United States District Court, D. Nevada
ORDER DISMISSING COMPLAINT FOR FAILURE TO DEMONSTRATE DEMAND FUTILITY [# 17] WITH LEAVE TO AMEND
JENNIFER A. DORSEY, District Judge.
This shareholder-derivative action challenges the EchoStar Corporation's compensation committee's decision to award its board chairman and principal shareholder Charles Ergen options for 1.5 million shares of stock-700, 000 more than the annual cap set by the company's stock-incentive plan. Without first making a demand on EchoStar's current board of directors, shareholder Greg Jacobi sued EchoStar, Ergen, and several of EchoStar's directors alleging that the award, and particularly the 700, 000 excess shares over the annual cap, was a "fundamentally unfair, " ultra vires act permitted by fiduciary breaches and resulting in Ergen's unjust enrichment. I find that Jacobi has failed to plead with sufficient particularly facts that show his pre-suit demand on the EchoStar board of directors was excused as futile, and I dismiss this action with leave to amend.
EchoStar is a Nevada holding company whose wholly-owned subsidiaries design and distribute digital set-top boxes for satellite TV service providers and cable companies, and provide digital broadcast and satellite services to DISH Network and other satellite services. Ergen has been Chairman and a director of EchoStar since 2007, he is the company's majority shareholder, and he served as EchoStar's CEO until 2009. Ergen no longer has managerial responsibility for EchoStar; "his only role is now to provide guidance' to management in his capacity as Chairman." Ergen is also the majority shareholder and Chairman of the Board of EchoStar's spinoff company, DISH Network, which is also one of EchoStar's primary customers.
On March 31, 2011, EchoStar's three-member compensation committee, consisting of Tom Ortolf, C. Michael Schroeder, and Joseph Clayton, awarded Ergen 1.5 million stock options to purchase EchoStar's Class A common stock, valued at $21.6 million. Jacobi alleges that the award violated the limitations of EchoStar's shareholder-approved Amended and Restated 2008 Stock Incentive Plan (the "SIP"), which provides, "no Participant may be granted Awards... in the aggregate in respect of more than 800, 000 Shares in any one calender year...." He characterizes the award as "not in fact compensation' at all, but rather a stealth dividend issued to the controlling shareholder." And he contends that the award of options for the excess 700, 000 shares two years after Ergen stepped down as CEO was an ultra vires act, and that the sheer size of the entire 1.5 million-option award "was fundamentally unfair to the Company for a host of reasons."
Jacobi sues the board of directors at the time of the award (Ergen, Ortolf, Schroeder, Michael Dugan, R. Stanton Dodge, Joseph Clayton, and David Moskowitz) for fiduciary breaches and corporate waste, and he sues Ergen separately for fiduciary breaches and unjust enrichment-all derivatively on behalf of EchoStar. "Derivative suits allow shareholders to compel the corporation to sue' and to thereby pursue litigation on the corporations behalf against the corporation's board of directors and officers." "But because the power to manage the corporation's affairs resides in the board of directors, a shareholder must, before filing suit, make a demand on the board, or if necessary, on the other shareholders, to obtain the action that the shareholder desires." At the time Jacobi filed suit, EchoStar's board of directors consisted of Ortolf, Schroeder, Ergen, Dodge, Dugan, Anthony Federico, and Pradman Kaul. Jacobi did not make a pre-suit demand on the board to challenge the award, and he alleges that demand would have been "a futile and useless act because the Current Board is incapable of making an independent and disinterested decision to institute and vigorously prosecute this action."
Defendants move to dismiss Jacobi's shareholder-derivative action, arguing that, "[h]ad [p]laintiff done what the law requires him to do-make a pre-suit demand-this litigation and the expenses associated with it would have been avoided" because the award of the excess 700, 000 options was canceled immediately after the lawsuit was filed. They contend that Jacobi has not sufficiently pled demand futility as required to permit him to maintain this action on behalf of EchoStar and, regardless, each of his claims should be dismissed under FRCP 12(b)(6) for failure to state a viable claim. The parties agree that the cancellation moots Jacobi's claim for corporate waste, but they disagree on the sufficiency of his other claims and demand-futility allegations. Having thoroughly considered the parties' extensive briefing and arguments at the hearing on this motion, I find that Jacobi's allegations do not sufficiently establish that a pre-suit demand would have been futile, and I dismiss his complaint with leave to amend.
A. Demand futility
Shareholder derivative suits are anathema to the general rule that "a corporation's board of directors has full control over the affairs of the corporation, '" which includes the decision "whether to take legal action on the corporation's behalf." Before a shareholder can file suit on the company's behalf, he must first demand that the board obtain for the company "the action that [he] desires." The pre-suit demand requirement is excused only if the plaintiff demonstrates in his complaint that the demand would have been futile. To determine demand futility, the district court applies the law of the state of incorporation-in this case, Nevada. When a shareholder files derivative claims without a pre-suit demand, he must plead "with particularity... the reasons for not obtaining the action or not making the effort." The relevant facts "must be put forth in the complaint and not merely in subsequent briefs." This heightened pleading burden "is... more onerous than that required to withstand a Rule 12(b)(6) motion."
1. Aronson or Rales ?
Nevada courts apply one of two tests developed by the Delaware courts to evaluate the plaintiff's allegations to determine whether demand is futile and thus excused. As the Nevada Supreme Court explained in Shoen v. SAC Holding Corp ., "in those cases in which the directors approved the challenged transaction, " the court applies the test from Aronson v. Lewis .  The two-pronged Aronson test "applies to determine if a complaint has created a reasonable doubt as to whether the directors, having made a business decision, were disinterested and independent, or likely entitled to the business judgment rule's protection." But "where the contested corporate transaction is not the result of director action, " the test from Rales v. Blasband applies, and "the demand futility analysis is limited to whether a majority of the directors had a disqualifying interest in the matter or were otherwise unable to act on the demand with impartiality."
All of Jacobi's claims challenge a single transaction: the compensation committee's March 31, 2011, award to Ergen of 1.5 million EchoStar stock options to purchase EchoStar's Class A common stock. Jacobi attempts to tie the board of directors into this action by vague allegations that "the Board granted" these stock options and "breached their fiduciary duties by authorizing, approving, and/or by abdication of duty permitting stock option grants in violation of the terms of the Incentive Plan." But these generalized statements do not square with the more particularly pled facts in the verified complaint that the decision was made exclusively by the three-member compensation committee.
For example, Jacobi states in paragraph 10 that "the Board allowed its compensation committee, the members of which are effectively controlled by Ergen, to determine his compensation." And although Jacobi highlights a number of things he alleges the board did not do, ("[t]he Board did not engage in arms-length negotiations when determining the amount of compensation to award Ergen, " or "seek the guidance of any consultants or advisors to determine what a fair award should be"), the well-pled facts reflect that all affirmative action taken with respect to this stock-option award was performed by the compensation committee alone. ("On March 31, 2011, the Compensation Committee awarded Ergen 1.5 million stock options... under the Incentive Plan, " which Jacobi alleges is administered by the Compensation Committee; "the Compensation Committee did not negotiate for and/or receive adequate consideration (if any at all) in return" for the award; "the Compensation Committee did not consult any advisors or consultants, " though it "engaged a compensation consultant... after the 2011 compensation decisions were already made"; and "[t]he Compensation Committee's actions in violating the express terms of ...