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Hughes v. Xiaoming Hu

Court of Chancery of Delaware

February 6, 2020, Submitted; April 27, 2020, Decided; April 27, 2020, EFiled

C.A. No. 2019-0112-JTL

Opinion

MEMORANDUM OPINION

LASTER, V.C.

Kandi Technologies Group, Inc. (the "Company") is a publicly traded Delaware corporation based in China. The Company has struggled persistently with its financial reporting and internal controls, encountering particular difficulties with related-party transactions. The complaint describes problems dating back to 2010. In March 2014, the Company publicly announced the existence of material weaknesses in its financial reporting and oversight system, including a lack of oversight by the Audit Committee and a lack of internal controls for related-party transactions. The Company pledged to remediate these problems. [*2]  Instead, in March 2017, the Company disclosed that its preceding three years of financial statements needed to be restated. In connection with the restatement, the Company disclosed that it lacked:

• Sufficient expertise relating to technical knowledge of US GAAP requirements and SEC disclosure regulations;

• Sufficient expertise to ensure the completeness of the disclosure of financial statements for equity investments;

• Sufficient expertise to ensure the proper disclosure of related-party transactions;

• Effective controls to ensure the proper classification and reporting of certain cash and non-cash activities related to accounts receivable, accounts payable, and notes payable; and

• Sufficient expertise to ensure the accuracy of the accounting and reporting of income taxes and related disclosures.

Despite having pledged three years earlier to get its house in order, the Company had none of these necessary competencies.

The plaintiff is a stockholder in the Company. The plaintiff filed this suit on the Company's behalf to recover damages from (i) the three directors who comprised the Audit Committee during the Company's period of persistent problems, (ii) the Company's CEO, and (iii) [*3]  the three CFOs who served in quick succession during the years leading up to the March 2017 restatement. The plaintiff contends that the director defendants consciously failed to establish a board-level system of oversight for the Company's financial statements and related-party transactions, choosing instead to rely blindly on management while devoting patently inadequate time to the necessary tasks. The plaintiff contends that the director defendants' failures led to the March 2017 restatement, which caused the Company harm. The plaintiff also contends that because the Company's performance was inflated during the pre-restatement period, the officer defendants received excessive compensation and were unjustly enriched.

The defendants have moved to dismiss the complaint pursuant to Rule 23.1, contending that the plaintiff failed to make a demand on the board or plead that demand would have been futile. The plaintiff obtained books and records before filing suit. The fruits of that investigation—and, just as important, what the Company conspicuously failed to produce—have enabled the plaintiff to plead a complaint that supports a reasonable pleading-stage inference of a bad faith failure of [*4]  oversight by the named director defendants. Four of the defendants comprise a majority of the board that would have considered a demand, and the substantial threat of liability renders them incapable of disinterestedly considering a demand. Demand would have been futile, so the Rule 23.1 motion is denied.

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2020 Del. Ch. LEXIS 162 *

WILLIAM HUGHES, JR., Derivatively on Behalf of Nominal Defendant KANDI TECHNOLOGIES GROUP, INC., Plaintiff, v. XIAOMING HU, XIAOYING ZHU, CHENG WANG, BING MEI, JERRY LEWIN, HENRY YU, LIMING CHEN, Defendants, and KANDI TECHNOLOGIES GROUP, INC., Nominal Defendant.

Notice: THIS OPINION HAS NOT BEEN RELEASED FOR PUBLICATION. UNTIL RELEASED, IT IS SUBJECT TO REVISION OR WITHDRAWAL.

Prior History: In re Kandi Techs. Grp., Inc., 2019 U.S. Dist. LEXIS 169414 (S.D.N.Y., Sept. 24, 2019)

CORE TERMS

audit committee, transactions, related-party, Audit, disclosure, oversight, futile, reasonable inference, financial statement, allegations, controls, internal control, purposes, internal audit, joint venture, minutes, motion to dismiss, receivable, expertise, reporting, Charter, ending, particularized, restatement, monitoring, documents, effective, financial reporting, board of directors, unjust enrichment

Business & Corporate Law, Corporate Governance, Directors & Officers, Scope of Authority, Actions Against Corporations, Standing, Claim Presentation, Derivative Actions, Enforcement of Corporate Rights, Demands, Demands, Futility, Civil Procedure, Pleadings, Heightened Pleading Requirements, Conditions Precedent, Management Duties & Liabilities, Fiduciary Duties, Business Judgment Rule, Duty of Good Faith, Duty of Loyalty, Duty of Care, Responses, Defenses, Demurrers & Objections, Motions to Dismiss, Evidence, Inferences & Presumptions, Inferences, Motions to Dismiss, Failure to State Claim