Opinion
No. 04 Civ. 5299 (JSR).
February 7, 2005
MEMORANDUM ORDER
By complaint filed July 7, 2004, plaintiff Wall Street Systems, Inc. ("WSS") seeks declaratory judgment against defendant Ricardo P. Lemence, a founder and minority shareholder of WSS, as to the amounts of salary owed to Lemence for the years 2001, 2002, and 2003. On August 27, 2004, defendant filed an Answer, Counterclaims, and Third Party Complaint, which he subsequently amended in a pleading filed On October 15, 2004, entitled Defendant's First Answer, Counterclaims and Third Party Complaint and Verified Shareholder's Derivative Third Party Complaint ("Am. Countercls."). The amended pleadings asserted, inter alia, counterclaims against WSS and third-party claims against WSS board members (and third-party defendants) Lucien Kneip, Joseph Patrina, J. Watkins Strouss, and James Patrina (collectively, the "Board"), and also sought to commence a derivative suit on behalf of WSS, Wall Street Systems Delaware, Inc., Wall Street Systems Participation, Inc. (a New York Corporation), and Wall Street Systems Participation, Inc. (a Delaware Corporation) against the aforementioned third-party defendants.
WSS and the third-party defendants have now moved to dismiss Counts 3 and 4 of the Amended Counterclaims pursuant to Rule 12(b)(6), Fed.R.Civ.P., and Counts 5, 6, 7, and 8 of the Amended Counterclaims pursuant to Rule 12(b) (6) and Rule 23.1, Fed.R.Civ.P. For the following reasons, the motion is granted in its entirety.
Counts 1 and 2 of the Amended Counterclaims are brought by Lemence in his individual capacity against plaintiff WSS for breach of contract and breach of fiduciary duty, respectively, and are not the subject of the instant motion to dismiss.
Although defendant has plead Count 3 ("fraud") and Count 4 (intentional misrepresentation/concealment) separately, they describe the same alleged scheme. Specifically, Lemence alleges that in May 2001 he was duped into consenting to allow the Board to reduce the annual salary he was otherwise due as a founder of WSS, by misrepresentations regarding WSS's cash flow and financial condition. See Am. Countercls. ¶¶ 132, 145-46. Under Rule 9(b), Fed.R.Civ.P., such allegations must be plead with particularity. Specifically, the complaint must "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir. 2000); see also Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994); Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993). Even in his amended pleading, Lemence has not remotely met these requirements and, hence, Counts 3 and 4 must be dismissed.
Although in such circumstances the Court might ordinarily consider giving Lemence leave to re-plead once again, here it is unnecessary to do so because Counts 3 and 4 are also defective on another ground. Under New York law (which governs these claims), the elements of common law fraud are "a material, false representation, an intent to defraud thereby, and reasonable reliance on the representation, causing damage to the plaintiff."Katara v. D.E. Jones Commodities, Inc., 835 F.2d 966, 970-71 (2d Cir. 1987). The elements of intentional misrepresentation/concealment are essentially the same. See Murray v. Xerox Corp., 811 F.2d 118, 121 (2d Cir. 1987). Yet, even in this amended pleading, Lemence has failed to adequately allege either materiality or intent as to both claims. These striking failures, occurring in an amended pleading, evidence the poverty of the claims and the futility of permitting further re-pleading. Accordingly, Counts 3 and 4 are dismissed with prejudice.
The third-party defendants have also moved to dismiss Lemence's third-party, shareholder derivative claims, namely, Count 5 (waste and conversion), Count 6 (unjust enrichment), Count 7 (breach of fiduciary duty for failure to establish and maintain adequate internal financial controls), and Count 8 (breach of fiduciary duties for failing to comply with shareholder resolutions). Rule 23.1, Fed.R.Civ.P., requires that a in a derivative action
[t]he complaint shall . . . allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors . . . and, if necessary, from the shareholders or members, and the reasons for the plaintiff's failure to obtain the action or for not making the effort. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association.
Fed.R.Civ.P. 23.1. 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) (per curiam).
Lemence concedes that he has not made a demand on the Board in compliance with Rule 23.1, but claims that such a demand would have been futile. However, where futility is alleged, the shareholder cannot simply state that any demand would be futile; instead he must plead specific facts explaining the reasons for the lack of demand. See Lewis v. Graves, 701 F.2d 245, 247 (2d Cir. 1983); 7C Wright Miller, Federal Practice and Procedure § 1831, at 116-17 (2d ed.). This Lemence has failed to do. Rather, he simply recites, in largely conclusory terms, that the Board is entrenched, self-interested, and the like. Am. Countercls. ¶ 108. This is not sufficient to meet Rule 23.1.
Here again the Court might ordinarily at least consider giving Lemence a third bite at the apple. But at oral argument, it became clear that any such permission would be improvident because Lemence would not be able to satisfy the requirements of Delaware Law (which governs this issue) for excusing a demand on the Board. See transcript, November 22, 2004. Specifically, under Delaware law a plaintiff must allege facts that show not only that the directors are biased or conflicted, but also that the specific transaction in question was not the product of a valid exercise of business judgment. See Aronson v. Lewis, 473 A.2d 805, 808, 814-15 (Del. 1984).
Lemence fails to satisfy either of these prongs. The fact that, as he alleges, the Board consists of friends of the person (Kneip) who, he alleges, made the primary misrepresentation to him, is insufficient to excuse demand. Id. at 814-16. Nor can the fact that the Board has remained unchanged for ten years, as Lemence alleges, somehow excuse giving the Board the opportunity to address Lemence's demands. Nor has Lemence alleged any facts indicating that the Board was lacking in business judgment. The shift from paying salaries to paying dividends was, on its face, a classic business judgment issue for a closed corporation like WSS. And although he also complains of WSS' purchase of a property at 11 Cobblers Lane, Armonk, New York, he has filed to show with any particularity why this was not a reasonably prudent investment at the time made.
Finally, even if one could overlook all the foregoing deficiencies, Lemence has failed to show that he can fairly and adequately represent the interests of all shareholders, as required under Rule 23.1. This is because an individual shareholder has a conflict of interest, and therefore cannot adequately represent other shareholders, when he simultaneously brings a direct and derivative action, as Lemence has done here.See, e.g., Ryan v. Aetna, 765 F. Supp. 133, 137 (S.D.N.Y. 1991); Petersen v. Federated Development Co., 416 F. Supp. 466, 475 n. 6 (S.D.N.Y. 1976).
Accordingly, for the foregoing reasons, Counts 3 through 8 of the Amended Counterclaims are dismissed with prejudice.
SO ORDERED.