Filed July 17, 2001.
Appeal from the District Court, Ramsey County, File No. C4971365.
Karl L. Cambronne, Becky L. Erickson, Chestnut Cambronne, P.A.;
Vernon J. Vander Weide, Head, Seifert Vander Weide, P.A.;
Mark Reinhardt, Garret Blanchfield, Reinhardt Anderson, (for appellants)
Thomas L. Kimer, Jeffrey D. Hedlund, Faegre Benson LLP, (for respondent Coss)
J. Patrick McDavitt, Briggs and Morgan, P.A., (for respondents Evans, et al.)
Peter S. Hendrixson, Mitchell W. Granberg, Dorsey Whitney LLP, (for respondent Green Tree)
Timothy D. Kelly, Kelly Berens, P.A., (for respondent Conseco)
Considered and decided by Crippen, Presiding Judge, Klaphake, Judge, and Halbrooks, Judge.
This opinion will be unpublished and may not be cited except as provided by Minn. Stat. § 480A.08, subd. 3 (2000).
Appellants Professional Management Associates, Inc., and Greenbaum Associates, Inc., contend that the trial court erred in determining that their third amended complaint did not comply with the terms of this court's prior remand in the case. Because the remand required appellants to demonstrate that demand on respondent Conseco's board was excused and because the trial court correctly found that appellants failed to plead facts that, if true, would show this excuse, we affirm.
In 1997, on behalf of Green Tree Financial Corporation, appellants sued respondent Green Tree directors Lawrence M. Coss, Richard G. Evans, W. Max McGee, Robert S. Nickoloff, and Robert D. Potts to recover alleged excessive compensation paid to former Chairman and Chief Executive Officer Lawrence M. Coss. In December 1998, following earlier proceedings not germane to this appeal, the trial court dismissed appellants' second amended complaint. In 1999, because respondent Green Tree Financial Corporation merged with Conseco, Inc., after the case began, this court reversed the dismissal and remanded with specific directions to allow appellants to amend their complaint to reflect their status as shareholders of Conseco and to add this corporation as a party, to plead a double-derivative action, and to make a demand for action on Conseco or demonstrate that demand was excused. Professional Mgmt. Assocs., Inc. v. Coss, 598 N.W.2d 406, 413-14 (Minn.App. 1999), review denied (Minn. Nov. 23, 1999) ( Coss II). In September 2000, the trial court dismissed appellants' third amended complaint.
It is undisputed that Delaware law governs the disposition of this case. It is also undisputed that in normal double-derivative pleadings where the decision being challenged was made by the board of a different corporation, the test for demand futility is whether the complaint "raises a reasonable doubt regarding the ability of a majority of the Board to exercise properly its business judgment in a decision on a demand" at the time of the complaint. Rales v. Blasband, 634 A.2d 927, 937 (Del. 1993). Appellants' complaint proposes to prove demand futility by departing from this test. They do not allege or propose to allege that the Conseco board could not properly exercise its business judgment. As the trial court observed, appellants pleaded instead that demand was excused because Conseco would receive a windfall if it pursued the cause of action and its board had not yet acted. The trial court dismissed the action because the pleadings did not conform to this court's directions on remand and because the complaint failed to state a claim upon which relief could be granted.
This court reviews "de novo the district court's formulation of the legal standard controlling respondents' motion to dismiss for failure to make a pre-suit demand." Professional Mgmt. Assocs., Inc. v. Coss, 574 N.W.2d 107, 110 (1998) (citation omitted), review denied (Minn. Apr. 14, 1998) ( Coss I). The appellate court reviews "the application of the correct legal standard for an abuse of discretion." Id. (citation omitted).
Green Tree merged with Conseco after appellants filed their derivative action. In Coss II, this court reversed the trial court's dismissal of the action and authorized appellants to continue their case by remanding to allow appellants to amend the complaint to reflect their status as Conseco shareholders, to add Conseco as a party, to plead a double-derivative action, and to make a demand on Conseco or demonstrate that demand was excused. Coss II, 598 N.W.2d at 413-14. The final paragraph of the opinion summarized the decision and this court's directions on remand:
Appellants have standing to maintain this action. Appellants must amend their complaint to reflect the fact that this is now a double derivative action. Appellants must bring a demand on Conseco's board or demonstrate that demand is excused.
Id. at 414.
Because this remand contained specific directions, the trial court's duty was "to execute the mandate * * * strictly according to its terms" and had "no power to alter, amend, or modify [the appellate court's] mandate." Halverson v. Village of Deerwood, 322 N.W.2d 761, 766 (Minn. 1982) (citations omitted). Likewise, appellants were required to follow the directions of the remand.
The demand requirement protects the corporate structure by recognizing that the directors of a corporation, and not the shareholders, have the power to manage the business and affairs of the corporation. Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993). Thus, a shareholder may not bring a cause of action to enforce the rights of the corporation unless the shareholder demands that the directors pursue the claim and the directors wrongfully refuse to do so or the shareholder shows that demand is excused because the directors cannot make an impartial decision. Id. In a double-derivative suit, the plaintiff shareholder must make a demand on both the parent corporation and the subsidiary or demonstrate that demand is excused for both. Coss II, 598 N.W.2d at 413.
Once the plaintiff shareholder makes a demand, the shareholder has tacitly acknowledged "the absence of facts to support a finding of futility" and thus cannot later claim that demand was excused. Spiegel v. Buntrock, 571 A.2d 767, 775 (Del. 1990) (citation omitted). If the plaintiff shareholder makes a demand and the board refuses to pursue the action, the court does not end its inquiry but reviews the board's decision under the traditional business-judgment rule by examining the good faith and reasonableness of the board's investigation and decision. Id. at 777. Absent an abuse of discretion by the board, the court will respect the board's decision not to pursue the action and will grant the board's motion to dismiss it. Id.
Appellants chose not to make a demand on the Conseco board. Instead, appellants pleaded that demand should be excused because the Conseco board has not involved itself in this action and because the corporation would receive a windfall if it did pursue the action. But because the Conseco board did not make the decision being challenged by appellants, the test for demand futility is whether the complaint
raises a reasonable doubt regarding the ability of a majority of the [Conseco board] to exercise properly its business judgment in a decision on a demand.
Rales, 634 A.2d at 937. The trial court rejected appellants' alternative theory of proving futility, and appellants are without authority to justify substituting that theory for Delaware's test.
To support their theory, appellants contend that demand should be excused because Conseco lacks standing to bring the claim under the Supreme Court's decision in Bangor Punta Operations, Inc. v. Bangor Aroostook R.R., 417 U.S. 703, 94 S.Ct. 2578 (1974). Ordinarily, a corporation may seek to recover damages to its assets. Del. Code Ann. tit. 8, §§ 122-123 (1991 Supp. 2000). Also, even though any injury to Green Tree took place before Conseco owned Green Tree, the right to pursue that cause of action passed to Conseco when it merged with Green Tree. See Lewis v. Anderson, 477 A.2d 1040, 1044 (Del. 1984) (stating derivative claims of the merged corporation constitute choses in action that pass to the surviving corporation by operation of Delaware code section 259(a)). But courts can determine in equity that a corporation lacks standing to pursue a cause of action under certain circumstances. Bangor Punta, 417 U.S. at 712, 94 S.Ct. at 2584.
In Bangor Punta, the U.S. Supreme Court found that a corporation could not cause its wholly owned subsidiary to sue the subsidiary's former directors for damages related to corporate mismanagement because the corporation would receive a windfall after buying all its shares from the alleged wrongdoers and receiving a fair price for the shares. Id. at 712, 718 n. 15, 94 S.Ct. at 2584, 2587 n. 15. The court rested its decision on the equitable principle that a shareholder may not complain of acts of corporate mismanagement if he acquired his shares from those who participated or acquiesced in the allegedly wrongful transactions.
Id. at 710, 94 S.Ct. at 2583 (citations omitted). This principle prevents shareholders from sitting idly by and sanctioning by silence an ultra vires act of the board of directors and later instituting an action if the act proves unprofitable to them. Bookman v. R.J. Reynolds Tobacco Co., 48 A.2d 646, 681 (N.J. Ch. 1946). The Supreme Court noted that this equitable principle might not have prevented recovery — therefore disproving appellants' contention that Bangor Punta provides an appropriate avenue for this court to adopt a new demand futility test — if the case had been brought by or on behalf of innocent shareholders that owned stock both at the time of the transaction and when the complaint was filed. Bangor Punta, 711-12 nn. 6-8, 94 S.Ct. at 2583-84 nn. 6-8. But the corporation in Bangor Punta "expressly disavowed any intent to obtain a pro-rata recovery on behalf of * * * minority shareholders" and the corporation did not bring the case on their behalf. Id. at 718 n. 15, 94 S.Ct. at 2587 n. 15.
Appellants' case is distinguishable from Bangor Punta, which was not a derivative action. Conseco did not buy all its Green Tree shares from the alleged wrongdoers. It bought a small percentage from the alleged wrongdoers and the rest from the public. And appellants would qualify as the innocent shareholders who did not acquiesce in the board's action, so equitable principles would not deprive Conseco of standing in this case to act on their behalf. Moreover, the Delaware Chancery Court has recognized that the innocent-shareholder equitable principle might allow a case to go forward under the proper circumstances. Courtland Manor, Inc. v. Leeds, 347 A.2d 144, 148-49 (Del.Ch. 1975). Appellants' argument that Conseco would have no equitable standing by virtue of the windfall it would receive because it did not pay for the cause of action fails because the court could fashion a remedy that would award damages only to innocent shareholders.
Equally important, appellants failed to show that proving Conseco's lack of standing establishes demand futility under Delaware law.
Appellants also contend that Conseco's inaction proves demand futility. Although appellants provide convincing reason why Conseco would choose not to bring a case on their behalf, if appellants made a demand on the board, appellants provide no authority for stating that proof of these facts would constitute a showing of demand futility or establish a reasonable doubt about the Conseco board's independence. Such a decision falls within the exercise of Conseco's business judgment. Moreover, the Third Circuit has noted that "a board's failure to take action, even if it is aware of wrongdoing, does not demonstrate futility." Blasband v. Rales, 971 F.2d 1034, 1052 (3d Cir. 1992) (citations omitted).
The remand in Coss II required appellants to make a demand on the Conseco board or demonstrate that demand was futile. Appellants chose not to make a demand on the board and their proposed theory for demand futility does not constitutes a proper excuse in a double-derivative action. Thus, appellants have stated a purported cause of action that fails on its face. Alternatively, appellants propose a direct, shareholder class action by questioning the applicability of a double-derivative action under the facts of this case. But as the trial court correctly stated, the law of the case precludes this course of action; the remand directed appellants to "amend their complaint to reflect the fact that this is now a double derivative action."