New York Law Review

Tag: business judgment rule

  • Erie County Employees Retirement System v. Blitzer, 28 N.Y.3d 268 (2016): Applying the Business Judgment Rule in Going-Private Mergers with Protective Conditions

    Erie County Employees Retirement System v. Blitzer, 28 N.Y.3d 268 (2016)

    In reviewing going-private mergers, the business judgment rule applies if the merger is conditioned from the outset on approval by both a special committee of independent directors and an uncoerced majority of the minority shareholders; otherwise, the entire fairness standard applies.

    Summary

    The New York Court of Appeals addressed the standard of review for going-private mergers. The court adopted the Delaware Supreme Court’s framework from MFW, holding that the business judgment rule applies if the merger is conditioned on approval by an independent special committee and an uncoerced majority of the minority shareholders. If these conditions aren’t met, the entire fairness standard is applied, placing the burden on the directors to show fair process and fair price. The court affirmed the dismissal of the plaintiff’s complaint, finding the conditions for the business judgment rule were met.

    Facts

    Kenneth Cole Productions (KCP) had two classes of stock, with Kenneth Cole holding the majority voting power. Cole proposed a going-private merger, offering to buy the remaining Class A shares. The KCP board formed a special committee to negotiate the terms. Cole’s offer was conditioned on approval by the special committee and a majority of the minority shareholders. The special committee negotiated the price, eventually recommending $15.25 per share, which the minority shareholders approved with 99.8% in favor. Shareholders sued, alleging breach of fiduciary duty.

    Procedural History

    Shareholders filed class actions in the trial court. The trial court granted the defendants’ motions to dismiss, finding no breach of fiduciary duty. The Appellate Division affirmed, holding that the entire fairness standard did not apply. The Court of Appeals granted leave to appeal.

    Issue(s)

    1. Whether the entire fairness standard should apply to the going-private merger.

    2. Whether the business judgment rule should apply to the going-private merger.

    Holding

    1. No, because the court adopted the Delaware Supreme Court’s framework in MFW, which outlines the conditions for the business judgement rule.

    2. Yes, because the conditions for the business judgement rule, as outlined in MFW, were met.

    Court’s Reasoning

    The court reviewed the history of freeze-out mergers and the standards of review applied, noting the inherent conflict of interest when a controlling shareholder seeks to take a company private. The court discussed the business judgment rule, which generally defers to directors’ decisions absent fraud or bad faith. The court specifically adopted the standard from MFW (Kahn v. M&F Worldwide Corp.), which states that the business judgment rule applies if the merger is conditioned from the outset on approval by both an independent special committee and an uncoerced majority of the minority shareholders. The court reasoned that this structure creates a situation akin to an arm’s-length transaction, protecting minority shareholders while respecting the board’s decisions. The court examined the facts under the MFW standard and found the complaint did not adequately allege that any of the six conditions were absent. The court emphasized the plaintiff’s failure to show that the special committee was not independent, lacked the ability to negotiate a fair price, or that the minority shareholders were coerced.

    Practical Implications

    This decision provides a clear framework for evaluating going-private mergers, which can provide more predictability to parties involved in these transactions. It confirms that, if structured correctly, these mergers can be reviewed under the business judgment rule. This means that if a merger satisfies the conditions set forth in MFW (an independent special committee, the committee is empowered to freely select its own advisors and to say no definitively, and an informed, uncoerced majority of the minority vote), courts will defer to the board’s decision, reducing the risk of shareholder litigation. Companies engaging in going-private mergers should carefully structure the process to meet these conditions. Plaintiff’s attorneys must allege specific facts to show any of the conditions were not met to avoid dismissal.

  • People v. Grasso, 11 N.Y.3d 64 (2008): Attorney General’s Authority to Sue for Excessive Executive Compensation in Not-For-Profit Corporations

    11 N.Y.3d 64 (2008)

    The Attorney General’s authority to bring claims against officers and directors of not-for-profit corporations is limited to the specific causes of action authorized by the Not-For-Profit Corporation Law (N-PCL), and the Attorney General cannot circumvent the statutory scheme by asserting common-law claims that would lower the burden of proof or eliminate statutory defenses.

    Summary

    This case concerns the Attorney General’s attempt to recover allegedly excessive compensation paid to Richard Grasso, the former Chairman and CEO of the New York Stock Exchange (NYSE), a not-for-profit corporation at the time. The Attorney General brought several causes of action, some based directly on the N-PCL and others grounded in common-law theories of unjust enrichment and breach of fiduciary duty. The Court of Appeals held that the Attorney General could only pursue the statutory claims because the common-law claims impermissibly lowered the burden of proof and bypassed the protections afforded to directors and officers under the N-PCL, effectively undermining the legislative intent behind the statute’s carefully constructed enforcement scheme.

    Facts

    Richard Grasso served as Chairman and CEO of the NYSE from 1995 until 2003. During his tenure, his compensation, including bonuses, significantly increased. In 2003, the NYSE approved a compensation package for Grasso totaling $187.5 million. The Attorney General alleged that the compensation was excessive, unreasonable, and not commensurate with Grasso’s services. The Attorney General claimed that the Compensation Committee, hand-picked by Grasso, ignored a benchmark system and provided inaccurate information to the Board regarding Grasso’s compensation.

    Procedural History

    The Attorney General brought suit against Grasso, alleging eight causes of action, including statutory claims under N-PCL 720(a) and (b) and non-statutory claims based on common-law principles. Grasso moved to dismiss the non-statutory claims for lack of authority. Supreme Court denied the motion, finding the Attorney General had standing under the parens patriae doctrine. The Appellate Division reversed, dismissing the non-statutory claims. The Court of Appeals affirmed the Appellate Division’s decision.

    Issue(s)

    Whether the Attorney General can maintain non-statutory causes of action against the former Chairman and CEO of a not-for-profit corporation, premised on the same underlying facts as statutory claims, when those non-statutory claims would circumvent the fault-based requirements and protections afforded by the N-PCL.

    Holding

    No, because the Attorney General cannot circumvent the legislative scheme of the N-PCL by asserting common-law claims that would lower the burden of proof required for the statutory claims or eliminate defenses, such as the business judgment rule, that the Legislature intended to provide to directors and officers of not-for-profit corporations.

    Court’s Reasoning

    The Court emphasized that while the N-PCL grants the Attorney General broad powers to oversee public corporations, this power is not unlimited. The Legislature created a comprehensive enforcement scheme with specific provisions allowing the Attorney General to bring actions against individual directors or officers for particular misconduct, such as unlawful transfers of corporate assets or breach of fiduciary duty, but these actions require a showing of fault or bad faith. The statute also affords officers and directors the protections of the business judgment rule. The Court reasoned that the Attorney General’s non-statutory claims—for a constructive trust, payment had and received, restitution of benefit awards, and improper loans—were an attempt to circumvent these statutory requirements by crafting causes of action with a lower burden of proof. For example, the claims for constructive trust and payment had and received sought the same relief as the statutory claims but lacked any element of knowledge or bad faith, effectively imposing strict liability. Similarly, the claim regarding improper loans sought to bypass the business judgment defense. The Court stated, “Although the Executive must have flexibility in enforcing statutes, it must do so while maintaining the integrity of calculated legislative policy judgments. That balance falters where, as here, the Executive seeks to create a remedial device incompatible with the particular statute it enforces.” By attempting to impose liability based solely on the size of Grasso’s compensation package, without proving the fault or bad faith required by the N-PCL, the Attorney General was overstepping the bounds of their authority and infringing on the Legislature’s policy-making role. The Court noted that it “has consistently held that a private right of action may not be implied from a statute where it is ‘incompatible with the enforcement mechanism chosen by the Legislature’.”

  • 40 West 67th Street v. Pullman, 8 N.Y.3d 144 (2006): Applying the Business Judgment Rule to Cooperative Tenancy Terminations

    40 West 67th Street v. Pullman, 8 N.Y.3d 144 (2006)

    When a residential cooperative terminates a shareholder’s tenancy based on objectionable conduct, the business judgment rule, not a court’s independent assessment of reasonableness, governs judicial review of the cooperative’s decision, requiring deference to the cooperative’s determination if made in good faith, within the scope of its authority, and to further a legitimate corporate purpose.

    Summary

    This case clarifies the application of the business judgment rule to cooperative housing disputes, specifically concerning the termination of a shareholder’s tenancy due to objectionable conduct. The cooperative sought to evict Pullman based on a history of disruptive behavior. The Court of Appeals held that the business judgment rule applies, meaning courts should defer to the cooperative’s decision if it was made in good faith, within its authority, and to further a legitimate purpose. This decision balances the rights of individual shareholders with the cooperative’s interest in maintaining a harmonious living environment, while also acknowledging the need for judicial scrutiny to prevent abuse of power by cooperative boards. The court affirmed the lower court’s grant of summary judgment to the cooperative.

    Facts

    Defendant Pullman purchased an apartment in the plaintiff cooperative building in 1998. Soon after moving in, Pullman began exhibiting behavior deemed disruptive and objectionable by the cooperative. This included numerous complaints about neighbors, accusations of illegal activity without evidence, a physical altercation, distribution of defamatory flyers, unauthorized alterations to his apartment, and commencement of multiple lawsuits against building residents and management.

    Procedural History

    The cooperative initiated proceedings to terminate Pullman’s tenancy. The Supreme Court denied the cooperative’s motion for summary judgment, arguing the cooperative needed to prove Pullman’s objectionable conduct to the court’s satisfaction. The Appellate Division reversed, granting summary judgment to the cooperative based on the business judgment rule. Pullman appealed to the Court of Appeals.

    Issue(s)

    Whether the business judgment rule, as opposed to an independent judicial evaluation of reasonableness, is the appropriate standard for reviewing a cooperative’s decision to terminate a shareholder’s tenancy based on objectionable conduct, pursuant to a provision in the proprietary lease.

    Holding

    Yes, the business judgment rule is the appropriate standard because the cooperative’s decision to terminate Pullman’s tenancy was made in good faith, within the scope of its authority as defined by the proprietary lease, and in furtherance of a legitimate corporate purpose – maintaining a harmonious and habitable environment for all residents.

    Court’s Reasoning

    The Court relied on its prior decision in Matter of Levandusky v. One Fifth Ave. Apt. Corp., which established the business judgment rule as the standard for judicial review of cooperative board decisions. The Court emphasized that the business judgment rule balances the interests of individual shareholders with the collective interests of the cooperative. “So long as the board acts for the purposes of the cooperative, within the scope of its authority and in good faith” (Levandusky, 75 N.Y.2d at 538), courts should defer to its decisions. The Court found that the cooperative followed proper procedures for termination, acted within the scope of its authority under the proprietary lease, and took action to further the legitimate corporate purpose of ensuring a peaceful living environment. The Court also found no evidence of bad faith, discrimination, or malice on the cooperative’s part. The Court acknowledged that RPAPL 711(1) requires “competent evidence” to show that a tenant is objectionable but reasoned that, in this context, the shareholder vote based on the objectionable behavior constitutes competent evidence, reviewed under the business judgment rule. The Court cautioned that while deferential, the business judgment rule should not be a “rubber stamp” for cooperative board actions and that courts should exercise heightened vigilance in tenancy termination cases to ensure the board acted legitimately. The Court quoted from Levandusky, stating that a board “may significantly restrict the bundle of rights a property owner normally enjoys” (75 NY2d at 536), when a shareholder-tenant voluntarily agrees to submit to the authority of a cooperative board.

  • Levandusky v. One Fifth Avenue Apartment Corp., 75 N.Y.2d 530 (1990): Business Judgment Rule for Co-op Board Decisions

    75 N.Y.2d 530 (1990)

    The business judgment rule, requiring good faith and legitimate corporate purpose, applies to decisions made by cooperative boards of directors, protecting them from judicial second-guessing absent evidence of bad faith, self-dealing, or discriminatory treatment.

    Summary

    Ronald Levandusky, a shareholder in a cooperative apartment building, sought to renovate his kitchen, including altering a steam riser. The co-op board initially approved the plans but later rescinded approval and issued a stop-work order after learning of the riser alteration, citing a policy against moving risers. Levandusky sued, arguing the board’s decision was arbitrary. The New York Court of Appeals held that the business judgment rule applies to decisions of cooperative boards, meaning courts should defer to board decisions made in good faith for a legitimate purpose. Because Levandusky failed to show the board acted outside its authority or in bad faith, the Court upheld the board’s decision.

    Facts

    Levandusky, a shareholder and former board president of One Fifth Avenue Apartment Corp., planned to renovate his kitchen. His plans, approved by the building architect and initially by the board, included modifications to plumbing risers but did not explicitly mention altering a steam riser. After the board learned of Levandusky’s intent to move the steam riser, they reaffirmed a policy against relocating risers and denied him a variance. Levandusky proceeded with the alteration, prompting the board to issue a stop-work order.

    Procedural History

    Levandusky filed an Article 78 proceeding to set aside the stop-work order. The Supreme Court initially granted his petition, then reversed itself, applying the business judgment rule. The Appellate Division modified the judgment, siding with Levandusky and finding the board’s decision unreasonable. The Court of Appeals reversed the Appellate Division, holding that the business judgment rule applied, and reinstated the Supreme Court’s revised ruling.

    Issue(s)

    Whether the business judgment rule is the appropriate standard for judicial review of decisions made by the board of directors of a residential cooperative corporation regarding building policy.

    Holding

    Yes, because the business judgment rule best balances the interests of individual shareholders and the cooperative as a whole, protecting board decisions made in good faith and for a legitimate purpose from undue judicial interference.

    Court’s Reasoning

    The Court reasoned that cooperative boards, like corporate directors, are responsible for managing the affairs of the entity. Applying the business judgment rule, which protects corporate directors’ decisions made in good faith and for a legitimate corporate purpose, is appropriate for cooperative boards as well. This standard prevents courts from second-guessing board decisions unless there is evidence of self-dealing, bad faith, or discriminatory treatment. The Court emphasized that cooperative living involves ceding some individual rights to the collective good, and the board’s authority is necessary to maintain the stability and desirability of the community. The Court rejected a “reasonableness” standard, finding it would lead to excessive judicial involvement in board decisions. The Court stated, “So long as the board acts for the purposes of the cooperative, within the scope of its authority and in good faith, courts will not substitute their judgment for the board’s.” The Court found that Levandusky did not meet the burden of proving that the board breached its fiduciary duty. The court noted the board acted on the advice of its engineer and was enforcing a consistent policy. Ultimately, the Court concluded, “Under the rule we articulate today, we decline to review the merits of the board’s determination that it was preferable to adhere to a uniform policy regarding the building’s piping system.” The concurring opinion agreed with the result, but argued for applying an “arbitrary and capricious” standard, typical of Article 78 proceedings, instead of the business judgment rule.

  • Auerbach v. Bennett, 47 N.Y.2d 619 (1979): The Business Judgment Rule and Special Litigation Committees

    Auerbach v. Bennett, 47 N.Y.2d 619 (1979)

    The business judgment rule protects decisions by a special litigation committee (SLC) to terminate a derivative suit, provided the committee members are disinterested, independent, and their investigative procedures are adequate and appropriate.

    Summary

    A shareholder derivative action was brought against directors of General Telephone & Electronics Corporation (GTE) for alleged illegal payments. The board formed a special litigation committee (SLC) of disinterested directors to determine if pursuing the lawsuit was in the company’s best interest. The SLC concluded it was not and moved to dismiss the suit. The court addressed the extent to which the SLC’s decision was protected by the business judgment rule. The Court of Appeals held that while the substance of the SLC’s decision is protected, courts can review the SLC’s disinterestedness, independence, and the adequacy of its investigation. Finding no issues with these factors in this case, the Court reinstated the dismissal of the derivative action.

    Facts

    GTE’s management initiated an internal investigation into potentially questionable payments to foreign officials. The audit committee, with the assistance of outside counsel and auditors, investigated worldwide operations from 1971 to 1975. Their report revealed possible bribes and kickbacks totaling over $11 million, involving some directors. A shareholder, Auerbach, filed a derivative action against GTE’s directors and its auditor, Arthur Andersen & Co. The board then created a special litigation committee (SLC) comprised of three disinterested directors who joined the board after the transactions in question.

    Procedural History

    The SLC determined that pursuing the derivative action was not in the corporation’s best interest and directed dismissal. The corporation and the defendant directors moved to dismiss the complaint. The Supreme Court, Special Term, granted the motions and dismissed the complaint. When Auerbach didn’t appeal, another shareholder, Wallenstein, appealed. The Appellate Division reversed the Special Term’s order and denied the defendants’ motions for summary judgment. The Court of Appeals granted defendants’ motion for leave to appeal.

    Issue(s)

    1. Whether the business judgment rule bars judicial inquiry into the decision of a special litigation committee of disinterested directors to terminate a shareholder derivative action.

    2. Whether the court can inquire into the disinterestedness and independence of the committee members and the appropriateness of their investigative procedures.

    Holding

    1. Yes, the business judgment rule generally protects the substantive decision of a special litigation committee to terminate a derivative suit because courts are ill-equipped to evaluate business judgments.

    2. Yes, because the court can inquire into the disinterested independence of the committee members and the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee, but absent evidence of bad faith or fraud, the court should respect the SLC’s determinations.

    Court’s Reasoning

    The Court reasoned that derivative claims belong to the corporation, and the decision to pursue them lies within the board’s judgment. The business judgment rule protects directors’ decisions made in good faith and with honest judgment. The Court acknowledged that courts are not equipped to evaluate business decisions. The Court emphasized that the business judgment rule shields the decisions of the SLC only if its members are disinterested and independent. The court can examine the committee’s investigative procedures to ensure adequacy and appropriateness, but it cannot delve into the committee’s substantive evaluation or the weight given to various factors. The court stated, “Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision…and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.” The Court found no evidence to challenge the disinterestedness of the SLC members or the adequacy of their investigation, which included engaging special counsel, reviewing prior reports, interviewing directors and employees, and obtaining legal advice. The court also addressed the intervener’s argument for further discovery, finding it speculative and not a basis to postpone summary judgment. The disclosure proposed by Wallenstein would only go to particulars as to the results of the committee’s investigation and work. Therefore, the Court modified the Appellate Division’s order and reinstated the Special Term’s dismissal of the complaint.