Opinion ID: 2534747
Heading Depth: 1
Heading Rank: 2

Heading: The Internal-Affairs Doctrine

Text: The internal-affairs doctrine is the long-recognized principle that `[t]he courts of one state have no visitorial power over the corporations of another state in matters of vital concern to internal policy and management....' Ellis v. Mutual Life Ins. Co. of New York, 237 Ala. 492, 504, 187 So. 434, 444 (1939)(quoting Hoglan v. Moore, 219 Ala. 497, 501, 122 So. 824, 828 (1929)). Thus, the Court in Ellis held that an action seeking a judgment declaring the manner in which Mutual Life Insurance Company of New York, a New York corporation, was to distribute its dividends was not appropriate for adjudication by an Alabama court. In more recent precedent the internal-affairs doctrine has come to imply that litigation in Alabama concerning some aspect of corporate governance must defer to the law of the state of incorporation. For example, in Massey v. Disc Manufacturing, Inc., 601 So.2d 449 (Ala. 1992), this Court considered claims of the usurpation of corporate opportunity. The Court quoted as a basis for its analysis the established rule of conflicts law that `the internal corporate relationship is governed by the law of the state of incorporation.' 601 So.2d at 454 (quoting P. John Kozyris, Corporate War and Choice of Law, 1985 Duke L.J. 1, 15). The Court implied that it was appropriate for an Alabama court to adjudicate the fiduciary duties of the directors in question so long as the court applied the law of the state of incorporation. However, in Massey, the Court determined that the complainantsthe minority shareholdershad failed to meet the contractual prerequisites for bringing their claim of breach of fiduciary duty and so reversed the judgment of the trial court. Although not a state-law case, the bankruptcy case of In re Chalk Line Manufacturing, Inc., (Bankr.No. 93-42773, Adv. No. 94-40003, July 26, 1994) (Bankr.ND. Ala.1994) (not published in Bankruptcy Reporter), considered an analogous factual context regarding minority-shareholder complaints of oppression and breach of fiduciary duty and provided a scholarly discussion of the state of Alabama law concerning the internal-affairs doctrine in an analogous factual context. Judge James S. Sledge, writing for the United States Bankruptcy Court, stated: In Alabama, the law of the state of incorporation governs the internal corporate relationship. Massey v. Disc Mfg., Inc., 601 So.2d 449 (Ala.1992). The Alabama Code authorizes and regulates foreign corporations doing business within the state. Ala.Code § 10-2A-225, et seq. (Michie 1975). The statute specifically refuses any authority to Alabama `to regulate the organization or the internal affairs of' a foreign corporation. Ala.Code § 10-2A-226 (Michie 1975). The plaintiffs and defendants hold shares in Chalk Line, Inc., a Delaware corporation[;] therefore, Delaware corporate law governs the resolution of their dispute. Alabama courts have long adhered to the internal affairs doctrine in choosing the appropriate state's law. In Boyette v. Preston Motors Corporation, 206 Ala. 240, 89 So. 746 (1921), the court held that the laws of Delaware regulated the relationship among stockholders in a corporation formed under the laws of that state. The court concluded that a stockholder subjects himself to the laws of the state of incorporation upon assuming the relations of a stockholder. Boyette, 206 Ala. at 244. The Alabama court defined `internal affairs' in Ellis v. Mutual Life Ins. Co., 237 Ala. 492, 187 So. 434 (1939), as follows: `where the act complained of affects the complainant solely in his capacity as a member of the corporation, whether it be as stockholder, director, president, or other officer, and is the act of the corporation, whether acting in stockholders meeting, or through its agent, the board of directors, that then such action is the management of the internal affairs of the corporation.'  Ellis, 237 Ala. at 502. The Alabama court has applied the internal affairs doctrine on numerous occasional since it decided Ellis, but has not undertaken further definition of the rule. Other courts, however, have elaborated on the scope of `internal affairs.' For example, in McDermott Incorporated v. Lewis a Delaware court stated that `this doctrine 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.' 531 A.2d 206, 214 (Del.1987). Although Alabama precedent establishes that the internal affairs doctrine is the rule on choice-of-law in Alabama, the Alabama courts have never specifically addressed whether the doctrine applies to a majority shareholder's breach of duty to the minority. Two case[s] in which the Alabama court might have decided the issue fail to provide a clear answer, and in fact, suggest contradictory results: Stroud v. John M. Cockerham & Assoc., 620 So.2d 643 (Ala.1993), and Galbreath v. Scott, 433 So.2d 454 (1983). Arguably, the Alabama courts have indicated an intent to apply the internal affairs doctrine in determining the liability of majority shareholders. In Stroud v. John M. Cockerham & Assoc., 620 So.2d 643 (Ala.1993), the plaintiffs, minority shareholders in a Virginia corporation with its principal place of business in Huntsville, Alabama, sued the majority shareholders. The plaintiffs alleged, among other things, that the majority shareholders breached their fiduciary duty in conspiring to `squeeze out' the minority shareholders. Id. at 646. The alleged `squeeze out' involved a transfer of shares from one group of shareholders to another. Id. The plaintiffs claimed that the transaction involved a wrongful issue of treasury shares. Id. The court concluded, however, that the undisputed evidence showed that the purchase of shares did not involve corporate funds and that the corporation merely served as a conduit. Id. at 648 The Stroud court cited only Virginia law in its opinion after determining that Ala.Code § 10-2A-226 required that Virginia law govern the corporation's internal affairs. Id. at 647 (citing Ala. Code § 10-2A-226 (Michie 1975)). The court did not, however, specifically address the issue of whether the internal affairs doctrine applied to claims for breach of fiduciary duty. The court applied a Virginia statute defining the authority of a corporation to purchase its shares, but concluded that the corporation did not purchase any shares Id. at 648. The Stroud court's application of Virginia law in this case suggests that the court would have resolved the issue of fiduciary breach with reference to Virginia law if the plaintiff had established evidence to support its allegations. As the court did not reach the issue of breach, however, the case provides only suggestive authority.  Galbreath v. Scott, 433 So.2d 454 (1983), suggests, but again does not authoritatively prescribe, an opposite result. In Galbreath, the minority shareholder in a Florida corporation sued the majority shareholder. Although the Galbreath court denied the minority shareholder individual recovery on grounds that the complaint stated claims which could only be asserted derivatively, the court discussed the trend in Alabama toward drawing distinctions between closely and widely-held corporations in the treatment of minority shareholder's claims of fiduciary breach by the majority. Id. at 457 (citing Burt v. Burt Boiler Works, Inc., 360 So.2d 327 (Ala.1978)[)]. The court did not discuss choice-of-law. The Galbreath decision suggests that the Alabama court might apply Alabama law in determining the liability of a majority shareholder to the minority. But again, the court has not definitively answered the question. Although the Alabama courts have not yet analyzed whether the law of the state of incorporation applies to the determination of the duty majority shareholder's [sic] owed the minority, this Court believes that the Alabama court would follow the Restatement (Second) of Conflict of Laws as that court has applied the Restatement's choice-of-law rules in similar situations involving corporations. See International Insurance Co. v. Johns, 874 F.2d 1447, 1458, n. 19 (11th Cir.1989) (holding that where Florida state court had not addressed choice-of-law issues with regard to director's liability, federal court could presume that Florida court would follow the Restatement (Second) of Conflict of Laws based on the Florida court's past reliance on the treatise). In Massey v. Disc Mfg., Inc., 601 So.2d 449 (Ala.1992), the court cited Restatement (Second) of Conflict of Laws § 309 (1971), in concluding that Delaware law should determine the extent of a director's liability to a Delaware corporation. The Restatement likewise provides the rule for determining choice-of-law issues involving the liability of majority shareholders to minority shareholders and the corporation. Restatement (Second) of Conflict of Laws § 306 (1971) provides: `Tee obligations owed by a majority shareholder to the corporation and to the minority shareholders will be determined by the local law of the state of incorporation, except in the unusual case where, with respect to the particular issue, some other state has a more significant relationship under the principles stated in § 6 to the parties and the corporation, in which event the local law of the other state will be applied.' The court in Massey cited to comment (c) to § 309 which states: `Issues relating to the validity of such acts, and to any resulting liability on the part of the directors and officers, cannot practicably be determined differently in different states. It would be impracticable, for example, for a share issue or declaration of dividends to be valid in one state and invalid in another. In the absence of a statute to the contrary, the local law of the state of incorporation will be applied in the great majority of instances to determine issues of this sort. The local law of some state other than that of incorporation should not be applied to determine such issues unless this other state has an interest that is superior to that of all other states in the issue to be decided or unless, for reasons explained in Comment g of § 302, its local law rule is the same as that prevailing in many of the other states in which the corporation does business or has shareholders. The local law of some state other than the state of incorporation is most likely to be applied to determine issues of this sort in a situation where the corporation does all, or nearly all, of its business and has most of its shareholders in this other state and has little contact, apart from the fact of its incorporation, with the state of incorporation.' Within the second category fall acts, such as seizing a corporate opportunity or causing the making of a contract or the commission of a tort. Issues relating to the liability of the directors and officers for acts such as these can practicably be decided differently in different states. It would be practicable, for example, for a director to be held liable for a given act in one state and to be held not liable for an identical act in another state. Nevertheless, in the absence of an applicable local statute, the local law of the state of incorporation has usually been applied to determine the liability of the directors or officers for acts such as these to the corporation, its creditors and shareholders. This law has usually been applied even in a situation where it might be thought that some other state had a greater interest than the state of incorporation in the issue to be determined. The local law rule of a state other than the state of incorporation is most likely to be applied in a situation where this rule embodies an important policy of the other state and where the corporation has little contact with the state of its incorporation. 601 So.2d 449, 454-55 (Ala.1992). The court's adoption of the Restatement's rationale that a director should not be held liable for an act in one state that would not create liability in another state, indicates that the court would adopt the similar rationale cited in comment (c) to § 306 applicable to determining the liability of majority shareholders. `In the absence of an applicable local statute, the local law of the state of incorporation will be applied in the great majority of instances to determine issues covered by the present rule. This is partly for the reason that these issues are of the sort which cannot satisfactorily be determined differently in different states. It would seem wrong, for example, to hold that a majority shareholder owes a fiduciary obligation to one shareholder under the local law of state X but does not owe such an obligation to a shareholder of the same class under the local law of state Y. As a result, the local law of some state other than the state of incorporation should not be applied to determine such issues unless this other state has an interest that is clearly superior to that of all other states in the issue to be decided or unless, for reasons explained in Comment g of § 302, its local law rule is the same as that prevailing in many of the other states in which the corporation does business or has shareholders. The local law of some state other than the state of incorporation is most likely to be applied in a situation where the corporation does all, or nearly all, of its business and has most of its shareholders in that other state and has little contact, apart from the fact of its incorporation, with the state of incorporation.' Restatement (Second) of Conflict of Laws § 306 cmt. c (1971). Although the Restatement would under some circumstances allow a court to apply the law of a state other than the state of incorporation, the comments suggest that this exception to the general rule is narrowly drawn and would not apply to a corporation doing business in many states and abroad. Id. The plaintiffs have presented the Court with no persuasive arguments for abandoning a general rule which is consistent with long-standing Alabama case law, the United States Constitution, and public policy. (Footnote omitted.) Although we note with approval the Bankruptcy Court's discussion in Chalk Line, we need not go so far as to adopt its entire rationale. Rather, in the context of this case, we hold that the internal-affairs doctrine as applied in this State does not deprive the trial court of jurisdiction over the claims in the underlying action, nor does it require the trial court to dismiss the instant action in deference to litigating those claims in Delaware. Thus, the internal-affairs doctrine cannot serve as the basis for a clear legal right for the writ of mandamus sought by BSI and the Bentley brothers. Rather, where the underlying claims implicate issues of corporate governance, the trial court will be constrained to apply the corporate law of Delaware. Further, we believe that the discussion from Chalk Line will provide a useful reference for the application of Alabama law to claims that may not implicate corporate governance, such as suppression.