Foreign Derivative Claims Face Hurdles in NY Courts

On October 22, 2013, Justice Schweitzer of the New York County Commercial Division issued a decision in Gutstadt v. National Financial Partners Corp., 2013 NY Slip Op. 32733(U), illustrating the many hurdles that shareholders of foreign corporations face when they try to bring shareholder derivative suits against New York residents.

Gutstadt was brought by two minority shareholders on behalf of an Ontario corporation against the corporation's majority shareholder and Board member, the corporation's accountant, and a New York company and that company's CFO. The derivative claims sounded in breach of fiduciary duty, fraud, conversion, and unjust enrichment and essentially alleged that the defendants had successfully conspired to fraudulently transfer the corporation's assets and business to the New York company through a series of transactions, in violation of the Ontario Business Corporations Act ("OBCA"). One of those transactions was memorialized in a stock purchase agreement containing a New York choice-of-law clause and a forum selection clause requiring any disputes arising out of the agreement to be arbitrated in New York.

Justice Schweitzer dismissed the case on three independent grounds. First, Justice Schweitzer found that he lacked subject matter jurisdiction because New York's internal affairs doctrine required him to apply the law of the jurisdiction where the corporation was incorporated to a shareholder derivative suit, and the OBCA required that a derivative plaintiff obtain leave from a Canadian court before bringing a derivative action, which plaintiffs admitted they had not obtained. Justice Schweitzer rejected plaintiffs' argument that the choice-of-law provision in the stock purchase agreement trumped the internal affairs doctrine because that provision did not apply to plaintiffs' tort claims "relating to the obligations of directors and controlling shareholders to minority shareholders" of the nominal defendant Ontario corporation.

Second, Justice Schweitzer found that all plaintiffs' claims were time barred under Ontario's two-year statute of limitations, which is shorter than New York's, because CPLR 202 provides that an "action based upon a cause of action accruing without the state cannot be commenced after the expiration of the time limited by the laws of either the state or the place without the state where the cause of action accrued, except that where the cause of action accrued in favor of a resident of the state the time limited by the laws of the state shall apply." Because the plaintiffs resided in Ontario and were suing derivatively on behalf of an Ontario corporation, Justice Schweitzer concluded that the plaintiffs' tort claims accrued in Ontario where the alleged economic losses were sustained, and thus CPLR 202 required him to apply the shorter Ontario statute of limitations.

Third, Justice Schweitzer dismissed all the claims pursuant to CPLR 327(a) under the forum non conveniens doctrine after finding that most of the traditional factors he was required to apply under that doctrine favored the dismissal of the case in favor of an Ontario forum (plaintiffs were Canadian residents, nominal defendant was a Canadian corporation, the fraudulent transactions took place in Canada, most of the witnesses are in Canada and their court attendance on New York cannot be compelled, Canadian law applied, and Canada's courts provided an available alternative forum, especially since plaintiffs had sued defendants in a prior pending action there for the same alleged misconduct).

In sum, before shareholders of foreign corporations decide to litigate their corporate governance disputes in New York, even where the relevant defendants reside in New York, they need to overcome the hurdles of the internal affairs doctrine, the potentially shorter statute of limitations that the CPLR often requires be applied, and the forum non conveniens doctrine.

For an illuminating discussion of three recent First Department cases dealing with demand futility in derivative lawsuits, see Peter Mahler’s New York Business Divorce Law blog post here