Wednesday, July 11, 2012
Shareholder Lacked Standing to Pursue Derivative Action
Shareholder Held Not To Fairly and Adequately Represent
Corporation in Derivative Action
On June 29, the Court of Appeals issued an important decision regarding standing to bring a derivative action, there affirming the trial court’s summary judgment and order of dismissal in favor of the various defendants. Watkins v. Stock Yards Bank & Trust Co., No. 2011-CA-000228-MR, 2012 WL 2470692 (Ky. App. June 29, 2012) (To Be Published).
Under the law governing business corporations, it is the board of directors that is charged to oversee the corporation’s management and affairs. KRS § 271B.8-010(2). In exceptional circumstances, where the board of directors is not pursuing the interests of the corporation, a shareholder may bring a derivative action pursuant to which, on the corporation’s behalf, the shareholder litigates in its name. There exist, however, substantive requirements for bringing a derivative action including, in most instances, that the shareholder may a demand upon the board of directors that it act, that the shareholder have been in that status at the time of the actions complained of, and that they remain a shareholder throughout the pendency of the action. In addition, KRS § 271B.7-400(1), provides that:
A derivative proceeding shall not be maintained if it appears that the person commencing the proceeding does not fairly and adequately represent the interests of the shareholders in enforcing the right of the corporation.
Watkins, an individual, was one of the four living beneficiaries of the NIB Trust, it being in turn a 40% shareholder of Beargrass, a Kentucky corporation that had been the owner of the Oxmoor Shopping Center. In 2003, Oxmoor had been sold by Beargrass for $72.4 million, which sale received the unanimous approval of Beargrass’ directors and shareholders. Seventeen months after that sale, the purchasers from Beargrass sold Oxmoor for $123 million. After that second sale, Watkins requested that the trustee of the trust commence a shareholder derivative action challenging the initial sale. Being apparently unsatisfied with the investigation made at that time and the determination, concurred in by the other beneficiaries of the trust, to not proceed with the derivative action, Watkins, on behalf of Beargrass, filed a combined derivative and individual action asserting breaches of fiduciary duty in the recommendation of the sale of the Oxmoor property for an inadequate price. An additional derivative action was subsequently filed against the prior managers of the Oxmoor property, they having been the acquirer from Beargrass.
Ultimately, the appellees moved for summary judgment, which was granted by the trial court, whereupon all of Watkins claims (both individual and derivative) were dismissed. He appealed. Certain of the defendants filed motions for attorney fees against Watkins, which motions were denied by the trial court, and they filed a cross-appeal.
The court relied primarily upon Davis v. Comed, Inc., 619 F.3d 585, 593-94 (6th Cir. 1980), a decision interpreting the analogous FRCP 23.01, in assessing whether Watkins did or did not fairly and adequately represent the interests of the shareholders. Applying its analysis, the court noted that all of the other shareholders of Beargrass had filed affidavits opposing the lawsuit and as well had voted to indemnify Osborn and Maynard, respectively the chairman and president of Beargrass, from any liability incurred in the lawsuit:
In this case, there are similarly situated shareholders, and Watkins is opposed by them all. Further, all of the beneficiaries of the NIB and TWB Trusts, except Watkins, opposed this action. Watkins has no support from any of the shareholders or beneficiaries he purports to represent. Accordingly, we conclude that Watkins does not fairly and adequately represent the interests of the shareholders as required by KRS 271B.7-400(1). Slip op. at 11.
In addition, there was evidence that Watkins sought to personally gain from the action notwithstanding the fact that it was brought as a derivative action for which any recovery would be a corporate asset:
As correctly noted by the trial court, a month after Watkins filed this suit, Watkins’s counsel sent a letter to [the trustee of the NIB Trust] and counsel for Osborn, Maynard and Stock Yards Bank, offering to dismiss all claims, including the derivative ones, in exchange for a payment $2.2 million to Watkins personally.
Watkins argues that the settlement letter was proper because it was a settlement of only his individual claims and that the parties knew the trial court would have to approve the settlement. However, we note that Watkins’s settlement letter clearly states that he is willing to dismiss all claims, including the derivative ones, if he personally received $2.2 million. We believe that Watkins’s willingness to settle all claims at the expense of the shareholders and beneficiaries reflects that his self-interests were in conflict with the interests of those he purports to represent. Slip op. at 9-10.
As for Watkins’s individual claims, they were dismissed on the basis that he asserted no individual injury, distinct from that suffered by the other shareholders of Beargrass, and further that the asserted injury was nothing more than the loss of the value of his stock:
We note that the violations of duties Watkins claimed Stock Yards Bank owed directly to him and the NIB Trust are the same duties he claims Stock Yards Bank owed to the other shareholders. Moreover, Watkins failed to demonstrate a specific injury to himself outside the diminution in the value of the corporate assets and his stock. Therefore, we conclude that the trial court did not err in dismissing his direct claims. See Sahni v. Hock, ___ S.W.3d __, 2007-CA-001785-MR (Ky. App. 2010) (concluding that depreciation and the value of the shareholder’s stock was not a sufficient type of direct personal injury necessary to sustain a direct cause of action). Slip op. at 13.
As for the denial of award of attorney fees against the plaintiff (see KRS § 271B.-400(4)), the court noted that the statute is discretionary with the trial court, and that there existed no basis for setting aside that determination on an abuse of discretion standard.
No word yet as to any appeal to the Kentucky Supreme Court.
This decision is important for a variety of reasons. First, we have here the affirmance of a determination, on summary judgment, that a shareholder does not adequately represent the interests of the corporation. This ruling should go a long way to support the dismissal, on similar bases, of other unjustified derivative actions. Second, the court has here confirmed that opposition from other similarly situated shareholders is a basis for denying standing and as well confirmed that a plaintiff shareholder who seeks to appropriate to themselves the benefit of the action is not an adequate shareholder representative. Similar claims were brought in the Sahni v. Hock action; in that case, the plaintiff, Hock, offered to settle all actions, including the derivative claims, for a payment to herself as an individual, but no dismissal resulted. Third, there has again been confirmed the rule that diminution in value of stock is a derivative and not an individual claim.
With respect to the issue of attorney fees, while the court’s ruling may be consistent with the statute as it currently exists, the question must be raised as to whether reform is needed in this area, especially in light of the prior direction from the Court of Appeals in Sahni v. Hock to the effect that an award of attorney fees is not appropriate if the plaintiff prevails even slightly in the action. It needs to be recognized that a derivative action imposes significant costs and expenses upon the corporation in violation of the general applicable rule that it is the board of directors that has control of the corporation’s management and affairs. When a plaintiff shareholder seeks to act in place of the directors, there exist a significant policy basis for requiring that they proceed in a reasoned and informed manner. For example, the bringing, on an individual basis, of claims that are clearly derivative would seem to be, of itself and to the extent thereof, a basis of the award of attorney fees. Second, bringing a derivative action on behalf of a corporation and then, for individual benefit, seeking to appropriate the fruits thereof should of itself be a basis for the award attorney fees. Third and last, the statute should be amended to provide for proportionate analysis, on a claim by claim basis, of the award of attorney fees, in effect overruling that portion of Sahni v. Hock that held that recovery on even a minor point by the plaintiff protected them from an award of attorney fees to the corporation and the defendants. While there is an obvious policy basis for the derivative action, the exceptional costs they incur justify constraints upon those who might bring them without due investigation of both the facts and the applicable law.