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.

Grosset involved JNI Corporation, a Delaware corporation whose principal place of business is in California.  The plaintiff, Sik-Lun Huang, was a shareholder of JNI.  Huang’s shareholder derivative suit, initially brought by another plaintiff, alleged that certain directors and officers had breached their fiduciary duties by, among other things, engaging in insider trading, committing corporate waste and grossly mismanaging the corporation.  While the case was on appeal, JNI shareholders voted to approve a transaction with Applied Micro Circuits Corporation (“AMCC”) pursuant to which AMCC purchased all outstanding shares of JNI stock, including Huang’s, and JNI became a wholly owned subsidiary of AMCC.  Shortly after the merger was completed, JNI moved to dismiss Huang’s suit on the grounds that he was no longer a shareholder of JNI, and thus lacked standing as a plaintiff to bring a shareholder derivative lawsuit.  The California Court of Appeal granted the motion to dismiss, holding that plaintiff lacked standing under Delaware law, and, in the alternative, that the plaintiff also lacked standing under California law because California “imposes a continuous ownership requirement that parallels Delaware law.”  Huang appealed, arguing that California law should apply and that he had complied with Section 800(b) of the California Corporations Code by “owning stock in the corporation at the time of the alleged wrongdoing and at the time the action was filed.”

On appeal, the California Supreme Court acknowledged the applicability of the “internal affairs doctrine,” which requires courts generally to apply the law of the state of incorporation to disputes between corporations and their officers and directors.  The Court noted, however, that application of Delaware law to the case at hand would be unnecessary if California law were identical.  The Court, therefore, turned first to an analysis of whether California law, like Delaware law, imposes a continuous ownership rule.

The Court examined Section 800(b) of the California Corporations Code.  That statute provides, in pertinent part:

No action may be instituted or maintained in right of any domestic or foreign corporation by any holder of shares . . . unless . . . : [¶] (1) The plaintiff alleges in the complaint that plaintiff was a shareholder, of record or beneficially . . . at the time of the transaction or any part thereof of which plaintiff complains or that plaintiff’s shares . . . thereafter devolved upon plaintiff by operation of law from a holder who was a holder at the time of the transaction or any part thereof complained of.

Cal. Corp. Code § 800(b) (emphasis added).  While the plain meaning of the “instituted or maintained” in Section 800(b) “point[ed] to a continuous ownership requirement,” neither this nor the legislative history, the Supreme Court held, “clearly impose[d]” such a reading.

In light of the absence of clear legislative meaning or intent, the Court held that “other considerations” supported requiring continuous ownership to maintain standing in a shareholder derivative suit.  Specifically, the Court reasoned that requiring plaintiff shareholders to continuously hold shares in the corporation they were suing was “all but compel[led]” by “basic legal principles pertaining to corporations.”  Fundamentally, a derivative claim “does not belong to the shareholder asserting it.”  Instead such standing is “justified only by the stockholder relationship.”  While the court allowed that “equitable considerations” might apply where a corporation merges solely to deprive a plaintiff standing or when a merger “is merely a reorganization that does not affect the plaintiff’s ownership interest,” no such facts had been alleged in the case before it.  “Consequently, when the stockholder relationship is terminated, either voluntarily or involuntarily a derivative plaintiff loses standing to sue because her or she no longer has even an indirect interest in any recovery pursued for the corporation’s benefit.” Or, more colloquially, such a plaintiff has “no dog in the hunt.”  In reaching its decision, the Court in Grosset explicitly overruled the California Court of Appeal’s decision in Gaillard v. Natomas Co., 173 Cal. App. 3d 410, 219 Cal. Rptr. 74 (Cal. App. 1985), where the court held that Section 800(b) required stock ownership only at the time the action was filed.

Grosset suggests that most important principle guiding the California Supreme Court in determining whether a plaintiff in a shareholder derivative action has standing to sue is whether, at the time of the suit, that plaintiff has an interest — either direct or indirect — in the outcome of the litigation.  Once a plaintiff ceases to be a shareholder he or she ceases to have such an interest.  This is true irrespective of whether that plaintiff chose to sell his or her shares and irrespective of the whether the plaintiff spent many years (and many dollars) litigating the case preceding the merger.  While there are circumstances where a plaintiff might retain standing despite not holding shares, such as when a merger is used to “wrongfully deprive” a plaintiff of standing or where a merger does not affect a plaintiff’s ownership interest, such circumstances are unusual and do not apply to the vast majority of mergers of California-based corporations.

For further information, please contact John Stigi at (213) 617-5589.