Commercial Division Dismisses Derivative Lawsuit After Board Rejects Shareholder Demand
The decision to bring a lawsuit on behalf of a corporation is entrusted to the corporation’s board of directors. A shareholder may not maintain a derivative lawsuit on behalf of a corporation without first making a demand on the board to bring the suit or pleading that it would be futile to make such a demand. On October 18, 2017, Justice Shirley Werner Kornreich of the New York Commercial Division dismissed a derivative lawsuit because the shareholder failed to allege that the defendant corporation’s board of directors acted in bad faith or with gross negligence when it rejected the shareholder’s demand. Reese v. Andreotti, No. 654132/2016, 2017 BL 391404, at *10 (N.Y. Sup. Ct. Oct. 18, 2017).
The shareholder alleged that the defendant corporation, Bristol-Myers Squibb, and members of its board of directors, failed to monitor the company’s compliance with the Foreign Corrupt Practices Act (“FCPA”), leading to a $14.7 million settlement with the Securities and Exchange Commission. Before filing suit, the shareholder demanded that the board of directors sue the individual directors allegedly responsible for the alleged FCPA violations.
The board retained a law firm to investigate the matters raised by the shareholder’s demand. At the conclusion of its investigation, the law firm issued a “thorough, 15-page single-spaced report” detailing its findings and recommending that the board refuse the shareholder’s demand.
In short, the report recommended that the corporation not sue the directors for breach of fiduciary duty because the investigation did not find any evidence that the directors knowingly failed to discharge their duties, and instead found that the company emphasized and enforced its FCPA compliance policies and procedures. The report also concluded that filing suit was not in the best interest of the company in light of the direct and indirect costs, including the potential impact on morale and the company’s relationships with its customers and the public.
After the board refused the shareholder’s demand, the shareholder filed an amended complaint, which the defendants moved to dismiss. Justice Kornreich noted that, by making a demand on the company’s board of directors, the shareholder tacitly acknowledged that making a demand was not futile, and that the board could fairly assess his claims without conflict of interest or lack of independence. Therefore, the court noted, the shareholder was required to allege particularized facts showing that the directors acted in bad faith or with gross negligence in refusing his demand.
The shareholder failed to meet that “extremely high burden,” the court held, because he merely identified further steps that the law firm could have taken in its investigation. At most, this raised a possibility that the firm conducted its investigation negligently, which was “not enough.”
In addition, the shareholder’s failure to address the financial and reputational costs of filing suit was “fatal” to his claim, in the court’s view, because a board of directors is “well within its rights” to conclude that bringing a lawsuit on behalf of a corporation is not in the best interests of the corporation or its shareholders.
Finally, the court held that, under controlling New York precedent, the shareholder was not entitled to conduct discovery into the reasonableness of the board’s refusal.
By Eric B. LaPre and Muhammad U. Faridi