Harhen v. Brown

• Decision Date: 08 February 2000
• Parties: LORETTA M. HARHEN v. STEPHEN L. BROWN & others.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

431 Mass. 838

730 NE 2d 859

LORETTA M. HARHEN v. STEPHEN L. BROWN & others.¹

Supreme Judicial Court of Massachusetts, Suffolk.

February 8, 2000.

June 27, 2000.

Present: MARSHALL, C.J., ABRAMS, LYNCH, GREANEY, IRELAND, & COWIN, JJ.

Jeffrey B. Rudman (Daniel P. Tighe with him) for Stephen L. Brown & others. Alan B. Morrison, of the District of Columbia (Jason B. Adkins with him) for the plaintiff.

Morris M. Goldings, for Raeburn B. Hathaway, Jr., was present but did not argue.

Thomas R. Kiley & Thomas B. Drohan, for F. William Sawyer, submitted a brief.

Loretta M. Smith, for Associated Industries of Massachusetts, amicus curiae, submitted a brief.

IRELAND, J.

The plaintiff, a policyholder of John Hancock Mutual Life Insurance Company (Hancock), made demand on Hancock's board of directors to commence litigation, alleging that the defendants, certain directors and employees of Hancock, had harmed Hancock by participating in or acquiescing in illegal lobbying of members of the Massachusetts Legislature. The board, a majority of whose members were disinterested, refused the plaintiff's demand through its committee.² The plaintiff then brought an action, claiming that the directors had wrongfully refused her demand and seeking to recover over $4 million from the defendants on Hancock's behalf. The defendants moved to dismiss the complaint, and a Superior Court judge allowed the defendants' motion without prejudice on the ground that the plaintiff had failed to plead with particularity that the committee appointed to respond to the plaintiff's presuit demand was interested; the judge therefore deferred to the business judgment of the committee. The Appeals Court reversed, Harhen v. Brown, 46 Mass. App. Ct. 793, 816 (1999), and we granted the defendants' application for further appellate review. Because disinterested directors are entitled to the protection of the business judgment rule in deciding whether to take action on a plaintiff's demand, and because the plaintiff has failed to allege facts of bad faith or that the board failed to investigate her demand, the Superior Court judge correctly allowed the defendants' motion to dismiss.

1. Facts. This case purports to be a derivative action brought pursuant to Mass. R. Civ. P. 23.1, 365 Mass. 768 (1974). We summarize the facts as alleged in the plaintiff's complaint and in the documents attached and incorporated in the complaint. See Nader v. Citron, 372 Mass. 96, 97-98 (1977) (in ruling on motion to dismiss, court accepts as true allegations of complaint); Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1220 (1st Cir. 1996) (court may consider documents referenced in plaintiff's complaint without converting motion to dismiss into motion for summary judgment).

At all material times the plaintiff was a policyholder of Hancock. Chartered in Massachusetts in 1862, Hancock is one of the "top six" life insurance companies in the United States. Hancock has approximately seven million policyholders located in all fifty States, over 10,000 employees, 120 subsidiaries, and over $107 billion in managed assets and over $54 billion in direct assets. Hancock is headquartered in Massachusetts, and the Commonwealth is Hancock's primary regulator.

Since 1991, Stephen Brown has been chairman of the board of directors and chief executive officer of Hancock. He previously had served as vice-chairman of the board, president, and chief operating officer. E. James Morton was Brown's predecessor; he served as chairman of the board and chief executive officer from 1987 to 1991, and thereafter remained a director and officer of Hancock. David F. D'Alessandro was senior executive vice-president of Hancock's retail sector until becoming president of Hancock on January 1, 1998. He also served as a director of Hancock at all material times. From 1982 through May, 1993, Raeburn B. Hathaway was a vice-president of Hancock and head of Hancock's government relations department. F. William Sawyer was Hancock's senior registered lobbyist and was responsible for Hancock's relations with the Massachusetts Legislature. He was neither an officer nor a director of Hancock.

The plaintiff's claims arise from Sawyer's lobbying activities on behalf of Hancock. In March of 1994, Hancock entered into settlement agreements regarding these lobbying activities with the United States Attorney's office and the State Ethics Commission, pursuant to which Hancock acknowledged it had violated the Commonwealth's illegal gratuity statute, G. L. c. 268A, § 3, and paid civil fines totaling $1,010,000.

As part of his lobbying efforts on Hancock's behalf, Sawyer cultivated friendships with Massachusetts government officials. He accomplished this through a variety of means, including the provision of entertainment, sports, food, and beverages. For example, in 1982, Sawyer took the then-chairman of the joint insurance committee and his wife to the Super Bowl football game, providing a gratuity of substantial value. See G. L. c. 268A, § 3 (a). Cf. Commonwealth v. Famigletti, 4 Mass. App. Ct. 584, 587 (1976). Sawyer also provided gratuities and entertainment to Massachusetts legislators during several conferences that were held in Puerto Rico, Florida, and Cape Cod. Between August 1, 1987, and May 30, 1993, Hancock's lobbyists provided entertainment, food, and golf on over 240 occasions.³

Brown, Morton, D'Alessandro, and Hathaway were members of Hancock's management committee. The committee was responsible for overseeing all aspects of Hancock's operations, including the government relations department. Members of the committee were kept informed of Sawyer's activities with government officials, and they "knew or should have known" of Sawyer's alleged illegal activities. The plaintiff alleged that the individual defendant directors, as members of the management committee, failed to take any action to assure Sawyer's compliance with the law, and that Hathaway "authorized" Hancock's funds "to be used in connection with Sawyer's illegal lobbying activities." Essentially, the plaintiff's complaint details Sawyer's lobbying activities and legal troubles, Hathaway's "encouragement" of Sawyer's conduct, and D'Alessandro, Morton, and Brown's alleged breach of the duty of care for failing to stop Sawyer's improprieties.

In the 1994 settlement agreements with the United States Attorney's office and the State Ethics Commission, Hancock agreed to reorganize its government relations department, retain outside counsel to review its lobbying activities, and institute auditing procedures by outside accountants. Further, Hancock instituted new procedures regarding lobbying activity, distributed these guidelines to employees, held training sessions concerning these new procedures, and placed a moratorium on entertainment of Massachusetts officials. Hancock stated that it had accepted Hathaway's early retirement and had reassigned Sawyer to a nonlobbying position.

On April 8, 1996, the plaintiff delivered a demand letter to Hancock's board of directors that set out the above allegations regarding Hancock's lobbying activities. She alleged that, as a consequence of their actions and inactions, the defendants had cost Hancock four million dollars in fines, legal fees paid for the defendants, and damage to Hancock's reputation. She demanded that Hancock seek reimbursement of this monetary loss from the individual defendants. Her demand letter also raised several issues regarding the lack of policyholder democracy, specifically the insulation of the Hancock board from policyholders created by procedures that made it difficult for policyholders to nominate board members. The board referred the demand to a committee of two directors, I. MacAllister Booth and Lawrence K. Fish. On September 13, 1996, the committee wrote a short letter to the plaintiff, refusing her demand to institute suit. In the letter, the committee indicated that Hancock's corporate secretary was willing to meet with the plaintiff regarding issues of insulation of the board. On October 8, 1996, the plaintiff's attorneys met with two Hancock employees who were willing to consider the plaintiff's proposed amendment of Hancock's bylaws, but who would not discuss the refusal of her demand to institute suit. The plaintiff then commenced this action.

2. Application of the business judgment rule to a presuit refusal of demand. (a) Corporate law background. In general, the status of a majority of the board as either "interested" or "disinterested" is of significance to the manner in which a case is litigated. As described below, in a derivative action,⁴ the board's status determines whether the plaintiff must make demand on the board or may seek to have demand excused as futile.

For purposes of shareholder derivative actions, we adopt the definition of an "interested" director that is stated in the Principles of Corporate Governance. See 1 ALI Principles of Corporate Governance: Analysis and Recommendations §§ 1.15 and 1.23 (1994); Demoulas v. Demoulas Super Mkts., Inc., 424 Mass. 501, 523-524 (1997).⁵ The purpose of the distinction between interested and disinterested directors is to ensure that the directors voting on a plaintiff's demand can exercise their business judgment in the best interests of the corporation, free from significant contrary personal interests and apart from the domination and control of those who are alleged to have participated in wrongdoing. See Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993). If the plaintiff has failed to allege facts that meet this standard with regard to a particular board member for purposes of ruling on a motion to dismiss, that member is deemed "disinterested."

In general, before filing a derivative action on behalf of a corporation, a plaintiff "must establish that ... all available means to obtain relief through the corporation itself" are exhausted by making demand on the corporations's board of directors to...