In re Duke Energy Corp. Derivative Litigation

Citation: Not availableDocket: CA 7705-VCG

Court: Court of Chancery of Delaware; August 31, 2016; Delaware; State Appellate Court

Original Court Document: View Document

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Duke Energy Corporation and Progress Energy, Inc. entered into a merger agreement in 2011, resulting in the formation of a new entity, New Duke, with a board consisting of 11 directors from Old Duke and 6 from Progress. Critical provisions included William Johnson, Progress's CEO, being appointed as CEO of New Duke, while Old Duke's CEO, James Rogers, was designated as executive chairman. This arrangement was disclosed to shareholders and necessary for regulatory approval from the North Carolina Utilities Commission (NCUC) and the Federal Energy Regulatory Commission (FERC).

The merger faced an 18-month delay due to regulatory approvals, during which Old Duke's directors expressed concerns over Johnson's fitness for the CEO role. The directors faced a dilemma: breach the merger agreement or comply while planning to dismiss Johnson post-merger. Ultimately, they chose to appear compliant, signing Johnson to a CEO agreement with a severance package shortly before the merger's deadline. Upon receiving FERC approval, Old Duke sought expedited NCUC approval, misrepresenting their intentions regarding Johnson's position. The merger closed on July 2, 2012, and the New Duke board appointed Johnson as CEO, following the agreement.

Director Ann Gray requested an executive session with the board where she expressed her belief that CEO Johnson was "not a good fit" and should be fired. Despite the legacy Progress directors being "shocked" and attempting to dissuade the decision, the board voted to discharge Johnson and replace him with Old Duke CEO Rogers, with the vote split along legacy lines. Following the decision, Gray informed Johnson of his unexpected termination. The complaint alleges that the firing led to significant negative consequences, including Johnson's entitlement to a severance package despite his brief tenure and actions taken by the NCUC, believing they were misled about the CEO appointment, resulting in damages. 

Lawsuits by Old Duke stockholders ensued, particularly Krieger v. Johnson, which involved claims of breach of duty and waste against the Director Defendants. The Krieger court dismissed the action, ruling that demand on the board was not excused under Delaware law, thereby collaterally estopping the current plaintiffs from pursuing claims related to the breach of fiduciary duty concerning Johnson's firing. However, the plaintiffs' primary claim—that the Old Duke board had decided to appoint Rogers prior to the merger and failed to inform the public and NCUC—was not addressed in Krieger. This claim was deemed to present sufficient facts suggesting intentional bad faith, allowing it to withstand a motion to dismiss. The court highlighted that while the board has discretion in deciding its CEO, it must act in compliance with the law and its duty of loyalty, which the complaint alleges was violated.

The Complaint identifies key parties involved, including plaintiffs Lesley C. Rupp and Richard A. Bernstein, who are representative stockholders of Duke Energy Corporation and have continuously held shares relevant to the case. Duke Energy, incorporated in Delaware and headquartered in North Carolina, is a major utility company trading on the NYSE under the symbol "DUK." It operates in the generation, transmission, distribution, and sale of electrical power, primarily serving commercial and residential customers in its regulated areas. Prior to a merger, Old Duke served over four million customers across several states and reported significant revenues and net income in 2011. Progress, another large utility company, merged with Duke and is now a wholly owned subsidiary, making Duke the largest utility company in the U.S. by revenue and power-generation capacity.

The Complaint also lists the Director Defendants—James E. Rogers, William Barnet, III, G. Alex Bernhardt, Sr., Michael G. Browning, Daniel R. DiMicco, John H. Forsgren, Ann Maynard Gray, James H. Hance, Jr., E. James Reinsch, James T. Rhodes, and Philip R. Sharp—who have each served as directors of Duke at all relevant times. Rogers, who has been with Duke since its merger with Cinergy in 2006, has served as both CEO and Chairman. Other directors hold significant positions in various companies and have extensive experience in related industries. The document indicates that these directors were in their positions throughout the time pertinent to the allegations in the Complaint. The author requests clarification from the parties on which causes of action and requests for relief are still relevant following their findings and whether further examination under specific legal rules is necessary.

William D. Johnson was President of Progress from 2005 and became Chairman and CEO in 2007. He held these roles briefly on July 2, 2012, following a merger that appointed him CEO and a Duke board member. John H. Mullin III served on the Progress board from 1999 to July 2, 2012, as lead director. Other legacy directors included John D. Baker II and Theresa M. Stone, both of whom joined the New Duke board post-merger but resigned in protest on July 27, 2012. The New Duke board comprised 15 members, including 11 Director Defendants and four legacy directors who did not resign.

The merger discussions began in June 2010 when the Old Duke board authorized management to explore a merger with Progress. On July 18, 2010, Old Duke CEO Rogers and Progress CEO Johnson discussed the merger, with Rogers indicating openness to Johnson becoming CEO post-merger. Mullin authorized Johnson to approach the Old Duke board. Progress ceased negotiations with a third party on July 19, 2010, and both companies signed a non-disclosure agreement on July 29, 2010. Subsequent meetings and exchanges of financial information occurred through December 2010, culminating in discussions about management structure and board composition.

The merger agreement was unanimously approved by both boards on January 8, 2011, and announced on January 10, 2011. Each share of Progress stock was to convert into 2.615 shares of Duke common stock, subject to a reverse stock split. The merger required approval from stockholders and regulatory bodies, including FERC, NCUC, and SCPSC.

Johnson was appointed as CEO of the New Duke following a merger with Progress, with Rogers as Executive Chairman and headquarters in Charlotte, North Carolina, while maintaining a presence in Raleigh. The merger agreement stipulated that no regulatory approvals could impose conditions that would materially harm either party's benefits from the merger. A walk-away date was set for January 8, 2012, with a potential six-month extension and a termination fee included.

Post-agreement, an Integration Team was formed, led by Johnson and Rogers, with significant contributions from Paula Sims. The companies applied for merger approval from the North Carolina Utilities Commission (NCUC) on April 4, 2011, supported by testimony from Johnson and Rogers, who confirmed Johnson's role as CEO during NCUC hearings. The NCUC hearings concluded on September 22, 2011, pending Federal Energy Regulatory Commission (FERC) approval.

Stockholders approved the merger on August 23, 2011, and FERC conditionally approved it on September 30, 2011, requiring a mitigation plan to address market power concerns. The first mitigation plan was submitted on October 17, 2011, but was rejected by FERC on December 14, 2011, although the companies were allowed to submit a new plan. Subsequently, the Defendants reportedly lost interest in the merger and sought to exit without incurring a termination fee, prompting Progress to consider litigation.

Johnson continued to pursue regulatory approvals as the walk-away date approached. The companies filed a second mitigation plan on March 26, 2012, and sought to expedite the merger process with the NCUC, indicating a desired closing date of July 1, 2012. FERC approved the second mitigation plan on June 8, 2012, leading to the NCUC Public Staff's non-opposition to the company's compliance strategy. However, NC-WARN opposed the final NCUC approval and sought the chance to cross-examine witnesses.

On June 25, 2012, the companies informed the North Carolina Utilities Commission (NCUC) that approval was urgent due to an impending deadline, prompting the NCUC to reopen hearings. Duke claimed no changes warranted this reopening. The NCUC allowed NC-WARN to voice objections before issuing a final order approving the merger on June 29, 2012. The South Carolina Public Service Commission (SCPSC), pending NCUC’s decision, approved the merger shortly after on July 2, 2012, with the merger officially closing at 4:02 PM that day. 

Post-merger, it was established that Johnson, CEO of Progress, would lead the new entity, New Duke, while Rogers, CEO of Old Duke, would serve as Executive Chairman. This leadership structure aligned with the companies' strategy to focus on regulated utility services rather than energy trading, a strength of Progress. Plaintiffs argue that the Director Defendants recognized Johnson’s role as a critical aspect of the Merger Agreement.

During the merger's closing, Rogers and Johnson were at Duke’s headquarters, where a telephonic board meeting commenced at 4:30 PM to elect Johnson as CEO and Rogers as Executive Chairman. Shortly after, Gray initiated a motion to replace Johnson with Rogers as CEO without prior notice or documentation. During discussions, legacy Progress directors expressed surprise and attempted to dispute the motion, with Gray citing Johnson’s "style" as the reason for the change. Ultimately, a vote led to Johnson’s dismissal, with ten legacy Duke directors supporting the motion and five legacy Progress directors opposing it. Johnson was informed of his removal shortly thereafter and resigned effective July 3, 2012. The following morning, Duke publicly announced the merger's completion and Rogers’ reinstatement as CEO.

Duke Directors decided to terminate Johnson as CEO before the merger's closing, despite no prior concerns expressed by any of the Director Defendants about his management. Plaintiffs allege that the Defendants planned this termination starting in May 2012, without consulting the legacy Progress directors, and knew they had assured regulators, including the NCUC, that Johnson would remain as CEO. By failing to inform these regulators of the CEO change, which was deemed material in the merger agreement, the Defendants allegedly misled them. Evidence for the Plaintiffs' claims includes actions taken between May 3 and May 30, 2012, where discussions about Johnson's removal took place among the Defendants, and Gray coordinated efforts for a CEO transition while withholding information from the Progress board. 

Following the CEO change, three senior Progress executives resigned, and S&P placed Duke’s debt on "watch for a possible downgrade," subsequently lowering its credit rating due to increased regulatory risks. The NCUC initiated an investigation, requiring testimony from key personnel, including Rogers, who acknowledged concerns about regulatory reactions to the CEO change. Gray provided further justification for Johnson's removal in her testimony beyond what was initially stated.

Johnson's removal was attributed to several factors, including his management of repairs and an insurance claim for the Crystal River 3 nuclear facility, where testimony revealed disputes about spending Progress funds versus timely repairs. Gray cited issues with the overall condition of Progress’s nuclear fleet and the company’s financial performance as additional reasons for Johnson's ouster. Plaintiffs assert these reasons are pretexts for the Defendants’ alleged wrongful actions. Following the merger's consummation, legacy directors Baker and Stone resigned in protest, with Stone characterizing the decision to remove Johnson as premeditated.

The Plaintiffs filed their initial complaint on July 17, 2012, and an amended complaint on July 30, alleging breaches of fiduciary duties by the Director Defendants. Count One claims these breaches occurred through conspiring against the merger agreement, concealing actions from regulatory bodies, and failing to address concerns about Johnson's leadership. Count Two focuses on disregarding input from legacy Progress directors and jeopardizing Duke’s reputation and compliance with merger agreements. The Plaintiffs argued that a pre-suit demand on the board would be futile due to the majority of board members being named as defendants.

Following the Defendants’ motion to dismiss, the Plaintiffs engaged in a leadership contest with other derivative suit plaintiffs, resulting in Bernstein being appointed as lead plaintiff. The case was stayed pending the resolution of a related federal securities suit, after which the stay was lifted, and the case was reassigned for further proceedings, including a hearing on the motion to dismiss.

Derivative suits related to the same facts were filed in multiple jurisdictions, including the Neiman Action, the consolidated Tansey v. Rogers action in the U.S. District Court for the Delaware District, and the Krieger Action in North Carolina state court. The Krieger Action, initiated by Duke stockholder Joel Krieger on July 20, 2012, in the North Carolina Business Court, alleged breaches of fiduciary duties by the ten Director Defendants, unjust enrichment by Johnson, and aiding and abetting breaches by Rogers. Krieger did not make a demand on the board, arguing that a majority of the directors were incapable of considering such a demand due to a substantial likelihood of personal liability for terminating Johnson and awarding him a $44 million severance package, which raised doubts about the validity of the business judgment exercised.

The Krieger defendants moved to dismiss, claiming a failure to make a demand and failure to state a claim. In April 2014, the court granted the defendants' motion, concluding that Krieger's failure to demand was not excused. The court applied Delaware law to scrutinize the demand futility arguments, specifically focusing on the potential liability of the directors due to the severance payment's amount and timing. The court determined that the allegations did not establish a substantial likelihood of liability and that the severance payments, which included a release of claims, cooperation in transition matters, and various covenants, did not amount to corporate waste. Ultimately, the court found that the value received in the severance was not so inadequate that no reasonable person in sound business judgment would consider it worth the payment made.

The court determined that the Plaintiff's allegations of waste in the context of the Krieger action do not sufficiently undermine the belief that the actions were taken honestly and in good faith. The Defendants seek to dismiss the Complaint under Court of Chancery Rules 23.1 and 12(b)(6), arguing that the Plaintiffs are collaterally estopped from relitigating the demand-futility issue, which was previously adjudicated against a plaintiff in the Krieger Action, who shares privity with the current Plaintiffs. The court addresses the collateral estoppel argument first, noting that the preclusive effect of a prior judgment is governed by the law of the forum where it was issued—in this case, North Carolina. Under North Carolina law, a prior judicial determination precludes relitigation of the same issue in a subsequent action if the party against whom estoppel is asserted had a full opportunity to litigate that issue earlier. The Plaintiffs, like the plaintiff in the Krieger Action, are pursuing derivative claims on behalf of Duke Corporation as common stockholders, thus sharing identical interests in any recovery. Although North Carolina courts have not explicitly ruled on privity among common stockholders in separate derivative claims, existing jurisprudence supports the idea that privity exists when parties share a legal interest. Consequently, the court finds privity between the Plaintiffs and the Krieger plaintiff, leading to the application of North Carolina's collateral estoppel analysis. For collateral estoppel to apply, the issues must be identical and must have been actually litigated in the prior action.

To establish collateral estoppel, four criteria must be met: (1) the issues must be identical, (2) they must have been actually litigated, (3) they must be material and relevant to the prior action's outcome, and (4) the prior determination must have been essential to the judgment. If any criteria are not met, collateral estoppel does not apply. In this case, the Defendants assert that the issue of demand futility related to allegations in the current complaint was litigated in the Krieger court, which concluded that demand was not excused—an outcome deemed material and essential to its judgment. 

The Krieger case involved claims of waste and breach of duty linked to an employment agreement with Johnson prior to a merger, which resulted in a significant severance payment. The complaint sought to address these claims derivatively, but under Delaware law, stockholders must first make a demand on the board of directors to pursue derivative actions. If demand is not made, as in both the Krieger and current cases, the action can be dismissed unless futility is demonstrated.

The Krieger court examined demand futility under the Aronson v. Lewis standard, identifying circumstances that could excuse demand based on doubts regarding director independence or proper business judgment. The plaintiff argued that the directors were likely to be liable for Johnson’s termination and the resulting severance payment. However, the court found insufficient grounds to conclude a substantial likelihood of director liability and determined that the allegations of waste did not undermine the presumption of good faith in the directors' decision-making. Consequently, the court dismissed the Krieger complaint under Rule 23.1.

The complaint seeks recovery for waste or breach of duty related to the Director Defendants' decision to enter a contract with Johnson, which would require Duke to pay millions in severance upon his termination. The court finds that the plaintiffs' argument to excuse demand under these claims is barred by the principle of collateral estoppel, based on the previous ruling in Krieger. All criteria for the North Carolina collateral-estoppel test are met, leading to the dismissal of these claims for lack of standing under Rule 23.1. The Krieger court also dismissed claims related to unmet aspirational employment goals stated in a Duke proxy.

However, the plaintiffs assert that prior to a merger, the Director Defendants had decided that Rogers, not Johnson, would be the CEO of New Duke, but failed to disclose this to the NCUC, thereby misleading it and resulting in damages once the facts were revealed. The plaintiffs argue that this concealment represents a violation of positive law, which indicates bad faith by the Director Defendants, thus excusing the demand requirement.

The court concludes that the plaintiffs are not collaterally estopped from pursuing this claim, as the issue of demand excusal based on a violation of positive law was not addressed in the Krieger case. The defendants argue that the issue of bad faith was raised in Krieger, but the court clarifies that it need not resolve this dispute since North Carolina law stipulates that issues are only precluded if essential to the previous judgment. The Krieger court did not rule on this specific ground, focusing instead on common-law duties related to Johnson's termination and subsequent losses for New Duke, which differ from the current claim concerning the violation of positive law.

Plaintiff’s Complaint alleges that the Director Defendants decided to terminate Johnson without informing the North Carolina Utilities Commission (NCUC) that prior representations were now false. They assert that this failure led to damages from Johnson's discharge and argue for judicial estoppel against the defendants regarding other issues considered in the earlier Krieger Action. However, the court determines that collateral estoppel does not apply to claims of violation of positive law and does not need to address the estoppel argument. The court notes that despite the claims being related to the same merger and Johnson's discharge, the legal issues are not identical to those in the Krieger Action. It emphasizes that the determination of demand excusal hinges on director bad faith rather than liability for waste or breach of duty. The court distinguishes this case from prior dismissals under Rule 23.1, where more compelling pleadings were presented. It concludes that North Carolina law does not apply collateral estoppel to these claims, as the causes of action, while arising from similar facts, are distinct from those previously adjudicated.

The Chancellor's decision in In re Wal-Mart Stores, Inc. highlights issues of collateral estoppel and demand futility under Arkansas law, which parallels North Carolina law. The case examined whether a demand on the board was futile concerning oversight of the "WalMex bribery" allegations against directors for their knowledge of a cover-up. While factual details differed between complaints, the fundamental issue—whether the Demand Board could decide on litigation initiation—remained consistent. 

In Asbestos Workers v. Bammann, a similar oversight claim against J.P. Morgan Chase's directors was precluded due to a prior New York ruling that dismissed a similar action for lack of demand futility. The court noted that the New York case involved assessing the likelihood of personal liability for directors regarding risk oversight, which mirrored the Delaware case despite differences in factual pleading. 

In contrast, the current case involves allegations of directors misleading regulators, raising distinct issues compared to those in prior cases. The judge emphasized that this should not allow plaintiffs to sidestep collateral estoppel by creatively framing new causes of action from the same factual scenario, as the interests of efficiency, finality, and comity necessitate a practical perspective. 

The demand requirement under Delaware law mandates that stockholders must either demand the board take action or demonstrate that the board cannot act in the corporation's interest to pursue a derivative suit. The plaintiffs claim that a demand on the New Duke board was futile, which the Company contests in its motion to dismiss.

To avoid dismissal under Rule 23.1, the Plaintiffs' Complaint must provide detailed reasons for not making a litigation demand, allowing the Court to evaluate if the board can exercise its business judgment regarding pursuing litigation. The Delaware Supreme Court has established two tests for assessing demand futility: the Aronson test, applicable when a derivative plaintiff challenges a prior board decision made by the same directors, and the Rales test, used when Aronson is not applicable. The parties agree that Aronson is the relevant test for this case; however, there are challenges in applying it. The Complaint alleges that the Director Defendants caused Duke to misrepresent that Johnson would continue as CEO, yet this decision is not asserted as wrongful. Instead, it is the failure to correct misleading disclosures and the knowledge of Johnson's removal that the Plaintiffs claim constitutes bad faith. Case law indicates that when Aronson cannot be applied, the Rales test is used for demand-excusal analysis. Rales is viewed as a general test, while Aronson applies to specific situations. The difficulty in categorizing the board's actions suggests that the two tests should not be seen as mutually exclusive. Demand is excused when the facts presented create reasonable doubt about the board's ability to impartially evaluate a demand to initiate litigation. The Rales test is employed here, although the result would be the same under the second prong of Aronson.

Under the business judgment rule, corporate directors can make decisions without judicial interference, provided they fulfill their fiduciary duties. Actions taken by disinterested directors are generally presumed to be in the corporation's best interest and made in good faith, unless this presumption is successfully challenged. However, directors cannot invoke this protection when authorizing litigation that scrutinizes their past actions, particularly if those actions were taken in bad faith. A derivative suit can be initiated by innocent shareholders against corporate fiduciaries who knowingly engaged in illegal acts that harmed the corporation.

In this case, the Plaintiffs argue that the Director Defendants lack business judgment protection regarding their representations to the North Carolina Utilities Commission (NCUC). The court finds that reasonable doubt exists about the applicability of the business judgment presumption, indicating that making a demand would be futile. It is uncommon for disinterested directors to lose this protection, but the allegations in this case suggest such a scenario.

The facts indicate that the Director Defendants facilitated a merger agreement between Old Duke and Progress, with the stipulation that Progress’s CEO, Johnson, would lead the new entity. They communicated this to the NCUC, which was essential for merger approval. However, during the regulatory approval period, the Director Defendants reconsidered Johnson's suitability for the CEO position, creating a conflict as they faced the potential collapse of a $13.7 billion merger. They sought legal counsel to evaluate their options, which included renegotiation or acceptance of Johnson as CEO, amidst the risks of losing merger benefits and incurring breakup fees.

The Complaint alleges that the Director Defendants decided to replace CEO Johnson with Rogers while concealing this decision from Progress and the public to minimize risks to the merger. They did not amend proxy statements or inform regulatory bodies about the change. Instead, they negotiated an employment agreement with Johnson, purportedly to hide the fact that he would not retain his position post-merger. After the merger was finalized, the New Duke board, controlled by the Director Defendants, appointed Johnson as CEO in compliance with the merger agreement. However, during an executive session, the legacy Progress directors were shocked to learn that the Director Defendants deemed Johnson unacceptable. Following discussion, the board voted to discharge Johnson, citing he was not a "good fit." Johnson was subsequently informed of his termination, which took effect immediately. The merger required approvals from the FERC and NCUC, with the latter deferring action until FERC's agreement. As the deadline approached, Duke requested expedited action from NCUC and represented that there had been no changes since the initial hearings, failing to disclose the CEO replacement decision. The NCUC approved the merger, which then closed. The excerpt also references North Carolina statute regarding the provision of false information to the Utilities Commission, classifying such actions as a Class 1 misdemeanor.

Every individual or entity under the Utilities Commission's jurisdiction that willfully withholds specified information or fails to file required reports with the Commission commits a Class 1 misdemeanor. Following the public knowledge of a leadership change post-merger, the North Carolina Utilities Commission (NCUC) initiated hearings due to allegations of misleading representations, which also prompted an investigation by the North Carolina Attorney General. Damages were reported in terms of reputation and finances. In Delaware, corporate directors are presumed to act in good faith, but knowingly causing a corporation to violate the law is a breach of this duty. The allegations suggest that Duke Energy may have violated the law, indicating potential bad faith by its directors.

Given the regulatory scrutiny over the merger, it was reasonable for the Director Defendants to anticipate that the NCUC would find the initial CEO's identity significant. The directors were aware that Duke had indicated Johnson as the CEO, despite having decided to terminate him prior to the merger, which contradicts their representations to the NCUC. The defendants contended that the allegations were merely conclusory and that they were seeking input from other directors before finalizing their decision. However, the manner in which they approached this decision—surprising other directors—raises concerns about their intentions. This is a motion to dismiss, and while the defendants may later justify their actions, the current pleadings sufficiently support the inference of pre-merger decision-making by the Director Defendants.

Members of the Old Duke board contacted Rogers to confirm his willingness to serve as CEO, while the legacy Progress directors were denied the chance to present supportive information for Johnson. The Director Defendants did not provide substantial reasoning for discharging Johnson, merely labeling him a “bad fit,” and unanimously voted for his removal. At this stage, it is inferred that the Director Defendants were aware of a false material representation made to the NCUC regarding the merger approval. If the Director Defendants caused Duke to violate Section 62-326, they could be held liable for corporate damages resulting from such actions, indicating a disloyalty to the corporation. Bad-faith acts undermine the presumption of proper business judgment, shifting the burden to the Director Defendants to justify their conduct. This raises concerns about their impartiality regarding any demands for liability, potentially excusing such demands under Rales. The court has partially granted and denied the Defendants' motion to dismiss for lack of standing, deferring a decision on the motion to dismiss for failure to state a claim pending further counsel discussions. An omnibus final order on these motions will be issued following further proceedings, with the Plaintiffs having presented sufficient facts to question the validity of the business judgment in the underlying transaction.