Palkon v. Holmes: Motion to Dismiss Granted

In Palkon v. Holmes, 2014 BL 293980 (D.N.J. Oct. 20, 2014), the United States District Court for the District of New Jersey dismissed a derivative suit brought by Dennis Palkon (“Palkon”) against Wyndam Worldwide Corporation (“WWC”) and its board of directors (collectively, the “Defendants”) for failure to state a claim. 

According to the allegations, WWC, a Delaware corporation, operated hotels and resorts throughout the world. Between April 2008 and January 2010, hackers on three occasions stole personal customer information from WWC and its subsidiaries. The company retained technology firms to investigate the breaches and provide recommendations on enhancing the company’s security. In April 2010, the Federal Trade Commission (“FTC”) investigated the cyber-attacks, and, two years later, commenced legal action against WWC for its security practices. 

WWC received a shareholder demand to bring a lawsuit based on online breaches in November 2012. The board’s audit committee evaluated the complaint, found that it was not well grounded, and decided against bringing an action pursuant to this demand. In June 2013, Palkon sent a letter demanding that the board attend to and correct the harm inflicted on the company by the security breaches. A few months later the full board decided not to pursue legal action. 

Palkon filed a derivative lawsuit asserting that the directors failed to implement adequate data-security mechanisms (e.g., elaborate passwords and firewalls) and to disclose data breaches to shareholders in a timely manner. These failures were alleged to have resulted in significant harm to the company’s reputation and generated significant legal fees. 

To challenge a refusal of demand, a plaintiff must raise a reasonable doubt that the refusal was a business judgment by pleading that it was either “(1) made in bad faith, or (2) based on an unreasonable investigation.” The Defendants moved to dismiss Palkon’s complaint because: (1) the board’s refusal to pursue legal action was a good faith exercise of business judgment made after reasonable investigation; (2) even if the refusal was wrongful, there are no relevant claims on which to bring action; and (3) Palkon’s proposed damages were “speculative and unripe.” 

The court found that the board’s investigation was reasonable and made in good faith. The court disagreed with plaintiff’s allegations that counsel used by the board had a conflict of interest as a result of representing the company in the FTC action. The law firm “did not have multiple, conflicting duties. Instead its obligations in the FTC and shareholder matters were identical…: it had to act in WWC’s best interest.” See Id. As for the reasonableness of the investigation, the court noted that the board had “enough information” to assess plaintiff’s claim, in part as a result of the FTC action and the investigation arising from the first demand. Thus, consideration of plaintiff’s demand did not “occur in a vacuum.” See Id. “Given the business judgment rule’s strong presumption, courts uphold even cursory investigations by boards refusing shareholder demands.” 

The primary materials for this case may be found on the DU Corporate Governance website.

Ashley Lloyd