Shareholders Beware: Serve Pre-Litigation Demands or Be Prepared to Plead Demand Futility with Particularity
August 09, 2019
In a recent case, Gammel v Immelt (2019 NY Slip Op 32005[U]), shareholders of General Electric Company (GE), brought a derivative shareholder action against the members of GE’s board of directors and various committees charged with overseeing GE’s business operations. Plaintiffs alleged causes of action sounding in gross mismanagement and breach of fiduciary duty, among others.
Defendants moved to dismiss the complaint, arguing that plaintiffs failed to make a pre-litigation demand upon GE’s board of directors and to plead demand futility with particularity. The Court granted defendants’ motion and dismissed the derivative shareholder action.
In the decision, New York County Commercial Division Judge Andrea Masley outlined the specific procedures that must be followed in shareholder derivative actions. Specifically, Business Corporation Law § 626(c) provides that in a shareholder derivative action, “the complaint 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.” A plaintiff is excused from making this pre-litigation demand if doing so would be futile.
A court may excuse the required pre-litigation demand if plaintiff pleads, with particularity, one of the three tests outlined in Marx v Akers (988 NY2d 189 ):
1. A majority of the directors are interested in the transaction. “[A] director may be interested under either of two scenarios: self-interest in a transaction or loss of independence due to the control of an interested director” (Matter of Comverse Tech., Inc. Derivative Litig., 56 AD3d 49, 54 [1st Dept 2008]).
2. The directors failed to inform themselves to a degree reasonably necessary about the transaction. This test can be accomplished if a plaintiff pleads that the directors ignored red flag warnings (see Brewster v Lacy, 2004 WL 5487868 [Sup Ct, NY County, June 21, 2014, Moskowitz, J., index No. 603873/2002], affd 24 AD3d 136 [1st Dept 2005]).
3. The directors failed to exercise their business judgment in approving the transaction. Here, a plaintiff must show that the corporation’s directors engaged in self-dealing or fraud or acted in bad faith that amounts to a breach of their fiduciary duty (see Goldstein v Bass, 138 AD3d 556, 557 [1st Dept 2016]; see also Matter of Levandusky v One Fifth Ave. Apt. Corp., 75 NY2d 530, 538 ).
If a commercial litigator fails to serve a pre-litigation demand and, thereafter, fails to plead any of these factors with particularity, they risk a dismissal of their complaint based on demand futility.