In a case which resolves conflicting authority in the California Courts of Appeal, the California Supreme Court held that Corporations Code § 800 requires a plaintiff in a derivative suit to maintain continuous stock ownership throughout the pendency of a litigation. In affirming the decision of the Fourth Appellate District, the Court determined that while the language of Section 800 does not expressly require continuous stock ownership to maintain suit, such a requirement is consistent with the rule of the majority of jurisdictions that have considered the issue, as well as basic principles that govern corporation law and shareholder litigation. With this decision, a derivative plaintiff that ceases to be a stockholder loses standing to continue the litigation, requiring dismissal of the action.
In September 2001, original plaintiff Richard Grosset brought this derivative action against the officers and directors of JNI Corporation (“JNI”). After Grosset sold his stock, the trial court allowed another JNI stockholder, Sik-Lin Huang, to bring a complaint in intervention in order to continue the litigation. Huang alleged causes of action for breach of fiduciary duty, waste of corporate assets, gross mismanagement, and insider trading. The defendants brought a motion to dismiss, which the trial court granted, with prejudice. Huang appealed.
While Huang’s appeal was pending, JNI stockholders approved a merger with a subsidiary of Applied Micro Circuits Corporation (AMCC), in which AMCC purchased all outstanding shares of JNI stock and JNI became a wholly owned subsidiary of AMCC. As result, Huang lost ownership of his JNI stock. The defendants moved to dismiss the appeal on the ground that Huang no longer had standing to pursue the derivative action on behalf of JNI. The Court of Appeal heard the motion and dismissed the appeal. Huang then filed a petition for review with the California Supreme Court. In a unanimous decision, the California Supreme Court affirmed.
The Grosset Court began its analysis with Corporations Code § 800, which imposes stock ownership requirements for standing to pursue a shareholder’s derivative suit. The Court explained that, while Section 800 does not expressly state a requirement for continuous stock ownership during the pendency of litigation, the phrase “initiated or maintained” seems to imply that only a shareholder may initiate or maintain a derivative action. It also noted the language in a comparable provision of Section 7.41 the Model Business Corporation Act (“commence or maintain”), which has been construed to mean that the dismissal of a derivative action is required once a plaintiff ceases to be shareholder. Further, the vast majority of jurisdictions that have considered this issue require continuous stock ownership for standing to maintain a derivative lawsuit, despite not having legislation that expressly provided for it.
California’s adoption of the continuous stock ownership requirement also comports with basic principles of corporations law and shareholder litigation. If successful, a derivative claim accrues to the direct benefit of the corporation and not to the stockholder who litigated it. As such, standing to maintain the claim is justified only by a stockholder relationship and the indirect benefits to be gained therefrom, such that the derivative plaintiff has the interest and incentive to zealously prosecute the action on behalf of the corporation. To allow a plaintiff to retain standing despite the loss of stock ownership would produce, as the Grosset Court stated, “the anomalous result that a plaintiff with absolutely no dog in the hunt is permitted to pursue a right of action that belongs solely to the corporation.”
In reaching this result, the California Supreme Court expressly disapproved the decision of Gaillard v. Natomas Co., (1985) 173 Cal.App.3d 410. In that case, the appellate court had held that a plaintiff was not required under Corporations Code § 800 to maintain continuous stock ownership in order to prosecute a derivative action on behalf of a corporation. This is no longer the law in California.
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