Indiana State District Council of Laborers and HOD Carriers Pension Fund v. Gary Brukardt

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.

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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