Kaufman v. Kansas Gas and Elec. Co.

• Decision Date: 29 May 1986
• Docket Number: No. 85-1899-K.,85-1899-K.
• Parties: Ellen Rae KAUFMAN, Plaintiff, v. KANSAS GAS AND ELECTRIC COMPANY, Nominal Defendant, and Wilson K. Cadman, et al., Defendants.
• Court: U.S. District Court — District of Kansas

634 F. Supp. 1573

Ellen Rae KAUFMAN, Plaintiff, v. KANSAS GAS AND ELECTRIC COMPANY, Nominal Defendant and Wilson K. Cadman, et al., Defendants.

No. 85-1899-K.

United States District Court, D. Kansas.

May 29, 1986.

Gene Mesh & Patricia A. Kindel, Cincinnati, Ohio, David M. Rapp, Wichita, Kan., for plaintiff.

Robert S. Medvecky, Reed & Priest, Washington, D.C., Richard C. Hite, Kahrs, Nelson, Fanning, Hite & Kellogg, Wichita, Kan., for nominal defendant.

MEMORANDUM AND ORDER

PATRICK F. KELLY, District Judge.

This case is before the Court on defendants' motion to dismiss for failure to comply with the "demand" requirement of F.R. Civ.P. 23.1. Plaintiff Ellen Rae Kaufman, a shareholder of Kansas Gas and Electric Company (KG & E), brought this derivative action for the benefit of KG & E, nominal defendant, against its Board of Directors, alleging waste of corporate assets due to mismanagement and breach of fiduciary duties in connection with KG & E's involvement in the construction and operation of the Wolf Creek Nuclear Power Plant. Plaintiff did not make demand upon KG & E's directors to instigate this suit themselves prior to filing her suit. Rule 23.1 requires that such demand be made; otherwise plaintiff must plead with factual particularity why such demand would have been futile. The basis of defendants' motion is that plaintiff failed to comply with the requirements of Rule 23.1, and therefore this suit must be dismissed.

For the reasons set forth below, the Court finds the demand was not excused as futile in this case, and accordingly will dismiss this derivative suit for failure to comply with Rule 23.1.

KG & E is an electric utility company located in Wichita, Kansas. KG & E has a 47% interest in the Wolf Creek Nuclear Power Plant (Wolf Creek) located near Burlington, Kansas; the remaining interests are held by Kansas City Power and Light Company (47%) and Kansas Electric Power Cooperative, Inc. (6%). Planning for Wolf Creek began in 1973. At that time the estimated cost of construction was 525 million dollars. By the time construction began in 1977, the estimated cost of the project had increased to 1.033 billion dollars. By July, 1984 the cost was estimated at 2.904 billion dollars. Although Wolf Creek was scheduled for completion in 1982, it did not begin operating until March of 1985. At this date it is on line and producing power.

Plaintiff, in her amended complaint, alleges that KG & E's Board of Directors was guilty of mismanagement during the construction of Wolf Creek. Specifically, she alleges their monitoring role was inefficient, ineffective, and inappropriate (¶ 12); their construction management was grossly inadequate (¶ 14); they lost control of the costs and scheduling (¶ 15); their budgeting process was deficient (¶ 18); they failed to remove the major site constructor from the job after concluding his performance was unacceptable in October, 1981 (¶ 22); and they failed to adequately control the quality of safety-related systems, resulting in a civil penalty of $40,000.00 imposed by the Nuclear Regulatory Commission (¶ 23).

On January 3, 1985, KG & E applied with the Kansas Corporation Commission (KCC) for rate increases to cover the costs of Wolf Creek. KG & E requested a rate base of 2.030 billion dollars. The KCC held extensive hearings to discover, inter alia, the reasonableness of the costs, acquisition, and construction of Wolf Creek, the reasonableness of the cost of operating Wolf Creek, the reasonableness of the management decisions to continue construction on a year to year basis, and whether any portion of the costs of acquiring and constructing Wolf Creek were incurred due to inefficiency or imprudence.

The KCC, in an order issued in September of 1985, allowed a rate base of only 994 million dollars, approximately one billion dollars less than requested. The Commission concluded that $450,000.00 of the construction costs and 1,828,262 man hours of labor were imprudently incurred. Except as to these findings of unreasonable increases in construction costs, the Commission did not base its findings on imprudence on the part of KG & E:

We are not basing this decision on a "prudence determination." Although substantial evidence has been presented that the excessive costs of Wolf Creek are the consequence of imprudent decisions and actions of the applicant, we do not make such a finding today. We do believe that KG & E has not performed adequately through much of the period during which Wolf Creek has been built and that more rigorous reviews of likely consequences and alternatives may have avoided the exorbitant costs associated with Wolf Creek. We do find that substantial risks were involved in the Wolf Creek project and a significant portion of the economic consequences should be shared by the company.

KCC Order Sept. 27, 1985, pp. 86-7, ¶ 4.

The plaintiff, in her complaint, further alleges that the directors failed to advise the shareholders of the enormous risks undertaken in the Wolf Creek project, including: low capital cost estimates; failure to achieve fuel savings sufficient to offset capital costs; unavailability of adequate nuclear accident insurance; decline in cost of alternative fuel and increase in availability of alternative fuel; probability of maintenance problems, costs of which must be borne by shareholders; and probability the KCC would deny the requested rate increase (¶ 31.) Plaintiff argues that had the shareholders been fully apprised of these facts, they would not have voted to continue construction in 1980 and 1981. (¶ 32.)

Plaintiff alleges that the directors, through mismanagement and breach of their fiduciary duty of due care, have wasted corporate assets in the construction and ownership of Wolf Creek. Plaintiff claims the shareholders have been damaged in the amount of one billion dollars (equal to the amount of requested rate increase denied by the KCC).

Discussion

F.R.Civ.P. 23.1 provides, in pertinent part, that in a derivative action "the complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort." (Emphasis added.)

Both parties are in agreement that plaintiff made no demand on the defendants. Plaintiff alleges she is excused from doing so because demand would be "futile". In paragraph 8 of her complaint, plaintiff states:

No demand has been made by plaintiff upon KG & E's Board of Directors to bring this action because the demand would be futile because the claims alleged herein arise from a long-term continuing course of corporate misconduct, mismanagement and waste which do not require demand under Rule 23.1. Demand is also not required because the directors of KG & E have not been duly diligent in respect to the building and construction of Wolf Creek and have thereby caused substantial waste of KG & E assets. The directors cannot defend their actions by any alleged "independent" business judgment or by not bringing this action against defendant directors since it is undoubtedly in the benefit of KG & E to recover the amount wasted and squandered by the defendant directors on the Wolf Creek facility.

Defendants argue, in their motion to dismiss, that plaintiff has failed to set forth any particularized factual allegations which would excuse demand under the controlling law.

The sole issue before this Court, then, is: when is a shareholder's demand upon a board of directors, to redress an alleged wrong to the corporation, excused as futile prior to the filing of a derivative suit?

As a preliminary matter, the parties have agreed that the choice of law question need not be resolved, as K.S.A. 60-223a is virtually identical to Rule 23.1. Moreover, the Kansas Supreme Court found federal law "persuasive" in its only decision interpreting the "demand" rule of K.S.A. 60-223a. Newton v. Hornblower, 224 Kan. 506, 582 P.2d 1136 (1978).

If the choice of law issue did need to be resolved, however, it is clear that federal law would control in determining whether the allegations of the complaint are particular enough, Allison v. General Motors Corp., 604 F.Supp. 1106, 1115 (D.Del.1985); Walden v. Elrod, 72 F.R.D. 5, 13 (W.D.Okla.1976), while state substantive law determines whether the reasons offered by plaintiff for excusing demand are adequate. Lewis v. Curtis, 671 F.2d 779 (3d Cir.), cert. denied 459 U.S. 880, 103 S.Ct. 176, 74 L.Ed.2d 144 (1982); Tabas v. Mullane, 608 F.Supp. 759, 765 (D.N.J. 1985); Allison v. General Motors Corp., 604 F.Supp. at 1106.

A cardinal rule of corporate law is that directors, rather than shareholders, manage the business and affairs of a corporation. Newton v. Hornblower, 224 Kan. 506, 582 P.2d 1136 (1978). Accordingly, the authority to sue for corporate injuries is primarily in the corporate management. In re Kauffman Mutual Fund Actions, 479 F.2d 257 (1st Cir.), cert. denied 414 U.S. 857, 94 S.Ct. 161, 38 L.Ed.2d 107 (1973). However, a shareholder is not powerless to challenge director action which results in harm to the corporation. "The machinery of corporate democracy and the derivative suit are potent tools to redress the conduct of a torpid or unfaithful management." Aronson v. Lewis, 473 A.2d 805, 811 (Del.1984). The derivative action developed in equity to enable shareholders to sue in the corporation's name where those in control of the company refused to assert a claim belonging to it. The nature of the action is twofold. First, it is the equivalent of a suit by the shareholder to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it. Aronson v. Lewis, 473 A.2d at 811.

By its very nature, the derivative action impinges on the managerial freedom of...