By: William R. Hart, Esq. and Robert J. Mulvihill, Esq.
Recently, Hart, King & Coldren represented the three Leisure World Corporations and their individual directors during the appeal phase of a lawsuit intended to recover significant monetary damages against the individual members of the Board of Directors. The damages supposedly arose because the Board members, on behalf of the Corporations, contributed to the fund created to oppose the conversion of El Toro Marine Corps Air Base to a commercial airport.
Hart, King & Coldren’s successful defense resulted in a significant and precedent setting opinion by the California Appellate Court and protects the decision making process of a corporation’s board of directors.
Background
The closure of the El Toro Marine Corps Air Station and its proposed conversion into an international airport has been the singular most controversial issue facing the citizens of southern Orange County during the past five years. The Leisure World community consists of some 18,000 residents and is situated adjacent to the former air base.
The Boards of Directors of the corporations that govern Leisure World were understandably concerned that the construction of an international airport would have a substantial negative impact on the community. These concerns include safety, noise, air pollution, traffic congestion, quality of life and decreased property values. Accordingly, three of the corporations that govern the Leisure World community contributed more than $550,000 to Taxpayers for Responsible Planning, a group whose main purpose was to oppose the airport conversion.
Shortly thereafter, three owners of units located within the Leisure World community filed a shareholder derivative suit against the individual directors of the Boards who voted in favor of the contributions, seeking to recover the contributions from the individual directors.
Filed by one or more shareholders, a shareholder derivative suit is intended to enforce the rights of the corporation and usually seeks to recover monies from directors who have allegedly failed to fulfill their obligations to the corporation. Typically, in these types of cases, one or more disgruntled shareholders attempt to recover from the directors what they believe to be the improper use of corporate funds, such as excessive payments to directors or officers; kickbacks or other improper payments to politicians; sale of corporate assets for less than fair value; etc. In essence, the disgruntled shareholders attempt to protect the rights of the corporation because the corporation’s board has allegedly failed to do so. Any recovery goes to the corporation, not the plaintiff shareholders.
In answering the Complaint, the Leisure World directors took the position that the contributions were permitted under the Articles and Bylaws and applicable statutes that govern the Boards’ actions. In addition, each corporation established a special litigation committee ("SLC") composed of disinterested directors (i.e., directors who were not involved in making the contested contributions) which conducted a thorough investigation of the Complaint’s allegations. More specifically, the SLCs interviewed the defendant directors, attempted to interview the plaintiffs, and engaged independent counsel to advise them regarding the legal aspects of the case and the pros and cons of continuing the lawsuit.
On appeal, the Fourth District Court of Appeal made a number of extremely important rulings. First, it determined that, under the Articles and Bylaws that govern the Leisure World corporations, the directors acted properly in voting to contribute funds to oppose the airport. Second, although the Court of Appeal left a number of questions regarding the scope of judicial review of an SLC’s actions undecided, the Court’s opinion became the first California appellate decision to expressly endorse the SLC defense, a general principle of corporate law that has found support in numerous other states. Third, for the first time in any published opinion in any state in the United States, the Court expressly held that the SLC concept is applicable to homeowner associations.
The importance of this decision is substantial to all corporations and homeowner associations within the State of California for the following reasons:
- If the corporation’s governing documents, as interpreted in accordance with the applicable provisions of the California Corporation’s Code permit such contributions, homeowner associations and other corporations in the vicinity of El Toro may use corporate funds to oppose the airport conversion; and
- Homeowner associations and other corporations involved in a shareholder derivative suit may appoint a Special Litigation Committee to investigate the claims. If the SLC is properly formed and if it reasonably determines, after conducting a sufficient investigation, that the derivative suit is not in the best interests of the corporation, the corporation or homeowner association may compel the dismissal of the lawsuit.
The determination of whether or not such contributions would be permissible requires a careful legal analysis of the corporation’s governing documents. In addition, in order for the conclusions of a Special Litigation Committee to have legal effect, it is essential that the committee be properly formed, that its investigation be detailed and comprehensive, and that its conclusions be supportable.
This publication presents information on legal matters of general interest and should not be relied upon for your specific legal needs. We urge you to seek further professional advice before taking action.
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