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ROYSTON v. EASTERN EMPIRE CORP.

UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA


April 17, 1975

LOUIS G. ROYSTON , et al.
v.
EASTERN EMPIRE CORPORATION , ET AL.

The opinion of the court was delivered by: HANNUM

MEMORANDUM

 HANNUM, J.

 This is a derivative action brought by four shareholders of Eastern Empire Corporation ("Eastern Empire") against 32 individuals and corporate defendants. *fn1" In a 37 page complaint devoid of clarity and precision the plaintiffs charge the defendants with various violations of the federal securities laws, *fn2" as well as numerous state law claims *fn3" which they seek to have considered pendent *fn4" to the federal violations. The Complaint alleges that Eastern Empire sustained serious losses *fn5" as a result of the alleged illegal activity of the defendants, and seeks monetary and injunctive relief.

 Presently before the Court are the motions of the defendants to dismiss the Complaint either in its entirety, or with specific regard to claims made against them individually. At least two such motions *fn6" raise a serious challenge to the standing of these plaintiffs to bring this derivative action.

 Rule 23.1 *fn7" of the Federal Rules of Civil Procedure mandates the requirements of standing in shareholder derivative actions. The essential elements of a derivative action sourced from Rule 23.1 are:

 

(1) The plaintiff must have been a shareholder at the time of the disputed transaction.

 

(2) The suit must not be collusive to confer jurisdiction on the federal court.

 

(3) The complaint must allege with particularity the efforts of the plaintiffs to seek redress of their grievance from the directors or shareholders.

 

(4) The reasons for the plaintiff's : (a) failure to obtain the redress sought, or (b) failure to make the effort.

 

(5) Fair and adequate representation of shareholder interests.

 The Court recognizes the importance of derivative actions as a safeguard against the abuses of corporate responsibility. However, the Court is equally mindful of the responsibility of the corporation, absent fraud or bad faith, to run its own affairs through its duly elected board of directors, and not to have that job done by the federal courts.

 The rationale for the subsequent development of Rule 23.1 was clearly articulated by the Supreme Court in Hawes v. City of Oakland, *fn8" 104 U.S. 450, 26 L. Ed. 827 (1881): ". . . before the shareholder is permitted in his own name to institute 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." at 460-461.

 With the purpose of Rule 23.1 clearly established, the Court now proceeds to an examination of the plaintiffs' efforts to comply with its requirements. The Complaint *fn9" states the plaintiffs were shareholders at all times pertinent to this action, and the affidavit of Clarence C. McGee attached to the Complaint further attests to his stock ownership throughout the time in question.

 However, the Court finds nowhere in the Complaint any allegation that the "action is not a collusive one to confer jurisdiction on a Court of the United States which it would not otherwise have." *fn10" In and of itself, the absence of such allegation is not fatal to plaintiffs' action, but it is indicative of a failure to be precise and specific.

  The next element of a properly filed derivative action is the allegation with particularity of plaintiffs' efforts to remedy the problem of which they complain. The words "allege with particularity" are not those of the Court, but are directly stated in Rule 23.1. Plaintiffs' purported compliance with this requirement is stated as follows: *fn11"

 

Plaintiffs have requested that Eastern Empire's management bring an action to remedy the wrongs done to Eastern Empire but defendants have refused and failed to do so and, since Eastern Empire's Board of Directors and management are dominated by some of the named defendants, further requests for such action would be useless.

 No reasonable construction of the words "allege with particularity" could be satisfied by the above quoted language from the Complaint.

 The vague and conclusory statements of the Complaint concerning a demand on the board of directors of Eastern Empire and their subsequent refusal to bring suit are wholly inadequate, and inconsistent with the interpretation of the requirements of Rule 23.1 in this Circuit. Landy v. Federal Deposit Insurance Corporation, 486 F.2d 139 (3rd Cir. 1973). In a well reasoned Opinion by Judge Rosenn the Court in Landy v. Federal Deposit Insurance Corporation, supra, affirmed the district court's dismissal of the complaint for failure to comply with the requirements of Rule 23.1.

 The plaintiffs have failed further to plead with particularity any facts which would otherwise excuse non-compliance with Rule 23.1.

 The requirements of Rule 23.1 are more than antiquated remnants of notice pleading. The continued vitality of this rule is evidenced in the words of Judge Hastie:

 

The Supreme Court and, following it, the Courts of Appeals have repeatedly stated and applied the doctrine that a stockholder's derivative action, whether involving corporate refusal to bring antitrust suits or some other controversial decision concerning the conduct of corporate affairs, can be maintained only if the stockholder shall allege and prove that the directors of the corporation are personally involved or interested in the alleged wrongdoing in a way calculated to impair their exercise of business judgment on behalf of the corporation, or that their refusal to sue reflects bad faith or breach of trust in some other way. (citations omitted)

 

Ash v. International Business Machines, *fn12" 353 F.2d 491 (3rd Cir. 1965).

 The Court has discovered some indication in the brief of one of the defendants that after subsequent investigation suits were filed by Eastern Empire against certain defendants named in this action. *fn13" This not only undercuts plaintiffs' standing to sue derivatively, but also indicates that plaintiffs' failure to comply with the requirements of Rule 23.1 has resulted in duplicative litigation with the consequent added strain on the federal judiciary.

 Most recently in this district, Judge Higginbotham followed the long tradition of enforcing the requirements of Rule 23.1, and dismissed a derivative action because the plaintiff failed to plead with sufficient particularity the elements of Rule 23.1. David Kusner v. First Pennsylvania Corporation, et al, 395 F. Supp. 276 (E.D.Pa. 1975).

 The First Circuit has also upheld the requirements of Rule 23.1. In Re Kauffman Mutual Fund Actions, 479 F.2d 257 (1st Cir. 1973) affirmed a dismissal of a derivative suit where plaintiff failed to allege sufficient reasons to excuse a prior demand on the directors. *fn14" Judge Aldrich's Opinion in the Kauffman case aptly states: "Rule 23.1 is not an ordinary, but an exceptional rule of pleading, serving a special purpose, and requiring a different judicial approach . . . it is clear that ' particularity ' must appear in the pleading itself ; the stockholder may not plead in general terms, hoping that, by discovery or otherwise, he can later establish a case. Indeed if the requirement could be met otherwise, it would be meaningless." at 263. *fn15" [emphasis supplied]. See also, Jones v. Equitable Life Assurance Society of the United States, CCH Fed. Sec. L. Rep. para. 94, 986 (S.D.N.Y. February 14, 1975). *fn16"

 The failure of plaintiffs in this derivative action to comply with the standards of Rule 23.1 leaves the Court no alternative but to dismiss the action. The well reasoned decisions of the Supreme Court as applied in this Circuit hold this to be a proper exercise of the Court's discretion.

 The issue of standing *fn17" is the most basic threshold consideration in every case, and the Court finds on the basis of this Complaint, the plaintiffs have no standing to bring this derivative action.

 The above shall constitute the Court's findings of fact and conclusions of law pursuant to Rule 52 of the Federal Rules of Civil Procedure, 28 U.S.C.

 ORDER

 AND NOW, this 10th day of APRIL, 1975, it is ORDERED that Motions of Defendants Diversified Growth Corporation, and Eastern Empire Corporation to dismiss the complaint are GRANTED.

 John B. Hannum / J.


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