derivative Shareholder actions:
Cohen v Beneficial Industrial loan Corp
Complaint alleged that since 1929, defendants (corp and certain managers and directors) engaged
in successful conspiracy to enrich themselves at expense of the corp. There was mismanagement
and fraud over 18 years. 100k was wasted or diverted.
NJ law made plaintiff liable for reasonable expenses and attorneys fees of defense if he failt to
win complaint when the shareholder who brings suit has less than 50k in stock. The petitioner
must indemnify corp before case can proceed.
Constitutionality of NJ statute:
Due process concerns: a state may set the terms on which it will permit litigations in its courts.
No type of litigation is more susceptible of regulation than that of a fiduciary nature
Equal protection concerns: shockholder who owns 5% or 50k in value doesnt have to provide
security or liability while smaller interests do. Court says this is okay. state can use amount of
financial interest to measure good faith and responsibility of the person bringing suit.
Erie Question Rule of procedure or substance? If procedural, fed rules apply if substantive, state
rules apply. It creates a new liability where none existed before. It goes beyond payment of
costs
Eisenberg v Flying Tiger Line, Inc.
Eisenberg sued to enjoin plan of reorg and merger. In july 1969, flying tiger organized deleware
subsidiary FTC FTC organics subsidiary FTL air freight Flying tiger merged into FTL and only
FTL survived. After merger Flying tiger ceased as OpCo TTL took over operations and flying
tiger shares were converted into identical number of FTC shares. Now bus operations are
confined to a wholly owned subsidiary of holding co whose stockholders are former flying tiger
shareholders. NY 627 makes plaintiff post security in derivative actions. But this is a class
action, so representative not derivative. (Injury to corp = derivative injury to shareholder =
representative)
Grimes v Donald
Delaware Co from texas. Publicly traded.
Employment agreement provides that Donald is responsible for the general management of the
affairs of company. And he reports to board termination w/o cause gives Donald payment of
base salary for 6.5 years annual incentive awards for remainder of term medical benefits for him
ife and children, employee bnefit plan
After base salary payments cease, gets pension and gets o sell his 200k units
Grimes worte to board in 1993 demanding that board abrogate these agreements. Board
considered and did not act on demand
::::
Distinction b/t direct and derivative claims:
Distinction depends upon nature of the worng alleged and relief which could result
Abdication claim: grimes seeks only a declaration of invalidity of agreements. Money recovery
will not accrue to corp as a result. Do it is direct
Abdication claim:
Grimes argued that penalties incurred in event that board attempts to interfere in donalds
management o company will deter board form exercising duties. The Donald agreements do
not preclude the DSC board from exercising its statutory powers and fulfilling its fiduciary duty.
Business judgment rule protects board heremarket for senior management demands significant
severance packages this will inevitably limit their future range of action by entering into
agreements. Claim dismissed
Demand req
Basis for claiming excusal: 1. Majoriy of board has material finaincial or familial interest, 2 a
majority of board is incapable of acting independently b/c of domination or control or 3 the
underlying transaction is not the product of a valid exercise of business judgment. Otherwise
must make a pre-suit demand on the board
Stockholder who makes a demand is entitled to know promptly what action the board has taken
in response to the deand stockholder who receives only preemptory refusal has the rigt to use
the tools at hand to obain the relevant corp records to determine whether or not there is a basis to
assert that demand was rongfully refused.
If stockholder makes pre-suit demand, cant contend later that demand was excused. By making
demand, waives right to contest independence of board.
If demand is denied, must plead w/ particularity why the boards refusal act to on derive. Claims
was wrongful.
If demand is refused, refusal gets business judgment rule protection
Marx v Akers:
Marx alleges that IBM board wasted corp assets by awarding excessive compensation to IBMs
executives andoutside directors.
Purpose of demand req is to relieve courts form deciding matters of corp gov. by providing copr
directors w/ opportunities to correct alleged abuses, provide corp boards w/ reasonable protection
from harassment by litigation on matters w/n the discretoion of directors, and discourage strike
suits commenced by shareholders for personal gain
Two prong test to determine whether a failure to serve a demand is justified. (DE approach)
two branches of Delaware test are disjunctiveonce director interest has been established, the
business judgment rule becomes inapplicable, and the demand excused w/o any further inquiry.
Whether a board has validly exercised its business judgment must be evaluated by determining
whether directors exercised procedural (informed decision) and substantive (terms of transaction)
due care
Other approach is universal demand. Requires a demand in all cases w/o exception. (AC, CT,
GA, MI, MS, MT, NE, NH, NC, VA, WI )
NY test: Bus Corp Law 626c resembles DE approach incorporates a reasonable doubt
standard demand would be futile if a complaint alleges w/ particularity that 1 a majority of
directors are interested in transaction or 2 the directors failed to inform themselves to a degree
reasonably necessary about transaction, or the directors failed to exercise their business judgment
in approving the transaction
Director interest may be either self interest or loss of independence b/c director w/ no direct
interest in a transaction is controlled by a self interested director. Demand is excused b/c of
futility when a complaint alleges that board did not fully inform to extent reasonably appropriate
under circumstances 3 demand excused when transaction ws so egregious on its face that it
could not have been product of sound business judgment
This case:
Motion to dismiss was proper back scratching agreements where all directors vote to approve
each others compensation do not constitute disinterested directors action.
Here only 3 directors are alleged to have received benefit of scheme. Plaintiff didnt allege that
majority of board was interested in setting exec compensation
In this case directors were self interested insofar as ocmplaint that they set each otheres
compensation.
So demand was excused on this part. But the compensation was not unreasonable.
SPECIAL LITIGATION COMMITTEE
Take a subset of untainted board members takes over litigation from shareholders. If principle
reason for demand being excused is that majority of board is interested, board can create special
lit igation that is not tainted via being filled w/ disinterested or new board members vested w/
decision power of board re whether to proceed w/ litigation or not.
Auerbach v Bennett it is a monitoring case (good faith duty of loyalty claim)
GTE directed that internal prelim investigation be made to ascertain whether that corp had
engaged in bribery. Management brought the issue to the attention of board. Board referred
matter to audit committee which retained law firm that had not acted as counsel to corp.. also
used outside auditors. Audit committee reported that it had found evidence that payment had
been made abroad and in US ~11 million
Board created special litigation committee board vested committee w/ all of the authority of
board to determine on behalf of board the osition that corp will take w/ respect to derivative
claims alleged on its behalf in shareholder derive actions
Committee released Arthur Andersen from liability committee also concluded that none of
individual defendants had violated NY standard of care. None had profited personally and
claims in this action are w/o merit.
SLCs have more power when demand is required (business judgment rule) than when it is
excused.
Test is whether SLC acted independently in good faith and with a reasonable investigation (with
burden of proof on defendant) and does dismissal pass independent judicial inquiry into business
judgment