Opinion ID: 187481
Heading Depth: 3
Heading Rank: 2

Heading: Ratification of Illegal Acts

Text: The District Court found that the essence of Plaintiff's Complaint is [f]ailure of supervision and oversight. Harper Woods, 577 F.Supp.2d at 132 n. 11. The District Court explained that the wrongs allegedly done to the company that gave rise to the derivative suit were breaches of fiduciary duty, not breaches of regulatory, civil, or criminal law. Id. at 132. The parties' experts agree that breaches of fiduciary duty for mismanagement and failure of supervision are capable of ratification by shareholders. See Moore Decl. ¶ 39, 3 J.A. 765-66; Girolami Decl. ¶ 6(3), 5 J.A. 1284-85. Ratification would render the wrongful actthe failure of supervision and oversightno longer a breach of duty to the company. Harper Woods, 577 F.Supp.2d at 133 (citing Moore Supp. Decl. ¶ 4, 5 J.A. 1469-70). Harper Woods seemingly disputes this characterization of its complaint, noting that the District Court accepted Mr. Moore's narrow characterization of the complaint instead of accepting as true all material allegations and construing the complaint in the light most favorable to Harper Woods. See Appellant's Br. at 16-17 (citing Warth v. Seldin, 422 U.S. 490, 501, 95 S.Ct. 2197, 45 L.Ed.2d 343 (1975)). It is at best questionable whether the complaint alleges anything more than breaches of fiduciary duty. The complaint asserts, in conclusory terms, that the directors caused BAE to engage in a pattern and practice of making illegal and improper payments and made false and misleading statements to conceal and cover up [the payments]. Complaint ¶ 5, 1 J.A. 29-30; see also id. ¶ 8, 1 J.A. 30-31 (alleging that BAE defendants undertook illegal and improper conduct ... including paying bribes or kickbacks to Prince Bandar); id. ¶ 113, 1 J.A. 97 (same). These unsupported assertions are insufficient to charge the defendant directors with illegal acts. Although we must construe the complaint liberally in Harper Woods' favor, we need not accept legal conclusions cast in the form of factual allegations. See Kowal, 16 F.3d at 1276. Our skepticism regarding the frailties of the complaint was fueled during oral argument when counsel for Harper Woods acknowledged that the complaint focuses on a breach of fiduciary duty, a failure to supervise, and in all likelihood, a deliberate turning of a blind eye. Tr. of Oral Argument at 7. In the end analysis, however, Harper Woods' arguments regarding the breadth of the complaint are much ado about nothing. Even if Harper Woods' complaint can be construed as an action against the directors for committing illegal acts, Harper Woods has not convincingly demonstrated that English law finds illegal acts incapable of ratification by shareholders. At oral argument, Harper Woods relied primarily on a 1915 Irish case, Cockburn v. Newbridge Sanitary Steam Laundry Co. Ltd., [1915] 1 I.R. 237 (C.A.). Although the Cockburn case recognized that [i]llegality and ultra vires are not interchangeable terms, the court in fact conflated the two, noting that it is difficult, if not impossible, to conceive a case in which a company can do an illegal act ... and act within its powers. Id. at 254. The court then discussed a case involving an ultra vires act unaffected by criminality, id., and concluded that the ultra vires argument is stronger when the whole matter is tainted with criminality. Id. at 255. The court held that, because the agreement entered into by the director-defendant in Cockburn was likely to be illegal, [i]t would, accordingly, have been quite beyond the powers of the company to have entered into it. Id. The Cockburn decision is perplexing, to say the least, in part because it can be read as nothing more than an application of the ultra vires exception to the Foss rule. In other words, whether or not illegal, the court found that the alleged wrongdoing in Cockburn undoubtedly involved an ultra vires action. In his second declaration, Mr. Moore dismisses Cockburn as an Irish case that is not binding on the English courts. Moore Second Decl. ¶ 27(c), 5 J.A. 1459. Mr. Moore makes a more compelling argument, however, when he points out that the reasoning underlying the decision [in Cockburn] is fundamentally incompatible with important and binding English authority, in particular Rolled Steel Prods. (Holdings) Ltd. v. British Steel Corp., [1986] Ch. 246[, 297 (C.A.)] and Arab Monetary Fund v. Hashim, [1993] 1 Lloyd's L. Rep. 543[, 569 (Q.B.)]. Id. In Rolled Steel, the court stated that the phrase `ultra vires' in the context of company law should for the future be rigidly confined to describing acts which are beyond the corporate capacity of a company. Rolled Steel, [1986] Ch. at 297 (Slade, L.J.). In other words, the court made it clear that a company has capacity to carry out a transaction which falls within its objects even though carried out by wrongful exercise of its powers. Id. at 303 (Browne-Wilkinson, L.J.). The Law Commission's Consultation Paper on Shareholder Remedies, cited by Mr. Moore, confirms this conclusion, stating that where an act which a company commits is illegal it is not also ultra vires unless it is also beyond the capacity it is given by the Companies Acts. See Moore Second Decl. ¶ 25(c), 5 J.A. 1458; see also THE LAW COMMISSION, SHAREHOLDER REMEDIES: A CONSULTATION PAPER ¶ 4.21 (The Stationery Office 1996) [hereinafter LAW COMMISSION CONSULTATION PAPER]. The Law Commission Consultation Paper continues, The description of the rule in Foss v[.] Harbottle [previously described in the consultation paper] applies to illegal acts which are ultra vires in this sense. Where the company proposes to do some other illegal act, a member may bring proceedings to restrain the company from so acting, but it is doubtful whether he can bring proceedings to recover damages for any loss which the company may suffer as a result without showing a fraud on the minority. LAW COMMISSION CONSULTATION PAPER at ¶ 4.21. Harper Woods' expert, Mr. Girolami, cites this language to show that the point is not free from doubt and that the Law Commission report does not espouse Mr. Moore's apparently doubt-free view that all illegal acts can be ratified by a simple majority. Girolami Second Decl. ¶ 6, 5 J.A. 1476-77. But Plaintiff has the burden of demonstrating standing to bring the derivative suit, see Prudential, [1982] Ch. at 221-22, and Harper Woods has not demonstrated that illegal acts cannot be ratified. Harper Woods also relies on treatises to support its claim that illegal acts cannot be ratified. However, only two treatises cite English cases in support of the proposition that the Foss rule does not apply if the alleged wrong is illegal or criminal. See Girolami Decl. ¶ 23(c), (f), 5 J.A. 1295, 1296-97. Only one of the cases cited Powell v. Kempton Park Racecourse, [1987] 2 Q.B. 242 (C.A.)concerns a criminally illegal action of the type alleged by Harper Woods. The other three cases do not concern criminally illegal conduct. See Drown v. Gaumont-British Picture Corp., Ltd., [1937] Ch. 402, 402 (shareholder sued to restrain company and its directors from paying a dividend out of capital); Baillie v. Oriental Tel. and Elec. Co. Ltd., [1915] 1 Ch. 503, 504, 515 (C.A.) (shareholder brought suit to have declared invalid certain special resolutions that he alleged were not validly enacted and thus not binding on the company); Const v. Harris, (1824) 37 E.R. 1191, 1191, 1196(Ch.) (member of a partnership brought suit to compel other partners to act according to a covenant previously entered into by the partnership). As for Kempton Park, the plaintiffs in that case sought an injunction to restrain the company from knowingly permitting illegal activities in an enclosure at the racetrack in violation of the Betting Act, 1853. See Powell v. Kempton Park Racecourse, [1987] 2 Q.B. 242, 253 (C.A.). The case concerned whether the alleged activity was in fact illegal, and the defendants did not argue that the court lacked jurisdiction to enjoin the defendants from committing a criminal act. Id. at 260 (Lindley, L.J.); id. at 268 (Lopes, L.J.). The Law Commission acknowledges that a shareholder may bring suit to restrain the company from acting in a certain way, LAW COMMISSION CONSULTATION PAPER at ¶¶ 2.29, 4.22, a type of suit that differs from a shareholder derivative suit and does not fall within the rule of Foss v. Harbottle . See Smith v. Croft (No. 2), [1988] Ch. 114, 167, 177; see also LAW COMMISSION CONSULTATION PAPER at ¶ 4.22. The aforecited Drown case is also a suit seeking to restrain a company and its directors from taking a certain action, although it involves the payment of a dividend rather than criminally illegal conduct. See Drown, [1937] Ch. at 402. Harper Woods has cited no case in which an English court has authoritatively held that a criminally illegal, but not ultra vires, act is outside the rule of Foss v. Harbottle and therefore a shareholder derivative suit may proceed. Mr. Girolami cites an Australian case, Australian Agric. Co. v. Oatmont Pty Ltd., (1992) 8 A.C.S.R. 255, in support of his claim that shareholder derivative actions may be permissible in cases involving nothing more than alleged criminal illegalities. But the decision simply cannot carry the weight of authority that Harper Woods would like. In his second declaration, Mr. Moore aptly disposes of the Australian case: Australian Agricultural Co. v. Oatmont Pty [1992] is an Australian case, again not binding on the English courts, and should be treated with caution in the light of the Australian courts' less restrictive approach to the rule in Foss v. Harbottle . Further, it is not clear that the comments quoted by Mr. Girolami at his paragraph 25 refer to an exception to the rule at all. It is clear that the court considers that causing the company to act illegally would be a breach of the directors' duties, but all that is said is that this could well give rise to a derivative action. It is not suggested that such an action could necessarily be pursued in the absence of one or more of the established exceptions to the rule in Foss v. Harbottle (in particular, fraud on the minority). Moore Second Decl. ¶ 27(d), 5 J.A. 1459-60. Because Harper Woods has failed to demonstrate that, under authoritative English law, the alleged activities of the defendantswhether construed as breach of fiduciary duties or illegal actsare incapable of ratification, the complaint falls within the rule of Foss v. Harbottle and the company itself is the proper plaintiff unless an exception to the rule applies.