Plaintiff, Pinnacle Consultants Ltd. ("Pinnacle"), is a Delaware corporation organized to purchase and sell stock for the benefit of its sole shareholder. Pinnacle was a shareholder of Defendant Leucadia National Corporation ("Leucadia"), a publicly owned corporation organized in New York. In 1985, 1991 and 1992, Leucadia's Board of Directors approved the issuance of warrants to two directors, Defendants Cummings and Steinberg. These warrants granted them options to purchase several thousand shares of Leucadia. The terms of the warrants were described in a proxy statement to shareholders, and they voted to approve the three transactions. In 1990, the Leucadia Board of Directors proposed a merger with Marks Investing Corporation ("MIC"), a corporation in which Leucadia held 56% of the stock. MIC also owned a 54% interest in TLC, a partnership which itself held approximately 58% of Leucadia National. In addition to being on the Board of Directors at Leucadia, Cummings and Steinberg were also on the Boards of MIC and TLC. A proxy statement was sent to the Leucadia shareholders, describing the proposed merger. In the proxy statement it was disclosed that TLC would vote its Leucadia shares in favor of the merger and that as a direct effect of the merger, Cummings, Steinberg and another director would own just over 50% of Leucadia stock. The merger was approved, with Pinnacle abstaining from voting.

In 1994, Pinnacle brought a derivative action in the United States District Court for the Southern District of New York against Leucadia and its officers and directors. Pinnacle alleged violations of the Racketeer Influenced and Corrupt Organizations Act (RICO) and other related claims. As prerequisites for the RICO claim, Pinnacle alleged irregularities in the issuance of the 1985, 1991, and 1992 warrants and failure of the proxy statement to state that Business Corporation Law § 612 prohibited TLC from voting its Leucadia shares in favor of the merger. The District Court held that the 1985 warrant claim was time barred and that the proxy statements on the 1991 and 1992 warrants were properly issued. Further, the court held that section 612 did not prohibit TLC from voting its shares because TLC was a partnership and not a corporation as required by section 612. The court also noted that Pinnacle did have viable state claims for breach of fiduciary duty and corporate waste. The United States Court of Appeals for the Second Circuit affirmed, and held that since at least two predicate claims were required by RICO, the alleged violation of section 612 alone was insufficient to support a RICO claim. As such, the court did not reach the question of whether section 612 had been violated.

Pinnacle then brought a derivative action in state court against Leucadia and its officers and Directors, alleging violation of section 612 in permitting TLC to vote in favor of the merger, as well as corporate waste in the issuance of the warrants and a breach of fiduciary duty. On the issue of the validity of the warrants the supreme court held that they were barred by collateral estoppel and dismissed those claims. The court further held that there was no violation of section 612 since the section only applies to corporations not partnerships. The supreme court, however, did find Pinnacle had stated a claim for breach of fiduciary duty and corporate waste. The Appellate Division dismissed the entire complaint, holding that Pinnacle lacked standing and was estopped from challenging any of the transactions, since it had not voted against them. The Appellate Division also held that Defendant's compliance with Business Corporation Law § 505 precluded claims of conversion and corporate waste.

1. Whether Plaintiff stated a claim for breach of fiduciary duty and waste.

2. Whether Business Corporation Law § 612 governs partnerships as well as corporations.

1. No. Plaintiff was collaterally estopped from raising a state claim for breach of fiduciary duty and corporate waste.

2. No. The language of Business Corporation Law § 612, is specifically limited to corporations.

State of the Law Before Pinnacle

The doctrine of collateral estoppel precludes the relitigation of an issue already determined in a prior decision. See Parker v. Blauvelt Volunteer Fire Co., 93 N.Y.2d 343 (N.Y. 1999). To have preclusive effect, the issue must be raised, necessarily decided, and material. The parties must also have had a full and fair opportunity to litigate the issue. Id. When an action is dismissed in federal court and a later state court claim is made, and an issue material to the state law claim is essentially the same as that of the federal claim, that issue is precluded even though the federal court did not have jurisdiction over the state claim. See Browning Ave. Realty Corp. v. Rubin, 207 A.D.2d 263 (N.Y. App. Div.1994).

Business Corporation Law § 612(b) prohibits a subsidiary corporation that is controlled by the parent corporation from voting shares of the parent corporation in the interest of protecting minority shareholders from management perpetuation. Norlin Corp. v. Rooney, Pace, Inc., 744 F.2d 255, 262 (2d Cir. 1984).

Since abstention is considered participation, the general principle for shareholder voting requires an affirmative objection in order to bring a later suit. See Diamond v. Diamond, 307 N.Y. 263, 266 (N.Y. 1954). This rule may not apply in the context of a publicly traded corporation, however, especially when a predetermined number of affirmative votes is required to approve the merger. See Pavlidis v. New England Patriots Football Club, 675 F. Supp. 696, 698-700 (D. Mass 1987).

Effect of Pinnacle on Current Law

First, the Court limited the general principle that a shareholder who participated in an activity may not subsequently challenge the legality of that activity in a derivative suit. The Court explained that this principle does not apply to a shareholder who has abstained from voting, particularly where there was a predetermined number of affirmative votes required, thus making abstention the equivalent of a negative vote.

Second, the Court clarified that Business Corporation Law § 612(b) applies only to corporations and not to partnerships. The Court was clear that although other jurisdictions may have different rules, the New York statute is unambiguous, and must be applied as written.

Unanswered Questions

Would this merger still be held valid if the issuance of the warrants to buy several hundred thousand shares of stock were found to be a breach of a fiduciary duty to the shareholders and a corporate waste? Would the directors in that case have to return their shares that they purchased as warrants?

As a matter of public policy, does it make sense to prohibit only corporations from cross-voting, and not partnerships?

If partnerships were excluded, by law, from cross-voting, would the fact that TLC voted for the merger void the merger completely or would the court only discount TLC's votes and allow the merger if it were approved by the requisite number of votes, outside of TLC's votes?

Survey of the Law in Other Jurisdictions

Regarding the collateral estoppel issue, the Pinnacle court's analysis is in accord with the position of the majority of other jurisdictions. In Murphy v. Duquesne University of the Holy Ghost, 1999 WL 1260481 (Pa. Super. 1999), the Superior Court of Pennsylvania found that, since "[b]oth the federal and state actions necessarily involved an examination of [the same issues]," the action was barred by collateral estoppel. There, the court applied a four-part test, including determinations of whether the "issue decided in prior action is identical to one presented in a later action" and "the prior action resulted in a final judgment on the merits." Id. at *8.

Similarly, the Supreme Court of Colorado, sitting en banc in Bebo Construction Co. v. Matto & O'Brien, 990 P.2d 78 (Colo. 1999), noted that "an issue is necessarily adjudicated when a determination on that issue was necessary to a judgment." Id. at 86. A final determination of such an issue "precludes relitigation of that issue in subsequent actions." Id. at 84.

The Supreme Court of Connecticut refused to apply collateral estoppel in Conn. Nat. Bank v. Rytman, 694 A.2d 1246 (Conn. 1997). There, the court found that dismissal of RICO claims in a prior federal court action did not have preclusive effect. The court reasoned that the plaintiff was not collaterally estopped from raising claims in state court which were "based on quite different legal theories arising under civil statutes and common law." Id. at 1255.

Regarding the Business Corporation Law issue, the Pinnacle court noted that the result may have been different under the corporate laws of other states. As Pinnacle points out, both the Model Business Corporation Act § 721(b) and Delaware General Corporations Law § 160(c) contain similar prohibitions on cross-voting. In Italo Petroleum Corp. of Am. v. Producers' Oil Corp. of Am., 174 A. 276 (Del. Ch. 1934), the Court of Chancery of Delaware noted that the relevant statute "prevents the voting either directly or indirectly by a corporation of its own stock belonging to it." Id. at 289.