Standing to Sue: Director who Resigns or is Removed

An appellate court in California held that a director of a California nonprofit public benefit corporation who had standing to sue the corporation and sue another director for self-dealing did not lose standing after she was removed. In Summers v. Colette, 2019 Cal. App. LEXIS 347, the court differentiated such circumstances from those of a for-profit corporation shareholder whose rights to maintain a derivative suit require “continuous stock ownership” throughout the litigation.

The opinion explains:

In Grossetsupra, 42 Cal.4th 1100 the Supreme Court considered whether section 800, which “imposes stock ownership requirements for standing to pursue a shareholder’s derivative suit,” requires “a plaintiff to maintain continuous stock ownership throughout the litigation.” (Grosset, at pp. 1107, 1110.) Section 800, subdivision (b), provides: “No action may be instituted or maintained in right of any . . . corporation by any holder of shares” unless, among things, the plaintiff alleges he or she was a shareholder at the time of the transaction of which he or she complains. The Supreme Court observed that “[t]he phrase ‘instituted or maintained’ [italics in original] . . . seems to imply that only a shareholder may initiate or maintain a derivative action.”5 (Grosset, at p. 1111.) After further reviewing the language and history of the statute, the Supreme Court concluded that, “while section 800(b) seems to point to a continuous ownership requirement, the ‘instituted or maintained’ language does not clearly impose it. Nonetheless, other considerations ultimately support this interpretation of the statute.” (Grosset, at pp. 1113-1114.) Those “other considerations” included that a continuous ownership requirement furthered “the statutory purpose to minimize abuse of the derivative suit” and that a “majority of other jurisdictions that have considered the issue require continuous stock ownership for standing to maintain a derivative lawsuit.” (Id. at p. 1114.)

Significantly, the “instituted or maintained” language that the Supreme Court concluded suggested a continuous stock ownership requirement in section 800, and which appears in the provision concerning a member’s standing to bring an action on behalf of a nonprofit corporation in section 5710, does not appear in the provision governing a director’s standing to bring an action on behalf of a nonprofit in sections 5233 and 5142. That difference in language suggests a difference in legislative intent.

The opinion goes on to add a policy argument to support the court’s holding:

As the Supreme Court observed in Holt, a “‘charity’s own representative has at least as much interest in preserving the charitable funds as does the Attorney General who represents the general public.’” (Id. at p. 756.) Such an individual “‘is also in the best position to learn about breaches of trust and to bring the relevant facts to a court’s attention.’” (Ibid.) A director who files an action such as this one will continue to provide the advantages identified in Holt even if later removed from office.

As the Supreme Court observed in Holt: “The protection of charities from harassing litigation does not require that only the Attorney General be permitted to bring legal actions in their behalf. This consideration ‘. . . is quite inapplicable to enforcement by the fiduciaries who are both few in number and charged with the duty of managing the charity’s affairs.’” (Holtsupra, 61 Cal.2d at p. 755.) Similarly, directors authorized to bring an action on behalf of a nonprofit corporation have been charged with managing the corporation’s affairs, and those permitted to maintain an action in the absence of a continuous directorship requirement are sufficiently “few in number.” (Ibid; accord, L.B. Research & Education Foundation v. UCLA Foundation (2005) 130 Cal.App.4th 171, 181.)

The opinion concludes that the removed director in the case had standing under Corporations Code Sections 5233, 5142, and 5223 at the time she instituted the action (when she was a director), and her subsequent removal as director did not deprive her of standing.

California Code Section 5233

(a) Except as provided in subdivision (b), for the purpose of this section, a self-dealing transaction means a transaction to which the corporation is a party and in which one or more of its directors has a material financial interest and which does not meet the requirements of paragraph (1), (2), or (3) of subdivision (d). Such a director is an “interested director” for the purpose of this section.

(b) The provisions of this section do not apply to any of the following:

(1) An action of the board fixing the compensation of a director as a director or officer of the corporation.

(2) A transaction which is part of a public or charitable program of the corporation if it: (i) is approved or authorized by the corporation in good faith and without unjustified favoritism; and (ii) results in a benefit to one or more directors or their families because they are in the class of persons intended to be benefited by the public or charitable program.

(3) A transaction, of which the interested director or directors have no actual knowledge, and which does not exceed the lesser of 1 percent of the gross receipts of the corporation for the preceding fiscal year or one hundred thousand dollars ($100,000).

(c) The Attorney General or, if the Attorney General is joined as an indispensable party, any of the following may bring an action in the superior court of the proper county for the remedies specified in subdivision (h):

(1) The corporation, or a member asserting the right in the name of the corporation pursuant to Section 5710.

(2) A director of the corporation.

(3) An officer of the corporation.

(4) Any person granted relator status by the Attorney General.

(d) In any action brought under subdivision (c) the remedies specified in subdivision (h) shall not be granted if:

(1) The Attorney General, or the court in an action in which the Attorney General is an indispensable party, has approved the transaction before or after it was consummated; or

(2) The following facts are established:

(A) The corporation entered into the transaction for its own benefit;

(B) The transaction was fair and reasonable as to the corporation at the time the corporation entered into the transaction;

(C) Prior to consummating the transaction or any part thereof the board authorized or approved the transaction in good faith by a vote of a majority of the directors then in office without counting the vote of the interested director or directors, and with knowledge of the material facts concerning the transaction and the director’s interest in the transaction. Except as provided in paragraph (3) of this subdivision, action by a committee of the board shall not satisfy this paragraph; and

(D) (i) Prior to authorizing or approving the transaction the board considered and in good faith determined after reasonable investigation under the circumstances that the corporation could not have obtained a more advantageous arrangement with reasonable effort under the circumstances or (ii) the corporation in fact could not have obtained a more advantageous arrangement with reasonable effort under the circumstances; or

(3) The following facts are established:

(A) A committee or person authorized by the board approved the transaction in a manner consistent with the standards set forth in paragraph (2) of this subdivision;

(B) It was not reasonably practicable to obtain approval of the board prior to entering into the transaction; and

(C) The board, after determining in good faith that the conditions of subparagraphs (A) and (B) of this paragraph were satisfied, ratified the transaction at its next meeting by a vote of the majority of the directors then in office without counting the vote of the interested director or directors.

(e) Except as provided in subdivision (f), an action under subdivision (c) must be filed within two years after written notice setting forth the material facts of the transaction and the director’s interest in the transaction is filed with the Attorney General in accordance with such regulations, if any, as the Attorney General may adopt or, if no such notice is filed, within three years after the transaction occurred, except for the Attorney General, who shall have 10 years after the transaction occurred within which to file an action.

(f) In any action for breach of an obligation of the corporation owed to an interested director, where the obligation arises from a self-dealing transaction which has not been approved as provided in subdivision (d), the court may, by way of offset only, make any order authorized by subdivision (h), notwithstanding the expiration of the applicable period specified in subdivision (e).

(g) Interested directors may be counted in determining the presence of a quorum at a meeting of the board which authorizes, approves or ratifies a contract or transaction.

(h) If a self-dealing transaction has taken place, the interested director or directors shall do such things and pay such damages as in the discretion of the court will provide an equitable and fair remedy to the corporation, taking into account any benefit received by the corporation and whether the interested director or directors acted in good faith and with intent to further the best interest of the corporation. Without limiting the generality of the foregoing, the court may order the director to do any or all of the following:

(1) Account for any profits made from such transaction, and pay them to the corporation;

(2) Pay the corporation the value of the use of any of its property used in such transaction; and

(3) Return or replace any property lost to the corporation as a result of such transaction, together with any income or appreciation lost to the corporation by reason of such transaction, or account for any proceeds of sale of such property, and pay the proceeds to the corporation together with interest at the legal rate. The court may award prejudgment interest to the extent allowed in Section 3287 or 3288 of the Civil Code. In addition, the court may, in its discretion, grant exemplary damages for a fraudulent or malicious violation of this section.

California Code Section 5142

(a) Notwithstanding Section 5141, any of the following may bring an action to enjoin, correct, obtain damages for or to otherwise remedy a breach of a charitable trust:

(1) The corporation, or a member in the name of the corporation pursuant to Section 5710.

(2) An officer of the corporation.

(3) A director of the corporation.

(4) A person with a reversionary, contractual, or property interest in the assets subject to such charitable trust.

(5) The Attorney General, or any person granted relator status by the Attorney General.

The Attorney General shall be given notice of any action brought by the persons specified in paragraphs (1) through (4), and may intervene.

(b) In an action under this section, the court may not rescind or enjoin the performance of a contract unless:

(1) All of the parties to the contract are parties to the action;

(2) No party to the contract has, in good faith, and without actual notice of the trust restriction, parted with value under the contract or in reliance upon it; and

(3) It is equitable to do so.

California Code Section 5223

(a) The superior court of the proper county may, at the suit of a director, or twice the authorized number (Section 5036) of members or 20 members, whichever is less, remove from office any director in case of fraudulent or dishonest acts or gross abuse of authority or discretion with reference to the corporation or breach of any duty arising under Article 3 (commencing with Section 5230) of this chapter, and may bar from reelection any director so removed for a period prescribed by the court. The corporation shall be made a party to such action.

(b) The Attorney General may bring an action under subdivision (a), may intervene in such an action brought by any other party and shall be given notice of any such action brought by any other party.