Levin v Kozlowski

[*1] Levin v Kozlowski 2006 NY Slip Op 52142(U) [13 Misc 3d 1236(A)] Decided on November 14, 2006 Supreme Court, New York County Fried, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on November 14, 2006
Supreme Court, New York County

Robert Mark Levin and KARL KORTE derivatively, on behalf of Tyco International Ltd., , Plaintiffs,

against

L. Dennis Kozlowski, LORD MICHAEL ASHCROFT, JOSHUA M. BERMAN, RICHARD S. BODMAN, JOHN F. FORT, III, STEPHEN W. FOSS, WENDY E. LANE, JAMES S. PASMAN, JR., W. PETER SLUSSER, MARK H. SWARTZ, JOSEPH F. WELCH, FRANK E. WALSH, JR. and MARK BELNICK, Defendants.



602113/02



For Plaintiffs:

Wolf Haldenstein Adler

Freeman & Herz LLP

270 Madison Avenue

New York, NY 10016

(Gregory Mark Nespole)

For Defendants:

Cravath, Swaine & Moore LLP

Attorney for defendant Tyco Iternational Ltd.

825 Eighth Avenue

New York, NY 10019

(Francis P. Barron; Stephen S. Madsen)

Weil, Gotshal & Manges LLP

Attorney for defendants Richard S. Bodman

and Wendey E. Lane

767 Fifth Avenue

New York, NY 10153

(Ashley R. Altschuler)

Cadwalader Wickersham & Taft LLP Attorney for defendants Michael A. Ashcroft,

John F. Fort, III, James S. Pasman and

Joseph F. Welch

One World Financial Center

New York, NY 10281

(Gregory A. Markel; Douglas I. Koff)

Latham & Watkins, LLP

Attorney for defendant Stephen W. Foss

Two Freedom Square

11955 Freedom Drive, Suite 500

Reston, VA 20190

(Laurie B. Smilan)

Kramer Levin Naftalis & Frankel LLP

Attorney for defendant Joshua M. Berman

1177 Avenue of the Americas

New York, NY 10036

(Alan R. Friedman; Steven S. Sparling)

O'Melveny & Myers LLP

Attorney for defendant W. Peter Slusser

7 Times Square Tower

7 Times Square

New York, NY 10036

(Martin Glenn)

Debevoise & Plimpton LLP

Attorney for defendant L. Dennis Kozlowski

919 Third Avenue

New York, NY 10022

(Robert N. Shwartz)

Stillman & Friedman PC

Attorney for defendant Mark H. Swartz

Stillman & Friedman PC

425 Park Avenue

New York, NY 10022

(Michael Grudberg)

Steptoe & Johnson LLP

Attorney for defendant Mark Belnick

750 Fifth Avenue

Suite 1900

New York, NY 10019

(Amy Lester)

Stroock & Stroock & Lavan LLP

Attorney for defendant Frank E. Walsh, Jr.

180 Maiden Lane

New York, NY 10038

(Laurence Greenwald; Michele Pahmer)

Bernard J. Fried, J.

This is a shareholder derivative action brought by two shareholders, Robert Mark Levin and Karle Korte, on behalf of defendant Tyco International Ltd. (Tyco). This action is one of many shareholder class and derivative actions filed against Tyco and its former officers and directors after Tyco publicly announced in 2002 that its former Chief Executive Officer/Chairman of the Board (L. Dennis Kozlowski), Chief Financial Officer/Director (Mark H. Swartz) and former Lead Director (Frank E. Walsh, Jr.), as well as former Chief Corporate Counsel Mark A. Belnick, had misappropriated Tyco's funds, and had engaged in an elaborate scheme to hide their wrongdoing from Tyco's former Board of Directors.

Motion Sequence Nos. 001, 002, 003, 004, 005 and 006 are consolidated for disposition. In Motion Sequence No. 001, Tyco moves, pursuant to CPLR 3211 (a) (5) and (a) (7), for an order dismissing the complaint with prejudice on the grounds that the claims asserted in the complaint are barred by the doctrine of collateral estoppel, and because plaintiffs lack standing, under Bermudian law, to assert derivative claims on behalf of a Bermuda corporation.

In Motion Sequence No. 002, defendants Richard S. Bodman and Wendy E. Lane move, pursuant to CPLR 3211 (a) (3), (5), (7) and (8), for an order dismissing the complaint with prejudice on the grounds of improper service, collateral estoppel, standing, and because the claims are barred as a matter of law by Tyco's Bye-Laws.

In Motion Sequence No. 003, defendant Walsh moves, pursuant to CPLR 3211 (a) (3), (5), (7) and (8), for an order dismissing the complaint on the grounds of collateral estoppel, lack of standing, failure to state a claim, and/or improper service.

In Motion Sequence No. 004, defendant Belnick moves, pursuant to CPLR 3211 (a) (3), (5) and (8), for an order dismissing the complaint with prejudice, on the grounds of improper service, collateral estoppel, and standing.

In Motion Sequence No. 005, defendants Kozlowski and Swartz move, pursuant to CPLR 3211 (a) (3) and (5), for an order dismissing the complaint on the grounds of lack of standing and collateral estoppel.

In Motion Sequence No. 006, defendants Michael A. Ashcroft, Joshua M. Berman, John F. Fort, III , Stephen F. Foss, James S. Pasman, Jr., W. Peter Slusser, and Joseph F. Welch move, pursuant to CPLR 3211 (a) (3), (5), (7) and (8), for an order dismissing the complaint with prejudice [*2]on the grounds of improper service, collateral estoppel, and standing, and because plaintiffs' claims are barred by Tyco's Bye-Laws.

For the reasons set forth below, the complaint is dismissed with prejudice on the ground of collateral estoppel.

Tyco, a Bermuda corporation with its principal executive offices located in Bermuda, is a diversified manufacturing and service conglomerate. Defendants Ashcroft, Berman, Bodman, Fort, Foss, Lane, Pasman, Slusser, and Welch (collectively, the Former Outside Directors) were non-management members of Tyco's Board of Directors (the Board) during the events underlying the allegations in plaintiffs' complaint. The other defendants are former Chief Executive Officer Kozlowski, former Chief Financial Officer Swartz, former Chief Corporate Counsel Belnick, and former Lead Director Walsh (collectively, the Individual Defendants).

In January 2002, the Board learned that Kozlowski had secretly caused Tyco to pay Walsh a $20 million fee in connection with Tyco's 2001 acquisition of CIT Group, Inc. (Complaint, ¶ 47).[FN1] In June 2002, the Board learned that Kozlowski was the target of a criminal investigation by the District Attorney of New York County and an investigation by the SEC (see Form 9/17/02 8-K Current Report of Tyco, at 2 [Aff. of Brad E. Konstadt, Exh A]). On June 3, 2002, Kozlowski resigned as chief executive officer and chairman of the Board (id.). The next day, he was indicted for violations of state sales tax laws, and was later charged with obstruction of justice (id.). On June 10, 2002, Belnick's employment was terminated (id. at 13). Kozlowski, Walsh, Belnick and Swartz were later indicted by the State of New York for criminal violations that victimized Tyco, and the SEC filed complaints against each of them. On December 17, 2002, Walsh pleaded guilty to a felony and settled the SEC civil action, agreeing to pay $20 million in restitution to Tyco. On June 17, 2005, Kozlowski and Swartz were both convicted of grand larceny, and were each sentenced to substantial prison terms.

On June 27, 2002, Tyco filed complaints against Walsh and Belnick, seeking recovery for losses suffered by Tyco as a result of their wrongful conduct. On September 12, 2002, Tyco filed a complaint against Kozlowski. On October 7, 2002, Tyco filed an arbitration claim against Swartz. When Swartz refused to proceed with arbitration, Tyco filed a complaint against him on April 1, 2003. On December 6, 2002, Tyco filed a complaint against Kozlowski and Swartz, alleging that they violated Section 16 (b) of the Securities Exchange Act of 1934, and seeking disgorgement of short-swing trading profits from prohibited transactions in Tyco stock.

On July 25, 2002, Tyco appointed Edward O. Breen as Chief Executive Officer and Chairman of the Board. On August 6, 2002, Eric M. Pillmore was appointed to the new position of Senior Vice President of Corporate Governance. On September 10, 2002, David J. Fitzpatrick was appointed Executive Vice President and Chief Financial Officer, replacing Swartz. On September 12, 2002, William B. Lytton was appointed Executive Vice President and General Counsel.

On September 12, 2002, the Board, as then constituted, voted not to nominate for reelection any of the then-current members of the Board who had been members prior to July 25, 2002, the date [*3]on which the new Chairman was appointed. Between August 2002 and January 2003, five members of the Board resigned, and were replaced by new members. At the annual meeting on March 6, 2003, shareholders elected the nominated slate of new candidates to the Board. By this date, all of the Former Outside Directors had stepped down from the Board, and were replaced by an entirely new group of directors. The new directors were re-elected at the annual meetings held in 2004, 2005, and 2006.

On March 7, 2003, the Board appointed a Special Litigation Committee to investigate and evaluate whether it would be in Tyco's interest to take additional action beyond the lawsuits already filed against Kozlowski, Swartz, Belnick, and Walsh. The Committee retained the firm of Covington and Burling to assist and advise it. On May 12, 2004, on the basis of the Committee's recommendations, the Board decided that Tyco would not pursue additional legal action against the Former Outside Directors, and would seek dismissal of the several derivative suits that had been filed.

On June 28, 2002, plaintiffs filed this action. In January 2003, plaintiffs' counsel, the law firm of Wolf, Haldenstein Adler Freeman & Herz LLP (Wolf Haldenstein) agreed to suspend this action indefinitely to await the outcome of a concurrent consolidated derivative action with a different named plaintiff, which was being prosecuted in federal district court in New Hampshire before Judge Paul J. Barbadoro (the Federal Action).[FN2] Although there was no formal order staying the instant action, the parties agreed to suspend all deadlines, and filed no Request for Judicial Intervention. During the subsequent years, Wolf Haldenstein was actively involved in the Federal Action, appearing with the title "Of Counsel" or "Counsel for Derivative Plaintiffs" on at least 20 different pleadings.

The Federal Action was part of a wave of lawsuits that began in February 2002, shortly after the $20 million payment to Walsh became public. Ultimately, there were 42 class actions alleging violations of the securities laws, eight class actions alleging violations of the Employee Retirement Security Act of 1974 (ERISA), and three derivative actions. The Judicial Panel on Multidistrict Litigation ordered all actions centralized in the District of New Hampshire. Judge Barbadoro divided the litigation into three consolidated categories: securities, ERISA and derivative. The consolidated securities and ERISA class actions have survived motions to dismiss as to Tyco and certain individual defendants.

On January 29, 2003, Shelly Evans, the plaintiff in the Federal Action, filed the first Consolidated and Amended Derivative Complaint (the First Amended Federal Complaint), listing Wolf Haldenstein as "Counsel for Derivative Plaintiffs," and naming Kozlowski, Swartz, Belnick, Walsh, and nine other former or then-current directors of Tyco as defendants. Tyco was named as a nominal defendant. In the First Amended Federal Complaint, the plaintiff alleged that the then-[*4]current and former directors breached their fiduciary duty to exercise due care, loyalty and diligence in the management and administration of Tyco, and wasted corporate assets.

On March 17, 2003, Tyco and the Former Outside Directors moved to dismiss the First Amended Federal Complaint on the grounds, inter alia, that: (1) Bermuda law governed, as Tyco is a Bermuda corporation; and (2) plaintiffs had not met the requirements under Bermudian law for pursuing the asserted derivative claims. The applicable Bermudian/English law requires that, to pursue a derivative action, a plaintiff must show that the alleged wrongdoers have committed a "fraud on the minority" that is, have committed an equitable fraud upon the company, and are preventing the company from taking action because they are in control, or are about to commit an ultra vires act. However, none of the individual defendants remained an officer or director, and four of them had been sued by Tyco. Thus, the defendants argued, it could not possibly be said that they controlled Tyco, or that they were about to engage in an ultra vires act.

The plaintiff never responded to the motion the dismiss.[FN3] Instead, the plaintiff sought leave to filed a Second Amended Derivative Complaint (the Second Amended Federal Complaint) in order to cure the pleading defects by adding the new directors of Tyco as defendants. Wolf Haldenstein was, once again, listed on the Second Amended Federal Complaint as "Counsel for Derivative Plaintiff."

In the Second Amended Federal Complaint, the claims against the former officers and directors were essentially the same as those asserted in the First Amended Federal Complaint. With respect to the new directors, the Second Amended Federal Complaint blamed them for conduct that took place during the "Kozlowski era," which was uncovered and disclosed after the new management and Board took over. The plaintiff alleged that the new Board members "assumed their duties" knowing that there were problems at Tyco (Second Amended Federal Complaint, ¶ 5); that "[t]he current Board, having stepped into the quagmire of Tyco's ongoing problems, has placed itself in an irreconcilable conflict" (id., ¶ 22); and that the new directors "have not rescued Tyco from the pernicious wrongdoing inflicted on it and, indeed have perpetuated the wrongdoing" (id., ¶ 3).

On February 26, 2004, the defendants in the Federal Action moved to dismiss the Second Amended Federal Complaint on the grounds that: (1) the element of wrongdoer control could not possibly be established against the former officers and directors; (2) the plaintiff had not pleaded (and could not show) that the new directors controlled a majority of the voting shares (the test under English law) and, in any case, had not pleaded (and could not show) that the new directors had committed equitable fraud by misappropriation of company property for their own benefit; and (3) the plaintiff had not pleaded (and could not show) that the former or new directors were threatening to commit a future ultra vires act.

By Opinion and Order dated October 14, 2004, Judge Barbadoro dismissed the Second Amended Federal Complaint in its entirety (In re Tyco Intl., Ltd., 340 F Supp 2d 94 [D NH 2004]). As a threshold matter, the court found that, because Tyco is a Bermuda corporation, Bermudian law would determine a shareholder's right to bring an action in the company's name, and that thus, it would "evaluate [plaintiff's] right to sue on Tyco's behalf under English law as it would be applied [*5]by a Bermudian court" (id. at 96). The court then determined that, "[u]nder English law, whether Evans is a proper plaintiff to sue on Tyco's behalf is viewed as a question of standing," and that "American courts, in turn, generally view standing as a component of subject matter jurisdiction" (id. at 96-97). The court held that the plaintiff's pleading, even if taken as true, did not demonstrate her standing to assert derivative claims on behalf of Tyco. The court did so "without engaging in jurisdictional fact finding because I conclude that I lack subject matter jurisdiction even if all of Evans' well-pleaded jurisdictional averments are true" (id. at 97).

In reaching this determination, the court found that "[a] shareholder's standing to sue on behalf of a corporation under English law is governed by the rule in Foss v Harbottle,'" (id. at 98 [citations omitted], which is derived from an "1843 [English] court case of the same name" (id., citing Foss v Harbottle [2 Hare 1 (Eng 843)]).[FN4] The court stated the rule as follows: "a shareholder may ordinarily bring a derivative claim on behalf of a corporation only if a simple majority of the shareholders could not ratify the conduct on which the suit is based" (id. at 98). The plaintiff primarily relied on two exceptions to the rule in Foss v Harbottle, which permit a shareholder to bring suit when the conduct at issue is ultra vires, or qualifies as a "fraud on the minority."

The court found that the action did not fall within the fraud-on-the minority exception, which "has two elements that work together to limit the circumstances in which a minority shareholder may seize control of the company's right to sue" (id.). The first element "is that the alleged wrongdoers must have control' over a majority of the stock with voting rights and the second is that the wrongdoers must have committed fraud,'" meaning "in a broader equitable sense," that "the alleged wrongdoer has benefitted at the company's expense as a result of his misconduct" (id. at 98, 99).

The court concluded that because "it is the current board's litigation judgment that [plaintiff seeks] to displace," the plaintiff's standing to pursue derivative claims hinged on the sufficiency of her allegations that the current directors (who the court assumed, for purposes of its decision, had sufficient "control" to satisfy Foss v Harbottle) engaged in fraud on the minority (id. at 100). As to the element of "fraud," the court held that the plaintiff did "not allege the kind of self-dealing by the current directors that is necessary to satisfy the fraud requirement" (id. at 100). The court found that the plaintiff did not allege that the directors had enjoyed any benefit beyond those normally enjoyed by directors, and that the directors' alleged desire to avoid personal liability and damage to their reputations are motivations shared by all corporate directors. The court concluded that "[i]f allegations of this sort could satisfy the self-dealing component of a fraud on the minority claim, the requirement would be meaningless because it would be satisfied in every derivative action in which a breach of fiduciary duty claim is asserted against a sitting board of directors" (id.).

With respect to the plaintiffs' contention that her case qualified under the "ultra vires" exception to the Foss v Harbottle rule, the court concluded that the exception applies only to prospective ultra vires acts. Where a shareholder seeks to bring a derivative action to recover damages for past ultra vires acts, she must demonstrate that the case qualifies under the "fraud on the minority" exception. Thus, the court found that the plaintiff's attempt to rely on the ultra vires [*6]exception also failed.

The plaintiff also contended that her case qualified under an "interests of justice" exception. The court cited authority casting doubt on the existence of such an exception, but found that, in any event, there would be no basis for the application of such an exception in the case before it.

Accordingly, the District Court concluded that the plaintiff in the Federal Action "lack[ed] standing to bring a derivative claim on Tyco's behalf," and dismissed all of the claims that had been asserted, including those against the Former Outside Directors and the Individual Defendants.

The plaintiff subsequently appealed. Wolf Haldenstein appeared as "Of Counsel" in the Notice of Appeal. On May 19, 2005, plaintiff voluntarily dismissed her appeal after defendants filed their responsive briefs.

Plaintiffs in the present derivative action filed their complaint on June 28, 2002, making substantially the same allegations as were included against the same defendants in the First Amended Federal Complaint and Count I of the Second Amended Federal Complaint. Wolf Haldenstein's name appears in both pleadings as "Counsel for Derivative Plaintiffs" on the Second Amended Federal Complaint, and as the submitting firm on the complaint now before this court. Plaintiffs here first claim that defendants' alleged conduct was "due to their intentional breaches or reckless disregard of their fiduciary duties to the company" (Complaint, ¶ 108). Second, plaintiffs claim that defendants grossly mismanaged Tyco because they "knew or recklessly disregarded the unreasonable risks associated" with their alleged misconduct (id., ¶ 117). Third, plaintiffs allege that defendants caused Tyco to waste corporate assets (id., ¶ 121). Fourth, plaintiffs include an additional claim of conversion against defendants Kozlowski, Swartz, Berman, Fort, Ashcroft, Foss and Belnick (id., ¶ 125). Plaintiffs' claims of breach of fiduciary duty and gross mismanagement in the present case (Complaint, Counts I and II, ¶¶ 106-112; 113-118) mirror Count I of the Second Amended Federal Complaint (Second Amended Federal Complaint, ¶¶ 438-447); plaintiff's claim of corporate waste (Complaint, Count III, ¶¶ 119-122) was also pleaded in the Second Amended Federal Complaint under Count II (Second Amended Federal Complaint, ¶¶ 448-445); and plaintiff's conversion claim was effectively subsumed in the claim of waste of corporate assets in the Federal Action, where the plaintiff alleged that defendants' misconduct caused Tyco to "incur[] significant expenses, liabilities, and obligations for the benefit of the individual defendants" (id., ¶ 450).

In a June 14, 2005 letter to Tyco's counsel, Wolf Haldenstein announced that it was reviving the instant action, stating that although it had "voluntarily agreed to stay proceedings in New York and cooperate with the prosecution of the federal derivative action in the district court in New Hampshire ... we intend to proceed with the New York action" in light of the federal plaintiff's dismissal of her appeal (Altschuler Aff., Exh F).

Defendants now move to dismiss the complaint with prejudice, primarily on the ground that plaintiffs' claims are barred by collateral estoppel. As set forth below, plaintiffs are precluded from relitigating the issue of standing, and the complaint is dismissed. Based upon this conclusion, it is unnecessary to reach the merits of defendants' remaining contentions.

Collateral estoppel is based upon the general notion that a party, or one in privity with a party, should not be permitted to relitigate an issue that has already been decided against it (see Pinnacle Consultants, Ltd. v Leucadia Natl. Corp., 94 NY2d 426, 431-432 [2000] [internal quotation marks and citation omitted] ["Collateral estoppel, or issue preclusion, prevents a party from relitigating in a subsequent action or proceeding an issue clearly raised in a prior action or [*7]proceeding and decided against that party"]). There are two requirements governing the application of collateral estoppel: (1) the party seeking the benefit of collateral estoppel must prove that the identical issue was necessarily decided in the prior action and is decisive in the present action; and (2) the party to be precluded from re-litigating an issue must have had a full and fair opportunity to contest the prior determination (Kaufman v Eli Lilly & Co., 65 NY2d 449 [1985]; accord D'Arata v New York Cent. Mut. Fire Ins. Co., 76 NY2d 659 [1990]; Kleiger-Brown v Brown, 306 AD2d 482 [2d Dept 2003]).

The first question that arises in every derivative suit is whether the elected board of directors of the nominal defendant company is disqualified from exercising its "inherent powers ... to manage the affairs of the corporation, which includes making decisions about whether or not to pursue ... litigation" (Wilson v Tully, 243 AD2d 229, 232 [1st Dept 1998]). That question which has nothing to do with the particular individual shareholder who brings suit is the fundamental question when considering shareholder standing to bring a derivative action (see Henik v LaBranche, 433 F Supp 2d 372, 381 [SD NY 2006] ["the demonstration of standing to sue derivatively does not require any showing of the characteristics specific to the individual shareholder who seeks standing, aside from the obvious demonstration that the plaintiff was a shareholder during the relevant period"]).

Plaintiffs' claims in the current case are substantially identical to the claims in the Federal Action. Therefore, the identical, controlling legal issue whether plaintiffs have standing to sue was already decided by Judge Barbadoro. Additionally, plaintiffs and their counsel have already had a full and fair opportunity to contest Judge Barbadoro's determination that they lack standing to bring the present shareholder derivative action. Thus, plaintiffs' claims are barred by collateral estoppel, and the complaint must be dismissed pursuant to CPLR 3211 (a) (5) (see Pinnacle Consultants, Ltd. v Leucadia Natl. Corp., 94 NY2d 46, supra [dismissing shareholder derivative action on collateral estoppel grounds where issues had been raised and decided against plaintiff in a prior federal court action]).

More specifically, with respect to the first prong of the collateral estoppel test, all of the allegations of the complaint in the present case were also made in the Federal Action, and thus, the issue of whether plaintiffs have standing to sue derivatively on Tyco's behalf is identical to that previously and necessarily adjudicated in the Federal Action (see Parker v Blauvelt Volunteer Fire Co., 93 NY2d 343 [1999] [citation omitted] [collateral estoppel " precludes a party from relitigating in a subsequent action or proceeding an issue clearly raised in a prior action or proceeding and decided against that party ... whether or not the tribunals or causes of action are the same'"]).

The complaint here alleges that: (1) Tyco's former directors knowingly or recklessly breached their fiduciary duty to Tyco by allowing Tyco's senior management to loot the company and create a false impression about the company's financial condition (Complaint,

¶¶ 106-112); (2) Tyco's former directors were guilty of gross mismanagement (id., ¶¶ 113-118); (3) Tyco's former directors caused Tyco to waste corporate assets (id., ¶¶ 119-122); and (4) Kozlowski, Swartz, Berman, Fort, Ashcroft, Foss, and Belnick converted corporate assets for personal use (id., ¶¶ 123-126).

In the prior Federal Action, plaintiffs claimed that: (1) Tyco's former directors had breached their fiduciary duty to the Company and committed equitable fraud and mismanagement (Second Amended Federal Complaint, ¶¶ 438-447); and (2) Tyco's former directors had engaged in a "continuing pattern and practice of wasting corporate assets" tantamount to conversion, because of [*8]which "Tyco has incurred significant expenses, liabilities, and obligations for the benefit of the individual defendants and has been injured thereby (id., ¶¶ 448-450).

Judge Barbadoro evaluated these substantially identical claims when granting defendants' motion to dismiss the Federal Action, and determined that, under Bermudian law, plaintiff's complaint, even if taken as true, did not demonstrate standing to assert derivative claims on behalf of Tyco. Specifically, Judge Barbadoro determined that plaintiff failed to make a prima facie showing that the company: (1) has a claim that defendants have engaged in "fraud," i.e., misappropriated something belonging to the company; or (2) is prevented from taking action because the alleged wrongdoers are in control (see In re Tyco Intl., Ltd., 340 F Supp 2d at 100). Accordingly, Judge Barbadoro dismissed the claims against both the current and former directors on the ground that plaintiff could not usurp control of Tyco's claims from Tyco's independent, shareholder-elected, decision-making body.[FN5]

In light of this prior adjudication of the issue of standing, plaintiffs are precluded from arguing the point again in the present case (see 4A NY Practice, Commercial Litigation in New York State Courts § 74:34 [2d ed 2005] [" even if there are variations in the facts alleged, or different relief is sought, the separately stated "causes of action" may nevertheless be grounded on the same gravamen of the wrong upon which the action is brought,' thereby collaterally estopping the plaintiff from raising the prior cause of action in the guise of a new legal theory or claim"], quoting Smith v Russell Sage Coll., 54 NY2d 185, 192 [1981]).

Indeed, standing "is one of the those questions of jurisdiction and justiciability which may preclude or collaterally estop relitigation of the precise issues of jurisdiction adjudicated" (Treeby v Aymond, 2000 WL 869502, * 4 [ED La 2000], affd 251 F3d 156 [5th Cir 2001]; see also Perry v Sheahan, 222 F3d 309, 318 [7th Cir 2000] ["A dismissal for lack of jurisdiction precludes relitigation of the issue actually decided, namely the jurisdictional issue"]).

For example, in Treeby, the district court enjoined a state court from allowing relitigation of a shareholder derivative action that had been dismissed in that district court for lack of standing. The district court noted that the "same impediments to the justiciability of [the] derivative claims, which [were] substantially the same as the Federal Derivative Action, remain[ed] extant as of the filing of the State Derivative Action" (2000 WL 869502, at * 4).

Similarly, in Meng v Schwartz (305 F Supp 2d 49 [D DC 2004]), the plaintiff sought to press a shareholder derivative action in federal court, despite a prior decision by the First Department holding that she lacked standing to bring that claim. The federal court dismissed the plaintiff's claim, holding that the plaintiff was collaterally estopped from raising the same issue in federal court that [*9]already had been decided against her in a New York state court (id.; see also Welt v Abrams, 832 F Supp 88, 92 [SD NY 1993] [a decision that plaintiff "does not have standing" in a prior action is "final in its determination," and therefore, "relitigation of the issue [in a subsequent action] is precluded" by res judicata or collateral estoppel]; Janitschek v Trustees of Friends World Coll., 249 AD2d 368 [2d Dept 1998] [plaintiff's complaint seeking to rescind sale of a college was barred by collateral estoppel because plaintiffs had brought identical claims in a prior proceeding and had been found to lack standing]).

The District Court in New Hampshire has already decided that the current Board of Directors is not disqualified and that thus, individual shareholders do not have standing to prosecute derivative claims on the Company's behalf. Under the doctrine of collateral estoppel, plaintiffs are precluded from relitigating that issue in this Court.

With respect to the second prong of the test, plaintiffs and their counsel have already had a full and fair opportunity to contest Judge Barbadoro's determination that they lack standing. Where, as here, the party seeking the benefit of collateral estoppel establishes that an issue was necessarily decided in the prior action, the burden shifts to the party attempting to defeat the application of collateral estoppel to establish the absence of a full and fair opportunity to litigate (see Parker v Blauvelt Volunteer Fire Co., 93 NY2d 343, supra). Plaintiffs here cannot show that they did not have a full and fair opportunity to litigate the matters at issue.

Although the particular Tyco shareholders named as plaintiffs in this suit are different from those in the Federal Action, "a nonparty to a prior litigation may be collaterally estopped by a determination in that litigation by having a relationship with a party to the prior litigation such that his own rights or obligations in the subsequent proceeding are conditioned in one way or another on, or derivative of, the rights of the party to the prior litigation" (D'Arata v New York Cent. Mut. Fire Ins. Co., 76 NY2d at 664]). Indeed, in derivative suits, shareholder plaintiffs are treated like equal and effectively interchangeable members of a class action because their claims belong to and are brought on behalf of the corporation, rather than on behalf of themselves (Auerbach v Bennett, 47 NY2d 619, 631 [1979] ["Derivative claims against corporate directors belong to the corporation itself"]). As a result, prior legal determinations in derivative suits can bind all other similarly situated plaintiffs who might bring subsequent derivative claims, thus avoiding wasteful and duplicative litigation:

Because the claim asserted in a stockholder's derivative action is a claim belonging to and on behalf of the corporation, a judgment rendered in such an action brought on behalf of the corporation by one shareholder will generally be effective to preclude other actions predicated on the same wrong brought by other shareholders.

Parkoff v General Tel. & Elecs. Corp., 53 NY2d 412, 420 (1981). Accordingly, collateral estoppel applies to (1) the shareholder plaintiff in the first derivative action; and (2) all parties who are in privity with that first shareholder plaintiff (see Auerbach v Bennett, 47 NY2d at 627-628 ["a dismissal on the merits of one derivative action is generally a bar to suits by other stockholders of the same corporation on the same cause of action"]; Janitschek v Trustees of Friends World Coll., 249 AD2d at 369 [plaintiff was "collaterally estopped from commencing the instant action because he was in privity with (the previous plaintiffs)"]; see also In re Sonus Networks, Inc. Shareholders Deriv. Litig., 422 F Supp 2d 281, 291 [D Mass 2006] [citation omitted] [" nonparty shareholders are [*10]usually bound by a judgment in a derivative suit on the theory that the named plaintiff represented their interests in the case"]).

Therefore, as Tyco shareholders in privity with the shareholder plaintiff in the Federal Action, plaintiffs have already had a full and fair opportunity to litigate the issue of standing in the Federal Action.

Moreover, in addition to the fact that both the claims in the Federal Action and in the current case are shareholders' derivative actions made on Tyco's behalf, plaintiffs' counsel in the current litigation were actively involved in the prior Federal Action. Wolf Haldenstein was listed with the title "Of Counsel" or "Counsel for Derivative Plaintiffs" on at least 20 different pleadings in the previous Federal Action, including both versions of the complaint, the Derivative Plaintiff's Memorandum in Opposition to Nominal Defendant Tyco International Ltd.'s Motion to Dismiss Second Amended Derivative Complaint and the Notice of Appeal (see Konstandt Aff., Exh I). As in a securities fraud class action, the plaintiff's lawyer in a derivative suit (who has the most to gain financially) is typically the "real mover and shaker" of the lawsuit, rather than the plaintiff (see Robinson v Sheriff of Cook County, 167 F3d 1155, 1157 [7th Cir], cert denied 528 US 824 [1999]). Thus, Wolf Haldenstein has already had the opportunity in the Federal Action to put forth its best arguments for why the identically situated plaintiff making substantively identical claims had standing to sue in that case.

Although plaintiffs concede that "[t]he claims in the Prior Action were substantially similar to those plaintiffs are making in the present case" (Pl Br, at 14), they nevertheless argue, in response to the dismissal motion, that: (1) the earlier decision was not on the merits; (2) this action raises a separate issue; and (3) they have not had a full and fair opportunity to litigate all issues. None of these arguments, however, has any merit. The issues that are dispositive of plaintiffs' claims have already been resolved on the merits by Judge Barbadoro, in a proceeding that is binding on them.

Plaintiffs first argue that they are not forbidden to relitigate the issues decided by Judge Barbadoro because his decision was not on the merits, but rather, dealt only with plaintiffs' standing. Contrary to plaintiffs' arguments, however, the doctrine of collateral estoppel does apply to the question of shareholder standing in derivative actions. In two cases decided subsequent to Judge Barbadoro's decision, both courts dismissed shareholder derivative suits as barred by prior decisions "on the merits," i.e., prior decisions dismissing derivative suits brought by fellow shareholders (and challenging the same alleged wrongdoing), where the prior dismissals were based on plaintiffs' failure to establish that a board of directors was disabled from acting (see Henik v LaBranche, 433 F Supp 2d at 379 (dismissing derivative action, and holding that a ruling on shareholder standing "does constitute a decision on the merits' for the purposes of preclusion"]; In re Sonus Networks, Inc. Shareholders Deriv. Litig., 422 F Supp 2d at 290 [dismissing derivative action and holding that the shareholder was precluded from relitigating the issue of demand futility decided in a previously dismissed derivative action, as prior dismissal was "on the merits"]).

Indeed, courts have repeatedly made clear that the requirement that the Board, rather than self-appointed shareholders, must decide whether to bring an action on behalf of the corporation is "a matter of substance' not procedure'" (Kamen v Kemper Fin. Servs., Inc., 500 US 90, 96-97 [1991] [citation omitted]), and "implements the basic principle of corporate governance that the decisions of a corporation including the decision to initiate litigation should be made by the board of directors or the majority of shareholders" (id. at 101 [citation omitted]; accord Henik v [*11]LaBranche, 433 F Supp 2d at 379 ["the issue of whether or not [a] board of directors did not lack the disinterestedness and independence needed to consider a demand albeit technically a procedural issue of standing to proceed derivatively does constitute a decision on the merits' for the purposes of preclusion"]; Locals 302 and 612 of Intl. Union of Operating Engineers - Empl. Constr. Indus. Retirement Trust v Blanchard, 2005 WL 2063852, * 6 [SD NY 2005] ["both the Supreme Court and Court of Appeals have found that demand rules in derivative actions are substantive in nature" because " the issue is not just "who" may maintain an action or "how" it will be brought, but "if" it will be brought.' No determination could be more substantive"]; Burns v Egan, 117 AD2d 38, 42 [3d Dept 1986] [Court held that relitigation of the standing issue was barred by res judicata, and specifically found that "the previous determination that plaintiffs lacked standing was on the merits'"]).

Moreover, a decision on derivative standing is clearly on the merits because it turns on the facts with respect to the board and its ability to exercise its powers. As the court in Henik explained, cases discussing the res judicata effect of a standing determination in other contexts are simply irrelevant in the derivative context, as shareholder derivative standing is different from other types of jurisdictional standing. In non-derivative cases, each plaintiff is situated differently, and the standing analysis is analyzed individually for each. In contrast, in all shareholder derivative suits brought on behalf of a given company, the real plaintiff the corporation is the same, and the central "standing" inquiry is whether its board is disqualified, such that it cannot perform its normal function of controlling the company's litigation decision-making:

[I]n the context of standing based upon demand futility, the facts submitted by an individual shareholder to demonstrate that she has standing to sue on behalf of the corporation are facts about the corporation and about members of the corporation's board of directors. Indeed, the demonstration of standing to sue derivatively does not require any showing of the characteristics specific to the individual shareholder who seeks standing, aside from the obvious demonstration that the plaintiff was a shareholder during the relevant period. Given this unique nature of the derivative standing inquiry, assuming the claims are the same, which they are here, the standing analysis for one shareholder will not differ from the standing analysis for another shareholder.

Henik v LaBranche, 433 F Supp 2d at 381.

The cases plaintiffs cite for the proposition that an adjudication of standing is not a determination on the merits are completely inapposite, as none of them involved the preclusive effect, in a second derivative suit, of a decision as to the board's authority in a prior derivative suit. For example, in Stevens v Kirk (171 AD2d 587 [1st Dept 1991]), the First Department held that the trial court had improperly dismissed state common law-claims as collaterally estopped where a federal court had dismissed those claims for lack of pendent jurisdiction. The federal court held that the plaintiff who was not a shareholder lacked standing under federal securities laws, and dismissed the state law claims for lack of federal subject matter jurisdiction, without ever reaching the question of whether plaintiffs would have otherwise had standing to purse those common-law claims in state court. Stevens has nothing to do with a situation where, as here, a federal court previously determined that a shareholder lacked standing to sue derivatively because the board was not disabled from making litigation decisions for the company. Likewise, in Tong v Hang Seng Bank, Ltd. (210 AD2d 99 [1st Dept 1994]), the Court considered the preclusive effect of a non-[*12]derivative suit on a derivative suit. The earlier determination, however, did not address the question of demand futility that was resolved favorably for the plaintiff in the second suit. The cases of Pullman Group, LLC v Prudential Ins. Co. of America (297 AD2d 578 [1st Dept 2002], lv dismissed 99 NY2d 610 [2003]), St. Pierre v Dyer (208 F3d 394 [2d Cir 2000]), and Citibank (South Dakota), N.A. v Martin (11 Misc 3d 219 [Civ Ct, NY County 2005]), also relied on by plaintiffs, are not derivative cases at all.

Plaintiffs next argue that the issue in the Federal Action is not identical to the issue in this action because they chose to bring this suit in New York, which they contend has different choice of law principles than New Hampshire. I reject this argument. As in the Federal Action, the threshold issue in this derivative suit is whether, under Bermuda law, Tyco's Board is disabled from acting, so that plaintiffs have derivative standing to sue on behalf of Tyco. The seminal question of shareholder standing, including the question of applicable law, has already been decided, and cannot be relitigated. For example, in Weston Funding Corp. v Lafayette Towers, Inc. (550 F2d 710 [2d Cir 1977]), the Court refused not only to reach the underlying merits of a claim, but also to reassess the choice of law applicable to it. The Court held that "even if Weston were not barred from maintaining a new action in the New York federal court, it would be estopped from challenging Judge Coolahan's choice of New Jersey law. ... The choice of New Jersey law issue is res judicata between the parties since it actually was litigated and decided" (id. at 715). Likewise, in NatTel, LLC v SAC Capital Advisors (2005 WL 2253756 [D Conn 2005], affd 2006 WL 957342 [2d Cir 2006]), the court held that an arbitration panel's decision barred plaintiffs' claims, despite their argument that the court should reach a different choice-of-law decision than had the arbitrators. As the court explained:

[Plaintiff] argues that the arbitration did not resolve the same issues as presented in this case because the arbitrators applied Bahamian law [the law of the place of incorporation], whereas a Connecticut court would apply Connecticut law. ... [C]ontrary to [plaintiff's] argument, the choice-of-law question was fully explored in arbitration. The [arbitration] panel, after a complete statement of its reasons, held that Bahamian law applied because [plaintiff's] claims involved matters of internal corporate governance. ... Thus [plaintiff] is collaterally estopped from relitigating the choice of law question, which already was decided against it in arbitration.

Id. at * 8.

Plaintiffs also argue that "there was never an opportunity to litigate in the Prior Action the issues raised in this action," because the "New Hampshire conflict of law statute precluded the parties or the court from considering any of these issues" (Pl Br, at 24). As plaintiffs concede, however, in the prior Federal Action, "the parties agreed that [the shareholders'] standing was a matter of Bermuda law" (id. at 15). That agreement precludes relitigation of the choice of law issue. To have preclusive effect, an issue must be "raised, necessarily decided and material in the first action" (Pinnacle Consultants, Ltd., 94 NY2d at 432 [citation omitted]). The issue, however, need not be resolved by the court in order to have preclusive effect. Rather, it may be resolved, like here, by the parties' agreement (see e.g. U.S. v Hansel, 999 F Supp 694 [ND NY 1998]).

Finally, plaintiffs contend that they have not yet had a full and fair opportunity to litigate because they have not had the opportunity to argue their case under New York's choice of law principles. This argument basically amounts to a theory that shareholders suing on behalf of the [*13]same corporation are entitled to litigate in every state, so that they might avail themselves of each state's choice of law principles. However, this is not the law in New York. In Hart v General Motors Corp. (129 AD2d 179 [1st Dept], appeal denied 70 NY2d 608 [1987]), the First Department reversed the denial of a forum non conveniens motion to dismiss, and applied Delaware law to dismiss a derivative suit involving a Delaware corporation doing business in New York. The Court held that the trial court had "erred in concluding that the ... transaction falls within that category of corporate acts where the liability of a director can be decided by different local law rules in different states'" (id. at 182 [citation omitted]). The Court reasoned that " [u]niform treatment of directors, officers and shareholders ... is an important objective which can only be attained by having the rights and liabilities of those persons with respect to the corporation governed by a single law'" that of the place of incorporation (id. at 84 [citation omitted]).

Indeed, courts "have long recognized the preclusive effect of judgments in derivative actions upon subsequent actions brought by stockholders who were not plaintiffs in the original action" because "if this were not the rule, shareholder plaintiffs could indefinitely relitigate the demand futility question in an unlimited number of state and federal courts, a result the preclusion doctrine specifically is aimed at avoiding" (Henik v LaBranche, 433 F Supp 2d at 380).

Accordingly, plaintiffs' derivative claims are barred, and the complaint is dismissed with prejudice.

Accordingly, it is

ORDERED that the motion to dismiss is granted, and the complaint is dismissed with prejudice, with costs and disbursements to defendants as taxed by the Clerk of the Court; and it is further

ORDERED that the Clerk is directed to enter judgment accordingly.

Dated: November 14, 2006

ENTER:

_______________________

J.S.C. Footnotes

Footnote 1:This statement of facts is taken from the complaint, from other court filings (including Declarations submitted in the Federal Action), and from publicly available Securities and Exchange Commission filings (SEC), which the court may consider under CPLR 3211 (see Gibraltar Steel v Gibraltar Metal Processing, 19 AD3d 1141 [4th Dept 2005]).

Footnote 2:At a November 15, 2002 pretrial conference, a Wolf Haldenstein attorney represented to Judge Barbadoro that "We have agreed to stay our action in New York State Court and to refer to this leadership structure [for plaintiffs' counsel in the Federal Action] and work in this case as we're given assignments, and accordingly, we withdraw our earlier filed objection to these proceedings going on here" (Tr, at 15 [Konstadt Aff., Exh J]).

Footnote 3:Indeed, Judge Barbadoro observed at oral argument that the "control" element would have required dismissal of the prior complaint as to the Former Outside Directors (see June 22, 2004 Tr, at 206 [Aff. of Ashley R. Altschuler, Exh D]).

Footnote 4:The validity of Foss v Harbottle in the derivative context was recently reaffirmed by the Supreme Court of Bermuda in Clark v Energia Global Intl. Ltd., [2001] No. 173, at 10 [Bermuda, September 18, 2002] [Konstadt Aff, Exh H]).

Footnote 5:Although Judge Barbadoro's decision focused on plaintiff's lack of standing to bring a derivative suit against the then-current directors, given the plaintiff's concession that the Former Outside Directors were not in control of Tyco, his conclusions extend, a fortiori, to the former directors named as defendants in that action, as well as the current action (In re Tyco Intl., Ltd., 340 F Supp 2d at 100 ["Although [the plaintiff] has sued several of Tyco's former directors and officers as well as the company's current directors, her standing to maintain each of her claims depend[s] upon the sufficiency of her allegations that the current directors have engaged in fraud on the minority. This is necessarily so because it is the current board's litigation judgment that she seeks to displace"]).