Derivative Standing and The Internal Affairs Doctrine

• Posted on: Jun 5 2023

By: Jeffrey M. Haber

The internal affairs doctrine is a “conflict of laws principle which recognizes that only one State should have the authority to regulate a corporation’s internal affairs—matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders—because otherwise a corporation could be faced with conflicting demands.”¹  Stated differently, “[u]nder the internal affairs doctrine, claims concerning the relationship between the corporation, its directors, and a shareholder are governed by the substantive law of the state or country of incorporation.”² 

However, the “internal affairs doctrine, although potent, has very specific applications.”³ In particular, the doctrine only “governs the choice of law determinations involving matters peculiar to corporations, that is, those activities concerning the relationships inter se of the corporation, its directors, officers and shareholders.”⁴ The doctrine “does not apply to those defendants who are not current officers, directors, and shareholders” of the corporation.⁵ 

The internal affairs doctrine has been consistently invoked by New York courts in derivative actions to apply foreign law on substantive issues, including those affecting a party’s right to sue.⁶ 

[Eds. Note: this Blog previously examined the internal affairs doctrine here.]

A plaintiff may sue derivatively so long as the plaintiff is a shareholder of the company “at the time of bringing the action,” and at the time of the alleged wrongdoing.⁷ “[A] plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing” to sue derivatively.⁸ 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.”⁹ To satisfy the requirement, the plaintiff must have “acquired his or her stock in the corporation before the core of the allegedly wrongful conduct transpired” and continued to own the stock “throughout the course of the activities that constitute the primary basis of the complaint.”¹⁰

“[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.”¹¹ For this reason, courts require the plaintiff to plead contemporaneous ownership with particularity rather than through boilerplate assertions.¹² 

[Eds. Note: this Blog previously examined derivative standing, in particular stock ownership, here.]

In Ezrasons, Inc. v. Rudd, 2023 N.Y. Slip Op. 02938 (1st Dept. June 1, 2023) (here), the Appellate Division, First Department examined these principles. As discussed below, the Court affirmed the dismissal of a derivative litigation brought on behalf of Barclays PLC due to the lack of derivative standing by the plaintiff under English law.

[Eds. Note: the factual discussion below comes from the record and briefing on appeal.]

In Ezrasons, plaintiff, a New York–registered corporation, brought a derivative action on behalf of Barclays PLC under English law against 46 individual defendants and Barclays PLC’s subsidiary BCI for allegedly breaching fiduciary duties to Barclays PLC. 

BCI and certain individual defendants moved to dismiss the complaint. 

The moving defendants advanced five reasons for dismissal: (1) the motion court lacked subject-matter jurisdiction under BCL § 1319; (2) plaintiff lacked standing under English substantive law — applicable under the internal affairs doctrine — because it was not a registered member of Barclays PLC; (3) plaintiff did not satisfy the ownership requirement of BCL § 626(b); (4) plaintiff did not allege facts sufficient to excuse the pre-suit demand requirement of BCL § 626(c); and (5) forum non conveniens.

In support of their motion, defendants submitted an affirmation from Barclays PLC Assistant Company Secretary stating, among other things, that plaintiff did not appear “as a registered, legal owner of Barclays PLC shares as of April 30, 2021,” on the official share register maintained by Equiniti Limited and Equiniti Financial Services Limited. Defendants also submitted an affirmation from an expert on English law, who opined on the requirements of English law governing shareholder derivative actions under both the Companies Act and common law. 

Following oral argument, the motion court granted defendants’ motion with prejudice. Speaking to the issue of standing and the internal affairs doctrine, the motion court held that the BCL “does not override the internal affairs doctrine on the issue of standing to bring a derivative claim because it is a mere statutory predicate to jurisdiction.” The motion court rejected plaintiff’s  argument that the First Department’s decision in Culligan Soft Water Co. v. Clayton Dubilier & Rice LLC, 118 A.D.3d 422 (1st Dept. 2014) “dictates a different outcome,” because “Culligan concerned regulation of conduct within New York and did not purport to alter settled New York law on the application of the internal affairs doctrine.” 

Having determined that substantive English law applied, the motion court held that “the membership requirement of the United Kingdom’s Companies Act is a substantive provision that … had to be met here” and that “Plaintiff lacks standing to sue” because it “is not a registered member of Barclays.” 

The motion court noted that: (1) “[t]here is an admission by [plaintiff’s] attorneys in the course of their opposition that they could become a member which speaks plainly that they are not members”; and (2) “[t]here is an affidavit … searching the record of documents that would show who are or are not members.” Consequently, the motion court rejected the “conclusory statement in the complaint” that plaintiff was a “registered” member of Barclays PLC and found that plaintiff lacked standing. 

On appeal, the First Department unanimously affirmed.

The Court held that “[t]he [motion] court correctly dismissed the complaint based on plaintiff’s lack of standing to bring this shareholder derivative action.”¹³ The Court explained that the motion court “correctly ruled that defendants made the showing necessary for dismissal for lack of standing under the ECA [English Companies Act].”¹⁴ The Court found that the “unrebutted affirmation from Barclays [Assistant Company Secretary] stating that inquiries with its registrar showed that plaintiff’s name did not appear as a registered, legal owner of Barclays PLC shares as of April 30, 2021,” to be dispositive “[d]espite the complaint’s verified allegations of plaintiff’s stock ownership and membership.”¹⁵ The Court also found persuasive “plaintiff’s counsel’s clear acknowledgment in its opposition brief to defendants’ dismissal motion that plaintiff was not a member” of Barclays PLC, which it noted was “an informal judicial admission entitled to some evidentiary weight.”¹⁶ 

The Court rejected plaintiff’s argument that BCL § 1319 regulates the internal affairs of foreign corporations, such that New York law applies to the substantive issues raised in the dispute.¹⁷ In doing so, the Court adopted the rationale of the court in City of Aventura Police Officers’ Retirement Fund v. Arison, 70 Misc. 3d 234 (Sup. Ct., N.Y. County 2020), which ruled that BCL  § 1319 merely confers jurisdiction upon New York courts over derivative suits on behalf of a foreign corporation.¹⁸ In that case, the court explained that BCL § 1319 is a jurisdictional provision and “does not require application of New York law in such suits,” and does not “override the internal affairs doctrine.”¹⁹ As such, the court held that the ECA’s requirement that suit be brought by a “member of the company” was an applicable substantive rule in a New York derivative suit. Accordingly, in applying the internal affairs doctrine, the Arison court held that the plaintiff lacked derivative standing under the English Companies Act.²⁰

The Court also rejected plaintiff’s argument that Cullen silently overruled the application of the internal affairs doctrine.²¹ Citing to multiple authorities, the Court stated that if it were to overrule a longstanding principle of law, it would do so explicitly.²² 

In conclusion, the Court reiterated that, as it has “demonstrated in many decisions since [Cullen], the internal affairs doctrine continues to apply to derivative actions.”²³

Footnotes

1. New Greenwich Litig. Trustee, LLC v. Citco Fund Servs. [Europe] B.V., 145 A.D.3d 16, 22 (1st Dept. 2016), lv. denied, 29 N.Y.3d 917 (2017) (quoting, Edgar v. MITE Corp., 457 U.S. 624, 645 (1982)); see also Culligan Soft Water Co. v. Clayton Dubilier & Rice LLC, 118 A.D.3d 422 (1st Dept. 2014).
2. Davis v. Scottish Re Group Ltd., 138 A.D.3d 230, 233 (1st Dept. 2016).
3. Matter of Am. Intl. Group, Inc., 965 A.2d 763, 817 (Del. Ch. 2009) (cited with approval, New Greenwich, 145 A.D.3d at 23).
4. Id. at 817 (internal quotation marks omitted).
5. Culligan, 118 A.D.3d at 422.
6. See, e.g., Lerner v. Prince, 119 A.D.3d 122, 127-128 (1st Dept. 2014); Hart v. General Motors Corp., 129 A.D.2d 179, 183 (1st Dept. 1987), lv. denied, 70 N.Y.2d 608 (1987).
7. 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).
8. Lewis, 477 A.2d at 1049.
9. Honzawa Holding Co. v. Hiro Enter. USA, 291 A.D.2d 318, 318 (1st Dept. 2002).
10. In re Bank of New York Deriv. Litig., 320 F.3d 291, 298 (2d Cir. 2003).
11. Roy v. Vayntrub, 15 Misc. 3d 1127(A), 2007 NY Slip Op 50868(U), at *6 (Sup. Ct., Nassau County 2007) (citing Barr v. Wackman, 36 N.Y.2d 371 (1975)).
12. 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.”).
13. Slip Op. at *1.
14. Id.
15. Id.
16. Id. (citing, Matter of Union Indem. Ins. Co. of N.Y., 89 N.Y.2d 94, 103-104 (1996)).
17. Id.
18. Id.
19. Id. (quoting, Arison, 70 Misc. 3d at 244 (internal quotation marks omitted)).
20. Arison, 70 Misc. 3d at 248-253.
21. Slip Op. at *1.
22. Id. at *1-*2 (citing, Matter of Orozco v. City of New York, 200 A.D.3d 559,562 (1st Dept. 2021) (“If we are to depart from settled principle, we should do so explicitly and not on the basis of a one-paragraph memorandum opinion that does not cite or discuss the relevant precedent let alone express an intent to overrule it”), lv. granted, 39 N.Y.3d 903 (2022); Arison, 70 Misc. 3d at 245 n.3 (“‘if the court in Culligan wanted to change the clear precedents about the internal affairs doctrine it most assuredly would have said just that, and why’”) (internal brackets omitted) (quoting, Stephen Blau MD Money Purchase Pension Plan Trust v. Dimon, 2015 N.Y. Slip Op., 32909(U), at*8 n.1 (Sup. Ct., N.Y. County 2015)).
23. Id. at *2 (citations omitted).

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.