Opinion
No. HHD CV 11 6018649S
July 14, 2011
MEMORANDUM OF DECISION MOTION TO DISMISS, #103
FACTS
On February 4, 2011, the plaintiff, Sojitz America Capital Corporation, filed a shareholder derivative suit against the defendant, Todd A. Kaufman, on behalf of the nominal defendant, Keystone Equipment Finance Corporation (Keystone). The complaint alleges the following facts. On March 7, 2001, the plaintiff entered into a stock purchase agreement with Keystone wherein the plaintiff became a shareholder of Keystone. At all relevant times until January 7, 2011, the defendant was executive vice president of Keystone. Effective January 7, 2011, the defendant became president of Keystone. As early as April 2001, the defendant provided certifications to various financial lending institutions with whom Keystone did business. Each certification provided by the defendant certified that at a meeting of Keystone's board of directors held on a particular date, resolutions were adopted and were therefore in full force and effect. The certifications provided by the defendant to the financial institutions were false, and Keystone has sustained damages as a result of the defendant's conduct. The plaintiff demanded that the board of directors take appropriate measures against the defendant to redress his breaches of fiduciary duty, but it has failed to do so.
Todd A. Kaufman shall be referred to as "the defendant" in this memorandum.
The defendant filed a motion to dismiss and memoranda have been submitted by both sides.
DISCUSSION
"A motion to dismiss . . . properly attacks the jurisdiction of the court, essentially asserting that the plaintiff cannot as a matter of law and fact state a cause of action that should be heard by the court." (Internal quotation marks omitted.) Bacon Construction Co. v. Dept. of Public Works, CT Page 16176 294 Conn. 695, 706, 987 A.2d 348 (2010). "A motion to dismiss tests, inter alia, whether, on the face of the record, the court is without jurisdiction." (Internal quotation marks omitted.) Wilcox v. Webster Ins., Inc., 294 Conn. 206, 213, 982 A.2d 1053 (2009). "Both statutory and Practice Book provisions provide for dismissals on the basis of nonjurisdictional grounds." Rios v. CCMC Corp., 106 Conn.App. 810 n. 8, 943 A.2d 544 (2008) (Citing General Statutes §§ 52-549t(b) and 33-724(a), and Practice Book § 13-14).
The defendant argues that General Statutes § 33-724 requires the court to dismiss the action because the Keystone board of directions determined that the maintenance of this action is not in the best interests of the corporation. In response, the plaintiff argues that the persons making such determination were not qualified, and otherwise failed to comply with the terms of the Statute in reaching that decision.
Section 33-724 provides in relevant part: "(a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) or (e) of this section has determined in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that the maintenance of the derivative proceeding is not in the best interests of the corporation. (b) Unless a panel is appointed pursuant to subsection (e) of this section, the determination in subsection (a) of this section shall be made by: (1) A majority vote of qualified directors present at a meeting of the board of directors if the qualified directors constitute a quorum; or (2) A majority vote of a committee consisting of two or more qualified directors appointed by a majority vote of qualified directors present at a meeting of the board of directors, regardless of whether such qualified directors constitute a quorum . . . (e) Upon motion by the corporation, the court may appoint a panel of one or more individuals to make a determination whether the maintenance of the derivative proceeding is in the best interests of the corporation . . ."
I Qualified Directors
The defendant claims that it satisfied the quorum requirement in § 33-724 because three of the four directors were qualified directors at the time the board determined that the derivative suit was not in the best interests of the corporation. In support of his argument, the defendant submitted an affidavit wherein he attached copies of the certificate of incorporation of Keystone, the bylaws of Keystone, the minutes of the board of directors meeting of Keystone held on March 15, 2011, and the findings and determination by the Keystone board of directors dated March 15, 2011. At the time the determination was made, the directors of Keystone were Paula J. Amazeen, William Hammock, Alan Kaufman and the defendant, Todd Kaufman. The defendant argues that all the directors except Hammock were qualified directors, while the plaintiff argues that the only qualified director was Hammock.
Section 33-724 provides in relevant part: "(a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) or (e) of this section has determined in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that the maintenance of the derivative proceeding is not in the best interests of the corporation. (b) Unless a panel is appointed pursuant to subsection (e) of this section, the determination in subsection (a) of this section shall be made by: (1) A majority vote of qualified directors present at a meeting of the board of directors if the qualified directors constitute a quorum . . ."
A "qualified director," as used in § 33-724, is defined in General Statutes § 33-605 as "a director who . . . does not have (A) a material interest in the outcome of the proceeding, or (B) a material relationship with a person who has such an interest." Section 33-605(b)(1) defines "material relationship" as "a familial, financial, professional or employment relationship that would reasonably be expected to impair the objectivity of the director's judgment when participating in the action to be taken." "Material interest" is defined as "an actual or potential benefit or detriment, other than one which would devolve on the corporation or the shareholders generally, that would reasonably be expected to impair the objectivity of the director's judgment when participating in the action to be taken." General Statutes § 33-60(b)(2). A director is not prevented from being a qualified director merely because of "status as a named defendant, as a director against whom action is demanded, or as a director who approved the conduct being challenged." General Statutes § 33-605(c)(3).
Section 33-605 is based on § 1.43 of the Model Business Corporation Act (MBCA) without substantial change. The official comment to § 1.43 provides in relevant part: "Whether a director has a material interest in the outcome of a proceeding . . . lie[s] along a spectrum. At one end of the spectrum, if a claim against a director is clearly frivolous or is not supported by particularized and well-pleaded facts, the director should not be deemed to have a `material interest in the outcome of the proceeding' . . . even though the director is a named defendant. At the other end of the spectrum, a director normally should be deemed to have a `material interest in the outcome of the proceeding' . . . if a claim against the director is supported by particularized and well-pleaded facts which, if true, would be likely to give rise to a significant adverse outcome against the director. Whether a director should be deemed to have a `material interest in the outcome of the proceeding' based on a claim that lies between these two ends of the spectrum will depend on the application of that test to the claim, given all the facts and circumstances."
In the present case, the plaintiff alleges that the defendant provided certifications "to various financial institutions with whom Keystone did business and on whom Keystone depended for its financial needs," and that the certifications provided by the defendant were false. The plaintiff further alleges that by submitting false certifications, the defendant "has exposed Keystone to considerable risks of liability in the form of, at least, allegations of bank fraud, common law fraud and rescission of existing bank lines." These allegations do not establish that the defendant has a material interest in the litigation because these allegations are not supported by particularized and well-pleaded facts that, if true, would likely give rise to a significant adverse outcome against the defendant.
As the defendant correctly points out, there is no specific allegation that the defendant's actions caused any damages to the corporation. While the plaintiff has alleged that the defendant has "exposed Keystone to considerable risks," there is no indication or discussion of whether any of the third-party lenders have sued the defendant for his actions. Moreover, a director cannot be disqualified merely because of his status as a named defendant. Therefore, the court finds that the defendant was a qualified director for purposes of the quorum requirement in § 33-724.
Alan Kaufman and Amazeen were also qualified directors for purposes of § 33-724. Alan Kaufman and Amazeen are not named defendants and do not have a material interest in the outcome of the proceeding, or a material relationship with a person who has such an interest. As discussed above, a material interest is defined as "an actual or potential benefit or detriment, other than one which would devolve on the corporation or the shareholders generally, that would reasonably be expected to impair the objectivity of the director's judgment when participating in the action to be taken." General Statutes § 33-605(b)(2). Alan Kaufman and Amazeen do not stand to benefit from the derivative suit in any manner other than one that would affect the corporation or shareholders generally. Therefore, the quorum requirement was met because three of the four directors were qualified directors for purposes of § 33-724.
The court does not need to reach the issue of whether Hammock is a qualified director because the quorum requirement is met. Nonetheless, Hammock is not a qualified director for purposes of § 33-724 because Hammock has a material relationship with the plaintiff. Hammock is the director designated by the plaintiff, and the plaintiff is the only preferred shareholder of Keystone. The plaintiff has a material interest in the outcome of the lawsuit because as the only preferred shareholder, it is entitled to financial preferences that the other shareholders are not entitled to.
II Inquiry
The defendant next argues that the board of directors determined that the maintenance of this action is not in the best interests of the corporation, and that the board reached its conclusion in good faith, after conducting a reasonable inquiry pursuant to § 33-724. The defendant further argues that the plaintiff bears the burden of proof that the board of directors did not comply with the requirements of § 33-724 because the majority of the board consisted of qualified directors. In response, the plaintiff argues that the alleged investigation was inadequate. Specifically, the plaintiff argues that there is no proof that the board conducted any interviews or analyzed the relevant bank instruments.
Section 33-724 provides in relevant part: "A derivative proceeding shall be dismissed by the court on a motion by the corporation if . . . [a majority vote of qualified directors] has determined in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that the maintenance of the derivative proceeding is not in the best interests of the corporation." Section 33-724(d) provides in relevant part: "If a majority of the board of directors consisted of qualified directors at the time the determination was made, the plaintiff shall have the burden of proving that the requirements of subsection (a) . . . have not been met."
The statute uses the "word `inquiry' rather than `investigation' . . . to make it clear that the scope of the inquiry will depend on the issues raised and the knowledge of the group making the determination with respect to the issues. In some cases, the issues may be so simple or the knowledge of the group so extensive that little additional inquiry is required. In other cases, the group may need to engage counsel and other professionals to make an investigation and assist the group in its evaluation of the issues." Model Bus. Corp. Act § 7.44. cmt. 2 at 7-329 (2008).
The official comment to § 7.44 of the MBCA, which is identical to § 33-724, provides that the MBCA, "authorizes the court to examine the [board's] determination to ensure that it has some support in the findings of the inquiry." (Emphasis added.) "The policy reason for this limited review is that a corporation should be free to determine in its own business judgment whether litigation is in its best interest, free from unnecessary interference." Frank v. LoVetere, 363 F.Sup.2d 327, 335 (D.Conn. 2005). "On the other hand, Connecticut's corporations law provides for shareholder derivative suits where they are warranted . . . The statutory standard of good faith and reasonableness creates a floor below which the board's actions and procedures cannot fall to be considered reasonably acceptable under the business judgment rule. Thus [the plaintiff's] burden . . . is not just to show that the [board's] inquiry and report were flawed, or that someone else might have reached a different conclusion, but that the [board's] inquiry and . . . conclusions [do not] follow logically." Id.
In the present case, the board determined that the maintenance of the lawsuit was not in the best interests of the corporation because its inquiry showed that: (1) the corporation had sustained no damages; (2) prosecution of the suit would likely involve expense to the corporation; (3) the most recent financial statements showed that the corporation's business is healthy; (4) a change in leadership would put the success of the corporation at substantial risk; and (5) prosecution of the lawsuit would call attention to the defects alleged by the plaintiff. The plaintiff has not met its burden of proving that the board's inquiry and conclusions do not follow logically. For example, it was logical for the board to conclude that prosecution of the lawsuit would likely involve expense the corporation where the lawsuit had already cost the company $69,000. (Defendant's Exhibit A, Appendix C.)
The board and its counsel examined the relevant facts and circumstances related to the lawsuit, analyzed its findings and determined that the maintenance of the suit was not in the best interests of the corporation based upon those findings. The court must defer to the board's determination because there is "some support" for it. The plaintiff's argument that there is no proof that counsel conducted any interviews or analyzed the operative bank instruments is not sufficient to show that the board's inquiry was unreasonable because interviews and analyses are not required.
The plaintiff also argues that the counsel conducting the investigation of the underlying demand lacked independence because he represents both the defendant and the corporation in this litigation. Whether counsel can continue to represent both of them is not relevant to the analysis under § 33-724. The case law that the plaintiff cites holds that dual representation of the corporation and the individual corporate officers alleged to have committed the wrongdoing is improper and an appropriate basis for disqualification, not for dismissal pursuant to § 33-724(a).
CONCLUSION
For the foregoing reasons, the defendant's motion to dismiss is hereby granted.