Significant Attorney’s Fees Awarded the Defendants In a Failed Derivative Action

Significant Attorney’s Fees Awarded the Defendants In a Failed Derivative Action

      Earlier this year, of the federal court for the Eastern District of Kentucky dismissed, on the grounds of a lack of standing, a derivative action purportedly brought on behalf of a Michigan nonprofit corporation. Pagtakhan-So v. Cueto, Civ. Act. No. 5:14-370-DCR, 2016 WL 617429 (E.D. Ky. February 16, 2016). That decision has now been appealed to the Sixth Circuit Court of Appeals. However, even while that appeal is pending, the trial court has ruled with respect to a motion for attorney’s fees filed by the defendants in that action, and a significant award of attorney’s fees has been made. Pagtakhan-So v. Cueto, Civ. Act. No. 5:14-370-DCR, 2016 WL 4094877 (E.D. Ky. August 1, 2016).

      In the initial decision, the derivative action that was filed on behalf of the nonprofit corporation had been brought by persons who were no longer directors of the corporation. No longer being directors, they lacked standing to bring a derivative action. In addition, it was found that they had failed to comply in any manner with Federal Rule of Civil Procedure 23.1, it governing derivative actions filed in federal court. On that basis, the claims were dismissed with prejudice.

      The second opinion involved the consideration of the defendant's motion for attorney’s fees. Under the Michigan Nonprofit Corporation Act, an award of attorney's fees to the defendants is permissible, the statue providing:

In an action brought in the right of a corporation by a record holder or beneficial owner of shares of the corporation or a member, the court having jurisdiction, upon final judgment and finding that the action was brought without reasonable cause, may require the plaintiff to pay to the parties named as defendants the reasonable expenses, including fees of attorneys, incurred by them in the defense of the action.

      Initially exhibiting what can only be described as chutzpah, the plaintiffs first asserted that this was not and was never intended to be a derivative action, a treatment that was evidenced by the failure to comply with Rule 23.1. This argument was rejected on the basis that the character of the action is derivative or direct is based upon the nature of the relief sought. Here, as the only alleged injury was to the corporation, the action must have been derivative on its behalf. Further, the court relied upon portions of the plaintiffs’ pleadings in which they, while not using the word “derivative,” indicated they were acting on the corporation’s behalf. In that the claims were derivative, the question was whether they were brought “without reasonable cause.” On bases including the complete failure to comply with the requirements of Rule 23.1, attorney’s fees were awarded. With respect to one defendant, those fees are in the amount of $40,805.84, and with respect to another individual defendant the attorney’s fees awarded are $50,623.00. As to the nonprofit corporation itself, it received attorney’s fees in $100,364.14. In total, the plaintiffs are responsible for attorney’s fees in the amount of $190,792.98.