[*1]
Morrison v Santana
2014 NY Slip Op 51006(U) [44 Misc 3d 1203(A)]
Decided on June 17, 2014
Supreme Court, Suffolk County
Emerson, J.
Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431.
This opinion is uncorrected and will not be published in the printed Official Reports.


Decided on June 17, 2014
Supreme Court, Suffolk County


Corey Morrison and GORDAN OSTOJIC, Plaintiffs,

against

Joseph Santana, PETER KELLY, CAROL FITZGERALD, TERRY LIERMAN and RICHARD D. GLASER, Defendants, and LIFE MEDICAL TECHNOLOGIES, INC., Nominal Defendant.




36213-12



JAMES E. CLARK, ESQ.



Attorney for Plaintiffs



57 West Main Street, Suite 220



Babylon, New York 11702



EATON & VAN WINKLE LLP



Attorneys for Defendants Peter Kelly,



Carol Fitzgerald, Terry Lierman, and Richard D. Glaser



Three Park Avenue, 16th Floor



New York, New York 10016


Elizabeth H. Emerson, J.

Upon the following papers numbered 1-27 read on this motionto dismiss and cross-motions to amend ; Notice of Motion and supporting papers 1-7 ; Notice of Cross Motion and supporting papers 8-17; 18-19 ; Answering Affidavits and supporting papers20-26 ; Replying Affidavits and supporting papers 27 ; and after hearing oral argument, it isORDERED that the motion by the defendants Peter Kelly, Carol Fitzgerald, Terry Lierman, and Richard D. Glaser for an order dismissing the complaint insofar as it is asserted against them is granted; and it is further



ORDERED that the cross motions by the plaintiffs for leave to amend the complaint are denied.



The plaintiffs commenced this shareholder derivative action on behalf of Life Medical Technologies, Inc. ("Life Medical" or the "Corporation" or the "Company"), a Delaware corporation, alleging breach of fiduciary duties and gross negligence. The defendants Peter Kelly, Carol Fitzgerald, Terry Lierman, and Richard D. Glaser move to dismiss the complaint on the ground that the plaintiffs did not make a demand on Life Medical's board of directors before



commencing this action or show that such a demand would be futile.[FN1]



For choice of law purposes, Delaware, the state of Life Medical's incorporation, determines the applicable law (see, O'Donnell v Ferro, 303 AD2d 567, 568; Katz v Emmett, 226 AD2d 588, 589). Delaware Chancery Court Rule 23.1 provides, in pertinent part, that every shareholder-derivative complaint shall "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors...and the reasons for the plaintiff's failure to obtain the action or for not making the effort." Thus, a shareholder filing a derivative suit must allege either that the board rejected his pre-suit demand that the board assert the corporation's claim or allege with particularity why the shareholder was justified in not having made the effort to obtain board action (see, Grimes v Donald, 673 A2d 1207, 1216, overruled on other grounds Brehne v Eiser, 746 A2d 244). It is undisputed that the plaintiffs did not make a demand on Life Medical's board of directors before commencing this action.



The failure to make a demand is excused when the demand would be futile (Security Police & Fire Professionals of Am. Retirement Fund v Mach, 30 Misc 3d 663, 669 [applying Delaware law], affd 93 ADd3d 562). The specific test for demand futility depends on whether the shareholders challenge an affirmative decision or a failure to act on the part of the board (Id.). Under Delaware law, to show demand futility when the complaint challenges a board's affirmative decision, the complaint must allege particularized facts creating reasonable doubt (1) that the directors are disinterested and independent or (2) that the challenged transaction was otherwise the product of a valid exercise of business judgment (Id.). When the complaint challenges a board's failure to act, demand futility is shown if the particularized factual allegations of the complaint create a reasonable doubt that the board is independent or [*2]disinterested in responding to the demand (Id.). The pleading burden for demand futility is more onerous than the burden a plaintiff must satisfy when confronted with a motion to dismiss, and conclusory allegations are not considered as expressly pleaded facts or factual inferences (Id.).



The complaint in this action challenges both affirmative decisions of the board as well as the board's failure to act. Specifically, the plaintiffs make the following allegations: In 2007, the defendant Carol Fitzgerald, who was then Life Medical's president, entered into a consulting agreement with the Company. In 2008, the Company extended the consulting agreement, and Fitzgerald agreed to raise $4 million for Life Medical in exchange for 5 million shares of common stock. In 2010, the board granted to Fitzgerald, who was then Life Medical's chief executive officer, a preferred share of stock that was equal to 51% of the issued and outstanding shares of common stock of the Corporation. Fitzgerald did not raise the $4 million and the board failed to take any action to recover the shares given to her. In 2012, the board elected the defendant Richard Glazer president of Life Medical and appointed him as chief executive officer with a compensation package consisting of 2,880,000 shares and an annual salary of $212,500. The plaintiffs contend that, since 2008, the Company's stock has seen a dramatic decline in value; that the defendants have wasted the Company's resources; and that they have failed to develop the Company's sole asset, a patent with less than five years remaining on its term. Moreover, there has been no annual meeting of the shareholders since 2011, despite due demand therefor.



Reasonable doubt must be raised as to a majority of the board of directors sitting at the time the complaint is filed (Id. at 670). Life Medical's board of directors consisted of the following six members when the complaint was filed: the defendants Joseph Santana, Peter Kelly, Carol Fitzgerald, Terry Lierman, and Richard Glaser, and non-party Oliver Jack Reynolds III.[FN2] Thus, the plaintiff must raise a reasonable doubt as to four of the directors. Fitzgerald and Glaser, as employees of Life Medical, received personal benefits from two of the challenged transactions that were not equally shared by the shareholders (Id. at 671-672). Fitzgerald also received personal benefits as a consultant. Accordingly, the court finds that both Fitzgerald and Glaser are interested directors (Id. at 672).



The plaintiff's allegations, however, are insufficient to raise a reasonable doubt as to the remaining directors. That the defendant directors face a substantial likelihood of personal liability for approving the contested transactions may render them personally interested in the decision whether to pursue the demanded litigation (93 AD2d at 565 [applying Delaware law]). However, the likelihood of personal liability is significantly diminished because Life Medical's certificate of incorporation provides that the directors are exculpated from liability to the fullest extent permitted by Delaware law (Id.). Such a provision exculpates the directors from personal liability to the Corporation or its stockholders for all claims except those based on fraudulent, illegal, or bad-faith conduct (Id.). Thus, the complaint must allege particularized facts that the [*3]defendant directors acted with scienter, i.e., that they had actual or constructive knowledge that their conduct was legally improper (Id.). The complaint contains no such allegations against Santana, Kelly, or Lierman.



The plaintiffs' proposed amended complaint alleges that Santana, Kelly, and Lierman lack independence because they are controlled by Fitzgerald and voted in a way that primarily benefitted her and not the Company. Independence means that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences (30 Misc 3d at 679). The mere fact that a director was on the board at the time of the acts alleged in the complaint does not make that director interested or dependent so as to infringe on his ability to exercise his independent business judgment on the issue of whether to proceed with the litigation (Id.). Even a director's approval of the transaction in question does not establish a lack of independence (Id.). Allegations of bias that are not supported by tangible evidence of an interest in the outcome of the litigation do not demonstrate a lack of independence (Id.). The court finds that the allegations in the proposed amended complaint are not sufficiently particular to raise a reasonable doubt regarding the independence of Santana, Kelly, or Lierman.



The plaintiffs, relying on Kaplan v Peat Marwick Mitchell & Co.(540 A2d 726), contend that Life Medical's failure to appear in this action is a tacit approval thereof. The plaintiffs contend that Life Medical and its board are two different entities and that the board's opposition to the action cannot be imputed to Life Medical. The plaintiffs' reliance on Kaplan is misplaced. In that case, the plaintiff shareholders brought a derivative action on behalf of the Chase Manhattan Corporation ("Chase") against Chase's independent auditor Peat Marwick Mitchell & Co. ("Peat Marwick"). Peat Marwick moved to dismiss the action for failure to satisfy the demand requirement. Chase did not join in the motion, but submitted an affidavit to the court in which it stated that it neither objected to nor supported the action being brought on its behalf. The Delaware Supreme Court viewed Chase's position of neutrality as a tacit approval of the continuance of the litigation, finding that the application of the demand-futility test presupposses that the corporation has taken a hostile position regarding the derivative litigation (Id. at 731-732).



Contrary to the plaintiff's contentions, Life Medical has taken a position that is hostile to this action. Unlike Kaplan, there has been no expression of neutrality by Life Medical, and a majority of Life Medical's board of directors has moved to dismiss the complaint. The Kaplan court explicitly acknowledged that it is a basic principle of the Delaware General Corporation Law that the business and affairs of a corporation shall be managed by the board of directors (Id. at 729). The Kaplan court also acknowledged that the Chase directors had decided not to oppose the prosecution of the derivative action (Id. at 732 [emphasis added]). Here, the Life Medical directors have opposed the action by moving to dismiss the complaint. The court finds that their opposition refutes any claim of Life Medical's neutrality (see, Bellikoff v PricewaterhouseCoopers, LLP, 300 Fed Appx 41, 43 [2nd Cir]).



Since the plaintiffs have failed to establish that a demand on Life Medical's board of directors would be futile, the demand requirement is not excused. Accordingly, the motion to dismiss is granted, and the cross motions to amend the complaint are denied.

Dated:June 17, 2014

J.S.C.

Footnotes


Footnote 1:The remaining defendant, Joseph Santana, was never served with the summons and complaint.

Footnote 2:Reynolds is not named as a defendant because, according to the plaintiffs, he supports their position.