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Commercial Division Dismisses Shareholder Derivative Suit Because General News Reports and Articles Were Insufficient to Plead Demand Futility with Particularity

Before filing a shareholder derivative suit, the plaintiff must typically serve a pre-litigation demand upon the company’s Board of Directors, except in narrow circumstances where the demand may be futile.  In Gammel v. Immelt, Justice Andrea Masley of the New York Commercial Division dismissed the shareholder derivative suit because the plaintiff did not meet the pre-litigation demand requirement and failed to plead with particularity the circumstances establishing the futility exception.[1]

According to the plaintiff-shareholders’ allegations in the Gammel complaint, although GE is one of the largest, most profitable, and most well-known companies in the world, it has recently fallen on tough times.  In late 2017 to early 2018, GE’s quarterly earnings and share price suffered steep declines after GE announced it needed to make a $15 billion capital contribution to bolster the insurance reserves of its long-term care (“LTC”) insurance business and took an $850 million loss at GE Power due to project cost overruns. 

Following the slide in the company’s stock price and the suspension of annual dividends, the plaintiff-shareholders filed suit in the Commercial Division against GE and the members of its Board of Directors, alleging breach of fiduciary duty, unjust enrichment, waste of corporate assets, abuse of control, and gross mismanagement.  The plaintiffs alleged that the directors failed to inform themselves of the issues in the LTC insurance and GE Power businesses and that they failed to control wasteful corporate jet expenditures.[2]  Although the plaintiffs did not make a pre-litigation demand upon the Board, they argued that doing so would have been futile in light of the “red flags” in numerous news reports and articles about trends in the LTC insurance and energy industries.[3]

Justice Andrea Masley granted the defendants’ motion to dismiss the complaint.  Justice Masley began by explaining the importance under Business Corporation Law (“BCL”) § 626 of filing a pre-litigation demand before bringing a shareholder derivative action.  BCL § 626 states that the complaint in any shareholder derivative action “shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort.”  However, under the Court of Appeals’ decision in Marx v. Akers,[4] a plaintiff’s failure to serve a pre-litigation demand may be excused if the plaintiff pleads with particularity that (1) a majority of the directors are interested in the transaction, (2) the directors failed to inform themselves to a degree reasonably necessary about the transaction, or (3) the directors failed to exercise their business judgment in approving the transaction.[5]

Justice Masley found that the plaintiffs’ complaint did not plead any of these conditions with particularity.  As to first exception under Marx, the complaint failed to plead any particularized facts that GE’s directors stood to financially benefit from the transactions at issue. 

As to second exception under Marx, the court found that the complaint did not sufficiently allege failure to inform because, even though the Board met regularly, there were no allegations that the issues with the LTC insurance business or GE Power were discussed at the Board’s meetings or that the Board was actually presented with red flags about these businesses that it chose to ignore.  Nor were there any allegations, the court noted, that the Board was aware of the allegedly wasteful corporate jet spending.  The court found that the complaint’s references to general media reports of downward trends in the LTC insurance and power industries were insufficient to establish that the directors were alerted to internal wrongdoing at GE.  Finally, the court found that the Board was entitled to rely on audit opinions provided by KPMG about GE’s financial performance and internal controls.[6]

As to third Marx exception, the court found the allegations related to wasteful corporate jet spending to be insufficient because there were no allegations that any director personally benefited from the use of the corporate jets or that any director engaged in specific fraudulent conduct relating to the corporate jets.  The court noted that, in any event, GE’s executives had repaid the company for their personal use of GE’s corporate aircraft.[7] 

Accordingly, the court found that plaintiffs’ failure to file a pre-litigation demand was not excused, and it therefore granted the defendants’ motion to dismiss.[8]

By Benjamin F. Jackson and Muhammad U. Faridi

[1] No. 650780-2018, 2019 BL 264106 (Sup. Ct. June 28, 2019).

[2] Id. at *1-2.

[3] Id. at *2-3.

[4] 88 N.Y.2d 189 (1996).

[5] Gammel, 2019 BL 264106 at *3-4.

[6] Id. at *4-7.

[7] Id. at *7-8.

[8] The Commercial Division also granted the part of the motion seeking dismissal of the complaint against the director defendants under BCL § 402(b), which “allows a corporation to shield a director from liability provided that the director was not engaged in intentional misconduct, bad faith, or a knowing violation of the law.”  Id. at *9.  GE’s certificate of incorporation contained the requisite exculpatory language, and there were no specific, particularized factual allegations sufficient to infer that the director defendants engaged in bad faith, intentional misconduct, or a knowing violation of the law.  Id.