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.
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