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Allegations of Wrongdoing Insufficient to Support Shareholders Derivative Action Pursuant to BCL 626 (c)

The Second Department determined plaintiffs failed to make allegations sufficient to support a shareholders derivative action pursuant to Business Corporation Law 626(c):

Pursuant to Business Corporation Law § 626(c), in order to assert a derivative cause of action, in their complaint, shareholders must “set forth with particularity [their] efforts . . . to secure the initiation of such action by the board or the reasons for not making such effort” … . Here, because the plaintiffs conceded that they made no demand upon the board, they were required to plead facts demonstrating that a demand would have been futile.

“Demand is futile, and excused, when the directors are incapable of making an impartial decision as to whether to bring suit” … . A plaintiff may satisfy this standard by alleging with particularity (1) “that a majority of the board of directors is interested in the challenged transaction,” which may be based on self-interest in the transaction or a loss of independence because a director with no direct interest in the transaction is “controlled” by a self-interested director, (2) “that the board of directors did not fully inform themselves about the challenged transaction to the extent reasonably appropriate under the circumstances,” or (3) “that the challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors” … . However, “[t]o justify failure to make a demand, it is not sufficient to name a majority of the directors as defendants with conclusory allegations of wrongdoing or control by wrongdoers” … .

Although the plaintiffs’ proposed amended complaint alleges that the individual defendants had a personal interest in the challenged transactions, it fails to describe the challenged transactions or to explain how any but one of the corporation’s four directors would have profited from them. These “conclusory allegations of wrongdoing or control by wrongdoers” are insufficient … . Instead, to adequately plead self-interest, the complaint must set forth facts alleging that the directors “receive[d] a direct financial benefit from the transaction which is different from the benefit to shareholders generally” … . The plaintiffs have failed to satisfy this standard. Similarly, the plaintiffs’ allegations that the corporation’s directors made “lavish and unnecessary expenditures” and paid themselves “unwarranted salaries” are insufficient because they fail to “allege compensation rates excessive on their face or other facts which call into question whether the compensation was fair to the corporation when approved, the good faith of the directors setting those rates, or that the decision to set the compensation could not have been a product of valid business judgment” … . Because the proposed amended complaint fails to adequately describe the challenged transactions or allege in what manner they were inappropriate, it also fails to “allege[ ] with particularity that the board of directors did not fully inform themselves about the challenged transaction[s] to the extent reasonably appropriate under the circumstances” or that “the challenged transaction[s were] so egregious on [their] face that [they] could not have been the product of sound business judgment” … . Accordingly, the plaintiffs’ allegations, incorporating the proposed amendments, remained palpably insufficient, and the Supreme Court erred in determining that the plaintiffs had satisfied the standard for leave to amend a pleading … . Walsh v Wwebnet inc, 2014 NY Slip Op 02575, 2nd Dept 4-16-14

 

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Corporate Officer Personally Liable for Outstanding Sales and Use Taxes

The Third Department determined the evidence was sufficient to hold a corporate officer personally liable for outstanding sales and use taxes.  The court explained the criteria for such personal liability:

Tax Law § 1133 (a) imposes personal liability on any person who is responsible for collecting tax under Tax Law article 28. A person required to collect tax (a responsible person) includes “any officer, director or employee of a corporation . . . who . . . is under a duty to act for such corporation . . . in complying with any requirement of [Tax Law article 28]” (Tax Law § 1131 [1]). Whether a person has a duty to act for a corporation and is responsible for collecting sales tax is a factual determination to be made on a case by case basis (…20 NYCRR 526.11 [b] [1], [2]). The factors that the courts have considered relevant to this determination include (1) authority to sign corporate checks, (2) responsibility for managing the corporation and maintaining its books, (3) ability to hire and fire employees, (4) status as a corporate officer, and (5) receipt of substantial income from the corporation or stock ownership … . Significantly, this Court has stressed that “[w]hat must be considered is [the person’s] authority and responsibility to exercise control over the corporation, not his [or her] actual assertion of such authority” … . Matter of Ippolito v Commissioner of NY State Dept of Taxation & Finance, 2014 NY Slip Op 02475, 3rd Dept 4-10-14

 

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Shareholder in a Cooperative Apartment Corporation Had Right to Inspect Books

The Second Department determined a shareholder in a cooperative apartment corporation (Acropolis) had a right to inspect the corporate books, including the  minutes of board meetings:

…[T]he petitioner satisfied the requirements of Business Corporation Law § 624(b), and is, therefore, entitled to a list of shareholders and their mailing addresses … as well as all Board meeting minutes from 2001 to the present. Moreover, in light of the terms of the relevant proprietary lease …, the petitioner established his contractual right to inspect all of Acropolis’s books of account from 2001 to the present. With respect to the petitioner’s entitlement to inspect additional corporate documents, “a shareholder has a common-law right to inspect a corporation’s books and records if the inspection is sought in good faith and for a valid purpose” … . Contrary to Acropolis’s contention, the Supreme Court was not required to hold a hearing prior to issuing its order and judgment directing it to allow the petitioner to review its books and records, because no substantial question of fact existed as to the petitioner’s good faith and purpose in seeking Acropolis’s books and records… . Matter of Goldstein v Acropolis Gardens Realty Corp, 2014 NY Slip Op 02436, 2nd Dept 4-9-14

 

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Tax Law Amendment Allowing New York to Collect Capital Gains Tax from a Nonresident Shareholder in an S Corporation Should Not Have Been Applied Retroactively to a Transaction Which Took Place Three and a Half Years Before the Amendment

In a full-fledged opinion by Justice Richter, over a dissenting opinion, the First Department determined an amendment to the tax law should not be applied retroactively.  The amendment allowed New York to collect capital gains tax from a nonresident shareholder in an S corporation which has distributed an installment obligation under section 453 (h)(1)(A) of the Internal Revenue Code:

Determining whether the retroactive application of a tax statute violates a taxpayer’s due process rights “is a question of degree” and “requir[es] a balancing of [the] equities”… . In James Sq. [21 NY3d 233], the Court of Appeals recently reaffirmed a three-prong test to determine whether the retroactive application of a tax statute passes constitutional muster. “The important factors in determining whether a retroactive tax transgresses the constitutional limitation are (1) the taxpayer’s forewarning of a change in the legislation and the reasonableness of . . . reliance on the old law,’ (2) the length of the retroactive period,’ and 3) the public purpose for retroactive application'”… .

…[P]laintiffs had “no warning and no opportunity [in 2007] to alter their behavior in anticipation of the impact of the [2010 amendment]”…. . * * *

In James Sq., the Court concluded that a retroactive period of 16 months “should be considered excessive and weighs against the State” (21 NY3d at 249). Here, the period of retroactivity was 3 1/2 years — nearly three times longer than the period found excessive in James Sq. As in James Sq., we conclude that this excessive period was “long enough . . . so that plaintiffs gained a reasonable expectation that they would secure repose in the existing tax scheme” … . * * *

The legislative history indicates that enactment of the legislation was necessary to implement the 2010-2011 executive budget by raising tax revenues by $30 million in that fiscal year. Indeed, defendants expressly state in their brief that the legislature made the law retroactive to prevent revenue loss. But “raising money for the state budget is not a particularly compelling justification” and “is insufficient to warrant retroactivity in a case [as here] where the other factors militate against it” (James Sq., 21 NY3d at 250). Caprio v New York State Dept of Taxation & Finance, 2014 NY Slip Op 02399l 1st Dept 4-8-14

 

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Trial Court Properly Pierced the Corporate Veil/Criteria for Review of a Bench Trial and for Piercing the Corporate Veil Explained

The Fourth Department determined the trial court had properly pierced the corporate veil to find the defendant physician personally liable to the plaintiff landlord.  The defendant ceased paying rent when he joined another urology practice.  The court noted that the defendant (Roehmholdt) made no effort to continue his business (Northtown Urology) at plaintiff’s location, but rather took more lucrative employment, encouraged his patients to follow him, and used corporate funds to satisfy a personal debt.  In the course of upholding the piercing of the corporate veil, the Fourth Department explained how it reviews determinations made in a bench trial:

As a preliminary matter, we note that, “[o]n an appeal from a judgment rendered after a nonjury trial, our scope of review is as broad as that of the trial court … . Upon such a review, the record should be‘viewed in the light most favorable to sustain the judgment’ …, and this Court should evaluate ‘the weight of the evidence presented and grant judgment warranted by the record, giving due deference to the trial court’s determinations regarding witness credibility, so long as those findings could have been reached upon a fair interpretation of the evidence’ …. ‘[T]he decision of the fact-finding court should not be disturbed upon appeal unless it is obvious that the court’s conclusions could not be reached under any fair interpretation of the evidence, especially when the findings of fact rest in large measure on considerations relating to the credibility of witnesses’ … .

With respect to piercing the corporate veil, we note that it is not “ ‘a cause of action independent of that against the corporation; rather it is an assertion of facts and circumstances which will persuade the court to impose the corporate obligation on its owners’ ” … . “ ‘A plaintiff seeking to pierce the corporate veil must establish that the owners, through their domination, abused the privilege of doing business in the corporate form, thereby perpetrating a wrong that resulted in injury to the plaintiff . . . Factors to be considered in determining whether [a corporation] has abused [that] privilege . . . include whether there was a failure to adhere to corporate formalities, inadequate capitalization, commingling of assets, and use of corporate funds for personal use’ ” … .

The burden of establishing that the corporate veil should be pierced is a heavy one … but “ ‘[b]roadly speaking, the courts will disregard the corporate form, or, to use accepted terminology, pierce the corporate veil, whenever necessary to prevent fraud or to achieve equity’ ” … . “A decision to pierce the corporate veil is a fact-laden [determination]” …, and “[n]o one factor is dispositive” … . A & M Global Management Corp v Northtown Urology Associates PC, 124, 4th Dept 3-28-14

 

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Corporate Officer Not Liable in Lead Paint Exposure Case Under “Commission of a Tort” Doctrine for Nonfeasance/No Evidence of Malfeasance or Misfeasance

The Fourt Department determined summary judgment should have been granted to a corporate officer in a lead paint exposure case. The court explained when the “commission of a tort” doctrine applies to corporate officers:

“The ‘commission of a tort’ doctrine permits personal liability to be imposed on a corporate officer for misfeasance or malfeasance, i.e., an affirmative tortious act; personal liability cannot be imposed on a corporate officer for nonfeasance, i.e., a failure to act” … . Such misfeasance may include exacerbating a hazardous lead paint condition by negligently attempting to correct it … . Here, defendant met his initial burden by presenting “evidence that, if uncontroverted, would have established that [he] did not personally participate in malfeasance or misfeasance constituting an affirmative tortious act” … . Plaintiff failed to raise an issue of fact in response, inasmuch as he submitted no evidence that defendant affirmatively created the dangerous lead condition at the property or did anything to make it worse; at most, defendant merely failed to remedy the condition. We thus conclude that he cannot be held individually liable to plaintiff in this action. Lloyd v Moore…, 200, 4th Dept 3-28-14

 

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Answer Submitted Pro Se by Corporation Is a Nullity

The Second Department noted that a corporation must be represented by counsel and an answer submitted by a corporation pro se was a nullity:

…[T]he Supreme Court erred in accepting an untimely, pro se answer from the defendant corporation, and in thereby denying that branch of the plaintiff’s motion which was for leave to enter a default judgment on the complaint. The proffered answer was a nullity, since a corporation must be represented by an attorney and cannot proceed pro se (see CPLR 321[a]…). Boente v Peter C Kurth Off of Architecture & Planning PC, 2014 NY Slip Op 00473, 2nd Dept 1-29-14

 

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No Fiduciary Duty Re: Purchase of One Shareholder’s Stock by Another in a Close Corporation

In affirming Supreme Court’s dismissal of a cause of action for breach of fiduciary duty based on one shareholder’s purchase of another shareholder’s stock in a close corporation, the Second Department noted that the status of an officer, director or shareholder of a close corporation does not, without more, create a fiduciary relationship:

“The elements of a cause of action to recover damages for breach of fiduciary duty are (1) the existence of a fiduciary relationship, (2) misconduct by the defendant, and (3) damages directly caused by the defendant’s misconduct” … . “A fiduciary relationship exists between two persons when one of them is under a duty to act for . . . the benefit of another upon matters within the scope of the relation” …

Contrary to the plaintiff’s contention, [the purchaser’s] status as an officer, director, or shareholder of a close corporation “does not, by itself, create a fiduciary relationship as to his individual purchase of [another shareholder’s] stock” … .  Varveris v Zacharakos, 2013 NY Slip Op 07028, 2nd Dept 10-30-13

 

Plaintiffs Not Entitled to Attorneys Fees in Shareholder Derivative Action Because They Did Not Go to the Board Before Going to Court

In a full-fledged opinion by Justice Friedman, the First Department determined the plaintiffs in a (putative) shareholder derivative action were not entitled to an award of legal fees pursuant to Business Corporation Law 626 because the plaintiffs went straight to court without first making a pre-suit demand upon the board for the desired action.  The plaintiffs sued the Goldman Sachs Group (GPS) to demand a reduction in employee compensation based on the prediction GPS would announce excessive employee compensation. When GPS announced a lower level of compensation, plaintiffs, claiming that the action had attained its objective, moved for a voluntary dismissal and for an award of legal fees.  In affirming Supreme Court’s denial of legal fees, the court wrote:

Plaintiffs argue that Business Corporation Law § 626(e) (quoted in pertinent part at footnote 5, supra) does not expressly require a showing that the demand requirement was complied with or excused as a prerequisite to an award of attorneys’ fees for bringing an action that brought a substantial benefit to the corporation (as plaintiffs claim—and defendants deny—that this action did). Plaintiffs further argue that there is no reason to construe the statute to imply such a requirement. We disagree. * * *

The demand requirement, far from being a meaningless formality, “rests on basic principles of corporate control–that the management of the corporation is entrusted to its board of directors, who have primary responsibility for acting in the name of the corporation and who are often in a position to correct alleged abuses without resort to the courts. The demand requirement thus relieves the courts of unduly intruding into matters of corporate governance by first allowing the directors themselves to address the alleged abuses. The requirement also provides boards with reasonable protection from harassment on matters clearly within their discretion, and it discourages strike suits commenced by shareholders for personal rather than corporate benefit” … . Central Laborers’ Pension Fund v Blankfein, 2013 NY Slip Op 05857, 1st Dept 9-17-13

 

 

Criteria for Shareholder’s Derivative Action and Shareholder’s Action to Inspect Corporate Books Explained

The Second Department explained the pleading criteria for a shareholder’s derivative action for inspection of corporation records.  Here the court determined the shareholders failed to first demand that the corporation initiate an action before bringing the derivative action, and the shareholders’ speculative and conclusory allegations were not sufficient to demonstrate a “proper purpose” for the inspection of corporate records:

A plaintiff in a shareholders’ derivative action must demand that the corporation initiate an action before commencing an action on the corporation’s behalf, and the complaint must “set forth with particularity” his or her efforts “to secure the initiation of such action by the board or the reasons for not making such effort” … . Demand may be excused because of futility where the complaint alleges with particularity, inter alia, that a majority of the board of directors is interested in the challenged transaction[s] … . However, “[i]t is not sufficient . . . merely to name a majority of the directors as parties defendant with conclusory allegations of wrongdoing or control by wrongdoers to justify failure to make a demand” … . Here, the plaintiffs’ submissions failed to allege specific facts supporting their contention that the defendant directors were interested, such that demand was not required, and the Supreme Court … properly granted that branch of the defendants’ motion which was to dismiss [the relevant] causes of action on that ground… . * * *

…”[A] shareholder has both statutory and common-law rights to inspect the books and records of a corporation if inspection is sought in good faith and for a valid purpose” (…Business Corporation Law § 624[f]). However, the plaintiffs failed to allege that their demand for an inspection of [the] books and records met the requirements for such relief under the Business Corporation Law (see Business Corporation Law § 624[b]). The plaintiffs also failed to state a cause of action for an inspection of [the] corporate books and records at common law, since a plaintiff asserting his or her common-law right must plead a “proper purpose” for the inspection …. Apart from the claim concerning the nonpayment of profit distributions …, the plaintiffs’ asserted purposes for the inspection were speculative, vague, and conclusory. As such, they were insufficient to establish a proper purpose for the inspection… . JAS Family Trust v Oceana Holding Corp, 2013 NY Slip Op 05734, 2nd Dept 8-28-13

 

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