Opinion
Nos. C 03-00539 WHA, C 03-00540 WHA (Consolidated with).
June 30, 2004
ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION REGARDING STANDING
INTRODUCTION
In this intra-corporate dispute, defendants challenged plaintiffs' standing to sue in the midst of a jury trial. Defendants contended that plaintiff Dux Capital Management Corporation lacked standing to recover as a shareholder because, at the critical juncture, it allegedly had only an "expectancy" in the shares and did not yet own any shares. The Court reserved this issue, with the consent of all sides, to be resolved with additional and more complete briefing after the verdict. Now, after careful consideration of all submissions, including post-trial briefs, and the parties' oral arguments, defendants' motion is GRANTED IN PART AND DENIED IN PART.
STATEMENT
The background is set out in prior orders herein. The essence of the case is the claim that defendants schemed to strip the minority shareholders of their shares by running Long Life Noodle Company through bankruptcy. The defendant directors on the board did so without due diligence and without considering other available alternatives that might have returned more value to the corporation and the shareholders. Plaintiff Dux Capital Management Corporation asserted claims on behalf of itself as an alleged shareholder of Long Life. In addition, Dux along with plaintiff Jerry Davis later, and separately, obtained an assignment to assert all claims against defendants that had accrued to Long Life immediately before the bankruptcy filing. After the close of plaintiffs' case in chief, defendants challenged plaintiffs' standing to assert a claim.The parties agree that Dux had no shareholder rights whatsoever prior to April 25, 2001 (Jury Instruction XVII). On April 25, 2001, Dux entered into a settlement agreement with George Chen, a minority shareholder of Long Life (to settle yet a different controversy) (TX 194B). The settlement agreement required George Chen to transfer 200,000 of his shares of Long Life common stock into escrow for Dux pending the expiration of the right of first refusal held by Long Life and other shareholders pursuant to the Long Life Noodle Company Shareholder Agreement ( id. ¶ 1). Pending expiration or exercise of the right of first refusal, the settlement agreement provided that Dux would have the right to vote on the 200,000 shares of George Chen ( id. ¶ 3). Finally, the settlement agreement also provided in relevant part ( id. ¶ 12.18) (emphasis added):
The Parties to this Agreement agree and understand that an application for good faith settlement will be filed in the Action pursuant to Code of Civil Procedure section 877.6 and is expected to be heard on May 7, 2001. A finding by the court that this Agreement is in good faith under Code of Civil Procedure Section 877.6 is a condition of the validity and enforceability of this Agreement.
On April 26, 2001, George Chen provided notice of his intent to transfer 200,000 shares of common stock at a value of $2.00 per share (TX 194). As for a finding of good faith by the superior court, both parties agreed orally, as well as in their submissions, that the California superior court approved the settlement on July 25, 2001 (Def. Br. dated May 31, 2004, at 2; Pl. Br. dated June 2, 2004, at 2).
Now, after trial, plaintiffs request judicial notice of the entire proceedings of the California Superior Court that led to the settlement. This request is DENIED. The trial is over; ergo the record is closed.
Soon after the settlement but prior to its approval by the superior court, on May 3, 2001, Long Life Noodle Company's board of directors decided to file for bankruptcy. Shortly thereafter, on May 9, 2001, the actual petition was filed. The bankruptcy court eventually confirmed a reorganization plan that rendered worthless all of the equity shares. As part of the reorganization, the bankruptcy court entered an order authorizing the disbursing agent to transfer and assign to Jerry Davis and Dux all of Long Life's claims that had existed as of May 9, 2001, i.e., immediately prior to the Chapter 11 bankruptcy filing, against defendants in this action. This bankruptcy order further provided that the disbursing agent made no representation that Long Life had any valid claims, rights, or causes of action as of May 9, 2001 (Tr. 933:9-25). The assignment was made and is the basis for the second string on plaintiffs' bow herein, the first being the Chen-Dux transfer agreement.
At the close of the case, with all parties' consent, the jury was instructed to avoid considering "the technical issue of whether plaintiffs, or which plaintiff, have or has any right to sue defendants" (Jury Instruction XXVIII). Instead, they were told to "assume that plaintiffs have the right to sue for such wrongs against the company and the common stockholders, if any, by reason of any breach of duty by the directors or the majority shareholder proven at trial" ( ibid.).
With respect to defendants' liability, the jury was instructed that "[e]ven though the bankruptcy proceedings were all in good order, the question is whether the directors on the board should have chosen the bankruptcy alternative rather than some other course of action expected to provide the company and its shareholders with more value" (Jury Instruction XXIV). Then, the jury was instructed on the fiduciary duties of the directors to the corporation and all shareholders and the duty of a majority shareholder to minority shareholders. The jury was also instructed on agency law as well as the law on alter ego.
With respect to damages, the jury was instructed that "plaintiffs would have to prove the value of the shares held by the common stockholders as of the date of the decision to commence bankruptcy proceedings. The measure of damages would be the value of those shares as of that date less the expected value of those shares in bankruptcy proceedings expected as of the date of the board's vote" (Jury Instruction XXXVIII). Then, the jury was instructed that it was "not permitted to include speculative damages, which means compensation for future loss or harm which, although possible, is conjectural or not reasonably certain . . . you should compensate a party for loss or harm caused by the injury in question which the evidence shows is reasonably certain to be suffered in the future" (Jury Instruction XL).
After receiving such instructions, the jury returned a special verdict against the three directors An-Ehr Chen, Yan Sheng Chan, and Cheng-Ling Lee; the majority shareholder Rextron International Limited; and two other corporate defendants Yageo Corporation and Yageo Holding (Bermuda) Limited. The jury also found that plaintiffs have proved that common stock had a value of $2 per share and proved damages of $400,000. In addition, after the punitive phase, the jury awarded punitive damages of $5,800 against An-Ehr Chen and $580,000 against Rextron.
ANALYSIS
1. DUX'S STANDING AS AN ALLEGED SHAREHOLDER.
A central issue to be resolved is whether the settlement agreement between George Chen and Dux can be construed as to give Dux any legal right to the Long Life shares and thereby endow Dux with standing as of May 9, 2001. This order finds the settlement agreement cannot be so construed. The settlement agreement was clear that it was a conditional contract. It contained an express condition of a court's approval and finding that the agreement was in good faith under California Code of Civil Procedure Section 877.6. The settlement agreement provided, in relevant part: "A finding by the court that this Agreement is in good faith under Code of Civil Procedure Section 877.6 is a condition to the validity and enforceability of this Agreement" (TX 194B, at ¶ 12.18). As of May 9, 2001 (the date of the bankruptcy petition), the superior court had not yet approved the settlement agreement. Accordingly, the settlement agreement by its own terms was not valid nor enforceable on May 9, 2001. Put differently, George Chen retained all his legal rights as a minority shareholder of Long Life and was under no duty yet to transfer the shares or the right to vote to Dux. (Thus, the cause of action accrued to George Chen. There was no assignment of the cause of action.)
Plaintiffs contend that the express condition should be now excused because the superior court's approval was simply ministerial. This contention is rejected. The superior court was under no obligation to rubber-stamp the settlement agreement. Rather, the superior court had discretion in determining whether the settlement was in good faith. Tech-Bilt, Inc. v. Woodward-Clyde Associates, 38 Cal. 3d 488, 502 (1985). "A determination as to the good faith of a settlement, within the meaning of Section 877.6, necessarily requires the trial court to examine and weigh a number of relevant factors." Toyota Motor Sales U.S.A., Inc. v. Superior Court, 220 Cal. App. 3d 864, 871 (1990). In fact, there are cases where a settlement agreement was not approved. See, e.g., Mattco Forge, Inc. v. Arthur Young Co., 38 Cal. App. 4th 1337, 1351-52 (1995) (reversing the trial court's approval as an abuse of discretion). Despite plaintiffs' contention, the superior court's approval of the settlement agreement was an express condition that was not guaranteed to be satisfied. Without such approval, Dux obtained no legal rights to George Chen's shares.
In California, legal title passes to the buyer of an executory agreement to purchase stocks only when there is delivery or something in the contract that specifies or implies a different intention. Stephenson v. Drever, 16 Cal. 4th 1167, 1174 (1997). In Stephenson, the California Supreme Court addressed whether the minority shareholder lacked standing due to termination of his employment at which point the close corporation was required to repurchase his shares under a buy-sell agreement. The Stephenson court held that the minority shareholder had standing because the termination itself did not strip away any legal rights to the shares. The buy-sell agreement between the minority shareholder and the corporation required the close corporation to repurchase his shares at fair market value upon termination of employment. Yet, after termination, the parties disagreed as to the fair market value of the shares. The court, therefore, reasoned that the minority shareholder had not delivered his shares to the corporation since there was still a dispute as to the fair market value. Id. at 1174-75. Moreover, since the buy-sell agreement expressly provided a procedure for appraising the fair market value which could delay any repurchase while providing for the right of repurchase upon termination, the court refused to infer that the parties intended for a shareholder's rights to cease immediately upon termination of employment. Instead, legal title to the shares and all the rights appurtenant as owner passed only upon consummation of the repurchase. Id. at 1174.
Herein, the settlement agreement between Dux and George Chen expressly provided for a condition that was not satisfied as of May 9, 2001. Without such satisfaction, the settlement agreement was still an executory contract analogous to the Stephenson contract. George Chen could not have delivered the legal title of the shares until satisfaction of the condition.
Moreover, nothing in the settlement agreement implied a different intention, i.e., Dux obtaining any right prior to the superior court's approval. The settlement agreement stated that "the voting rights . . . shall be valid and enforceable during the pendency of any writ of mandate which may be filed by any party to the Action to overturn the Court's determination of good faith" (TX 194B, at ¶ 12.18). Thus, the parties created an express provision for validity of the voting rights pending appeal of any good-faith determination. No similar voting right was created pending the initial application for good-faith determination. The voting right was conditioned upon the superior court's approval. The fact that the settlement agreement expressly provided rights in one situation and not another tends to negate any inference that the parties intended for Dux to obtain voting rights or any other rights prior to the superior court's initial determination of good faith. The maxim expressio unius est exclusio alterius fits this situation. See Stephenson, 16 Cal. 4th at 1175. As in Stephenson, the record owner George Chen retained all legal rights and thus would have standing. Dux obtained no legal rights prior to May 9, 2001.
Of course, the settlement agreement only applies to any right to vote obtained by Dux from George Chen. The express condition in the settlement agreement does not apply to any proxy right obtained by Dux from George Murphy. As aforementioned, Dux has based his standing upon the settlement agreement between it and George Chen.
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Alternatively, plaintiffs contend that Dux was a pledgee of corporation stock which endowed Dux with legal interest in the stock. Plaintiffs' argument, however, rests upon the settlement agreement. As discussed above, the settlement agreement conferred no legal right to plaintiffs as of May 9, 2001. By its own terms, the settlement agreement was neither valid nor enforceable until the superior court approved it as a good-faith settlement.
The authorities cited by plaintiffs are distinguishable. Plaintiffs rely on Lawrence v. I.N. Parlier Estate Co., 15 Cal. 2d 220, 228 (1940), and Weingand v. Atlantic Savings and Loan Association, 1 Cal. 3d 806, 818-19 (1970). Plaintiffs cite Lawrence for the proposition that a pledgee of a corporate stock has legal interest in the stock even though the stock certificate was not reissued to the pledgee. In Lawrence, the pledger endorsed his stock certificate to the pledgee and delivered it to the corporation without transferring the stocks. Former California Civil Code Section 320b provided a pledgee who registered as such with the right to vote. Accordingly, the Lawrence court acknowledged that a pledgee of corporate stock has a legal interest in the stock while the pledger retained ownership of his stock. 15 Cal. 2d at 228-29.
Herein, there is no evidence that Dux ever registered as a pledgee. Even if Dux had registered, in 1975, the California legislature enacted the present California Corporation Code 702(b), which no longer provides a legal right to vote for a pledgee unless a pledger actually transferred the shares. Section 702(b) states: "a shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, and thereafter the pledgee shall be entitled to vote the shares so transferred." Thus, this order questions the continuing vitality of Lawrence for the proposition that a pledgee has legal interest in stock simply due to its status as a registered pledgee. Under Section 702(b), George Chen's shares were never transferred to Dux as to entitle Dux with the right to vote as a pledgee.
Similarly, Weingand is also inapposite. In Weingand, the pledgees were the original shareholders who transferred their shares in exchange for installment payments and security in their own shares. Pending full payment, the pledge agreement expressly limited the rights of the pledger-purchasers in their dealings with the corporation. Prior to full payment, the pledgers defaulted on their promissory note to the pledgees and the corporation became insolvent. The Weingand court held that the pledgee-shareholders had standing to sue, even though the shares had been transferred, because the pledgers allegedly committed fraud in creating the pledge agreement and violated conditions of the pledge agreement prior to full payment. Thus, Weingand stands for the proposition that original shareholders retain standing to sue on an executory contract to transfer shares until the contract has been fully performed. To that extent, Weingand deprives plaintiff Dux of any standing based on the settlement agreement. Dux's potential status as pledgee does not give it any legal right to the stock as to exercise the rights of a shareholder.
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Plaintiffs also contend that Dux had standing as the beneficial owner of the 200,000 shares set forth in the settlement agreement. Plaintiffs' argument fails due to their own procedural posture in litigating this action. California Corporation Code only acknowledges the right of beneficial owners in two situations: (1) beneficiary of an employment benefit plan or of any entity defined in Section 3(a) of the federal Investment Company Act of 1940 (Cal. Corp. Code 711) and (2) a shareholder derivative action (Cal. Corp. Code 800). The first situation is inapplicable to the facts of this case. As to the second, to this Court's knowledge, plaintiffs have never litigated this action as a derivative action. To the extent plaintiffs asserted any claim on behalf of the corporation, they asserted those claims based on an assignment. Plaintiffs have never attempted to comply with all of the prerequisite procedural requirements in order to bring a derivative action. Cal. Corp. Code 800; see also FRCP 23.1. Failure to comply with the requirements of the statute deprives a litigant of standing. Shields v. Singleton, 15 Cal. App. 4th 1611, 1618 (1993); In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 870, 899-900 (9th Cir. 1999).
Instead, plaintiffs sought to bring a direct individual action on their own behalf. For example, plaintiffs contended that defendants' failure to hold an annual meeting precluded them from electing directors to the board. Under California law, shareholders are entitled to vote, to be given notice of any meetings, and to be able to request the superior court to determine the validity of any election if denied the right to vote. See Cal. Corp. Code 700, 701, 709(a). Shareholder is defined as "one who is a holder of record of shares." Cal. Corp. Code 185. No authority has been provided and the Court could not find any where beneficial ownership conferred standing for a direct action. All of the authorities provided by plaintiffs on this issue arise from derivative actions. See Pearce v. Superior Court, 149 Cal. App. 3d 1058 (1984); Theophilos v. Commissioner, 85 F.3d 440 (9th Cir. 1986); 9 Witkin, Summary of California Law, Corporations § 180. The Court declines to extend the rights of beneficial ownership to direct actions.
2. ASSIGNED CORPORATION'S CLAIMS.
The later assignment approved by the bankruptcy court raises a different set of issues. The assignment was independent of the Chen-Dux settlement agreement. It happened later in the chronology, although it reached back to claims immediately prior to the bankruptcy filing. At the close of plaintiffs' case in chief and renewed in post-trial brief on standing, defendants contend that plaintiffs failed to prove any assigned claim for a breach of fiduciary duty to the corporation. They contend plaintiffs failed to prove any damages to the corporation had accrued as of the time immediately prior to the bankruptcy filing. At the outset, this order notes that this issue is outside the scope of the standing issue reserved by the Court. Rather, this would normally be a Rule 50 motion.
Defendants may have believed there was some latitude, however, due to the Court's request for precise information on what the trial record showed was the number of common shares outstanding as of May 9, 2001. Since defendants have raised this issue, this order will address it.
As noted, defendants contend that Long Life had suffered no damages immediately prior to the bankruptcy petition and instead suffered damages, if any, only after the bankruptcy filing. They contend that prior to the bankruptcy filing, any damages were speculative. Since the assignment only allowed plaintiffs to assert claims that existed as of May 9, 2001, immediately prior to the bankruptcy petition, defendants argue that no corporate claim for breach of fiduciary accrued prior to the bankruptcy petition.
Defendants' argument fails to consider the main factual issue for the jury: whether the directors on the board breached their fiduciary duty by choosing the bankruptcy alternative rather than some other course of action expected to provide the company and its shareholders with more value. The directors decided to file for bankruptcy on May 3, 2001. It is at this point in time that a breach of fiduciary claim may have accrued. If plaintiffs' damages were reasonably certain and not speculative at the time of wrongdoing, then the cause of action accrued. Allen v. United Food Commercial Workers Intern. Union, 43 F.3d 424, 427 (9th Cir. 1994); see also 6 Witkin, Summary of California Law, Torts §§ 1325-26. In determining whether damages are speculative, courts must distinguish between uncertain damage, which precludes recovery, from an uncertain amount or extent of damage, which does not prevent recovery. Allen, 43 F.3d at 427-28; Walker v. Pacific Indemnity Co., 183 Cal. App. 2d 513, 517 (1960).
Comporting with the aforementioned law, the parties agreed to the following instructions. The jury was instructed that "plaintiffs would have to prove the value of the shares held by the common stockholders as of the date of the decision to commence bankruptcy proceedings" (Jury Instruction XXXVIII). Then, the jury was instructed that it was "not permitted to include speculative damages, which means compensation for future loss or harm which, although possible, is conjectural or not reasonably certain . . . you should compensate a party for loss or harm caused by the injury in question which the evidence shows is reasonably certain to be suffered in the future" (Jury Instruction XL).
After receiving such instructions, the jury returned the special verdict against the three directors An-Ehr Chen, Yan Sheng Chan, and Cheng-Ling Lee; the majority shareholder Rextron International Limited; and two other corporate defendants Yageo Corporation and Yageo Holding (Bermuda) Limited. The jury also found that plaintiffs have proved that the common stock had a value of $2 per share and proved total damages of $400,000 (with respect to the Chen-Dux shares). Thus, the jury found that damages were not speculative as of the board's decision to file for bankruptcy.
The Court understands the bankruptcy order and assignment as intended to allow recovery for any viable claim by the company itself against its directors for placing the company into bankruptcy rather than evaluating other options that would have provided more value to the corporation and all the shareholders. The jury was so instructed with consent of the parties (Tr. 884:18-888:7) (no objections were raised by the parties at the charging conference). The trial record viewed favorably to plaintiffs would support the jury's conclusion that damages were not speculative. Plaintiffs have proved their assigned corporate claim.
The only remaining issue, then, is the amount of damages for the corporate claim. There were 1,346,153 common shares. At trial, the only evidence proffered was for the value of common shares. Hence, plaintiffs only proved, as found by the jury, the value of the common stock at $2 per share. Accordingly, damages for the corporate claim amounts to $2,692,306.
Defendants' request for a downward adjustment in light of the fact that Rextron relinquished its 700,000 common shares in bankruptcy. Had this been a true derivative action, then the award of damages to the corporation would have allowed Rextron to share in the recovery. This would have been a nonsensical result awarding the wrongdoer. Plaintiffs, however, did not pursue a derivative action as noted above. Rather, as an assignment, Rextron would not share in the recovery. Since the jury found Rextron liable, equity does not demand relieving the wrongdoer of liability.
CONCLUSION
For the foregoing reasons, Dux lacks standing to assert any claim on its own behalf but plaintiffs Dux and Davis jointly had standing based on the assignment of the corporation's claims. As such, any finding of liability or damages based on an injury solely to Dux as a minority shareholder is not adopted. Thus, Dux had no standing to obtain damages from Rextron based on a breach of fiduciary duty of the majority shareholder to the minority shareholder. As to all other defendants, they either owed a fiduciary duty to the corporation or could be deemed liable under agency law for the board's actions. Thus, this order adopts the jury's findings and An-Ehr Chen, Yan Sheng Chan, Wen Ching Lee, Yageo Corporation and Yageo Holding (Bermuda) Limited are jointly and severally liable to Dux and Davis as assignees of the corporate claim in the amount of $2,692,306. In addition, An-Ehr Chen is liable for punitive damages of $5,800. Judgment will be entered accordingly and all Rule 50 motions must be timely filed.
IT IS SO ORDERED.