United States: California Court Of Appeal Holds That Challenges To Corporate Elections Under Corporations Code Section 709 May Be Predicated Upon Breach Of Fiduciary Duty And Conflict Of Interest Allegations

In Morrical v. Rogers, No. A137011, 2013 Cal. App. LEXIS 811 (Cal. App. Oct. 10, 2013), the California Court of Appeal, First District, held that the summary procedures set forth in California Corporations Code § 709 may be used to contest corporate elections predicated upon complex and substantive allegations of corporate or directorial misconduct, such as conflicts of interest and breaches of fiduciary duty.  The Court rejected defendants' argument that the California Legislature intended to limit Section 709 proceedings to challenges predicated upon technical or procedural irregularities in the corporate election process.  This decision reinforces the broad authority of California state courts to adjudicate even complex matters in summary proceedings in order to determine the validity of corporate elections.

Section 709 of the California Corporations Code permits shareholders, or any person who claims to have been denied the right to vote, to challenge the validity of corporate elections by California corporations or elections by foreign corporations that are held in California.  The Section 709 proceeding here was one of many legal actions springing from a series of longstanding disputes between plaintiff and her brothers (the "Brothers") over the management of a group of family-owned corporations.  In it, plaintiff challenged an election that restructured the board of directors and effectively gave control of the corporation to an outside management company.  Plaintiff argued that the vote, which was passed by the Brothers over her objection, was invalid because the Brothers' financial transactions with the management company gave them a material financial interest that should have disqualified them from voting.  The resulting election was invalid under California Corporations Code § 310, she claimed.

Plaintiff sued individually and derivatively on behalf of two of the family corporations.  She named as defendants the management company Altamont Management and the new Altamont directors appointed during the election (collectively, "Altamont").  Plaintiff did not sue either of the Brothers.  Altamont moved for judgment on the pleadings because the Brothers had not been joined, but the California Superior Court for San Mateo County denied the motion.

Eight weeks later, the Superior Court held a seven-day bench trial.  At the parties' request, the judge deferred her ruling so the parties could talk settlement.  When those efforts were unsuccessful, the judge issued an oral ruling in favor of plaintiff.  The court held that plaintiff had carried her burden of proving that the voting directors had a financial interest and that Altamont had failed to show that the election was just and reasonable to the company.  In the resulting judgment, the trial court declared the election and appointment of the Altamont directors invalid, set aside numerous acts taken by the Altamont directors in connection with the election and prohibited the Altamont directors from acting as directors and in related roles.  The trial court stayed enforcement of the judgment while Altamont appealed.

The Court of Appeal affirmed the trial court's use of a Section 709 summary proceeding to adjudicate the alleged breach of fiduciary duties and conflict of interest.  In a detailed analysis, the Court concluded that the plain language of Section 709, the context of the statutory scheme, the legislative history and the relevant case law did not limit Section 709 to challenging corporate elections based upon technical or procedural irregularities, as Altamont had argued.  In fact, the Court noted, courts have repeatedly used Section 709 or predecessor statutes to decide similarly complex issues affecting the validity of an election, such as alleged manipulation of stock records, financial transactions underlying stock issuance, the validity of a voting trust agreement and the legality of an underlying contract.

The Court also rejected Altamont's argument that summary determination of such complex allegations violates a defendant's procedural due process rights under the California Constitution.  Specifically, Altamont argued that Section 709 proceedings deprive defendants of sufficient time to find and present witnesses because the statute requires a hearing within five days after the complaint is filed.  The Court disagreed.  The "hearing" required by the statute was not necessarily a full trial on the merits.  Moreover, a savings clause in the statute adequately protected defendants' due process rights by allowing them to move for a later hearing for good cause.  The Court also denied Altamont's discovery-based constitutional claims.  The summary nature of Section 709 proceedings did not imply a corresponding restriction on discovery, and Altamont was not unfairly denied discovery in the trial court.  The Court, however, noted that its rejection of Altamont's due process claims did not preclude the possibility that summary proceedings involving complex issues might result in due process violations in other cases, particularly if a party is deprived of adequate discovery and preparation time.

The Court, though, nevertheless reversed and remanded the case because plaintiff had not joined the Brothers, whose interests could be impaired by the result of the lawsuit.

The Morrical decision highlights the broad-based powers California state trial courts have to decide even complex allegations in Section 709 proceedings, when those allegations relate to validity of corporate elections.  The decision is significant also for foreign corporations as well as California corporations, as Section 709 expressly applies to foreign corporations "if the election was held or the appointment was made in this state."  Cal. Corp. Code § 709(a).

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