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In re First Solar Derivative Litigation

United States District Court, D. Arizona

June 30, 2016

In re First Solar Derivative Litigation

          ORDER

          David G. Campbell United States District Judge.

         Nominal Defendant First Solar, Inc. has filed a motion to dismiss this derivative action for failure to make a pre-suit litigation demand. Doc. 70. First Solar has also filed a motion for judicial notice. Doc. 72. The motions are fully briefed (Docs. 75, 76, 77, 78), and the Court heard oral argument on June 21, 2016. For the reasons set forth below, the Court will grant the motion to dismiss.

         I. Background.[1]

         First Solar is one of the world's largest producers of photovoltaic solar panels. Its stock is publicly traded on the NASDAQ Global Market. After going public in 2006, the company experienced explosive growth. Between 2008 and the beginning of 2012, however, the value of the company's stock fell from nearly $300 per share to less than $50 per share. This dramatic decline was due in part to the discovery of two serious manufacturing defects which caused the company to incur nearly $254 million in warranty and related charges. Doc. 67, ¶ 6.

         The first of these defects - the Low Power Modules or LPM defect - caused certain panels to experience power loss within months of installation that was greater than warranted by the company. First Solar learned of this issue in March 2009 upon receiving a complaint from one of its German customers. A task force organized to investigate the issue determined that the defect was caused by a manufacturing process implemented in June 2008. The company discontinued the process and agreed to remediate affected panels. The company did not publicly disclose the LPM defect or the associated remediation costs until July 2010.

         The second defect - the hot climate defect - caused certain panels to experience premature degradation in hot climates. The board of directors learned of this issue in April 2011 when the Vice President of Technology, David Eaglesham, gave a report showing that the panels were degrading at a rate of 11% in hot climates. The company did not disclose the defect or its financial impact until February 2012. The company ultimately spent $37.8 million to resolve this issue.

         On March 15, 2012, a group of shareholders who purchased First Solar stock between April 2008 and February 2012 brought a class action against the company and several of its officers, asserting that the company's failure to disclose the LPM and hot climate defects constituted securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 and Securities Exchange Commission ("SEC") Rule 10b-5. See Smilovits v. First Solar Inc., No. 12-CV-00555-PHX-DGC. Less than one month later, Plaintiffs filed this derivative action without making a litigation demand on the First Solar Board of Directors. Doc. 1. The Court stayed this action pending resolution of the securities fraud case. Doc. 45.

         On August 11, 2015, the Court entered an order in the securities fraud litigation granting in part and denying in part First Solar's motion for summary judgment. Smilovits, 119 F.Supp. 3d 978. The Court held that the plaintiffs had presented a triable issue as to whether defendants made material misrepresentations of fact with scienter. Id. at 1009. The Court explained:

Plaintiffs have . . . presented sufficient evidence for a reasonable jury to conclude that Defendants (1) had a duty to disclose the LPM defect to investors and failed to do so in order to mislead investors, (2) concealed the scope of the LPM defect with the intent to mislead investors, (3) had a duty to disclose the hot climate degradation to investors and failed to do so in order to mislead investors, and (4) engaged in accounting fraud with respect to both defects with intent to mislead investors.

Id. On the question of whether plaintiffs in the securities fraud case could establish loss causation, the Court found two irreconcilable lines of cases in the Ninth Circuit. Because the Court found that the plaintiffs could establish loss causation under one line of cases but not the other, the Court certified the question for immediate interlocutory appeal. Id. at 1000. The Ninth Circuit accepted the appeal, and it is now pending.

         Due to this unexpected delay in concluding the securities fraud litigation, the Court lifted the stay in this case so that Plaintiffs could amend their complaint and Defendants could file a motion to dismiss. Doc. 65. Plaintiffs filed their second amended complaint on March 11, 2016. Doc. 67. The complaint asserts claims for breach of fiduciary duty, insider trading and misappropriation of information, and unjust enrichment. ¶¶ 316-31.

         The fiduciary duty claim is brought against eight individuals who were directors between April 30, 2008 and February 29, 2012 - Michael Ahearn, Craig Kennedy, James Nolan, William Post, J. Thomas Presby, Paul Stebbins, Michael Sweeney, and Jose Villarreal. Ahearn was First Solar's CEO during part of the relevant period and is a defendant in the securities fraud litigation. The other seven directors, who will be referred to in this order as "outside directors, " are not employees of First Solar and have not been sued in the securities fraud case. The fiduciary duty claim is also brought against five individuals who were officers during the same period - Robert J. Gillette, Mark R. Widmar, James Zhu, Bruce Sohn, and David Eaglesham, all of whom are defendants in the securities fraud litigation. ¶¶ 316-21. Plaintiffs allege that these 13 Defendants breached their fiduciary duties by "knowingly, recklessly, or negligently sign[ing] or approv[ing] the issuance of false annual and quarterly financial statements that misrepresented and failed to disclose the full impact of the [LPM defect] on the Company's earnings and the premature degradation of modules in hot climates." ¶ 320. In other words, the fiduciary duty claim is premised on the same wrong alleged in the securities fraud case - failure to disclose the LPM defect and hot climate problem in First Solar's financial reports. In their opposition to the motion to dismiss, Plaintiffs characterize this as a breach of Defendants' fiduciary duty of candor. Doc. 75 at 10.

         The insider trading claim is brought against Directors Ahearn, Nolan, Sweeney, and Presby, and Officers Meyerhoff, Sohn, and Eaglesham. Doc. 67 ¶¶ 322-26. Plaintiffs allege that these Defendants sold First Solar common stock on the basis of proprietary, non-public information concerning the manufacturing defects and their likely effect on the company's financial condition. Id. The unjust enrichment claim names the same defendants and alleges that they "were unjustly enriched as a result of the insider trading profits they received while breaching their fiduciary duties owed to First Solar." ¶ 329.

         II. Legal Standard.

         A. Rule 23.1.

         Plaintiff shareholders purport to bring this action on behalf of First Solar. Usually, the decision to initiate litigation on behalf of a corporation is entrusted to the board of directors. See Rosenbloom v. Pyott, 765 F.3d 1137, 1147-48 (9th Cir. 2014) (citing Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95 (1991)). But in cases where the board cannot be trusted to represent the corporation's interests faithfully, individual shareholders may bring derivative claims on the corporation's behalf. Fed.R.Civ.P. 23.1(a); see Rosenbloom, 765 F.3d at 1147-48.

         Because the board is presumptively entitled to make the decision to bring suit, shareholders seeking to bring such an action must plead with particularity whether they demanded that the directors bring the action, and, if not, why it would have been futile to make such a demand. Fed.R.Civ.P. 23.1(b)(3). This requirement allows the court to determine, at the outset of the litigation, whether the board is capable of representing the interests of the corporation faithfully, or whether a majority of the directors has a conflict of interest that justifies the plaintiff shareholders' bypassing of the board. See Kamen, 500 U.S. at 102. In determining whether plaintiffs have satisfied Rule 23.1's pleading requirement, courts accept the allegations of the complaint as true, draw all reasonable inferences in the plaintiffs' favor, and consider the allegations in combination. See Rosenbloom, 765 F.3d at 1155-56; In re Pfizer Inc. S'holder Derivative Litig., 722 F.Supp.2d 453, 458 (S.D.N.Y. 2010).

         B. Delaware Law of Demand Futility.

         "Although Rule 23.1 supplies the pleading standard for assessing allegations of demand futility, the substantive law which determines whether demand is, in fact, futile is provided by the state of incorporation of the entity on whose behalf the plaintiff is seeking relief." Rosenbloom, 765 F.3d at 1148 (citation and internal quotation marks omitted). Because First Solar is a Delaware corporation, Delaware substantive law applies.

         Delaware courts have articulated two standards for evaluating demand futility. The Aronson test applies to derivative claims that challenge a specific board decision - "where it is alleged that the directors made a conscious business decision in breach of their fiduciary duties." Wood v. Baum, 953 A.2d 136, 140 (Del. 2008). To establish demand futility under Aronson, the plaintiff must show either (1) a reason to doubt that the directors are disinterested and independent, or (2) a reason to doubt that the challenged transaction was the product of a valid exercise of business judgment. Id. (citing Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984)). The Rales test applies when a specific business decision is not challenged, but where plaintiffs allege a violation of the board's oversight duties. Id. To establish demand futility under Rales, the plaintiff must show a reason to doubt that the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand. Id. (citing Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993)).

         The line between Aronson and Rales blurs when a derivative claim alleges wrongdoing by a majority of the board but does not challenge a specific board decision. See Rosenbloom, 765 F.3d at 1150 (collecting cases). For such hybrid claims, courts excuse demand if "Plaintiffs' particularized allegations create a reasonable doubt as to whether a majority of the board . . . faces a substantial likelihood of personal liability." Id.; see also In re Citigroup Inc. S'holder Derivative Litig., 964 A.2d 106, 121 (Del. Ch. 2009) ("Demand is not excused solely because the directors would be deciding to sue themselves. . . . Rather, demand will be excused based on a possibility of personal director liability only in the rare case when . . . ‘a substantial likelihood of director liability . . . exists.'") (quoting Aronson, 473 A.2d at 815); In re Pfizer, 722 F.Supp.2d at 460 (Rales and Aronson tests both met "by the Complaint's particularized allegations that a majority of the directors face a substantial threat of personal liability arising from their alleged breach of their non-exculpated fiduciary duties"). It is "a rare case where the circumstances are so egregious that there is a substantial likelihood of liability." In re Baxter Int'l, Inc. Shareholders Litig., 654 A.2d 1268, 1271 (Del. Ch. 1995) (citing Aronson, 473 A.2d at 815).

         Delaware law recognizes a presumption that directors act "on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Citigroup, 964 A.2d at 124 (citing Aronson, 473 A.2d at 812). "The burden is on plaintiffs, the party challenging the directors' decision, to rebut this presumption." Id. "Additionally, directors of Delaware corporations are fully protected in relying in good faith on the reports of officers and experts." Id. at 133 (citing 8 Del. Code § 141(e)).

         "Where directors are contractually or otherwise exculpated from liability for certain conduct, then a serious threat of liability may only be found to exist if the plaintiff pleads a non-exculpated claim based on particularized facts." Wood, 953 A.2d at 141. First Solar's Certificate of Incorporation provides that the Company's directors shall be exculpated to the maximum extent permitted by Delaware law. Doc. 71-3 at 6.[2] Delaware law recognizes the validity of "[a] provision eliminating or limiting the personal liability of a director to the corporation . . . for monetary damages for breach of fiduciary duty as a director, provided that such provision 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 stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; . . . or (iv) for any transaction from which the director derived an improper personal benefit." Del. Code § 102(b)(7). Thus, in a nondisclosure case such as this one, "plaintiffs must plead particularized factual allegations that support the inference that the disclosure violation was made in bad faith, knowingly or intentionally." Citigroup, 964 A.2d at 132 (quotation marks and citation omitted).[3]

         III. Against Which Board is Demand Futility Tested?

         The board of directors sitting when Plaintiffs filed their most recent amendment in March 2016 consists of 11 individuals, four of whom were not on the board when Plaintiffs filed their original complaint in April 2012. In addition, one individual (Defendant Villarreal) has left the board since April 2012. Compare Doc. 71-1 at 13 with Doc. 71-2 at 15.[4] Thus, as a preliminary matter, the Court must determine whether demand futility is tested against the April 2012 board or the March 2016 board.

         The parties agree that Braddock v. Zimmerman, 906 A.2d 776 (Del. 2006), provides the framework for deciding this issue. In Braddock, the Delaware Supreme Court explained that "when an amended derivative complaint is filed, the existence of a new independent board of directors is relevant to a Rule 23.1 demand inquiry only as to derivative claims in the amended complaint that are not already validly in litigation." Id. at 786. A claim is "validly in litigation" if (1) "the original complaint was well pleaded as a derivative action, " (2) "the original complaint satisfied the legal test for demand excusal, " and (3) "the act or transaction complained of in the amendment is essentially the same as the act or transaction challenged in the original complaint." Id. A claim is not validly in litigation unless it "can or has survived a motion to dismiss." Id. at 779.

         Defendants argue that none of Plaintiffs' claims were validly in litigation prior to the filing of the second amended complaint in March 2016 because neither the original complaint nor the first amended complaint adequately pleaded demand futility. Doc. 70 at 14. Perhaps because they view the choice of board as largely "a moot point, " Plaintiffs offer only a half-hearted response. Doc. 75 at 23.

         First, Plaintiffs argue that they are excused from establishing demand futility against the current board because the original complaint was not dismissed. But that fact does not mean that the original complaint "satisfied the legal test for demand excusal." Braddock, 906 A.2d at 778. "[T]he filing of an amended complaint may trigger a new requirement to make demand if the earlier complaint could not have survived a motion to dismiss, even if it had not actually been dismissed." In re NYFIX, Inc., 567 F.Supp.2d 306, 311 (D. Conn. 2008) (citing Braddock, 906 A.2d at 778).

         Second, Plaintiffs argue that the original complaint adequately pleaded demand futility. Doc. 75 at 24. But it is their burden to show as much, In re Affiliated Computer Servs., Inc. S'holders Litig., No. CIV.A. 2821-VCL, 2009 WL 296078, at *8 (Del. Ch. Feb. 6, 2009), and they have not carried it. Plaintiffs fail to cite even a single allegation from the original complaint that they believe satisfies Rule 23.1(b). See Doc. 75 at 24. Because Plaintiffs have failed to show that their claims were validly in litigation before March 2016, demand futility must be tested against the current board.

         As already noted, the current board includes four individuals who joined after the events at issue in this case. These individuals are considered disinterested as a matter of law. See Sandys v. Pincus, No. CV 9512-CB, 2016 WL 769999, at *15 (Del. Ch. Feb. 29, 2016) ("Siminoff and Doerr are disinterested because they joined the board after the alleged Caremark violations occurred."). As a result, Plaintiffs must show that demand is excused as to six of the seven remaining directors.[5] Because each of these remaining directors was on the board when the alleged wrongdoing occurred, and continue on the board today, the Court will refer to them in this order as the "continuing directors."

         In their briefs, Plaintiffs acknowledged that they cannot establish demand futility against the current board for the insider trading claim because it concerns only four of the 11 directors. Doc. 75 at 24. At oral argument, Plaintiffs argued that more than four directors are affected by this claim because proof of the insider trading claim would necessarily establish that the entire board had material, non-public information - which would support a non-disclosure claim against the rest of the continuing directors. Plaintiffs cite no case where non-defendant directors were deemed unable to make an impartial board decision based on evidence that might be presented against defendant directors if a lawsuit were authorized. Nor have Plaintiffs shown that the evidence that might be presented in an insider trading claim would create a substantial likelihood of personal liability for the non-defendant directors. The Court cannot conclude that Plaintiffs' novel theory, explained for the first time during oral argument and not supported by specific evidence or legal authority, rebuts the presumption that the non-defendant directors would act in the company's best interests in responding to the insider trading claim. See Citigroup, 964 A.2d at 124 (recognizing this presumption).

         Because Plaintiffs have not shown that more than four directors face a substantial likelihood of personal liability on the insider trading claim, the Court will dismiss the claim. The unjust enrichment claim derives from the insider trading claim and must also be dismissed. See Staehr v. Mack, No. 07 CIV. 10368 DAB, 2011 WL 1330856, at *10 (S.D.N.Y. Mar. 31, 2011) ("Demand futility for an unjust enrichment claim based on insider trading allegations will rise and fall with the insider trading claims.").

         IV. Is Demand Excused as to Plaintiffs' Fiduciary Duty Claim?

         Plaintiffs contend that demand is excused against the continuing directors, which constitute a majority of the current board, with respect to their fiduciary duty claim. Plaintiffs allege that these Defendants breached their fiduciary duties by ...


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