Opinion
NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS
APPEAL from a judgment of the Superior Court of Los Angeles County, George H. Wu, Judge. Los Angeles County Super. Ct. No. BC316891
Doniger & Fetter, Thomas Doniger, Henry D. Fetter; Takehara & Stuart and Ronald M. Takehara for Plaintiffs and Appellants.
Munger, Tolles & Olson, Bart H. Williams, Allison B. Stein and Joseph J. Ybarra for Defendants and Respondents.
KITCHING, J.
INTRODUCTION
In this derivative lawsuit, plaintiffs, minority shareholders of a holding company that owned a bank, alleged that the bank’s directors, officers, and majority shareholders committed misfeasance. The board of directors of the bank’s holding company appointed a special litigation committee (the Committee) to investigate the charges and to determine whether the holding company should undertake the litigation. The Committee recommended that the derivative action be terminated. The trial court entered summary judgment against the minority shareholders based upon the special litigation committee defense.
The minority shareholders appeal. To overcome the special litigation defense on summary judgment, the minority shareholders must raise a triable issue of material fact to show that the Committee was not independent or that the Committee conducted an inadequate investigation. (Desaigoudar v. Meyercord (2003) 108 Cal.App.4th 173, 185 (Desaigoudar).) Because the minority shareholders did not raise a triable issue of material fact, we affirm.
FACTUAL AND PROCEDURAL BACKGROUND
Following the usual standard of review from a summary judgment, we strictly construe the moving party’s affidavits and liberally construe those by the opposing parties. (JEM Enterprises v. Washington Mutual Bank (2002) 99 Cal.App.4th 638, 643.)
1. The Bank and Its Management
Defendant and respondent Western Security Bancorp (Bancorp) was the holding company of defendant and respondent Western Security Bank, N.A. (Bank).
The Bank was founded in 1984. The Bank was regulated and annually audited by the Office of the Comptroller of the Currency (OCC).
In 1992 and 1993, the Bank’s management team and control group included defendants and respondents: (1) chairman of the board, John C. Bell, who held 49.96 percent of Bancorp’s stock; (2) executive vice president and chief operating officer, Edward J. Mylett, Jr., who held 4.41 percent of Bancorp’s stock; (3) senior vice president and chief financial officer Joseph J. DeMieri, who held 13.98 percent of Bancorp’s stock; and (4) president and chief executive officer Jerome E. Farley, who held 7.71 percent of Bancorp’s stock.
There were three outside directors who jointly held about 15 percent of Bancorp’s stock and who also appear as respondents and defendants: (1) Edward D. Carlin; (2) Larry T. Smith; and (3) Carol Dunn Trussell.
The officers, title and share holdings are as of May 2002, the date of the issuance of proxy materials for Bancorp’s sale of the Bank to Citizens Business Bank.
2. The Truck Loan Program
In 1997 or 1998 the Bank implemented a truck loan program targeting sub-prime borrowers, who had greater credit risks. Pursuant to the truck loan program, the Bank financed the acquisition of used trucks and trailers by independent truckers. Plaintiffs presented evidence that the Bank loaned approximately $25 to $29 million for the purchase of used trucks and trailers. Because the target borrowers had a higher rate of risk than traditional banking customers, the Bank charged interest rates higher than regular loans.
3. The Salary Continuation Agreements
In 1997, the Bank instituted an executive compensation plan involving salary continuation agreements. The salary continuation agreements were designed for the purpose of retaining executives.
The salary continuation agreements were an insurance-based retirement plan. The agreements were funded by insurance polices purchased by the Bank. Specifically, the Bank purchased life insurance policies for certain executives and made a one time premium payment for each policy.
Pursuant to the salary continuation agreements, designated executive officers were to receive 80 percent of their salaries for life following separation from the Bank at the age of retirement. If the executive separated earlier, the payment at retirement age would be reduced by a formula based on the length of service. According to the agreements, however, members of the control group could voluntarily retire nine months after receiving the agreements and obtain life-time benefits. If an executive passed away, the insurance company was required to pay the Bank a policy benefit. The policy benefit could be greater than the amount paid the executives.
Four members of the control group, defendants Bell, Farley, Mylett and DeMieri, received salary continuation agreements. There is no evidence in the record as to how much the Bank paid to the insurance company to purchase the salary continuation agreements.
4. Sale of the Bank to Bancorp
Bancorp sold its interest in the Bank in 2002 to Citizens Business Bank (Citizens). The sale price was $6,225,000. Prior to the sale, the members of the control group agreed to shorten the obligation owed to them under their salary continuation agreements from a life entitlement to a 15-year entitlement.
Plaintiffs presented evidence that the sale price of the Bank was low, which was a reflection of the Bank’s poor financial performance. During the eleven year period prior to its sale, the Bank experienced an average annual loss of $133,727. Throughout its existence, the Bank never achieved a return on average investments of one percent, which was the average for similar banks operating in California.
According to the Findley Reports, during the last eleven years of its operation, the Bank satisfied the threshold criteria to receive a “commendable” rating only in 1994 and 1996. In other years, it was not recognized at all due to its sub-par performance. At the time of the sale, Marshall & Stevens, a business evaluation firm hired by Bancorp, compared the Bank to 22 comparable banking institutions. The Bank was ranked last.
The Findley Reports is a banking publication which has, for more than 30 years, reported annually on the financial performance of every banking institution in California. To formulate its analysis, the Findley Reports uses financial information submitted to the regulatory agencies by each banking institution.
5. Plaintiffs File Derivative Action
In June 2004, plaintiffs and appellants Anthony Stella, Jack Leeney, and Ralph Sorrentino, minority shareholders of Bancorp, filed this derivative lawsuit against Bancorp and all seven members of its board of directors, who all appear as defendants and respondents. The complaint alleged that defendants’ actions deflated the value of the Bank, dissipated the Bank’s assets, and caused the shareholders to lose approximately $20 million upon the Bank’s sale. The complaint alleged breach of fiduciary duty, fraud, waste and negligence.
Plaintiffs alleged defendants improperly approved the salary continuation agreements that provided post retirement benefits. Plaintiffs alleged there was no justifiable business purpose for the salary continuation agreements, they were implemented without appropriate analysis, they were excessive, and that the Bank was not in a financial position to fund the obligations. Plaintiffs alleged the Bank’s sale triggered the payment of approximately $8,000,000 to the management team as payment on the salary continuation agreements, which sum was more than the Bank’s sale price. Plaintiffs further alleged the agreements were used as a “vehicle by which the Control Group looted the Bank of approximately half of its fair market value,” thereby drastically reducing shareholder value when the Bank was sold.
Plaintiffs also alleged defendants negligently caused the Bank to enter into the truck loan program that was high risk and without adherence to banking regulations, proper underwriting guidelines or appropriate corporate governance and monitoring procedures. Plaintiffs alleged the program was imprudently designed to quickly increase the Bank’s appearance of profitability in the short-term for purposes of selling the Bank, even though it was known that the loans would ultimately result in substantial losses to the Bank. Plaintiffs also asserted that the program resulted in a financial disaster that diminished the value of the Bank’s sale price.
Finally, plaintiffs alleged several defendants improperly received reimbursement from the Bank for construction to improve their own personal residences. Additionally, it was alleged some defendants improperly received reimbursement from the Bank for personal expenses including travel, meals, lodging, entertainment, club membership, club dues, and automotive expenses. As example, plaintiffs later claimed that the Bank improperly paid for a golf outing to the Pebble Beach golf course.
Plaintiffs sought compensatory and punitive damages, an injunction, and an accounting. Defendants answered.
6. The Bank’s Board of Directors Appoints A Special Litigation Committee
In September 2004, the trial court stayed the derivative action pending an internal investigation by a special litigation committee (the Committee).
In September 2004, Bancorp’s board of directors appointed Julieann K. Coyne (Coyne) and Thomas L. Jeffries (Jeffries) to serve as members of the board of directors. The board also appointed Coyne and Jeffries to serve as the Committee. The board directed the Committee to investigate plaintiffs’ claims and determine whether the litigation should continue.
The Committee hired the law firm of Corbin & Fitzgerald to act as the Committee’s legal counsel. Corbin & Fitzgerald had not previously represented Bancorp, the Bank, or any individual defendant.
7. The Committee Prepares A Written Report
Corbin & Fitzgerald, sometimes accompanied by Coyne or Jeffries, interviewed a total of 10 persons, including: the seven individual defendants; Clayton Cook, a former member of Bancorp’s board of directors who was rumored to have disagreements with Bell; Robert Gallivan, the insurance salesman who prepared the salary continuation agreements; and William Maier, the contractor who had done the questioned construction work. If Coyne did not attend an interview, she received a report from Corbin & Fitzgerald.
Corbin & Fitzgerald reviewed 13 boxes of documents produced by defendants and 222 boxes produced by Citizens Business Bank. The boxes contained copies of the Bank’s expense ledger, the truck loan documents, and invoices for the construction work. While Corbin & Fitzgerald’s billing statements show it expended approximately 190 hours in rendering services to the SLC, there is no description of the work performed. The billing statements are redacted.
Corbin & Fitzgerald drafted the report for the Committee, which was reviewed and modified pursuant to the direction of Coyne and Jeffries. Coyne spent a total of 42.75 hours as a member of the Committee, 15 of which were drafting the special litigation report, 6 hours were in organization, and 2 hours were to open a bank account. Jeffries spent a total of 15 hours as member of the Committee, five hours of which was devoted to drafting and reviewing the final report.
On March 14, 2005, the Committee issued a twelve page report recommending termination of this derivative action. The Committee concluded that continuation of the derivative lawsuit would not be in the interests of Bancorp. The report stated: “Neither the facts nor the law support the Derivative Action. The allegations are based on misunderstandings of what occurred at the Bank. There is virtually no evidence to support the specific allegations. . . . [¶] Although the dearth of evidence would alone support its Determination, the . . . Committee further considered the costs and uncertainties of litigation, the lack of damages, and a possible defense based on the statute of limitations.” The report also noted that it was difficult to prove that the defendants’ actions fell outside the business judgment rule, and the defendants might be entitled to indemnification from Bancorp for the costs of defending the case.
The report set forth a history of the Bank: “John Bell, together with the other original Board members, founded the Bank in 1984. . . . [¶] In 1989, the Office of the Comptroller of the Currency (“OCC”) and the FDIC performed audits at the Bank. The OCC was particularly critical of loans that the then-president, Herb Prinze, had made. Prinze was fired and Bell ran the Bank on an interim basis with the senior vice presidents. [¶] At the direction of the OCC, in 1992-93, the Board sought to bring in more experienced personnel. The Bank then had a “Camel rating 4,” based on [] a scale of 1 to 5 (with 1 meaning excellent and 5 meaning imminent seizure). The Bank then created a new management team. This team closed branches, made personnel cuts and wrote off bad loans. After eighteen months, they had turned the Bank around from a Camel rating 4 to a Camel rating 1, an incredible turnaround.”
The report set forth the origin of the salary continuation agreements: “In 1996, the Bank purchased Ancor Finance, owned by William Brosnan. Ancor Finance was a finance company that specialized in high-rate loans. Brosnan was hesitant about becoming part of the Bank without some sort of retirement protection. Therefore, Brosnan suggested a salary continuation agreement. As discussed below, the Board was eager to maintain continuity of management, and therefore approved salary continuation agreements for Brosnan, Bell, Farley, Mylett, and DeMieri.”
The report further stated: “The Board was concerned about the stability of its management team. The members of the management team, particularly Mylett, were receiving solicitations from other banks, especially banks with a Camel rating of 4 that wanted to duplicate the Bank’s success. The Board had approved a salary continuation agreement for Brosnan (not challenged by plaintiffs) in 1996. Based upon the need for stability, the Board approved salary continuation agreements for Bell, Farley, and Mylett in 1997 and DeMieri in 1999. . . . The premiums were paid when the plans were executed.”
The Committee found that salary continuation agreements were common in the industry, as 220 of the approximate 300 banks in California had such agreements. The Committee noted that the purchasing bank, Citizens, “had its own salary continuation agreements with its key executives. It was not opposed to the salary continuation agreements in principal. However, its own salary continuation agreements only lasted for fifteen years. And having recently acquired other banks with salary continuation agreements, Citizens [] wanted uniformity. In order not to block the acquisition, the holders of the agreements agreed to amend them to provide 80% of the final salaries for fifteen years only, in lieu of any other benefits under the agreements.”
The Committee summarized the process by which the Board approved the salary continuation agreements: “Before approval, Farley prepared an analysis of the salary continuation agreements that considered all of the appropriate factors, based on offering agreements to himself and Mylett. . . . The disinterested directors who were not receiving salary continuation plans understood the plans and believed that they were necessary to keep management intact.” Moreover, the Committee explained that “[i]n its audits, the OCC never complained about the plans or the total compensation received by management.
The Committee explained that “[p]laintiffs’ basic contention is that the salary continuation agreements affected the purchase price and therefore siphoned money from the shareholders to the holders of the agreements. This contention is incorrect, based on the structure of the agreements as an insurance-based pension plan.” The retirement benefits to be paid pursuant to the salary continuation agreements were funded through life insurance policies on each recipient. The cash surrender value of the policies constituted an asset to the Bank that offset any liability for the post-retirement payments paid to the recipients.
The Committee concluded that the salary continuation agreements did not justify pursuing the derivate action for the following reasons: the prevalence of the agreements in the banking industry; the execution of the agreements and the payment of the premiums long before negotiation for the sale of the Bank; the full disclosure to the Board of the pros and cons of the agreements and the consideration of alternatives; and the existence of the cash surrender value of the policies as a countervailing asset to the liability of making payments under the agreements.
The Committee found that the truck loan program initially was successful. The Committee explained that in 1996, the Bancorp acquired Ancor Finance as a means of growth. The Committee stated in the report: “Ancor Financing specialized in accounts receivable loans, i.e., factoring. The loans were profitable at first but became less so in the face of more competition. Ancor Finance therefore branched out to making ‘trucking loans,’ i.e., loans made to trucking independent owner-operators to purchase their trucks, with the Bank holding a security interest in the truck. As described by [defendant] Mylett, the borrowers had low incomes and did not have long credit histories. On the other hand, the rates were very high – sometimes 22 [percent]. A review by counsel of the trucking loan files supports Mylett’s statements.”
The Committee explained that the program was an initial success. In 1999, many of the borrowers defaulted when the price of diesel fuel rose significantly. The Committee found that General Electric suffered the same problem.
The Committee also explained that in 2000, when the number of defaults began to rise, the Bank instituted new underwriting criteria that essentially ended the program. The total loss to the Bank was approximately $3 million. The Committee also noted that defendant Trussell, a member of the board, “believed that in hindsight the program had probably been a mistake, but she confirmed that the Board was aware of the problem.” According to the report, Trussell stated that “the truck loans were made as deliberate business decision after due diligence.”
The Committee concluded that the truck loan program did not support the derivative lawsuit. The Committee noted that the OCC never objected to the program and the portfolio generated only 20 percent of the Bank’s historical losses. The Committee also found there was no evidence the program was devised in order to create a false “snapshot” of the Bank’s financial worth. The Committee explained that otherwise, management would have attempted a merger far earlier than 2002. The report noted that it was after the trucking portfolio suffered losses that the Bank began negotiations with Citizens.
The Committee concluded that the allegations that the directors received improper benefits were unfounded. The Committee found that defendants Bell, Farley, Mylett, and DeMieri each personally paid to remodel their own homes. Further, Bell believed the expenditure for an alarm on his house was appropriate because it lowered the insurance premium on a policy held by the Bank. Also, the Bank had paid for shelves in defendant Farley’s home office; however, this payment would not warrant litigation as the cost was less than $10,000.
With regard to other expenses, such as the trip to Pebble Beach costing $15,000, the Committee concluded such expenses were appropriate “public relations and business development tool[s].” The Committee also reported that it had “identified and investigated the most suspicious [expenses]. There was some basis for them. [However, n]o rational plaintiff would sue on the basis of these expenses.”
For example, in the report, the Committee explained that the records showed a tuition reimbursement to defendant Bell’s son in the amount of $2,244 for Pepperdine Business School. The Committee explained: “This was pursuant to a highly organized program that paid for classes related to banking. A number of employees were reimbursed through this program, including two tellers unrelated to Bell.”
In conclusion, the Committee stated: “The Committee’s opinion is that the Derivative Action arose from personal disappointment with Bell as Lakeside Country Club, combined with a lack of understanding of the salary continuation agreements. When there things are put aside, the Derivative Action is a not a lawsuit that a well-advised plaintiff would pursue.”
8. Defendants Move for summary judgment
Defendants filed a summary judgment motion contending the special litigation committee defense entitled them to judgment as a matter of law. Defendants asserted that the Committee was independent and that it conducted an adequate investigation into the merits of plaintiffs’ claims before determining that the derivative litigation was not in the best interests of the Bank.
9. Plaintiffs’ Opposition to Summary Judgment
In their opposition, plaintiffs asserted that there were triable issues of material fact as to whether the Committee was independent and whether the Committee conducted an adequate investigation into the merits of plaintiffs’ contentions.
a. Plaintiffs’ Evidence Regarding the Independence of the Committee
Plaintiffs presented the following evidence to support their assertion that Coyne and Jeffries, the Committee members, were not independent.
The Chairman of the Board of Bancorp, defendant Bell, consulted with his life-long friend and attorney, John Karns, about the lawsuit. Karns and defendant Bell considered a number of people who would be appropriate to be members of a special litigation committee, including Julieann K. Coyne and Thomas L. Jeffries. Defendants’ counsel, Munger, Tolles & Olsen, also evaluated these individuals.
Karns was not only defendant Bell’s friend, but Karns owned shares in the Bank, had sat on the Bank’s board of directors, had represented the Bank, and was also a personal friend, attorney and investment partner of both Coyne and Jeffries.
In the 1980’s, Coyne owned a consulting business. During that time, she was an organizing consultant to the Bank in the early 1980’s, during which time she advised the Bank before it opened for business. She helped obtain the initial staff for the Bank. Coyne was a former shareholder in Bancorp. Coyne had known defendant Bell since the early 1980’s. Coyne and Bell had mutual friends.
In addition, Coyne has known most of the members of the Bank’s board for years. Defendant Mylett and Coyne have known one another for 25 years. Defendant Mylett was one of Coyne’s clients. Coyne received loans from the Bank, had her checking account there, and had set up the checking account for the Committee there.
Jeffries was an executive of a printing company that served the banking and securities industry. Jeffries was an initial investor in the Bank, when he purchased 25,000 shares of stock. Jeffries formerly served on the board of two companies he started. Jeffries first met Bell in the 1960’s and they had a number of friends in common. Jeffries was a guest at a golf outing arranged by Bell at Pebble Beach.
Neither Coyne nor Jeffries previously had served as a Bancorp board member or as an officer of Bancorp or the Bank.
Bancorp’s counsel Karns selected the law firm of Corbin & Fitzgerald as potential counsel for the Committee. Chairman Bell contacted Coyne to be present for a meeting at the law offices of Corbin & Fitzgerald. Prior to that time, neither Coyne nor Jeffries had ever heard of the law firm.
The following persons were present at the first meeting at Corbin & Fitzgerald: Coyne, Dennis Kinnaird (counsel for Bancorp and Bell), Bell, and attorneys from Corbin & Fitzgerald. Jeffries was not present. During the meeting, Coyne asked Bell and his attorneys to leave the room to meet with the attorneys from Corbin & Fitzgerald.
After a second meeting, Coyne hired Corbin & Fitzgerald to act as the Committee’s legal counsel. Neither Coyne nor Jeffries considered another law firm to represent the Committee.
b. Plaintiffs’ Evidence Regarding the Alleged Inadequacy of the Committee’s Investigation
Plaintiffs presented evidence that the Committee did not interview, consult, nor engage any outside experts, such as banking consultants. The Committee did not talk to bank management level employees who implemented the truck loan program.
Plaintiffs also presented evidence that the Committee did not independently analyze or investigate any of the information it received from defendants, insurance salesman Gallivan, or the contractor, Maier. The Committee did not conduct an independent economic analysis of the salary continuation agreements or the truck loan program, or have an accounting expert do such an evaluation.
Plaintiffs asserted that the Committee did not compare the Bank’s executive salaries with those of other banks. Plaintiffs noted that Committee member Coyne testified at deposition that once a witness provided an explanation for a questioned action, the Committee did not conduct additional research.
Plaintiffs noted that there was no evidence that the Committee or its counsel examined relevant corporate governance documents, such as minutes of the Bank’s board of directors. In addition, the board of director’s minutes of the Bank and of Bancorp contain no evidence showing that either board (Bank or Bancorp) evaluated the salary continuation agreements.
Plaintiffs also relied on the declarations of expert witnesses, Thomas Tarter and Gary Findley, and a former bank employee, Shawn Faeth, to raise triable issues of fact that the Committee did not conduct an adequate investigation into the merits of plaintiffs’ allegations.
i. Plaintiffs’ Expert, Thomas Tarter, Declares The Investigation Was Inadequate
Thomas Tarter (Tarter) was the managing director of the Andela Consulting Group, Inc., a consulting firm providing services relating to financial management and boards of directors. He had 35years of experience in the financial industry.
After reviewing pertinent information, Tarter declared that the investigation done by the Committee into the salary continuation agreements and truck loan program was inadequate, superficial, and lacked in-depth independent analysis. Tarter declared that a proper investigation would have involved, among other aspects: (1) a review of the process by which the Bank’s board determined to grant the salary continuation agreements and implement the truck loan program, including whether the Board examined peer compensation packages and the profitability of the truck loan program; (2) a determination of the cost to the Bank of the salary continuation agreement; (3) an analysis of the Bank’s profitability to determine entitlement to salary continuation compensation and the need to retain executives; (4) a comparison of the regulatory guidelines for the truck loan program; (5) an examination of board minutes and board packets to ascertain the depth of the analysis given to the board before authorization of the salary continuation agreements and the truck loan program; (6) an analysis of the truck loan files; and (7) a review of the Bank’s books and records to address concerns that the Bank improperly paid for personal expenses.
Tarter declared that his “review of the . . . Board Minutes disclosed no substantive consideration, in any form, of the [salary continuation agreements] and any aspect of their proposal, evaluation, adoption, implementation and funding. This wholesale departure from normal corporate governance and custom and practice strongly suggests that the claims based on the SCA’s are meritorious.”
Tarter noted that the Committee interviewed only the beneficiaries of the salary continuation agreements, the man who sold the agreements, and the contractor who provided services to the defendants. Tarter’s review showed the Bank was “burdened by a particularly heavy load of executive compensation for a bank of its size and profitability.”
Tarter further declared that he reviewed all of the “Board Packages” of the Bank and the Bank Board Minutes from 1996 to 2002 which were produced by defendants and by CBB. His purpose in reviewing the board packets and board minutes was to determine whether the adoption of the Truck Loan Program conformed to regulatory guidelines and to the norms for corporate governance in the banking industry. Tartar expected to find that any adoption by the Board of Directors of Bank of the Truck Loan Program would be based upon a highly detailed board packet, including substantial financial analysis and projections, as well as the other elements specifically referred to in the regulatory guidelines. Tartar explained that there were no board packets that contained the material required by the regulatory guidelines. He found no minutes addressing the evaluation, adoption, implementation, monitoring and operation of the truck loan program. Tartar concluded that the Bank failed to employ normal corporate governance with respect to the sub-prime truck loan program.
Tartar also declared that he conducted a limited financial analysis of the truck loan program. He declared that the program was profitable in 1998 and 1999, but began incurring a pre-tax income loss in 2000. He further declared that for the period from 1998 to 2001, the truck loan program was not profitable.
According to Tarter, had the Committee gone behind the statements given by those interviewed, the Committee could have learned that the “disastrous financial consequences of the [truck loan program] necessarily diminished the perceived value of the Bank and caused it to be sold at a highly diminished price due to its financial condition.”
Further, Tartar explained that the Committee failed to properly examine the Bank’s check journals and expense logs and that the Committee did not employ a bookkeeper or accountant to review the documents. Tarter declared that based upon his review of the nature, frequency and amount of expenses in 1999 and 2000, there were $339,300 in questionable expenditures “well outside the norms for the industry and inappropriate in an institution with such poor financial performance.”
ii. Plaintiffs’ Expert, Gary Findley, Declares, inter alia, that the Bank had a Net Loss
Gary Findley (Findley) was an attorney specializing in the organization, reorganization, merger and acquisition of independent banks and other financial institutions. He was the president and owner of Findley Reports, Inc., which published the Findley Reports. (See fn. 5.) He examined financial information from the appropriate regulatory agencies and the Bank’s books and records. Findley analyzed the Bank’s financial performance and concluded it was poor and reflected ineffective management. Findley explained that during the eleven years prior to the Bank’s sale to Citizens, Bank’s average profits showed a loss of $133,000 per year. He declared that the sale price for the Bank was low.
Findley further declared the following: At most, one-half of the banks have salary continuation agreements, and if they do, they are usually not given to all members of senior management; the Bank had excessive compensation obligations to the senior management, including the overly burdensome salary continuation agreements; the salary compensation agreements were unreasonable as they permitted payments for voluntary retirement inconsistent with industry standards; the salary continuation agreements were given in spite of the Bank’s poor performance; the shareholders did not receive adequate disclosure of the cost of the agreements.
Findley concluded his declaration as follows: “If one assumes that elimination of the [salary continuation agreement] program would have restored $5 [million] to the book value of Bank at the time of [the] sale to [Citizens] and that the losses to Bank on account of the [truck loan program] in an amount of $5 [million] had not been incurred, the book value of the Bank would have increased by approximately $10 [million]. Assuming that Bank [was] an average performing Bank, that 10 [million] increase in book value would result in an increase in the sale price of approximately $20 [million.] Under such assumed circumstances, the sale price to [Citizens] would have then approximated $26 [million] – not the $6 [million] actually paid.”
iii. Plaintiff’s Witness and Former Bank Employee, Shawn Faeth, Filed a Declaration About the Truck Loan Program
Shawn Faeth (Faeth) worked at the Bank from 1994 to 2000. He declared that “[i]n or about 1997 or 1998, I was offered a position to work at Ancor finance [sic] for William Brosnan doing ‘assert-based lending.’ It was my understanding the Bank had purchased Mr. Brosnan’s company with the hope of growing its loan portfolio into other areas due to the lack of growth in the commercial lending area.” Faeth explained that the truck loan program was rung through Ancor Finance.
Faeth declared that Brosnan and other unidentified members of the control group told him that the truck loan program was to “quickly increase the appearance of the profitability of the Bank by increasing earning assets.” He also declared that he did “not recall the exact words used but it was made clear to me that the Bank’s goal was to put as many loans on the books as possible in the shortest period of time.”
According to Faeth, when the Bank instituted the truck loan program, management went into it “blind with little or no research, making loans up to 80% of whatever invoice was sent over by the dealers.” Faeth explained that the trucks were over valued as collateral; there were no underwriting manuals or guidelines; and only after the Bank repossessed trucks, did management learn that dealers had over valued them.
Faeth further declared: “Prior to the implementation of the Truck Loan Program . . . the Bank did not engage in any analysis, study or comprehensive due diligence directed to sub-prime lending – a new field for the Bank.” Faeth explained that there were no profitability projections prepared for the program. He noted that Bank employees were “pushed to fund as many truck loans as possible, regardless of creditworthiness, and without reference to any profitability goals, limits or short or long term lending policy or program.”
Faeth also compared the truck loan program against the Bank’s automobile loan program. Faeth explained that the loans differed because auto loans were local in nature in contrast to the truck loans, pursuant to which the truck drivers were often out of state, which led to higher costs for repossession. In addition, Faeth noted that in contrast to the auto loan program, the Bank did not have dealer loan agreements with the truck dealers, which would have provided the Bank with recourse against the dealers if the loans went into default. Faeth explained: “The lack of recourse against the truck dealers also meant that the truck dealers had no financial motivation to carefully ‘vet’ the loans, including the collateral and the borrower.”
When Faeth questioned the soundness of the program, defendant Mylett threatened to fire him. The Committee did not contact Faeth about the truck loan program.
10. The Trial Court Grants Summary Judgment
The trial court granted summary judgment in favor of defendants. In a statement of decision, the trial court found that plaintiffs failed to raise a triable issue of material fact as to either the independence of the Committee or the adequacy of its investigation. The trial court overruled defendants’ objections to the declarations of Tarter, Findley, and Faeth. The trial court noted, however, that it was not considering portions of the Faeth declaration that constituted unsupported hearsay and those portions which lacked any foundation.
The trial court entered judgment in favor of defendants. Plaintiffs timely appealed from the judgment.
CONTENTIONS
Plaintiffs contend that they raised triable issues of material fact as to whether the Committee was independent and whether the Committee conducted an adequate investigation.
STANDARD OF REVIEW
“This court reviews de novo a trial court’s order granting a motion for summary judgment. [Citation.] A defendant moving for summary judgment must show that either one or more elements of the plaintiff’s cause of action cannot be established, or that there is a complete defense to that cause of action. (Code Civ. Proc., § 437c, subd. (p)(2); Aguilar v. Atlantic Richfield Co. (2001) 25 Cal.4th 826, 849.)” (Hemady v. Long Beach Unified School Dist. (2006) 143 Cal.App.4th 566, 573.)
“Once the defendant meets its burden, the burden shifts to the plaintiff to set forth ‘specific facts’ showing that a triable issue of material fact exists. [Citations.] The moving party’s affidavits must be construed strictly and the opponent’s affidavits must be construed liberally, and any doubts as to the propriety of granting the motion must be resolved in favor of denial. [Citation.]” (JEM Enterprises v. Washington Mutual Bank, supra, 99 Cal.App.4th at p. 643.)
“[T]he summary procedures utilized in California protect legitimate shareholder suits while permitting exclusion of meritless claims. When the special litigation committee defense reaches the trial court on summary judgment, traditional summary judgment rules apply. . . . Therefore, if a trial court detects a factual dispute concerning the independence of the special litigation committee or the adequacy of its investigation, the case may not be dismissed short of trial.” (Desaigoudar v. Meyercord (2003) 108 Cal.App.4th 173, 189-190 (Desaigoudar).)
DISCUSSION
1. The Special Litigation Committee Defense
The trial court found that plaintiffs did not raise a triable issue of material fact as to the independence of the special litigation committee or the adequacy of its investigation. We therefore begin by setting forth a brief explanation of derivative lawsuits, the business judgment rule and the defense based upon findings of a special litigation committee.
a. Shareholders’ Derivative Lawsuits
A corporation is a legal entity separate from its shareholders. When a corporation suffers injury, the corporation possesses the right to sue for redress. If a corporation fails to pursue litigation, a shareholder may file a derivative action on behalf of the corporation. The rights of the plaintiff shareholders derive from the primary corporate right to redress the wrongs against it. (Desaigoudar, supra, 108 Cal.App.4th at p. 183.)
b. Business Judgment Rule
The business judgment rule is codified in Corporations Code section 309 (section 309). (Desaigoudar, supra, 108 Cal.App.4th at p. 183.) Section 309 provides in pertinent part: “(a) A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. [¶] (b) In performing the duties of a director, a director shall be entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by any of the following: [¶] (1) One or more officers or employees of the corporation whom the director believes to be reliable and competent in the matters presented. [¶] (2) Counsel, independent accountants or other persons as to matters which the director believes to be within such person's professional or expert competence. [¶] (3) A committee of the board upon which the director does not serve, as to matters within its designated authority, which committee the director believes to merit confidence, so long as, in any such case, the director acts in good faith, after reasonable inquiry when the need therefor is indicated by the circumstances and without knowledge that would cause such reliance to be unwarranted. [¶] (c) A person who performs the duties of a director in accordance with subdivisions (a) and (b) shall have no liability based upon any alleged failure to discharge the person's obligations as a director.”
The business judgment rule is based upon the principle that management of a corporation is best left to those to whom it has been entrusted, not to the courts. The rule requires judicial deference to the business judgment of corporate directors when there is no fraud, breach of trust or conflict of interest exists. (Desaigoudar, supra, 108 Cal.App.4th at p. 183.)
With respect to pursuing litigation, directors have the same discretion as they have in other business matters. When a board of directors acts in good faith within the scope of its discretionary power and reasonably believes its refusal to commence an action is good business judgment in the best interest of the corporation, a stockholder is not authorized to interfere with such discretion by commencing an action. (Desaigoudar, supra, 108 Cal.App.4th at p. 184.)
c. Special Litigation Committee
The business judgment rule can protect a board’s good faith decision to reject a derivative lawsuit. A board of directors, however, cannot avail itself of the protection of the business judgment rule in deciding not to pursue a derivative lawsuit when a majority of the board had a personal interest in the outcome of the lawsuit. Thus, when a shareholder alleges wrongdoing on the part of a majority of directors, the common practice is for the board to appoint a special litigation committee of independent directors to investigate the challenged transaction. (Desaigoudar, supra, 108 Cal.App.4th at pp. 184-185.)
A decision by a special litigation committee not to prosecute a lawsuit can be a defense to a shareholder’s derivative action in California. (Desaigoudar, supra, 108 Cal.App.4th at pp. 184-185.) In addition, “judicial review of the decision of a special litigation committee is governed by the business judgment rule.” (Id. at p. 179.)
2. Independence of the Special Litigation Committee and Adequacy of its Investigation
To prevail on a motion for summary judgment based upon the special litigation committee defense, the moving party must establish that the Committee was independent and that it conducted an adequate investigation. Thus, on a motion for summary judgment, the court’s responsibility is to determine if there are triable issues of fact as to whether a committee of disinterested directors acting in good faith determined that a derivative action was not in the best interests of the corporation. (Desaigoudar, supra, 108 Cal.App.4th at p. 179.)
a. Plaintiffs Failed to Raise a Triable Issue of Material Fact as to the Independence of the Committee
With respect to whether the members of a special litigation committee are independent, we must determine whether each member was “ ‘ “in a position to base his decision on the merits of the issue rather than being governed by extraneous considerations or influences.” ’ ” (Desaigoudar, supra, 108 Cal.App.4th at p. 189.) In this regard, a “director’s position with respect to the allegations of the claim and all extraneous influences are subject to the court’s scrutiny.” (Ibid.)
According to Katz v. Chevron Corp. (1994) 22 Cal.App.4th 1352, “[a] director’s association with a company that does business with the corporation does not in and of itself establish a lack of independence.” (Id. at p. 1368.) Instead, the issue is whether the members of the special litigation committee were in a position to be influenced by the alleged association. (Id.)
In this case, the Committee was comprised of two members, Coyne and Jeffries. As to their independence, defendants established that neither Coyne nor Jeffries had previously served as an officer or director of Bank or Bancorp. In fact, they were not officers or directors during any of the challenged transactions. In addition, neither Coyne nor Jeffries had any ongoing business dealings with any defendant during the time that they served on the Committee.
Plaintiffs assert that they raised a triable issue of material fact as to the independence of Coyne and Jeffries. Summarizing, plaintiffs assert the following: Coyne and Jeffries had known defendant Bell for decades, they had mutual friends in common, and they all used the same attorney, John Karns. Bell, Coyne and Jeffries all consulted with Karns prior to formation of the Committee. Plaintiffs also assert that defendant Bell in conjunction with attorney Karns selected Corbin & Fitzgerald to be counsel for the Committee.
Plaintiffs asserted that Coyne was not independent because: she performed work for Bank; she was a former shareholder of Bank; she had taken loans from the Bank (with the last loan paid off four to five years prior to her deposition); she had an account at Bank since it first opened; and she opened the Committee’s bank account at the Bank.
With respect to Coyne, plaintiffs presented evidence that she served as an organizational consultant and headhunter to financial institutions like banks. Specifically, plaintiffs presented evidence that Coyne had met defendant Bell in 1982 or 1983 in her capacity as a consultant and head-hunter for those opening banks or savings and loans. At that time, Coyne participated in the formation of the Bank by serving as a headhunter and providing the Bank with some of its personnel. In her capacity as a headhunter for Bank, Coyne received a monthly retainer until the Bank opened in 1984. Coyne continued to place personnel at the Bank for the next four to five years after it opened.
Coyne testified at deposition: “I had a business, it was called Coyne and Associates. . . . I was the consulting organizing person who would help potential boards of directors open banks or savings and loans. . . . I would help them do whatever they needed to have done to work for the government agencies; hire the key personnel, put the policies and procedures in order, get the location, help them get other directors, help them sell their stock. So I was known in the financial institution industry as somebody who worked with potential boards to open up their organization and to staff it appropriately so they can move forward.”
Moreover, prior to her appointment to the Board, Coyne was acquainted with most of the directors on the board of Bancorp or Bank, including defendants Larry Smith, Edward Mylett, Jerome Farley and John Bell. With respect to defendant Mylett, Coyne had known him for 25 years, and he had hired personnel Coyne presented to him in her capacity as a headhunter.
With respect to Jeffries, plaintiffs note that he had been involved in printing, copying, computer re-sales and internet start-up businesses. Plaintiffs assert that Jeffries was not independent because: Jeffries met Bell in the 1960’s at the Jonathon Club; Jeffries was an initial investor in the Bank with 25,000 shares (which he still owned at the time of this 2005 deposition); Jeffries had limited contact with defendant Bell over the years at a country club; and he was a guest at a Pebble Beach golf outing paid for by the Bank.
With respect to the Pebble Beach golf outing, plaintiffs assert that because Jeffries was a beneficiary of the outing, he had a conflict of interests with respect to one the Bank’s transactions the Board asked him to investigate.
Plaintiffs also presented evidence that Coyne, Jeffries, and defendant Bell all employed the same lawyer, John Karns. According to Coyne’s deposition testimony, she first met attorney Karns when she was an organizing consultant for the Bank in 1982. He worked for her on a number of legal matters. Before agreeing to serve on the Committee, Coyne consulted with attorney Karns.
Jeffries had known attorney Karns for 45 years. They meet in 1962. Karns had served as Jeffries’ attorney over the years. Karns contacted Jeffries to inquire whether Jeffries would serve on the Committee.
Having considered the foregoing facts and reviewed the deposition testimony of Coyne, Jeffries and defendant Bell, we reject plaintiffs’ assertion that there are triable issues of material fact as to Coyne’s or Jeffries’ independence. The deposition testimony of Coyne, Jeffries and Bell shows that they were not close social acquaintances, but instead, knew each other tangentially and had some common acquaintances. In other words, the social relationships between Coyne and Bell and Jeffries and Bell were not significant. There is nothing about these relationships to suggest that Coyne and Jeffries were somehow subject to extraneous considerations or influences because they knew defendant Bell and interacted with him during infrequent social encounters.
In addition, with respect to business relationships, the record shows that Coyne served as a consultant/headhunter for the Bank in the early 1980’s. She ceased placing personnel at the Bank in the 1980’s. The fact that she had taken loans from Bank and maintained accounts there are not significant business contacts.
Moreover, with respect to Jeffries, the only business relationship he had with the Bank or defendant Bell was his initial investment of 25,000 shares in Bank. This investment, however, does not raise a triable issue of material fact as to Jeffries’ independence. If anything, such an investment would have given Jeffries an incentive to truly investigate the merit of plaintiffs’ claims. If Jeffries concluded that plaintiffs’ claims had merit, he would have had a financial incentive to pursue the litigation on behalf of Bank in order to increase the value of his investment.
Finally, the fact that Coyne, Jeffries, and Bell shared the same attorney, Karns, does not raise a triable issue of material fact as to Coyne and Jeffries’ independence. There is no evidence that Karns acted improperly by suggesting to Bell that Coyne and Jeffries could serve on a special litigation committee. In this regard, the Desaigoudar court explained that “it is an inescapable aspect of the corporation’s predicament that a special litigation committee has to be appointed by interested directors.” (Desaigoudar, supra, 108 Cal.App.4th at p. 188.)
Moreover, there is nothing improper about Coyne and Jeffries consulting with Karns as to whether they should serve on the Committee. As this litigation demonstrates, service on a special litigation committee can be difficult, time consuming, and embroil one in derivative lawsuit litigation. Seeking legal advice before agreeing to accept such an appointment should only be encouraged.
The present facts are akin to those in Desaigoudar, supra. There, the court affirmed summary judgment in favor of the defendants based upon the special litigation committee defense. The court concluded that the plaintiffs had failed to raise a triable issue of material fact as to the independence of the members of the special litigation committee. In Desaigoudar, two directors, Waite and McCranie, were appointed to the board of the corporation and the special litigation committee after the events alleged in the complaint. Neither had served as a director, officer, or employee of the corporation. The special litigation committee retained a law firm that had never represented the corporation or any of the five individual defendant board members. The Desaigoudar court explained that committee members Waite and McCranie did not have any significant business dealings with any of the defendants and that they did not have any significant social contact with any of the defendants. (Desaigoudar, supra, 108 Cal.App.4th at pp. 192-193.)
On the record presented, plaintiffs have failed to raise a triable issue of material fact as to the independence of Coyne or Jeffries. Neither person had any significant business or social contacts with any defendant in this case. Plaintiffs have not presented evidence to show that Coyne or Jeffries were subjected to extraneous influences or considerations that would have made them less than independent.
Significantly, section 309, subdivision (b)(2), expressly permits a director to rely upon information and financial data prepared by independent counsel. In this case, defendants established that the Committee retained independent outside counsel, Corbin & Fitzgerald, to assist it in investigating plaintiffs’ claims. While Bell and attorney Karns arranged the first meeting with Corbin & Fitzgerald, at that meeting Coyne asked that everyone exit the meeting room, including defendant Bell and his attorneys, so that she could meet with the Corbin & Fitzgerald lawyers in private. Then, after a second meeting with the lawyers from Corbin & Fitzgerald, which Coyne and Jeffries attended, the Committee selected the firm to be counsel for the Committee.
Coyne did not interview any other law firms. She testified that the Committee had a lot of work to perform in a short amount of time and wanted to hire counsel as quickly as possible.
Corbin & Fitzgerald had not represented any individual defendant, Bank or Bancorp. Plaintiffs presented no evidence to suggest that Corbin & Fitzgerald had a conflict of interest or was otherwise not independent. In addition, Committee members Coyne and Jeffries had never met anyone from Corbin & Fitzgerald prior to the firm’s retention in this case. Notably, Corbin & Fitzgerald prepared the written report on behalf of the Committee.
In conclusion, with respect to the law firm of Corbin & Fitzgerald, plaintiffs failed to raise a triable issue of material fact as to the independence of the law firm. There is no evidence that the firm was influenced by any extraneous considerations.
b. Plaintiffs Failed to Raise a Triable Issue of Material Fact to Show that the Committee’s Investigation was Inadequate
Plaintiffs contend there are triable issues of material fact with regard to whether the Committee conducted an adequate investigation. We disagree.
In order to raise a triable issue of material fact as to the inadequacy of the investigation, plaintiffs must show that the procedures employed by the Committee were so inadequate to suggest fraud or bad faith. (Desaigoudar, supra, 108 Cal.App.4th at p. 189.) According to the Desaigoudar court, “ ‘[p]roof . . . that the investigation has been so restricted in scope, so shallow in execution, or otherwise so pro forma or halfhearted as to constitute a pretext or sham, consistent with the principles underlying the application of the business judgment doctrine, would raise questions of good faith or conceivably fraud which would never be shielded by that doctrine.’ ” (Id. at p. 189.)
In Katz, supra, the court explained: “A prima facie showing of good faith and reasonable investigation is established when a majority of the board is comprised of outside directors and the board receives the advice of investment bankers and legal counsel.” (Katz, supra, 22 Cal.App.4th at pp. 1368-1369.)
On this record, defendants have thus made a prima facie showing of a reasonable investigation. The special litigation committee was comprised of two outside and independent directors, Coyne and Jeffries, who hired independent and outside counsel, Corbin & Fitzgerald, to investigate plaintiffs’ allegations.
Corbin & Fitzgerald billed a substantial 190 hours for its time to investigate plaintiffs’ allegations. In addition, the Corbin & Fitzgerald attorneys examined more than 220 boxes of documents, they participated in the interviews of ten witnesses, including the defendants, the person who sold the salary continuation agreements (Robert Gallivan), and the contractor who worked on the homes of some of the directors.
As noted by the trial court in its statement of decision, while the firm’s billing records are redacted, the record shows that plaintiffs made no attempt to depose the attorneys. Notably, the trial court found and we agree that “[t]here is no evidence that Plaintiffs were precluded discovery on the steps taken by the [Committee] or its counsel to investigate Plaintiffs’ claims. In fact, Plaintiffs were provided with all interview memoranda and notes, and, in addition to having access to all of the documents that were reviewed by the [Committee] or its counsel, Plaintiffs were provided a binder of documents that the [Committee] considered to be significant. Moreover, Plaintiffs never sought to depose Corbin & Fitzgerald. Further, while Plaintiffs now argue that the [Committee’s] investigation was inadequate because of its failure to contact more persons with relevant information (such as Shawn Faeth, a Bank employee who was involved at a high level with the Truck Loan Program), Plaintiffs themselves refused to be interviewed by the [Committee] and thus failed to assist the [C]ommittee in locating additional witnesses and identifying other appropriate avenues of inquiry.”
In addition, the written report further supports the conclusion that the Committee undertook an adequate investigation. The Committee looked into each one of plaintiffs’ allegations. The Committee examined salary continuation agreements, explained their history, and noted the facts that Citizens, the purchasing bank, and the OCC had no objection to the agreements.
Likewise, the Committee investigated the truck loan program and reviewed numerous documents related to the practice. The Committee noted that the OCC did not object to the program and that other lenders, like General Electric, suffered similar problems as the Bank when the price of diesel fuel rose. In addition, the Committee rejected plaintiffs; suggestion that the program was conducted to provide some sort of false snap shot of the Bank’s financial worth. The Committee found that the Bank’s management commenced merger negotiations after the truck loan portfolio suffered losses.
On this record, plaintiffs have failed to raise a triable issue of material fact that the Corbin & Fitzgerald’s investigation was inadequate or pro formaor halfhearted as to constitute a pretext or sham.
Plaintiffs, however, make a number of additional criticisms of the Committee’s investigation. Plaintiffs assert that Coyne and Jeffries spent little time on their task to evaluate plaintiff’s allegations. Together Coyne and Jeffries expended a total 57.75 hours in service of the Committee, only half of which was actually spent investigating or evaluating the charges. The rest of the time was spent on writing the Committee’s report and organizational matters.
Plaintiffs also assert that the Committee did not cross-check the data provided by those interviewed with outside sources. In fact, plaintiffs note that in her deposition Coyne testified that she accepted at face value the information she received from those interviewed.
In addition, plaintiffs criticize the Committee because it did not consult with experts on banking matters, executive compensation, or loan programs. Plaintiff also assert that the Committee did not interview persons involved in the truck loan program, such as bank management level employees, like Shawn Faeth. The Committee did not examine the applicable banking regulations, nor interview employees in the Bank who worked in the truck loan program.
Plaintiffs also assert that the Committee did not look at the Bank’s minutes, books, records, or bylaws, or other documents that might have disclosed if the Board had done any analysis when the truck loan program was instituted and the salary continuation agreements were granted.
Finally, plaintiffs assert that the declarations of Tartar, Findley and Faeth raise a triable issue of material fact as to the adequacy of the Committee’s investigation.
Considering plaintiffs’ criticisms and the declarations of plaintiffs’ exerts, as well as the Bank’s former employee Shawn Faith, we reject plaintiffs’ assertion that the Committee’s investigation was inadequate. Our task is not to review the merits of the Committee’s conclusions. (Desaigoudar, supra, 108 Cal.App.4th at p. 179.) However, “ ‘[i]t [is] necessary for the court to consider whether, on the facts alleged, the refusal of the directors to prosecute the claims was so clearly against the interests of the corporation that it must be concluded that the decision of the directors did not represent their honest and independent judgment.’ ” (Desaigoudar, supra, 108 Cal.App.4th at p. 189.)
Plaintiffs have made no showing that if the Committee had performed all the additional investigatory steps suggested by plaintiffs, the Committee would have reached a different result as to the merits of plaintiffs’ claims. In other words, plaintiffs have not shown that the refusal of the Committee to prosecute the claims was clearly against the interests of Bank.
For example, plaintiffs did not present expert testimony to show that had the Bank not purchased the salary continuation agreements or initiated the truck loan program, the sale price of the Bank would have been higher. In fact, the expert declaration of Findley is speculative and lacks probative value. He declared that if one assumed that elimination of the salary continuation agreements would have saved the Bank $5 million, the sale price of the Bank would have increased by approximately $20 million. Such speculative evidence does not raise a triable issue of material fact.
We hold that on the facts before us, a reasonable trier of fact could not conclude that the Committee’s investigation was so inadequate to suggest bad faith. Plaintiffs have therefore failed to raise a triable issue of material fact as to the adequacy of the Committee’s investigation.
DISPOSITION
The summary judgment is affirmed. Defendants are awarded costs on appeal.
We concur:
KLEIN, P. J., CROSKEY, J.