Court Opinion

ID: 4247391
Source: CourtListenerOpinion
Date Created: 2018-02-22 18:27:27.793618+00
Date Added: 2024-06-11T14:17:11.770464
License: Public Domain

J-S71017-17

                                   2018 PA Super 41

    JUDITH BRAUN, DERIVATIVELY ON                      IN THE SUPERIOR COURT
    BEHALF OF USA TECHNOLOGIES, INC.                             OF
                                                            PENNSYLVANIA
                             Appellant

                        v.

    STEPHEN P. HERBERT, STEVEN D.
    BARNHART, JOEL BROOKS, ALVIN F.
    MOSCHNER, WILLIAM J. REILLY, JR.,
    WILLIAM J. SCHOCH, DEBORAH G.
    ARNOLD, AND DAVID M. DEMEDIO, AND
    USA TECHNOLOGIES, INC., A
    PENNSYLVANIA CORPORATION

                             Appellees                      No. 1345 EDA 2017

                  Appeal from the Order Entered March 8, 2017
                In the Court of Common Pleas of Chester County
                       Civil Division at No: 2016-05225-MJ

BEFORE: PANELLA, STABILE, and PLATT,* JJ.

OPINION BY STABILE, J.:                              FILED FEBRUARY 22, 2018

        Appellant, Judith Braun, Derivatively on Behalf of USA Technologies,

Inc., appeals from the March 8, 2017 order sustaining the preliminary

objections of Appellees, Stephen P. Herbert, Steven D. Barnhart, Joel Brooks,

Alvin F. Moschner, William J. Reilly, Jr., William J. Schoch, Deborah G. Arnold,

and David M. DeMedio, and USA Technologies, Inc., a Pennsylvania

corporation, (collectively “Appellees”).       We affirm.

____________________________________________

*   Retired Senior Judge assigned to the Superior Court.
J-S71017-17

      On June 1, 2016, Appellant filed this shareholder derivative action

against Appellees alleging breach of fiduciary duties. The trial court provided

the following summary of the facts:

            [USA Technologies, Inc. (‘USAT’)] is a Pennsylvania
      corporation headquartered in Malvern, Pennsylvania that provides
      cashless electronic payment technology, telemetry and other
      services to customers primarily in small ticket, unattended point-
      of-sale (‘POS’) markets such as food and beverage vending,
      commercial laundry, amusement and arcade, kiosks, taxicabs and
      other transportation. USAT’s service enables customers to buy or
      lease POS electronic payment devices, and to process credit and
      debit card and mobile payments using USAT’s software and
      payment processing services. USAT has been publicly traded on
      the NASDAQ exchange since 2007.

             On September 10, 2015, the auditor reported to USAT
      management that it could not confirm the collectability of certain
      unpaid customer balances and disagreed with the amount of
      USAT’s reserve for bad debt. USAT ultimately agreed to increase
      its reserves by $450,000 and to revise its prior press release to
      reflect that increase in bad debt expense. On September 28,
      2015, USAT was advised that it needed to also consider whether
      internal control deficiencies amounted to a ‘material weakness’
      that would be required to be disclosed in the Company’s Form 10-
      K filing. Management subsequently agreed and on September 29,
      2015, USAT filed a Notification of Late Filing on Form 12b-25 (the
      ‘Notice’) with the [Securities and Exchange Commission (‘SEC’)],
      explaining that the Company was unable to file its annual report
      (its 2015 Form 10-K) on time.

            On September 30, 2015, after USAT’s auditors had
      confirmed to its Audit Committee that they were now comfortable
      with USAT’s reserves and financial statement, USAT’s delayed
      Form 10-K was filed with the SEC.

            On October 1, 2015, USAT as well as [Stephen P.] Herbert
      and [David M.] DeMedio were named as defendants in a putative
      securities fraud class action captioned Steven P. Messner, et al v.
      USA Technologies, Inc. et al, Civil Action No. 15-5427 (E.D. Pa.).

                                      -2-
J-S71017-17

       The action was dismissed with prejudice on April 13, 2016, and is
       currently on appeal.[1]

              On December 17, 2015, [Appellant] sent USAT’s Board [a]
       demand letter requesting that it ‘investigate, address, remedy,
       and commence proceedings against’ certain of USAT’s current and
       former officers and directors for breach of fiduciary duties and
       violations of applicable laws in connection with the material
       weaknesses in USAT’s internal controls and certain fiduciaries’
       public statements.

              On February 5, 2016, by unanimous written consent in lieu
       of a meeting, the Board adopted resolutions forming the [Special
       Litigation Committee (‘SLC’)], composed of outside directors Joel
       Brooks, CPA and William J. Reilly, Jr. The SLC retained Abraham
       C. Reich and Gerald E. Arth of Fox Rothschild as its counsel for the
       investigation and analysis of the demand.

                                           […]

             On July 15, 2016, the SLC issued its Report. The SLC
       concluded that the claims made in the Demand were unwarranted
       and that bringing any derivative action would not be in the best
       interests of USAT. On August 1, 2016, USAT’s Board conducted a
       special meeting at which it adopted the findings and
       recommendations of the SLC.

Trial Court Opinion, 3/8/17, at 2 n.1 (pagination ours).

       In summary, Appellee USAT failed to identify a large number of

outstanding,     uncollectible,    small   balance   accounts.   USAT’s   auditors

discovered the discrepancy and, at their behest, USAT increased its reserves

for bad debt and correspondingly lowered its net income projections for fiscal

year 2015.     The accounting error was concededly the result of a material

weakness in USAT’s internal controls. Appellant’s derivative action demanded

____________________________________________

1  As we will discuss more fully in the main text, the Third Circuit affirmed
dismissal of the federal suit.

                                           -3-
J-S71017-17

that USAT pursue litigation against those allegedly responsible for the error,

and USAT’s board of directors rejected Appellant’s demand.

      On August 17, 2016, Appellees filed preliminary objections to

Appellant’s complaint based on the SLC’s report and the USAT board’s

adoption of the SLC’s findings and recommendations. On March 8, 2017, the

trial court entered an order sustaining the preliminary objections. This timely

appeal followed.

      Appellant states the question involved as follows:

            Whether the trial court erred or abused its discretion when
      it granted [Appellees’] preliminary objections and concluded that
      the SLC was disinterested and independent, given that (1) the SLC
      consisted of only Audit Committee members—responsible for
      duties directly implicated by the wrongdoing to be investigated by
      the SLC; (2) the SLC members worked closely with the Company’s
      former CFO, the sole person who was terminated as a result of
      the wrongdoing, yet the SLC members did not share any of the
      blame; and (3) the SLC members had long standing ties to the
      Company and the Audit Committee and other structural issues
      demonstrating that they could not exercise independent judgment
      under the circumstances?

Appellant’s Brief at 4.

      The trial court sustained Appellees’ preliminary objections because it

concluded that the business judgment rule protected USAT’s rejection of

Appellant’s litigation demand.

             The business judgment rule insulates an officer or director
      of a corporation from liability for a business decision made in good
      faith if he is not interested in the subject of the business
      judgment, is informed with respect to the subject of the business
      judgment to the extent he reasonably believes to be appropriate
      under the circumstances, and rationally believes that the business
      judgment is in the best interests of the corporation.

                                     -4-
J-S71017-17

Cuker v. Mikalauskas, 692 A.2d 1042, 1045 (Pa. 1997). The Cuker Court

held that the business judgment rule applies in Pennsylvania. Id. at 1046-

48.

               The business judgment rule reflects a policy of
       noninterference with business decisions of corporate managers,
       presuming that they pursue the best interests of their
       corporations, insulating such managers from second-guessing or
       liability for their business decisions in the absence of fraud or self-
       dealing or other misconduct or malfeasance.

Id. at 1046. “[I]f a court makes a determination that a business decision was

made under proper circumstances, however that concept is currently defined,

then the business judgment rule prohibits the court from going further and

examining the merits of the underlying business decision.” Id. at 1048. The

Cuker Court defined the proper circumstances for a corporate board’s decision

to reject a shareholder’s litigation demand:

             Factors bearing on the board’s decision will include whether
       the board or its special litigation committee was disinterested,
       whether it was assisted by counsel, whether it prepared a written
       report, whether it was independent, whether it conducted an
       adequate investigation, and whether it rationally believed its
       decision was in the best interests of the corporation (i.e., acted in
       good faith). If all of these criteria are satisfied, the business
       judgment rule applies and the court should dismiss the action.

Id. at 1048. Thus, if the business rule applies in this case, the trial court did

not err in dismissing Appellant’s derivative action. Id.2

____________________________________________

2  In addition, the Cuker Court adopted §§ 7.02-7.10 and 7.13 of the
American Law Institute’s (“ALI”) Principles of Corporate Governance and
published them as an appendix to its decision. Cuker, 692 A.2d at 1049-55.

                                           -5-
J-S71017-17

       We will not reverse an order sustaining preliminary objections unless

the trial court abuses its discretion or commits an error of law. Lemenestrel

v. Warden, 964 A.2d 902, 910 (Pa. Super. 2008), appeal denied, 983 A.2d

729 (Pa. 2009). As is evident in Lemenestrel, our review of the trial court’s

application of the business judgment rule requires analysis of evidence in

addition to the complaint. See id. at 915-17. Thus, we will exercise plenary

review.

       Appellant’s sole argument is that the two members of the SLC, Appellees

Joel Brooks and William J. Reilly, were not disinterested and independent. The

trial court found the following with regard to Brooks and Reilly:

              [T]wo of USAT’s current outside directors, Joel Brooks, CPA
       and William J. Reilly, Jr. were appointed to serve as the members
       of the SLC with Mr. Brooks serving as the chair. Mr. Brooks is a
       certified public accountant and active member of the American
       Institute of Certified Public Accountants, who earned a degree in
       accounting from Rider University. Since May 2015, he has served
       as the Vice President, Finance for MeiraGTx Limited, a private
       biotechnology company.        He previously served as the CFO,
       Treasurer and Secretary of Sevion Therapeutics, Inc., formerly
       known as Senesco Technologies, a biotechnology company whose
       shares are traded on the American Stock Exchange.

             Mr. Reilly served as President and Chief Executive Officer of
       Realtime Media, Inc., and in a progression of executive roles with

____________________________________________

We will cite sections of the ALI Principles rather than pages of the Atlantic
Reporter and we will quote the principles as they appear in Cuker. Under the
ALI Principles, a corporation may seek dismissal of an action against a director
or senior executive where either the board or a committee, such as the SLC,
determines that the action is contrary to the corporation’s best interests. ALI
Principles, § 7.07(a)(2) and § 7.08(a).      Appellant does not argue that
Appellees failed to follow the procedural requirements set forth in the ALI
Principles.

                                           -6-
J-S71017-17

       Checkpoint Systems, Inc. He also has a background in public-
       company corporate governance, having formerly served on the
       board of directors of Veramark Technologies, Inc., prior to his
       current service on the boards of USAT and Agilence, Inc. In
       addition to his business and Board responsibilities, Mr. Reilly was
       elected to serve as a member of the Board of Supervisors of
       Thornbury Township, Pennsylvania.

Trial Court Opinion, 3/8/17, at 6 n.1 (pagination ours).

       Section 7.09 of the ALI Principles of Corporate Governance3 provides

that a special litigation committee must consist of “two or more persons, no

participating member of which was interested in the action, and should as a

group be capable of objective judgment in the circumstances.” ALI Principles

of Corporate Governance, § 7.09(a)(1). The Lemenestrel Court held that

“mere service on the board does not make the special litigation committee

member ‘interested.’” Lemenestrel, 964 A.2d at 919.

       In Lemenestrel, the plaintiff shareholders alleged in their demand

letter that the defendant directors engaged in self-serving acts that resulted

in loss of value to the plaintiffs’ stock.       Id. at 908.   The special litigation

committee found no evidence of wrongdoing, but the committee members

were named as defendants in the resulting derivative action. Id. at 909. In

analyzing the plaintiffs’ claim that the committee members were not

disinterested, this Court relied on § 1.23 of the ALI Principles, defining an

“interested” director.     In pertinent part, § 1.23 provides that a director, if

____________________________________________

3   As noted above, the Cuker Court adopted portions of the ALI Principles.

                                           -7-
J-S71017-17

named as a defendant, is interested unless the allegations are “based only on

the fact that the director approved of or acquiesced in the transaction or

conduct that is the subject of the action,” and the complaint “does not

otherwise allege with particularity facts that, if true, raise a significant

prospect that the director would be adjudged liable to the corporation or its

shareholders.”    Id. at 919, (quoting ALI Principles, § 1.23(c)(2)).        In

Lemenestrel, the trial court found that the members of the litigation

committee had no direct involvement in the alleged self-dealing of several

board members. Id. at 921-22. The trial court also found that the friendship

between the wife of a committee member and the wife of a defendant director

(the women had attended college together and kept up occasional contact)

did not render the committee member interested within the meaning of

§ 1.23. Id. at 921-22. The record supported the trial court’s findings, and

this Court affirmed dismissal of the action. Id.

      The instant facts have already been litigated in federal court. Fain v.

USA Technologies, Inc., 707 Fed. Appx. 91 (3d Cir. 2017). Fain does not

control the instant matter, as it was decided under federal law and the Third

Circuit was not considering the propriety of the SLC members under Cuker,

but we will rely on the Third Circuit’s analysis of the facts as persuasive

authority. In Fain, the plaintiff claimed that USAT “fraudulently understated

the amount of ‘bad debt’ on [USAT’s] balance sheet in order to artificially prop

up [USAT’s] perceived financial health.” Id. at 94. The Third Circuit noted

                                     -8-
J-S71017-17

that the error was relatively small—4% of quarterly and 2% of year-end

revenue. Id. at 97. The Third Circuit found the small size of the error not to

be indicative of the scienter required under federal law. Id. “On this record,

the most likely inference, given the small-balance nature of the accounts, is

that lower staffers simply misclassified these bad debts or otherwise failed to

deem them uncollectible, not that Defendants were aware of and were

recklessly disregarding them.” Id. “This is particularly so given the short

time span between misstatement and correction—a mere three weeks.” Id.

      We find the Third Circuit’s analysis instructive because it illustrates why

mere service on a board does not render an SLC member interested. Simply

put, the extent of a director’s knowledge of, or complicity in, a disputed act is

not self-evident based on his or her status as a director.           A director,

particularly an outside director, is not necessarily aware of mistakes that occur

at lower levels of the company.     To this end, the ALI Principles require a

plaintiff to allege with particularity the wrongdoing at issue.    Section 7.04

provides:

            The complaint shall plead with particularity facts that, if
      true, raise a significant prospect that the transaction or conduct
      complained of did not meet the applicable requirements of Parts
      IV (Duty of Care and the Business Judgment Rule), V (Duty of Fair
      Dealing), or VI (Role of Directors and Shareholders in Transactions
      in Control and Tender Offers), in light of any approvals of the
      transaction or conduct communicated to the plaintiff by the
      corporation.

ALI Principles of Corporate Governance, § 7.04(a)(1). More to the point in

this case, a defendant director is not interested in the disputed conduct if the

                                      -9-
J-S71017-17

plaintiff “does not otherwise allege with particularity facts that, if true, raise

a significant prospect that the director would be adjudged liable to the

corporation or its shareholders.”    Lemenestrel, 964 A.2d at 919 (quoting

§ 1.23(c)(2)(B) of the ALI Principles) (emphasis added).

      In addition to the facts set forth in the trial court’s opinion, Appellant

notes that Brooks and Reilly were members of USAT’s audit committee and

Brooks was the longest-standing member of USAT’s board and chairman of

the audit committee. Appellant alleged that Brooks “knowingly or recklessly

made improper statements in [USAT’s] public filings concerning [USAT’s]

internal controls and bad debt expenses.        In addition, defendant Brooks

knowingly or recklessly utterly failed to implement an appropriate and

adequate internal control system.” Complaint 6/1/16, at ¶ 12. The complaint

repeats identical allegation against Reilly. Id. at ¶ 14. Appellant argues that,

because the audit committee was responsible for overseeing financial integrity

and internal controls, neither SLC member was disinterested. Citing USAT’s

2014 annual report, Appellant notes that USAT’s audit committee is

responsible for “evaluating [USAT’s] accounting principles … and reviewing the

adequacy and effectiveness of [USAT’s] internal controls.” Id. at ¶¶ 23-24;

Appellant’s Brief at 17. Likewise, the audit committee was required to review

the quarterly reports with USAT’s independent auditor and review disclosures

from USAT’s CEO and CFO relevant to USAT’s annual report. Id. at ¶ 24.

Appellant also notes that USAT’s audit committee reviewed the company’s bad

                                     - 10 -
J-S71017-17

debt allowance during its meetings. Appellant’s Brief at 18. Appellant believes

Brooks and Reilly used their positions on the SLC to insulate themselves from

scrutiny and shift blame to USAT’s former CFO.4 Appellant claims that the

wrongdoing alleged in her demand letter suggests that the audit committee

failed to do its job. Id. at 19.

       Nowhere does Appellant allege with any particularity that either Brooks

or Reilly is liable to the corporation as a result of their service on USAT’s board

and audit committee. Rather, Appellant seemingly relies on what she believes

Brooks and Reilly must have known.             Nothing in the record indicates that

either member of the SLC helped devise USAT’s internal controls or was

personally responsible for the misstatement of bad debt. The Fain Court’s

analysis undermines Appellant’s theory insofar as it establishes that the

mistakes at issue most likely were not within the immediate purview of an

outside director. Regardless of the Fain Court’s analysis, Appellant made no

____________________________________________

4  Appellant criticizes the trial court’s reliance on § 1.23 of the ALI Principles,
claiming that the trial court conflated Appellant’s arguments about the SLC’s
interest in the underlying conduct and the SLC’s lack of independence.
Appellant fails to develop any legal argument as to the distinction between
“disinterested” and “independent,” as those terms are used in Cuker. In any
event, we believe the trial court correctly analyzed whether Brooks and Reilly
were disinterested. In arguing that Brooks and Reilly insulated themselves
from scrutiny, Appellant clearly argues that they were not disinterested.
Appellant does not assert that Brooks and Reilly, in their roles as SLC
members, were under the control of nonmembers and thus lacking in
independence. We are cognizant that the Cuker Court did not adopt § 1.23,
but Lemenestrel cited that section in analyzing the disinterestedness of SLC
members. Lemenestrel is binding on the trial court and three-judge panels
of this Court.

                                          - 11 -
J-S71017-17

allegations and produced no evidence to support, with any particularity, her

claim to the contrary.    Furthermore, a passage in USAT’s audit committee

charter substantially undermines Appellant’s claim: “it is not the duty of the

Audit Committee to plan or conduct audits or to determine that [USAT’s]

financial statements are complete and accurate and are in accordance with

generally accepted accounting principles and applicable rules and regulations.

These are the responsibilities of management and the independent auditor.”

Appellees’ Memorandum of Law in Support of Preliminary Objections, 8/17/16,

at Exhibit E, p. 5. In summary, Appellant has failed to allege with particularity

how Brooks and Reilly were not disinterested and independent, and therefore

she has failed to establish any fraud, malfeasance, or self-dealing that would

preclude application of the business judgment rule. Cuker, 692 A.2d at 1046,

1048.

        Appellant also argues that Brooks and Reilly have close ties to USAT’s

CFO, Appellee David M. DeMedio, who was terminated because of the

accounting mistake at issue. Appellant argues that Brooks and Reilly regularly

interacted with DeMedio, and that the three men shared responsibility for the

accounting errors. As noted above, Appellant argues that Brooks and Reilly

used their positions on the SLC to protect themselves and blame DeMedio.

Once again, we conclude that Appellant has failed to allege with any

particularity that the relationship between Brooks, Reilly, and DeMedio

precluded the former two from serving as disinterested SLC members. We

                                     - 12 -
J-S71017-17

find it unsurprising that a company’s outside directors and audit committee

members would maintain a relationship with its CFO. That, without more,

does not preclude the outside directors from serving as disinterested and

independent SLC members.       Again, we discern no error in the trial court’s

finding that Brooks and Reilly were disinterested and independent, and that

Appellant failed to establish any fraud, malfeasance, or self-dealing that would

preclude application of the business judgment rule.

      For all of the foregoing reasons, we conclude that USAT’s decision to

reject Appellant’s litigation demand is protected by the business judgment

rule, and we affirm the order sustaining Appellees’ preliminary objections.

      Order affirmed.

Judgment Entered.

Joseph D. Seletyn, Esq.
Prothonotary

Date: 2/22/18

                                     - 13 -