Takeaway
In short, this case distinguishes a shareholder's direct, representative challenge to the loss of voting rights from a derivative suit, so New York's security-for-expenses requirement did not bar the action.
Max Eisenberg, a New York shareholder of Flying Tiger Line, sued on behalf of himself and similarly situated shareholders to stop a 1969 reorganization and merger. Under the plan, Flying Tiger became an operating subsidiary of a newly formed holding company, and former Flying Tiger shareholders received shares in the holding company. Eisenberg alleged that the arrangement diluted minority shareholders' voting rights by depriving them of a vote over the affairs of the operating company.
Flying Tiger, a Delaware corporation with its principal place of business in California, removed the suit from New York state court to federal district court on diversity grounds. It then invoked New York Business Corporation Law § 627, which requires certain plaintiffs bringing derivative actions to post security for the corporation's litigation expenses. The district court ordered Eisenberg to post $35,000 in security. When he did not do so, the court dismissed the action. Eisenberg appealed.
Issue #1
Whether a federal court sitting in diversity must enforce a state statute requiring security for expenses in a qualifying shareholder action.
Holding
Yes. Under Cohen v. Beneficial Industrial Loan Corp., a federal diversity court must apply a state security-for-expenses statute when the state court would apply it in like circumstances.
Reasoning
The court rejected any simple characterization of the security requirement as either substantive or procedural. Cohen held that Erie requires a federal diversity court to give effect to a state statute conditioning the maintenance of certain shareholder suits on the posting of security for expenses, provided the statute would govern in the state forum.
Issue #2
Whether New York's security-for-expenses statute or Delaware law governed the availability of security in this removed diversity action.
Holding
New York's statute governed because New York courts would apply it to this suit, even though Flying Tiger was incorporated in Delaware.
Reasoning
New York Business Corporation Law § 1319(a)(3) expressly permits a foreign corporation doing business in New York to invoke § 627 against a New York resident plaintiff. New York therefore treats its security requirement as applicable independently of which state's substantive corporate law governs the merits.
reasoning omitted
Issue #3
Whether Eisenberg's challenge to the reorganization was a derivative action subject to New York Business Corporation Law § 627.
Holding
No. Eisenberg asserted a representative shareholder claim for injury to shareholders' voting rights, not a derivative claim brought in the corporation's right for a judgment in its favor.
Reasoning
Section 627 applies only to actions described in § 626: suits brought in the corporation's right to obtain a judgment for the corporation's benefit. The central asserted injury here was the loss of shareholders' own right to participate in the affairs of the operating company. That voting right belonged to shareholders individually, not to Flying Tiger itself.
reasoning omitted
reasoning omitted