Opinion
16417, 652020/13.
03-31-2016
ASBESTOS WORKERS PHILADELPHIA PENSION FUND, Plaintiff, Mark Svechin, etc., Plaintiff–Appellant, v. James A. BELL, et al., Defendants–Respondents, William H. Gary, III, Defendant, JPMorgan Chase & Company, Nominal Defendant–Respondent.
Barrack, Rodos, & Bacine, New York (Alexander Arnold Gershon of counsel), for appellant. Shearman & Sterling LLP, New York (Stuart J. Baskin of counsel), for James A. Bell, Crandall C. Bowles, Stephen B. Burke, David M. Cote, James S. Crown, Ellen V. Futter, Laban P. Jackson, Jr., David C. Novak, Lee R. Raymond, and William C. Weldon, respondents. Debevoise & Plimpton LLP, New York (Gary W. Kubek of counsel), for James Dimon, Michael J. Cavanagh, Ina R. Drew and JPMorgan Chase & Company, respondents.
Barrack, Rodos, & Bacine, New York (Alexander Arnold Gershon of counsel), for appellant.
Shearman & Sterling LLP, New York (Stuart J. Baskin of counsel), for James A. Bell, Crandall C. Bowles, Stephen B. Burke, David M. Cote, James S. Crown, Ellen V. Futter, Laban P. Jackson, Jr., David C. Novak, Lee R. Raymond, and William C. Weldon, respondents.
Debevoise & Plimpton LLP, New York (Gary W. Kubek of counsel), for James Dimon, Michael J. Cavanagh, Ina R. Drew and JPMorgan Chase & Company, respondents.
FRIEDMAN, J.P., ANDRIAS, GISCHE, KAPNICK, JJ.
Opinion Judgment, Supreme Court, New York County (Charles E. Ramos, J.), entered June 13, 2014, dismissing the complaint, unanimously affirmed, with costs.
This derivative action was brought by both an institutional and an individual shareholder of JP Morgan Chase & Co. (JPMorgan), without any pre-suit demand having been made. The named defendants are 11 current and former members of JPMorgan's Board of Directors and two former officers. The claims arise out of JPMorgan's securitization and sale of its subprime and other troubled residential mortgages. Plaintiffs' claims are mainly based on allegations that defendants were aware that these mortgages would fail and that they authorized the sale of securities holding these mortgages (RMBS) as a means of removing toxic assets from JPMorgan's balance sheet without sufficiently accounting for reserves. Plaintiffs allege that the board's actions were intended to make JP Morgan appear more financially secure than it actually was in the short run, all the while knowing that the substantial losses (in the billions of dollars) would subsequently be realized by JPMorgan, based upon repurchase obligations and other lawsuits by the government and RMBS investors. Plaintiffs also claim that in January 2007 the board improperly abdicated its obligation of board oversight by authorizing a management committee to sell off JPMorgan's toxic RMBS without any further action by the board. That authorization was subsequently extended two additional times.
On this appeal the only issue is whether Supreme Court correctly dismissed the action on the ground that plaintiffs neither made a pre-suit demand on the board nor pleaded facts sufficient to support a claim of demand futility. For the reasons set forth below, we find that the motion court correctly determined that plaintiff was not excused from making a pre-suit demand on the board and, consequently, that the complaint was properly dismissed.
Preliminarily we reject plaintiffs' argument that to the extent their claims are premised on an abdication of responsibility, it is a direct claim for which no pre-suit demand is required. Here, because plaintiffs could not prevail on their claims without also showing injury to the corporation, the claims are derivative not direct, implicating the law of pre-suit demands (see Tooley v. Donaldson Lufkin & Jenrette, Inc., 845 A.2d 1031 [Del.2004] ).
Since JPMorgan is incorporated under Delaware law, Delaware law applies to plaintiff's claims and the issue of demand futility (Del.Ch. Ct. rul 23.1; Wandel
v. Dimon, 135 A.D.3d 515, 23 N.Y.S.3d 200 [1st Dept.2016] ; see e.g. Siegel v. J.P. Morgan Chase & Co., 103 A.D.3d 598, 960 N.Y.S.2d 104 [1st Dept.2013], lv. denied 21 N.Y.3d 856, 2013 WL 2350363 [2013] ; In re Citigroup Inc. Shareholder Derivative Litig., 964 A.2d 106, 120 [Del.Ch.2009] ). In Delaware, as a condition precedent to a plaintiff bringing a shareholder derivative action on behalf of a corporation, the plaintiff must make a pre-suit demand that the board pursue the contemplated action (see e.g. Simon v. Becherer, 7 A.D.3d 66, 775 N.Y.S.2d 313 [1st Dept. 2004] ). A pre-suit demand upon a board may be excused, however, if such a demand would have been “futile.” Where the underlying lawsuit seeks to challenge affirmative board action, a two prong test is applied in assessing the futility of such a demand (Aronson v. Lewis, 473 A.2d 805, 814 [Del.1984], overruled in part on other grounds Brehm v. Eisner, 746 A.2d 244 [Del.2000] ). The Aronson test is “whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment” (Aronson v. Lewis, 473 A.2d at 814 ). Since this test is in the disjunctive, if either prong is satisfied, pre-suit demand is excused (Brehm v. Eisner, 746 A.2d at 256 ). On the other hand, where a complaint alleges board inaction, demand futility can be established by particularized facts creating a reasonable doubt that at the time the complaint was filed, the board could not have properly exercised its independent and disinterested business judgment in responding to the demand (In re Goldman Sachs Group, Inc. Shareholder Litig., 2011 WL 4826104, 2011 Del.Ch. LEXIS 151 [Del.Ch.2011], affd. sub nom. Southeastern Penn. Transp. Auth. v. Blankfein, 44 A.3d 922 [Del.2012] ; Rales v. Blasband, 634 A.2d 927 [Del.1993] )(Rales test). Under either standard, plaintiffs have not satisfied the requirements of demand futility.
Plaintiffs did not plead with particularity facts establishing that a majority of the board at the time they commenced this action was interested or lacked independence. With the exception of Dimon, who was both a director and officer of JPMorgan, the board members were all outside directors. Independence requires that a director's decision be based on the merits of the subject before the board rather than extraneous considerations or influences (see In re JP Morgan Chase & Co. Shareholder Litig., 906 A.2d 808, 821 [Del.Ch. Ct.2005], affd. 906 A.2d 766 [Del.2006] ). No claim is made that any of the outside directors stood on both sides of the transactions at issue or that any of them stood to receive any personal financial gain. Rather the claim that the individual board members lack independence is based on plaintiffs' argument that they will likely face individual liability for their acts. The fact that a director will be called upon to consider whether to sue himself or herself does not, in itself, warrant a conclusion that he or she lacks independence (see e.g. Rales v. Blasband, 634 A.2d at 936 ). The alleged facts must, instead, support a conclusion that the potential for liability rises to a the level of substantial likelihood (In re
Citigroup Inc. Shareholder Derivative Litig., 964 A.2d at 121 ). Where, as here, the corporate charter provides that directors are exculpated from liability to the extent authorized by Delaware Code Annotated, title 8, § 102(b)(7), the likelihood of liability is significantly lessened (Wandel v. Dimon, 135 A.D.3d at 516–517, 23 N.Y.S.3d 200). Liability ensues only for fraudulent, illegal or bad faith conduct and demand futility requires particularized allegations that the board actions were made with scienter, that is with actual knowledge that its conduct was legally improper (see In re Goldman Sachs Group, Inc. Shareholder Litig., 2011 WL 4826104, *18, 2011 Del.Ch. LEXIS 151, *58–59 ; Security Police & Fire Professionals of Amer. Retirement Fund v. Mack, 93 A.D.3d 562, 940 N.Y.S.2d 609 [1st Dept.2012] ). Although plaintiffs state that the board's actions were made in bad faith, the facts pleaded do not support such a conclusion. In fact, Delaware courts have rejected similar arguments in connection with demand futility on claims involving alleged improprieties in connection with subprime mortgages and financial institutions (see In re Goldman Sachs Group, Inc. Shareholder Litig., 2011 WL 4826104, *19–20, 2011 Del.Ch. LEXIS 151, *64–67 ; In re Citigroup Inc. Shareholder Derivative Litig., 964 A.2d at 130–13 ; see Wandel v. Dimon, 135 A.D.3d at 517–518, 23 N.Y.S.3d 200). We likewise reject plaintiffs' argument.
The second prong of Aronson, requiring particularized allegations creating reasonable doubt that the challenged transaction was not the product of a valid exercise of business judgment, also was not satisfied by plaintiffs. Plaintiffs contend that the board's action, including the adoption of the January 2007 resolution delegating authority to a management committee, was not a valid exercise of business judgment. However, this factual assertion examines the board's course of action in hindsight and hinges on certain warning signs that plaintiff alleges the board failed to heed, including some losses that reverted back to JPMorgan's balance sheet by September 2008. Delaware law presumes that in making a business decision the board of directors acts in good faith and in the honest belief that the action is taken in the best interests of the company (In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 52 [Del.2006] ). In order to satisfy the second prong of the Aronson test, plaintiffs are required to plead particularized facts sufficient to raise a reason to doubt that [1] the action was taken honestly and in good faith or [2] the board was adequately informed in making the decision (JP Morgan Chase & Co., Shareholder Litig., 906 A.2d at 824 ). These facts do not rebut the presumption of regularity of the board's decision making process (Brehm v. Eisner, 746 A.2d at 259 ). Although risky, the conduct plaintiff challenges, the board's authorization of the securitization and sale of investments, involves “legal business decisions that were firmly within management's judgment to pursue” (Goldman Sachs Group, Inc. Shareholder Litig., 2011 WL 4826104 at *20, 2011 Del.Ch. LEXIS 151 at *65 ; see e.g. J.P. Morgan, at 820, 824, 960 N.Y.S.2d 104 ). The fact that investors later sued or made repurchase demands does not raise a reasonable doubt that the decision to engage in such transactions was not a valid exercise of business judgment (see In re Goldman Sachs Group Shareholder Litig. , 2011 WL 4826104 *20, 2011 Del.Ch. LEXIS 151 *66 ). The Delaware courts have rejected similar allegations involving subprime mortgages and resulting losses (see In re Goldman Sach Group Shareholder Litig., 2011 WL 4826104, *19–20, 2011 Del.Ch. LEXIS 151, *64–67 ; In re Citigroup Inc. Shareholder Deriv. Litig., 964 A.2d at 130–132 ). Thus, neither prong of the Aronson test is satisfied and the failure to make a pre-suit demand is not excusable on that basis.
Even if plaintiffs' claims regarding the board abdication constitute board inaction, implicating application of the alternative Rales test for demand futility, it fails. Where the claim is that the board directors consciously disregarded a known duty to act, in dereliction of their duties, the burden on the plaintiff to plead particularized and provable facts is even greater. This claim, sometimes referred to as “a breach of duty of care” or a “lack of oversight” claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment” (see In re Caremark Intl., Inc. Derivative Litig., 698 A.2d 959, 967 [Del.Ch.1996] ) The test of whether a pre-suit demand is excused in these situations is whether, at of the time the complaint was filed, the board of directors could not have properly exercised its independent and disinterested business judgment in responding to a demand to act (Wandel v. Dimon, 135 A.D.3d at 517, 23 N.Y.S.3d 200, citing Rales v. Blasband, 634 A.2d at 934 ).
To adequately plead a lack of oversight claim, a plaintiff must set forth particularized facts that there was a “sustained or systematic failure” by the board to exercise oversight, demonstrating “the lack of good faith that is a necessary condition to liability” (In re Caremark, at 971). Plaintiffs' claim that the individual directors are responsible for corporate losses because they failed to monitor corporate operations is insufficient. As under the Aronson test, the allegations must be that a majority of the board lacked independence due to a “substantial likelihood,” not just a “mere threat” of individual liability (Wandel v. Dimon, 135 A.D.2d at 517, 23 N.Y.S.3d 200). Thus, plaintiffs' allegations regarding the potential of board member personal liability fails for the same reason it fails under the Aronson test.
Under these circumstances, a pre-suit demand is not excusable and Supreme Court was correct in granting defendants' motion to dismiss the complaint.