New York Law Review

Tag: Corporate Waste

  • Pinnacle Consultants, Ltd. v. Leucadia National Corp., 92 N.Y.2d 426 (1998): Collateral Estoppel and Limits on Statutory Interpretation

    92 N.Y.2d 426 (1998)

    Collateral estoppel bars relitigation of issues previously decided in federal court, and statutes should be interpreted according to their plain language, even if policy arguments favor a broader reading.

    Summary

    Pinnacle Consultants, a shareholder of Leucadia National Corporation, brought a derivative action alleging breach of fiduciary duty, corporate waste, and violation of Business Corporation Law § 612 concerning a merger. The New York Court of Appeals affirmed the dismissal of the complaint, holding that Pinnacle’s claims regarding warrants were barred by collateral estoppel because the Second Circuit had already ruled on their validity. The court also held that § 612, which restricts voting rights of subsidiary corporations, does not apply to partnerships, regardless of policy arguments suggesting it should.

    Facts

    Leucadia’s board approved warrants for Chairman Cumming and President Steinberg in 1985, 1991, and 1992. In 1990, Leucadia merged with Marks Investing Corporation (MIC). Leucadia owned 56% of MIC, and MIC owned 54% of TLC Associates, a partnership that owned approximately 58% of Leucadia. The merger gave Cumming, Steinberg, and director Jordan control of Leucadia. TLC intended to vote its Leucadia shares in favor of the merger. Pinnacle, a Leucadia shareholder, neither voted for nor against the merger.

    Procedural History

    Pinnacle initially sued Leucadia in federal court, alleging RICO violations based on the warrants and the proxy statement’s alleged failure to disclose that Business Corporation Law § 612 prohibited TLC from voting its shares. The District Court dismissed most claims but found a potential claim for breach of fiduciary duty and corporate waste, dismissing it for lack of federal jurisdiction. The Second Circuit affirmed, finding the warrants valid and holding it unnecessary to decide the § 612 issue. Pinnacle then sued in New York state court. The Supreme Court dismissed some claims based on collateral estoppel but found a valid claim for breach of fiduciary duty and waste. The Appellate Division dismissed the entire complaint. The New York Court of Appeals granted leave to appeal.

    Issue(s)

    1. Whether Pinnacle’s claims regarding the issuance of warrants are barred by collateral estoppel.

    2. Whether Business Corporation Law § 612 prohibits TLC, a partnership, from voting its shares in favor of the merger.

    Holding

    1. Yes, because the Second Circuit previously determined that the warrants were validly issued, precluding relitigation of the issue in state court.

    2. No, because § 612 explicitly applies only to corporations, not partnerships.

    Court’s Reasoning

    The Court held that collateral estoppel applied because the validity of the warrants was already decided by the Second Circuit when it dismissed Pinnacle’s RICO claim. The Second Circuit’s finding that there was “no fraud shown in the issuance of the warrants” (101 F.3d at 905) and that the directors’ business judgment was conclusive regarding valid consideration barred Pinnacle’s state law claims. The court emphasized that even though the state law claims were dismissed for lack of jurisdiction in federal court, the underlying issue had already been decided. The court also rejected Pinnacle’s argument that § 612 barred TLC from voting its shares. The court acknowledged the policy arguments for preventing cross-voting between parent companies and subsidiaries, but stressed that § 612 explicitly applies only to corporations. The Court stated, “[W]e must respect the legislative judgment that the prohibition on cross-voting between parents and subsidiaries applies only to corporations. This statute is unambiguous, and we must apply it as written.” The court contrasted New York’s law with Delaware law and the Model Business Corporation Act, which have broader provisions restricting cross-voting in situations where the subsidiary is not necessarily a corporation but is controlled by the parent.

  • Marx v. Akers, 93 N.Y.2d 323 (1999): Excusing Demand in Shareholder Derivative Suits

    93 N.Y.2d 323 (1999)

    In New York, demand on a board of directors before filing a shareholder derivative suit is excused if the complaint alleges with particularity that a majority of the directors are interested in the challenged transaction, failed to adequately inform themselves, or failed to exercise business judgment.

    Summary

    Plaintiff, a shareholder of IBM, brought a derivative action against IBM’s board, alleging excessive compensation for executives and outside directors. The defendants moved to dismiss for failure to make a demand on the board to initiate a lawsuit and for failure to state a cause of action. The New York Court of Appeals considered whether the lower court abused its discretion in dismissing the complaint for failure to make a demand and whether the complaint stated a cause of action. The Court of Appeals affirmed the dismissal, holding that demand was not excused regarding executive compensation and that the complaint failed to state a cause of action for corporate waste concerning payments to outside directors.

    Facts

    The plaintiff alleged that during a period of declining profitability at IBM, the director defendants engaged in self-dealing by awarding excessive compensation to the 15 outside directors on the 18-member board. The plaintiff also alleged that the director defendants violated their fiduciary duties by voting for unreasonably high compensation for IBM executives. The plaintiff did not make a demand on IBM’s board to initiate a lawsuit before commencing the action.

    Procedural History

    The Supreme Court dismissed the complaint, holding that the plaintiff failed to establish the futility of a demand. The Appellate Division affirmed the dismissal, concluding that the complaint lacked sufficient details to infer the futility of a demand, especially considering statutory authority allowing directors to set their own compensation. The case then came before the New York Court of Appeals.

    Issue(s)

    1. Whether the Appellate Division abused its discretion by dismissing the plaintiff’s complaint for failure to make a demand on IBM’s board of directors to initiate a lawsuit.

    2. Whether the plaintiff’s complaint fails to state a cause of action for corporate waste.

    Holding

    1. No, because the plaintiff failed to allege with particularity that demand would have been futile with respect to the executive compensation claim.

    2. Yes, because the plaintiff failed to state a cause of action for corporate waste in connection with the allegations concerning payments to IBM’s outside directors.

    Court’s Reasoning

    The Court of Appeals addressed the demand requirement under Business Corporation Law § 626(c), which requires a shareholder to demand that the corporation initiate an action before commencing a derivative suit, unless demand is futile. The court analyzed different approaches to demand futility, including the Delaware approach and universal demand requirements adopted by some states, but ultimately relied on New York precedent, particularly Barr v. Wackman. The court clarified that conclusory allegations of wrongdoing are insufficient to excuse demand. A demand is excused if the complaint alleges with particularity that: (1) a majority of directors are interested in the transaction; (2) the directors failed to inform themselves adequately; or (3) the transaction was so egregious that it could not have been the product of sound business judgment.

    Regarding executive compensation, the court found that the plaintiff failed to allege that a majority of the board was interested in setting the compensation, nor did the allegations of faulty accounting procedures move beyond conclusory allegations. However, the court found that demand was excused concerning the compensation of outside directors because they constituted a majority of the board and would directly benefit from increased compensation. Nevertheless, the court held that the complaint failed to state a cause of action for corporate waste because it lacked factually based allegations of wrongdoing or excessive compensation rates. The court emphasized that merely alleging a lack of relationship between compensation and duties performed or the cost of living is insufficient to state a cause of action. The court noted, “The courts will not undertake to review the fairness of official salaries, at the suit of a shareholder attacking them as excessive, unless wrongdoing and oppression or possible abuse of a fiduciary position are shown.”

  • GAF Corp. v. Werner, 66 N.Y.2d 97 (1985): Federal Arbitration Act and Enforceability of Arbitration Agreements

    GAF Corp. v. Werner, 66 N.Y.2d 97 (1985)

    The Federal Arbitration Act preempts state laws that would otherwise prevent arbitration of disputes, even when those disputes involve issues of corporate waste and overreaching that are also the subject of a court action.

    Summary

    This case addresses the enforceability of arbitration agreements under the Federal Arbitration Act (FAA) when a dispute involves issues that are also part of a related court action. The New York Court of Appeals held that the FAA’s policy favoring arbitration preempts state laws or policies that would prevent arbitration, even if the arbitration involves issues of corporate waste and overreaching that are also involved in a court action under Business Corporation Law § 720. The court emphasized the strong federal policy favoring arbitration and reversed the Appellate Division’s decision to stay arbitration.

    Facts

    Jesse Werner was terminated from GAF Corporation after losing a proxy fight. Werner’s employment agreement contained an arbitration clause. Following his termination, Werner demanded arbitration regarding unpaid salary and benefits. GAF sought to stay arbitration, arguing that the issues in arbitration were intertwined with a shareholder derivative action alleging mismanagement, waste, and self-dealing during Werner’s tenure as chairman. GAF argued that allowing arbitration could lead to inconsistent results and prejudice other defendants in the derivative action.

    Procedural History

    Special Term denied GAF’s motion to stay arbitration and granted Werner’s motion to compel arbitration, but stayed trial of so much of the consolidated action as related to Werner’s compensation rights under the employment agreement until completion of the arbitration. The Appellate Division reversed, granting a stay of arbitration. Werner appealed to the New York Court of Appeals.

    Issue(s)

    Whether the Federal Arbitration Act requires arbitration of a dispute arising under an employment agreement, despite the dispute involving issues of corporate waste and overreaching that are also the subject of a related court action under Business Corporation Law § 720.

    Holding

    Yes, because the Federal Arbitration Act expresses a strong federal policy favoring arbitration agreements, which preempts state laws or policies that would prevent arbitration, even if the arbitration involves issues of corporate waste and overreaching that are also involved in a court action.

    Court’s Reasoning

    The court emphasized the strong federal policy favoring arbitration agreements as declared in the Federal Arbitration Act. The court cited several Supreme Court cases, including Southland Corp. v. Keating, to support the principle that the FAA withdraws from the states the power to require resolution in a judicial forum of claims that the parties have agreed to arbitrate. The court reasoned that Business Corporation Law § 720, which GAF argued was intended to protect shareholders, was similar to the California Franchise Investment Law struck down in Southland. The court stated, “The preeminent concern of the Congress being that arbitration agreements within the coverage of the Act be carried out, such agreements are to be rigorously enforced, absent a countervailing policy in another Federal statute, even if the result is ‘piecemeal’ litigation of the issues in separate proceedings in different forums.” The court also addressed GAF’s concern that the arbitration might have a preclusive effect on the judicial proceedings, noting that the judge could consider differences in expertise, authority, fact-finding procedures, and the interests of the parties when deciding whether to give preclusive effect to the arbitrator’s holding. Ultimately, the court held that the FAA preempts any state law or policy, including Business Corporation Law § 720, that would prevent the arbitration of the dispute between GAF and Werner. The court found no overriding Federal policy preemptive of the policy favoring arbitration enunciated by the Federal Arbitration Act. The court also noted that under New York law, a broad arbitration clause requires submission to arbitration of all issues, including fraud in the inducement of the contract, except such as are specifically excluded by enumeration in the arbitration clause itself.

  • Parkoff v. General Telephone & Electronics Corp., 53 N.Y.2d 454 (1981): Res Judicata in Stockholder Derivative Suits

    Parkoff v. General Telephone & Electronics Corp., 53 N.Y.2d 454 (1981)

    A judgment in a stockholder derivative action bars a subsequent similar action by another shareholder if the first action was not collusive or fraudulent, the second shareholder wasn’t excluded from the first action, and both actions arise from the same transactions.

    Summary

    Parkoff, a GTE stockholder, initiated a derivative action alleging corporate waste and breach of fiduciary duty by officers and directors. The lower courts dismissed the complaint based on the business judgment rule and the ruling in *Auerbach v. Bennett*. The New York Court of Appeals affirmed the dismissal, not on the lower court’s reasoning regarding the business judgment rule, but based on *res judicata*. The Court found that a prior derivative suit, *Cramer v. General Telephone & Electronics*, covered the same underlying issues and barred Parkoff’s claim because Parkoff wasn’t excluded from participating in the *Cramer* action. The Court clarified that while *Auerbach* did not bar Parkoff’s suit because he was denied intervention in that case and the *Auerbach* claim was distinct, *Cramer* did preclude Parkoff’s suit.

    Facts

    Following a report by GTE’s audit committee concerning questionable payments, several shareholders filed derivative actions, including Auerbach, Limmer, and Cramer. GTE’s board created a special litigation committee to assess these actions. The committee concluded that pursuing the actions was not in the corporation’s best interest. Parkoff later filed a similar derivative action. Parkoff’s suit alleged four instances of misuse of corporate funds and assets concerning the disposition of GTE’s interest in the Philippine Long Distance Telephone Company, bribes to domestic state government employees and private domestic customers, illegal domestic political contributions, and illegal compensation to GTE subsidiaries in foreign countries.

    Procedural History

    Special Term denied the defendant’s motion to dismiss, but the Appellate Division reversed and granted summary judgment, dismissing the complaint. The Appellate Division reasoned that absent evidence of fraud or bad faith, the business judgment rule barred inquiry. The Court of Appeals reversed in part and affirmed in part, dismissing based on *res judicata*, not the business judgment rule. The Court considered the effect of previous decisions in *Auerbach v. Bennett* and *Cramer v. General Telephone & Electronics*.

    Issue(s)

    1. Whether the dismissal of a prior stockholder derivative action, *Auerbach v. Bennett*, bars a subsequent similar action by another shareholder, Parkoff?
    2. Whether the dismissal of a prior stockholder derivative action, *Cramer v. General Telephone & Electronics*, bars a subsequent similar action by another shareholder, Parkoff?

    Holding

    1. No, because Parkoff was denied intervention in the *Auerbach* action, and the underlying misconduct in *Auerbach* was separate from Parkoff’s claims.
    2. Yes, because the *Cramer* action involved the same underlying issues as Parkoff’s claims, and Parkoff did not seek intervention and was not excluded from participating in that action.

    Court’s Reasoning

    The Court reasoned that a judgment in a shareholder’s derivative action generally precludes other actions based on the same wrong by other shareholders. This rule is subject to exceptions: (1) the prior judgment was not the product of collusion or fraud, and (2) the shareholder sought to be bound wasn’t prevented from joining the prior action. The Court stated, “corporate shareholders — who in principle have an equal interest and right in seeing that claims for wrongs done to the corporation are prosecuted — should not be compelled against their will to have the prosecution of the corporate claims depend on the diligence and ability of the first shareholder to institute litigation when their own attempts to participate in the litigation have been rebuffed”. Because Parkoff was denied intervention in *Auerbach*, that case did not bar his claim. Furthermore, the *Auerbach* case only concerned improper payments to foreign officials, unlike the broader scope of Parkoff’s claims. However, the *Cramer* action did include similar allegations to Parkoff’s, and Parkoff was not excluded from participating in the *Cramer* litigation. The court emphasized that the District Court in *Cramer* decided the state law claims on the merits, and that the decision was affirmed. The court noted that “the preclusive effect of a prior valid judgment in subsequent litigation on the same claim is in no way dependent on the correctness of the earlier judgment”. Therefore, *res judicata* applied, and Parkoff’s action was barred.