Eisenberg v. The Flying Tiger Line, Inc.

United States Court of Appeals for the Second Circuit · 1971 · Corporations

Corporationsderivative actionrepresentative actionsecurity for costsNew York Business Corporation Law § 627New York Business Corporation Law § 626shareholder voting rightsmerger

Facts

Eisenberg, a New York resident and shareholder of Flying Tiger, sued on behalf of himself and similarly situated shareholders to enjoin a 1969 reorganization and merger. Under the plan, Flying Tiger created subsidiaries, merged into one of them, ceased as the operating company, and its shareholders received shares in a holding company while operations continued in a wholly owned subsidiary. Eisenberg alleged that these maneuvers were intended to dilute or deprive minority shareholders' voting rights in the operating company. Flying Tiger sought to require Eisenberg to post security for costs under New York's statute applicable to derivative suits.

Issue

Was Eisenberg's action a derivative suit within the meaning of New York Business Corporation Law §§ 626 and 627, so that he could be required to post security for costs? More specifically, was a shareholder challenge to a merger allegedly depriving shareholders of voting rights a corporate claim or a personal shareholder claim?

Rule

In a diversity case, a federal court must apply the forum state's security-for-costs statute if the state court would do so. Under New York law, however, § 627 applies only to derivative actions under § 626, and a suit is not derivative when the injury asserted is to shareholders personally, such as deprivation of their voting rights, rather than to the corporation, and when the action is not brought in the right of the corporation to procure a judgment in its favor.

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Nora Patel, a minority shareholder of Lakefront Freight Systems, a Delaware corporation doing business in New York, sues in federal court in Brooklyn to block a restructuring. Under the plan, the operating business will be placed in a wholly owned subsidiary while existing shareholders will hold stock only in a new parent, and Nora alleges the change will eliminate shareholders' ability to vote on the operating company's affairs.

If the corporation moves to require Nora to post security for costs under New York Business Corporation Law § 627, how should the court rule?

Explanation. Section 627 applies only to derivative actions covered by § 626. Under the majority's reasoning, a suit is not derivative when the right asserted belongs to shareholders personally and the corporation could not procure a judgment in its own favor on that claim. A claim that shareholders were deprived of voting power over operating-company affairs asserts a personal shareholder right, so security cannot be required. (Derived from Eisenberg v. The Flying Tiger Line, Inc. (1971).)