Lewis v. Graves, 280

• Decision Date: 28 February 1983
• Docket Number: No. 280,D,280
• Citation: 701 F.2d 245
• Parties: Fed. Sec. L. Rep. P 99,106 Harry LEWIS, Plaintiff-Appellant, v. Charles L. GRAVES, James E. Cunningham, John A. Morgan, W.E. Earles, Charles L. Davis, James A. Hunt, John D. Ritchie, Robert K. Richie, Hosea W. Bailey, G.W. Douglas Carver, Graham D. Mattison, Morgan Stanley & Co., Incorporated, Smith Barney, Harris Upham & Co., The Babcock & Wilcox Company, and J. Ray McDermott & Co., Inc., Defendants-Appellees. ocket 82-7398.
• Court: U.S. Court of Appeals — Second Circuit

Page 245

701 F.2d 245

Fed. Sec. L. Rep. P 99,106

Harry LEWIS, Plaintiff-Appellant, v. Charles L. GRAVES, James E. Cunningham, John A. Morgan, W.E.

Earles, Charles L. Davis, James A. Hunt, John D. Ritchie,

Robert K. Richie, Hosea W. Bailey, G.W. Douglas Carver,

Graham D. Mattison, Morgan Stanley & Co., Incorporated,

Smith Barney, Harris Upham & Co., The Babcock & Wilcox

Company, and J. Ray McDermott & Co., Inc., Defendants-Appellees.

No. 280, Docket 82-7398.

United States Court of Appeals, Second Circuit.

Argued Jan. 10, 1983.

Decided Feb. 28, 1983.

Stanley Nemser, New York City (Nemser & Nemser, New York City, of counsel), for plaintiff-appellant.

Richard E. Nolan, New York City (Joel B. Gardner, Davis, Polk & Wardwell, New York City, of counsel), for defendant-appellee J. Ray McDermott & Co., Inc. and the individual defendants-appellees.

Cravath, Swaine & Moore, New York City, of counsel, for defendant-appellee Morgan Stanley & Co., Inc.

Sullivan & Cromwell, New York City, of counsel, for defendant-appellee The Babcock & Wilcox Co.

White & Case, New York City, of counsel, for defendant-appellee Smith Barney, Harris Upham & Co., Inc.

Before FEINBERG, Chief Judge, CARDAMONE and DAVIS ^*, Circuit Judges.

CARDAMONE, Circuit Judge:

We review on this appeal the single issue of whether the district court erred in dismissing plaintiff's shareholder derivative suit for failure to make a demand upon the directors of defendant J. Ray McDermott & Co., Inc. (McDermott). A derivative suit often brings into the litigation arena parties holding widely divergent views as to how the affairs of a corporation can best be conducted. Directors of a corporation ordinarily believe that they have been good stewards of the corporate assets. They also believe that, by virtue of their offices, they are in a better position to decide whether it is in a corporation's best interests to pursue remedies for alleged wrongs committed against it. A derivative plaintiff, on the contrary, usually has little or no confidence that the corporation's directors will pursue remedies designed to correct alleged wrongdoing. Like darkened ships passing in the night, neither has a fair view of the other. Beginning from such irreconcilable positions, it is no wonder that the demand requirement is insisted upon by corporate directors and just as strongly resisted by derivative plaintiffs.

BACKGROUND

On March 28, 1978 plaintiff Harry Lewis commenced the instant shareholder derivative action on behalf of McDermott alleging violations of sections 10(b) and 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. Secs. 78j(b), 78n(a) (1976), Rules 10b-5 and 14a-9 promulgated thereunder, 17 C.F.R. Secs. 240.10b-5, 240.14a-9 (1982), and common law. Filed in the United States District Court for the Southern District of New York the complaint named as defendants McDermott; each of McDermott's directors then in office; The Babcock and Wilcox Company (Babcock), acquired in 1978 by McDermott; Smith Barney, Harris Upham & Co., McDermott's investment advisor in connection with the Babcock acquisition; and Morgan Stanley & Co., Inc., Babcock's investment advisor. The complaint challenged the propriety of two seemingly separate series of transactions: McDermott's highly publicized acquisition of and subsequent merger with Babcock in 1978, and the issuance of McDermott stock to various McDermott officers and directors pursuant to the firm's 1968 and 1974 Career Executive Stock Plans (Stock Plans).

Plaintiff made no demand on McDermott's board of directors to institute a suit or take over his derivative action. Rather, plaintiff alleged in his complaint that such a demand was excused because all of the individual defendants were the directors of McDermott at the time of the acts complained of and they have knowingly participated, assisted, aided and abetted in the wrongful acts, transactions and delinquencies herein complained of and they have benefited thereby and they have failed to take action thereon despite the fact that they have known about these acts. No action could or would be permitted to be instituted by McDermott without the consent of its directors and any demand upon them to institute such an action against themselves would have been futile.

In 1981 defendants moved for judgment on the pleadings pursuant to Rules 12(c) and 23.1 of the Federal Rules of Civil Procedure on the ground that plaintiff had failed to make a demand on the board as required by Rule 23.1. In an order dated February 4, 1982 District Court Judge John M. Cannella held that plaintiff's allegations of futility were insufficient to excuse the failure to make a demand and granted defendants' motion for judgment on the pleadings. The district court gave plaintiff leave to replead if an appropriate demand made on McDermott's board within 30 days was subsequently refused. On April 1, 1982 plaintiff advised the court that it had not and would not make such a demand. The judgment was then entered from which plaintiff Lewis appeals.

DISCUSSION

A

Rule 23.1 requires, in pertinent part, that in a derivative action "[t]he complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort" (emphasis added).

Requirements for demand upon directors by a plaintiff who pursues the extraordinary remedy of a derivative suit have been recognized for over a century in this country, see Hawes v. Oakland, 104 U.S. 450, 460-61, 26 L.Ed. 827 (1882), and for even longer in England. Note, Demand on Directors and Shareholders as a Prerequisite to a Derivative Suit, 73 Harv.L.Rev. 746, 746 (1960). This long-standing requirement in federal practice is presently codified in Rule 23.1. See Note, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U.Chi.L.Rev. 168, 171 n. 23 (1976) (The Demand and Standing Requirements ). Decisional law written prior to the Rule's enactment is therefore applicable. C. Wright, Federal Courts Sec. 73, at 318 (2d ed. 1970). Thus, the Supreme Court's statement in Hawes that a derivative plaintiff must "show to the satisfaction of the court that he has exhausted all the means within his reach to obtain, within the corporation itself, the redress of his grievances, ... and this [effort] must be made apparent to the court," 104 U.S. at 460-61, is still a useful guide.

With this background in mind we focus on the primary purposes of the demand rule. The rule is intended " 'to give the derivative corporation itself the opportunity to take over a suit which was brought on its behalf in the first place, and thus to allow the directors the chance to occupy their normal status as conductors of the corporation's affairs.' " Elfenbein v. Gulf & Western Industries, Inc., 590 F.2d 445, 450 (2d Cir.1978) (quoting Brody v. Chemical Bank, 517 F.2d 932, 934 (2d Cir.1975)); see The Demand and Standing Requirements, supra, at 171 (by forcing shareholders to exhaust intracorporate remedies by first making demand, the demand requirement furthers a principle basic to corporate organization, that the management of the corporation be entrusted to its board of directors). Permitting corporations to assume control over shareholder derivative suits also has numerous practical advantages. Corporate management may be in a better position to pursue alternative remedies, resolving grievances without burdensome and expensive litigation. See Cramer v. General Telephone & Electronics Corp., 582 F.2d 259, 275 (3d Cir.1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed.2d 90 (1979). Deference to directors' judgments may also result in the termination of meritless actions brought solely for their settlement or harassment value. See id. Moreover, where litigation is appropriate, the derivative corporation will often be in a better position to bring or assume the suit because of superior financial resources and knowledge of the challenged transactions.

Despite the strong policy and practical advantages favoring exhaustion of intracorporate remedies, the demand requirement of Rule 23.1 is not without exception. Under the law of this circuit, demand need not be made where "futile." See Abramowitz v. Posner, 672 F.2d 1025, 1033 (2d Cir.1982); Elfenbein, 590 F.2d at 450; Cathedral Estates v. Taft Realty Corp., 228 F.2d 85, 88 (2d Cir.1955). The reasons advanced for a claim of futility must be pled with particularity in the complaint itself. See Elfenbein, 590 F.2d at 450 (quoting Fed.R.Civ.P. 23.1); Cramer, 582 F.2d at 275; 3B J. Moore & J. Kennedy, Moore's Federal Practice p 23.1.19 (2d ed. 1982). As correctly recognized by the district court, the decision as to whether a plaintiff's allegations of futility are sufficient to excuse demand depends on the particular facts of each case and lies within the discretion of the district court. See Abramowitz, 672 F.2d at 1033; Elfenbein, 590 F.2d at 450. Thus, the district court's holding--that plaintiff's allegations of futility were insufficient--cannot be reversed unless it constituted an abuse of discretion. We find none.

Demand is presumptively futile where the directors are antagonistic, adversely interested, or involved in the transactions attacked. See Abramowitz, 672 F.2d at 1033. Pointing to the fact that all of the McDermott directors at the time of the complaint had previously approved the Babcock acquisition and the Stock Plans distributions, plaintiff argues that their acquiescence in the dealings complained of was sufficient "involvement" to excuse demand. We agree with the district court, however, that absent specific allegations of self-dealing or bias on the part of a majority of the board, mere approval and acquiescence are insufficient to render demand futile.

While we have not had occasion...