Corporate Securities Law Blog

In Tzolis v. Wolff, 2008 WL 382345 (N.Y. Feb. 14, 2008), a majority of the New York State Court of Appeals held, over a vigorous dissent, that New York law permitted members of a limited liability company (“LLC”) to bring derivative suit on the LLC’s behalf.  As a result, under New York law, the right to bring a derivative suit has been broadened, and is no longer limited to shareholders of a corporation or limited partners of a partnership.  This ruling represents the third decision in just one week by a state’s highest court addressing the scope of legal standing for plaintiffs in shareholder derivative suits.  (We previously reported on decisions by the Delaware Supreme Court and California Supreme Court.)

(This is an update to our February 14, 2008 blog post.)

In Grosset v. Wenaas, Case No. 139285, 2008 WL 383196 (Cal. Feb. 14, 2008), the California Supreme Court held that California law, like Delaware law, imposes a “continuous ownership” requirement on plaintiffs in shareholder derivative suits.  Thus, to have standing to assert and prosecute a shareholder derivative action, a plaintiff shareholder must hold stock in the corporation he or she is suing continuously throughout the entire litigation process.  This requirement applies even where the shareholder is involuntarily divested of his or her ownership interest in the corporation by virtue of a corporate merger.  While it was firmly established previously under both California and Delaware law that a shareholder could lose standing to sue by voluntarily selling his or her shares in the corporation, the decision in Grosset confirms that under California law a shareholder also may lose standing involuntarily by virtue of a merger.

In Schoon v. Smith, 2008 WL 375826 (Del. Feb. 12, 2008), the Delaware Supreme Court “decline[d] to enlarge” the standing requirement for plaintiffs in stockholder derivative actions, holding that non-stockholding directors lack standing to bring a derivative suit.  Although the court expressly reserved the power to grant “equitable standing” — standing that has not been formally granted by statute, but can be granted at the discretion of the court — it refused to make such a grant to non-stockholding directors.  Finding that there was no “failure of justice” sufficient to warrant an expansion of the equitable standing doctrine, the court concluded that the rights of the stockholders could best be protected by the stockholders themselves and not a non-stockholding board member.  This decision from Delaware’s highest court confirms that Delaware courts are unlikely to expand derivative standing to those who lack a personal financial stake in the corporation.

On January 25, 2008, the Internal Revenue Service ("IRS") released Private Letter Ruling ("PLR") 200804004. This new PLR has apparently reversed an important position that served as guidance to public companies and practitioners regarding the tax deductibility of certain performance-based pay under Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). For background, Code Section 162(m) generally limits the ability of public companies from deducting compensation in excess of $1 million paid to certain executive officers. However, compensation that meets the requirements of "performance-based compensation" is exempt from the $1 million limit under Code Section 162(m). Generally, compensation qualifies as performance-based only if it is payable when predetermined performance objectives are actually achieved in accordance with performance criteria that has been approved by shareholders. The regulations under Code Section 162(m) provide that compensation does not fail to qualify as performance-based merely because compensation is payable upon death, disability or a change in ownership or control.