Opinion ID: 355121
Heading Depth: 1
Heading Rank: 2

Heading: dismissal of price waterhouse & company as a party defendant

Text: 32 The plaintiffs' appeal at our No. 77-1156 is from the district court's dismissal of Price Waterhouse as a party defendant for noncompliance with Rule 23.1, F.R.C.P. In taking this action the district court held that the complaint failed to allege efforts by the plaintiffs to obtain action by Gulf's board of directors against Price Waterhouse and the reasons for their failure to obtain the action or for not making the effort as required by Rule 23.1. 33 In Hawes v. Oakland, 104 U.S. 450, 26 L.Ed. 827 (1882) the Supreme Court held (pp. 460-461) 34 that before the shareholder is permitted in his own name, to initiate and conduct a litigation which usually belongs to the corporation, he should show, to the satisfaction of the court, that he has exhausted all the means within his reach to obtain, within the corporation itself, the redress of his grievances, or action in conformity to his wishes. He must make an earnest, not a simulated effort, with the managing body of the corporation, to induce remedial action on their part, and this must be made apparent to the court. If time permits, or has permitted, he must show, if he fails with the directors, that he has made an honest effort to obtain action by the stockholders as a body, in the matter of which he complains. And he must show a case, if this is not done, where it could not be done, or it was not reasonable to require it. 35 In Landy v. Federal Deposit Insurance Company, 486 F.2d 139 (3d Cir. 1973), cert. denied, 416 U.S. 960, 94 S.Ct. 1979, 40 L.Ed.2d 312 (1974), this court said (p. 146): 36 As a general principle, the responsibility for determining whether or not a corporation shall enforce in the courts a cause of action for damages is, like other business questions, ordinarily a matter of internal management left to the discretion of the directors . . . Otherwise a litigious stockholder could easily intrude upon authority of those who are vested with responsibility for the operation of the corporation's business. Whether to forego an action or to bring suit for damages is a matter of business judgment. Such decision may involve not merely a consideration of legal principles but a balancing of business interests and relationships. 37 We pointed out that the rationale of this principle is reflected in Rule 23.1, F.R.C.P. which provides procedural implementation for the rule laid down in Hawes v. Oakland. Rule 23.1 provides, in substance, that a shareholder may not bring a derivative action to enforce a right of the corporation against a third party unless the corporation has failed to assert a right which might properly be asserted by it and the complaint alleges, with particularity, the efforts made by the shareholders to obtain corporate action and the reasons for failure to obtain it. The pertinent provisions of the rule in this regard are: 38 The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort. 39 In attempting to show compliance with these provisions of Rule 23.1, the plaintiffs point to four letters summarized in the amended complaint and appended to it which, they contend, demonstrate a sufficient effort to apprise Gulf's board of directors of their desire to have the corporation institute an action for damages against Price Waterhouse. The four letters were written by an attorney representing two of the plaintiffs, Mr. and Mrs. Fred Horenstein, prior to the filing of their original complaint. The letters were addressed to James E. Lee, president of Gulf. 40 The first letter, dated November 30, 1973, was, substantially, a request for information by the shareholders as to the amounts and circumstances of Gulf's illegal political contributions and the subsequent repayment of them. The second letter, dated December 27, 1973, was an inquiry as to the payment by Gulf of any fines in connection with the illegal contributions and the corporation's intentions regarding reimbursement from the officers and directors responsible for making the contributions. 41 Neither of these letters was addressed to the board of directors of Gulf and neither contained any reference to Price Waterhouse. The two letters called for nothing more than a responsive communication from Lee, to whom they were addressed and, thus, did not constitute a demand by the Horensteins for action by the directors of Gulf against Price Waterhouse. 42 The third letter, dated January 21, 1974, contained what it stated was a formal demand that the board of directors seek reimbursement from the responsible individuals for all damages sustained by the corporation in connection with the payment of fines and injury to the corporation's reputation resulting from the illegal contributions. On its face the letter indicated that a copy of it was sent to the board of directors. However, Price Waterhouse was not mentioned in it and there was nothing in the letter suggesting that Price Waterhouse, Gulf's outside independent auditor, was intended to be included among the individuals referred to in the letter as responsible for damages incurred by the corporation. In fact, the plaintiffs admit that these first three letters were written without awareness of the possible culpability of Price Waterhouse. They argue, however, that the letters informed the directors of the basis of the claim they wished enforced by the corporation and that this was sufficient notice to them for the purposes of Rule 23.1. 43 Since, obviously, there can be no claim for damages against an unknown and unspecified party, the plaintiffs cannot mean that any of the first three letters or combination of them literally communicated to Gulf's directors the existence of a claim against Price Waterhouse which should be enforced by Gulf. Moreover, the request for action against the responsible individuals for all damages to Gulf does not, considered in the context of all three letters, suggest any liability on the part of Price Waterhouse to Gulf. It is completely lacking in the specificity which would give the directors a fair opportunity to initiate the action, which the shareholders subsequently undertook, which it is the purpose of the demand requirement of the rule to provide. See Halprin v. Babbitt, 303 F.2d 138, 141 (1st Cir. 1962); 3B Moore's Federal Practice pp. 23.1-81 to 23.1-82 (2d ed. 1977). The appellants argue that the directors were in a better position than the shareholders to make the investigation necessary to uncover wrongdoers. This argument, however, does not address the requirement of Rule 23.1 in issue or the vital point that subsequently the shareholders named Price Waterhouse as a defendant in their complaint without having first specifically demanded that the directors act against that defendant. 44 The fourth and last Horenstein letter was dated March 13, 1975. It referred to recent newspaper disclosures 8 and suggested that the Directors should seek reimbursement for the contributions, all fines imposed, litigation and counsel expenses, lost interest, taxes and increased public relations costs expended to repair Gulf's damaged reputation and for the damage to Gulf's reputation. 45 This fourth letter, like the earlier ones, was addressed to Lee, Gulf's president. It does not appear that a copy of it was sent to the directors of Gulf. Again, no mention of Price Waterhouse was made in the letter. The opening sentence states that the Horensteins renew and expand their demand of January 21, 1974. The expansion referred, perhaps, to the increased dollar amounts of reimbursement which the corporation should seek in view of the 1975 disclosures and the enlarged scope of related damages to Gulf. The expanded demand, if such it was, referred, however, only to reimbursement from responsible individuals. Under the facts of the case, it was not error for the district court to conclude that this letter, like the others, did not encompass a demand to bring suit against Price Waterhouse and thus did not satisfy Rule 23.1. 46 The plaintiffs contend that if the allegations in the complaint are insufficient in respect to the requirement of Rule 23.1, the district court erred in refusing to grant their request for leave to amend or supplement the complaint to include additional demand letters written by various of the plaintiffs to Gulf's directors or their counsel after the filing of the senders' complaints. The district court did not abuse its discretion in this regard. The contemplated showing of demand made upon the directors after the filing of the shareholders' derivative complaints could not have satisfied the demand requirement of the rule. See McDonough v. First National Boston Corp., 416 F.Supp. 62, 65 (D.Mass.1976). For such a demand would not have afforded the directors the opportunity to make the judgment in the first instance whether and in what manner action should be taken. As the court deciding Lucking v. Delano, 117 F.2d 159, 160 (6th Cir. 1941), stated, Obviously the filing of the complaint cannot be regarded as a demand to sue, for by starting the action appellants have usurped the field. The same vice clearly infects demands made after the filing of the complaint. To hold that demands to satisfy Rule 23.1 may be made on the directors after a derivative suit has been initiated would be to reduce the demand requirement of the rule to a meaningless formality. See In re Kauffman Mutual Fund Actions, 479 F.2d 257, 263 (1st Cir.), cert. denied, 414 U.S. 857, 94 S.Ct. 161, 38 L.Ed.2d 107 (1973). 47 The plaintiffs argue that Rule 23.1 is intended to benefit the corporation and its directors only and that, therefore, Price Waterhouse lacks standing to raise the defense of noncompliance with the Rule, particularly since counsel representing Gulf and several of its directors waived the right of those defendants to assert a defense based upon the rule. Price Waterhouse contests the validity of Gulf's waiver which was, apparently, not the result of official action by the board of directors. This question we need not decide, however, since, assuming the effectiveness of the waivers as to the parties which executed them, we are convinced that they would not affect Price Waterhouse's rights. For it is well settled, contrary to the plaintiffs' contention, that defendants other than the corporation whose rights the shareholder plaintiffs are seeking to vindicate may successfully raise the defense of failure to comply with Rule 23.1. See Brody v. Chemical Bank,517 F.2d 932 (2d Cir. 1975); Landy v. Federal Deposit Insurance Corp., 486 F.2d 139 (3d Cir. 1973), cert. denied, 416 U.S. 960, 94 S.Ct. 1979, 40 L.Ed.2d 312 (1974); In re Kauffman Mutual Fund Actions, 479 F.2d 257 (1st Cir.), cert. denied, 414 U.S. 857, 94 S.Ct. 161, 38 L.Ed.2d 107 (1973); Ash v. International Business Machines, Inc., 353 F.2d 491 (3d Cir. 1965), cert. denied, 384 U.S. 927, 86 S.Ct. 1446, 16 L.Ed.2d 531 (1966); Meyers v. Keeler, 414 F.Supp. 935 (W.D.Okl.). 48 We are in accord with the conclusion of the district court that the amended complaint failed to allege an adequate demand upon the directors of Gulf for action against Price Waterhouse or any sufficient reason for failing to make such demand or the reasons for the plaintiffs' failure to obtain from the directors the action they now say they sought against Price Waterhouse. The amended complaint, therefore, failed to comply with the express requirements of Rule 23.1 which are mandatory and the district court rightly acted for that reason. Its order of dismissal of Price Waterhouse as a party defendant entered November 18, 1976, must accordingly be affirmed.