DERIVATIVE ACTIONS -- FORCING DIRECTORS TO ACT

Posted about 2 years ago. Applies to Florida, 2 helpful votes

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I. Introduction Corporations can become large and powerful entities that while responsible to a large number of shareholders are controlled by a small group of directors. Directors often forget this responsibility, and a corporation’s misdirected actions may well bring harm to the shareholders and the corporation itself. To remedy these errors, shareholders may under Florida Statute §607.07401 bring suit on behalf of the corporation against one or more directors. Below is a quick primer to assist the unfamiliar lawyer in bringing suit in a derivative action. II. Demand Only a shareholder of a corporation can file suit on a corporation’s behalf as a derivative action. Failure to offer proof of such ownership is a fatal defect in the pleading. The person filing suit may be the beneficial recipient of shares through a voting trust. Moreover, a person cannot disapprove of a corporation’s conduct, buy shares, and then commence suit. Claims may only be brought for corporations while the person was a shareholder. There is some leeway in this regard. For example, a spouse who gained shares as partial settlement during a divorce had standing for conduct during the other spouse’s ownership. Kaplus v. First Continental Corp., 711 So.2d 108 (Fla. 3d DCA 1998). Courts have even allowed suits to progress where the shareholder has a personal claim against the corporation. First American Bank and Trust by Levitt v. Frogel, 726 F.Supp. 1292 (S.D. Fla. 1989). Some jurisdictions allow standing as long as the conduct occurred while share were owned. DiGovanni v. All-Pro Golf, Inc., 332 So.2d 91 (Fla. 2d DCA 1976). Others are not so forgiving by ruling that an action abated if a shareholder were to give up control of all shares during the action. Schilling v. Belcher, 582 F.2d 985 (5th Cir. 1978). Finally, not-for- profit corporations are exempt from chapter 607 actions. Ferola v. Blue Reef Holding Corp., Inc., 719 So.2d 389 (Fla. 4th DCA 1998). Suits are not limited to derivative actions where there is direct ownership of the corporation. Gadd v. Pearson, 351 F.Supp. 895 (M.D. Fla. 1972). When the corporation is the parent of another, a double derivative action is possible. This action may even be permissible when the initial corporation has only a minority interest in the second. West v. West, 825 F.Supp.1033 (N.D. Ga. 1992). This demand must be stated separately to the first and then second corporation, hence the name of the action. Failure to characterize the particular suit as a double derivative is fatal to the pleading. Crow v. Context Industries, Inc., 260 So.2d 865 (Fla. 3d DCA 1972). The attorney that considers filing a double derivative action should be cognizant of the fact there is little law on point within Florida and will need to look elsewhere such as Delaware for more detailed guidance in many situations. III. Notice Mere filing of a complaint does not begin the usual judicial process found in most other suits. First, notice of the demands to be made must be given to the directors 90 days prior to the commencement of any suit. This waiting period is to insure the directors recognize there is a potential suit, and insure the corporation make an appearance at court proceedings. Francini v. International Marble Trades, Inc., 546 So.2d 777 (Fla. 3d DCA 1989) (corporation required to be named as an indispensable party.) Suit may be brought earlier than 90 days from the day of demand if written notice is received stating the directors refuse or intend to ignore the demand. The prospective claimant may also press forward if less than 90 days have passed by informing the court of a belief that neglecting the action will lead to greater harm. Doing so may have negative consequences should the suit fail. Demand may be ignored when making one would obviously be futile such as when the named directors are a family that controls the corporation. Cheryl Guagliardo et al. v. Joe L. Guagliardo et al, 5 Fla. L. Weekly Supp. 395 (Fla. 13th Jud. Cir. 1998). A formal complaint can only be filed after these steps are taken. IV. Internal Determination Corporations may file a motion to stay proceedings after the filing of a complaint in order to complete an internal investigation. This preserves the corporation’s right should an investigation take longer than 90 days. More importantly, the court may dismiss an action on the recommendation of the corporation based on the results of the investigation; provided the investigation was conducted independently. The key word is independent, and independence is always determined by a facts and circumstances test for each case. McDonough v. Americom International Corp., 950 F.Supp. 1016 (M.D. Fla. 1995). A determination to recommend dismissal based on the results of an investigation might be conducted by either 1) a majority of the independent directors provided such still constitutes a quorum; 2) a majority vote of a committee comprised by at least two or more independent directors appointed by a majority vote of independent directors even if this number is not enough for a quorum; or 3) a panel of one or more independent persons appointed by the court. While the statutory language given is that a court “may" dismiss, the interpretation is closer to “should" dismiss. Again, independence matters in giving leeway for allowing a suit to continue despite a negative determination. Kloha v. Duda et al, 226 F.Supp. 2d 1342 (M.D. Fla. 2002). V. Settlements The clear language of the statute expresses the legislatures opinion regarding settlement once an action has commenced. A proceeding commenced under this section may not be discontinued or settled without the court approval. If the court determines that a proposed discontinuance or settlement will substantially affect the interest of the corporation shareholders or a class, series, or voting group of shareholders, the court shall direct that notice be given to the shareholders affected. The court may determine which party or parties to the proceeding shall bear the expense of giving notice. Florida Statutes §607.07401(4) The court is further restricted by the inability to modify settlements. A court must either take or reject a settlement in its entirety; there is no line item veto. Levinson v. American Laser Corp., 438 So.2d 179 (Fla. 2d DCA 1983). VI. Damages and Fees Damages sought in a complaint may consist of the usual requests for damages in a suit. There are no special limitations. However, there is case law preventing the award of punitive damages as derivative actions are considered equitable actions. Lanman Lithotec, Inc. v. Gurwitz, 478 So.2d 475 (Fla. 5th DCA 1985). Fees can be awarded to the prevailing party, plaintiff or defendant. Fortunately, plaintiffs are no longer required to post a bond or other security to cover the potential costs of litigation. Another favorable consideration to suit is the availability of fee enhancements to damage awards. Lane v. Head, 566 So.2d 508 (Fla. 1990). (The enhancement is awarded to cover fees, and attorneys may not take an additional percentage out of this enhancement as further satisfaction of a contingency award) By the same token, the defense might also be awarded fees at the discretion of the court under this statute should the suit be without merit. Therefore, pressing to bypass the 90 day waiting period may influence the finder of fact in this area should the complaint have little merit.

Additional Resources

Key Cases - Derivative Actions 1 . Schein v. Chasen, 313 So. 2d 739 (Fla. 1975). The court determined that under Florida law appellants' complaint failed to state a claim. Refusing to adopt rulings from other jurisdictions, the court adhered to previous state precedent that actual damage to a corporation must be alleged in a complaint to substantiate a stockholder's derivative action. 2. Batur v. Signature Props. of Northwest Fla., Inc., 903 So. 2d 985, 995 (Fla. 1st DCA 2005). Dismissals of shareholder derivative actions may entail an evidentiary hearing with respect to the disputed issues of bias, conflict of interest, objectivity and reasonableness in the preparation and presentation of the report (or, under, section 607.07401(3) the conduct itself) of the investigation that the statute requires before allowing a corporation to scuttle a shareholder's derivative action. 3. Timko v. Triarsi, 898 So. 2d 89 (Fla. 5th DCA 2005). Shareholder lost standing to prosecute a derivative shareholder action when he was divested of his ownership interest in his shares in a separate legal proceeding. 4. Atkins v. Topp Telecom, Inc., 874 So. 2d 626, 627 (Fla.4th DCA 2004). There was no requirement that a trial court engage in the second-step analysis prior to adopting an independent investigator's determination that pursuing a shareholder's derivative action was not in a corporation's best interests. A court should inquire into the independence and good faith of the special investigative committee, as well as into whether the committee conducted a reasonable analysis in support of its recommendations. In an effort to balance the interests of a corporation against those of a special investigative committee, the trial court has further discretion to then "apply its own business judgment" in order to determine whether the committee recommendation was supported by the evidence. 5. C.A.T. LLC v. Island Developers, Ltd., 827 So. 2d 373 (Fla. 3d DCA 2002). Trial court erred in dismissing company's derivative action which sought declaratory judgment regarding conveyance of certain property, because under statute, shareholders' derivative actions could be brought in the form of declaratory actions. 6. Harrington v. Batchelor, 781 So. 2d 1133 (Fla. 3d DCA 2001). Shareholder could sue for breach of a shareholder agreement, even though the injury she complained of, the failure to use best efforts to sell the corporation, affected all shareholders equally. 7. Salit v. Ruden, 742 So. 2d 381 (Fla .4th DCA 1999). Appellants sued appellee law firm for its alleged role in a scheme to wrest control of appellee corporation from them. Their claim was based on the fact that the actions of appellee attorney were taken in his capacity as senior partner of appellee law firm, which put a large amount of pressure on him to produce business. Pursuant to Fla. R. Civ. P. 1.140(b)(6), the trial court dismissed all counts of appellant's amended complaint against appellee law firm with prejudice; appellants sought review. On appeal, the court reversed the trial court's order and remanded the matter back to the trial court with directions to allow appellants to replead their tortious interference with a contract and injurious falsehood claims. Although the court did recognize that appellants' professional malpractice claim was properly dismissed in light of the fact that appellants had not been represented in an individual capacity, it gave appellants leave to plead a derivative claim upon remand. The court also held that appellant's defamation claims should have survived the motion to dismiss. 8. Kaplus v. First Continental Corp., 711 So. 2d 108 (Fla.3d DCA 1998). The court concluded that appellant had standing to proceed in a shareholder's derivative action as her ownership of the shares of stock devolved by operation of law as marital assets. 9. Haas v. Roe, 696 So.2d 1254 (Fla.2d DCA 1997). Appellant, individual shareholder of law firm, sued the firm and appellees, other shareholders in the law firm. Appellees filed boilerplate answers to complaint and their motion to dismiss was granted. At a hearing to determine reasonable fees, appellant's expert admitted that the claims were misjoined when appellant could not file a shareholder's derivative action and a direct action in the same lawsuit. However, appellant's expert maintained that both claims were separately tenable. The court held that the lower court erred in granted appellees' request for attorney fees. The court stated that pursuant to the statute, fees were only appropriate when the claim was completely untenable. The court found that here, when neither appellees nor the lower court had recognized the misjoinder issue, the suit was not frivolous, and the claims against appellees, though procedurally untenable, were not completely untenable. 10. First American Bank and Trust by Levitt v. Frogel, 726 F.Supp. 1292 (S.D. Fla. 1989). The bank contended that the securities fraud claim failed to state with the requisite particularity the acts of fraud, that breach of fiduciary duty and corporate mismanagement were not actionable under § 10(b), that irreconcilable conflicts between the shareholder's direct and derivative claims prevented him from adequately representing the interests of the class, that the shareholder failed to assert the requisite demand on the directors, and that the shareholder failed to post required security. The court held that the shareholder alleged specific acts of fraud by the bank and bank directors with sufficient particularity. The court also held that the failure to disclose imprudent lending practices, to report loan repayments accurately, and to report bad business ventures amounted to an intentional act to defraud the public under § 10(b). Furthermore, the court held that no conflict between the derivative count and the direct count existed to prevent the shareholder from serving as a fair and adequate class representative. The court also held that the shareholder demonstrated that demand would have been futile. Finally, the court held that security posting was not requested..

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