Doppelt v. Denahan, Index No. 652447/2013, 5/29/15 (Scarpulla, J.)

Shareholder derivative action; standing; motion to dismiss

By Frank Tantone | Staff Writer

Defendants were board members of a corporation. Plaintiff, was a shareholder of defendants’ corporation. The corporation issued a proxy statement to solicit shareholder approval to externalize the corporation’s management. The shareholders voted 82% in favor of externalizing the company’s management. Thereafter, Plaintiff sent a demand letter to the board to take action to prevent the harm to the company that would result from the externalization. Plaintiff alleged a breach of fiduciary duties by the Defendants when they approved the externalization. The directors refused Plaintiff’s demand.

As a result, Plaintiff commenced a shareholder derivative action against the Defendants. The complaint alleged a breach of the fiduciary duties of good faith, loyalty, care and candor against the individual defendants.

Defendants moved to dismiss because Plaintiff cannot show that demand was wrongfully refused. Defendants claimed that there was an adequate investigation into the subject of Plaintiff’s demand letter. As such, Defendants were sufficiently apprised of the demanded litigation, but chose that not pursuing such litigation was in the best interest of the corporation. Defendants mainly pointed to their one-page response letter, written by outside counsel, that Plaintiff’s demand was reviewed and that the externalization decision was appropriate. However, Plaintiff argues that the Board wrongfully refused his demand because it “provided no information about the method, process and self-interest of the decision-makers” in its letter rejecting the demand.

The court found Defendant’s contention unavailing. In considering whether the board conducted a reasonable investigation into the demand, the court used factors, such as: (a) whether independent counsel was hired; (b) whether a report was produced, including the length of the report and whether it contained any explanation of the board’s procedures, reasoning, and conclusions; (c) whether the claims at issue were properly identified; (d) whether the testimony of directors, officers, employees was reviewed; and (e) the number of times that the board met regarding the demand.

The court also noted that the hiring of outside counsel could not overcome the lack of evidence demonstrating the actual investigation. Further, Defendants’ written response did not directly address any of Plaintiff’s numerous specific allegations. The bare conclusions in Defendants’ written response only pointed to assessments that were never backed by further evidence. Therefore, the court ruled that the business judgment rule could not shield the Independent Directors’ decision not to pursue the litigation demanded by Plaintiff.  As a result, the Court denied the motion to dismiss. Therefore, Plaintiff had proper standing to sue as a shareholder in this derivative action.

Doppelt v. Denahan, Index No. 652447/2013, 5/29/15 (Scarpulla, J.).

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