Lerner v. Prince

• Decision Date: 22 May 2014
• Citation: 987 N.Y.S.2d 19,119 A.D.3d 122,2014 N.Y. Slip Op. 03763
• Parties: Stanley LERNER, etc., Plaintiff–Appellant, v. Charles O. PRINCE, III, et al., Defendants–Respondents, Citigroup Inc., Nominal Defendant–Respondent.
• Court: New York Supreme Court — Appellate Division

119 A.D.3d 122

987 N.Y.S.2d 19

2014 N.Y. Slip Op. 03763

Stanley LERNER, etc., Plaintiff–Appellant,

v.Charles O. PRINCE, III, et al., Defendants–Respondents,Citigroup Inc., Nominal Defendant–Respondent.

Supreme Court, Appellate Division, First Department, New York.

May 22, 2014.

Greenfield & Goodman LLC, New York (Richard D. Greenfield of counsel), for appellant.

Cravath, Swaine & Moore LLP, New York (Richard W. Clary and Rory A. Leraris of counsel), for respondents.

Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York (Brad S. Karp, Richard A. Rosen and Susanna M. Buergel of counsel), for Charles O. Price, Robert Druskin, Sallie L. Krawcheck, Robert E. Rubin, Gary Crittenden, John C. Gerspach, Lewis B. Kaden, David C. Bushnell, Thomas G. Maheras, Michael Klein, Geoffrey O. Coley, Randolph H. Barker, Michael Raynes, Nestor Dominguez, and Janice L. Warne, respondents.

Wachtell, Lipton, Rosen & Katz, New York (Lawrence B. Pedowitz and Bradley R. Wilson of counsel), for Citigroup Inc., respondent.

KARLA MOSKOWITZ, J.P., ROSALYN H. RICHTER, SALLIE MANZANET–DANIELS, JUDITH J. GISCHE, JJ.

MOSKOWITZ, J.

This purported shareholder derivative action arose out of the subprime mortgage crisis meltdown and the financial crisis that followed. Plaintiff Stanley Lerner is a shareholder of nominal defendant Citigroup Inc. (Citigroup), a Delaware corporation with its principal place of business in New York. At the end of the third quarter of 2007, Citigroup reported multi-billion dollar asset write-downs stemming from its holdings in mortgage-related securities. In late 2007, plaintiff made a formal pre-suit demand (the demand) on Citigroup's board of directors (the Board), asking that the Board sue senior management, including present and former Citigroup officers and directors, for alleged mismanagement of the company's subprime assets.

In early 2008, the Board informed plaintiff that it would consider the demand at a future meeting, and gave him opportunities to make further submissions in support of the demand. However, plaintiff made no such submissions. In March 2008, the Board informed plaintiff that it had formed a committee (the demand committee) to investigate and analyze the allegations in the demand. The Board appointed defendant Franklin A. Thomas as the sole member of the demand committee and retained nonparty Potter Anderson & Corroon LLP (Potter Anderson) as its independent counsel. After Thomas retired from the Board in April 2009, the Board replaced him with defendant Michael E. O'Neill, who had recently joined Citigroup as a director, as the sole member of the demand committee.

Plaintiff commenced this action in July 2009. Potter Anderson offered to meet in person with plaintiff, his counsel, and O'Neill; that meeting occurred on September 16, 2009. On May 27, 2010, the Demand Committee met with the Board and recommended that the Board refuse the demand—a recommendation that the Board unanimously accepted.

By amended complaint dated June 22, 2010, plaintiff alleged that the single-member demand committee was a “sham in its inception” and that the Board's more than two-year delay in responding to the demand constituted constructive and wrongful refusal. Accordingly, plaintiff asserted causes of action including breach of fiduciary duty and aiding and abetting breaches of fiduciary duty. Plaintiff also alleged that defendants had wasted corporate assets by causing Citigroup to expend millions of dollars in an investigation that was allegedly a sham.

By letter dated June 25, 2010 (the refusal letter), three days after the date of the amended complaint, the Board's counsel informed plaintiff that on May 27, 2010, it had unanimously adopted the demand committee's recommendation to reject plaintiff's demand. Defendants invited plaintiff on more than one occasion to amend his pleadings further to take the refusal letter into account; however, plaintiff declined to do so, insisting that a further amendment was unnecessary because the amended complaint already anticipated the Board's refusal of the demand.

In October 2010, defendants moved to dismiss the amended complaint, asserting that the Board's refusal of the demand, undertaken after a thorough investigation, was protected under the business judgment rule.¹ Further, defendants argued, plaintiff had failed adequately to plead facts creating a reasonable doubt as to the good faith or reasonableness of the Board's investigation and its refusal of the demand. The outside director defendants submitted the June 25, 2010 refusal letter as an exhibit to their motion.

On November 9, 2010, before the IAS court had decided defendants' motion to dismiss, plaintiff served document requests on defendants. On or about December 1, 2010, defendants refused to produce any documents, objecting to the document requests on the ground, among others, that plaintiff was not entitled to discovery under either Delaware or New York law on a pre-answer motion to dismiss.

In January 2011, plaintiff moved to compel the requested discovery and to convert defendants' dismissal motions to summary judgment motions. In May 2011, the IAS court denied the motion to compel and convert, finding that there was no basis to permit discovery. Further, the court found, there appeared to be no reason for the court to exercise its discretion and convert the pre-answer motion to a motion for summary judgment.

Next, by order entered May 17, 2012, the IAS court granted defendants' motions to dismiss the amended complaint without leave to replead. In so doing, the court first found that under New York State's choice-of-law rules, the substantive law of the state of incorporation governs compliance with the demand requirement. Thus, because Citigroup was incorporated in Delaware, Delaware law governed the action. The court also found that even though the refusal letter postdated the amended complaint, defendants had been obliged to submit the refusal letter on their motions because it established that the action was a “demand refused” action, requiring a heightened pleading standard. ² Moreover, the IAS court, citing Scattered Corp. v. Chicago Stock Exchange, Inc., 701 A.2d 70, 73–74 [Del.1997],revd. in part on other grounds by Brehm v. Eisner, 746 A.2d 244, 253 [Del.Supr.2000] ), noted that, in resolving motions to dismiss in demand-refused cases, “courts routinely reference[d] the substance of the demand refusal letters.” Accordingly, the IAS court stated, it would consider the refusal letter, and would consider the claims in the amended complaint under the “wrongful refusal of demand” standard.

With respect to the merits, the court found that the amended complaint failed to allege particularized facts creating a reasonable doubt about the Board's reasonableness and good faith in investigating plaintiff's demand. Indeed, the court found, the refusal letter included facts regarding the steps that the demand committee took in investigating plaintiff's demand. Additionally, the court determined, the facts that plaintiff had alleged—for example, that the demand committee had only one member—were insufficient to raise doubt about the good faith of the committee's investigation. The court therefore concluded that the business judgment rule shielded the Board from further inquiry, and that, as a result, plaintiff lacked standing to pursue the derivative claims arising out of the demand.

To begin, the IAS court properly denied plaintiff's motion to compel discovery. The parties disagree on whether New York or Delaware law governs discovery. Plaintiff argues that the availability of discovery is procedural, not substantive, and therefore is governed by the law of the forum. Thus, plaintiff argues, New York law governs, and the law in New York provides that discovery is available concerning a decision of a board of directors not to pursue a claim on behalf of a corporation (citing Parkoff v. General Tel. & Elecs. Corp., 53 N.Y.2d 412, 442 N.Y.S.2d 432, 425 N.E.2d 820 [1981] ). Defendants argue, on the other hand, that Delaware's discovery rules are part of its substantive law, and thus, that Delaware law applies to foreclose plaintiff's discovery request. At any rate, defendants argue, no matter which law applies, the result would be the same, as plaintiff was not entitled to discovery under the law of either New York or Delaware.

Because New York is the forum state, New York's choice-of-law principles determine whether a particular issue—in this case, the availability of discovery—is substantive or procedural ( see Tanges v. Heidelberg N. Am., 93 N.Y.2d 48, 54, 687 N.Y.S.2d 604, 710 N.E.2d 250 [1999] ). Under New York choice-of-law rules, matters of procedure are governed by the law of the forum ( id. at 53, 687 N.Y.S.2d 604, 710 N.E.2d 250;Marine Midland Bank v. United Mo. Bank, 223 A.D.2d 119, 122, 643 N.Y.S.2d 528 [1st Dept.1996],lv. dismissed88 N.Y.2d 1017, 649 N.Y.S.2d 383, 672 N.E.2d 609 [1996] ). On the other hand, New York choice-of-law rules provide that substantive issues such as issues of corporate governance, including the threshold demand issue, are governed by the law of the state in which the corporation is chartered—here, Delaware ( Hart v. General Motors Corp., 129 A.D.2d 179, 182, 517 N.Y.S.2d 490 [1st Dept.1987],lv. denied,70 N.Y.2d 608, 521 N.Y.S.2d 225, 515 N.E.2d 910 [1987] ).

We find that plaintiff's right to discovery in this demand-refused case is a substantive question, rather than a procedural one, and therefore is governed by Delaware law. Although New York courts have applied the law of the forum when deciding matters, such as discovery, affecting the conduct of the litigation ( see e.g. People v. Greenberg, 50 A.D.3d 195, 198, 851 N.Y.S.2d 196 [1st Dept.2008],lv. dismissed10 N.Y.3d 894, 861 N.Y.S.2d 266, 891 N.E.2d 299 [2008];see also Paris v. Waterman S.S. Corp., 218 A.D.2d 561, 564, 630 N.Y.S.2d 716 [1st Dept.1995],lv. dismissed96 N.Y.2d 937, 733 N.Y.S.2d 376, 759...