Clear Rules Matter: New York’s Internal Affairs Doctrine Governs Whether a Shareholder Has the Right to File Derivative Claims on Behalf of a Foreign Corporation in New York Court
In an important ruling for shareholders, directors, and officers of foreign corporations, the New York Court of Appeals in Ezrasons, Inc. v. Rudd recently held that the beneficial owner of shares of Barclays PLC (Barclays)—a bank holding company incorporated under the laws of England and Wales—lacked standing to file derivative claims against Barclays directors and officers in New York court. In reaching that conclusion, the Court—in a 6-1 decision—applied New York’s “firmly entrenched” internal affairs doctrine and rejected the plaintiff’s argument that, even though it had no standing to sue derivatively under English law, New York’s Business Corporation Law (BCL) granted it the right to file derivative claims in New York court against Barclays directors and officers.[1] The internal affairs doctrine is a “choice-of-law rule providing that, with rare exception, the substantive law of the place of incorporation governs disputes relating to the rights and relationships of corporate shareholders and managers.”[2] The Court’s decision is a win for all corporate stakeholders seeking stability and predictability in resolving disputes between a corporation’s shareholders and its directors and officers.
Plaintiff Argues that New York’s BCL Granted It Derivative Standing to Sue the Barclays Directors and Officers in New York Court
The lawsuit was filed in the Commercial Division of the New York State Supreme Court by Ezrasons, Inc. The complaint asserted derivative claims against current and former Barclays directors and officers, alleging that they breached fiduciary duties owed to Barclays under English law and that those breaches damaged the company.
Significantly, the plaintiff admitted that it was a beneficial owner—not a registered owner—of Barclays shares. Based on this, the defendants moved to dismiss the complaint for lack of standing, arguing that under English law the right to maintain a derivative claim on behalf of an English corporation is limited to registered members of the corporation whose names are recorded on the company’s official register of members. The defendants argued that the trial court had to apply the internal affairs doctrine to determine which law governed whether plaintiff had derivative standing to sue the Barclays directors and officers. According to the defendants, under the internal affairs doctrine, English law governed that issue and, under English law, the plaintiff lacked derivative standing to sue these corporate managers.
The plaintiff countered that the internal affairs doctrine did not apply. Its principal argument was that section 626(a) of New York’s BCL displaced the internal affairs doctrine and granted certain classes of persons and entities standing to sue derivatively on behalf of a foreign corporation in New York court despite conflicting foreign substantive law. Section 626(a) of the BCL provides, in relevant part, that “[a]n action may be brought in the right of a … foreign corporation to procure a judgment in its favor, by a holder of shares or of voting trust certificates of the corporation or of a beneficial interest in such shares or certificates.”[3] According to the plaintiff, it had standing to sue derivatively on behalf of Barclays in New York because it held a “beneficial interest in [Barclays] shares,” despite the fact that it had no right to sue derivatively on Barclays’ behalf under English law.
The Court Rejects Plaintiff’s Standing Argument and Holds That the Legislature Did Not Override the Internal Affairs Doctrine
The Court recognized that, as a judicially-created rule, New York’s internal affairs doctrine may be overridden by statute. But the Court concluded that section 626(a) of the BCL did not unambiguously override the well-established internal affairs doctrine as it applies to shareholder derivative standing.
The Court adopted the defendants’ view that section 626 of the BCL establishes a baseline for a New York court to entertain an action brought derivatively on behalf of foreign corporation, without precluding a New York court’s application of substantive foreign law that would limit or preclude a plaintiff’s derivative standing. Importantly, the Court emphasized that “[u]nder the internal affairs doctrine, … foreign substantive law controls in the event of any conflict between New York law and the law of a company’s place of incorporation on matters relating to its internal affairs.”[4] And, “[w]hether a particular stakeholder is authorized to represent the company, much less in litigation against its managers, is a question that plainly implicates corporate rights and internal relationships.”[5]
Key Takeaways
The Court’s decision promotes the primary rationales for New York’s internal affairs doctrine: predictability and ensuring that a corporation is not “faced with conflicting demands.”[6]
As for shareholders in foreign corporations, the decision is a strong reminder that New York courts will, with rare exception, apply the substantive law where the corporation was organized to determine whether the shareholder has the right to file derivative claims against directors and officers in New York court. If applicable foreign law is not identified and complied with, an otherwise valuable derivative claim could be dismissed at the beginning of the case for lack of standing. On the opposite side of that coin, if a shareholder files derivative claims against a foreign corporation’s directors and officers in New York, those directors and officers can avail themselves of defenses provided by substantive foreign law—including a defense of lack of shareholder standing—and be reasonably certain that the New York court will apply that applicable foreign law.
