Davis v. Scottish Re Group Ltd.

OPINION OF THE COURT

Andreas, J.

Plaintiff, a resident of Mexico, holds more than 2.4 million shares (representing approximately 48%) of the noncumulative perpetual preferred shares (PPS) of defendant Scottish Re Group Limited (Scottish Re), a Cayman Islands reinsurance company. Prior to a 2011 merger, which is one of the transactions at issue, he also held more than 13 million shares (representing approximately 20%) of Scottish Re’s common stock.

In this action, plaintiff asserts both direct and derivative causes of action against Scottish Re, its American operating subsidiary Scottish Re (U.S.), Inc. (SRUS), certain members of the Board of Directors of Scottish Re and SRUS (the Directors), Massachusetts Mutual Life Insurance Company (sued here as MassMutual Insurance), Cerberus Capital Management, L.P. (sued here as Cerberus Capital, LLC), and various entities affiliated with MassMutual and Cerberus (collectively, the Investors). Plaintiff alleges, inter alia, that the Directors, under the control of the Investors, directed Scottish Re to undertake an undervalued cash-out merger, in which the Investors acquired all of the outstanding common shares of Scottish Re, and a dividend strategy that benefited the Investors and unfairly prejudiced the minority shareholders.

Supreme Court granted defendants’ motions, made pursuant to CPLR 3211 (a) (1), (3), (7) and (8), to dismiss the fourth, sixth, seventh, ninth and tenth causes of action for lack of standing, and to dismiss the complaint as against the Benton Street Partners defendants for lack of jurisdiction (46 Misc 3d 1206[A], 2014 NY Slip Op 51898[U]). We now modify to grant plaintiff leave to replead the fourth and sixth causes of action, to the extent authorized herein, and otherwise affirm.

In determining whether plaintiff has standing, we must first analyze the fourth and sixth causes of action to determine whether they are direct claims, as pleaded by plaintiff, or derivative claims.

Under 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 (see Hart v General Motors Corp., 129 AD2d 179, 182 [1st Dept 1987], lv denied 70 NY2d 608 [1987]), in this case the Cayman Islands. To determine whether a claim is derivative or direct, Cayman law looks to whether the shareholder’s loss is merely “a reflection of the loss suffered by the company” and “would be made good if the company had enforced its full rights against the party responsible” (Johnson v Gore Wood & Co., [2002] 2 AC 1 [HL] 36 [appeal taken from Eng] [internal quotation marks omitted]). Particularly,

“[u]nder Cayman law, shareholders may not recover ‘reflective losses,’ which are losses that the company itself could recover if it chose to initiate legal action. The Cayman courts have held that ‘[w]here a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder’s shareholding where that merely reflects the loss by the company . . . there is no discretion involved.’ Johnson v Gore Wood & Co., [2002] 2 A.C. 1, House of Lords. A shareholder cannot sue in a personal capacity for a loss unless that loss is distinct from that of the company, and this rule applies regardless of whether the company itself intends to sue” (Varga v McGraw Hill Fin. Inc., 2015 NY Slip Op 31453[U], *28 [Sup Ct, NY County 2015]).

In the fourth cause of action, plaintiff alleges that the Directors and the Investors breached their fiduciary duties and “unfairly prejudice [d]” the minority shareholders

“by pursuing and implementing a dividend policy, and other corporate actions, that resulted in PPS and ordinary shareholders not obtaining any dividend payments in the past, and placing shareholders in a position of not expecting to obtain significant dividend payments in the near future, while at the same time creating windfall dividends for the Investors in a manner which is clearly oppressive, unjust and inequitable, and which in essence constitutes a disguised partial liquidation of the Company.”

Plaintiff seeks to recover damages to be determined at trial, which he believed to be in excess of $40,000,000.

The claim, as pleaded, cannot be sustained. Plaintiff’s attempt to characterize the dividend policy of which he complains as discriminatory, making the claim a direct one, contains allegations that confuse derivative and individual rights (see Abrams v Donati, 66 NY2d 951, 953 [1985]). The deficiencies in plaintiff’s pleadings, detailed by the dissent, make it virtually impossible to discern just how the dividend policy was discriminatory and therefore affected plaintiff individually within the meaning of Brinckerhoff v JAC Holding Corp. (10 AD3d 520, 521 [1st Dept 2004] [holding that where some shareholders “received a lesser benefit than other shareholders” the harm was “suffered individually”]).

However, plaintiff should be given an opportunity to replead to remedy the pleading deficiencies cited by the dissent with respect to his Brinckerhoff claim as against the Directors only. Although a challenge to a decision to pay dividends would generally be derivative, plaintiff asserts, inter alia, that his claim is direct because the disproportionate payment of dividends is discriminatory and directly harmed him as a minority shareholder. Thus, rather than corporate mismanagement, plaintiff asserts unequal treatment in the form of an intentional, premeditated plan to pay the Investors huge windfall dividends while freezing out minority shareholders in order to induce them to sell their shares to the Investors at a steep discount.

In the sixth cause of action, plaintiff alleges that the Directors and Investors breached their fiduciary duties when they improperly forced him out of holding his ordinary shares “by unfair procedures imposed in the Merger transaction by conflicted parties who intentionally misled other minority shareholders, improperly inducing and coercing them into a misinformed and invalid vote to approve the Merger.” Plaintiff alleges, inter alia, that the Directors: (i) failed to give a complete and unbiased opinion about the share price, disclose the conflicts, and pursue alternative proposals, and (ii) used the false threat that the minority would receive no compensation if the merger did not go through. Plaintiff further alleges that “[t]he Investors, having been in a position to significantly influence the conduct of the Board and the Company, breached their fiduciary duty to minority shareholders by pursuing the Merger transaction and using their influence to cause the Board to act.” As to his claim for relief, plaintiff alleges that

“[t]he Company and the ordinary shareholders have been damaged by the Director Defendants’ and the Investors’ breaches of fiduciary duty in the Merger in an amount to be proven at trial but believed to be in excess of $5,000,000. In the alternative, Defendants’ breaches of fiduciary duty entitle the ordinary shareholders to rescission of the Merger and/or a redistribution to them of approximately one third of the Company’s book value of $600 million, which was their proportionate share of the total value of the Company when the ordinary shareholders were bought out in the Merger.”

This claim, as pleaded, cannot stand as it merges direct claims with derivative claims, with plaintiff alleging that the board’s conduct caused harm to both himself and the company and seeking rescission of the merger as alternative relief (see Abrams v Donati, 66 NY2d at 953-954; Serino v Lipper, 123 AD3d 34, 40-41 [1st Dept 2014]). However, plaintiff should be given leave to replead to separate his direct claim of being induced by the Directors to part with his common shares in Scottish Re for less than their true value from his derivative claim alleging harm to the company (see Shaker v Al-Bedrawi, [2002] EWCA [Civ] 1452, [2003] Ch 350), and to set forth facts to establish the special circumstances necessary under Cayman Islands law to create a fiduciary duty between the Directors and plaintiff as a minority shareholder.

The dissent believes that leave to replead should not be granted because “the complaint gives no indication that any special circumstances exist here,” and “plaintiff makes clear in his complaint that there was no such [special factual] relationship.” I disagree.

Under Cayman Islands law, a director does not owe any fiduciary duties to minority shareholders solely based on his or her relationship to the company (see Peskin v Anderson, [2001] BCC 874, 1 BCLC 372, 2000 WL 1841707 [2000]). However, under Peskin,

“there may be special circumstances in which a fiduciary duty is owed by a director to a shareholder personally and in which breach of such a duty has caused loss to him directly (e.g. by being induced by a director to part with his shares in the company at an undervalue), as distinct from loss sustained by him by a diminution in the value of his shares (e.g. by reason of the misappropriation by a director of the company’s assets), for which he (as distinct from the company) would not have a cause of action against the director personally.

“The fiduciary duties owed to the company arise from the legal relationship between the directors and the company directed and controlled by them. The fiduciary duties owed to the shareholders do not arise from that legal relationship. They are dependent on establishing a special factual relationship between the directors and the shareholders in the particular case. Events may take place which bring the directors of the company into direct and close contact with the shareholders in a manner capable of generating fiduciary obligations, such as a duty of disclosure of material facts to the shareholders, or an obligation to use confidential information and valuable commercial and financial opportunities, which have been acquired by the directors in that office, for the benefit of the shareholders, and not to prefer and promote their own interests at the expense of the shareholders” (Peskin, [2001] BCC at 880, 1 BCLC 372 [32]-[33]; see also Hayat v Al-Mazeedi, 28 Mass L Rptr 243, 2011 WL 1532109, *3-4, 2011 Mass Super LEXIS 73, *8-10 [Super Ct, Jan. 10, 2011, No. 08-1004]).

In Peskin, as examples of the requisite special factual relationship, the court referred to

“instances of the directors of a company making direct approaches to, and dealing with, the shareholders in relation to a specific transaction and holding themselves out as agents for them in connection with the acquisition or disposal of shares; or making material representations to them; or failing to make material disclosure to them of insider information in the context of negotiations for a take-over of the company’s business; or supplying to them specific information and advice on which they have relied” (Peskin, [2001] BCC at 880, 1 BCLC 372 [34]).

Here, plaintiff has alleged, inter alia, that the merger transaction “was effected through improper misinformation and coercion so as to induce the minority shareholders into selling their shares at a severely depressed price,” that the Directors “presented inaccurate and biased information to the minority shareholders to induce a favorable vote” and engaged in a “deliberate campaign of misinformation,” and that the Directors “deliberately intimidated the ordinary shareholders by repeatedly asserting that in the absence of the Merger, the ordinary shareholders would receive no compensation whatsoever for their shares” (compare Feiner Family Trust v Xcelera.com, Inc., 2008 WL 5233605, *7, 2008 US Dist LEXIS 102019, *22-23 [SD NY, Dec. 15, 2008, No. 07-Civ-1914 (RPP)] [denying leave to file a third amended complaint because it “fail(ed) to describe any contact between (the) Plaintiffs and Defendants that could give rise to a fiduciary relationship, such as acting as Plaintiffs’ agent in the context of a specific transaction, or supplying them with specific information and advice on which they relied, or failing to make disclosures of insider information in the context of a take-over”], affd 352 Fed Appx 461 [2d Cir 2009]). Accordingly, at the motion-to-dismiss stage, we cannot determine, as a matter of law, that plaintiff will be unable to allege the requisite special circumstances for imposition of a fiduciary duty running from directors to shareholders under Cayman law, and the breach thereof.

However, to the extent the fourth and sixth causes of action are predicated on the majority shareholders’ alleged breach of their fiduciary duties to the minority, they lack merit since there are no such fiduciary duties under the governing law of the Cayman Islands, which undisputedly follows English law (see Dragon Inv. Co. II LLC v Shanahan, 49 AD3d 403, 404 [1st Dept 2008]; Feiner Family Trust v VBI Corp., 2007 WL 2615448, *7, 2007 US Dist LEXIS 66916, *22 [SD NY, Sept. 11, 2007, No. 07-Civ-1914 (RPP)]; see also Phillips v Manufacturers’ Secs. Ltd., [1917] 116 LT 290, 296). Hence, leave to replead is not granted as against the Investors.

The derivative claims asserted in the seventh, ninth and tenth causes of action, were correctly dismissed for plaintiff’s failure to comply with order 15, rule 12A of the Grand Court Rules of the Cayman Islands. The rule is applicable in the courts of this state as a substantive, rather than procedural, condition precedent to the continuation of a derivative action, as the underlying remedy is extinguished if a plaintiff fails to file an application to continue the derivative action (see ARC Capital, LLC v Kalra, 2013 NY Slip Op 31316 [U], *8 [Sup Ct, NY County 2013]; see also Tanges v Heidelberg N. Am., 93 NY2d 48, 54 [1999]). Accordingly, the law of the forum of incorporation governs plaintiff’s derivative claims (see 2013 NY Slip Op 31316[U], *10), and plaintiff is barred from asserting those claims. Indeed, plaintiff does not even allege that he attempted to comply with the Grand Court Rule.

We disagree with the contrary view that the rule is unlike the condition precedent of a derivative demand merely because it contemplates a legal determination by a court rather than a business judgment by a board committee. While the Grand Court Rule involves a purely legal judgment made by the court alone, rather than a business judgment by the board, we find this to be a distinction without a difference. A derivative demand, on the one hand, and an application under the Grand Court Rule, on the other, each constitute conditions precedent to the right to bring the lawsuit. For purposes of deciding whether a derivative action may proceed, there is no meaningful legal difference between the two.

In view of this ground for dismissal, it is unnecessary to consider whether plaintiff’s derivative causes of action are also barred by the English common-law proscription against derivative suits brought by individuals.

Finally, while it is the policy of New York courts to give effect to forum selection clauses (see Sterling Natl. Bank v Eastern Shipping Worldwide, Inc., 35 AD3d 222, 222 [1st Dept 2006]), plaintiff may not enforce the forum selection clause against the Benton entities. Plaintiff is not a signatory to the merger agreement containing the forum selection clause he seeks to enforce against the Benton entities, and was at most an incidental beneficiary (see Magdalena v Lins, 123 AD3d 600, 600-601 [1st Dept 2014]; ComJet Aviation Mgt. v Aviation Invs. Holdings, 303 AD2d 272, 272 [1st Dept 2003]). Moreover, the agreement expressly negates an intent to permit enforcement by persons or entities not parties thereto (see Specialists Entertainment, Inc. v Moore, 115 AD3d 424, 425 [1st Dept 2014]). Nor do any of the exceptions allowing enforcement by or against a nonsignatory apply to permit him to enforce the forum selection clause (see Freeford Ltd. v Pendleton, 53 AD3d 32, 39 [1st Dept 2008], lv denied 12 NY3d 702 [2009]).

Accordingly, the order of Supreme Court, New York County (O. Peter Sherwood, J.), as amended, entered on or about October 15, 2014, which, to the extent appealed from as limited by the briefs, granted defendants’ motions to dismiss the fourth, sixth, seventh, ninth and tenth causes of action for lack of standing, and to dismiss the complaint as against the Benton Street Partners defendants for lack of jurisdiction, should be modified, on the law, the facts, and in the exercise of discretion, to allow plaintiff to replead, as limited herein, the fourth and the sixth causes of action, and otherwise affirmed, without costs.