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.”