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Derivative Litigation, Documentary Evidence and The Lack of Legal Capacity to Sue

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  • Posted on: Oct 26 2020

A shareholder’s derivative action is a lawsuit “brought in the right of a … corporation to procure a judgment in its favor, by a holder of shares or of voting trust certificates of the corporation or of a beneficial interest in such shares or certificates.” Marx v. Akers, 88 N.Y.2d 189, 193 (1996) (quoting Business Corporation Law § 626 (a)). Derivative claims against corporate officers and directors belong to the corporation itself. Auerbach v. Bennett, 47 N.Y.2d 619, 631 (1979). See also Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) (“The nature of the action is two-fold. First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it.”).

In New York, as in most jurisdictions, a derivative plaintiff must be a shareholder of the company “at the time of bringing the action,” and at the time of the alleged wrongdoing. See, e.g., BCL § 626(b); Pessin v. Chris-Craft Indus., 181 A.D.2d 66, 70 (1st Dept. 1992).  See also Lewis v. Anderson, 477 A.2d 1040, 1049 (Del. 1984). “[A] plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing” to sue derivatively. Lewis, 477 A.2d at 1049. Accordingly, courts have focused on the plaintiff’s stock ownership during both points in time, and in particular at the time of the alleged misconduct.

In New York, the contemporaneous ownership rule is “strictly enforced.” Honzawa Holding Co. v. Hiro Enter. USA, 291 A.D.2d 318, 318 (1st Dept. 2002). To satisfy the requirement, the plaintiff must have owned stock in the corporation “throughout the course of the activities that constitute the primary basis of the complaint.” In re Bank of New York Deriv. Litig., 320 F.3d 291, 298 (2d Cir. 2003). “This is not to say that a plaintiff must have owned stock in the company during the entire course of all relevant events. It does mean, however, that a proper plaintiff must have acquired his or her stock in the corporation before the core of the allegedly wrongful conduct transpired.” Id.

“[F]ailure to satisfy the . . . contemporaneous ownership requirement of § 626(b) is such a fundamental lack of capacity that it results in failure to state a cause of action.” Roy v. Vayntrub, 15 Misc. 3d 1127(A), 2007 N.Y. Slip Op. 50868(U) (Sup. Ct., Nassau County 2007), at *6 (citing Barr v. Wackman, 36 N.Y.2d 371 (1975)). For this reason, courts require the plaintiff to plead contemporaneous ownership with particularity rather than through boilerplate assertions. See, e.g., In re Computer Sciences Corp. Deriv. Litig., 2007 WL 1321715, at *15 (C.D. Cal. Mar. 26, 2007) (“[G]eneral allegation[s] [are] insufficient to allege contemporaneous ownership during the period in which the questioned transactions occurred.”).

In Sebrow v. Sebrow, 2020 NY Slip Op. 20269 (Sup. Ct., Bronx County Oct. 16, 2020) (here), the court addressed the standing of a derivative plaintiff seeking relief on behalf of a family-owned corporation and found that the plaintiff failed to satisfy the standing requirements for bringing a derivative action.

Sebrow arose out of alleged malfeasance and misconduct of Zvi Sebrow (“Zvi” or “defendant”) with respect to Worbes Corporation (“Worbes”), a family-owned corporation.

In January 1997, Abraham Sebrow (“Abraham”), Joseph Sebrow (“Joseph”), Zvi, and David Sebrow (“David”) signed a stockholders’ agreement for Worbes, Worbes Leasing Corporation (“WLC”) and S & S Soap Co., Inc., all of which are family businesses. Pursuant to the stockholders’ agreement, Abraham, Joseph, Zvi, and David each owned twenty-five (25) shares of Worbes. Prior to their deaths, Abraham and Joseph transferred their shares to their children, the defendant and David respectively, through their testamentary dispositions. Through the testamentary dispositions, Zvi and David became the owner of fifty (50) shares of Worbes.

In May 2017, David passed away. Although he had executed a will, he never made a testamentary disposition of his shares in Worbes to his issue, or to any other person with the defendant’s consent. Following David’s death, Zvi became the sole shareholder of Worbes. He has never allowed any third party to become a shareholder of Worbes.

Defendant moved to dismiss the complaint under CPLR §§ 3211(a)(1) and (a)(7) due to plaintiff’s lack of legal capacity to bring the lawsuit as a shareholder of Worbes and for failure to state a claim. In support of the motion, defendant submitted, among other things, the stockholders’ agreement.

The Court granted the motion due to plaintiff’s lack of capacity to sue.

The Court found that the language of the stockholder’s agreement governed the resolution of the matter. Pursuant to the agreement, no stockholder of the family businesses could “sell, transfer, assign, mortgage, [or] hypothecate his shares” to any third-party “without the unanimous consent of all the other stockholders”. Slip Op. at *3. However, a stockholder of the companies could “make a testamentary disposition of his shares to his issue”, which would be subject “to the terms and conditions contained in th[e] [stockholder’s] agreement.” Id. at *4. Thus, said the Court, “unless David made a testamentary disposition of his shares to his issue, or the defendant consented to David’s transfer of his shares in Worbes to his wife, such transfer or disposition of the shares in Worbes shall be a nullity and unenforceable.” Id. 

The Court found that there was no such transfer. Under David’s will, his residuary estate, both real and personal property, was bequeathed to plaintiff, his wife. Id. Thus, “David had not made a testamentary disposition of his shares in Worbes to his issue, and the defendant ha[d] not consented to any third party becoming a shareholder of Worbes.” Id. 

The Court noted that “[e]ven if th[e] Court accept[ed] David’s Will and Testament as true, there [was] no evidence that David made a testamentary disposition of his shares to his issue or obtained a consent from the defendant.” Id. “Therefore,” concluded the Court, “after David’s death, as of the date of th[e] motion, the defendant remain[ed] as the sole shareholder of Worbes, and the plaintiff [was] not a shareholder of Worbes.” Id.


New York courts have long required plaintiffs bringing a derivative action to have a stake in the company on whose behalf the action is commenced.  After all, if the plaintiff is not a shareholder of the company, then he/she has no right to vindicate the company’s rights and obtain a judgment on its behalf. In Sebrow, the Court reinforced this rule.

Sebrow also highlights the importance of documentary evidence in moving to dismiss a complaint. Under CPLR § 3211(a), a party may make a motion to dismiss on the “ground that . . . a defense is founded upon documentary evidence.” To qualify as “documentary,” the content of the document must be “essentially undeniable and …, assuming the verity of [the paper] and the validity of its execution, will itself support the ground on which the motion is based.” Amsterdam Hospitality Grp., LLC v. Marshall-Alan Assocs., Inc., 120 A.D.3d 431, 432 (1st Dept. 2014) (quoting David D. Siegel, Practice Commentaries, McKinney’s Cons. Laws of N.Y., Book 7B, C.P.L.R. C3211:10 at 22). Materials that qualify as “documentary evidence” include judicial records, such as judgments and orders, as well as documents reflecting out-of-court transactions, such as contracts, deeds, wills, and mortgages. Fontanetta v. Doe, 73 A.D.3d 78, 84-85 (2d Dept. 2010) (citation omitted). 

In Sebrow, dismissal was warranted because the documentary evidence (e.g., the stockholder’s agreement) “utterly refute[d] plaintiff’s factual allegations” (Goshen v. Mutual Life Ins. Co. of N.Y., 98 N.Y.2d 314, 326 (2002)), and “conclusively establishe[d] a defense to the asserted claims as a matter of law.” Weil, Gotshal & Manges, LLP v. Fashion Boutique of Short Hills, Inc., 10 A.D.3d 267, 270-71 (1st Dept. 2004). (internal quotation marks omitted).

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