Bansbach v. Zinn

• Decision Date: 30 October 2003
• Citation: 801 N.E.2d 395,769 N.Y.S.2d 175,1 N.Y.3d 1
• Parties: JOHN M. BANSBACH, Appellant, v. MICHAEL F. ZINN et al., Respondents.
• Court: New York Court of Appeals Court of Appeals

1 N.Y.3d 1

801 N.E.2d 395

769 N.Y.S.2d 175

JOHN M. BANSBACH, Appellant, v. MICHAEL F. ZINN et al., Respondents.

Court of Appeals of the State of New York.

Argued September 16, 2003.

Decided October 30, 2003.

Harold B. Obstfeld, P.C., New York City (Harold B. Obstfeld of counsel), for appellant.

Robinson Brog Leinwand Greene Genovese & Gluck P.C., New York City (David C. Burger of counsel), for respondents.

Judges G.B. SMITH, CIPARICK, ROSENBLATT, GRAFFEO and READ concur.

OPINION OF THE COURT

Chief Judge KAYE.

This is a shareholder derivative action brought to recover damages allegedly suffered by Besicorp Group Inc., a public company, as a result of illegal conduct by defendant Michael Zinn—its founder, majority stockholder, board chairman, chief executive officer and president.¹ Because a derivative action is brought on the corporation's behalf, the law generally requires that demand first be made on the board of directors to pursue the claim. Here, plaintiff made no prelitigation demand on the Besicorp board, contending that demand was futile both because the board was dominated and controlled by Zinn and because a decision to indemnify Zinn was so egregious it could not have been the product of the directors' business judgment. At issue in this appeal is whether a prior litigation collaterally estops plaintiff from raising futility; if not, whether demand was in fact futile; and whether plaintiff is entitled to summary judgment.

I. Facts

In 1996, the federal government began a criminal investigation into defendant Zinn's involvement in the congressional campaign of Maurice Hinchey. The government issued subpoenas to Besicorp and others for documents and testimony before a grand jury concerning contributions by individuals associated with Besicorp in the 1992 and 1994 Hinchey campaigns and the use of Besicorp's assets in connection with those campaigns.

Defendant Zinn was finance chairman of the 1992 Hinchey campaign. In order to circumvent the Federal Election Campaign Act's prohibitions on corporate campaign contributions, Zinn allegedly arranged that he and certain Besicorp officers and employees would make contributions to the campaign and the company would reimburse them with raises or cash bonuses, deducted as business expenses by the corporation on its federal income tax returns; Zinn allegedly also solicited contributions from others and caused Besicorp to reimburse him by way of a bonus. On May 22, 1996, weeks after the subpoenas were issued, defendants Gerald A. Habib, Harold Harris and Richard E. Rosen convened a special board meeting and determined that the corporation would indemnify Zinn (and certain others) for legal fees and expenses in connection with the subpoenas, and that the corporation would be reimbursed if indemnification was unwarranted.² According to plaintiff, the corporation immediately began making substantial payments for legal fees and other charges associated with the government investigation.

One year later, on May 15, 1997, Zinn and Besicorp were indicted for their participation in the illegal scheme. The following month, they each agreed to plead guilty to aiding and abetting the submission of false statements to the Federal Election Commission; Besicorp agreed to plead guilty to the charge of making and signing a false corporate income tax return, and Zinn to aiding and abetting the preparation and presentation of a false federal income tax return. During the plea allocution on June 19, 1997, Zinn acknowledged in open court, under penalty of perjury, that he knowingly and willfully violated the law. In his words:

"I made funds available to certain employees of my company through bonuses and advances so that their contributions to the 1992 congressional campaign of Maurice Hinch[e]y were in fact contributions of Besicorp. I knew the campaign would be reporting those contributions to the Federal Election Commission and I intended the campaign not identify the true source of the contribution. I was also aware and intended that those bonuses and advances be deducted in the ordinary course of events on Besicorp's tax return."

Plaintiff complains that the board took no action at that time to seek reimbursement, but instead during June and July 1997 authorized additional payments by the corporation for Zinn's legal fees and expenses.

On August 13, 1997, plaintiff commenced this derivative action alleging that defendants breached their fiduciary duties and wasted corporate assets by authorizing the use of Besicorp funds to pay legal costs in the federal investigation and by not seeking reimbursement from Zinn. On October 22, 1997, Zinn was sentenced to a six-month term of imprisonment with two years of supervised release, and fined $36,673; Besicorp was fined $36,400. As the sentencing court observed: "Mr. Zinn took advantage of the fact that he was the chief executive officer of a public corporation and he dipped into the corporate treasury to pay for his own political goals at the expense of the minority shareholders, many of whom did not share his political interest.. . . This is a case where in order to commit the election law violation, the person perpetrating the offense engaged in a fraud on his own shareholders and his own company and a breach of his duty of undivided loyalty and also in a tax fraud." After October 22, Besicorp made no further payments for Zinn's defense costs. Up to that time, Besicorp had allegedly advanced $273,010.99 for Zinn's defense, a fraction of the total legal costs the corporation incurred in connection with the illegal scheme.

Zinn resigned as an officer and director on November 11, 1997, and Daley succeeded him. On January 23, 1998—more than six months after Zinn pleaded guilty to knowingly violating the law and several months after plaintiff brought this lawsuit—the corporation's Legal Defense Management Committee, which consisted of Daley, Habib and Rosen, sought partial reimbursement from Zinn of the expenditures the corporation incurred on his behalf ($186,000). The Committee (Daley abstaining) agreed to accept a $161,000 seven percent interest-bearing promissory note from Zinn (crediting him with a $25,000 bonus), payments to begin on June 1, 1998.

Defendants moved to dismiss plaintiff's action for failure to make a demand on the board of directors pursuant to section 626 (c) of the Business Corporation Law. In April 1998, Supreme Court granted defendants' motion and dismissed the action. With dismissal of the case in hand, on January 19, 1999 Besicorp's Legal Defense Management Committee—company counsel, officers and directors (including Habib, Rosen, Daley and Zinn)—met by telephone to continue their discussion regarding indemnification. By this time Zinn had been released from prison, and was reinstated as a Besicorp officer and director. The minutes recite that the Committee reviewed a report of independent counsel retained to advise whether the corporation could indemnify Zinn for his costs and expenses, and whether the corporation was obligated to seek reimbursement from him. That report is not part of the record before us. The minutes also reflect that Zinn attended virtually the entire meeting.

The Committee found that Zinn's conduct relating to the 1992 Hinchey campaign was "undertaken in good faith," that he "reasonably believed at the time to be in the best[] interests of the Company" and that he "had no reasonable cause to believe that his conduct was unlawful." The Committee unanimously voted that the corporation indemnify Zinn for all legal costs and expenses related to his defense, subsequent guilty plea, sentencing and incarceration, and also indemnify him for any covered costs he previously paid. As revealed in Besicorp's March 2, 1999 proxy statement, this action authorized payment of Zinn's $36,673 fine, acknowledged that he had no further obligation on the $141,000 balance remaining on the promissory note, and authorized repayment of approximately $39,180 of legal fees and expenses incurred by third parties that Zinn had paid. The minutes of the board meeting do not reflect what consideration, if any, the board gave to Zinn's sworn admissions to having knowingly violated the law, thus exposing the corporation to criminal penalties and other harm.

Shortly after the Committee's action, the Appellate Division reversed Supreme Court's dismissal of plaintiff's complaint, concluding that for purposes of a CPLR 3211 (a) (7) motion, the allegations of business dealings among the board members indicating a lack of independence were sufficient to excuse demand as futile. The Court rejected plaintiff's proffered alternative ground—that the conduct was so egregious that it could not have been the product of sound business judgment (258 AD2d 710 [3d Dept 1999]).

In April 2000, after obtaining dismissal of another derivative suit brought against the corporation, defendants moved for summary judgment dismissing plaintiff's derivative suit. Defendants argued that, based on Lichtenberg v Zinn (260 AD2d 741 [3d Dept 1999], lv denied 94 NY2d 754 [1999])—decided by the Appellate Division just after its reinstatement of plaintiff's complaint—plaintiff was collaterally estopped from claiming that demand on the corporation was excused by the directors' personal and business dealings. Plaintiff opposed defendants' motion and cross-moved for summary judgment. Supreme Court denied defendants summary judgment on collateral estoppel grounds, finding the Lichtenberg challenge different from the present complaint, and granted plaintiff summary judgment with respect to Zinn's liability based on his guilty plea admissions. The Appellate Division reversed and dismissed the action, concluding that "the precise issue" being litigated here was litigated in Lichtenberg, and that plaintiff could not rely on facts occurring after commencement of his action to excuse demand on the alternative ground (294 AD2d 762, 763 [3d Dept 2002])...