Opinion
CIVIL ACTION NO. 99-2332, SECTION "N"
February 15, 2002
ORDER AND REASONS
Before the Court are: (1) defendant Kalmus' Motion for Partial Summary Judgment on Plaintiffs Claims of Breach of Fiduciary Duty; (2) defendant Bhansali's Motion for Partial Summary Judgment on Plaintiffs Claims of Breach of Fiduciary Duty; and (3) defendant Kalmus' Motion for Summary Judgment on his counterclaims against the plaintiffs. For the reasons that follow, Kalmus' motion for summary judgment on his counterclaims is DENIED, and both motions for partial summary judgment dismissing plaintiffs' breach of fiduciary claims are GRANTED.
I. BACKGROUND
This matter arises out of the management of two corporations created to implement the manufacture of printed circuit boards in India: International Circuits, Limited ("ICL") (incorporated under the law of Illinois) and International Technologies (India), Limited ("ITIL") (incorporated under the law of India). Plaintiffs, Dhanpat Mohnot, Surendra Purohit, and Sunil Purohit, brought this action against Rajeev Bhansali in Louisiana state court in May 1999, seeking damages for fraudulent misrepresentations and RICO violations that Bhansali allegedly committed as a director of ICL and ITIL. After Bhansali removed the action to this Court, plaintiffs filed an amending complaint adding Christopher Kalmus as a defendant. Plaintiffs later filed a second amending complaint, which added claims for breach of fiduciary duty against each defendant. It is these claims which are the subject of the instant motions.
Plaintiffs also filed a third amending complaint, asserting fraud claims against both defendants.
Early in these proceedings, Kalmus moved to dismiss the breach of fiduciary claim against him on grounds that it was a derivative claim for injury to the corporations and that plaintiffs lacked standing to bring the action, having failed to make demand on the boards of directors as required by Illinois law. The Court found that the claim was derivative, but that plaintiffs' allegations passed muster under Rule 12(b)(6) because they alleged "complete control" of the corporations by the defendants. See Order Reasons, June 23. 2000 (Clement, J.). If true, this would establish the futility of making demand on the directors, thereby excusing plaintiffs' failure to take this essential step. Because the motion was pursuant to Rule 12(b)(6), the Court accepted plaintiffs' allegations as true. Id. at p. 4.
Defendants Kalmus and Bhansali now move under Rule 56 to dismiss the breach of fiduciary duty claims on two grounds: (1) that plaintiffs have not satisfied the steps necessary to bring these derivative claims; and (2) that no genuine issue of material fact exists with respect to the defendants' fulfillment of their fiduciary duties. Because the Court finds that plaintiffs do not meet the requirements for bringing this derivative claim, the Court does not reach the second issue.
II. LAW AND ANALYSIS
A. Motions for Partial Summary Judgment on Breach of Fiduciary Duty Claims:
Because the defendants' motions are under Rule 56, plaintiffs may no longer rely on conclusory statements in their pleadings and affidavits. Where, as here, the party moving for summary judgment has shown "that there is an absence of evidence to support the nonmoving party's case," the nonmoving party "must go beyond the pleadings and designate specific facts showing that there is a genuine issue for trial." Kee v. City of Rowlett, Texas, 247 F.3d 206, 210 (5th Cir.), cert. denied, 122 S.Ct. 210 (2001). "A dispute over a material fact is genuine if the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Id. (internal quotations omitted). "The substantive law determines which facts are material." Id.
"Illinois follows the widespread rule that an action for harm to the corporation must be brought in the corporate name." Frank v. Hadesman Frank Inc., 83 F.3d 158, 160 (7th Cir. 1996); Small v. Sussman, 713 N.E.2d 1216, 1219 (Ill.App. 1st Dist. 1999). "When shareholders have been injured in common, they must bring a derivative action in the corporate name." Fidelity National Title Ins. Co. of New York v. Intercounty Nat'l Title Ins. Co., 161 F. Supp.2d 876, 881 (N.D. Ill. 2001); Frank, 83 F.3d at 160. It is only where the investor has alleged a distinct personal injury — an injury he does not share with his fellow investors — that he may assert a direct action against a corporate officer or director. Id. This Court, by order of Judge Clement, has held that plaintiffs' breach of fiduciary claims are derivative in nature. Plaintiffs do not contest this holding. See Response to Uncontested Facts ¶ 2. Thus, the issue presented is whether plaintiffs have complied with Illinois' requirements for bringing such an action.
See Order Reasons, June 23, 2000 (Clement, J.) at p. 3. The Court also has held that the fraud claims asserted in Counts One and Two of the Third Supplemental and Amending Complaint are derivative. See Order Reasons, Feb. 23, 2001 (Clement, J.) at p. 3. Thus, these claims are subject to the same requirements for bringing a derivative action as are the claims for breach of fiduciary duty. The fraud claims remain pending as to defendant Bhansali. However, the Court does not have before it today a motion seeking to dismiss these claims on the grounds asserted in the instant motion.
The law of the state of incorporation dictates the requirements for bringing a derivative action. Silver, 16 F. Supp. 2d at 968 (citing Kamen, 500 U.S. at 101). Thus, Illinois law governs the claims for injury to ICL. Plaintiffs argue that Illinois law governs the claims relating to ITIL as well, because ICL is ITIL's majority shareholder. Defendants likewise assume the application of Illinois law to ITIL. Given the uncertainty of plaintiffs' status as shareholders of ITIL and that Illinois allows "double derivative" actions ( i.e., suits by shareholders of a holding corporation for harm to a subsidiary), see discussion infra at page 4, the Court agrees with the parties that application of Illinois law is appropriate to determine whether plaintiffs may bring suit for injury to ITIL.
Under Illinois law, to bring a derivative action for injury to the corporation, a shareholder must make pre-suit demand on the corporation's directors to assert the claim. See 805 Ill. Comp. Stat. § 5/7.80(b) (shareholder must allege "demand made, if any, to obtain action by the directors . . . or why he or she did not make the demand"); Silver v. Allard, 16 F. Supp.2d 966, 969 (N.D. Ill. 1998). One "purpose underlying the demand requirement is to provide the directors an opportunity to exercise their business judgment and determine whether litigation is in the best interest of the corporation." Silver, 16 F. Supp.2d at 968 (citing Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 96 (1991)). Another purpose of the requirement is to prevent suits that are designed "to deny other investors, particularly creditors, a share of the recovery." Frank, 83 F.3d at 161. In a double derivative suit, such as this one, where shareholders of a holding corporation assert harm to a subsidiary, "the shareholder must make a pre-suit demand upon both the holding company and the subsidiary." Silver, 16 F. Supp.2d at 969 (citing Brown v. Tenney, 125 Ill.2d 348, 532 N.E.2d 230, 235-36 (1988)); see also Powell v. Grant, 556 N.E.2d 1241, 1245 (Ill.App. 4th Dist. 1990). Alternatively, the shareholder must show why he failed to make demand on the directors. Id. "[T]he doctrine of futility excuses demand on directors when the majority of the directors are the alleged wrongdoers." Powell, 556 N.E.2d at 1245 (applying Delaware test for demand futility set forth in Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984)). To demonstrate demand futility where the plaintiffs have made no demand on the board of directors, plaintiffs must "raise a reasonable doubt that the directors are disinterested and independent." Silver, 16 F. Supp. 2d at 970 (applying Aronson test).
"A double derivative suit is one in which a "shareholder of a holding company seeks to enforce a right belonging to the subsidiary, [but] only derivatively to the holding company.'" Silver, 16 F. Supp. 2d at 968 n. 2 (citing Brown v. Tenney, 125 Ill.2d 348, 532 N.E.2d 230, 233 (1988)). A "holding company" is a corporation with concentrated ownership of shares in another company, by which it influences policies of the company whose shares it owns. Id. at n. 4. Here. it is undisputed that ICL is the majority shareholder of ITIL, and the Court already has held that plaintiffs are shareholders of ICL. See Order Reasons, Feb. 23, 2001 (Clement, 1.) at p. 10. Plaintiffs seek damages for alleged breaches of fiduciary duty to both ICL and ITIL.
Plaintiffs maintain that pre-suit demand would have been futile here because the defendants, at certain times, have run the day-to-day operations of the two corporations. However, the relevant inquiry is whether the alleged wrongdoers controlled a majority of each board of directors at the time suit was filed (not when the alleged wrongs occurred) such that demand on the boards of directors to assert the claims would have been futile. See Spilyards v. Abboud, 662 N.E.2d 1358, (Ill.App. 1st Dist 1996) ("Director disinterest and independence . . . is determined at the time the complaint is filed . . . ."); In re Cendant Corp. Derivative Action Litigation, 96 F. Supp.2d 394, 401 (D.N.J. 2000) ("Futility is determined by looking to the composition of the board at the time the derivative action claim is asserted.") (applying Aronson test, which is followed by Illinois courts, and holding that futility of demand is not shown where only half, not majority, of board members were interested in the alleged wrong-doing).
Plaintiffs have failed to produce any evidence demonstrating that, as of the commencement of this action, a majority of the members of either board of directors were interested or involved in the alleged wrongdoing such that demand on them to assert the claims herein would have been futile. Indeed, the undisputed evidence shows that the plain: ifs, not the defendants, held a majority of seats on the ICL board and that the plaintiffs outnumbered the defendants on the ITIL board. Plaintiffs contend that they were passive as directors, that the defendants held all responsibility for running the corporations. However, on the issue of demand futility, the relevant question is not whether individual members of the boards of directors were assertive or whether the defendants, as officers, held more responsibility over day-to-day operations than the plaintiffs. Rather, the question is whether, at the time suit was filed, the directors — a majority of them — were interested in the wrongdoing such that demand on them to assert the claims would have been futile. The Court finds that plaintiffs have failed to produce any evidence from which a reasonable jury could conclude that demand on the ICL and ITIL directors to assert the claims herein would have been futile. Accordingly, defendants are each entitled to judgment as a matter of law dismissing plaintiffs' breach of fiduciary duty claims without prejudice.
Plaintiffs contend that the minutes of ITIL board meetings, relied upon by the defendants, contain certain unspecified inaccuracies. Given plaintiffs' previous reliance on these very minutes, the Court is unpersuaded by this nebulous aspersion. Even if the Court were to accept the argument, however, it would not change the Court's analysis. Plaintiffs do not contest that they held positions on both boards of directors, and they have presented no evidence that a majority of the directors on those boards were interested in the alleged wrongdoing or otherwise lacked independence at the time this suit was filed.
Even if the plaintiffs' professed meekness were at issue, their self-serving statements in this regard are belied by both the facts and the law. In 1998, when plaintiffs became dissatisfied with defendant Bhansali's management of ITIL, they held a board meeting in New Orleans and took action by appointing R.K. Bothra as chief financial officer and B.K. Agnihotri as chairman of the board. Thus, plaintiffs were not as derelict as they claim. Nor would the law aid them if they were. Illinois law imposes on all directors the duty to attend and participate in board meetings and to inform themselves of the material facts necessary to exercise their judgment with the same degree of care that a prudent man would exercise in the management of his own affairs. Stamp v. Touche Ross Co., 636 N.E.2d 616, 620-21 (Ill.App. 1st Dist. 1993).
B. Kalmus' Motion for Summary Judgment on His Counterclaims:
Kalmus, as plaintiff-in-counterclaim, seeks summary judgment on his counterclaims against the plaintiffs. According to Kalmus, plaintiffs breached their fiduciary duties as directors by (1) accepting loans and stock from ITIL, (2) misdating and signing without reading ITIL financial reports and minutes of ITIL board meetings, and (3) failing to raise additional funds for ITIL. He argues that these acts caused ITIL to lose money and fail, thereby causing him to lose his investment and suffer damages in the form of unpaid salary and unreimbursed expenses. The plaintiffs, as defendants-in-counterclaim, oppose the motion on four grounds: (1) that Kalmus' counterclaims are derivative claims for which Kalmus has failed to make the requisite demand; (2) that Kalmus has failed to demonstrate any basis, contractual or otherwise, for holding plaintiffs (as opposed to the corporations) liable for his unpaid salary and corporate expenses; (3) that Kalmus has failed to carry his burden of proving a causal link between his damages and the alleged breaches of fiduciary duty; and (4) that they require the deposition of Bhansali to oppose the motion on the merits.
The Court agrees with plaintiffs that, with the exception of his direct claim for unpaid salary and expense reimbursement, Kalmus' claims all seek to recover for injuries to ITIL. As discussed supra, to enforce these derivative claims, Kalmus must have made pre-suit demand upon both the ITIL and the ICL boards of directors. The demand that must be made is to enforce the corporate right — here, a cause of action for alleged breaches of fiduciary duty — so that the board can determine whether to pursue the litigation. See Silver, 16 F. Supp. 2d at 968. The letter sent by Kalmus' counsel to plaintiffs' counsel (one day before filing the counterclaim) demanding that the plaintiffs return proceeds from a land sale does not satisfy this requirement. It does not ask the directors to pursue claims for breaches of fiduciary duty or any other claim, and even if it did, Kalmus has failed to show that he made demand of any sort on any of the other members of the boards of directors. With respect to the claim for salary and expenses, Kalmus has failed to demonstrate any basis, contractual or otherwise, for holding plaintiffs (as opposed to the corporations) liable for his unpaid salary and expenses.
Kalmus suggests obliquely that his claim for breach of the "shareholder agreement" is not a derivative claim and thus not subject to the demand requirement. The Court disagrees. This claim, as described in Kalmus' counterclaim, is that plaintiffs breached an alleged verbal promise to raise additional funds (second generation financing) for ITIL, which "resulted in the alleged damages to the business venture in this litigation." Rec. Doc. 36 at p. 28 (emphasis added). Even if it were not derivative, it would not change the result here, for Kalmus has failed to prove at this juncture the existence of any contract between the plaintiffs and Kalmus in his personal capacity. Certainly, he has failed to show that he is entitled to judgment as a matter of law awarding him damages for breach of such a contract.
Based on the record as it stands today, it appears likely that Kalmus' derivative claims are subject to dismissal without prejudice; and his claim for salary and expenses, at least as to plaintiffs, dismissal with prejudice. However, as with the fraud claims against Bhansali, no motion is before the Court seeking summary judgment on these grounds.
III. CONCLUSION
Accordingly, for the foregoing reasons, IT IS ORDERED that: (1) defendant Kalmus' Motion for Partial Summary Judgment on Plaintiffs Claims of Breach of Fiduciary Duty is GRANTED, such claims to be dismissed without prejudice; (2) defendant Bhansali's Motion for Partial Summary Judgment on Plaintiffs Claims of Breach of Fiduciary Duty is GRANTED, such claims to be dismissed without prejudice; and (3) Kalmus' Motion for Summary Judgment on his claims against Dhanpat Mohnot, Surendra Purohit, and Sunil Purohit is DENIED.