finding that issues had been raised and decided against plaintiff in previous federal action and, as a result, dismissing shareholder derivative action on basis of collateral estoppelSummary of this case from Parker Madison Partners v. Airbnb, Inc.
Argued January 4, 2000
February 17, 2000
Appeal by permission, Court of Appeals, Appellate Division of Supreme Court in First Judicial Dept. New York County (Herman Cahn, J.)
Tanner Propp, L.L.P., New York City (Lester J. Tanner of counsel), for appellant.
Weil Gotshal Manges, L.L.P. New York City (Joseph S. Allerhand, Stephen A. Radin, Miranda B. Schiller and Anthony J. Albanese of counsel), for respondents
At the heart of this factually complex commercial case are two legal issues: first, whether a claim has been stated for breach of fiduciary duty and waste, and second, whether Business Corporation Law § 612 was violated in connection with a merger effectuated by the corporate defendant. Concluding that there was neither, we affirm the Appellate Division order dismissing the complaint.
Plaintiff Pinnacle Consultants, Ltd., a Delaware corporation, has since 1987 owned stock in defendant Leucadia National Corporation, a publicly-owned financial services corporation organized in New York. The other defendants are Leucadia's Board of Directors individually. Defendant Ian Cumming has served as Leucadia's chairman since 1987, and defendant Joseph Steinberg as president since 1979. Allegations of wrongdoing center on four transactions: three involve the issuance of warrants; the fourth concerns the merger.
In 1985, 1991 and 1992, the Board of Directors approved the issuance of warrants that gave Cumming and Steinberg, separately, options to purchase several hundred thousand shares of Leucadia stock. The terms of those warrants were described in proxy statements to Leucadia's shareholders, and the shareholders voted to approve each transaction. In 1989, Leucadia repurchased the majority of the 1985 warrants. In 1990, the Leucadia Board of Directors proposed a merger with Marks Investing Corporation (MIC). Leucadia owned 56% of MIC's stock, and MIC owned a 54% interest in TLC Associates, a partnership. TLC, in turn, owned an approximately 58% interest in Leucadia. Cumming and Steinberg, in addition to their positions with Leucadia, were directors of both MIC and TLC. The proffered reason for the merger, as set forth in the proxy statement sent to Leucadia's shareholders, was to simplify the circular ownership structure among Leucadia, MIC and TLC.
At the time, there were more than 15 million shares outstanding.
The proxy statement also revealed that the merger would give Cumming, Steinberg and another director — defendant John W. Jordan II — a controlling interest in Leucadia. Prior to the merger, Cumming and Steinberg each owned 4.39% of MIC's stock, and Jordan owned 15.2%. In addition, Cumming and Steinberg each owned 23% of TLC. Following the merger, TLC would be dissolved, and its assets — over 8.6 million shares of Leucadia stock — would be distributed to its owners in proportion to their interest. The result would leave Cumming and Steinberg each with slightly over 22.1% of Leucadia's stock, and Jordan with 5.87%. Together, Cumming, Steinberg and Jordan would own just over 50% of Leucadia. The proxy statement also revealed that TLC intended to vote its Leucadia shares — 58.7% of the outstanding shares — in favor of the merger. Therefore, excluding the directed voting shares, the merger would be approved if 8% of the remaining outstanding shares voted in favor. On May, 11, 1990, Leucadia's shareholders approved the merger. Pinnacle did not vote its shares for or against the merger, nor did it return the proxy.
In 1994, Pinnacle — a corporation that buys and sells stock for the benefit of its sole shareholder, who is also its president — brought a derivative action in the United States District Court for the Southern District of New York against Leucadia and its officers and directors, alleging violations of the Racketeer Influenced and Corrupt Organizations Act (RICO) ( 18 U.S.C. § 1962[b]-[d]), as well as various other claims. As predicate acts for its RICO claim, Pinnacle alleged wrongdoing in the issuance of the 1985, 1991 and 1992 warrants, and failure of the proxy statement to state that Business Corporation Law § 612 prohibited TLC from voting its shares in favor of the merger. The District Court dismissed the suit in part, holding that Pinnacle's claims concerning the 1985 warrants were time-barred; that the proxy statements relating to the 1991 and 1992 warrants were not false or misleading; that the warrants were properly issued under Business Corporation Law § 505; and that Business Corporation Law § 612 did not prohibit TLC — a partnership — from voting its shares in favor of the merger. The court held, however, that Pinnacle did state claims for breach of fiduciary duty and corporate waste under New York law, but dismissed those claims for lack of Federal jurisdiction.
The United States Court of Appeals for the Second Circuit affirmed, holding that the authorizations of the warrants were proper and did not constitute predicate fraudulent acts under RICO. Specifically, the court held that Leucadia complied with Business Corporation Law § 505; that it issued the warrants to Cumming and Steinberg because of the "dramatic turnaround that Leucadia experienced;" and that the corporation "could reasonably determine that the issuance of the warrants was deserved on the basis of past service" (Pinnacle Consultants, Ltd. v. Leucadia National Corp., 101 F.3d 900, 905). In addition, the court held that there was "no fraud shown in the issuance of the warrants," and that "the Directors' business judgment is conclusive that valid consideration was received for the warrants" (id.). Further, because at least two predicate acts were necessary under RICO, the single alleged Business Corporation Law § 612 violation could not alone support a RICO claim, and the court held that it was unnecessary to reach the question whether section 612 had been violated (id., at 906). Finally, the court held that there was no diversity of citizenship to support Federal jurisdiction for any State law claims (id., at 906-907).
Pinnacle then brought the instant derivative action in State court against Leucadia and its officers and directors, alleging that defendants had violated Business Corporation Law § 612 by permitting TLC to vote its shares in favor of the merger with MIC. Pinnacle also claimed that, by issuing the warrants, defendants violated Business Corporation Law § 505 and committed fraud, corporate waste, conversion and breach of fiduciary duty. Supreme Court dismissed, as barred by collateral estoppel, the claim that the warrants had been improperly issued. In addition, the court held that section 612 had not been violated because it applies only to corporations — not partnerships. The court, however, held that Pinnacle had stated a claim for breach of fiduciary duty and corporate waste.
The Appellate Division modified Supreme Court's judgment and dismissed the entire complaint, holding that Pinnacle lacked standing and was estopped from challenging any of the transactions because, as a shareholder, it had not voted against them. Further, the Appellate Division held that Business Corporation Law § 612 did not prohibit TLC from voting its shares in favor of the merger because that section does not apply to partnerships; that the proxy statement for the merger disclosed all relevant facts; and that defendants' compliance with Business Corporation Law § 505 precluded Pinnacle's claims that defendants had committed conversion and corporate waste in issuing the warrants. We granted leave and now affirm.
On appeal to this Court, Pinnacle urges first, that, as officers and directors of Leucadia, the individually named defendants breached their fiduciary duty and committed corporate waste by issuing the warrants to Cumming and Steinberg, and second, that under Business Corporation Law § 612 TLC should have been precluded from voting its shares in favor of the merger.
Pinnacle's claims concerning the warrants are barred by collateral estoppel. Collateral estoppel, or issue preclusion, prevents a party from "relitigating in a subsequent action or proceeding an issue clearly raised in a prior action or proceeding and decided against that party" (Parker v. Blauvelt Volunteer Fire Co., 93 N.Y.2d 343, 349). The doctrine applies if the issue in the second action was "raised, necessarily decided and material in the first action," and if the party "had a full and fair opportunity to litigate the issue in the earlier action" (id.; see also, Gramatan Home Investors Corp. v. Lopez, 46 N.Y.2d 481, 485).
Here, Pinnacle's claims that defendants breached their fiduciary duty and committed corporate waste by issuing the warrants to Cumming and Steinberg were raised and necessarily decided in the Federal court action. As predicate acts for its RICO claim, Pinnacle alleged that Leucadia's Board of Directors illegally authorized the warrants and that they were not supported by valid consideration (see, Business Corporation Law § 505[a]). The Second Circuit rejected Pinnacle's argument, holding that the warrants had been validly issued in order to reward Cumming and Steinberg for Leucadia's "dramatic turnaround;" that there was "no fraud shown in the issuance of the warrants;" and that "the Directors' business judgment is conclusive that valid consideration was received for the warrants" (101 F.3d, at 105). Thus, the court concluded that the warrants were properly issued and that their issuance was economically justified as compensation for Cumming and Steinberg's service to Leucadia.
From this decision, it follows necessarily that issuance of the warrants was not corporate waste and not a breach of fiduciary duty. Indeed, the premise of Pinnacle's corporate waste and breach of fiduciary duty claims is that, in authorizing the warrants, the directors improvidently exercised their business judgment. That, however, was the very issue decided by the Second Circuit against Pinnacle (see, Browning Ave. Realty Corp. v. Rubin, 207 A.D.2d 263, 266-267 [where Federal court dismissed RICO claim, subsequent State law claims raising same issue barred by collateral estoppel], lv denied 85 N.Y.2d 804).
Further, it is of no moment that, after dismissing Pinnacle's RICO claim, the Second Circuit dismissed its State law waste and fiduciary duty claims for lack of Federal jurisdiction rather than on the merits. Indeed, in view of the RICO dismissal, the Federal court lacked subject matter jurisdiction to determine the merits of the pendant State law claims. Nevertheless, since, as noted, the Federal court's dismissal of the RICO claim necessarily determined the same issues raised by the corporate waste and breach of fiduciary duty claims, the State law claims are barred by collateral estoppel (see, id. [applying collateral estoppel even though, in dismissing RICO claim, Federal court never assumed jurisdiction over State law claims]).
Moreover, Business Corporation Law § 505(h) states that "[i]n the absence of fraud in the transaction, the judgment of the board shall be conclusive as to the adequacy of the consideration * * * for the issue of rights or options for the purchase from the corporation of its shares." As the Appellate Division recognized, since the Second Circuit found "no fraud shown in the issuance of the warrants" (101 F.3d, at 105), plaintiff's challenge cannot stand.
We next turn to Pinnacle's argument that Business Corporation Law § 612(b) barred TLC from voting its shares in favor of the merger. At the outset, defendants contend — as the Appellate Division held — that Pinnacle lacks standing, and is estopped from bringing this claim, because it failed to vote its shares against the merger. In support of this argument, defendants rely on the general principle that a shareholder who participated in an activity may not subsequently challenge its legality in a derivative suit (see, Diamond v. Diamond, 307 N.Y. 263, 266 [plaintiff who had participated in corporate action estopped from bringing suit challenging that action]). In addition, defendants cite cases finding estoppel where shareholders in closely-held corporations did not oppose the challenged actions (see, e.g., Kranich v. Bach, 209 AD 52, 54; Winter v. Bernstein, 149 Misc.2d 1017, 1020, affd as modified 177 A.D.2d 452).
While it might be reasonable to expect a shareholder in a close corporation to object affirmatively to an action before bringing suit, the dynamics are quite different in a publicly-traded corporation. To be sure, a shareholder in a publicly-held corporation who votes in favor of a merger — and thus participates in the challenged activity — might be deemed to have acquiesced to it (see, Vierling v. West Chemical Products, 143 A.D.2d 829, 830 [plaintiff who voted his shares in favor of merger estopped from bringing suit]; Kahn v. Household Acquisition Corp., 591 A.2d 166, 176-177 [Del Sup Ct] [same]). But that does not also mean that the shareholder who abstains from voting must be estopped from later bringing suit. This is especially true where, as here, a predetermined number of affirmative votes are required to approve the merger, thus making abstention the equivalent of a negative vote (see, Pavlidis v. New England Patriots Football Club, 675 F. Supp. 696, 698-700 [D Mass] [shareholders who abstained not deemed to have acquiesced to merger where "merger approval required the affirmative vote of a majority of each class entitled to vote"]).
TLC was not, in any event, barred by Business Corporation Law § 612 from tendering its shares in favor of the merger. Section 612(b) states:
"Treasury shares and shares held by another domestic or foreign corporation of any type or kind, if a majority of the shares entitled to vote in the election of directors of such other corporation is held by the corporation, shall not be shares entitled to vote or to be counted in determining the total number of outstanding shares."
This section states that a subsidiary — that is, a corporation a majority of whose voting shares are owned by the parent corporation — may not vote shares held in the parent corporation (see, CIBC Bank and Trust Co. v. Banco Central do Brasil, 886 F. Supp. 1105, 1114 [SDNY]). The reason for this rule is that, "[i]f cross-ownership and cross-voting of stock between parents and subsidiaries were unregulated, officers and directors could easily entrench themselves by exchanging a sufficient number of shares to block any challenge to their autonomy" (Norlin Corp. v. Rooney, Pace, Inc., 744 F.2d 255, 262 [2d Cir]).
Pinnacle argues that TLC was, in effect, a subsidiary of Leucadia, because Leucadia owned a controlling interest (56%) in MIC, and MIC, in turn, owned a controlling interest (54%) in TLC. Indeed, as noted, Cumming and Steinberg served as directors of all three companies, which supports Pinnacle's argument that TLC was in fact under Leucadia's control. Thus, Pinnacle contends that section 612(b) barred TLC from voting its shares in favor of the merger.
Regardless, however, of whether TLC was effectively controlled by Leucadia, section 612(b) does not apply in this case, because that section explicitly applies only to corporations, and TLC was a partnership. Section 612(b) is very particular: it applies only to shares held by a "domestic or foreign corporation of any type or kind" (emphasis added). In fact, section 612(b) uses the term "corporation" no less than three times to define its scope. As the Appellate Division, trial court and the United States District Court concluded, this statute applies only to corporations — not to partnerships. We must respect the legislative judgment that the prohibition on cross-voting between parents and subsidiaries applies only to corporations.
We note that the same policy behind section 612(b) might support a statute barring any entity from voting shares controlled by the parent corporation. For instance, Model Business Corporation Act § 721(b), and Delaware General Corporations Law § 160(c), prohibit cross-voting where a subsidiary "directly or indirectly" owns shares in the parent corporation (see also, 5 Fletcher Cyclopedia of Private Corporations, § 2040). A Delaware court explained that "indirectly" includes stock held by a "third party" or an "individual" that "would vote it as ordered by the [parent] corporation's directors" (Italo Petroleum Corp. of America v. Producers' Oil Corp., 174 A 276, 278 [Del. Ch.]). Thus, had Delaware law, or the Model Act, been applicable, TLC might have been precluded from voting its shares in favor of the merger. Section 612(b), however, specifically limits its restrictions on cross-voting to subsidiary corporations. This statute is unambiguous, and we must apply it as written.
In light of our holding, we need not reach defendants' argument regarding pre-litigation demand on the corporation (see, Business Corporation Law § 626[c]).
Accordingly, the order of the Appellate Division should be affirmed, with costs.
Order affirmed, with costs. Opinion by Chief Judge Kaye. Judges Bellacosa, Smith, Levine, Ciparick, Wesley and Rosenblatt concur.