New York Law Review

Tag: Shareholder Derivative Action

  • Abrams v. Donati, 66 N.Y.2d 951 (1985): Distinguishing Individual vs. Derivative Claims in Shareholder Lawsuits

    Abrams v. Donati, 66 N.Y.2d 951 (1985)

    A shareholder does not have an individual cause of action for wrongs against a corporation, even if they lose the value of their investment, unless the wrongdoer breached a duty owed to the shareholder independent of any duty to the corporation.

    Summary

    This case clarifies the distinction between individual and derivative claims in shareholder lawsuits. The plaintiff, a shareholder and former president of Donrico, Inc., sued the defendants, alleging a conspiracy to terminate his employment and depress the value of his stock. The court held that the plaintiff’s claims were primarily derivative, alleging harm to the corporation, not individual harm distinct from that suffered by other shareholders. Because the plaintiff did not demonstrate a breach of duty owed directly to him, his individual cause of action was properly dismissed.

    Facts

    Plaintiff Abrams was a shareholder and the president of Donrico, Inc.
    The defendants allegedly conspired to terminate Abrams’ employment as president.
    The alleged conspiracy also aimed to depress the value of Donrico’s stock.
    The purpose of depressing the stock value was to allow the corporation to acquire the stock at a depreciated price under a shareholders’ agreement.
    Abrams alleged that the defendants diverted corporate assets by padding expenses and fraudulently reducing the price of Donrico’s products to a corporate purchaser owned by one of the conspirators.

    Procedural History

    Abrams brought an action against the defendants alleging individual and derivative claims.
    Abrams discontinued his second cause of action which sought damages for wrongful termination of his employment contract.
    The lower court dismissed Abrams’ first cause of action.
    The Appellate Division affirmed the dismissal, and the Court of Appeals affirmed the Appellate Division’s judgment.

    Issue(s)

    Whether a shareholder can bring an individual cause of action for wrongs allegedly done to the corporation, where the shareholder claims the wrongs resulted in the termination of their employment and a depression in the value of their stock.

    Holding

    No, because the allegations of mismanagement and diversion of assets primarily plead a wrong to the corporation, for which a shareholder may sue derivatively but not individually, unless the wrongdoer breached a duty owed to the shareholder independent of any duty owing to the corporation.

    Court’s Reasoning

    The court relied on the established principle that a shareholder generally lacks an individual cause of action for wrongs done to the corporation. The court cited Citibank v. Plapinger, noting a shareholder has no individual cause of action for a wrong against a corporation, even if he loses the value of his investment.
    The Court acknowledged exceptions where the wrongdoer breached a duty owed to the shareholder independent of any duty owing to the corporation, citing General Rubber Co. v. Benedict and Hammer v. Werner as examples.
    The court emphasized that allegations of mismanagement or diversion of assets, without more, plead a wrong to the corporation, requiring a derivative suit. The court stated, “[A]llegations of mismanagement or diversion of assets by officers or directors to their own enrichment, without more, plead a wrong to the corporation only, for which a shareholder may sue derivatively but not individually.”
    The court found that Abrams’ complaint confused derivative and individual rights, warranting dismissal. The court explained that there was “no claim that plaintiff sustained a loss disproportionate to that sustained by Donrico, or that defendants breached an independent duty owed plaintiff…”
    The court also considered the fact that Abrams had discontinued his second cause of action, which sought damages for the wrongful termination of his employment contract. The court noted that the Appellate Division’s failure to grant leave to replead was appropriate, especially since the claim against Houbigant, Inc., had already been dismissed on the ground that it alleged wrongs to Donrico resulting in a proportionate decrease in the value of plaintiff’s stock, which afforded him no right to individual relief. This highlights the court’s focus on whether the harm was primarily to the corporation or distinctly to the shareholder.

  • Independent Investor Protective League v. Time, Inc., 50 N.Y.2d 265 (1980): Standing in Derivative Suits After Corporate Dissolution

    50 N.Y.2d 265 (1980)

    A shareholder derivative action may be maintained even after the corporation has dissolved and distributed its assets, provided the shareholder meets the contemporaneous ownership requirement.

    Summary

    This case addresses whether shareholders can bring a derivative suit on behalf of a corporation after it has dissolved and distributed its assets. Plaintiffs, former shareholders of Sterling Communications, Inc., sued Time, Inc., alleging mismanagement that depressed Sterling’s stock value before Time acquired it. The New York Court of Appeals held that the dissolution of Sterling did not automatically eliminate the shareholders’ standing to bring a derivative action, provided they were shareholders at the time of the alleged wrongdoing. The court reasoned that shareholders retain an interest in corporate assets even after dissolution, and the Business Corporation Law protects their remedies.

    Facts

    Time, Inc. invested in Sterling Communications, Inc. starting in 1965, eventually gaining substantial control, owning 80% of the stock by 1973. A majority of Sterling’s directors were also Time officers. In September 1973, Sterling shareholders approved the sale of all assets to Time and authorized Sterling’s dissolution and asset distribution. Plaintiffs, former Sterling shareholders, filed a derivative suit six months later, alleging that Sterling’s officers and directors, at Time’s direction, deliberately mismanaged Sterling between 1970 and 1973, depressing its stock value and enabling Time to acquire Sterling at a deflated price.

    Procedural History

    The Special Term granted Time’s motion for summary judgment, finding that plaintiffs lacked standing because they were not Sterling shareholders when the suit was filed, as Sterling had been dissolved. The Appellate Division unanimously affirmed this decision, stating that because the corporate entity no longer existed, the plaintiffs lacked standing. The New York Court of Appeals reversed the Appellate Division’s order.

    Issue(s)

    Whether shareholders of a dissolved corporation have standing to maintain a derivative action on behalf of the corporation for actions that occurred prior to the dissolution.

    Holding

    Yes, because the dissolution of a corporation does not automatically deprive its shareholders of the right to pursue derivative claims for pre-dissolution misconduct, provided they meet the contemporaneous ownership requirement.

    Court’s Reasoning

    The court rejected the argument that corporate dissolution automatically extinguishes a shareholder’s right to bring a derivative action. It emphasized that under New York’s Business Corporation Law, a dissolved corporation can still sue and be sued. The court acknowledged the dual requirements for derivative standing under Business Corporation Law § 626(b): contemporaneous ownership (owning stock at the time of the alleged wrong) and continuous ownership until the action is commenced. The contemporaneous ownership rule prevents speculation in litigation. While typically, voluntarily disposing of stock terminates shareholder rights, dissolution is not a voluntary act. The court reasoned that dissolution does not abruptly end the shareholder’s interest, especially concerning the distribution of corporate assets. Citing Business Corporation Law § 1006(b), the court stated, “The dissolution of a corporation shall not affect any remedy available to * * * [its] shareholders for any right or claim existing * * * before such dissolution.” The court concluded that the dissolution, by itself, does not preclude a qualified plaintiff from being deemed a shareholder at the time of bringing the derivative action. The court modified the Appellate Division’s order, denying Time’s motion to dismiss, except concerning shareholders who exercised appraisal rights under Business Corporation Law § 623(e).

  • Diamond v. Oreamuno, 24 N.Y.2d 494 (1969): Corporate Opportunity Doctrine and Insider Trading Profits

    24 N.Y.2d 494 (1969)

    Corporate officers and directors breach their fiduciary duty when they use inside information, gained through their positions, to profit from transactions in the company’s stock, and the corporation can recover those profits even without a showing of direct corporate damage.

    Summary

    A shareholder derivative action was brought against officers and directors of Management Assistance, Inc. (MAI), alleging that the chairman and president, Oreamuno and Gonzalez, used inside information about a significant decline in MAI’s earnings to sell their shares before the information became public, thereby avoiding substantial losses. The plaintiff sought to compel the defendants to account to the corporation for these profits. The New York Court of Appeals held that the officers breached their fiduciary duty by exploiting inside information for personal gain, and the corporation was entitled to recover the profits, regardless of whether the corporation suffered direct damages. The court emphasized the need to prevent corporate insiders from profiting from their privileged positions.

    Facts

    Management Assistance, Inc. (MAI) financed computer installations. Due to a sharp increase in IBM service charges, MAI’s net earnings dropped significantly in August 1966. Oreamuno and Gonzalez, MAI’s chairman and president, respectively, learned of this decline before it was publicly disclosed. Prior to the public release of this information, Oreamuno and Gonzalez sold 56,500 shares of their MAI stock at $28 per share. After the information was made public, the stock price plummeted to $11 per share. The plaintiff alleged that Oreamuno and Gonzalez realized $800,000 more than they would have if they had waited for the public disclosure.

    Procedural History

    The plaintiff, a shareholder, filed a derivative action against the officers and directors. The defendants moved to dismiss the complaint for failure to state a cause of action, which was initially granted by the Special Term. The Appellate Division modified the order, reinstating the complaint against Oreamuno and Gonzalez. The case then went to the New York Court of Appeals on a certified question.

    Issue(s)

    Whether officers and directors may be held accountable to their corporation for gains realized from transactions in the company’s stock as a result of their use of material inside information, even in the absence of direct damage to the corporation.

    Holding

    Yes, because corporate fiduciaries, entrusted with valuable inside information, may not appropriate that asset for their own use, even if no direct injury to the corporation is proven. The primary concern is determining which party, the corporation or the insiders, has a higher claim to the profits derived from the exploitation of the information.

    Court’s Reasoning

    The court reasoned that a person who acquires special knowledge by virtue of a fiduciary relationship cannot exploit that knowledge for personal benefit but must account to their principal for any profits. This principle prevents agents and trustees from extracting secret profits from their position of trust. The court rejected the argument that the corporation must demonstrate damages to recover, emphasizing that the purpose of a fiduciary duty action is to prevent such breaches by removing the incentive for self-dealing. The court noted that “to prevent them, by removing from agents and trustees all inducement to attempt dealing for their own benefit in matters which they have undertaken for others, or to which their agency or trust relates.”

    The court further explained that a corporation has a significant interest in maintaining its reputation and the public’s confidence in its management and securities. The court quoted Presiding Justice Botein, stating, “ [t]he prestige and good will of a corporation, so vital to its prosperity, may be undermined by the revelation that its chief officers had been making personal profits out of corporate events which they had not disclosed to the community of stockholders.” The court distinguished between officers who share the same risks and benefits as other shareholders and those who exploit their privileged positions for special advantages. It cited Section 16(b) of the Securities Exchange Act of 1934 as an example of a similar remedy under federal law, although it acknowledged that the federal statute might not apply in this specific case because the defendants held the shares for longer than six months. The court found no conflict with federal law, citing Section 28(a) of the Securities Exchange Act of 1934, which states that “ [t]he rights and remedies provided by this title shall be in addition to any and all other rights and remedies that may exist at law or in equity ”.

    The court also addressed the concern of potential double liability by noting that the likelihood of a separate suit by purchasers was remote and that the defendants could interplead any potential claimants. In conclusion, the court emphasized that it was sitting as a court of equity and should prevent unjust enrichment from wrongful acts, stating, “Dishonest directors should not find absolution from retributive justice by concealing their identity from their victims under the mask of the stock exchange.”