holding that allegations of personal friendships amongst board members are insufficient to establish domination and controlSummary of this case from Schachter v. Kaminsky
February 4, 1999
Appeal from the Supreme Court (Connor, J.).
This shareholder derivative action was brought by plaintiff on behalf of Besicorp Group, Inc., a corporation engaged in the business of power production and heating technology. In May 1997, Besicorp and its then president and chair of its board of directors, defendant Michael F. Zinn (hereinafter defendant), were indicted for alleged violations of Federal campaign finance laws. The charges stemmed from a scheme allegedly concocted by defendant, whereby defendant would solicit campaign contributions from various Besicorp employees and then reimburse the employees for such contributions through falsely labeled "raises" and "bonuses", all in an effort to hide the fact that Besicorp was making the contributions in violation of applicable Federal laws. One month later, in June 1997, Besicorp and defendant each pleaded guilty to two felonies — filing a false tax return and causing a false statement to be filed with the Federal Elections Commission. It appears that defendant was sentenced to six months in prison and two years of supervised release and that Besicorp and defendant each were fined approximately $36,000.
According to plaintiff, Besicorp's subsequent filings with the Securities and Exchange Commission in July 1997 revealed that the corporation had incurred approximately $800,000 in legal fees and expenses in connection with the Federal investigation during the fiscal year ending March 31, 1997. Specifically, plaintiff asserted that a July 1997 proxy statement indicated that Besicorp had "agreed to advance indemnification payments on behalf of certain persons" involved in the campaign finance proceedings and that the "indemnification payments advanced on behalf of [defendant] as of July 25, 1997, for legal fees * * * totaled $208,250", an amount that "could vary significantly depending on the ultimate outcome of the matter". Neither filing indicated, according to plaintiff, that the corporation's board of directors, then consisting of defendant and defendants Gerald A. Habib, Harold Harris and Richard E. Rosen, had taken any action to recover damages from defendant and/or defendant Michael J. Daley, Besicorp's then vice-president, chief financial officer and corporate secretary, for the harm caused to Besicorp as a result of defendant's scheme or to obtain repayment from defendant or Daley for the sums advanced for legal fees.
Plaintiff thereafter commenced this action in August 1997 alleging, inter alia, that defendant and Daley breached their fiduciary duties to Besicorp and wasted corporate assets. Defendant and Daley moved to dismiss the complaint pursuant to CPLR 3211 (a) (7), contending, inter alia, that plaintiff had failed to comply with Business Corporation Law § 626 Bus. Corp. (c) by making a demand upon Besicorp's board of directors to bring the action in the corporation's name. A similar motion was filed by Besicorp, Habib, Harris and Rosen. Supreme Court granted the requested relief and this appeal by plaintiff ensued.
Although Business Corporation Law § 626 Bus. Corp. (a) permits shareholders to bring an action in the right of a domestic or foreign corporation and secure a judgment in its favor, Business Corporation Law § 626 Bus. Corp. (c) requires that the complaint in such action "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." This "demand" requirement, or the necessity of offering a sufficient explanation for failing to make one, "derives from one of the basic principles of corporate control — that the management of the corporation is entrusted to its board of directors * * * who have primary responsibility for acting in the name of the corporation and who are often in a position to correct alleged abuses without resort to the courts" ( Barr v. Wackman, 36 N.Y.2d 371, 378 [citation omitted]). Thus, the rule has developed in this State that demand will be excused because of futility when a complaint alleges with particularity that (1) a majority of the board of directors is interested in the challenged transaction; (2) the board members did not fully inform themselves of the challenged transaction to the extent reasonably appropriate under the circumstances; or (3) the challenged transaction was so egregious on its face that it could not have been the product of sound business judgment ( see, Marx v. Akers, 88 N.Y.2d 189, 200-201). "Director interest", in turn, "may either be self-interest in the transaction at issue * * * or a loss of independence because a director with no direct interest in a transaction is `controlled' by a self-interested director" ( id., at 200).
On a motion to dismiss pursuant to CPLR 3211 N.Y.C.P.L.R. (a) (7), this Court must, of course, assume each fact alleged in the complaint to be true and construe the complaint liberally in favor of the plaintiff ( see, Barr v. Wackman, supra, at 375). Accordingly, our inquiry here distills to whether plaintiff "set forth sufficient details `from which it may be inferred that the making of a demand would indeed [have been] futile'" ( Tak Shing David Tong v. Hang Seng Bank, 210 A.D.2d 99, 100, quoting Curreri v. Verni, 156 A.D.2d 420, 421).
A review of the underlying complaint reveals that plaintiff is relying upon the "interested director" prong of Marx v. Akers (supra) by alleging that defendant so dominated and controlled Habib, Harris and Rosen that a demand upon the board would have been futile. In this regard, plaintiff alleges that Habib, Harris and Rosen, each of whom purportedly were hand-picked by defendant for service on Besicorp's board of directors, were personal friends of defendant and had business relationships with him as well. Specifically, as to the alleged business relationships, plaintiff alleges that defendant and a third party had once formed a corporation with Harris and that such corporation, in turn, did business with Besicorp. When such corporation failed to meet its obligations with Besicorp, plaintiff alleges, Besicorp "wrote off" a note payable to it in the amount of $127,500 and defendant reimbursed Harris for a $14,000 payment made to finance the failed project. As to Habib and Rosen, plaintiff alleges that each had sought to do business with Besicorp and that Habib had submitted a written marketing and business consulting services proposal to Besicorp. Although we agree that the mere allegation of personal friendships is insufficient to establish domination and control, we find the allegations of business dealings to be sufficient to permit the complaint to survive the respective motions to dismiss. Accordingly, Supreme Court's order granting defendants' respective motions to dismiss must be reversed and the complaint reinstated.
To the extent that plaintiff's complaint may be read as alleging that. the board of directors' conduct in the payment of defendant's legal fees was so flagrant and egregious that it could not have been the product of sound business judgment ( see, Marx v. Akers, supra), we find plaintiff's conclusory assertions in this regard to be insufficient to excuse demand upon this basis.
As Supreme Court did not convert the motion to dismiss to a motion for summary judgment, we have not considered the affidavits submitted by Habib, Harris and Rosen ( cf., Rovello v. Orofino Realty Co., 40 N.Y.2d 633, 636).
Mikoll, J. P., Mercure, Yesawich Jr. and Peters, JJ., concur.
Ordered that the order is reversed, on the law, with costs, and motions denied.