36 N.Y.2d 371 | NY | 1975
Plaintiff brought this shareholder’s derivative action without first making a demand upon the corporation’s board of directors to secure initiation of an action in favor of the corporation or otherwise to remedy the acts of which he complains. He alleges that a demand would have been futile because the board of directors participated in, authorized and approved the challenged acts and its members are themselves subject to liability and, therefore, cannot be expected to vote to sue themselves.
Three of the defendants moved to dismiss the complaint on the ground that the reasons offered in justification of the failure to make a demand are insufficient under subdivision (c) of section 626 of the Business Corporation Law. The issue is whether allegations of board participation in and approval of acts involving bias and self-dealing by minority "affiliated” directors and breach of fiduciary duties of due care and diligence by the remaining majority "unaffiliated” directors through their participation and approval, though there is no claim of self-dealing as to them, are sufficient to withstand a motion to dismiss for failure to make a demand.
Subdivision (c) of section 626 of the Business Corporation Law provides that, in any shareholder’s derivative action brought in the right of the corporation to procure judgment in its favor, "the complaint shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort.”
The Supreme Court denied the motion to dismiss and the Appellate Division, one Justice dissenting, affirmed. This appeal is before us pursuant to leave granted by the Appellate Division upon the certified question whether the affirmed order denying the motion to dismiss was properly made.
For reasons which follow, we have concluded that the question should be answered in the affirmative and the deter
Plaintiff, a shareholder of Talcott National Corporation ("Talcott”), brought this shareholder’s derivative action
The remaining 11 defendants are not alleged to be affiliated with Talcott otherwise than in their capacity as directors. In the complaint they are characterized as "men of affairs actively engaged in the pursuit of their own substantial business interests”, and hereinafter will be referred to as the unaffiliated directors. They are alleged to have failed to exercise their independent judgment as directors. The complaint also alleges that the individual defendants constitute the present members of Talcott’s board of directors, and were directors at the time of the contested acts.
The motion to dismiss the complaint was made by defend
According to the complaint, Talcott is engaged through its various subdivisions in the fields of commercial, industrial and real estate financing, product and equipment manufacturing, insurance, and leather processing. It is alleged that in late 1972 defendant Gulf & Western determined to acquire control of Talcott because Talcott’s finance-related business (principally operated by its 93% owned subsidiary, James F, Talcott, Inc.) represented a potential valuable expansion of the finance business conducted by Gulf & Western’s wholly-owned subsidiary, defendant First Capital. This led to an "agreement in principle” for the merger of Talcott into Gulf & Western at a value of $24 per Talcott share. The agreement was approved by the board of directors of each corporation. Thereafter, plaintiff asserts, the affiliated directors, in return for certain pecuniary and other personal benefits, entered into a "plan and scheme” with Gulf & Western to help it obtain control over Talcott on an altered basis substantially less favorable to Talcott and its shareholders than the previously approved merger proposal.
Various actions are claimed to have been taken pursuant to this scheme, not only by the individual affiliated directors and the corporate defendants but also by Talcott’s board itself. (1) The Talcott-Gulf & Western merger was abandoned by Talcott’s board of directors and in its place was substituted a tender offer by First Capital of $20 per Talcott share. Talcott’s board of directors is claimed to have approved this tender offer as "fair and reasonable” and recommended it to Talcott’s common shareholders. The complaint alleges that "[s]uch approval and recommendation were not in the exercise of an honest business appraisal of the tender offer but was [sic] made for the benefit of G & W and the controlling defendants.” (2) Nine Talcott officers, three of whom are presently directors, entered into favorable new employment contracts with James F. Talcott, Inc., Talcott’s coveted finance-related
The complaint goes on to assert that the "controlling defendants”, the six affiliated directors, including the three appellants, have breached their fiduciary obligations to Talcott in return for personal benefits, have failed to exercise due care, skill and diligence in the conduct of Talcott’s affairs and have wasted its assets. The complaint then alleges that "the other defendants, as directors of Talcott, by participating in, authorizing or approving the acts and transactions complained of, have breached their fiduciary duties to Talcott and its shareholders, have failed to exercise due care and diligence in discharging their duties, and have wasted Talcott’s assets.”
Specifically relevant to the matter at issue in this case is paragraph 25 of the complaint which alleges: "Plaintiff has made no demand on the Board of Directors of Talcott to take action with respect to the wrongs herein alleged since the majority of the Talcott Board of Directors participated in, authorized, and approved the acts and transactions com
On behalf of Talcott (see n 1, supra) the complaint seeks judgment directing defendants to account to Talcott for profits they gained by reason of the acts alleged and for damages sustained by Talcott. It also seeks to enjoin the defendants from effectuating the employment and consulting agreements already described as well as to enjoin Gulf & Western and First Capital from voting any shares acquired in the tender offer and exercising any control over Talcott.
Appellants claim that the challenged acts are "plainly corporate” and at most indicate erroneous business judgments which as a matter of law are not wrongful.
In affirming the Supreme Court’s denial of appellants’ motion to dismiss, the Appellate Division stated that a demand is excused "where the board itself is accused of patent breach of its fiduciary duties and its members are named as parties defendant”. We agree. Liberally construed, the complaint alleges acts for which a majority of the directors may be liable and plaintiff reasonably concluded that the board would not be responsive to a demand. In our view, this conclusion finds support in the history and purposes of the demand rule in shareholder derivative suits, in the liberal rules of pleading and in the law of corporate directors’ liability for breach of duty.
Though the demand requirements stated in subdivision (c) of section 626 of the Business Corporation Law were enacted on the basis of part of former rule 23 (subd [b]) (now rule 23.1) of the Federal Rules of Civil Procedure (McKinney’s Cons. Laws of NY, Book 6, Business Corporation Law, § 626, subd [c], Legislative Studies and Reports), the statute actually codifies an early rule of equity in shareholder derivative actions. (See, e.g., Robinson v Smith, 3 Paige Ch 222, 233; Brinckerhoff v Bostwick, 88 NY 52, 59-60, writ of error dsmd 106 US 3; Sage v Culver, 147 NY 241, 245-247). The rule was sometimes stated as a strict pleading requirement (see, e.g., Greaves v Gouge, 69 NY 154, 157; Hawes v Oakland, 104 US 450, 461), and has been codified as such in New York ("the complaint shall set forth with particularity” [Business Corporation Law, § 626, subd (c); italics supplied]).
It is clear then that the demand is generally designed to weed out unnecessary or illegitimate shareholder derivative suits. This prophylactic device assuredly should not be allowed to frustrate the true derivative suit, the very thing it was designed to protect. (See Dykstra, Revival of the Derivative Suit, 116 U of Pa L Rev 74; see, also, Prunty, Shareholders’ Derivative Suit, 32 NYU L Rev 980.)
Accordingly, a futile demand need not be made. Chancellor Walworth of New York’s early Court of Chancery stated what may be regarded as one of the guidelines for determining futility in the famous case of Robinson v Smith (3 Paige Ch 222, 233, supra), as follows: "if it appeared that the directors of the corporation refused to prosecute by collusion with those who had made themselves answerable by their negligence or
The basic question is whether from the particular circumstances of the liability charged it may be inferred that the making of such a demand would indeed be futile. Thus, it is well established that a demand will be excused where the alleged wrongdoers control or comprise a majority of the directors. (See, e.g., Ripley v International Rys. of Cent. Amer., 8 AD2d 310, affd 8 NY2d 430; Steinberg v Altschuler, 158 NYS2d 411.) And, while justification for failure to give directors notice prior to the institution of a derivative action is not automatically to be found in bare allegations which merely set forth prima facie personal liability of directors without spelling out some detail, such justification may be found when the claim of liability is based on formal action of the board in which the individual directors were participants.
It is not sufficient, however, merely to name a majority of the directors as parties defendant with conclusory allegations of wrongdoing or control by wrongdoers. This pleading tactic would only beg the question of actual futility and ignore the particularity requirement of the statute. The complaint here does much more than simply name the individual board members as defendants. It sets out, with particularity, a series of transactions allegedly for the benefit of Gulf & Western and the affiliated directors. Though there are no allegations that the unaffiliated directors personally benefited from the transactions, they are claimed to have disregarded Talcott’s interests for the sole purpose of accommodating Gulf & Western, which, in turn, would allegedly reciprocate by promoting the self-interest of the affiliated directors. Acting officially, the board, qua board, is claimed to have participated or acquiesced in assertedly wrongful transactions.
Considered most favorably to the plaintiff the board’s acts, as a necessary part of a series of intertwined events and agreements which benefited the affiliated directors rather than Talcott, cannot be regarded as immune from question in a shareholder’s derivative action as a matter of law. If true, the allegations of the complaint—the circumstances surrounding the board’s approval of the tender offer for First Capital’s acquisition of control over Talcott, including the employment
We reject appellants’ proposition that allegations of directorial fraud or self-interest is, in every case, a prerequisite to excusing a derivative shareholder from making a demand upon the board. (Compare, e.g., Matter of Kauffman Mut. Fund Actions, 479 F2d 257, 265, cert den 414 US 857; but see concurring opn of Chief Judge Coffin;
This case does not require us to delimit the boundaries of a director’s affirmative duties to the corporation which he undertakes to serve. We regard it as sufficient to reiterate the long-standing rule that he does not. exempt himself from liability by failing to do more than passively rubber-stamp the decisions of the active managers. (See, generally, Dyson, Director’s Liability for Negligence, 40 Ind LJ 341; Feuer, Liabilities of Directors and Officers, 5 NYL Forum, 127, 235; Symposium on Corporate Responsibility, 10 Col J Law & Soc Prob 15, 18-28; Ann., 25 ALR3d 941, 1001-1022.) As a consequence, a derivative shareholder’s complaint may, in a particular case, withstand a motion to dismiss for failure to make a demand upon the board, even though a majority of the board are not individually charged with fraud or self-dealing. Particular allegations of formal board participation in and approval of active wrongdoing may, as here, suffice to defeat a motion to dismiss. We believe the better approach in these cases is to rest the determination of the necessity for a demand in the sound discretion of the court to which the issue is first presented,
We hold, therefore that, in light of the allegations of the complaint, the Supreme Court did not abuse its discretion in finding substantial compliance with subdivision (c) of section 626 of the Business Corporation Law and in denying appellants’ motion to dismiss for failure to make a demand on the board of directors. The certified question should be answered in the affirmative.
Order affirmed, with costs. Question certified answered in the affirmative.
. Plaintiff also seeks relief in a representative capacity on behalf of himself and other similarly situated Talcott shareholders. The parties and the courts below have treated the action as derivative for purposes of determining plaintiff’s compliance with the demand requirements of subdivision (c) of section 626 of the Business Corporation Law since those requirements are imposed only for derivative-type suits. Since this case is before us in the posture of a motion to dismiss the complaint, in view of our disposition it is unnecessary for us to explore the distinctions between derivative and "individual” or "representative” shareholder suits (see 2 Hornstein, Corporation Law and Practice, §§ 601-603; see, also, 3B Moore, Federal Practice [2d ed], par 23.1.16, subd [1]). Thus, we also have treated the complaint only in its derivative aspect.
. Appellants’ affidavit in support of their motion to dismiss states that two additional persons not mentioned in the complaint or named as defendants "were and are members of the Board of Directors of Talcott”. If so, the complaint still names a majority of the directors — 16 of the possible 18 persons who are presently directors and who were also directors at the time of the challenged acts.
. In his concurring opinion, Chief Judge Coffin made the following cogent observations: "Moreover, these are times when corporations are exceeding in size and impact even the giantism of the past, when new layers and dimensions of corporate obligation are being recognized, and when the importance of directorate oversight of the management technocracy is greater than ever. A higher degree of professionalism, sensitivity, and scrutiny may fairly be expected on the part of directors today than in a simpler era. I am therefore reluctant, by resort to formula, to set boundaries to the action or inaction of directors, beyond which demand on them shall always be required.” (479 F2d 257, 268.)
. This seems to be the preferred approach in the Federal courts (see 3B Moore, Federal Practice [2d ed], par 23.1.19; see, e.g., Herpich v Wallace, 430 F2d 792, 802; Fields v Fidelity Gen. Ins. Co., 454 F2d 682, 685).