IN THE COURT OF APPEALS OF TENNESSEE
AT NASHVILLE
October 16, 2008 Session
INDIANA STATE DISTRICT COUNCIL OF LABORERS and HOD
CARRIERS PENSION FUND
v.
GARY BRUKARDT, et al.
Appeal from the Chancery Court of Davidson County
No. 05-1392, II, Carol McCoy, Chancellor
______________________________
No. M2007-02271-COA-R3-CV - Filed February 19, 2009
______________________________
This is a shareholder class action which was dismissed by the trial court for failure to state a claim.
The case alleges breach of fiduciary duty and self-dealing against members of the Board of Directors
who procured and approved a merger. For the reasons stated herein, we hold that the complaint
alleges sufficient facts to allow the case to go forward, and, therefore, dismissal was in error. The
decision below is reversed and the case is remanded for further proceedings.
Tenn. R. App. P. 3 Appeal as of Right; Judgment of the Chancery Court Reversed.
WALTER C. KURTZ, SR. J., delivered the opinion of the court, in which ANDY C. BENNETT , J., and
RICHARD DINKINS, J. joined.
James G. Stranch, III, J. Gerard Stranch, IV, and Joe P. Leniski, Jr., Nashville, Tennessee; Darren
J. Robbins, Randall J. Baron, A. Rick Atwood, Jr., and David T. Wissbroecker, San Diego,
California; and William K. Cavanagh, Jr., Springfield, Illinois, for appellant.
Michael L. Dagley, Matthew M. Curley, Nashville, Tennessee; Lawrence O. Kamin, and Derek
M. Schoemann, New York, New York; for appellee Renal Care Group, Inc.
Ames Davis, Nashville, Tennessee, Mary C. Gill, Atlanta, Georgia, and Mark T. Calloway,
Charlotte, North Carolina, for individual appellees.
1
OPINION
I. Introduction and Background
This is a shareholder class action1 filed against board members of Renal Care Group, Inc.
(Renal Care) related to its 2005 merger with Fresenius Medical Care AG (Fresenius) alleging
breach of fiduciary duty and self-dealing.2 The trial court dismissed the amended complaint for
failure to state a claim. Tenn. R. Civ. P. 12.02(6). Plaintiff appeals.
The merger was announced in May 2005. Several days later plaintiff filed its original
complaint. Defendants then removed the case to federal court. The merger went forward. The
stockholders ratified, and the merger closed in March 2006. In the meantime, the federal court
remanded this case back to state court, but nothing transpired until September 13, 2006, when
plaintiff filed the amended complaint which is the subject of this appeal.
On December 22, 2006, defendants moved to dismiss the amended complaint. The
motion was granted August 30, 2007.
According to the complaint, the defendants sought the merger in order to cover alleged
Medicare fraud and back dating of stock options but also to insure that they would be free of any
possible liability for such acts. It is then alleged that the defendants, employed investment
bankers who were themselves conflicted, did not freely market the company, imposed improper
deal protection devices, and then sold the merger to their shareholders by failing to disclose the
very problems that motivated the merger.
The appellees moved to dismiss. In support of their motion they filed:
1. Proxy statement;
2. Certificate of Incorporation of Renal Care Group, Inc.; and
3. News releases and news articles related to the merger and the affirmative
results of the merger.
1
Derivative claims were also alleged. They have been dismissed, and appellant has not
appealed the dismissal of those claims. The distinction between a derivative claim and a direct
shareholder action have on occasion not been clearly defined. See Tooley v. Donaldson, Lufkin,
and Jenretta, 845 A.2d 1031 (Del. 2004). That issue, however, has not been raised in this case.
2
The defendants sued were Gary Burkhardt, President, CEO and Board Member,
William Johnson, Chairman and Board Member, Harry Jacobson, Joseph Hatts, William
Lapham, Thomas Lowery, Stephen McMurry, Peter Grun, and Thomas Smith. Also sued was
Ronald Hines, Vice President and CFO, Raymond Hakin, another Vice President, and Dirk
Allison, a former Vice President and CFO.
2
The motion was heard on August 16, 2007, and at the close of the hearing, the chancellor
ruled orally that the record showed that the Board did not lack sufficient independence; the Board
had appropriately relied on two (2) financial advisors; and there was no way the Board could
have assessed a value to the stock options issue and Medicare fraud issue at the time of the
merger, as those potential claims had not matured at the time of the merger. She then asked
defense counsel to draw an order which “adopts the facts set out in the Memorandum of Law in
support of the Motion to Dismiss as submitted by the defendants.” The result was a 33-page
lawyer-drawn order (with 34 footnotes) dismissing the complaint. The order entered on August
30, 2007, is considerably broader than the oral ruling.
Appellants’ counsel takes umbrage at the findings in this lengthy order and the process by
which the order was generated.3 Ultimately this issue is not relevant as this Court reviews the
dismissal de novo.
The amended complaint is 61 pages long and on occasion suffers from editorial
and redundant inclusions. Its introduction summary, although itself lengthy, is set out below, as
the allegations in the complaint are obviously at the heart of this appeal.
Summary of the Action
1. This is a stockholder class action brought by plaintiff on
behalf of the former holders of Renal Care common stock. It is
also a derivative action brought on behalf of Renal Care for the pro
rata benefit of those former shareholders. The action is brought
against certain former officers and directors of Renal Care, and
arises out of their unlawful actions in connection with the sale of
Renal Care to Fresenius in a cash-out merger (the “Acquisition”),
as well as in connection with defendants’ improper backdating
and/or timing of insider stock options over a number of years. All
told, defendants’ misconduct caused hundreds of millions of
dollars in damages to the Class and the Company.
2. Several things happened in late 2004 that spurred defendants,
within a matter of days, to seek out the Acquisition with Fresenius.
First, on October 26, 2004, defendants announced that the
3
This Court and our Supreme Court have expressed a preference for judgments prepared
by the “independent labor of the judge” in cases involving the need for detailed factual findings
and/or complex legal analysis. Delevan-Delta Corp. v. Roberts, 611 S.W.2d 51, 52-53 (Tenn.
1981); Goolsby v. Upper Cumberland Oil, 34 S.W.3d 309, 313 (Tenn. Ct. App. 2000). Lawyer
written orders are not prohibited, however, as the appellate court relies on the fact that the trial
judge has “carefully examine[d] them [and] establishe[d] that [the order] accurately reflects her
views and conclusions, and not those of counsel.” Delevan-Delta, 611 S.W.2d at 53.
3
Company had been subpoenaed by the Department of Justice
(“DOJ”) in connection with a Medicare fraud investigation into,
among other things, questionable billing practices regarding certain
tests and therapies that were administered to patients and then
billed to Medicare. This subpoena was of serious concern to
defendants because they had, over the years, caused the Company
to charge Medicare nearly 40% more for those tests and treatments
than defendants’ true costs. Thus, defendants were facing untold
millions of dollars in civil and criminal fines and penalties.
3. Second, in November 2004, the Securities and Exchange
Commission (“SEC”) launched an investigation into stock option
pricing practices at various companies, including, among others,
Analog Devices, Inc. (“Analog Devices”). Analog Devices
disclosed this investigation in a November 30, 2004, 10-K filing
with the SEC, which was picked up and reported by the financial
press. The Analog Devices 10-K stated:
We have received notice that the
SEC is conducting an inquiry into our granting of
stock options over the last five years to officers and
directors. We believe that other companies have
received similar inquiries. Each year, we grant
stock options to a broad base of employees
(including officers and directors) and in some years
those grants have occurred shortly before our
issuance of favorable annual financial results. The
SEC has requested information regarding our stock
option grants, and we intend to cooperate with the
SEC. We are unable to predict the outcome of the
inquiry.
4. This announcement, on the heels of the DOJ subpoenas, sent
another shockwave through defendants because, from 1996 until
2003, defendants had repeatedly engaged in the improper practice
of backdating stock options to the dates of quarterly and/or annual
lows in the Company’s stock price, and/or had timed stock grants
to coincide with, and take advantage of, the release of positive
news (and the corresponding lift that news had on the Company’s
stock). By doing so, defendants were able to ensure tens of
millions of dollars in stock option profits for themselves and/or
other Company insiders, while at the same time causing tens of
millions of dollars in harm to the Company.
4
5. Defendants were able to allay shareholder suspicion regarding
their improper options pricing activity by filing with the SEC, as
exhibits to quarterly or annual reports, option grant agreements,
many of which were misdated, which gave the illusion of
legitimacy to the option grants. Indeed, it was not until the Wall
Street Journal published an article in May 2006 exposing
defendants’ options misconduct that Renal Care’s former
shareholders learned what had really been going on. According to
the Wall Street Journal’s statistical analysis, the odds are 100
million to one against the timing of defendants’ stock option grants
being mere coincidence.
6. Third, on December 2, 2004, the DOJ confirmed that Gambro
Healthcare (“Gambro”) would pay more than $350 million in
criminal fines and civil penalties to settle allegations of fraud
against government healthcare programs, including kickbacks paid
to physicians, false statements made to procure payment for
unnecessary tests and services, and payments made to a sham
equipment company. This too was of great concern to defendants
because, for years, they had caused the Company to engage in
business relationships with physicians and medical groups
(including some run by defendants themselves) that failed to meet
anti-kickback and fair market value safe harbor requirements. The
investigation of Gambro, which soon spread to include defendants
and the Company, also threatened to expose defendants to untold
millions of dollars in civil and criminal fines and penalties.
7. The announcement of the DOJ and SEC investigations, as
well as the massive settlement Gambro had just agreed to pay,
signaled to defendants that the jig was up, as their misconduct was
bound to come to light, and soon. The problem then became: what
was the best strategy for defendants to try to escape liability to the
Company and its shareholders for their breaches of fiduciary duty?
Defendants quickly arrived at an answer: a merger, which
(hopefully) would discourage any derivative suits and
simultaneously provide for a much deeper pocket to indemnify
defendants against not only shareholder litigation but any
governmental action that might be taken.
8. Thus, only five days after the DOJ announced its $350 million
settlement with Gambro, only nine days after Applied Digital
announced that it was one of a number of companies being targeted
5
by the SEC for options mispricing, and barely six weeks after the
October 2004 DOJ subpoena was handed down, merger
discussions had already begun in earnest between defendants and
Fresenius. And rather than shopping around for a higher bidder
that might be less accommodating to them, defendants pressed
forward with plans to sell the Company to - and obtain indemnity
from - Fresenius.
9. For its part, Fresenius was getting such a good deal for Renal
Care that it was not only willing to divest itself of various assets at
fire sale prices to obtain antitrust clearance for the Acquisition, it
was also willing to contractually indemnify defendants for the
liability their various improper actions had subjected them to. As
defendant Gary Brukardt (“Brukardt”), the Company’s then-Chief
Executive Officer (“CEO”), would later delicately put it, when
asked about yet another DOJ subpoena to the Company: “When we
structured our transaction with Fresenius Medical Care, the
possibility of such a subpoena was expressly contemplated by the
provisions of the merger agreement.”
10. Given the liability that the members of the Company’s Board
of Directors (“Board”) faced, as detailed herein, those members
were clearly conflicted with regard to their decision to pursue the
Acquisition. Indeed, defendants were no strangers to conflicts of
interest, as their years of improper related-party transactions and
improper stock option grants demonstrate. Thus, it is not
surprising that, given their resolve to get a merger done, they
willfully ignored still more conflicts of interest that arose in
connection with the Acquisition, both on the part of the Company
insiders who were “negotiating” the Acquisition and the
investment advisors who were counseling them in connection
therewith.
11. For example, Board members were aware that Fresenius was
seeking to employ both Brukardt and defendant William P.
Johnston (“Johnston”), the Chairman of the Company’s Board,
following completion of the Acquisition. Yet defendants not only
failed to form a special committee (assuming they could find any
independent Board members) to negotiate and oversee the process
by which the Acquisition was conducted, the Board completely
abdicated the Acquisition process to Brukardt and Johnston, who
then (with the other defendants’ knowledge) simultaneously
negotiated both the Acquisition terms with Fresenius, their soon-
6
to-be employer, and the terms of their post-Acquisition
employment agreements. It is no surprise, then, given these
numerous conflicts of interest and abdications of fiduciary duty,
that Brukardt and Johnston simultaneously negotiated deals that
benefitted themselves and their future employer and were unfair to
the Company and its shareholders.
12. The Board’s investment advisors also were conflicted in
connection with the Acquisition. For example, not only did these
advisors receive fees that were contingent on the closing of the
Acquisition (thus motivating them to opine that the Acquisition
was “fair” so that they could get paid million of dollars on the
deal), but one of those advisors, Banc of America Securities, LLC
(“Banc of America”), also agreed to provide financing to Fresinius
in connection with the Acquisition. Thus Banc of America
essentially represented both sides in the Acquisition, and was
motivated to favor Fresenius in that representation to reduce its bad
debt exposure (by ensuring Fresenius paid less than full and fair
value for Renal Care).
13. To further ensure the success of the Acquisition, the Board
locked up the Acquisition by agreeing to various “deal-protection”
devices such as: (I) a $96.25 million termination fee; (ii) a no
solicitation/no shop agreement; and (iii) a matching rights
provision to ensure that Fresenius, and only Fresenius, would
acquire the Company.
14. Moreover, to coerce the Company’s public shareholders into
approving the Acquisition, thus (hopefully) evading personal
liability for their breaches of fiduciary duty, defendants caused the
Company, on July 21, 2005, to file with the SEC and disseminate
to the Company’s public shareholders the Definitive Proxy
Statement concerning the Acquisition (“the Proxy”), which
misstated and/or omitted material information regarding the
Acquisition that was essential to the Company’s former public
shareholders’ ability to cast a fully-informed vote on the
Acquisition. The Proxy’s misstatements and omissions include: (I)
information regarding defendants’ and their advisors’ conflicts of
interest in the Acquisition; (ii) the reasons why the Board did not
appoint a special committee to evaluate the fairness of the
Acquisition; (iii) the undisclosed options pricing claims, which
were assets of the Company worth tens of millions of dollars, but
which the shareholders were not compensated for in the
7
Acquisition; (iv) the forecasts and projections prepared by Renal
Care’s management for fiscal years 2005 through 2008; (v) the
estimates of transaction synergies created by the Acquisition; and
(vi) the basis for and data underlying the analyses performed by
Morgan Stanley & Company, Inc. (“Morgan Stanley”), the Board’s
other financial advisor, in its fairness opinion. By concealing
material information from shareholders for the purpose of avoiding
personal liability, defendants committed fraud in the merger. Thus,
any continuous ownership requirement to assert derivative claims
on behalf of the Company that might otherwise apply is nullified.
15. In sum, in pursuing the unlawful plan to sell Renal
Care, the Board members violated applicable law by directly
breaching and/or aiding and abetting the other defendants’
breaches of their fiduciary duties of loyalty, due care, candor,
independence, good faith and fair dealing that were owed to the
Company’s shareholders. And by participating in and/or
permitting the options mispricing, each of the defendants’ breaches
of their fiduciary duties of loyalty, due care, candor, independence,
good faith and fair dealing that were owed to the Company.
16. In essence, the Acquisition was the product of a
hopelessly flawed process that was designed to ensure the sale of
Renal Care to Fresenius, while allowing defendants to obtain
continued employment with the surviving corporation for
themselves, and/or substantial change of control benefits, and/or
indemnification for their prior misconduct - all to the detriment of
Renal Care and its former public shareholders. Thus, the Company
and its shareholders have been damaged.
II. MOTION TO DISMISS AND STANDARD OF REVIEW
The standard of review and the rules governing consideration of a Tenn. R. Civ. P. 12.02(6)
motion have been repeated may times:
A Rule 12.02(6) motion to dismiss admits the truth of all of
the relevant and material averments contained in the complaint, but
it asserts that the averments nevertheless fail to establish a cause of
action. See, e.g., Stein v. Davidson Hotel Co., 945 S.W.2d 714, 716
(Tenn. 1997). Therefore, when reviewing a dismissal of a complaint
under Rule 12.02(6), this Court must take the factual allegations
contained in the complaint as true and review the trial court’s legal
conclusions de novo without giving any presumption of correctness
8
to those conclusions. See, e.g., Doe v. Sundquist, 2 S.W.3d 919, 922
(Tenn. 1999). Because a motion to dismiss a complaint under
Tennessee Rule of Civil Procedure 12.02(6) challenges only the legal
sufficiency of the complaint, courts should not dismiss a complaint
for failure to state a claim based upon the perceived strength of a
plaintiff’s proof. See, e.g., Bell ex rel. Snyder v. Icard, Merrill,
Cullis, Timm, Furen & Ginsburg, P.A., 986 S.W.2d 550, 554 (Tenn.
1999). As Rule of Civil Procedure 8.01 only requires that a
complaint set forth “a short and plain statement of the claim showing
that the pleader is entitled to relief,” courts should liberally construe
the complaint in favor of the plaintiff when considering a motion to
dismiss for failure to state a claim. See, e.g., Pursell v. First Am. Nat.
Bank, 937 S.W.2d 838, 840 (Tenn. 1996). Although the allegations
of pure legal conclusions will not sustain a complaint, see Ruth v.
Ruth, 213 Tenn. 82, 372 S.W.2d 285, 287 (1963), courts should grant
a motion to dismiss only when it appears that a plaintiff can prove no
set of facts in support of the claim that would entitle the plaintiff to
relief, see, e.g., Cook v. Spinnaker’s of Rivergate, Inc., 878 S.W.2d
934, 938 (Tenn. 1994).
* * * *
A complaint “need not contain in minute detail the facts that give rise
to the claim,” so long as the complaint does “contain allegations from
which an inference may fairly be drawn that evidence on these
material points will be introduced at trial.” Donaldson v. Donaldson,
557 S.W.2d 60, 61 (Tenn. 1977).
White v. Revco Discount Drug Centers, 33 S.W.3d 713, 718, 725 (Tenn. 2000). Accord, Givens v.
Mullikin ex rel McElwaney, 75 S.W.3d 383, 391, 399, 403-404 (Tenn. 2002); Kersey v. Bratcher,
253 S.W.3d 625, 628 (Tenn. Ct. App. 2007). Not only are the factual assertions presumed true, but
the plaintiff is to be given the benefit of all reasonable inferences. Trau-Med of America v. Allstate,
71 S.W.3d 691, 696 (Tenn. 2002). See, generally, Pivnick, Tennessee Circuit Court Practice § 11.3
(2008 ed.). Furthermore, matters outside the pleadings generally should not be considered in
deciding whether to grant the motion. Trau-Med, 71 S.W.3d at 696.
The reliance on an affirmative defense in granting a motion to dismiss is very seldom
sustainable.
[W]e are hesitant to dismiss her complaint based upon the
potential existence of a factual affirmative defense. In Anthony v.
Tidwell, 5670 S.W.2d 908, 909 (Tenn. 1977), we held that a
“complaint is subject to dismissal under rule 12.02(6) for failure to
state a claim if an affirmative defense clearly and unequivocally
9
appears on the face of the complaint.” We also noted that “[i]t is not
necessary for the defendant to submit evidence in support of his
motion when the facts on which he relies to defeat plaintiff’s claim
are admitted by the plaintiff in his complaint.” Therefore, when the
affirmative defense involves only an issue of law, such as whether the
statute of limitations has run, see Tidwell, 560 S.W.2d at 909; Dukes
v. Noe, 856 S.W.2d 403, 404 & n.1 (Tenn. Ct. App. 1993),
application of this standard is certainly appropriate.
Nevertheless, when the affirmative defense relates primarily
to an issue of fact, different concerns may often counsel against
deciding the merits of the affirmative defense in a motion to dismiss.
First, the liberal pleading requirements of Rule of Civil Procedure
8.01 require a plaintiff only to set forth “a short and plain statement
of the claim showing that the pleader is entitled to relief.” See White,
33 S.W.3d at 718. As one commentator has noted, the very purpose
of Rule 8.01 is defeated if a plaintiff must plead facts not strictly
related to the prima facie claim solely “to anticipate matters that may
be set up as affirmative defenses.” See Rhynette Northcross Hurd,
The Propriety of Permitting Affirmative Defenses to be Raised by
Motions to Dismiss, 20 Univ. Mem. L.Rev. 411, 415 (1990). Second,
and more importantly, a court resolving a factual dispute only upon
the complaint’s allegations may not fully consider whether other
evidence exists that defeats or mitigates the defense. Consequently,
an injustice may occur if a court dismisses a complaint on a factual
affirmative defense merely because no rebuttal of that defense
appears within the complaint’s allegations. Id.
Givens, 75 S.W.3d at 404.
It is of import that a motion to dismiss is not converted to a summary judgment motion. The
motion to dismiss for failure to state a claim is just that, while a summary judgment motion goes
beyond the “allegations of the complaint” to the “merits of the litigation.” Brick Church
Transmission v. Southern Pilot, 140 S.W.3d 324, 328 (Tenn. Ct. App. 2003). If converted, then the
nonmoving party is “entitled to submit affidavits in opposition to the Motion and to make further
discovery if such is necessary.” Id. at 329. The general attitude toward these motions was expressed
by Judge [now Justice] Koch when he observed that “[T]hese motions are not favored [citation
omitted] and are now rarely granted in light of the liberal pleading standards in the Tennessee Rules
of Civil Procedure.” Dobbs v. Guenther, 846 S.W.2d 270, 273 (Tenn. Ct. App. 1992).
The appellees have addressed the movement in the federal system away from the above Tenn.
R. Civ. P. 12.02(6) standards and for the adoption of a stricter standard applicable to the validity of
a complaint. See Bell Atlantic Corp. v. Twombly, ____ U.S. _____, 127 S.Ct. 1955 (2007). See,
10
generally, Blumstein, A Higher Standard, Twombly Requires More for Notice Pleading, 43 T.B.J.
12 (Aug. 2007). While there are valid arguments in favor of this standard, it has not been adopted
in Tennessee, and this Court is not in a position to adopt the stricter Twombly standard.
III. STATEMENT OF ISSUES
The appellant states the issues as follows:
1. Whether the trial court erred by adopting defendant’s view
of the factual allegations in the Complaint.
2. Whether the trial court erred by making extrajudicial
findings of fact.
3. Whether the trial court erred by taking judicial notice of
hearsay documents and treating them for the truth of the
matter asserted.
4. Whether the Complaint adequately alleges that defendants
breached their fiduciary duties in connection with the sale
of Renal Care to Fresenius.
5. Whether the trial court erred in applying the affirmative
defense of shareholder ratification at the pleading stage.
6. Whether the trial court erred in applying the alleged
exculpatory provision in Renal Care’s Certificate of
Incorporation to bar plaintiff’s well-pleaded allegations of
breaches of fiduciary duties of loyalty and good faith, by
defendants.
The appellee, of course, proponents of good advocacy, reverse the issues by stating them
in the affirmative, but they do not differ from the above.
1. Did the trial court apply the correct legal standards in
rejecting certain inferences and unsupported legal
conclusions advanced by Plaintiff and by considering only
well-pled allegations and certain publicly-available
materials in dismissing the Amended Complaint?
2. Did the trial court correctly hold that the Complaint failed
to state a claim for breach of the duty of loyalty where the
only alleged interests of a majority of directors approving
11
the transaction were that they were to receive essentially
duplicative indemnification rights from the acquirer, and
that they did not attempt to value derivative claims which
had not been asserted and did not even exist at the time of
the merger?
3. Did the trial court correctly hold that the Complaint failed
to state a claim for breach of the duty of care where the
Defendants obtained a record price for the shareholders, but
where they negotiated with a single strategic buyer, agreed
to certain standard deal-protection devices, and relied on
the advice of two respected financial advisors who, as is
typical in such situations, had fully-disclosed interests in
seeing the transaction completed?
4. Did the trial court correctly hold that the Complaint failed
to allege any material misstatements or omissions in the
proxy that caused harm to shareholders and for which
damages are an appropriate remedy?
5. Did the trial court correctly hold that Plaintiff’s duty of
loyalty and care claims are barred by the doctrine of
shareholder ratification where Plaintiff failed to
demonstrate that the near-unanimous shareholder vote
approving the merger was anything less than fully-
informed?
6. Did the trial court correctly hold that Plaintiff’s duty of care
and disclosure claims are barred by the exculpatory
provision in Renal Care’s Certificate of Incorporation
where Plaintiff failed to adequately allege a breach of
loyalty or good faith?
IV. PROCEDURAL ISSUES BELOW
The appellant asserts that it was error for the Chancellor to rely on her personal
experience with proxy statements and that this reference somehow taints the validity of the
proceedings in the trial court. The Court agrees with the appellee that this is a nonissue. The
Court cannot read the Chancellor’s comments as the appellant suggests. Her remarks simply
related to the fact that she read the disclosures and had some personal experience in reading
proxy statements.
12
The motion to dismiss was never converted to a summary judgment (See Tenn. R. Civ. P.
12.02), and yet the Chancellor did consider materials beyond what was contained in the
complaint. This Court has already made reference to the general rule that matters outside the
pleadings should not be considered on a motion to dismiss for failure to state a claim. Trau-Med
71 S.W.3d at 696. See also International Merchant Services v. ATM Central, 2004 WL 170392
(Tenn. Ct. App. Jan. 27, 2004) (trial court reversed when it considered evidence outside the
complaint in granting motion to dismiss for failure to state a claim).
There are exceptions to the above rule, and the appellee contends that these exceptions
apply here. The exceptions are reflected as follows:
Numerous cases, as the note below reflects, have allowed
consideration of matters incorporated by reference or integral to the
claim, items subject to judicial notice, matters of public record,
orders, items appearing in the record of the case, and exhibits
attached to the complaint whose authenticity is unquestioned; these
items may be considered by the district judge without converting
the motion into one for summary judgment.
Wright and Miller, Federal Practice and Procedure, Civil § 1357, p. 376 (3d ed. 2004).
The above, as noted, is reflected in numerous court decisions and is well recognized. See, e.g.,
Wyser-Pratte Management Inc. v. Telxon Corp., 413 F.3d 553, 560 (6th Cir. 2005) (“In addition
to allegations in the complaint, the court may also consider other materials that are integral to the
complaint, are public records, or are otherwise appropriate for taking judicial notice”); Rothman
v. Gregor, 220 F.3d 81, 88-89 (2d Cir. 2000) (court may consider SEC disclosure documents
without converting motion to dismiss to summary judgment).
The appellant contends the proxy statement should not have been considered, and the
certificate of incorporation should not have been considered. Given the authorities cited above,
the Court disagrees and finds these materials properly considered. Tennessee law allows for
judicial notice (TRE 201) of public records. Cohen, Shepard, and Paine, Tennessee Law of
Evidence § 2.01[4][c] (5th ed. 2005). Obviously the proxy statement is to only be considered for
what it says, not for the truth of the information in the statement.
The appellant, however, is correct in its assertion that the trial court should not have
considered newspaper articles and press releases. The trial court’s order states that she relied on
these materials, and it was these materials that brought before the trial court information such as:
the shareholders voted “overwhelmingly” for the merger; the price was competitive in
comparison to a recent merger; the sales price was a 39.5% premium over the average market
closing over the prior year; and the sales price was extremely attractive. None of the facts cited
above, many of which were central to the dismissal, can be found in the complaint.4 These self-
4
They are contained in defendant’s exhibits in support of its motion, numbers 5-13,
13
generated press releases and other news articles are not subject to judicial notice under Tenn. R.
Evid. 201, nor are they otherwise admissible for the truth of the matter asserted. Tenn. R. Evid.
802. They should not have been considered. The error allowing consideration of these materials
was of some import in the erroneous granting of the motion to dismiss.
V. DECISION
The appellees are correct in asserting that the legal probabilities favor them, but legal
probabilities unattached to facts do not equate to the granting of a motion to dismiss.
Take for instance the allegation related to the use of deal protection measures. Deal
protection measures are often found to be proper when a board of directors uses them to insure
that they elicit the highest offer from the bidder confident that its efforts will not be thwarted by a
marginally more attractive bid. Omnicare, Inc. v. NCS Healthcare Inc., 818 A.2d 914 (Del.
2003)5. However, Delaware law does not bestow unbridled discretion to consent to deal
protection measures in derogation of the fiduciary duty toward the shareholder. Omnicare, Inc.
makes clear that if judging the reasonableness of deal protecting measures, the court must engage
in a fact intensive inquiry and consider the factors considered by the Board. Omnicare, Inc., 818
A.2d at 930-934. Here no such factual inquiry was made.
The appellees also assert that the contention regarding the back-dated stock options
and/or the investigation for Medicare fraud were not yet mature, and, as such, were so contingent
as to not be an issue in the transaction. Here again, however, the Court is confronted only by
facts alleged in the complaint.
There are occasions when potential derivative claims must be valued and therefore
disclosed in the merger process. “Delaware law imposes upon a board of directors the fiduciary
duty to disclose fully and fairly all material facts within its control that would have significant
impact on a stockholder vote.” Stroud v. Grace, 606 A.2d 75, 85 (Del. 1992). A fact is material
if there is a substantial likelihood that a reasonable stockholder would consider it important in
deciding how to vote. Rosenblatt v. Getty Oil, 493 A.2d 929, 944 (Del. 1985).
Allegations of Medicare fraud speak for themselves. (See infra page 4, ¶ 2) The
backdating of stock options has been described as follows:
[T]his practice involves a company issuing stock options to
an executive on one date while providing fraudulent
5
The parties agree that Delaware substantive law applies. Furthermore, this Court has
cited to several Delaware Chancery Court decisions. The Delaware Chancery Court is
recognized as the “preeminent business court in the nation” and “is the primary forum for
corporate governance litigation in the United States.” Balotti and DiComillo, Corporate and
Commercial Practice in the Delaware Court of Chancery 54 Bus. Law 757 (Feb. 1999).
14
documentation asserting that the options were actually issued
earlier. These options may provide a windfall for executives
because the falsely dated stock option grants often coincide with
the market lows. Such timing reduces the strike prices and inflates
the value of stock options, thereby increasing management
compensation. This practice allegedly violates any stock option
plan that requires strike prices to be no less than the fair market
value on the date on which the option is granted by the board.
Further, this practice runs afoul of many state and federal common
and statutory laws that prohibit dissemination of false and
misleading information.
Ryan v. Gifford, 918 A.2d 341, 345 (Del. Ch. 2007). The consequences:
A director who approves the backdating of options faces at the very
least a substantial likelihood of liability, if only because it is
difficult to conceive of a context in which a director may
simultaneously lie to his shareholders (regarding his violations of a
shareholder-approved plan, no less) and yet satisfy his duty of
loyalty. Backdating options qualifies as one of those “rare cases [in
which] a transaction may be so egregious on its face that board
approval cannot meet the test of business judgment, and a
substantial likelihood of director liability therefore exists.”
Plaintiff alleges that three members of a board approved backdated
options, and another board member accepted them. These are
sufficient allegations to raise a reason to doubt the
disinterestedness of the current board and to suggest that they are
incapable of impartially considering demand.
* * * *
To make matters worse, the directors allegedly failed to disclose
this conduct to their shareholders, instead making false
representations regarding the option dates in many of their public
disclosures.
I am unable to fathom a situation where the deliberate violation of
a shareholder approved stock option plan and false disclosures,
obviously intended to mislead shareholders into thinking that the
directors complied honestly with the shareholder-approved option
plan, is anything but an act of bad faith. It certainly cannot be said
to amount to faithful and devoted conduct of a loyal fiduciary.
15
Ryan, 918 A.2d at 355-356, 358.6
The complaint alleges facts (see, infra, pages 4-5, ¶ 3-5) which assert the backdating issue
and its potential impact. This in turn precludes the possibility of finding that disclosure was not
“material” based on the facts alleged in the complaint.
The discussion above may admittedly be putting the cart before the horse. What the
complaint asserts is that the directors sought merger for an improper purpose, and, therefore, they
breached their fiduciary duties of “loyalty,” “due care,” and “good faith,” and this in turn was to
the detriment of the shareholders.7 The issues already addressed were but two of the factual
allegations related to the mechanism of the sale.
The trial court simply swept away the entire lawsuit by determining that not only were
some of the affirmative claims factually unsupported but also that other assertions were barred by
defenses.
The trial court ruled that the case was barred by shareholder ratification. This defense,
however, is based on the vote of fully informed stockholders. Yiannatsis v. Stephanis, 653 A.2d
275, 280 (Del. 1995). Thus, the plaintiff’s case is caught by circular reasoning. If everything
was in the proxy statement, then the ratification should have trumped the lawsuit. However, if
there are factual issues regarding disclosure, then ratification cannot be sustained as a defense.
The Court is of the opinion that the allegations in the complaint regarding non-disclosure are still
appropriately unresolved at the motion to dismiss stage, so this defense must be rejected as a
ground for granting a motion to dismiss.
Although the appellees did not brief the issue before this Court, the trial judge held on the
issue of disclosure that “[T]he original complaint’s allegations were described in some detail in
the Proxy.” In fact, the 61-page Proxy contains this description on page 36:
The complaints allege that Renal Care Group and its
directors engaged in self-dealing and breached their fiduciary
duties to the Renal Care Group shareholders in connection with the
merger agreement because, among other things, Renal Care Group
used a flawed process, the existence of the previously disclosed
subpoena from the Department of Justice, the lack of independence
6
Potential criminal liability for backdating stock options is discussed at Ryan, 981 A.2d
at 356 n.38.
7
Scores of cases address the duty of board members in a merger and the obligation of the
courts to provide oversight. The lexicon seems to be referenced as “Revlon duties” from the
discussion of board obligations in seeking or considering a merger in Revlon v. MacAndrews &
Forbes, 506 A.2d 173 (Del. 1986).
16
of one of Renal Care Group’s financial advisors and the existence
of Renal Care Group’s supplemental executive retirement plan.
Renal Care Group believes that the allegations in the complaints
are without merit. Completion of the merger is subject to
customary conditions, including the absence of any order or
injunction prohibiting the closing. The complaints seek to enjoin
and prevent the parties from completing the merger.
This cannot be deemed to be a “detailed” narration of the allegations in the complaint, nor does it
preclude material disclosures as an issue.
Delaware law provides a shelter for corporate board members at Del. Corp. Code §
102(b)(7), which was adopted by Renal Care in its Certificate of Incorporation:
No person shall be personally liable to the Corporation or its
shareholders for monetary damages for breach of fiduciary duty as
a director; provided, however, that the foregoing shall not
eliminate or limit the liability of a director (I) for any breach of the
director’s duty of loyalty to the Corporation or its shareholders, (ii)
for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of the law, (iii) under Section
147 of Delaware General corporation Law, or (iv) for any
transaction from which the director derived an improper personal
benefit.
The allegations in the complaint, as filtered through Tennessee motion to dismiss case
law, cannot be barred at this stage by Del. Corp. Code § 102(b)(7). The complaint sufficiently
alleged bad faith and other conduct by the directors that would take them outside the protection
of the statute.
The trial court held that a majority of the Board voting on the merger had no conflicts of
individual interests and, therefore, the vote cannot be impeached by self interest. Orman v.
Cullman, 794 A.2d 5, 22 (Del. Ch. 2002) (board action is valid if majority is disinterested). The
complaint, however, alleges facts inconsistent with the resolution of this issue by the trial court at
the motion to dismiss stage. It is alleged that defendants, Brukhardt, Hutts, Lapham, McMurray,
Jacobson, Hinds, Hakim and Allison were all particularly exposed to backdating liability because
they either received backdated stock options or sat on compensation committees that granted
them.
Appellants contend that by engineering the merger which included indemnification, all
defendants were able to significantly minimize their exposure to liability in connection with the
alleged brewing problems at Renal Carre. As a result of the Acquisition, defendants secured
indemnification for prior misconduct “to the fullest extent permitted by law” “until expiration of
17
the applicable statute of limitations with respect to any such claims against [defendants] arising
out of such acts or omissions.” Because of the potential liability defendants faced, this
indemnification provision was a benefit procured by all defendants not disclosed to Renal Care’s
public shareholders.
The trial court concluded that the alleged indemnification benefit was not material
because it essentially extended existing agreements defendants had with Renal Care. This
conclusion is inconsistent with the observation in Louisiana Mun. Police Employee’s Ret. Sys. v.
Crawford. 918 A.2d 1172, 1180 n.8 (Del. Ch. 2007). First as a matter of Delaware law, Renal
Care could only indemnify defendants for “acts in good faith and in the best interests of the
corporation.” But Fresenius, as a third party indemnifying Renal Care directors, is not bound by
“the restrictions of statutory corporate law” and can extend indemnifications to defendants for
breaches of the duty of loyalty and good faith. In other words, the indemnification offered by
Fresenius covers defendants’ liability for option backdating, a breach of the duty of good faith,
whereas the indemnification offered to defendants by Renal Care could not. The Crawford court
describes this distinction as “quietly critical.” Thus, the plaintiffs contend, that only by securing
indemnification from Fresenius via the acquisition could defendants be assured of coverage for
their option backdating misconduct. Crawford, 918 A.2d at 1180 n.8.
Second, and of importance for directors who issued but did not receive backdated and/or
improperly timed options, the expanded indemnification offered by Fresenius for disloyal and
bad faith breaches of fiduciary duty protects against “considerable personal loss” where
defendants have received “no corresponding benefit” in the form of backdated and/or improperly
timed stock options. Put differently, any defendants who did not receive the benefit of backdated
and/or improperly timed options will have nothing to offset their liability: “[s]uch directors may
face considerable personal loss if found liable, making indemnification that much more
important to them.” Id.8
The appellees rely on In re Sea-Land Corp. Shareholders, 642 A.2d 792, 804-805 (Del.
1993), summary aff’d 633 A.2d 371 (Del. 1993), for the proposition that indemnification does
not taint the merger process. Sea-Land, however, involved indemnification which was only
equal to or not materially greater than what was already provided. 642 A.2d at 804-805.
Still another reason for the granting of the dismissal was the finding by the Chancellor
that “plaintiff has not demonstrated that any of the alleged breaches of fiduciary duty, even if
true, caused any qualified harm to the shareholders.” The use of the word “demonstrated” is
unfortunate, as it indicates an obligation on the pleader beyond the requirements of Tenn. R. Civ.
P. 8.01.
8
Appellees make light of this holding, as it was in a footnote. The Court observed that
most all the decisions written by the Delaware Chancellors make use of numerous and lengthy
footnotes, and it appears to be part of their culture of decision writing.
18
A plaintiff is not required “to prove damages at the pleading stage as an element of the
prima facie case for breach of fiduciary duty of disclosure.” In re Tri-Star Pictures, Inc., 634
A.2d 319, 334 (Del. 1993). Furthermore, plaintiff has alleged that the disclosure violations
negatively impacted the shareholders’ economic interests. The Court is of the opinion that the
detailed allegations, which include economic impact on the stockholders, are sufficient to survive
the motion to dismiss.
It is not this Court’s intent to write a tome on Delaware corporation law. Nor is it the
intent of this Court to address all the potential claims raised in the complaint and dismissed by
the trial court. The opinion in this case does, however, directly address the propriety of the
granting of the motion to dismiss on this record. The issues addressed above merely illustrate the
error of deciding to dismiss without the development of a full factual record. Here the trial court
strayed from the principle that it must take well-pleaded material factual allegations as true, and
the complaint must be liberally construed in the plaintiff’s favor.
Illustrative of the approach to be taken is the decision of the Vice Chancellor in Ryan v.
Lentil Chemical, 2008 WL 2923427 (Del. Ch. July 29, 2008), review granted by Delaware
Supreme Court, 2008 WL 4294938 (Del. September 15, 2008). Ryan involved a post merger
challenge by stockholders alleging they were negatively impacted by the merger. They
challenged the merger for conflicts on the board, failure to use reasonable efforts to obtain the
highest price, use of deal protective measures, and failure to disclose all material facts. The
defendants moved for summary judgment.
The Vice Chancellor first observed that the pay out of $48 per share appeared
“very attractive,” but there were issues beneath the surface and when one “scratches the patina”
of the merger “a troubling board process emerges.” Ryan, 2008 WL 2923427, at *1. That
troubling board process ultimately led the Vice Chancellor to conclude that the case should go
forward on the “Revlon” claims, and the “deal protection” claims. The case is instructive on a
number of substantive issues related to the causes of action in this case, but this Court rather
focuses on the process as related to the dismissal of the claims below.
Whatever the ultimate outcome in Ryan, that court could only evaluate the substantive
merits of the pled claims when it “scratch[ed] the patina” of the merger. A motion to dismiss
does not scratch below the surface, and this Court is of the opinion that the allegations in the
complaint were of sufficient specificity to allow the case to further proceed.
This case is reversed and remanded to the trial court for further proceedings as she may
direct consistent with the Tennessee Rules of Civil Procedure. It may well be that many (if not
all) of the issues may be capable of resolution on summary judgment. This opinion should in no
way be interpreted as validating the appellant’s claims. This opinion merely holds that the
granting of a motion to dismiss was in error given the allegations in the complaint.
19
CONCLUSION
For the reasons set forth above, the decision of the Chancery Court is reversed, and this
case is remanded for further proceedings consistent with this opinion. Costs are taxed to the
appellees.
____________________________
Walter C. Kurtz, Senior Judge
20