in writing required unanimous shareholder consent. (Pl. 3(g) Exh. 7 at 4) At the time of the alleged certificate amendment, DGCL § 228 allowed shareholders to act by written consent, in lieu of a meeting, provided that such consent was signed by at least the minimum number of outstanding shares that would be required to take action at a meeting of shareholders, Del. Code Ann. tit. 8 § 228(a), and that prompt written notice of any such acts were provided to all non-consenting shareholders. Del Code Ann. tit. 8 § 228(d) (Pl. 3(g) Exh. 10). Because Pure Tech's by-laws required a two-thirds vote in a shareholder meeting, DGCL § 228, standing alone, would require that two-thirds of Pure Tech's shareholders approve the board's action in writing.
Thus, for Pure Tech to have amended legally its certificate in March 1989, it would have had to take one of the following two steps: 1) follow its by-laws and have the Board vote unanimously for an amendment in writing and then have the shareholders affirm the vote unanimously in writing; or 2) follow a combination of its by-laws and DGCL § 228 and have the Board unanimously vote for an amendment in writing and then have the shareholders approve the vote in writing by a two-thirds majority.
Defendants argue that "because the certificate specifically gave the board the power to amend the by-laws without shareholder assent (Lucas Aff. Exh D, Article Sixth P 2(a)), [they] understood the board resolution to permit the Company to effect the amendment by using the [DGCL] § 228 consent procedure and by obtaining a simple majority of shareholder votes, the minimum required by statute." (Def. Mem. at 24) The board resolution eliminating shareholders' preemptive rights constituted, according to defendants, "a de facto amendment to the by-laws with respect to this transaction." (Lucas Aff. P 20) Thus, in defendant's view, the amendment not only revised the certificate, but also revised the by-laws to require a simple majority rather than a unanimous vote in writing to approve a certificate amendment by the board.
Defendants' argument is unconvincing. Under Delaware law, an informal by-law amendment is permitted only under limited circumstances. Corporate by-laws may be amended by implication and without formal action only "by clear proof of a definite and uniform custom or usage, not in accord with the by-laws regularly adopted, and by acquiescence therein." In re Ivey & Ellington, Inc., 28 Del. Ch. 298, 42 A.2d 508, 509-10 (1945); see also Petrick v. B-K Dynamics, Inc., 283 A.2d 696, 699 (Del. Ch. 1971) (same); In re Osteopathic Hosp. Ass'n, 41 Del. Ch. 369, 195 A.2d 759, 762 (1963) (same); Nowling v. Aero Services Int'l, 734 F. Supp. 733, 740 (E.D.La. 1990) (same). The burden of proof on the issue of course of conduct lies with the party contending that the by-law has been properly altered. Belle Isle Corp. v. MacBean, 29 Del. Ch. 261, 267, 49 A.2d 5, 8 (1946). Defendants have offered no evidence that it was customary for Pure Tech corporate actions not authorized by its by-laws to be approved by a simple majority vote of shareholders. Under such circumstances, defendants have not carried their burden of proof and their argument must fail.
The only way, then, that defendants could have amended the certificate legally was for the board to have approved the amendment unanimously, and then for the shareholders to have approved the amendment either unanimously in writing according to the by-laws, or by a two-thirds vote in writing pursuant to a combination of DGCL § 228 and the by-laws. None of these steps, however, was completed.
Pure Tech's by-laws, Article III § 7(b), and DGCL § 141(f), Del. Code Ann. tit. 8, § 141(f), allowed board action without a meeting only with the written consent of all the directors. Not all of the directors gave their written consent at the time the charter was amended. The approval of one of the directors, Frank Tammera, Sr., was not received until April 26, 1989, almost one month after the alleged amendment took place. (Pl. 3(g) Exh. 11) Thus, the board's action was not unanimous, and even if the shareholders had complied with applicable law and approved the amendment, the amendment would still have had no legal effect.
Even assuming, arguendo, that Pure Tech's board did unanimously approve the amendment, Pure Tech's shareholders did not grant the required written consent. Only 57.14% of Pure Tech's shareholders approved the board's action, below both the 100% consent required under Pure Tech's by-laws and the 66.66% consent required under a combination of the by-laws and DGCL § 228. (Pl. 3(g) Exh. 13)
Defendants present two arguments to increase the percentage of the shareholders' written consent. First, they attempt to add to the shareholder consents the shares of the directors. Delaware courts have rejected this procedure. Belle Isle Corp., 49 A.2d at 9. Second, defendants argue that when the number of shares owned by those plaintiffs and others who waived their preemptive rights are added to the 57% shareholders who voted for the amendment, Pure Tech's shareholders actually approved the amendment by 94%. The main precedent defendants rely on for this novel interpretation of shareholder voting is Stroud v. Grace, 606 A.2d 75 (Del. 1992). Stroud, however, is distinguishable from the facts in this case because the shareholder vote there did not violate the corporation's by-laws. Id. at 84.
Defendants contend also that plaintiffs' action is barred by Delaware's three-year statute of limitations. (Def. Mem. at 12) The court must first determine if Delaware's statute of limitations applies to this case. It does not.
In cases based on diversity jurisdiction, a federal court applies the statute of limitations that would be applied by the state in which it sits. Klaxon Co. v. Stentor Electric Mfg. Co., 313 U.S. 487, 85 L. Ed. 1477, 61 S. Ct. 1020 (1941). Because plaintiffs are not New York residents and the cause of action accrued outside New York, New York's "borrowing statute," N.Y. Civ. P. L. & R. § 202 (McKinney 1990), applies. The statute provides:
An action based upon a cause of action accruing without the state cannot be commenced after the expiration of the time limited by the laws of either the state or the place without the state where the cause of action accrued except that where the cause of action accrued in favor of a resident of the state, the time limited by the laws of the state shall apply.
Thus, which foreign statute of limitations applies depends on where the cause of action "accrued."
There are two possible approaches to determine where a cause of action accrued for the purposes of the borrowing statute: 1) the traditional place-of-injury approach; and 2) the modern conflicts-of-law approach. Because the New York Court of Appeals has not definitively resolved this issue, the Second Circuit has been forced to predict how New York courts would resolve it.
The first case in which the Second Circuit treated this issue, Sack v. Low, 478 F.2d 360 (2d Cir 1973) involved violations of securities laws. Judge Friendly refused to extend the teaching of Babcock v. Jackson, 12 N.Y.2d 473, 191 N.E.2d 279, 240 N.Y.S.2d 743 (1963) to his analysis of the borrowing statute. Sack, 478 F.2d at 367. He could discern "no inkling that the New York courts are applying its sophisticated teachings, rather than the rigid approach of the First Restatement of Conflicts, to the problem of where a cause of action arose under the borrowing statute." Id. In Arneil v. Ramsey, 550 F.2d 774 (2d Cir. 1977) the Court revisited this issue without finding anything "to indicate that New York law has changed in this respect." Although the Court followed Sack's holding, it also engaged in a Babcock -inspired analysis of New York's interest in the case. Id. at 779. In 1981, the last time the Second Circuit addressed this issue, the Court continued to cite with approval Sack and Arneil, but did not explain why this approach was still warranted. Industrial Consultants, Inc. v. H.S. Equities, Inc., 646 F.2d 746, 747 (2d Cir.), cert. denied 454 U.S. 838, 70 L. Ed. 2d 120, 102 S. Ct. 145 (1981); see also Stafford v. International Harvester Co., 668 F.2d 142, 149 (2d Cir. 1981) (approving the lower court's conclusion that without definite guidance from the New York Court of Appeals, a "conservative position" was best).
There are at least three reasons why the modern conflicts approach should be applied to an analysis of the "borrowing statute" in this case. First, three of the four Second Circuit cases that rejected the Babcock approach limited their holding to securities fraud litigation. See Industrial Consultants, 646 F.2d at 747. The issue presented here is not securities fraud, but rather the proper governance of a Delaware corporation. The interest of a particular state's regulatory scheme rather than that of the federal government therefore is at stake, and that state is not the place of injury. The interest analysis of Babcock and its progeny are particularly well suited for such cases. Further, this Circuit has rejected borrowing statutes of limitations, as did the Court in Sack, Arneil, and Industrial Consultants, for claims under § 10(b) of the 1934 Act. Ceres Partners v. Gel Assocs., 918 F.2d 349, 352-364 (2d Cir. 1990). Thus, the precedential value of these earlier cases has been seriously undermined.
Second, after Sack, New York courts have provided more than the "inkling" Judge Friendly sought that the modern conflicts analysis should be applied. In Martin v. Julius Dierck Equipment Co., 52 A.D.2d 463, 468, 384 N.Y.S.2d 479, 483 (2d Dept. 1976), aff'd, 43 N.Y.2d 583, 403 N.Y.S.2d 185, 374 N.E.2d 97 (1978), the Court applied the "grouping of contacts, or center of gravity, conflict of laws doctrine" to its analysis of the "borrowing statute." On appeal, the Court of Appeals decided the case on different grounds, and did not analyze the Appellate Division's holding that a more modern approach to the "borrowing statute" applied. Martin v. Julius Dierck Equipment Co., 43 N.Y.2d 583, 403 N.Y.S.2d 185, 374 N.E.2d 97 (1977). At one point, however, the Court of Appeals seemed to endorse the Appellate Division's "interest" test, id. at 588, 403 N.Y.S.2d at 187, while at another point it described the test as the traditional "place of injury." Id. at 591, 403 N.Y.S.2d at 189. At least one commentator has noted that Martin, in the Appellate Division's opinion, marked a departure from earlier Second Circuit decisions. See N.Y. Civ. Prac. L. & R. § 202, Practice Commentaries C202:3 (1990); see also Stafford, 668 F.2d at 149 (discussing ambiguity in Court of Appeal's Martin decision).
Third, application of Babcock's interest analysis is especially appropriate considering that the policy behind the "borrowing statute" is to "protect New York resident-defendants from suits in New York that would be barred by shorter statutes of limitations in other states where non-resident-plaintiffs could have brought suit." Sack, 478 F.2d at 367. Here, plaintiffs do not reside in New York.
If interest analysis is used in this case, Delaware's three-year statute of limitations would apply, Del. Code Ann. tit. 10, § 8106, and the claim would be time-barred. All of the issues in this claim involve interpreting both the by-laws of Pure Tech, a Delaware corporation, and Delaware corporate statutes. Delaware has a keen interest in this litigation not only because several provisions of one of its corporation's by-laws have been allegedly violated, but also because plaintiffs' claim implicates several sections of Delaware's general corporate laws that effect not just Pure Tech's internal affairs but also the potential governance of thousands of other Delaware corporations which are regulated by the same Delaware laws that are the subject of this litigation. New Jersey, the site of Pure Tech's principal operations and corporate meetings, is the only other state with any interest in this litigation. Because of the nature of this claim, however, Delaware has the superior interest: the issues solely involve a Delaware corporation's internal governance, and do not effect any other state's laws or regulations.
Other district courts have applied the Babcock interest test to their analysis of the "borrowing statute," see Haberman v. Tobin, 466 F. Supp. 447, 450 (S.D.N.Y. 1979); Natural Resources Corp. v. Royal Resources Corp., 427 F. Supp. 880, 884-885 (S.D.N.Y. 1977), but these cases were decided before the reaffirmance of the place-of-injury test in Industrial Consultants and Stafford. Although the interest test would be especially appropriate in this case, I feel compelled, as have other district judges who favored the interest analysis, see Avagliano v. Sumitomo Shoji America, Inc., 614 F. Supp. 1397, 1405 (1985); Lang v. Paine, Webber, Jackson & Curtis, Inc., 582 F. Supp. 1421 (1984), to follow the Second Circuit's adherence to the traditional place-of-injury test.
Under this traditional test, if the injury is economic, as it is here, the cause of action accrues where the economic harm was felt. Arneil, 550 F.2d at 780. Thus, to the extent that plaintiff Chamchikian, a Michigan resident, became poorer because of Pure Tech's alleged illegal elimination of his preemptive rights, he became a poorer Michigander, while plaintiff Elkay's economic harm was experienced in Nevada, where the partners resided. (Lazar Aff. P 6; Kravetz Aff. P 3) However, under the holding of Stafford, 668 F.2d at 151-52, this court cannot apply either Michigan's or Nevada's statute of limitations because defendants, who have no contacts with either Michigan or Nevada, would not be subject to personal jurisdiction in either state. See M.C.L. § 600.715 (Michigan's "long-arm" statute); N.R.S. § 14.065 (Nevada's "long-arm" statute); Casentini v. Ninth Judicial Dist. Court of State in and for County of Douglas, 877 P.2d 535, 539 (Nev. 1994) (listing requirements for personal jurisdiction). In such situations, New York's statute of limitations applies. Cuccolo v. Lipsky Goodkin & Co., 826 F. Supp. 763, 767-68 (S.D.N.Y. 1993). Because this claim is based on alleged contract violations, New York's statute of limitations is six years. N.Y. Civ. Prac. L. & R. § 213(2). Plaintiffs' claim therefore is timely.
Defendants' amendment of its certificate having violated both its by-laws and Delaware law, and the claim having been timely brought, the only remaining issue is what the remedy is under Delaware law for such improper corporation action. Delaware courts would void such corporate action. See, e.g., Jackson v. Turnbull, 1994 Del. Ch. LEXIS 25, No. Civ.A.13042, 1994 WL 174668 at *6 (Del. Ch. Feb. 8, 1994) (corporate action is void when it violates DGCL); Russell v. Morris, 1990 Del. Ch. LEXIS 39, No. Civ.A.10009, 1990 WL 15618 at *6 (Del. Ch. Feb. 14, 1990) (when corporate action is invalid, court can "declare the transaction invalid and determine an appropriate remedy"); Frantz Mfg. Co. v. EAC Indus., 501 A.2d 401, 407 (violation of by-laws "nullified any board action"). Because the amendment to the charter eliminating plaintiffs' preemptive rights is void, plaintiffs are entitled to restoration of those rights. See 11 William M. Fletcher, Fletcher Cyclopedia of the Law of Private Corporations § 5141 (perm. ed. 1986) (discussing rule and citing cases).
Defendants' papers fail to present any issue of material fact. Under these circumstances, plaintiffs' motion is granted as to the eleventh claim. Consarc Corp. v. Marine Midland Bank, N.A., 996 F.2d 568, 572 (2d Cir. 1993); C.R.A. Realty Corp. v. Enron Corp., 842 F. Supp. 88, 90 (S.D.N.Y. 1994) ("The issue in dispute is purely a matter of law, and summary judgment is appropriate").
* * *
In sum, defendants' motion to dismiss is denied as to claims five through seven, ten, and twelve, but is granted with respect to claim nine. Plaintiffs' motion for summary judgment on claim eleven is granted.
Although plaintiffs have warded off a dismissal motion, they should be aware that there is strong evidence in defendants' papers that plaintiffs' complaint was filed in violation of Fed. R. Civ. P. 11. If, for example, defendants' allegation that plaintiffs have "seen lease negotiation documents and voluminous engineering drawings" relating to construction of the plant (Def. Reply Mem. at 15 n.7) proves to be true, then plaintiffs' claim that no such plans were ever made must have been asserted in bad faith. Further, defendants have produced a letter submitted to the SEC in January 1990 (Def. Reply Mem. Exh. B), which was allegedly in plaintiffs' possession before the complaint was filed, that disproves plaintiffs' claim (Pl. Mem. at 50-51) that Pure Tech only retroactively gave reasons for the failure of the plant's construction in 1991. A conference will be held on November 10, 1994 to determine whether plaintiffs, having won the battle under Fed. R. Civ. P. 12(b)(6), should retreat from the field before they lose the war under Fed. R. Civ. P. 56 and 11, and to determine also whether judgment should be entered separately on plaintiffs' eleventh claim, and the underlying issue of law certified pursuant to 28 U.S.C. § 1292(b).
Dated: New York, New York
October 14, 1994
Michael B. Mukasey
U.S. District Judge