RunflatAmerica v. Malkasian CA2/4 ( 2015 )

Filed 4/3/15 RunflatAmerica v. Malkasian CA2/4
NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or
ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for
purposes of rule 8.1115.
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION FOUR
RUNFLATAMERICA, LLC, B248002
Plaintiff and Appellant, (Los Angeles County
Super. Ct. No. BC468838)
v.
MICHAEL MALKASIAN,
Defendant and Respondent.
RUNFLATAMERICA, LLC, B252766
Plaintiff and Appellant, (Los Angeles County
Super. Ct. No. BC468838)
v.
MICHAEL MALKASIAN, et al.,
Defendants and Respondents.
APPEAL from judgments of the Superior Court of Los Angeles County,
Barbara Scheper, Judge. Affirmed.
Eagan Avenatti, Michael J. Avenatti and Scott H. Sims for Plaintiff and Appellant.
Ogden & Motley and Dale E. Motley for Defendant and Respondent Michael
Malkasian.
Burke & Associates, Michael Kerry Burke, for Defendant and Respondent
Tucker Taylor.
Law Offices of Martin N. Buchanan, Martin N. Buchanan, Girardi ǀ Keese,
Graham B. LippSmith and Lauren E.S. Horwitz, for Defendant and Respondent Harvey
Vechery.
_____________________________________
Appellant, RunflatAmerica LLC, is a shareholder of Runflat America Corp.
(RAC). Respondents Michael Malkasian and Tucker Taylor were members of RAC’s
board of directors when the board voted to transfer all of RAC’s assets to a company
owned by respondent Harvey Vechery. In these consolidated appeals, appellant
challenges the dismissal of its breach of fiduciary duty claim against respondents. We
conclude (1) the claim is derivative in nature and cannot be maintained without a demand
on RAC’s board of directors (Corp. Code, § 800); (2) respondents may raise the demand
requirement as a defense; (3) appellant did not sufficiently allege that a demand on
RAC’s board of directors would have been futile, even after the trial court granted it
leave to amend on this issue, and (4) the court did not abuse its discretion in denying
further leave to amend. The judgments of dismissal are affirmed.
FACTUAL AND PROCEDURAL SUMMARY
In September 2011, appellant’s owner Rick Cole filed a complaint against
Malkasian for breach of fiduciary duty and wrongful termination, alleging that Malkasian
and others had conspired to remove Cole from the board of directors of RAC, a company
that produced inserts for military vehicle tires. Cole alleged he was terminated as the
company’s president and chief executive officer (CEO), Malkasian was appointed to
2
those positions, and all RAC assets were turned over to RAC’s purported creditor,
American Pinnacle Fund.
In January 2012, Cole, this time joined by appellant, filed a first amended
complaint against Malkasian, Taylor, and Vechery. The first amended complaint alleged
that Vechery “participated in the management of RAC and served in an executive
capacity.” He was alleged to have engineered the appointment of Malkasian and Taylor
to RAC’s board of directors, the removal of Cole from all positions at RAC, and the
transfer of RAC’s assets to one of Vechery’s companies to satisfy an allegedly
unenforceable promissory note. Both Cole and appellant asserted claims for breach of
fiduciary duty, and Cole alone asserted a claim for wrongful termination.
In February 2012, Malkasian demurred on the ground that Cole could not sue for
breach of fiduciary duty because he was not a shareholder of RAC. Taylor and Vechery
joined Malkasian’s demurrer and demurred separately on the grounds that RAC was not
named as a party and neither plaintiff had complied with the prerequisites for bringing a
shareholder derivative claim. Shortly after that, Malkasian submitted a supplemental
brief, in which he joined in Taylor and Vechery’s demurrer and argued that RAC and the
other directors were indispensable parties. Cole and appellant opposed, contending the
action was direct, not derivative.
The court heard the demurrers in June 2012. It sustained them as to Cole’s
wrongful termination and breach of fiduciary duty claims. As to the latter, the court ruled
Cole could not “maintain a derivative action for damages suffered by the corporation”
because the first amended complaint did not allege he was a shareholder. The court
overruled the demurrers as to appellant’s breach of fiduciary duty claim, without
addressing respondents’ argument that appellant had not alleged compliance with the
prerequisites for a derivative action. At the hearing, the court stated it was not persuaded
that appellant had failed to join indispensable parties, but the requirement for making a
pre-litigation demand on RAC’s board of directors was not discussed at all. Both
plaintiffs were granted 10 days to amend. No amendment was filed within that period,
3
and the case proceeded only on appellant’s breach of fiduciary duty claim. In a response
to an order to show cause whether the case should be related to RunflatAmerica, LLC v.
Michelin North America, Inc. (Los Angeles County Super. Ct. No. BC477901),1 Taylor
and Vechery commented on the “apparent anomaly” in the ruling on the demurrers, but
none of the parties sought a clarification of that ruling.
In November 2012, Malkasian moved for summary judgment. He argued that the
first amended complaint was a shareholder derivative action, and that it failed to allege a
pre-litigation demand on RAC, as well as that there was no evidence of misconduct and
no damages because RAC’s assets were never actually transferred to American Pinnacle
Fund. Appellant opposed. It took the position that in overruling the demurrers the court
had ruled the action was direct, and that even if it were derivative, the demand futility
exception applied because the RAC board removed Cole as a director and CEO after he
attempted to dissuade the directors from transferring all of RAC’s assets to Vechery’s
company for no consideration.
At the hearing on Malkasian’s motion, appellant’s counsel argued that the court’s
ruling on the demurrers had misled appellant into believing its breach of fiduciary duty
claim was direct, and, for that reason, it had not amended the complaint. The court
disagreed, pointing out that its written decision stated the action was derivative and gave
both plaintiffs leave to amend. Appellant’s counsel argued in the alternative that the
action was direct or that the first amended complaint sufficiently alleged “a self-
interested transaction” by the RAC board, such that demand on the board would have
been futile.
The court found the first amended complaint stated a derivative action but failed to
allege demand futility. It declined to carve out an exception for cases in which a
1
The dismissal of that derivative action against several tire companies for trade
libel, intentional interference with contractual relations, and violations of the unfair
competition law was affirmed on appeal in RunflatAmerica, LLC v. Michelin North
America, Inc. (Mar. 26, 2014, B246418 & B249242 [nonpub. opn.]).
4
derivative action would benefit a defendant in complete control of a corporation. It also
found the evidence did not establish that Vechery was a majority shareholder of RAC or
that American Pinnacle Fund “presently controls RAC.” The court granted summary
judgment in favor of Malkasian and dismissed the case against him. The dismissal was
appealed in case No. B248002.
Although at the hearing on Malkasian’s motion appellant’s counsel represented
that appellant would file a motion for leave to amend, it did not. In May 2013, the court
granted Taylor and Vechery’s motions for judgment on the pleadings for the same
reasons it had granted Malkasian’s summary judgment motion, but it gave appellant leave
to amend the first amended complaint to allege demand futility. Accordingly, appellant
filed a second amended complaint, which included allegations that Vechery “exercised
full control over all the board members of RAC in the latter half of 2010, including
Malkasian and Taylor, as well as Don Mazzoni, Mitchell Lederer, and Don Mills,” all of
whom acted at Vechery’s “express instruction” in terminating Cole; and that Vechery had
a fiduciary duty to appellant because of his “management position—a position of full
control over [RAC’s board] by virtue of his strong business persuasion in the Los
Angeles community.”
The second amended complaint also alleged that a pre-litigation demand would
have been futile because “the transfer of RAC’s assets to Vechery’s company by a
Vechery controlled board for no consideration was a self-interested transaction,” not
subject to the business judgment rule. Appellant referenced “the November 19, 2010
Board minutes” as supporting the claim that the board “transferred all of the assets of
RAC to Vechery’s company under the guise of satisfying an alleged $100,000
promissory note between RAC and the company that had a maturity date of February 9,
2005 (i.e., well over five years prior to the actual asset transfer). However, as of the date
of transfer, the promissory note had already been satisfied and/or the legal ability of
Vechery’s company to collect on the note had long passed.”
5
The board minutes were attached to the complaint. They stated that “[t]he board
received reports concerning the corporation’s financial status, and considered the report
of Rick Cole . . . of the following: that the corporation was insolvent; that the corporation
could not pay its debts or obligations, including its current corporate lease; that the
corporation should be dissolved or wound down due to insolvency; and that the
corporation needed to arrange for the transfer of its assets to its secured creditor,
American Pinnacle Fund immediately.” The board terminated Cole as RAC’s CEO,
authorized Malkasian to transfer all RAC assets to American Pinnacle Fund to give effect
to an October 8, 2010 resolution, and resolved that the corporation should retain counsel
and submit a wind down plan to shareholder approval.
RAC was named as a defendant in the body of the second amended complaint but
not in the caption. Appellant served RAC’s agent for service of process and sought an
entry of default after RAC failed to appear. The court refused to enter default because
RAC had not been substituted as a Doe defendant in the caption. It later ruled that
naming RAC as a defendant in the body of the second amended complaint was
unauthorized since leave to do so “was neither requested nor granted,” and it denied as
untimely appellant’s motion for leave to file a third amended complaint to substitute
RAC in as a Doe defendant.
In October 2013, the court granted Vechery’s motion for judgment on the
pleadings and sustained Taylor’s demurrer to the second amended complaint on the
ground that appellant had failed to allege demand futility with sufficient particularity. It
explained that the second amended complaint made only conclusory allegations, did not
state how many directors were on the board, and failed to allege that all were conflicted.
The court alternatively ruled RAC was an indispensable party of whose existence
appellant had been aware since the inception of the case; it therefore could not be named
as a Doe defendant. In its opposition, appellant sought leave to amend solely in order to
add RAC. At the hearing, appellant’s counsel requested one more opportunity to amend,
representing that amendment was possible without providing any detail. The court
6
responded that it already had granted leave to amend to allege demand futility and
“assume[d] that you . . . made your best effort in the second amended complaint and it’s
woefully insufficient.” The court granted Taylor and Vechery’s oral motion to dismiss.
The dismissal was appealed in case No. B252766.
We consolidated the two appeals for oral argument and decision. In October
2014, appellant requested that we take judicial notice of RAC’s suspension by the
California Franchise Tax Board. We vacated submission and requested supplemental
briefing on whether the appeal should be dismissed due to RAC’s suspension, and
whether appellant was required to allege demand futility based on the composition of
RAC’s board at the time its derivative action was filed.
DISCUSSION
I
A demurrer and a motion for judgment on the pleadings test the legal sufficiency
of the factual allegations in the complaint and are subject to de novo review.
(Kapsimallis v. Allstate Ins. Co. (2002) 104 Cal.App.4th 667, 672.) A motion for
summary judgment used to test the sufficiency of a complaint has the legal effect of a
demurrer or motion for judgment on the pleadings. (American Airlines, Inc. v. County of
San Mateo (1996) 12 Cal.4th 1110, 1118.) We review the court’s ruling, rather than its
reasoning, and will affirm the decision if it is correct on any theory. (Berg & Berg
Enterprises, LLC v. Boyle (2009) 178 Cal.App.4th 1020, 1034 (Berg).) We deem true all
properly pleaded, material facts in the complaint, but not “contentions, deductions, or
conclusions of fact or law.” (Kapsimallis v. Allstate Ins. Co., at p. 672.) We consider
judicially noticeable facts, admissions by the plaintiff, and exhibits attached to the
complaint that contradict its allegations and bear on its truthfulness. (Sarale v. Pacific
Gas & Electric Co. (2010) 189 Cal.App.4th 225, 244–245; Bounds v. Superior Court
(2014) 229 Cal.App.4th 468, 477; Del E. Webb Corp. v. Structural Materials Co. (1981)
123 Cal.App.3d 593, 605.)
7
A. Derivative v. Direct Shareholder Action
The parties disagree whether the breach of fiduciary duty claim is direct or
derivative. “Under California law, ‘a shareholder cannot bring a direct action for
damages against management on the theory their alleged wrongdoing decreased the value
of his or her stock (e.g., by reducing corporate assets and net worth). The corporation
itself must bring such an action, or a derivative suit may be brought on the corporation’s
behalf.’ [Citations.] A different rule would ‘authorize multitudinous litigation and
ignore the corporate entity.’ [Citation.]” (Schuster v. Gardner (2005) 127 Cal.App.4th
305, 312.)
“An action is derivative if “‘the gravamen of the complaint is injury to the
corporation, or to the whole body of its stock or property without any severance or
distribution among individual holders, or if it seeks to recover assets for the corporation
or to prevent the dissipation of its assets.”’ [Citation.] Shareholders may bring a
derivative suit to, for example, enjoin or recover damages for breaches of fiduciary duty
directors and officers owe the corporation. [Citation.] An individual cause of action
exists only if damages to the shareholders were not incidental to damages to the
corporation. [Citation.] Examples of direct shareholder actions include suits brought to
compel the declaration of a dividend, or the payment of lawfully declared or mandatory
dividends, or to enjoin a threatened ultra vires act or enforce shareholder voting rights.
[Citation.]” (Schuster v. Gardner, supra, 127 Cal.App.4th at p. 313.)
Appellant assumes that, in overruling respondents’ demurrers to its breach of
fiduciary duty claim in the first amended complaint, the court necessarily concluded the
claim was direct. The assumption is belied by the court’s decision, which describes the
claim as derivative. Appellant’s contention that the court is bound by its initial ruling on
the demurrers to the first amended complaint also is incorrect. The court may reconsider
its rulings at any time before entry of judgment. (Kerns v. CSE Ins. Group (2003) 106
Cal.App.4th 368, 388.)
8
The gravamen of both the first and second amended complaint is that respondents’
breach of fiduciary duty led to mismanagement and dissipation of RAC’s assets.
Although that claim is derivative in nature, appellant relies on an exception to
shareholder derivative actions recognized by some jurisdictions, primarily in the context
of closely held corporations.2 (See, e.g., Thomas v. Dickson (Ga. 1983) 301 S.E.2d 49,
50–51 [allowing direct action by wife of deceased minority shareholder to recover unpaid
dividends that other two shareholders had distributed to themselves as bonuses].) As
appellant acknowledges, the application of this exception is not uniform, and California
courts have not adopted it. In Nelson v. Anderson (1999) 72 Cal.App.4th 111, 127, the
court rejected an argument similar to the one appellant makes here—that a derivative
action is “nonsensical” if the wrongdoer would share in the award of damages. The court
reasoned that a derivative action is an action in equity and a court of equity may
distribute damages so as to achieve an equitable result. (Ibid.)
A majority of the jurisdictions that have considered the exception on which
appellant relies have rejected it because the established distinction between direct and
derivative actions ensures predictability in commercial transactions, and derivative
actions protect creditors and the corporate entity. (See generally Cooper et al., supra,
9 U.C. Davis Bus. L.J. at pp. 182–188.) The minority approach is typically justified by
the inapplicability of the policy reasons favoring derivative actions in the case of closely
held corporations. (Id. at pp. 188–191.)
Applying a similar analysis, in Jara v. Suprema Meats, Inc. (2004) 121
Cal.App.4th 1238, the court reasoned that the three primary considerations favoring
derivative actions—avoidance of multiple shareholder actions, encouraging the
intracorporate resolution of disputes, and preserving corporate assets for the benefit of
2
“Closely held corporations are corporations with few shareholders, where
management and ownership are often united, and where a lack of ready market for the
shares exists.” (Cooper, et al., Too Close for Comfort: Application of Shareholder’s
Derivative Actions to Disputes Involving Closely Held Corporations (2009) 9 U.C. Davis
Bus. L.J. 171, 174 (hereafter Cooper, et al.).)
9
creditors—were inapplicable in the case of a minority shareholder alleging a direct action
for breach of fiduciary duty against the corporation’s other two shareholders, who paid
each other excessive compensation without the plaintiff’s approval. Since the plaintiff
was the only minority shareholder in the closely held corporation, there was no danger of
“a multiplicity of lawsuits.” (Id. at p. 1259.) There also was no reason to favor
“intracorporate resolution of disputes and protecting managerial freedom” because “the
defendants constitute[d] the entire complement of the board of directors and all the
corporate officers.” (Ibid.) And there was no need to preserve corporate assets for
creditors because the corporation’s business was unaffected. (Ibid.)
There are several reasons not to apply the direct action exception in this case. The
pleadings do not allege RAC was a closely held corporation, and it is doubtful such an
allegation can be made in good faith.3 Evidence appellant submitted in opposition to
Malkasian’s summary judgment motion indicates RAC had several dozen shareholders,
but none of the five directors identified in the second amended complaint was a
shareholder. Moreover, appellant does not, and apparently cannot, allege that it was a
minority shareholder, or that Vechery’s company was RAC’s majority shareholder.
Because this is not a case of a minority shareholder of a closely held corporation
asserting an individual claim, the policy considerations favoring a derivative shareholder
action based on the directors’ alleged breach of fiduciary duty apply.
B. The Effect of RAC’s Suspension
Appellant asked us to take judicial notice that the California Secretary of State
website showed RAC’s status as “FTB suspended.” It is unclear when the suspension
took place. Since the action is derivative, we asked the parties whether the appeal must
be dismissed in light of RAC’s suspension. After considering their supplemental briefs,
we conclude that a dismissal is not required.
3
Under Corporations Code section 158, a close corporation’s articles must
identify it as such and must provide that its shares cannot be held by more than 35
persons.
10
A corporation whose powers have been suspended for nonpayment of the
corporate franchise tax lacks capacity to prosecute or defend an action, or to appeal from
an adverse judgment. (Rev. & Tax. Code, § 23301; Bourhis v. Lord (2013) 56 Cal.4th
320, 324.) The purpose of this rule is to enhance tax collections, and a suspended
corporation may validate actions taken during the suspension by paying the taxes and
obtaining a revival of its powers. (Peacock Hill Assn. v. Peacock Lagoon Constr. Co.
(1972) 8 Cal.3d 369, 371.) Lack of capacity to sue is not a jurisdictional matter. (Traub
Co. v. Coffee Break Service, Inc. (1967) 66 Cal.2d 368, 371.) Rather, it gives rise to a
plea in abatement that may be waived if not raised at the earliest opportunity. (Color-
Vue, Inc. v. Abrams (1996) 44 Cal.App.4th 1599, 1604.) Courts have discretion to allow
the corporation to pay the tax and obtain a certificate of revival. (Cadle Co. v. World
Wide Hospitality Furniture, Inc. (2006) 144 Cal.App.4th 504, 511–514.)
In Reed v. Norman (1957) 48 Cal.2d 338, a shareholder appealing an adverse
judgment in a derivative action on behalf of a suspended corporation claimed the
corporate books and records necessary to compute the taxes were in the hands of the
mismanaging corporate officials. The court acknowledged that Revenue and Taxation
Code section 23301 was a bar in a derivative action on behalf of a suspended corporation,
but concluded it would be inequitable to allow the statute to “stand as a shield for
protecting allegedly dishonest corporate officials.” (Reed v. Norman, at p. 343.)
Alternatively, the court noted that although the corporation had been suspended for
several years, the defendants had delayed filing a motion to dismiss, and even assuming
the plaintiff could not maintain the action, he should have an opportunity to pay the back
taxes and revive the corporation, as allowed by Revenue and Taxation Code section
23305. (Id. at p. 344.)
Respondents argue the equitable exception in Reed v. Norman, supra, 48 Cal.2d
338, should not apply in this case because they have not moved to have the appeal
dismissed, and therefore have not attempted to use RAC’s suspension as a shield. Taking
respondents at their word leads to the conclusion that they have waived the defense of
11
incapacity because they failed to raise it at their earliest opportunity—in a motion to
dismiss following appellant’s request for judicial notice. (Color-Vue, Inc. v. Abrams,
supra, 44 Cal.App.4th at p. 1604.) Dismissing the appeal on the court’s own motion
would nevertheless allow Revenue and Taxation Code section 23301 “to stand as a
shield,” protecting them from liability. (Reed v. Norman, at p. 343.)
Respondents rely on an out-of-state case, Price v. Upper Chesapeake Health
Ventures, Inc. (Md. Ct. App. 2010) 995 A.2d 1054, to argue that the equitable exception
in Reed v. Norman, supra, 48 Cal.2d 338, should not apply in the absence of an
intentional failure to pay taxes. Foreign decisions decided under similar statutes and
similar factual situations may be persuasive in the absence of California authority on
point. (Estate of Salisbury (1978) 76 Cal.App.3d 635, 642.) That is not the case where,
as here, the foreign court distinguished existing California authority. The Maryland court
noted specifically that Reed v. Norman “did not include any language limiting its
exception to cases where there is evidence that the corporate directors failed to file or pay
taxes in order to avoid liability,” and that it allowed the shareholder to revive the
corporation, as permitted by California law (Rev. & Tax. Code, § 23305). (Price, at
p. 1067 & fn. 18, citing Reed v. Norman, at p. 344.) We are bound to follow the decision
of our state Supreme Court. (Auto Equity Sales, Inc. v. Superior Court (1962) 57 Cal.2d
450, 455.)
Having found no controlling authority requiring the dismissal of the appeal, we
proceed to dispose of it on the merits.
C. Respondents’ Standing to Raise the Demand Requirement
Appellant argues respondents lack standing to challenge its compliance with
Corporations Code section 800, subdivision(b)(2), which requires a plaintiff to plead
“with particularity” the attempts that were made to secure board action before bringing
suit, or, alternatively, the factual basis upon which the plaintiff believes that a demand on
the board would have been futile. (Bader v. Anderson (2009) 179 Cal.App.4th 775, 782
(Bader).)
12
Appellant cites Patrick v. Alacer Corp. (2008) 167 Cal.App.4th 995 for the
proposition that “[t]he shareholder plaintiff’s ‘lack of standing . . . to sue derivatively for
. . . failure on [its] part to make a demand upon the board of directors’ are defenses
‘peculiar to the corporation alone, and may be properly raised only by the nominal
defendant who, for purposes of those matters, ceases to be a nominal defendant and
becomes an actual party defendant.’” (Id. at p. 1006, quoting Swenson v. Thibaut (1978)
39 N.C.App. 77 [250 S.E.2d 279, 294].) The issue before the Patrick court was whether
a corporation may demur to a derivative action brought for its benefit. The court
concluded a demurrer was proper only as to the shareholder’s lack of standing. (Patrick,
at p. 1008.) In doing so, the Patrick court cited, without discussing, the principle that in
derivative actions “the proper party to invoke a given defense should be the party whom
the defense is designed to protect.” (Patrick, at p. 1006, quoting Note, Defenses in
Shareholders’ Derivative Suits—Who May Raise Them (1952) 66 Harv. L.Rev. 342, 343.)
It also cited, again without discussing, Swenson’s assumption that a shareholder’s failure
to make a demand on the board of directors is a defense that may only be raised by the
corporation. (Patrick, at p. 1006; Swenson, at p. 294.)
The assumption that the demand requirement protects only the corporation is
incorrect. (See, e.g., Markowitz v. Brody (S.D.N.Y. 1981) 90 F.R.D. 542, 562 [defense of
failure to plead demand or futility under Fed. Rules Civ. Proc., rule 23.1, 28 U.S.C., is
intended to benefit not only corporation, but also corporate directors].) In Kaplan v.
Peat, Marwick, Mitchell & Co. (Del. 1988) 540 A.2d 726, the Delaware Supreme Court
reasoned that a third-party defendant’s standing to raise the demand requirement must be
determined based on its nature and purpose. (Id. at p. 730.) The court explained that
“[t]he purpose of pre-suit demand is to assure that the stockholder affords the corporation
the opportunity to address an alleged wrong without litigation and to control any
litigation which does occur.” (Ibid.) It concluded that third-party defendants may
challenge the sufficiency of a shareholder’s demand. (Ibid.; cf. Simmonds v. Credit
Suisse Securities (USA) LLC (9th Cir. 2010) 638 F.3d 1072, 1097, fn. 22, vacated on
13
other grounds in Credit Suisse Securities (USA) LLC v. Simmonds (2012) ___ U.S. ___
[132 S.Ct. 1414] [holding third parties may raise demand requirement under section 16(b)
of Securities Exchange Act of 1934 (15 U.S.C. § 78p(b))]; Shlensky v. Dorsey (3d Cir.
1978) 574 F.2d 131, 142 [“defendants other than the corporation whose rights the
shareholder plaintiffs are seeking to vindicate may successfully raise the defense of
failure to comply with [the demand requirement]”].)
California courts apply Delaware law on the issue of demand futility. (See Bader
v. Anderson, supra, 179 Cal.App.4th at p. 791, fn.5; Oakland Raiders v. National
Football League (2001) 93 Cal.App.4th 572, 586, fn. 5.) They also recognize that the
demand requirement protects “the managerial role of directors” and aims “to curb
potential abuse.” (See, e.g., Bader, at p. 782.) Thus, it cannot be said that directors are
not protected by the demand requirement under California law, or that the purpose of the
requirement would not be served if defendants other than the corporation were allowed to
raise it as a defense. We decline to adopt the restrictive approach to respondents’
standing that appellant suggests.
D. Demand Futility
Appellant argues that RAC’s absence should be interpreted as non-opposition and
acquiescence to the action. Its reliance on Kaplan v. Peat, Marwick, Mitchell & Co.,
supra, 540 A.2d 726 for this argument is misplaced. In that case, the court excused the
plaintiff’s failure to make a demand on a corporation that had been joined as a nominal
defendant and had declared its position of neutrality on a motion to dismiss the lawsuit.
(Id. at p. 731.) It held “that when a corporation chooses to take a position in regards to a
derivative action asserted on its behalf, it must affirmatively object to or support the
continuation of the litigation,” and that a declared “position of neutrality must be viewed
as tacit approval for the continuation of the litigation.” (Ibid.) It would be speculative to
characterize RAC’s failure to appear in this case as a declared “position of neutrality” or
a sign of acquiescence, and we see no reason to excuse the demand requirement on that
basis.
14
Appellant also argues that the first and second amended complaint sufficiently
alleged that a demand on RAC’s board of directors would have been futile because the
board was not disinterested. A plaintiff in a derivative action must allege “with
particularity” its efforts to secure board action, “or the reasons for not making such
effort.” (Corp. Code, § 800, subd. (b)(2); Bader v. Anderson, supra, 179 Cal.App.4th at
p. 790.) Futility is sufficiently pled if the allegations create “‘a reasonable doubt . . . that:
(1) the directors are disinterested and independent and (2) the challenged transaction was
otherwise the product of a valid exercise of business judgment.’” (Id., at p. 791, quoting
Aronson v. Lewis (Del. 1984) 473 A.2d 805, 814 (Aronson), overruled on other grounds
in Brehm v. Eisner (Del. 2000) 746 A.2d 244, 253–254.) The test is “disjunctive;
accordingly, there is demand excusal if either prong is satisfied.” (Bader, at p. 791, citing
Brehm, at p. 256.)
As to the first prong, “general, conclusory facts are insufficient” to raise doubts
about the directors’ independence and disinterestedness. (Oakland Raiders v. National
Football League, supra, 93 Cal.App.4th at p. 587.) “The proof must be of ‘facts specific
to each director from which [the trier of fact] can [find a reasonable doubt] that that
particular director could or could not be expected to fairly evaluate the claims of the
shareholder plaintiff.’ [Citation.]” (Ibid.) “Where the claim is that specified directors
lack independence because they are dominated by a controlling shareholder, the general
allegation that the controlling shareholder ‘“personally selected”’ the directors is
insufficient. [Citation.] Rather, in addition to alleging control, the plaintiff is required to
present specific facts showing ‘that through personal or other relationships the directors
are beholden to the controlling person. [Citation.]’ [Citations.] And in this context,
simple allegations, of themselves, that a director has a personal friendship or outside
business relationship with the controlling person will not suffice to cast a reasonable
doubt as to the director’s independence. [Citation.]” (Bader, supra, 179 Cal.App.4th at
p. 792.) The plaintiff must allege a relationship between a controlling person and director
so substantial that the “‘non-interested director would be more willing to risk his or her
15
reputation than risk the relationship with the interested director . . . .’” (Ibid., citing Beam
v. Stewart (Del. 2004) 845 A.2d 1040, 1052 (Beam).)
Appellant’s allegations that Vechery managed RAC and controlled RAC’s board
are conclusory and nonspecific. Neither the first nor the second amended complaint
offers particularized facts as to Vechery’s involvement in RAC’s day-to-day activities or
his relationship with the individual directors. (Bader, supra, 179 Cal.App.4th at pp. 798–
799.) At best, the second amended complaint suggests that Vechery’s control was due to
his position of prominence in the Los Angeles business community. Such a general
allegation is insufficient. (See Beam, supra, 845 A.2d at pp. 1051–1052 [allegations that
majority shareholder and other directors moved in the same social circles, and developed
business relationships and friendships were insufficient to rebut presumption of
independence].) The suggestion that Vechery engineered the appointment of Malkasian
and Taylor to the board also is insufficient. (See Aronson, supra, 473 A.2d at pp. 814–
816 [allegation that director owning 47 percent of corporation’s stock “personally
selected” each corporate director did not support claim that directors lacked
independence].) These allegations do not permit a determination of independence or
disinterest “on a director-by-director basis.” (Bader, at p. 790.)
Under the second prong, the allegations must establish that the “‘challenged
transaction was [not] otherwise the product of a valid exercise of business judgment.’”
(Bader, supra, 179 Cal.App.4th at p. 791; Aronson, supra, 473 A.2d at p. 814.) The
business judgment rule “establishes a presumption that directors’ decisions are based on
sound business judgment, and it prohibits courts from interfering in business decisions
made by the directors in good faith and in the absence of a conflict of interest.
[Citations.]” (Berg, supra, 178 Cal.App.4th at p. 1045.) “In most cases, ‘the
presumption created by the business judgment rule can be rebutted only by affirmative
allegations of facts which, if proven, would establish fraud, bad faith, overreaching or an
unreasonable failure to investigate material facts. [Citation.]”’ (Id. at p. 1046.)
16
Appellant’s main contention is that a demand on the board would have been futile
because of its decision to transfer RAC’s assets to American Pinnacle Fund, Vechery’s
company, in satisfaction of a promissory note that was either satisfied or uncollectable.
This allegation is expressly based on the November 19, 2010 board minutes attached to
the second amended complaint, but the minutes indicate the board relied on financial
reports, including a report by Cole, regarding RAC’s insolvency and the need to assign its
assets to “its secured creditor, American Pinnacle Fund.” The minutes also indicate the
board gave effect to a prior resolution regarding the transfer of assets.
To the extent the board minutes are inconsistent with the allegations in the
complaint, we may accept the minutes as true. (SC Manufactured Homes, Inc. v. Liebert
(2008) 162 Cal.App.4th 68, 83 [when exhibits attached to complaint conflict with
allegations, we may accept as true contents of exhibits].) Directors are entitled to rely on
competent financial reports prepared by officers of the corporation. (Bader, supra, 179
Cal.App.4th at p. 788, citing Corp. Code, §309.) The minutes do not show, and appellant
does not allege with any particularity, that the reports presented at the November 19,
2010 meeting placed the directors on actual or inquiry notice that the debt to American
Pinnacle Fund was based on a note that was either satisfied or uncollectable. The
operative complaint does not contain any allegations regarding the resolution to transfer
assets adopted at the October 8, 2010 meeting; it does not name all members of the RAC
board in 2010, nor does it identify the directors who voted for that resolution.
Appellant alleges no facts in support of its conclusory allegation that the
promissory note was satisfied, and the note itself is not attached to the pleadings, nor is
its language quoted in full. “Where a complaint is based on a written contract which it
sets out in full, a general demurrer to the complaint admits not only the contents of the
instrument but also any pleaded meaning to which the instrument is reasonably
susceptible. [Citation.]” (Aragon-Haas v. Family Security Ins. Services, Inc. (1991)
231 Cal.App.3d 232, 239.) We must accept the plaintiff’s interpretation of the contract in
those circumstances unless it is “clearly erroneous.” (Ibid.) Without access to the full
17
text of the note, it is impossible to accept at face value appellant’s essentially legal
conclusion that the note was unenforceable because it had matured more than five years
earlier. (Civ. Code, § 1641 [“The whole of a contract is to be taken together, so as to
give effect to every part, if reasonably practicable, each clause helping to interpret the
other”].) In any event, its conclusion about the enforceability of the note appears to be
clearly erroneous as it is based on the general four-year statute of limitations for contract
actions (Code Civ. Proc., § 337, subd. 1.), as opposed to the six-year statute of limitation
for enforcing a promissory note payable at a definite time (Com. Code, § 3118, subd. (a)).
(See Cadle Co. v. World Wide Hospitality Furniture, Inc., supra, 144 Cal.App.4th at
p. 514, fn. 8.)
Alternatively, appellant argues that the resolution to assign all RAC assets to one
creditor was not protected by the business judgment rule because it was a prohibited
preferential treatment of that creditor, in violation of the trust-fund doctrine, which
imposes on the directors of an insolvent corporation a duty not to “divert, dissipate, or
unduly risk corporate assets that might otherwise be used to pay creditors claims.” (Berg,
supra, 178 Cal.App.4th at p. 1041.) Respondents contend that the trust-fund doctrine
does not apply in this case because appellant is not a creditor of RAC. That contention is
not well taken because the directors’ duty to preserve the assets of an insolvent
corporation is coextensive with their duties to the corporation. (See Berg, at pp. 1039,
1041, italics omitted.)
However, neither the first, nor the second amended complaint alleges with any
particularity that RAC had other creditors besides American Pinnacle Fund or that the
directors knew or should have known of their existence, so as to support an inference of a
knowing or grossly negligent violation of the trust-fund doctrine. (See Katz v. Chevron
Corp. (1994) 22 Cal.App.4th 1352, 1366, quoting Aronson, supra, 473 A.2d at p. 812
[“under the business judgment rule[,] director liability is predicated upon concepts of
gross negligence”].) To the extent the board’s resolution attached to the second amended
complaint suggests the directors knew RAC “could not pay . . . its current corporate
18
lease,” it is unclear whether RAC already had defaulted on the lease. In any event,
“leases” are included in the assets Malkasian was authorized to collect and transfer to
American Pinnacle Fund. Cole appears to have mentioned the existence of a balance on a
corporate credit card for the first time in e-mail correspondence with Malkasian in mid-
December 2010, after the November 2010 board meeting. That correspondence, which is
attached to the second amended complaint, suggests the information had not been
included in the reports the board reviewed at the meeting, and there is no allegation why
the board should nevertheless have been on inquiry notice regarding the omitted
information.
Appellant’s pleadings are insufficient for yet another reason. Demand futility “is
gauged by the circumstances existing at the commencement of a derivative suit.” (Bader,
supra, 179 Cal.App.4th at p. 791, quoting Aronson, supra, 473 A.2d at p. 810.) If a
majority of the board members have been replaced by the time the lawsuit is filed, the
question is whether the reconstituted board would impartially consider the merits when
presented with a shareholder demand for action. (Bader, at pp. 791–792, citing Rales v.
Blasband (Del. 1993) 634 A.2d 927, 934.) In his demurrer to the second amended
complaint, Taylor noted the lack of any allegation as to the board’s composition at the
time Cole filed his original complaint. Indeed, the second amended complaint alleges
that at the time Cole sued Malkasian in September 2011 he thought a demand on the
board would have been futile because in December 2010 Malkasian had warned him “not
to interfere” with RAC’s operation. That allegation is irrelevant. Cole did not and could
not bring a derivative action because he was not a shareholder of RAC. Moreover, in its
opposition to Malkasian’s summary judgment motion, appellant admitted it was
undisputed that Malkasian had resigned from the board in January 2011.
Appellant’s derivative action did not commence until the first amended complaint
was filed in January 2012. Yet, there are no allegations regarding the composition of the
board at that time, or at any time after 2010. Rather, appellant appears to tacitly assume
that all board members, including Malkasian, remained on the board. That assumption is
19
unreasonable in light of Malkasian’s undisputed resignation a year before the derivative
action was filed. Absent a specific allegation about the board’s composition in January
2012, we cannot reasonably infer that the board membership remained substantially
unchanged. Appellant claims to have sufficiently alleged that Vechery and American
Pinnacle Fund controlled the board at all times. But the second amended complaint
alleges only that Vechery “exercised full control over all of the board members of RAC
in the latter half of 2010.” There are no specific factual allegations regarding actual
control of RAC by American Pinnacle Fund, and in ruling on Malkasian’s summary
judgment motion, the court found no evidence of such control.
Because appellant has not alleged with particularity that demand on the RAC
board would have been futile at the time its derivative action commenced, it lacks
standing to pursue that action.
II
Appellant argues the trial court abused its discretion in denying leave to amend at
various points during the proceeding. As a general rule, leave to amend is liberally
allowed at all stages of a proceeding if there is a reasonable possibility that a defect in a
complaint may be cured by amendment. (Kempton v. City of Los Angeles (2008) 165
Cal.App.4th 1344, 1347–1348; Edwards v. Superior Court (2001) 93 Cal.App.4th 172,
180.) ‘“The burden of proving such reasonable possibility is squarely on the plaintiff.’”
(Maxton v. Western States Metals (2012) 203 Cal.App.4th 81, 95.) Despite the general
rule of liberality, appellate courts are less likely to find an abuse of discretion where a
proposed amendment was offered after an unwarranted delay or lack of diligence.
(Melican v. Regents of University of California (2007) 151 Cal.App.4th 168, 175.)
A. Leave to Amend the First Amended Complaint
In case No. B248002, appellant argues the court should have granted leave to
amend when it treated Malkasian’s motion for summary judgment as a motion for
judgment on the pleadings. In order to oppose a summary judgment motion on issues not
encompassed in the operative complaint, a plaintiff typically must seek leave to amend
20
the complaint at or prior to the hearing on the motion. (Schweitzer v. Westminster
Investments, Inc. (2007) 157 Cal.App.4th 1195, 1214.) If the summary judgment motion
is in essence a motion for judgment on the pleadings, a request to amend may be made at
the hearing or before the entry of judgment. (Kirby v. Albert D. Seeno Construction Co.
(1992) 11 Cal.App.4th 1059, 1069.)
Malkasian’s summary judgment motion was supported by evidence, but the court
made very limited factual findings. To the extent it granted the motion because the first
amended complaint did not allege demand futility, it treated the motion as one on the
pleadings. But the record does not show that appellant requested leave to amend either at
the hearing or before the court entered judgment for Malkasian. At the hearing,
appellant’s counsel represented that appellant would have amended earlier had it not been
misled by the court’s overruling of the demurrers to its first amended complaint. The
court explained appellant already had been granted leave to amend and could have
amended. Appellant’s counsel also represented that appellant would soon file a motion
for leave to amend to allege demand futility, but no such motion was filed.
As a general rule, where a previous demurrer that should have alerted the plaintiff
to a deficiency in the pleading has been overruled, it would be unfair to deny the plaintiff
an opportunity to amend if the court changes its mind and grants a motion for judgment
on the pleadings on the same issue. (Higgins v. Del Faro (1981) 123 Cal.App. 3d 558,
566.) But appellant’s argument that it was misled by the court’s overruling of the
demurrers to the first amended complaint is less convincing because the court’s decision
was apparently incomplete and internally inconsistent. The court ruled only on the issue
of standing to bring a derivative action, and did not address the demand requirement or
demand futility either in its tentative decision or on the record. In addition, the court
granted leave to amend to both plaintiffs even though it sustained the demurrers only as
to Cole’s claims. Appellant took a risk when it relied on the court’s decision without
seeking clarification. Its continued assumption that the breach of fiduciary duty claim
was direct when the court expressly stated it was derivative was particularly unwarranted.
21
In any event, appellant was allowed to file a second amended complaint after the
court sustained Taylor and Vechery’s motion for judgment on the pleadings. As we
explained, the twice amended pleading still failed to allege demand futility with sufficient
particularity. We may not reverse a trial court’s rulings unless they were prejudicial and
resulted in a miscarriage of justice. (See Cal. Const., art. VI, § 13.) Thus, even were we
to agree that the court erred in not allowing appellant to amend as a matter of right when
it treated Malkasian’s motion as a motion for judgment on the pleadings, the error is
harmless in light of the insufficient subsequent amendment.
B. Leave to Amend the Second Amended Complaint
In case No. B252766, appellant proceeds on the assumption that the second
amended complaint was its first real opportunity to allege demand futility, and the court
abused its discretion in not allowing further amendment of that complaint. As we already
explained, the record belies that assumption. Although respondents had argued from the
beginning that the breach of fiduciary duty claim was derivative and the court’s decision
on the demurrers to the first amended complaint described it as such, for the majority of
the proceedings in the trial court appellant insisted the claim was direct. By the time the
second amended complaint was filed in May 2013, appellant’s claim had been pending
for 16 months, and appellant had missed at least two opportunities to seek leave to allege
demand futility. It cannot claim prejudice when the delay in amendment was at least in
part attributable to its own choices. (See Telles Transport, Inc. v. Workers’ Comp.
Appeals Bd. (2001) 92 Cal.App.4th 1159, 1167 [party may not claim prejudice where
error caused by its conduct or by failing to take reasonable steps to avoid or correct it];
Careau & Co. v. Security Pacific Business Credit, Inc. (1990) 222 Cal.App.3d 1371,
1387 [amendment liberally allowed where the pleader did not have “‘“a fair prior
opportunity to correct the substantive defect”’”].)
Nor has appellant met its burden of showing a reasonable possibility of amending
to allege demand futility. It made no such showing in its oppositions to and at the
combined hearing on Taylor’s demurrer to the second amended complaint and Vechery’s
22
motion for judgment on the pleadings. In its opening brief on appeal, appellant
represented that it can allege “facts sufficient to demonstrate that it was not a valid
exercise of business judgment for any of RAC’s Board of Directors to liquidate all of
RAC’s assets for no consideration,” and that it can “plead specific allegations
demonstrating that none of the individual board members of RAC was disinterested, nor
did they independently determine that APF should receive all of RAC’s assets over and
above legitimate, existing creditors of RAC which ended up receiving nothing in return
for their claims.” These conclusory statements do not make clear what specific facts
appellant proposes to allege to fulfill the requirement of pleading demand futility “with
particularity.” (Corp. Code, § 800, subd. (b)(2).)
At oral argument, for the first time, appellant’s counsel referred us to “Cole’s
declaration,” without specifying where that declaration appears in the record or the facts
contained in it. In the absence of adequate citations to the record, we are not required to
search it in order to support an appellant’s contentions. (Nwosu v. Uba (2004) 122
Cal.App.4th 1229, 1246.) While the showing of a reasonable possibility of amendment
may be made for the first time on appeal (Dudley v. Department of Transportation (2001)
90 Cal.App.4th 255, 260), there is no reasonable explanation why the second amended
complaint could not have been drafted to allege facts within Cole’s own knowledge, on
which appellant had relied in its opposition to Malkasian’s summary judgment motion.
Even were we to consider the evidence appellant offered in opposition to the
summary judgment motion, we would find appellant’s showing on appeal to be
insufficient. Cole’s declaration states he “attempted to dissuade” the board from
transferring RAC’s assets to Vechery’s company for no consideration because the
promissory note had matured in 2005, to which the board responded by removing him as
CEO. The declaration does not state that the board agreed with Cole’s interpretation of
the promissory note and proceeded with the asset transfer anyway. If, as we explained
earlier, Cole was relying on the wrong statute of limitation, then the board’s disagreement
23
with his interpretation cannot evidence bad faith.4 The declaration mentions no other
creditor claims, stating only that RAC has not been able to “provide anything of value to
its shareholders.” There is no indication Cole alerted the board, either in October or
November 2010, that the transfer of assets to American Pinnacle Fund may be a
preferential treatment of that creditor.
Although Taylor’s demurrer to the second amended complaint pointed to the lack
of an allegation about the board’s composition at the time Cole filed his lawsuit,
appellant did not address the issue of the board’s composition until we requested
supplemental briefing. Even then, appellant proceeded on the assumption that the board
remained substantially the same, without offering any particularized facts regarding its
composition at any time after 2010. Instead, it offered additional facts about events that
took place in 2010, and emphasized the corporation’s failure to file for bankruptcy or
wind down. The allegation in the second amended complaint that Malkasian was
authorized to wind it down, coupled with Malkasian’s resignation from the board two
months later, begs the question who was to wind down the corporation after his
departure.5
In its supplemental briefing, appellant relies on RAC’s suspension to argue that a
demand on the board of a suspended corporation is necessarily futile. The argument is
4
The promissory note, which is attached to Cole’s declaration, contains a
provision waiving the obligee’s “diligence in taking any action to collect any sums owing
under” it. That provision further undercuts Cole’s interpretation of the note as
uncollectable due to mere passage of time.
5
We note that at oral argument and in his supplemental brief, Taylor’s counsel
represented that his client and other board members had resigned by the time the
derivative action commenced. Appellant’s counsel did not address these representations,
which, if true, would raise questions about the good faith of appellant’s continued
reliance on the assumption that RAC’s board remained substantially unchanged. From
the record and the parties’ representations, it is impossible to determine with any
confidence whether appellant can amend to allege in good faith that RAC had an active
board after 2010 and that its composition remained substantially unchanged.
24
flawed. Initially, appellant misreads Braddock v. Zimmerman (Del. Supr. 2006) 906 A.2d
776 as generally allowing a reassessment of the demand requirement in derivative actions
“as of the date of the filing of an amended complaint,” and assumes that the case allows it
to file an amendment based on current facts. The court in Braddock considered the
application of the demand requirement to cases in which an independent board is elected
during the pendency of a derivative action. (Id. at p. 785.) The court held that where “a
plaintiff’s complaint has been dismissed and the plaintiff is given leave to file an
amended complaint, . . . the plaintiff must make a demand on the board of directors in
place at [the] time the amended complaint is filed or demonstrate that demand is legally
excused as to that board.” (Id. at p. 786.) Since appellant proceeds on the assumption
that the RAC board has not changed, and the only indication is that, if the board changed,
the change occurred before the filing of the derivative action, Braddock is inapposite.
Furthermore, appellant’s attempt to use the corporation’s suspension to excuse the
demand requirement is unsupported by California authority. It is based on an old out-of-
state case, Favorite Oil Co. of Beaumont & Cleburne v. Jef. Chaison Townsite Co.
(Tex.Civ.App. 1913) 162 S.W. 423, which held that demand on the board of a “defunct”
corporation would be futile because the corporation could not sue or be sued. (Id. at
pp. 423, 425.) Appellant fails to appreciate that the case was decided under a statutory
scheme limiting the period for reviving such a corporation to six months. (Ibid.) As we
already have explained, California law encourages the payment of taxes and revival of
suspended corporations, and allows a shareholder in a derivative action to revive a
corporation that has been suspended for years. (Reed v. Norman, supra, 48 Cal.2d at
p. 344.) If corporate officials may not use the suspension as a shield (ibid.), a shareholder
should not be allowed to use it as a sword. Such a use would be equally inequitable, as
well as contrary to the letter and spirit of Revenue and Taxation Code sections 23301 and
23305.
C. Leave to Join RAC
In case No. B252766, appellant also challenges the court’s conclusion that the
25
joinder of RAC in the second amended complaint was unauthorized and its denial of
appellant’s subsequent requests for leave to join RAC as a nominal defendant. Since we
conclude that appellant is not entitled to further leave to amend to allege demand futility,
we need not address the court’s rulings on the joinder issue.
DISPOSITION
The judgments of dismissal are affirmed. Respondents are entitled to their costs
on appeal.
NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS
EPSTEIN, P. J.
We concur:
WILLHITE, J.
COLLINS, J.
26