Decided November 22, 2010.
The attorneys of record are:
Christopher G. Karagheuzoff, Esq. and Eric B. Epstein, Esq.; Dorsey Whitney LLP, New York, NY,; (Donald P. Jacobs, Esq., Michael a. Covino, Esq., Allen L. Harris, Esq.; Budd Larner, P.C., co-counsel) for Plaintiffs.
Craig Weiner, Esq., Douglas Gross, Esq., and Allen M. Levine, Esq.; Hofheimer Gartlir Gross, LLP, New York, NY,; Charles J. Hecht, Esq., Daniel Tepper, Esq.; Wolf Haldenstein Adler Freeman Hertz LLP, New York, NY, for Defendants.
Plaintiffs CMIA Partners Equity Limited (CMIA Partners), Paolo G. Cugnasca and Valentina Cugnasca, as Trustees of the Emcor Defined Benefit Plan for the benefit of Paolo Cugnasca (Emcor), bring this action derivatively, on behalf of nominal defendant CMIA China Fund II, Limited (CMIA II or the Fund), to recover Fund losses allegedly resulting from the actions of defendants Patrick G. O'Neill, Fred Knoll, John De Lande Long, and Douglas Brennan, four of CMIA II's six directors (the director defendants). The complaint asserts causes of action against the director defendants for breach of fiduciary duty and corporate waste, and seeks a declaratory judgment that each of these defendants is individually liable for any damages sustained by the Fund as a result of their actions.
In motion sequence number 001, the director defendants move to dismiss plaintiffs' complaint based on: (1) lack of standing to assert a derivative claim under Cayman Islands law (CPLR 3211 [a] ); (2) the doctrine of forum non conveniens (CPLR 327); (3) the basis of a prior pending proceeding in the courts of Singapore (the Singapore Suit) (CPLR 3211 [a] ); and/or (4) failure to state a cause of action (CPLR 3211[a]). In the alternative, the director defendants seek to stay this action pending disposition of the ongoing Singapore Suit (CPLR 2201).
In motion sequence number 002, nominal defendant CMIA II joins the director defendants in their motion to dismiss the complaint.
The investment fund CMIA II (the Fund) was formed and incorporated in 2005 as an exempt liability company under the laws of the Cayman Islands. The Fund was formed to engage in investment opportunities, primarily in China, and it is run by a six-member Board of Directors comprised of the four director defendants, plus Singapore resident Lee Chong Min (Lee) and Hong Kong resident Anson Wang (Wang). CMIA Partners holds 16.35% of the Fund's ordinary shares, and Emcor holds 1.36%. Paolo G. Cugnasca, one of Emcor's two trustees, was a director of the Fund until he allegedly resigned his position on March 24, 2009.
Defendant Douglas Brennan was appointed to replace Paolo G. Cugnasca as a director of the Fund on March 25, 2009.
The Fund is currently managed by nonparty CMIA Capital Partners (Singapore) PTE Ltd. (the Manager), pursuant to an Amended and Restated Investment Management Agreement dated August 1, 2006 (the IMA). Both the Manager and CMIA Partners are wholly owned by director Lee, who additionally serves as one of the Manager's two directors. The Fund is sub-advised by nonparty KOM Capital Management LLC (KOM), pursuant to the terms of two Amended and Restated Agreements between KOM and the Manager dated August 1, 2006, one Sub-Advisory and the other Advisory. According to the complaint, each of the four director defendants has a financial interest in and/or, is an officer, director, or employee of KOM.
According to the complaint, the Manager has operating control of the Fund's activities and investments, subject to the overall supervision of the Fund's Investment Committee and the Board. Pursuant to an Amended and Restated Private Placement Memorandum for the Fund, dated July 20, 2007, the Manager must seek approval of the Fund's Investment Committee in relation to all investment and divestiture decisions made on behalf of the Fund.
In their complaint, plaintiffs allege that the four director defendants breached their fiduciary duties to the Fund, and committed corporate waste, when, inter alia, they caused the Fund, in May 2009, to commence the Singapore Suit against the Manager and Lee. In the Singapore Suit, which remains ongoing, the Fund has accused the Manager and Lee of, inter alia, breaching their fiduciary duties to the Fund, misappropriating $50 million in Fund assets, and breaching the IMA. The Manager and Lee have denied any wrongdoing and have asserted counterclaims in the Singapore Suit seeking damages from the Fund, as well as from KOM and the director defendants.
CMIA Partners and Emcor thereafter commenced the instant derivative action, in which they allege that by commencing the Singapore Suit, the director defendants have caused the Fund to incur unnecessary and significant legal fees, and have exposed the Fund to potentially substantial liabilities. Plaintiffs allege that the defendant directors had no reasonable basis for subjecting the Fund to these costs and potential risks. Instead, they were substantially motivated by self-interest — in having KOM take over management of the Fund and its assets, and in furthering a personal vendetta against the Manager and Lee arising out of personal animus.
More specifically, plaintiffs allege that the Singapore Suit was brought as part of an ongoing and systematic campaign by defendants to malign, discredit, and replace the Manager and Lee, rather than in the bona fide interests of the Fund. Plaintiffs contend that the roots of this hostile campaign can be traced back to various disagreements that arose over the management of the Fund, beginning in 2006. For example, the complaint alleges that in late 2006, director O'Neill became angry with Lee when the Fund's Board of Directors failed in pursuing a public listing. Although O'Neill accused the Manager and Lee of a conflict of interest, plaintiffs allege that the Fund's efforts to obtain a public listing were abandoned only after O'Neill and the Manager could not agree on certain operating matters.
O'Neill's anger against Lee allegedly intensified after Lee refused to appoint KOM as a sub-advisor on a new, unrelated private-equity fund that the Manager had developed and initiated during the time that the Fund was attempting to obtain a public listing. According to plaintiffs, Lee's rejection of KOM, with the resulting loss of business opportunities, further angered the other director defendants and drove them to begin their vendetta against the Manager and Lee.
Plaintiffs allege that, in furtherance of this vendetta, in mid-2007, O'Neill accused the Manager of mismanagement involving an agreement to merge certain Fund holdings with another company in return for shares of that company. In or about October 2008, the Fund suffered a significant loss arising out of events associated with this transaction. The complaint alleges that O'Neill used this loss to advance his own interests, by convening a meeting of the Fund's Board of Directors in Hong Kong on November 10, 2008, at which he proposed that the Fund terminate the Manager's IMA. Directors Lee and Wang allegedly objected to this proposal, on the ground that the Board did not have the authority to terminate the IMA under the Fund's Articles of Association. Nevertheless, the Board of Directors voted, three to two, in favor of termination.
According to plaintiffs, the loss resulted from events arising out of the general collapse of global credit markets in 2008, which caused the shares of the merged fund to become worthless. According to the director defendants, the loss resulted from the Manager and Lee's manipulation and unauthorized use of these Fund assets. The circumstances surrounding this loss are at the core of the Singapore Suit.
Cugnasca was one of three directors to vote in favor of the termination at that meeting. Director Knoll was not present.
Thereafter, by letter dated November 17, 2008, defendants O'Neill, Knoll, and Long sent the Manager a notice of termination of the IMA, which notice was to become effective 90 days after service. In response to this notice, on November 18, 2008, Lee sent an e-mail advising his fellow directors that the Board did not have the authority to terminate the IMA because the Fund's Articles of Association expressly required unanimous shareholder approval.
The Fund's Articles of Associations provide, in pertinent part:
Any investment advisory or management contract entered into by the Company (except any such agreements entered into by the Manager and/or Advisor on behalf of the Company pursuant to its discretionary authority under the Management Agreement and/or the Advisory Agreement) may not be terminated by the Company unless such termination is approved by a unanimous vote cast at a meeting at which all the issued and outstanding Shares are represented.
Long Aff., Exh. A: Articles of Association, ¶ 8.
The next day, on November 19, 2008, the Fund's Board of Directors reconvened in New York, at which time O'Neill allegedly proposed that the directors vote to remove Lee and Wang from their positions as directors. No vote was taken on this proposal, which also, allegedly, would have violated the Articles of Association. However, the Board did approve a resolution to convene an Extraordinary general Meeting (EGM) of the shareholders, for the purpose of voting on whether to amend the Articles of Association: (1) to remove the right of shareholders to control the removal of the Fund's managers; and (2) to authorize a majority of the Board to remove any director without shareholder approval.
The resolution to convene the EGM was confirmed by the Board in a subsequent meeting held on November 24, 2008. The shareholders were notified of the EGM by notice dated November 26, 2008. The EGM took place in Bermuda on December 8, 2008. Although 51.8 percent of shareholder votes were cast in favor of the proposed amendments, the proposal did not pass because it failed to garner the two-thirds shareholder vote as required by Cayman Islands law.
As these events unfolded, CMIA Partners began a first derivative action against some of the Fund's directors in the courts of the Cayman Islands. In that derivative action, CMIA Partners sought to: (1) ensure that the November 17, 2008 notice of termination would not be given effect; and (2) enjoin any action that might be taken by the Fund pursuant to the December 8, 2008 shareholder vote. The Cayman Islands' derivative suit was discontinued after the directors agreed that they would take no further action pursuant to the notice of termination or pursuant to any resolution purporting to arise out of the December 8, 2008 EGM. Nevertheless, plaintiffs allege, the defendant directors continued to pursue their campaign against the Manager and Lee, culminating with the commencement of the Singapore Suit in May 2009.
Plaintiffs contend here that defendants were substantially motivated to commence the Singapore Suit for reasons other than the interests of the Fund and its shareholders, and that the complaint sufficiently states a cause of action for breach of fiduciary duty under Cayman Islands law. Plaintiffs, on the Fund's behalf, seek to recoup the legal fees and the Fund assets that the defendant directors caused to be expended in furtherance of their allegedly self-interested campaign against the Manager and Lee. Defendants move to dismiss the complaint on the ground that plaintiff shareholders lack standing to bring a derivative action on behalf of the Fund under Cayman Islands law. Alternatively, defendants argue that: dismissal is warranted because New York is not a convenient forum to litigate this dispute, which involves claims that are nearly identical to those being litigated by the parties in the pending Singapore Suit; and the complaint fails to state a cause of action for breach of fiduciary duty under Cayman Islands law.
On September 13, 2010, after defendants' motions had been argued and submitted, plaintiffs filed an amended complaint asserting, as an additional basis for their breach of fiduciary duty claim, that the director defendants had failed to provide the Fund's shareholders with unaudited and audited financial statements, as required under the Fund's Articles of Association. Plaintiffs allege that defendants failed to provide the requisite statements in order to shield their alleged misconduct, and the high cost of the Singapore Suit, from shareholders.
Plaintiffs allege that they became aware of the high cost of the Singapore Suit, because the director defendants did provide Fund shareholders with an IRS Schedule K-1 in June 2010, which indicated a loss of some $2.7 million in Fund assets. Plaintiffs allege, on information and belief, that most, if not all of this loss resulted from the expenditures for legal fees, expenses, and travel incurred by defendants in their pursuit of the Singapore Suit.
The court provided all defendants with an opportunity to supplement their motion papers to address the newly added allegations, but defendants have asked the court to direct their existing motions to dismiss to the Amended Complaint.
The court first must determine which law to apply to this controversy. New York courts look to the law of the state of incorporation in adjudicating a corporation's internal affairs. Galef v Alexander, 615 F2d 51, 59 (2d Cir 1980), citing Russian Reinsurance Co. v Stoddard, 240 NY 149, 154 (1925); Hart v General Motors Corp., 129 AD2d 179, 183 (1st Dept), app den 70 NY2d 608 (1987) (applying Delaware law); see Greenspun v Lindley, 44 AD2d 20, 22 (1st Dept), affd 36 NY2d 473 (1975) (dicta). The Fund was incorporated in the Cayman Islands. Plaintiffs concede that the right of shareholders to bring a derivative suit on behalf of a Cayman Islands company is governed by Cayman Islands law. The court, thus, will look to Cayman Islands law.
Under CPLR 4511(b), the court may take judicial notice without request (as here), of the "laws of foreign countries." "When it is necessary to establish the law of a foreign country, the foreign law must be proved as a matter of fact." MBIA Ins. Co. v Royal Bank of Can., 28 Misc 3d 1225A (Sup Ct, Westchester County, 2010), citing Fitzpatrick v International Ry. Co., 252 NY 127, 138 (1929) (relying on uncontested affidavit of English attorney). The common law of a foreign jurisdiction may be proved by witnesses or by printed reports of cases. CPLR 4511(d). Application of the foreign law, once proved, to the facts of the case, is for the court to determine as a matter of law. Fitzpatrick, 252 NY at 140.
Defendants have submitted an Affidavit of Guy Locke, an attorney admitted to practice as a solicitor in England, and as an Attorney-at-Law in the Cayman Islands. Locke attests that he specializes in "contentious insolvency and corporate litigation," and that, "[a]s a result of my area of practice, I routinely give advice on, amongst other things, minority shareholder's rights, derivative actions and shareholder disputes." Locke Affid., ¶ 2. In his Affidavit, Locke addresses the issue of standing to bring derivative claims, as well as substantive issues regarding clauses of the Fund's Articles of Association, applying Cayman Islands law. ¶¶ 3-4. On the issue of standing, Locke explains that,
"[i]n the context of a derivative action under Cayman Islands' law, the courts of the Cayman Islands apply English common law principles. . . . [T]he general rule is that the proper plaintiff to an action to recover loss suffered by a company is the company itself: Foss v. Harbottle,  2 Hare 461, annexed as Exhibit A. The Cayman Islands Court of Appeal has expressly adopted and confirmed the principles set forth in Foss v. Harbottle as applicable to Cayman Islands companies. See Schultz v Reynolds, cited as [1992-1993] C.I.L.R. 59.
¶¶ 5-6 (attaching Foss and Schultz as Exhs. A and B). The court's analysis of the principles set forth in the Foss case, and their application to the facts here, is based on its review of the attached foreign decisions, Locke's discussion of these and additional decisions, as well as Federal decisions discussing the English rule and the procedural requirements of a motion to dismiss for lack of standing.
The court finds that defendants have established Locke's expertise in Cayman Islands law. Plaintiffs, who concede Locke's expertise, rely on purported expert John Trehey, but Trehey is not admitted to practice law in the Cayman Islands. Trehey Affid., ¶ 1.
The general rule under English law is that, "derivative claims are owned and controlled by the company, not its shareholders." Winn v Schafer, 499 FSupp2d 390, 396 (SDNY 2007); see Feiner Family Trust v VBI Corp., 2007 WL 2615448, *5, 2007 US Dist LEXIS 66916, *17 (SDNY 2007) ("shareholders cannot ordinarily bring derivative actions for wrongs to the company since the company itself would be the proper plaintiff"). Under the rule,
[A] shareholder may ordinarily bring a derivative claim on behalf of a corporation only if a simple majority of shareholders could not ratify the conduct on which the suit is based. Underlying the rule is a commitment to the principle of majority rule with respect to matters of ordinary corporate governance.
In re Tyco Intl., Ltd., 340 FSupp2d 94, 98 (DNH 2004). Locke Affid., ¶ 7.
The rule in Foss v Harbottle is subject to four exceptions, permitting a shareholder to bring a derivative suit when the conduct at issue: (1) infringes on a shareholder's personal rights; (2) requires a special majority to ratify; (3) qualifies as a "fraud on the minority"; or (4) is ultra virus. Winn, 499 FSupp2d at 396. Plaintiffs argue that they have standing to bring this derivative suit because: (1) the act of commencing the Singapore Suit could not be ratified by a simple majority of Fund shareholders; and (2) the director defendants' alleged misconduct in bringing the Singapore Suit constitutes a "fraud on the minority."
Plaintiffs first argue that the act of commencing the Singapore Suit could not be ratified by a simple majority of Fund shareholders because the overall purpose and potential effect of the Suit is to remove and replace the Manager of the Fund, which under the Fund's Articles of Association requires unanimous shareholder consent. Plaintiffs assert that, under Cayman Islands law, in determining whether a breach of fiduciary duty can be ratified by a simple majority of a corporation's shareholders, it is appropriate to take into account not just the nature of the act itself, but its purposes and effects. Trehey Aff. ¶ 10, citing Kerry v Maori Dream Gold Mines (1898) 14 TLR 402 (attached as Exh. A).
Initially, the court notes that the Kerry case is not a derivative action and does not address what factors are to be considered in determining whether a wrong is capable of ratification by a majority of shareholders. Indeed, in City of Harper Woods Employees' Retirement System v Olver, 577 FSupp 2d 124, 132-133 (DDC 2008), affd 589 F3d 1292 (DC Cir 2009), which did involve a derivative action, the federal district court held that it was important to distinguish between the wrongs done to a company by the individual defendants and the wrongs done by the company as a result of the misconduct.
The suit in Kerry was brought by shareholders on behalf of themselves, to enjoin a company's Board of Directors from proceeding with a transaction that, although approved by a majority of the shareholders, was designed to advantage one group of shareholders against another. In finding in favor of the disadvantaged shareholders, the court held that, because the company had no right to stipulate for an advantage to one set of shareholders over another, the arrangement was not one which it was competent for the shareholders to carry out.
In City of Harper Woods, the directors allegedly had permitted their company to make a series of payments to a Saudi prince, which the plaintiffs had asserted were improper bribes. The plaintiffs alleged that the directors had permitted or encouraged this alleged bribery, in part, to enhance their own power, prestige and profit, thereby jeopardizing the company's financial health and exposing it to possible damages. The plaintiffs had argued that a derivative action could be stated because the alleged authorization of bribe payments was unratifiable. The federal district court held, however, that the wrongs done to the company by the individual directors was the breach of fiduciary duty in causing the company to violate regulatory, civil and criminal law, and not the directors' causation of the company's violations. The court noted that under English law, such breaches of fiduciary duty are capable of ratification by a simple majority of shareholders. Id. at 133.
In this case, the alleged wrong underlying the derivative action is the conduct by the director defendants in causing the Fund to commence the Singapore Suit, not the potential effects of that Suit. To the extent that the director defendants' acts could be considered a breach of their fiduciary duties to the Fund, that breach is capable of ratification by a simple majority of shareholders under English and, therefore, Cayman Island law.
Further, while it is true that the Articles of Association preclude the Fund from directly terminating the Manager's Agreement without unanimous shareholder approval, plaintiffs have not identified any provision of the Articles of Association that would prohibit the Fund from seeking relief from possible Manager misconduct through the courts. Plaintiffs have acknowledged that the director defendants have a fiduciary duty to act in the best interests of the Fund, which necessarily would include protecting the Fund from possible self-dealing and misappropriation on the part of the Manager. Although the Singapore Suit could potentially result in the Manager's removal, such removal could occur only upon the direction of the Singapore court, after its determination that the Fund has proven its claims against the Manager, and not by the direct action of the Fund or its directors. To hold, as plaintiffs suggest, that the director defendants are prohibited from taking any action which might subject the Manager to possible removal by the courts, even if self-dealing or wrongdoing were established, would, in the circumstances present here, leave the Fund with no recourse against a possibly self-dealing Manager and leave the director defendants with no means to fulfill their fiduciary obligations to the Fund.
Plaintiffs next argue that they have standing to bring this action based on the "fraud on the minority" exception. Plaintiffs contend that "[a] fraud on the minority is deemed to occur when the defendants in a derivative action have breached a duty, usually a fiduciary duty, under circumstances such that they are able, whether by reason of their ownership of a majority of the shares or otherwise, to prevent the company from bringing an action in its own name to rectify or remedy the breach." Plaintiffs' Memo at 12-13.
In order to invoke the fraud on the minority exception, the shareholder derivative plaintiff must plead and prove each of the following: first, the "alleged wrongdoers must have control' over a majority of the stock with voting rights," and second, those wrongdoers "must have committed fraud'."
Winn, 499 F Supp 2d at 396; see Feiner, 2007 WL 2615448. Wrongdoer control means control of a company's voting shares. "Fraud" in this context, as interpreted under English law, "requires that there be self-dealing by the alleged wrongdoers." Winn at 397; see City of Harper Woods, 589 F3d at 1303 ("[t]he wrongdoer control exception may be applicable when director-defendants have allegedly committed fraud' by using their powers or positions at the company to benefit themselves at the company's expense"); Tyco, 340 FSupp2d at 99 ("fraud is not present unless the alleged wrongdoer has benefitted at the company's expense as a result of his misconduct"). A breach of fiduciary duty that does not involve self-dealing by those in control is not properly brought as a derivative action.
Here, plaintiffs do not allege that the defendant directors hold a majority of the Fund's voting shares. Rather, the director defendants have presented evidence to show that none of the them directly owns any voting interest in the Fund and that their affiliates and families collectively own, or have the power to vote, only 22.56% of Fund shares.
Plaintiffs note, however, that "a corporation's Board of Directors will be deemed to have control of a majority of the corporation's voting shares for purposes of the fraud on the minority exception if the evidence demonstrates that it has acquired de facto control," citing Tyco, 340 FSupp2d at 99. Plaintiffs argue that the director defendants exercise de facto control of the Fund, in that they constitute a majority of the Board of Directors, and directly and/or indirectly, control the votes of a majority of Fund shares with respect to matters concerning the Manager. Plaintiffs contend that indicia of such control include the fact that a majority of the Fund's shares were voted in favor of the Board's resolution at the EGM held on December 8, 2008, notwithstanding the fact that the director defendants had not provided the shareholders with any explanation or reason to vote for their proposal, or disclosed any plan for appointment of a substitute manager. Plaintiffs also note that, under the Fund's subscription agreement, a standing proxy is given to the Fund's Board of Directors by all shareholders that, although revocable, puts the directors in a position to vote all shares of the Fund.
Nonetheless, the fact that 51% of the Fund's shares were voted in favor of the Board's resolution at the December 8, 2008 EGM does not, of itself, prove that the director defendants have effective control of those shares at all membership meetings. Further, plaintiffs have not presented evidence to show that the revocable proxies given by the Fund's 22 shareholders necessarily provide the director defendants with de facto control.
In any event, even if this court accepts that plaintiffs have adequately established that the director defendants have acquired de facto control of the Fund's voting shares, plaintiffs have failed to allege facts sufficient to establish that the director defendants have engaged in the kind of self-dealing necessary to invoke the fraud on the minority exception.
The complaint alleges that the director defendants' use of Fund resources in a self-serving attempt to replace the Manager of the Fund with KOM, a firm in which they collectively have a direct financial interest, constitutes a clear abuse of their powers as directors, which is the essence of a fraud on the minority. However, those courts that have applied this exception recognize that fraud is not present unless the alleged wrongdoer has benefitted at the company's expense as a result of his misconduct. See City of Harper Woods, 577 FSupp2d at 135; Winn, 499 FSupp2d at 398; Tyco, 340 FSupp2d at 99-100. Here, plaintiffs have failed to establish that by commencing the Singapore Suit, the defendant directors benefitted themselves at the expense of the Fund.
It may be true that director defendants, in causing the Fund to commence the Singapore Suit, are hoping to remove the current Manager, in which the director Lee has a financial interest, and to replace the Manager with the sub-advisor KOM, in which the defendant directors have a financial interest. The fact that the Fund's directors each has a financial interest in one of the two companies that manage and advise the Fund is, apparently, permitted by the Fund and its shareholders and is not, by itself, considered self-dealing. Additionally, as previously indicated, the defendant directors will not be able to achieve this objective unless the Fund prevails in the Singapore Suit by establishing that the current Manager and/or Lee have engaged in self-dealing or misconduct sufficient to require such removal. Plaintiffs have not established that the removal and replacement of a Manager, after a court has determined that it has engaged in such wrongdoing, could be considered self-dealing at the expense of the Fund or its shareholders, even if the replacement manager is an entity in which other directors also may hold a financial interest.
As plaintiffs have not established that the director defendants' action, in causing the Fund to commence the Singapore Suit against the Manager and Lee, could not be ratified by a simple majority of the Fund shareholders, or that the action amounts to self-dealing on the part of the director defendants, the court finds that they lack standing to bring this derivative action under Cayman Islands law. Moreover, since defendants' motions to dismiss on the basis of lack of standing are granted, the court need not reach the merits of the defendants' other arguments in favor of dismissal. Accordingly, it is
ORDERED that the motions by defendants to dismiss the complaint (Motion Sequence Numbers 001 and 002) are granted, and the complaint is dismissed with costs and disbursements to defendants as taxed by the Clerk upon the submission of an appropriate bill of costs; and it is further
ORDERED that the Clerk is directed to enter judgment accordingly.