Marx v. Akers
88 N.Y.2d 189, 666 N.E.2d 1034, 644 N.Y.S.2d 121 (1996)
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Rule of Law:
In a shareholder derivative action, a pre-suit demand on the board of directors is excused as futile when the complaint alleges with particularity that a majority of the board is interested in the transaction, the board failed to inform themselves to a reasonably necessary degree, or the challenged transaction was so egregious it could not have been the product of sound business judgment.
Facts:
- Plaintiff Marx, a shareholder of International Business Machines Corporation (IBM), was concerned about the compensation being paid to IBM's executives and its outside directors.
- During a period of declining profitability for the company, IBM's board of directors awarded compensation packages to its executives.
- The board, which consisted of 18 members (15 of whom were outside, non-employee directors), also voted to increase the compensation for the outside directors.
- The compensation for outside directors was increased from a base of $20,000 plus $500 per meeting to an annual retainer of $55,000 plus 100 shares of IBM stock.
- Marx believed this compensation was excessive and constituted a waste of corporate assets.
- Without first demanding that the IBM board of directors initiate a lawsuit to challenge the compensation, Marx filed a shareholder derivative action.
Procedural Posture:
- Plaintiff Marx filed a shareholder derivative action against IBM and its board in the New York Supreme Court, which is the trial court of first instance.
- Defendants moved to dismiss the complaint, arguing that Marx had failed to make the required pre-suit demand on the board and that the complaint failed to state a cause of action.
- The Supreme Court granted the defendants' motion to dismiss, finding that Marx had not sufficiently shown that making a demand would have been futile.
- Marx appealed the dismissal to the Appellate Division of the Supreme Court, which is the intermediate appellate court.
- The Appellate Division affirmed the trial court's dismissal.
- Marx, as appellant, was granted leave to appeal to the Court of Appeals of New York, the state's highest court, with IBM and its board as appellees.
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Issue:
Is a shareholder excused from making a pre-suit demand on the board of directors in a derivative action where the complaint alleges that a majority of the board approved excessive compensation for themselves and for company executives?
Opinions:
Majority - Smith, J.
No. A shareholder is not automatically excused from the pre-suit demand requirement merely by alleging that a majority of the board approved the challenged transaction. Demand futility must be pleaded with particularity under a three-part test: (1) a majority of the board is interested in the transaction, (2) the board was not fully informed, or (3) the transaction was so egregious that it could not have been the product of sound business judgment. Applying this test, the demand regarding executive compensation was not excused because only three of the eighteen directors were executives, meaning a majority of the board was not self-interested in that transaction. However, demand was excused for the claim regarding director compensation because the fifteen outside directors who constituted a majority of the board received a direct financial benefit from the transaction, making them interested. Despite demand being excused on this claim, the complaint fails to state a cause of action for corporate waste because it makes only conclusory allegations that the compensation was excessive, without pleading particularized facts showing the compensation was facially exorbitant or could not have been the product of valid business judgment.
Analysis:
This case significantly clarifies the standard for demand futility in New York, rejecting a lenient interpretation of prior precedent that excused demand whenever a majority of the board was named as defendants. By establishing a more rigorous three-part test, the court strengthens the power of the board of directors under the business judgment rule and makes it more difficult for shareholders to bypass the board's authority to manage corporate litigation. This decision raises the pleading requirements for shareholders, forcing them to allege specific facts demonstrating director interest, lack of due care, or egregious conduct, thereby helping to weed out non-meritorious derivative suits at an early stage. The ruling also affirms that conclusory allegations of excessive compensation are insufficient to state a claim for corporate waste, requiring plaintiffs to provide factual support that the compensation is beyond the bounds of reasonable business judgment.
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