UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
November 21, 2011
JAMES KAUTZ, DERIVATIVELY ON BEHALF OF ISTAR FINANCIAL INCORPORATED, PLAINTIFF-APPELLANT,
JAY SUGARMAN, GLENN AUGUST, ROBERT W. HOLMAN, JR., ROBIN JOSEPHS, JOHN G. MCDONALD, GEORGE R. PUSKAR, DALE ANNE REISS, JEFFREY A. WEBER, NICHOLAS A. RADESCA, CATHERINE D. RICE, TIMOTHY J. O'CONNOR, DEFENDANTS-APPELLEES, ISTAR FINANCIAL INCORPORATED, NOMINAL
Appeal from a judgment of the United States District Court for the Southern District of New York (Richard J. Sullivan, Judge).
Kautz v. Sugarman
Rulings by summary order do not have precedential effect. Citation to a summary order filed on or after January 1, 2007, is permitted and is governed by Federal Rule of Appellate Procedure 32.1 and this court's Local Rule 32.1.1. When citing a summary order in a document filed with this court, a party must cite either the Federal Appendix or an electronic database (with the notation "summary order"). A party citing a summary order must serve a copy of it on any party not represented by counsel.
At a stated term of the United States Court of Appeals for the Second Circuit, held at the 2 Daniel Patrick Moynihan United States Courthouse, 500 Pearl Street, in the City of New York, 3 on the 21st day of November, two thousand eleven.
PRESENT: AMALYA L. KEARSE, JOSEPH M. MCLAUGHLIN, JOSE A. CABRANES, Circuit Judges.
UPON DUE CONSIDERATION, IT IS HEREBY ORDERED, ADJUDGED, AND 29 DECREED that the judgment of the District Court be AFFIRMED.
Plaintiff-appellant James Kautz appeals from a judgment granting defendants-appellees' motion 32 to dismiss his derivative securities class action complaint for failure to make a pre-suit demand as 33 required by Fed. R. Civ. P. 23.1. See Kautz v. Sugarman, No. 10 Civ. 3478, 2011 WL 1330676 (S.D.N.Y. 34 Mar. 31, 2011) ("Kautz I"). We assume the parties' familiarity with the underlying facts and the 35 procedural history of this case.
This appeal arises out of two parallel shareholder derivative complaints filed in the Southern 37 District of New York for the benefit of Nominal Defendant iStar Financial Inc. ("iStar") against current 38 and former iStar directors and officers for breaches of fiduciary duties, waste of corporate assets, unjust 1 enrichment, and related claims. Kautz did not make pre-suit demand on iStar, electing instead to plead 2 demand futility in his complaint. He alleged that demand was futile for four reasons: (1) the Board of 3 Directors (the "Board") had already rejected the demand of another alleged shareholder (that of Addie 4 Vancil, the plaintiff in the parallel derivative suit) (the "Vancil Demand") and therefore no reasonable 5 shareholder would believe that the Board would consider another pre-suit demand in good faith; (2) 6 three of the directors were members of iStar's audit committee during the relevant period, and therefore 7 had participated in the alleged misconduct that formed the factual basis for the derivative suit; (3) one of 8 the directors, Robert Sugarman, was also the Chief Executive Officer of iStar and therefore lacked 9 independence; and (4) several of the director defendants had participated in a decision to permit three of 10 iStar's executives who might have otherwise been implicated in the alleged wrongdoing to retire or 11 resign, rather than being fired for cause. See Amended Complaint ("Am. Compl.") ¶ 151, Kautz I, 2011 12 WL 1330676, No. 10 Civ. 3478 (S.D.N.Y. June 28, 2010).
13 On August 13, 2010, defendants moved to dismiss both the Kautz complaint and the Vancil 14 complaint, arguing that Kautz had failed to plead demand futility and that both Vancil and Kautz had 15 failed to state a claim on which relief can be granted. In Kautz's memorandum in opposition to the 16 defendants' motion to dismiss, he argued that his allegation that the directors had improperly permitted 17 several iStar executives to retire or resign necessarily gave rise to an inference that those directors had 18 also executed mutual releases with the departing executives. Those directors, according to Kautz, would 19 therefore face significant personal financial liability should the executives be found to have engaged in 20 wrongdoing, and therefore could not be relied upon to address his demand in good faith. Accordingly, 21 he argued, demand on those directors (who, not incidentally, comprised a majority of the Board) was 22 excused. See Kautz I, 2011 WL 1330676, at *10.
23 The District Court consolidated the two cases for argument and made several rulings in a joint 24 opinion, only two of which are relevant to us today. First, the court held that the Board's negative 25 response to the Vancil Demand did not excuse the requirement that Kautz make his own pre-suit 26 demand. Id. at *8. Second, it found that Kautz had failed to allege the existence of mutual releases 1 between the directors and the departed executives. Id. at *10. The court granted the motion to dismiss 2 as against Kautz and directed that the case be closed.*fn1 Id. at *10-11.
On appeal, Kautz argues that the court erred by failing to consider the Board's treatment of the 4 Vancil Demand to be a relevant factor in its analysis of Kautz's allegation of demand futility. He further 5 argues that the court erred in holding that he had not sufficiently alleged the existence of mutual releases 6 between certain of the Board members and iStar. We address the court's two rulings in turn.
A. Standard of Review
Where a "challenge is made to the legal precepts applied by the
district court in making a
discretionary determination," we review the court's conclusions de
novo. Scalisi v. Fund Asset Mgmt., L.P.,
380 F.3d 133, 137 (2d Cir. 2004). However, where the District
Court's "determination of the sufficiency
of allegations of [demand] futility depends on the circumstances
of the individual case," we have
13 theorized that we may review its rulings for abuse of discretion.
Id. (internal quotation marks omitted).
14 We decline to address here what seems to be an open question of
the appropriate standard of review in
15 demand futility cases, see id. at 137 & n.6, because our ruling
today would be required under either
B. Demand Futility
A derivative suit "permits an individual shareholder to bring suit to enforce a corporate cause of 19 action against officers, directors, and third parties." Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95 20 (1991) (emphasis and internal quotation marks omitted). Rule 23.1 of the Federal Rules of Civil 21 Procedure requires that any person seeking to bring a derivative suit against a company must first 22 demand that the company's board of directors take remedial action on behalf of the company. That 23 person must then plead with particularity his "effort . . . to obtain the desired action from the directors . 24 . . [and] the reasons for not obtaining the action." Fed. R. Civ. P. 23.1(b)(3). If the person deems 1 demand to be futile, he must plead with particularity his "reasons for . . . not making the effort." Id.
Demand futility is evaluated under the law of the state of the company's incorporation, Kamen, 500 U.S. 3 at 108-09, which in this case is Maryland.
Under Maryland law, a plaintiff alleging demand futility must plead and prove that "a majority of 5 the directors are so personally and directly conflicted or committed to the decision in dispute that they 6 cannot reasonably be expected to respond to a demand in good faith and within the ambit of the 7 business judgment rule." Werbowsky v. Collomb, 766 A.2d 123, 144 (Md. 2001);*fn2 see Waller v. Waller, 49 8 A.2d 449, 453 (Md. 1946). This exception to the demand rule is "a narrow one." Scalisi, 380 F.3d at 9 140; see Werbowsky, 766 A.2d at 144 (futility based on director conflict is "a very limited exception" to the 10 demand rule). Accordingly, demand is rarely, if ever, properly excused under Maryland law. See 11 Washtenaw Cnty. Emps. Ret. Sys. v. Wells Real Estate Inv. Trust, Inc., No. 07-cv-862, 2008 WL 2302679, at 12 *14 & n.6 (N.D. Ga. Mar. 31, 2008) (collecting cases and noting that, since Werbowsky and as of 2008, 13 only one court in the country had found demand to be futile when applying Maryland law). 14 C. Demand was not Excused by the Board's Response to the Vancil Demand 15 Several months before Kautz filed his complaint, Vancil made her demand upon the Board and 16 was rebuffed for reasons that are not before us today. See Kautz I, 2011 WL 1330676, at *1-2. Kautz 17 accordingly alleged that his demand was excused because, given the Board's "shocking response (or lack 18 thereof)" to the Vancil Demand, he could not rely upon the Board to respond to his own demand in 19 good faith. Id. at *8. The District Court rejected this argument, holding that under Delaware law, to 20 which Maryland's courts oftimes look for guidance,*fn3 "the board's response to one derivative plaintiff 1 cannot form the basis for an assertion of demand futility by another." Id. Kautz alleges that this 2 conclusion was erroneous. We disagree.
3 As noted by the District Court, "it is well settled [in Delaware] that the board's response to one 4 derivative plaintiff cannot form the basis for an assertion of demand futility by another." Kautz I, 2011 5 WL 1330676, at *8; see Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 731 n.2 (Del. 1988) 6 ("Plaintiffs cannot effectively rely on an earlier demand made by another . . . shareholder."); Decker v. 7 Clausen, Civ. A. Nos. 10,684, 10,685, 1989 WL 133617, at *2 (Del. Ch. Nov. 6, 1989); Maurer v. Johnson, 8 Civ. A. No. 9725, 1989 WL 997172, at *1 (Del. Ch. May 12, 1989) ("Plaintiffs' argument . . . that 9 demand by these plaintiffs would be futile 'on its face' because of the Board's rejection of a prior 10 demand based on the same transaction is without merit. If such were the case, any two shareholders 11 could convert a 'demand rejected' derivative cause of action into one for which demand was excused.").
12 Kautz does not point to a single case in which demand is excused as against one plaintiff because an 13 unrelated plaintiff earlier made an unsuccessful demand. We decline to create such a rule out of whole 14 cloth, and find that Kautz's first assignment of error is meritless.*fn4 15 D. Kautz did not Establish the Existence of Mutual Releases 16 Kautz also argued before the District Court that some or all of iStar's directors would face 17 personal financial liability from a shareholder derivative suit because, he claimed, they had executed 18 mutual releases with the departed executives. See Kautz I, 2011 WL 1330676, at *10. He now alleges that 19 the District Court erred in finding that he had not sufficiently pleaded the existence of those mutual 20 releases. Although Kautz correctly states that the District Court must accept all well-pleaded facts in the 21 complaint as true, see Swierkiewicz v. Sorema N.A., 534 U.S. 506, 508 n.1 (2002), this second assignment of 1 error suffers from a fatal problem: Kautz does not in fact plead the existence of these alleged releases in 2 his complaint. See Am. Compl. ¶ 151 (setting out six sub-paragraphs that allegedly explain why a 3 demand on the Board "would be a futile, wasteful and useless act"). In three nearly-identical footnotes, 4 Kautz alleged that "[t]ypically, when an executive of a public company resigns or retires, that executive 5 enters into an agreement pursuant to which the executive, inter alia, is released from certain claims." Am. 6 Compl. ¶ 124 n.4 (identical text in nn.5-6). However, Kautz's complaint continued, "upon information 7 and belief, it has not been disclosed in iStar's public filings" whether any of the three departing 8 executives "executed such a release in connection with" their departures. Id. (identical text in nn.5-6).
As the District Court noted, "the pleadings allege no facts to support the existence of mutual releases 10 between iStar and the departing Defendants," Kautz I, 2011 WL 1330676, at *10, but merely a string of 11 speculations. See id.*fn5
12 Nevertheless, even if Kautz had properly pleaded the existence of the alleged mutual releases, we 13 would not question the considered judgment of the District Court in the circumstances presented here.*fn6 14 Under Maryland law, the mere fact that a director may have a financial interest that would be harmed if 15 an investigation goes forward does not render that director so "personally and directly conflicted" as to 16 excuse demand. Scalisi, 380 F.3d at 139-40; see Werbowsky, 766 A.2d at 143 (demand not excused when 17 directors earn lucrative fees from their positions and might perceive demand as threatening those 18 positions); In re Davis Selected Mut. Funds Litig., No. 04 Civ. 4186, 2005 WL 2509732, at *3 (S.D.N.Y. Oct. 19 11, 2005) (allegation that "directors would be required to sue themselves and their fellow directors" 1 insufficient under Maryland law to excuse demand); Sekuk Global Enters. Profit Sharing Plan v. Kevenides, 2 Nos. 24-C-03-007496, 24-C-03-007876, 24-C-03-008010, 2004 WL 1982508, at *8-9 (Md. Cir. Ct. May 3 25, 2004) (rejecting argument that uninsured directors' potentially "ruinous" financial liability excused 4 demand). Kautz's assertion that some or all of the directors have signed mutual releases, and therefore 5 might face significant financial liability should the suit go forward, simply cannot excuse him from 6 complying with Maryland's extremely strict demand requirement.
We have considered all of Kautz's arguments on appeal and find them to be without merit. 9 Neither the Board's rejection of the Vancil Demand nor its alleged mutual release agreements with the 10 departed executives rendered demand futile. Kautz's complaint therefore does not comport with the 11 requirements of Fed. R. Civ. P. 23.1 and must be dismissed.
12 Accordingly, without necessarily commenting on every aspect of the District Court's thorough 13 and well-reasoned Memorandum and Order of March 31, 2011, we AFFIRM the judgment of the 14 District Court.
FOR THE COURT,
Catherine O'Hagan Wolfe, Clerk of Court