Corporate Counsel Daily, Court dismisses third amended complaint brought on behalf of Cabot Oil, (Jan 3, 2024)

By Kristin J. Angelino, J.D.

Plaintiff stockholders failed to establish demand futility as required by Rule 23.1 of the Federal Rules of Civil Procedure.

The federal district court in Houston dismissed, with prejudice, the third amended complaint brought by stockholders on behalf of Cabot Oil & Gas Corporation, for failure to plead with particularity facts showing that a pre-suit demand by stockholders on the Cabot board would have been futile, as required by Federal Rule of Civil Procedure 23.1 (In re Cabot Oil & Gas Corporation Derivative Litigation, January 2, 2024, Rosenthal, L.).

This case, a derivative litigation brought by stockholders on behalf of Cabot Oil, arose from Cabot Oil’s hydraulic fracturing in Susquehanna County, Pennsylvania. The plaintiff stockholders alleged that Cabot’s directors and officers breached their fiduciary duties by failing to exercise oversight and by causing Cabot to issue material misrepresentations about whether its fracking complied with applicable environmental laws and regulations. The court cited caselaw indicating that unless a board of directors permits a stockholder to proceed with litigation on behalf of a corporation, the stockholder can only proceed if the stockholder (1) demanded that the directors pursue the claim and they wrongfully refused; or (2) demand is excused because the directors are incapable of making an impartial decision regarding the litigation. Here, since the plaintiff stockholders did not make a pre-suit demand on Cabot’s board before filing this action, the motion to dismiss required the court to decide whether the plaintiffs pleaded with sufficient particularity facts showing that a pre-suit demand on the Board would have been futile, as required by FRCP 23.1.

Caremark claims. Relying on the law of Delaware, which is the state where Cabot is incorporated, the court stated that to successfully plead demand futility for failing to remediate environmental violations, a company’s stockholders must sufficiently allege a “Caremark claim,” that is, the stockholders must allege with particularity (1) facts that imply that Cabot’s board failed to provide a corporate reporting system to permit board-level review of compliance with the applicable law; or (2) that the board was provided with sufficient notice of corporate non-compliance with the law (a so-called “red flag”), and therefore its failure to remediate amounts to bad faith.

Plaintiffs argued that their complaint sufficiently alleged the second Caremark prong. The court ruled that the plaintiffs’ allegations did not adequately plead demand futility because the documents on which they relied did not show a serious failure of oversight sufficient to support an inference of bad faith. At most, the court held, the documents supported the conclusion that the defendants responded in a weak, inadequate or even grossly negligent manner to the regulatory actions of the Pennsylvania Department of Environmental Protection, which is not enough for Caremark liability. Further, the court held that, although the plaintiffs were correct that the documents on which they relied showed that defendants had some successes and some failure in remediation, the documents also showed that Cabot was working in good faith to remediate its defective wells and restore contaminated water supplies.

Disclosure claims. In addition to the Caremark claims, plaintiffs also alleged that certain directors made material misrepresentations or omissions in their public filings, referred to as the “disclosure claims.” The plaintiffs argued that they satisfied the demand futility standard for the disclosure claims because they alleged that half of Cabot’s board members issued public statements they knew were false. Specifically, plaintiffs argued that five of Cabot’s ten directors faced a substantial likelihood of liability from causing Cabot to make certain alleged misrepresentations in its public filings. The alleged misrepresentations (divided into three categories) concerned three of Cabot’s wells. Examining each category, the court concluded that plaintiffs either failed to sufficiently allege a claim against at least half the board, or the documents that plaintiffs relied on failed to preclude the inference that the directors knew the statements were false at the time they were made. Therefore, the court held that the plaintiffs failed to plead particularized allegations sufficient to show demand utility on the disclosure claims.

Contribution claims. Plaintiffs further alleged that three directors caused Cabot to issue alleged misstatements that are the subject of a coordinated securities class action suit against Cabot and sought contribution and indemnification from these defendants (the “contribution claims”). The court held that plaintiffs failed to establish demand utility on these claims because this inquiry is intertwined with plaintiffs’ disclosure claims.

Brophy claim. Plaintiffs also alleged a Brophy claim against one director by stating that he faced a substantial likelihood of liability for using material, non-public information to improperly profit from the sale of Cabot stock and therefore could not fairly consider a demand. The court disagreed, holding that plaintiffs failed to allege facts sufficient to support an inference that at least four other directors (which would constitute half of the board) could not fairly consider a demand, and therefore demand utility on this claim was not established.

Corporate waste and unjust enrichment. Finally, plaintiffs alleged that the defendants wasted corporate assets and were unjustly enriched by the board’s decision to repurchase corporate stock while the price was allegedly inflated and pay compensation to directors and officers who allegedly breached their fiduciary duties. The court disagreed, holding that the allegations did not state a claim for corporate waste since there was no allegation about how much the stock was worth at the time of the repurchases. The court also held that plaintiffs failed to state a claim for unjust enrichment, since such claim was premised on the same conduct.

The case is No. 4:21-cv-02046.

Attorneys: Jacob A. Goldberg (The Rosen Law Firm, P.A.) for Jody Ezell, Leon Fischer and Robert Isaacs. Peter Andrew Stokes (Norton Rose Fulbright LLP) for Dan O. Dinges, Scott C. Schroeder and Dorothy M. Ables.

Companies: Cabot Oil & Gas Corporation

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