportedly trading at “artificially high levels.” Id. Based on this alleged conduct, Stevenson claims that the Individual Defendants breached their duties of due care, loyalty, and good faith and committed gross mismanagement. Id. ¶¶ 92-103. Stevenson also brings claims for waste and unjust enrichment against all of the Defendants. Id. ¶¶ 104-08. Stevenson seeks damages against each Individual Defendant, including exemplary and punitive damages, pre-judgment interest, equitable and/or injunctive relief including attachment, impoundment, or imposition of a constructive trust over proceeds of allegedly improper trading in Force Protection stock by any Individual Defendant, injunctive relief to “reform and improve” the Company’s corporate governance and internal controls, an award of attorneys’ fees and litigation expenses, and other unspecified relief. Id.. ¶ 109.

C. Defendants’ Motion to Dismiss

All Defendants moved to dismiss the Complaints. Force Protection filed briefs arguing that both Complaints must be dismissed because the Plaintiffs failed to adequately plead that they have standing to pursue claims on Force Protection’s behalf, as required by South Carolina Rule of Civil Procedure 23(b)(1). Specifically, Force Protection argues that Plaintiffs’ Complaints must be dismissed because Plaintiffs (a) have not adequately alleged continuous ownership of Force Protection stock, and (b) failed to plead particularized facts showing that they were legally excused from making a pre-suit demand on the Company’s board of directors. The Individual Defendants have also moved to dismiss under Rule 12(b)(6) for failure to state a claim upon which relief can be granted. Echoing some of the arguments made in Force Protection’s briefs, the Individual Defendants argue that the Complaints do not state viable claims for alleged failures of oversight or intentional or bad faith approval of false statements, that their business decisions are protected by the business judgment rule, that they are exculpated from monetary liability by Nevada statutory law and the Company’s Articles of Incorporation, and that the Complaints fail to state claims for waste, insider trading, or unjust enrichment.

Discussion

Lack of Standing

(a) continuous ownership of stock

Defendant Force Protection first asserts that the Hughes complaint does not allege continuous ownership of stock pursuant to SCRCP 23(b)(1), which states in relevant part, “In a derivative action brought by one or more shareholders, . . . the complaint . . . shall allege that the plaintiff was a shareholder or a member at the time of the transaction of which he complains or that his share or membership thereafter devolved on him by operation of law.”  Instead of stating precise allegations of stock ownership, the Hughes complaint merely states that Hughes owned stock “during some or all of the relevant period.” Hughes Compl. at ¶¶ 19-20.  Essentially, the Hughes complaint pleads the same language as SCRCP 23(b)(1).  Plaintiffs and Defendant cite conflicting authority on whether merely pleading the rule language is adequate to survive a motion to dismiss in a shareholder’s derivative suit.  For this reason, I grant Defendant Force Protection’s motion to dismiss the Hughes complaint for failure to allege continuous ownership of stock, but I do so without prejudice and grant Plaintiff Hughes leave to modify his complaint accordingly.

Defendant Force Protection does not assert that Plaintiff Stevenson has not alleged continuous ownership of stock.

(b) failure to make a pre-suit demand on the board of directors

Defendant Force Protection next claims that both the Hughes and Stevenson complaints fail to allege with particularity their reasons for not making a pre-suit demand on the board of directors.  SCRCP 23(b)(1) states in relevant part, “In a derivative action brought by one or more shareholders, . . . the complaint . . . shall allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the board of directors or comparable authority and, if necessary . . . the reasons for his failure to obtain the action or for not making the effort.”  Because Force Protection is a Nevada corporation, Nevada law will govern, and where there is little or no Nevada law, Nevada courts often look to Delaware. Brown v. Kinross Gold U.S.A., Inc., 531 F.Supp. 2d 1234 (D. Nev. 2008).  Pre-suit demand need not be made if the facts pleaded show that making such a demand was futile. Shoen v. S.A.C. Holding Corp., 137 P.3d 1171, 1175 (Nev. 2006).  In Shoen, the Nevada Supreme Court expressly adopted Delaware’s standard for establishing demand futility.  “Demand futility is shown where the totality of the facts alleged, create a reasonable doubt that, as of the time the complaint is filed, a majority of the board of directors could have properly exercised independent and disinterested business judgment in responding to a demand.” Id. at 1185. (emphasis added).  “Reasonable doubt”, in this regard, is a flexible and workable concept found in various corporate contexts and is “akin to the concept that the stockholder has a ‘reasonable belief’” that the board lacks impartiality. Grimes v. Donald, 673 A.2d 1207, 1217 (Del. 1996). (overruled on other grounds). 

In determining whether Plaintiffs have met their burden for pleading demand futility, the Court must “accept as true each of the complaints’ particularized factual allegations and draw every fair factual inference flowing from those particularized alleged facts in [the plaintiff’s] favor.” Shoen at 1180.  In making the required judgment, “the question is whether the accumulation of all factors creates the reasonable doubt.” Harris v. Carter, 582 A.2d 222, 229 (Del. Ch. 1990).  In other words, whether “the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that a board of directors – on the date the complaint is filed – could properly exercise its independent and disinterested business judgment in responding to a demand.” Rales v. Blasband, 634 A.2d 927, 933 (Del. 1993).  To sufficiently raise a substantial likelihood of liability, “the alleged facts need only give rise to a reason to doubt business judgment protection, not ‘a judicial finding that the directors’ actions are not protected by the business judgment rule.’” In re Walt Disney World Co. Deriv. Litig., 825 A.2d 275, 289 (Del. Ch. 2003).  In the instant case, we must therefore analyze the Hughes and Stevenson complaints for particularized facts, if any, which could give rise to this “reasonable doubt”. 

As stated earlier, the crux of both the Hughes and Stevenson complaints is that through a prolonged failure of oversight, a majority of the board of directors directly caused harm to come to Force Protection, Inc., and thereby injured the shareholders.  To establish liability for a failure of oversight, a plaintiff must show that “(1) the directors know or (2) should have known that violations of law were occurring and, in either event, (3) that the directors took no steps in a good faith effort to prevent or remedy that situation, and (4) that such failure proximately resulted in the losses complained of.” In re Caremark Inter. Inc. Deriv. Litig., 698 A.2d 951, 971 (Del. Ch. 1996).  Here, plaintiffs allege that the board was not disinterested because it faced a “substantial likelihood” of personal liability for the alleged wrongful conduct. See Guttman v. Huang, 823 A.2d 492, 501 (Del. Ch. 2003).   

Specifically, the Hughes complaint alleges that four of the five directors (Davis, Moody, Thompson, and Day) were not qualified to make a disinterested business decision due to a substantial likelihood of personal liability. Hughes Compl. ¶¶ 22-34.  Similarly, the Stevenson complaint alleges that three of the five directors (Davis, Moody, and Thompson) were not qualified to make a disinterested business decision, and were therefore subject to personal liability.  Stevenson Compl. ¶¶ 6-16.  Both complaints assert that a majority of the directors on the board served on the company’s audit committee when much of the alleged wrongdoing occurred, and when significant “red flags” allegedly appeared and reappeared showing an urgent need for board action to prevent significant harm to the company. Hughes Compl. ¶¶ 40-42; Stevenson Compl. ¶¶ 55-56.  This is important because publicly traded companies, such as Force Protection, Inc., rely upon audit committee members to ensure that the corporation has proper internal controls in place. See In re Lernout & Hauspie Sec. Litig., 286 BR 33, 37-40 (D. Mass. 2001) (explaining that an audit committee plays a “critical” role in the corporation). 

In fact, both complaints have entire sections devoted to overcoming the “Demand Futility” of Rule 23(b)(1) SCRCP, and express lengthy, particularized factual allegations against the board. Hughes Compl. ¶¶ 75-80 Stevenson Compl. ¶¶ 81-91.  Because both complaints state with particularity dates and events which they claim give rise to their causes of action - which they claim are the “red flags” at issue – the “reasonable doubt” articulated in Shoen is present.  These allegations and dates are specific enough to survive Rule 23(b)(1) SCRCP.  Therefore, at this early stage in the proceedings, Defendant’s motion to dismiss for Plaintiffs’ failure to make a pre-suit demand is denied.

Failure to State a Claim – Nevada Law and the Business Judgment Rule

The individual Defendants assert that Plaintiffs fail to state a claim under 12(b)(6) SCRCP, which allows a motion to dismiss for “failure of the pleading to state facts sufficient to constitute a cause of action.” Id.  In considering a motion to dismiss a complaint based on a failure to state facts sufficient to constitute a cause of action, the trial court must base its ruling solely on allegations set forth in the complaint. Spence v. Spence, 628 S.E.2d 869, 874 (S.C. 2006). If the facts alleged and inferences reasonably deducible therefrom, viewed in the light most favorable to the plaintiff would entitle the plaintiff to relief on any theory, then dismissal under Rule 12(b)(6) is improper. Baird v. Charleston County, 511 S.E.2d 69 (S.C. 1999).  The complaint should not be dismissed merely because the court doubts the plaintiff will prevail in the action. Toussaint v. Ham, 357 S.E.2d 8 (S.C. 1987). 

The Defendants emphasize two statutory defenses in arguing that Plaintiffs’ complaints should be dismissed: the Nevada exculpation statute (N.R.S. § 78.138(7)) and the business judgment rule (N.R.S. § 78.138(3)) (Def. Memo. p. 12-16).  The parties seem to agree that neither the exculpatory statute nor the business judgment rule apply to breaches of the duty of loyalty or acts and omissions in bad faith. (Defs. Reply Br. p. 7-8; Plf. Hughes Memo p. 20-23; Plf. Stevenson Memo p. 20-22).  Indeed, it is well settled that directors “breach their duties of loyalty by failing to discharge [their] fiduciary obligation[s] in good faith.” Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006).  “The business judgment rule . . . does not apply in cases in which the corporate decision lacks a business purpose, is tainted by conflict of interest, or is so egregious as to amount to a no-win situation or results from an obvious and pro-longed failure to exercise oversight or supervision.” Buchanan v. Henderson, 131 BR 859, 868 (Bankr. D. Nev. 1990). (emphasis added) (reversed on other grounds).  This “prolonged oversight” spoken of in Buchanan is precisely what is alleged in the instant case; therefore, taking the facts plead in the complaint as true, which I must, the business judgment rule does not apply to the breaches of loyalty and acts in bad faith alleged in the Hughes and Stevenson complaints. Additionally, in this particular area, Nevada law offers no greater protection than the business judgment rule – it too does not insulate the directors from liability for actions taken in bad faith or disloyalty.  N.R.S. § 78.138(7).  Therefore, under both Nevada law and the business judgment rule, the causes of action for bad faith and disloyalty can proceed; however, the cause of action for breach of due care is more problematic.

Both complaints explicitly charge the Defendants with breaching their fiduciary duties of care. Stevenson Compl. ¶ 93; Hughes Compl. ¶¶ 22(a), 23(a), 24(b), 25(b), 26(a), 28(a), 29(a), 30(b), 31 and 32.  These claims cannot give rise to any monetary liability because Nevada law and the business judgment rule exculpate the Defendants from such liability. N.R.S. § 78.138(7).  So, with regards to the Hughes and Stevenson causes of action for breach of duties of due care, Defendant Force Protection’s motion to dismiss is granted.      

Failure to State a Claim – Waste, Insider Trading, and Unjust Enrichment

Finally, the individual Defendants move to dismiss Plaintiffs’ claims for waste, insider trading, and unjust enrichment.  It is not appropriate at this time to address these claims, and therefore their motion is denied – the issues of standing and the exculpatory provisions of the business judgment rule and Nevada law are merely threshold issues to proceed, while the claims for waste, insider trading, and unjust enrichment actually reach the merits. The individual Defendants can however renew their motion attacking the merits at a later date after some discovery can be had.    

Conclusion

I have considered the arguments on both sides, supporting and opposing documents, and based on same GRANT Defendant’s motion in part, and DENY Defendant’s motion in part.

1. I GRANT Defendant Force Protection’s motion to dismiss the Hughes complaint for failure to allege continuous ownership of stock under Rule 23(b)(1) SCRCP, but I do so without prejudice and grant Plaintiff Hughes leave to modify their complaint accordingly.

2. Defendant Force Protection’s motion to dismiss for lack of standing under Rule 23(b)(1) SCRCP for failure to make a pre-suit demand on the board of directors is DENIED.                

3. The individual Defendants’ motion to dismiss for failure to state a claim under Rule 12(b)(6) SCRCP is DENIED.

AND IT IS SO ORDERED.

 

____________________________________ Roger M. Young, Circuit Judge

February 10, 2009
Charleston, South Carolina.