MOZES ON BEHALF OF GENERAL ELEC. CO. v. Welch
| Decision Date | 26 June 1986 |
| Docket Number | Civ. No. B-85-635(WWE). MDL No. 654(WWE). |
| Citation | 638 F. Supp. 215 |
| Parties | Faye MOZES, derivatively on Behalf of GENERAL ELECTRIC CO., Plaintiff, v. John F. WELCH, Jr., John F. Burlingame, Edward E. Hood, Lawrence A. Bossidy, Dennis D. Dammerman, Richard T. Baker, Lawrence E. Fouraker, Gertrude G. Michelson, Barbara Scott Prieskel, and Lewis T. Preston, Defendants, and General Electric Co., Nominal Defendant. |
| Court | U.S. District Court — District of Connecticut |
COPYRIGHT MATERIAL OMITTED
Andrew B. Bowman, Westport, Conn., Eugene A. Spector, pro hac vice, Jay S. Cohen, pro hac vice, Gross & Sklar, P.C., Philadelphia, Pa., for plaintiff.
Robert B. Fiske, Jr., New York, N.Y., for defendants.
RULING ON MOTION TO DISMISS
This shareholder's derivative action follows the indictment and guilty plea of General Electric Corporation ("G.E.") to submitting to the United States Government approximately $800,000 in incorrect time and labor charges.1
In December of 1978 the Re-Entry Systems division of G.E. was awarded contracts by the Department of the Air Force for the production and delivery of re-entry vehicles for Minuteman missiles. Approximately seven years later, on March 26, 1985 G.E. and two of its former employees were indicted in the United States District Court for the Eastern District of Pennsylvania on charges arising out of those contracts. The indictment charged G.E. and the two former employees with 104 counts of making false statements to the Air Force and Defense Contract Audit Agency, and four counts of presenting false labor claims to the United States government. G.E. subsequently pled guilty to all counts against it.
Three days after G.E.'s indictment, on March 29, 1985, plaintiff's counsel wrote a demand letter to G.E.'s Board of Directors requesting that it take legal action against "those persons responsible for making, presenting and supervising false labor-cost claims to the government and making false statements to the Air Force and the Defense Contract Audit Agency." Additionally, the letter indicated that "legal action should be taken against the members of G.E.'s Audit Committee, including directors, for grossly negligently or purposely permitting such illegal acts."
On April 9, 1985 the general counsel for G.E., Walter A. Schlotterbeck, responded that the matter would be considered at a meeting of the G.E. Board, which meeting was to be held on April 23. On April 26 Schlotterbeck notified plaintiff's counsel that the Board had appointed a Special Litigation Committee to consider what legal action, if any, should be taken. He also informed plaintiff's counsel that he would notify him when the Special Litigation Committee had made its recommendation to the Board and the Board had acted thereon.
On May 21, following the guilty pleas entered by G.E., plaintiff's counsel wrote and asked for a "good-faith estimate of when the Special Litigation Committee would arrive at its recommendation." On May 29 Schlotterbeck responded by informing counsel that the Special Litigation Committee had retained the law firm of Shearman and Sterling as independent counsel and that although he was unable at that time to give an estimate of the date by which the Committee would report to the Board, as soon as independent counsel "had a better grasp of the scope of the problem and might be able to arrive at a time frame," plaintiff's counsel would be so advised.
On June 17 the plaintiff filed a shareholder's derivative action in the United States District Court for the Eastern District of Pennsylvania against the same present defendants, which complaint consisted of allegations substantially the same as those in the present action. On November 19 plaintiff voluntarily discontinued the suit in the Eastern District of Pennsylvania. The present lawsuit was instituted on November 22, 1985 and is considered a part of the multi-district litigation entitled In re General Electric Securities Litigation, Civil No. MDL-654(WWE).
On January 8, 1986 the defendants moved to dismiss the complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure (a) for failure to comply with Rule 23.1 of the Federal Rules of Civil Procedure and (b) for failure to present a justiciable controversy and (c) as to the outside director defendants pursuant to Rule 12(b)(2) for lack of personal jurisdiction. The plaintiff resists the motion and in response asserts; (a) that it is permissible for the plaintiff to make a demand and later claim that the demand has proven futile; (b) that any further demand is futile in the present case because the Board has failed to provide a definitive response to plaintiff's initial demand, although it had a reasonable time in which to do so; (c) that the claim for damages is timely and (d) that the court has jurisdiction over all G.E. directors.2
The court finds that the most significant basis of the defendants' motion to dismiss is the claimed failure on the part of the plaintiff to comply with Fed.R.Civ.P. 23.1, which rule states in pertinent part:
In a derivative action brought by one or more shareholders or members to enforce a right of a corporation or of an unincorporated association the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall ... 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.
Although there is some authority to support the proposition that a plaintiff who makes a demand thereby waives any argument that demand is futile, see Stotland v. GAF, 469 A.2d 421 (Del.1983), the court will examine the plaintiff's claim of futility.
The policy underlying the demand requirement of Rule 23.1 is "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." Brody v. Chemical Bank, 517 F.2d 932, 934 (2d Cir.1975). See also, Siegal v. Merrick, 84 F.R.D. 106 (S.D. N.Y.1979). Indeed, since the seminal case of Hawes v. Oakland, 104 (14 Otto) U.S. 450, 26 L.Ed. 827 (1881) it has been well established that "before the shareholder is permitted in his own name to institute and conduct a litigation which usually belongs to the corporation, he should 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, or action in conformity with his wishes." Id. 104 U.S. at 460-461. In other words, forcing shareholders to exhaust intracorporate remedies by making demand on directors allows the directors a chance to occupy their proper position as managers of the corporation's business, giving the corporation an opportunity to take control of a suit that will be brought on its behalf. In view of this principle, "the federal courts should not interfere ... nor should they sanction the interference by shareholders with the duties of the board of directors unless it is clear that the board has no intention of taking the appropriate action itself." Brooks v. American Export Industries, Inc., 68 F.R.D. 506, 510 (S.D.N.Y.1975).
Hence, it is the mandate of Rule 23.1 that the shareholder must either make a demand on the board or plead with particularity the exceptional circumstances that demonstrate why a demand would be futile. In order that the court be able to determine whether a board has abdicated in favor of the corporate shareholders, by either refusing a demand or acting in such a manner as to make demand clearly futile, it must look solely to the complaint itself. Elfenbein v. Gulf & Western Industries, Inc., 590 F.2d 445, 450 (2d Cir.1978); Lewis v. Curtis, 671 F.2d 779, 784 (3d Cir.), cert. denied, 459 U.S. 880, 103 S.Ct. 176, 74 L.Ed.2d 144 (1982). Further, the court is to consider whether the demand requirement was met on the facts that existed at the time the litigation was commenced. Cramer v. General Telephone & Electronics Corporation, 582 F.2d 259, 276 (3d Cir. 1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed.2d 90.
In order to apply these principles the court turns to the allegations as set out in the complaint. The contentions which plaintiff would have the court accept in order that this case be "demand-excused" fall into several broad categories: 1) the director defendants have for many months been aware of the wrongs forming the basis for plaintiff's claims but have chosen not to protect GE or seek to recover amounts due to it and have refused to take action with respect to these claims because such action would require them to sue themselves, their friends and business associates; 2) the director defendants participated in, acquiesced in and approved the wrongs alleged in the complaint and have permitted the wrongs alleged and/or have remained inactive; thus, each of the director defendants has an irreconcilable conflict of interest in terms of the prosecution by virtue of participation in the mismanagement of GE; 3) almost eight months have passed since plaintiff's original demand letter and she has received no definitive reply. In response to this last claim, defendants countered that the eight month period does not constitute an adequate and reasonable amount of time under the circumstances of this case in which to respond to the demand. Defendants assert that the filing of the present lawsuit was therefore premature. The court will discuss each claim seriatim.
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