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Still Standing MCLE ARTICLE AND SELF-ASSESSMENT TEST By reading this article and answering the accompanying test questions, you can earn one MCLE credit. To apply for credit, please follow the instructions on the test answer sheet on page 29. by Peter Zablotsky and Sa’id Vakili Still ST ANDING Defendants in shareholder derivative lawsuits are unlikely to disqualify plaintiffs who can meet ownership and demand requirements UNDER CALIFORNIA LAW, to qualify as separate direct and derivative claims and may An exception exists when the interests of a derivative plaintiff and institute an action maintain a direct action and a derivative the plaintiff in the direct action are so adverse on behalf of a corporation, the plaintiff must action.2 Nothing prevents shareholders from or in such conflict with the interests of the show: 1) status as a shareholder of record, enforcing their personal rights against the other shareholders that the plaintiff cannot holder of a beneficial interest, or holder or a corporation while simultaneously enforcing adequately represent the other shareholders. voting trust certificate, 2) shareholder status the rights of the corporation in a derivative For example, in Hornreich v. Plant Indus- at the time of the wrong to the corporation action. As the court held in Denevi v. LGCC, tries,6 which was prosecuted under the pro- giving rise to the action (the contemporane- one who has “suffered injury both as an visions of Rule 23.1,7 the plaintiff and his ous-ownership rule), and 3) that reasonable owner of a corporate entity and in an indi- brother sold their company to an independent effort was made to inform the corporate vidual capacity is entitled to pursue remedies corporation in exchange for shares of the directors about the action and induce them to in both capacities.”3 Typically, the personal latter’s corporate stock. As part of the trans- commence suit (a prelitigation demand), and derivative claims arise out of the same action, the plaintiff was also hired by the unless those efforts would have been “useless” course of action, but the plaintiff’s injuries and acquiring corporation in exchange for or “futile” (demand futility).1 Various chal- claims differ from those of the corporation.4 covenants not to compete. When a dispute lenges have been advanced to disqualify plain- Moreover, in the case of closely held corpo- arose several years later, the plaintiff was tiff shareholders in derivative actions in state rations with a small number of shareholders, fired. He sued on the sales and employment court. Whether based on the existence of a the distinction between direct and derivative contracts, and later filed a shareholder deriv- simultaneous direct claim or action, the lack actions may blur if the acts of one or a few of contemporaneous ownership, the principles director- or officer-shareholders directly affect Peter Zablotsky is a professor of law at Touro of guardian ad litem, or even Rule 23.1 of the the corporation and the other shareholders. College Jacob D. Fuchsberg Law Center in New York. Federal Rules of Civil Procedure, these chal- Thus, even a shareholder who has other indi- Sa’id Vakili is an attorney with Vakili & Leus, LLP, lenges have met with little success. vidual claims may also be a plaintiff in a and has a practice emphasis in business and As a general rule, a shareholder may have derivative action.5 employment litigation. Los Angeles Lawyer October 2014 27 ative suit and an unlawful detainer action. He but others have permitted shareholders to bring a derivative action.25 made three offers of omnibus settlement that act as plaintiffs in a derivative action despite Along the same lines, in Patrick v. Alacer appeared to include a settlement of the deriv- having positions adverse to the defendant Corporation,26 a wife sought standing as a ative case as well as the other actions. Under directors. For example, in Tyco Laboratories, plaintiff shareholder based on the community these facts, the court found that he could Inc. v. Kimball,17 the plaintiffs who brought property interest in her husband’s shares. In not adequately represent the other share- the derivative action owned a substantial addition, she alleged that the increase in the holders’ interests.8 interest in the corporation and may have stock’s value, in excess of that attributed to Similarly, in Zarowitz v. Bank of America been in an adversary position to the defendant a fair return on her husband’s original invest- Corporation,9 two sets of litigation were directors earlier over control of the corpora- ment, was community property. The court again involved: the bank sought damages tion. The court found, however, that this did held that a wife could establish standing as a from the plaintiff and other former employ- not disqualify them from representing the derivative plaintiff based on her community ees for its losses, and one plaintiff—William corporation’s shareholders in a derivative property interest in her husband’s shares, a T. Powers—sued individually for wrongful ter- action. The court reasoned that the plaintiff beneficial ownership that gave the spouse mination and defamation. Meanwhile, a series shareholders were pursuing common interests standing.27 The court reasoned that since of four class actions and a dozen derivative with the other shareholders by seeking redress income arising from a spouse’s skill, efforts, actions were filed against the bank’s officers on the corporation’s behalf for alleged and industry is community property, the com- and directors. With the exception of Powers, breaches of fiduciary duties and other viola- munity should receive its fair share of the the other plaintiffs reached a comprehensive tions of state and federal laws, and that any profits deriving from the spouse’s devotion of settlement agreement with the bank’s insur- recovery would inure to the corporation’s more than minimal time and effort to han- ers. Powers attempted to block two of the set- benefit and not to the plaintiffs in their indi- dling his or her separate property.28 The court tlements because he thought they would have vidual capacities.18 noted that even if the stock was initially her an adverse effect on his damages action for Finally, in Ravenswood Investment husband’s separate property, the plaintiff wrongful termination. Under these facts, the Company, L.P. v. Bishop Capital Corp.,19 the spouse might have acquired a community court agreed that the plaintiff had a conflict plaintiff shareholders had offered to buy the property interest in it through their alleged of interest with the other shareholders and corporation’s outstanding shares and had joint devotion of time and effort to it during thus had no standing to object to the settle- attempted to buy select assets from it. The their marriage.29 ment of the derivative action.10 court found that this history did not establish In holding that the trial court erred in Regarding close corporations, in Smith that they had an “antagonistic” economic sustaining a demurrer to the derivative cause v. Ayers,11 a derivative action involving a interest and held that they were adequate rep- of action on the ground that the wife lacked family feud over a closely held corpora- resentatives of all the shareholders.20 The standing, the appellate court commented on tion, the court found that the derivative court concluded that “[u]ltimately, it is the the nature of the standing requirements. The plaintiff could not adequately represent the defendant’s burden to show that the deriva- court stressed that the legislature extended interests of other similarly situated share- tive plaintiff does not fairly and adequately standing from record owners to beneficial holders, largely because there were none. represent the other shareholders,” and that the owners as part of “‘the 1975 liberalization of The plaintiff’s stake in the corporation was burden had not been met.21 Unless particular the standing requirements,’” which were 1/10,000,000 of the authorized shares. circumstances reveal a clear conflict between intended to “bring California in line with Moreover, he received no cooperation from the direct and derivative actions (which would the majority rule that ‘it is sufficient that the any other shareholders; he was a class of disqualify a plaintiff in any event), the mere plaintiff be an equitable shareholder or unreg- one.12 In holding that he could not fairly and existence of simultaneous direct and deriva- istered owner of shares.’” The court further adequately represent the interest of other tive claims will not lead to the disqualification reasoned that while a trust may be the only similarly situated shareholders, the court dis- of the plaintiff shareholder. record shareholder, the plaintiff’s alleged tinguished another case, Larson v. Dumke,13 community property interest in a corporation Contemporaneous Ownership in which the court allowed a derivative action essentially makes her an unregistered share- to proceed with a class of one because the Conflicts of interest are not the only challenge holder, and that the community property plaintiff, who was the original founder of raised against plaintiff shareholders. The con- interest in the corporation satisfies the liberal the franchise, still retained an interest of temporaneous ownership rule requires that standing requirement of beneficial owner- almost 25 percent.14 the plaintiff be a shareholder when the action ship.30 Similarly, in Owen v. Modern Diversified is filed and when some part of the transaction Finally, it is worth noting the relevance of Industries, Inc.,15 the court held that the complained of occurred.22 In addition, the the continuing-wrong doctrine in the con- holder of a small number of shares of cor- plaintiff must remain a shareholder for the temporaneous ownership context.
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