Commercial Division Blog

Posted: January 12, 2014 / Categories Commercial, Derivative Actions, Corporations

Derivative Claim Dismissed for Failure to Allege Demand Futility with Particularity

On January 6, 2014, Justice Bransten of the New York County Commercial Division issued a decision in Zacharius v. Kensington Publishing Corp., 2014 NY Slip Op. 50011(U), addressing a number of business divorce issues, including the standard for pleading demand futility.

Zacharius involved a dispute between shareholders in a closely held corporation. The court's decision in Zacharius addressed several issues, including whether the plaintiff's derivative claim for breach of fiduciary duty should be dismissed for failure adequately to plead demand futility. The court held that it should, explaining:

New York law requires that shareholder derivative actions "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." See NY Bus. Corp. Law § 626(c) (McKinney 2013). The Court of Appeals clarified this statutory stricture in Marx v. Akers, 88 NY2d 189, 200 (1996), holding that demand is excused because of futility when a complaint alleges with particularity that a majority of the board of directors is interested in the challenged transactions or is controlled by a self-interested director.

Control or lack of independence of directors must be alleged with particularity. Director interest may be either self-interest in a transaction, or a lack of independence owing to complete domination and control by a self-interested director. The allegation that a shareholder has appointed directors to the board does not place their independence in doubt.

The Complaint fails to name any directors besides Steven and Judith Zacharius, or even how many directors sit on the board. The sole averment in the Complaint relating to directors is that they were appointed by Steven Zacharius. New York law requires a description of self-interest or control with greater particularity than simply stating that the board was "hand-picked."
. . .
The Complaint does not show the requisite domination and control by Steven or Judith Zacharius, such that the board could not have exercised its business judgment and put the interests of Kensington before that of Steven and Judith. Without any particularized allegations showing that Steven or Judith Zacharius dominated and controlled the board such that any demand would be futile, the Complaint fails to meet the burden imposed by BCL section 626(c).

(Internal quotations and citations omitted) (emphasis added).

Zacharius stands a reminder that the requirement to make a demand--or show demand futility--is a real requirement under New York law and that boilerplate recitation of demand futility may not survive judicial scrutiny if challenged.