New York Law Review

Tag: Director Liability

  • Barr v. Wackman, 36 N.Y.2d 371 (1975): Excusing Demand in Derivative Suits Based on Board’s Breach of Duty

    Barr v. Wackman, 36 N.Y.2d 371 (1975)

    A shareholder derivative suit demand on the board of directors is excused when the complaint alleges particularized facts demonstrating that a majority of the directors may be liable for breach of their duties of due care and diligence to the corporation, even without allegations of fraud or self-dealing.

    Summary

    A shareholder derivative action was brought against Talcott National Corporation directors, alleging they breached their fiduciary duties. The plaintiff didn’t demand the board initiate action, claiming it would be futile because the board participated in the alleged wrongdoing. The court addressed whether allegations of board participation and approval of acts involving bias by affiliated directors, coupled with the remaining directors’ alleged failure to exercise due care, were sufficient to excuse demand. The court held that the demand was excused because the complaint sufficiently alleged that a majority of the directors might be liable, making it unlikely they would pursue the action.

    Facts

    Plaintiff, a shareholder of Talcott National Corporation, brought a derivative action against several directors, including affiliated directors (those with official capacities beyond their directorships) and unaffiliated directors (those whose only connection was as directors). The complaint alleged that the affiliated directors, seeking personal benefits, conspired with Gulf & Western Industries to facilitate its acquisition of Talcott on terms less favorable to Talcott’s shareholders. As part of this scheme, the board allegedly abandoned a merger agreement, approved a tender offer, authorized favorable employment contracts for officers, and sold a subsidiary at a loss, all to benefit Gulf & Western and the affiliated directors. The unaffiliated directors allegedly failed to exercise independent judgment and due care.

    Procedural History

    The defendants moved to dismiss the complaint for failure to make a demand on the board as required by Business Corporation Law § 626(c). The Supreme Court denied the motion, and the Appellate Division affirmed. The case was appealed to the New York Court of Appeals by permission of the Appellate Division on a certified question regarding the propriety of the denial of the motion to dismiss.

    Issue(s)

    Whether allegations of board participation in and approval of acts involving bias and self-dealing by minority affiliated directors and breach of fiduciary duties of due care and diligence by the remaining majority unaffiliated directors are sufficient to withstand a motion to dismiss for failure to make a demand.

    Holding

    Yes, because the complaint alleges acts for which a majority of the directors may be liable, and therefore, the plaintiff reasonably concluded that a demand would be futile. The court emphasized that the board’s actions, as part of a series of events benefiting the affiliated directors rather than Talcott, were not immune from question in a derivative action.

    Court’s Reasoning

    The court reasoned that the demand requirement, codified in Business Corporation Law § 626(c), is rooted in the principle that corporate management is entrusted to the board of directors. The demand rule aims to allow directors to correct alleged abuses without court intervention and to protect them from harassment by litigious shareholders. However, a demand is excused when it would be futile, such as when the alleged wrongdoers control or comprise a majority of the directors. The court emphasized that it is insufficient to merely name a majority of directors as defendants with conclusory allegations. Here, the complaint presented particularized transactions benefiting Gulf & Western and the affiliated directors, while the unaffiliated directors allegedly disregarded Talcott’s interests. The court stated, “Plaintiff may prove that the exercise of reasonable diligence and independent judgment under all the circumstances by the unaffiliated directors, at least to meaningfully check the decisions of the active corporate managers, would have put them on notice of the claimed self-dealing of the affiliated directors and avoided the alleged damage to Talcott. If the unaffiliated directors abdicated their responsibility, they may be liable for their omissions.” The court explicitly rejected the notion that directorial fraud or self-interest is always required to excuse demand, noting that directors have affirmative duties of due care and diligence beyond avoiding self-dealing. The court emphasized, “Particular allegations of formal board participation in and approval of active wrongdoing may, as here, suffice to defeat a motion to dismiss.” The court concluded that the determination of whether a demand is necessary rests in the sound discretion of the court, based on a liberal construction of the complaint. The court cited Kavanaugh v Commonwealth Trust Co., 223 NY 103, 106 stating, “No custom or practice can make a directorship a mere position of honor void of responsibility, or cause a name to become a substitute for care and attention. The personnel of a directorate may give confidence and attract custom; it must also afford protection.”

  • Kavanaugh v. Gould, 223 N.Y. 103 (1918): Director Liability for Neglect of Duty

    Kavanaugh v. Gould, 223 N.Y. 103 (1918)

    Directors of financial institutions owe a duty of care to the institution, requiring them to exercise the same degree of care and prudence that men prompted by self-interest generally exercise in their own affairs; failure to exercise such care can result in liability for losses sustained by the company.

    Summary

    This case addresses the liability of a director, George Gould, for losses sustained by the Commonwealth Trust Company due to his alleged neglect of duties. Gould was a director for a short period and never attended meetings or acquainted himself with the company’s business. The court reversed the lower courts’ decision in favor of Gould, holding that the trial court failed to make necessary findings on whether Gould was negligent and whether his neglect caused the losses. The Court of Appeals emphasized that directors cannot use their position as a mere honor without responsibility and must be involved in the general affairs of the company.

    Facts

    The Commonwealth Trust Company was established in March 1902. George Gould became a director on April 3, 1902, and resigned on October 29, 1902. During this time, the trust company experienced substantial losses due to mismanagement, largely stemming from its heavy investment in the United States Shipbuilding Company. Gould never attended any director meetings nor familiarized himself with the trust company’s business practices.

    Procedural History

    The case initially addressed the sufficiency of the complaint in prior appeals (181 N.Y. 121 and 191 N.Y. 522). Following trial, the lower courts ruled in favor of the defendant, Gould. The plaintiff appealed, arguing the trial court failed to make findings on the core issues of Gould’s negligence and causation of losses. The New York Court of Appeals reversed the Appellate Division’s judgment and ordered a new trial, finding that the trial court’s failure to make findings on the key issues constituted a mistrial.

    Issue(s)

    Whether the trial court erred by failing to make findings on (1) whether Gould was negligent in his duties as a director, and (2) whether such negligence caused the losses sustained by the Commonwealth Trust Company.

    Holding

    Yes, because the trial court failed to determine the key issues of the director’s neglect and the losses attributable to that neglect; therefore, a mistrial occurred, warranting a new trial. The court stated, “A judgment must be based upon facts found, not facts refused.”

    Court’s Reasoning

    The court reasoned that directors of financial institutions have a duty to exercise the same level of care and prudence that men prompted by self-interest would exercise in their own affairs. The court cited precedent such as Hun v. Cary, 82 N.Y. 65. Directors must be knowledgeable about the general affairs, business policies, investments, and resource allocation of the institution. The court highlighted several questionable transactions, including speculation in the company’s own stock, improper loans to entities connected to the company’s president, and excessive loans related to the United States Shipbuilding Company. The Court emphasized that “[n]o custom or practice can make a directorship a mere position of honor void of responsibility, or cause a name to become a substitute for care and attention.” The court determined that there was evidence from which a finding of Gould’s neglect and the resulting losses could be made. The absence of findings on these issues by the trial court necessitated a new trial. The court noted that a refusal to find a fact requested is not equivalent to an affirmative finding to the contrary. The court emphasized that there was evidence suggesting Gould should have been aware of the company’s affairs and the president’s actions, and whether he should have acted to prevent further risky loans was a question of fact for the trial court. The Court indicated that the core question was “whether, as a director, he should have known, by the July 22d meeting, something of the company’s affairs and the transactions and methods of its president, and whether, upon the evidence and under the conditions above stated, he should have, in the exercise of reasonable care, done something to prevent the continuance of such methods and further loans on shipbuilding bonds without a check or supervision.”