Court Opinion

ID: 181091
Source: CourtListenerOpinion
Date Created: 2010-12-14 20:56:11+00
Date Added: 2024-06-11T17:25:54.085385
License: Public Domain

NOT PRECEDENTIAL

         UNITED STATES COURT OF APPEALS
              FOR THE THIRD CIRCUIT
                   _____________

                      No. 09-3834
                     _____________

                     JERALD KING,
          Derivatively on behalf of Cephalon Inc.,
                                     Appellant
                             v.

     FRANK BALDINO, JR.; WILLIAM P. EGAN;
   MARTYN D. GREENACRE; VAUGHN M. KAILIAN;
     KEVIN E. MOLEY; CHARLES A. SANDERS;
     GAIL R. WILENSKY; DENNIS L. WINGER;
      CEPHALON INC., a Delaware Corporation
                 _____________

        Appeal from the United States District Court
                 for the District of Delaware
              (D.C. Civil No. 1-08-cv-00054)
        District Judge: Honorable Gregory M. Sleet
       Magistrate Judge: Honorable Mary Pat Thynge
                       _____________

        Submitted Under Third Circuit LAR 34.1(a)
                   December 13, 2010

Before: RENDELL, JORDAN and HARDIMAN, Circuit Judges

            (Opinion Filed: December 14, 2010)
                     _____________

               OPINION OF THE COURT
                   _____________
RENDELL, Circuit Judge.

       Jerald King, a shareholder, brought this derivative suit on behalf of the

biopharmaceutical company Cephalon, Inc., alleging that the defendant officers and

directors failed adequately to oversee Cephalon’s sales and promotions practices with

respect to its products Actiq, Provigil, and Gabitril. King alleges, further, that the

officers’ and directors’ failure in that regard resulted in large losses and potential future

losses to the company arising from federal and state investigations into Cephalon’s

marketing practices, including a $425 million settlement Cephalon entered into with the

federal government to settle federal and state Medicaid claims related to those practices.

       King appeals the order of the Magistrate Judge granting the defendants’ motion for

judgment on the pleadings because King failed to plead that a pre-suit demand on the

board would have been futile. 1 For substantially the reasons set forth in the Magistrate

Judge’s thorough and well reasoned opinion, King v. Baldino, 648 F. Supp. 2d 609 (D.

Del. 2009), we will affirm.

                                                   I.

       Federal Rule of Civil Procedure 23.1 requires derivative plaintiffs to plead 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; or (B) the

reason for not obtaining the action or not making the effort.” Fed. R. Civ. P. 23.1(b)(3).

Although Rule 23.1 provides the pleading standard for derivative actions in federal court,

       1
        The parties consented to have a magistrate judge decide the case under 28 U.S.C.
§ 636(c) and Fed. R. Civ. P. 72.
                                               2
the substantive rules for determining whether a plaintiff has satisfied that standard “are a

matter of state law.” Blasband v. Rales, 971 F.2d 1034, 1047 (3d Cir. 1992) (citing

Kamen v. Kemper Fin. Servs., 500 U.S. 90 (1991); other citations omitted).

       Under Delaware law, which applies in this case because Cephalon is a Delaware

corporation, whether a plaintiff has adequately pleaded demand futility depends on

“whether or not the particularized factual allegations . . . 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 judgment in responding to a demand.” Rales v.

Blasband, 634 A.2d 927, 934 (Del. 1993). In this case, the District Court found that King

failed to plead facts showing that the defendants lacked independence, King, 648 F. Supp.

at 618-19, and King does not challenge that determination on appeal.

       Instead, King’s appeal focuses on the second prong, whether he pleaded that the

defendants were insufficiently “disinterested” to respond to a demand. To plead that

directors are not sufficiently “disinterested,” a plaintiff must plead facts establishing that

they “face a ‘substantial likelihood’ of personal liability.” Guttman v. Huang, 823 A.2d

492, 501 (Del. Ch. 2003). In other words, the facts pleaded must establish a “substantial

likelihood” of success on the merits of plaintiff’s claims. In this case, the hurdle for

establishing that the directors face a “substantial likelihood” of liability is particularly

high, because the type of claim that King asserts — based on officers’ and directors’

alleged failure properly to oversee the corporation — is “possibly the most difficult

theory in corporation law upon which a plaintiff might hope to win a judgment.” In re

Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, 967 (Del. Ch. 1996). A plaintiff

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may only establish a “substantial likelihood” of liability on such a claim by pleading

particular facts that show:

              (1) that the directors knew or (2) should have known that
              violations of law were occurring and, in either event, (3) that
              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. 2

Id. at 971.

       A plaintiff may satisfy this standard by alleging facts that show an utter failure to

oversee the corporation, e.g., “the company entirely lacked an audit committee or other

important supervisory structures, or . . . a formally constituted audit committee failed to

meet.” David B. Shaev Profit Sharing Account v. Armstrong, No. 1449-N, 2006 WL

391921, at *5 (Del. Ch. Feb. 13, 2006) (footnotes and citations omitted). Alternatively, a

plaintiff may plead facts showing that “‘the directors were conscious of the fact that they

were not doing their jobs,’” and that they “ignored ‘red flags’ indicating misconduct in

defiance of their duties.” Id. (quoting Guttman, 823 A.2d at 506-07). “Red flags” in this

context are “facts showing that the board ever was aware that [the corporation’s] internal

controls were inadequate.” Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006).

                                                  II.

       We agree with the Magistrate Judge that King’s complaint failed to satisfy that

standard. As a preliminary matter, the complaint’s demand futility allegations are framed

in rote, conclusory language from the caselaw. They do not contain “particularized

       2
         The fourth element, proximate cause, may be considered an affirmative defense
that does not need to be pleaded in the complaint. Caremark, 698 A.2d at 971.
                                              4
facts,” and, more specifically, do not “identify which individual director defendants

breached his or her fiduciary duties, and when those duties were breached.” King, 648 F.

Supp. 2d at 623.

       King also did not allege with particularity facts indicating that Cephalon lacks

adequate oversight systems. As the Magistrate Judge observed, the complaint

acknowledges the existence of certain controls at Cephalon, including an Audit

Committee and internal compliance auditors, but does not allege any procedural

deficiencies in those mechanisms. Id. at 622-23. On appeal, King argues that the fact of

violations of law, as evidenced by Cephalon’s settlement with the federal government,

establishes that Cephalon’s internal control systems were inadequate. But this

understates the plaintiff’s pleading requirement. Delaware law requires the plaintiff to

allege particularized facts concerning the inadequacies in the corporation’s oversight

mechanisms. Having failed to do so, King’s complaint cannot survive defendants’

motion for judgment on the pleadings. See id. at 621-22 & n. 58, 59 (citations omitted).

       King further failed to allege “red flags,” in the sense of “facts showing that the

board ever was aware that [the corporation’s] internal controls were inadequate.” Stone,

911 A.2d at 370. The purported “red flags” that King cites all involve the company’s

marketing and sales practices. King does not allege any specific connection between any

of those practices and the board. In the absence of facts showing that the board was

aware of any of those actions, the Magistrate Judge’s holding that King’s complaint was

inadequate was correct.

                                              5
       As the Magistrate Judge observed, this case is like a number of derivative cases

brought in Delaware courts that have been dismissed because they seek “to equate a bad

outcome with bad faith.” King, 648 F. Supp. 2d at 626. Like the plaintiffs in those other

cases, King “fail[s] to realize that the directors’ good faith exercise of oversight

responsibility may not prevent employees from violating the laws, or from causing the

corporation to incur significant financial liability, or both.” Stone, 911 A.2d at 373,

quoted in King, 911 A.2d at 626. Without particularized facts that the directors knew or

should have known about the misconduct and consciously failed to act, King cannot

establish that the defendants face a “substantial likelihood” of personal liability on his

claims.

                                                  III.

       Finally, there is some discussion in the briefs as to whether King should have the

opportunity to amend his complaint. It appears that King requested leave to amend in the

District Court, but only in one sentence in the conclusion of his response to defendants’

motion for judgment on the pleadings. King has not submitted a proposed amended

complaint or explained, to the Magistrate Judge or to this Court, how an amended

pleading would cure the defects in his original complaint. Given those failures, the

Magistrate Judge did not abuse her discretion in granting defendants’ motion with

prejudice. Cf. Jones v. ABN Amro Mortg. Grp., Inc., 606 F.3d 119, 125-26 (3d Cir. 2010)

(no abuse of discretion to deny leave to replead where “there was ‘no indication’ that

repleading would correct the defects”).

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                                          IV.

For the foregoing reasons, we will affirm the order of the District Court.

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