Bansbach v. Zinn, 1 N.Y.3d 1 (2003)

Demand on a board of directors is excused as futile in a shareholder derivative suit when the board is incapable of making an impartial decision about whether to pursue the litigation, particularly when a majority of the board is interested in the challenged transaction due to self-interest or a loss of independence caused by a controlling, self-interested director.

Summary

This shareholder derivative action sought damages for Besicorp Group Inc. due to alleged illegal conduct by its founder, Michael Zinn. The plaintiff did not make a pre-litigation demand on the board, arguing it would be futile. The key issues were whether a prior litigation collaterally estopped the plaintiff from claiming futility, whether demand was indeed futile, and whether the plaintiff deserved summary judgment. The Court of Appeals found that collateral estoppel did not apply, demand was futile due to Zinn’s control over the board, and the plaintiff was entitled to summary judgment against Zinn regarding liability. The board’s decision to indemnify Zinn despite his guilty plea and the corporation’s implication demonstrated their inability to act impartially.

Facts

Michael Zinn, Besicorp’s founder, was investigated for illegal campaign contributions. Zinn allegedly reimbursed employees for contributions to Maurice Hinchey’s campaign using company funds. The board, including Habib, Harris, and Rosen, decided to indemnify Zinn for legal fees. Zinn and Besicorp were indicted; Zinn pleaded guilty to aiding the submission of false statements to the Federal Election Commission, admitting he knowingly violated the law. Despite this, the board continued to authorize payments for Zinn’s legal fees. After Zinn resigned, the Legal Defense Management Committee sought partial reimbursement but later voted to indemnify Zinn for all costs, including his fine, after he was reinstated.

Procedural History

The plaintiff filed a derivative action alleging breach of fiduciary duty and waste of corporate assets. The Supreme Court initially dismissed the action for failure to make a demand. The Appellate Division reversed, finding sufficient allegations of a lack of board independence to excuse demand. After another derivative suit was dismissed, the defendants moved for summary judgment, arguing collateral estoppel based on Lichtenberg v. Zinn. Supreme Court denied the motion and granted the plaintiff summary judgment regarding Zinn’s liability. The Appellate Division reversed, but the Court of Appeals then reinstated the Supreme Court’s order with modifications.

Issue(s)

1. Whether the prior litigation, Lichtenberg v. Zinn, collaterally estops the plaintiff from arguing demand futility.

2. Whether demand on the Besicorp board was futile, excusing the plaintiff from the pre-litigation demand requirement.

3. Whether the plaintiff is entitled to summary judgment against the defendants.

Holding

1. No, because there is no identity of issue between the present case and Lichtenberg v. Zinn.

2. Yes, because the board was dominated and controlled by Zinn, who had a clear self-interest in the matter, making it futile to expect them to initiate action against him.

3. Yes, as to the liability of Zinn, because his own sworn admissions establish that he acted in bad faith and had reasonable cause to believe that his conduct was unlawful; no as to the other defendants, because factual issues remain regarding their motivations.

Court’s Reasoning

The Court of Appeals held that collateral estoppel was inapplicable because the issues in Lichtenberg v. Zinn were different. In Lichtenberg, the directors’ independence was challenged concerning stock options, whereas this case involves indemnification related to Zinn’s criminal conduct. Furthermore, in this case, the directors were personally implicated in the alleged wrongdoing.

The court found that demand was futile because the board was controlled by Zinn, demonstrated by their initial indemnification of his legal fees, delaying reimbursement, and ultimately indemnifying him even after his guilty plea. The Court highlighted the board’s decision to indemnify Zinn for his actions, despite his admission of knowingly violating the law, indicated they could not objectively determine whether to pursue litigation against him.

Regarding summary judgment, the Court determined that Zinn’s own admissions under oath that he knowingly and willfully violated campaign finance laws and tax laws precluded a finding that he acted in good faith or reasonably believed his actions were in the best interest of the corporation. The Court quoted Zinn’s allocution: “I made funds available to certain employees of my company through bonuses and advances so that their contributions to the 1992 congressional campaign of Maurice Hinch[e]y were in fact contributions of Besicorp…” This constituted active and deliberate dishonesty, barring indemnification under New York’s Business Corporation Law. Summary judgment was not granted against the other defendants due to remaining factual issues about their motivations.