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Posted: May 20, 2018

Derivative Action Dismissed for Failure to Plead Demand or Demand Futility

On May 9, 2018, Justice Sherwood of the New York County Commercial Division issued a decision in Glaubach v. PricewaterhouseCoopers, LLP, 2018 NY Slip Op. 30875(U), dismissing a derivative action for failure to plead demand or demand futility, explaining:

Under Delaware law, and Delaware Chancery Court Rule 23.1, to have standing to pursue a derivative claim on behalf of a company, a plaintiff must make a pre-suit demand that the board pursue the contemplated action. Such a presuit demand may be excused, however, if such a demand would have been futile. Either presuit demand or demand futility must be pleaded with particularity in order for a derivative claim to survive a dismissal motion.

ln the instant case, the amended complaint fails to allege that Glaubach ever demanded that the Personal Touch board pursue an audit malpractice claim against PwC or that such a demand would have been futile. First, while Glaubach alleges demands that he made on the board of directors. His demands were for the Board to investigate alleged wrongdoing of certain company executives, not to investigate and commence an action against PwC for auditing malpractice. Specifically, he demanded that the Board take action against all parties who received monies fraudulently characterized as educational expenses. This fails to satisfy Delaware’s presuit demand requirement for the derivative accounting malpractice claim.

Moreover, the complaint fails to sufficiently allege demand futility. Where the subject of the derivative suit is not a business decision of the board but, instead, is a wrong committed against the company by a third party, or the board’s inaction, demand is only excused when the plaintiff alleges particularized facts raising a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand. A claim that the board failed to act, sometimes referred to as a lack of oversight claim, is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment. In order to rebut the presumption of disinterestedness under the Ra/es test, the plaintiff must plead particularized facts that, if proved, would establish that a majority of the directors face a substantial likelihood of personal liability for the wrongdoing alleged in the complaint. Demand futility is examined with respect to the board’s membership at the time the amended complaint is filed, unless the alleged claims were validly being litigated at the time of the original pleading.

Here, the amended complaint fails to meet the requirements of demand futility. Glaubach’s claim is that the board violated their oversight duties. There are, however, no particular facts establishing that a majority of the board at the time plaintiffs commenced this action was interested or lacked independence. Plaintiffs fail to allege that any, much less a majority, of the directors faced a substantial likelihood of liability for PwC’s alleged malpractice. The complaint fails to allege that there were direct tics between PwC and Personal Touch’s board members, or any allegations that the board was dominated by a director or officer who condoned PwC’s alleged improper conduct. The amended complaint does not even detail the size of the board or its current composition, or that a majority of them were involved in, or even stood to gain by any alleged fraudulent conduct, or other improper conduct by PwC. It fails to meet the heightened pleading standard set forth in Delaware Chancery Court Rule 23.1, as it fails to plead in a director-by-director fashion, instead, asserting conclusory and speculative statements about the board. The Personal Touch executives Glaubach asserts were looting the company for their personal benefit, Slifkin, Balk and Marx, were not a majority. In fact, Slifkin resigned from the Board in July 2013 , and these executives were not alleged to have control over the board. Glaubach ‘s conclusory allegations that the board is populated by persons with ties to one of the alleged wrongdoers, falls far short of the requirement of particularized allegations that a majority of the board would face a substantial likelihood of personal liability. Accordingly, this first claim is dismissed for Glaubach’s lack of standing.

(Internal quotations and citations omitted).

This decision illustrates the special pleading requirements for derivative actions (where a shareholder brings an action on behalf of a corporation). Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding bringing an action on behalf of a corporation or other business entity.

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