Derivative Actions: Corporation Cannot Avoid the Lawsuit by Removing the Dissident Director
Under California law, a member of a corporation’s board of directors can sue, on behalf of the corporation, the other members of the board and the corporation if there has been misconduct or waste of corporate assets. This is one example of what is called a derivative lawsuit. Shareholders can also bring such actions. This is called “derivative action” because the action is brought to recover money damages or injunctive relief for the company, not the individual. See our discussion here. With most lawsuits, the person who files a lawsuit is seeking a personal recovery of money for damages or injuries. That is, any money judgment recovered will go to the person bringing the lawsuit. By contrast, in a derivative lawsuit, the director or shareholder bringing the lawsuit is suing on behalf of the corporation with the intent of protecting the interests and value and assets of the corporation. Any money judgment recovered will go to the corporation.
Under California law, to bring such a derivative lawsuit, one must be a member of the board of directors. This is the legal concept of “standing.” Without standing, an individual is not allowed to bring a lawsuit. One interesting question is whether a sitting member of a board of directors loses his or her standing if he/she is removed from the board of directors. The California Court of Appeals recently held that the answer is “no.” See Summers v. Colette, Case No. B285488 (Cal. App. 2nd Dist. April 15, 2019).
The Summers case involved a California nonprofit public benefit corporation called the Wildlife Waystation. The Wildlife Waystation was established in 1976 with a “mission . . . to rescue and provide sanctuary for all kinds of wildlife and to educate and inform the public about these animals.” The Waystation has been supported over the years by private donations, grants, and bequests. At the relevant time period, the board of directors had four members including Margaret Summers and Martine Colette. A dispute arose between the two directors when Summers came to believe the Colette was engaged self-dealing and other misconduct. As Summers wrote in her complaint: Colette “treated the Waystation as her own personal fiefdom.”
Summers confronted Colette about her misconduct and, in response, Colette sought to remove Summers as a member of the board. Indeed, a board meeting was called, and two directors voted to remove Summers, Summers voted “no”, and the fourth member of the board abstained. Shortly thereafter, Summers brought her lawsuit on behalf of the Wildlife Waystation. After the case was filed, Colette again called a meeting of the board and again called for the removal of Summers as a director. The vote was again successful.
At the trial level, among other legal arguments, Colette argued that Summers had been removed as a director and, therefore, lost her ability to bring the lawsuit. Because there was a legitimate legal argument about the first vote to remove Summers as a director, Colette also argued that the second vote — which was admittedly conducted correctly — terminated Summer’s ability to maintain the lawsuit. The trial court agreed and dismissed the lawsuit.
The Court of Appeals reversed holding that a director cannot lose his/her standing by being removed from the board. The court first looked to the relevant statute — Cal. Corp. Code, §§ 5142, 5223 and 5233). In reading the statutes, the court held that the statutory language was “inconclusive.” The statutes did not clearly express one way or the other whether a director had to remain a member of the board to maintain the derivative action. Second, the court looked to California caselaw where lawsuits were allowed to proceed in somewhat similar circumstances. For example, in cases involving a charitable trust, the California Supreme Court held that various members its governing board had standing to bring an action against other trustees for breach of fiduciary duties. The Summers court also looked cases decided in other states including the case of Tenney v. Rosenthal, 6 N.Y.2d 204 (N.Y. App. 1959) where the court refused to dismiss a case brought by a director even though the director was subsequently removed as a member of the board. The Summers court noted with approval this language from Tenney:
“Strong reasons of policy dictate that, once he properly initiates an action on behalf of the corporation to vindicate its rights, a director should be privileged to see it through to conclusion. Other directors, themselves charged with fraud, misconduct or neglect, should not have the power to terminate the suit by effecting the ouster of the director-plaintiff.”
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For more information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters, and he proudly serves business owners in San Diego and the surrounding communities. Contact Mr. Leonard by email or by calling (858) 483-9200. Like us on Facebook.