The following e-filed documents, listed by NYSCEF document number (Motion 005) 70, 71, 72, 73, 74, 75, 76, 77, 86, 100, 101, 102, 112, 118 were read on this motion to/for DISMISS. DECISION + ORDER ON MOTION This action is one of four interrelated cases in which former friends and business associates, Johnathan Davis and Dev Pragad, seek to gain the upper hand against one another over who controls Newsweek, a media brand. In this particular action, Pragad, as president of plaintiff NW Media Holdings Corp. (“NW Media”), which owns Newsweek LLC and related entities, has caused NW Media to sue IBT Media, an entity that Davis controls. NW Media seeks indemnification for alleged losses under the Membership Interest Purchase Agreement dated December 13, 2018 (“Purchase Agreement”). According to defendant IBT, “[t]his retaliatory lawsuit was orchestrated by Dev Pragad as a means to use NW Media’s corporate assets to fund his personal vendetta against his former friend, Johnathan Davis, NW Media’s co-owner, without corporate authority” (NYSCEF Doc. No. 71, p. 1). Defendant IBT argues Pragad should have brought this action derivatively. This motion to dismiss centers around whether or not Pragad had authority to commence this direct action in the name of the corporation against IBT, as opposed to a derivative action. This motion is legally fascinating because there appear to be two distinct lines of cases that lead to opposite results. Under the first line, heralded by Sterling Industries Inc v. Ball Bearing Pen Corp, 298 NY 483 (1949), the president would not have authority to initiate litigation. In Sterling, two groups controlled the plaintiff corporation on a 50/50 basis. A pen company, whose representatives comprised one of the groups, had agreed to make the plaintiff corporation the exclusive sales agent for the pen company’s fountain pens for one year. The president of the plaintiff company called a special meeting of the board of directors to consider whether or not to sue the pen company for breach of contract. Two of the directors said yes. Naturally, the other two directors from the pen company said no. Thus, the board was deadlocked. The Court of Appeals held that, where the by-laws of the corporation did not refer to the right of the president to commence litigation, but instead provided that the act of a majority of the board should constitute the act of the board, the authority of the president to commence litigation terminated “when a majority of the board of directors at the special meeting refused to sanction it.” (Id. at 490) In so holding, the court reasoned that absent legislative action, the intention of the parties controls: “The circumstances of the organization of plaintiff corporation indicate that the parties intended that the corporation should be managed by its board of directors and that the board should take no affirmative action if not sanctioned by a majority. That is the arrangement the parties intended and there is no basis on which to hold such an arrangement illegal. Had the Legislature intended to eliminate the problem of a deadlock it could have done so by the simple expedient of requiring an odd number of directors. Instead, apparently realizing the desire for equal control in some closely held corporations, it has continued to permit the election of a board of directors with an even number of directors. The fact that a deadlock may result does not necessarily mean that the present law is inadequate and that it should be remedied by the approval of presidential power where none in fact exists thus disregarding fundamental rules of agency law.” (Sterling at 491–92; see also COR Mktg. & Sales, Inc. v. Greyhawk Corp., 994 F. Supp. 437, 441 [W.D.N.Y. 1998]).1 Nevertheless, the Court of Appeals did not leave the Sterling plaintiff without a remedy. It noted the availability of a derivative action (Id. at 493). Cases following Sterling cement the concept that, where the by-laws do not overtly give the president the right to commence litigation, and there is board or shareholder deadlock about the propriety of doing so, the president then lacks the authority to bring an action directly in the name of the corporation. For example, Crane, A.G., v. 206 West 41st Street Hotel Assoc LP, 87 AD3d 174 [1st Dep't 2011] involved a fight among shareholders about whether or not to defend a foreclosure action. The stockholder’s agreement specified that any action of the board required unanimous approval of the directors and that any action of the stockholders themselves required unanimous approval (id. at 176). The defendant company was owned 50/50 between two additional LLCs. Separate individuals owned these additional LLCs. The individual who owned one of the 50/50 owners of the defendant also owned the plaintiff/lender. When the lender sought to foreclose on property, the 50/50 board of course deadlocked on whether or not to defend the action. Relying on Sterling, the Appellate Division, First Department held that the general partner of the other LLC/president, who had wanted to defend against the foreclosure, had no authority to do so. In reaching this conclusion, the court noted that the president could not act against the wishes of his co-owner when the agreement between the two required unanimous approval (id. at 178) and that the president’s “actual authority to defend the foreclosure action was terminated when the stockholders refused unanimously to sanction it” (id.) As in Sterling, the Appellate Division majority in Crane noted the availability of a derivative suit for breach of fiduciary duty should the failure to defend the foreclosure have been improper (id. at 179). Other cases have similarly applied Sterling. In particular, in Stone v. Frederick, 245 AD2d 742 (3d Dep’t 1997), Stone, a 50 percent owner sued Frederick, the other 50 percent owner, in an attempt to take over the company. In dismissing the case, the court held “where there are only two stockholders each with a 50 percent share, an action cannot be maintained in the name of the corporation by one stockholder against the other with an equal interest and degree of control over corporate affairs; the proper remedy is a stockholder’s derivative action” (id. at 745; see also, Giaimo v. EGA Associates, 68 AD3d 523, 524 [1st Dep't 2009] ["[a]s the president of a closely held corporation, Edward lacked the authority to act unilaterally against Robert’s interest”]). By contrast, nearly a decade after Sterling, in Paloma Frocks, Inc. v. Shamokin Sportswear Corp., 3 NY2d 572 [1958], the Court of Appeals seemingly cut back on Sterling’s holding. In Paloma, the motion on appeal was for a stay of arbitration. The Court held that, because the corporate president of defendant Shamokin had authority to execute the underlying contract containing an arbitration clause, the president also could initiate arbitration under that contract (Id. At 575). Years earlier, Paloma had entered a contract with defendant Shamokin whereby Shamokin was to help Paloma manufacture dresses. Shamokin contended that Paloma owed it for services under the contract containing the arbitration clause. Paloma’s president, Harry Toffel, also owned ½ of Shamokin. Paloma, through Toffel, countered with a proceeding to stay arbitration. Bernstein, Shamokin’s president, admitted that the Shamokin directors had not acted in the matter and that a meeting of Shamokin’s board would have been an ‘idle gesture’ because the Toffel side, which controlled 50 percent of Shamokin, as well as owning Paloma, would never have voted in favor of Shamokin suing Paloma. The Court of Appeals held that Bernstein, as president of Shamokin, had the presumptive authority to commence arbitration. The Court of Appeals reasoned first that there had been no direct prohibition from the board of directors. More importantly, the Court reasoned that, because all the directors had previously agreed to the contract containing the arbitration clause, they had already agreed in advance that “Paloma-Shamokin controversies would go to arbitrators.” (Id. At 575). All Bernstein was doing was carrying out a previously agreed arrangement (Id. ["[a]uthorization of a corporation president to agree to a general arbitration clause amounts to an authorization to the president to carry on an arbitration of such disputes as may arise”]). The Court specifically noted that “We do not suggest that the board of directors could not forbid a particular arbitration, but there was no prohibition here” (id.). The decision did not address whether the arbitration should have been brought as a derivative action or whether the arbitrators could have dealt with the derivative/direct issue. The Paloma court mentioned another case from the year prior, Rothman & Schneider v. Beckerman, 2 NY2d 493 (1957). In that case, Rothman was the nominal president of the plaintiff corporation, who also held half the stock and half the board seats. Schneider was the secretary-treasurer, who effectively held the other half of the stock and the other half of the board seats. By agreement when Rothman retired, Schneider assumed the responsibilities of president. Later, Schneider sued Beckerman, Rothman’s son-in-law, for unfair competition. After the lawsuit was commenced, Rothman, whom the record demonstrated was largely retired, interposed an affidavit objecting to the suit. In allowing the suit to proceed, the Court of Appeals considered the parties’ course of conduct over many years whereby Schneider “and Rothman had acted ‘as equals and partners’, neither questioning the authority of the other, and both signing papers and verifying pleadings in litigation ‘indiscriminately’” (id. at 498). The Court also considered that Rothman had given up active participation in the business prior to the suit (id.). The Court distinguished Sterling on the grounds that the Sterling board had actually refused to condone litigation when requested to act and that Sterling’s suit was essentially against corporate “‘insiders’ which was another corporation consisting of two individuals who owned half of plaintiff’s corporation’s stock” (Id. at 497). Finally, it would be remiss not to consider a case the Court of Appeals decided the year after Paloma, that of West View Hills Inc. v. Lizau Realty Corp, 6 NY2d 344 (1959). In West View Hills, plaintiff corporation sued the defendant corporation, along with its officers and stockholders, for sticking it with certain construction costs. The officers of the plaintiff corporation were identical to the officers of the defendant corporation. The president, who held a minority interest, had caused the plaintiff corporation to bring the suit. In allowing the suit, the Court of Appeals distinguished West View Hills from “the classic case requiring resort to a stockholder’s derivative action to protect minority interests” (id. at 347). The Court distinguished Sterling by the fact that the West Hill board had taken no action, while the Sterling board refused to sanction the president’s authority to bring the suit (id. at 348). Some later cases have balanced the two lines of authority by drawing a distinction between the presumptive authority of the president and a negative board vote (see 328 56th Rest., Inc v. Polldon Rest. Inc., 39 AD2d 689, 690 [1st Dep't 1972] ["'[w]hile the president of a corporation has presumptive authority to prosecute suits in the name of a Corporation (cf. Rothman v. Schneider & Beckerman, 2 NY2d 493), such presumption would not obtain where the Board of Directors has resolved to the contrary or failed to authorize the President to institute such action [in the by laws e.g.]“; see also Fernandez v. Hencke, 93 A.D.3d 440, 441 [1st Dep't 2012] ["[w]here there is no direct prohibition by the board, the president of a corporation has presumptive authority, in the discharge of his duties, to defend and prosecute suits in the name of the corporation”]; Family M Foundation v. Manus, 71 AD3d 598, 599 [1st Dep't 2010] ["This is not a case where one 50 percent shareholder seeks to assert a claim on behalf of the corporation against another 50 percent shareholder who possesses an equal degree of control." [emphasis supplied]). Turning to the facts, on September 13, 2018, defendant IBT, which Davis owns, sold Newsweek, a media brand, to NW Media, a company that Davis and Pragad own 50/50. Pragad is also the president of NW Media. By this action, NW Media seeks indemnification under the Purchase Agreement, claiming it was forced to pay IBT’s taxes, landlord, and certain other creditors. As detailed in the complaint, since the 2018 sale, IBT’s creditors have sought to recover IBT’s debts from plaintiffs directly (Compl. 122 [NYSCEF Doc. No. 2]), which plaintiffs have largely paid. Plaintiffs also contend that IBT is in receipt of misdirected funds after the sale of Newsweek from IBT to NW Media. Specifically, plaintiffs allege that Marion Kim transferred money to IBT without authorization and for no legitimate purpose (Compl. 135), but plaintiffs have not sued her. In addition, plaintiffs allege that certain revenues were misdirected to IBT as a result of its former association with Newsweek. (Compl. 136). Finally, plaintiffs allege that the defendants destroyed Newsweek’s documents and data, but they fail to identify cognizable damages from this destruction. It is undisputed that, prior to bringing this lawsuit, Pragad, as president of NW Media, showed Davis, a 50 percent owner of NW Media, a draft complaint and that Davis strenuously objected in writing to its filing. Although there was no formal vote because Pragad ignored Davis’ request for a board meeting (see letter dated June 30, 2022 from Davis’ counsel to NW Media’s counsel, NYSCEF Doc. No. 34, Index No. 652366/2022), Davis’ objection created deadlock as Davis is a 50 percent owner and Pragad is the other 50 percent owner. To avoid the consequences of the Sterling line of cases discussed above, that would mandate a derivative suit against Davis at the very least, plaintiffs have split their claims. In another action, Pragad v. Davis, 652334/2022, Pragad has sued Davis “derivatively and double derivatively” for breaches of fiduciary duty concerning the same activities involved here. The exact same facts are used in this case to sue everyone else, except Davis. The impetus behind this split emerged at oral argument. Mr. Pragad does not want to have to use his own funds, or obtain litigation financing, which, apparently, he would have to do were this a derivative suit. By this motion, IBT has moved to dismiss this case claiming that, under the Sterling line of cases, Pragad can only sue it derivatively. This case fits squarely into Sterling. The by-laws of NW Media do not confer a right on the president to commence litigation. Instead, the by-laws specifically state “the business of the corporation shall be managed by its board of directors” (see By-Laws of NW Media Holdings Corp Article III §1, NYSCEF Doc. No. 76), and require a vote of the majority of the Board to act (§8[a]). The by-laws contain a tie breaking mechanism for director deadlock in §8(d): “If the Board of Directors is unable to act because they are deadlocked (an equal number of Directors have voted for and against a matter duly presented to the Board for vote), the matter shall be referred to the Shareholders of the Corporation for a vote pursuant to Article II of these By-Laws” Thus, NW Media’s corporate by-laws require a vote of the majority of the board of directors or, in the event of deadlock, the shareholders. However, it is undisputed that, although there was no formal vote, Davis did not consent. To the contrary, he expressed extreme disapprobation to the filing of this lawsuit. Thus, the board was deadlocked, there being only two members. Accordingly, under Sterling and its progeny, as the president of a closely held corporation, Pragad lacked the authority to act unilaterally against Davis’ interest. Plaintiffs claim that because there was no vote, Sterling is inapplicable. However, this ignores section 8(a) which unambiguously requires a vote for the board to act. Without one, no lawsuit could be commenced. In addition, the reality is undisputed that Davis asked for a board vote, but the request was ignored (see NYSEF Doc. No. 34, Index No. 652366/2022). To try to fit this case into the Paloma line of cases, NW Media argues that the situation here is indistinguishable because Davis and Pragad, incidental to the Purchase Agreement, executed a “Unanimous Written Consent” whereby they both, as directors of NW Media authorized the other to “execute the [Purchase Agreement], and any and all instruments, writings and other documents necessary to carry out the transaction contemplated under the {Purchase} Agreement” (see NYSCEF Doc. No. 44, Index No. 652277/2022). Of course, “the transaction” was the purchase of Newsweek. Cobbling this document with the forum selection clause from the Purchase Agreement (12[b]), plaintiffs make the leap in logic that NW Media, through Pragad, has the authority to bring suit to enforce the indemnification provision in the Purchase Agreement against IBT in New York. However, this argument cannot help NW Media escape the plain text of the corporate bylaws, that require a vote of the majority of the board of directors to act. Nor can NW Media dispute that Davis did not consent, but, to the contrary, strenuously objected to the filing of this lawsuit. Moreover, Pragad ignored Davis’ request for a board vote. Thus, the board was deadlocked, there being only two members. To suggest otherwise elevates form over substance. Because the by-laws in section 8(d) refer a matter to a shareholder vote in the event of deadlock, the by-laws specifically contemplated deadlock. The problem is NW Media has only two shareholders: none other than Pragad and Davis. Thus, there is no way, as a practical matter, to break the tie. What is apparent from the by-laws, though, is that Pragad and Davis bargained for equal control of NW Media and contemplated the possibility of board deadlock if they did not agree. All the “Unanimous Written Consent” entailed was authorization to enter into and carry out the purchase of Newsweek. That “Unanimous Consent” cannot override contemporaneously executed by-laws that require a majority of the board of directors to act and provide for resolution of deadlock, at least in theory. This situation further differs from Paloma because, in Paloma, there was no board objection prior to the president bringing suit. Here, Davis vociferously objected. Nor did Paloma, or West Hills for that matter, involve a dispute between two 50/50 shareholders. To the extent Paloma and Rothman can be read to authorize suit against corporate “outsiders” (see Stone v. Frederick, 245 AD2d 742,745 [3d Dept 1997]), it does not matter that Pragad has split up his claims by suing Davis in a separate lawsuit and IBT in this one. In Sterling, as in most of the other cases following it, the individual director, rather than the defendant corporation, was the shareholder of the plaintiff. Yet still, the court precluded a direct suit. IBT is no different than the pen company in Sterling, or the debtor in Crane.. In any event, it cannot be said that IBT, which is Davis’ company, and a party to the contract to sell Newsweek, is a “total stranger and third party” (cf. ABC Publications Inc v. New York Times Co, 103 NYS2d 693, 694 (Sup. Ct NY Cty. 1951). It is not possible to discount Davis’ ownership of IBT and that Davis did not agree to sue IBT, just like the pen company’s principals would not consent in Sterling (see Sterling, 298 NY at 490 ["we consider here not rights of outsiders or third parties, but only those of organizers of plaintiff corporation and representatives of Pen Co." ]; see also COR Mktg. & Sales, Inc. v. Greyhawk Corp., 994 F. Supp. 437 [W.D.N.Y. 1998] [as suit was essentially between 50 percent shareholders of corporation, it was required to be brought as shareholders' derivative action]). Thus, the situation at hand fits precisely into the Sterling line of cases. Although IBT may have a separate duty to NW Media, the fact remains Davis controls IBT and Davis has objected to the institution of the suit. This leaves plaintiff, who is essentially Dev Pragad, recourse through a derivative suit only. Accordingly, it is ORDERED THAT IBT Media Inc.’s motion to dismiss is granted without prejudice to plaintiff commencing a derivative action. Check One: Case Disposed X Non-Final Disposition Check if Appropriate: Other (Specify Decision and Order on Motion to Dismiss ) Dated: December 28, 2022
