Who Can File A Corporate Lawsuit?

In battles between 50-50 directors/shareholders, can one director bring a lawsuit on behalf of the corporation against the other director/shareholder?

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In many small corporations there are two shareholders and directors who each own 50% of the outstanding shares.?When the relationship breaks down, litigation often ensues.?The question is how should that litigation be handled??When there is an allegation that a shareholder/director has diverted corporate assets or misappropriated corporate opportunities, the usual course of action is a corporate derivative action.?This involves naming the corporation as a nominal defendant and the gist of the complaint is that the damages accrue to the corporation, not the individual instigating the lawsuit.?This is essentially a lawsuit between the two shareholders/directors.

???????????But what if the allegedly aggrieved party does not want to pay for the litigation personally??Can he or she sue in the name of the corporation and therefore use corporate assets to fund the litigation??Even when the other 50% shareholder/director objects to the lawsuit and does not vote to authorize the action??Does a 50% shareholder/director have standing to initiate a lawsuit in the name of the corporation against the other 50% shareholder/director in any circumstance?

???????????A 1993 California Court of Appeals decision entitled Anmaco, Inc. v. Bohlken addressed this issue (but did not set forth a definitive answer!).?Other cases have examined the law of other jurisdictions but, again, have not pronounced an easy-to-follow rule.?Corporate litigation attorneys will find that, depending on the needs of their client, they can formulate an argument to fit every situation.?(One court noted that “The merry-go-round of the corporate president’s power to institute legal action I the corporate name still spins; and dizzily!”

The Anmaco Cases Involved Two Equal Shareholders

???????????The Anmaco corporation had two directors—Mr. Pearlman and Mr. Bohlken.?They were also the two equal shareholders.?Mr. Pearlman filed a complaint in the name of himself and Anmaco against Mr. Bohlken alleging various wrongs against the corporation.

???????????Mr. Bohlken filed a motion for summary judgment arguing that Mr. Pearlman, as President and a 50% shareholder, had no authority to bring an action on behalf of the corporation.?The court granted the motion.

???????????The issue addressed by the court was whether the corporation’s president has the authority to institute action on behalf of the corporation.

???????????Mr. Bohlken relied on a New York case for the proposition that there was no presumed or implied authority on the part of a corporation’s president to institute an action in the name of the corporation.?The New York court noted that the correct vehicle for such a suit is a shareholders’ derivative action.

Does A Corporate President Have Implied Power To Sue In The Name Of The Corporation?

???????????On the other hand, Mr. Pearlman argued that by virtue of the corporate bylaws, he, as president of Anmaco has “general supervision, direction and control of the business and officers of the corporation.”?The court, however, noted that the bylaws also provide that the president’s exercise of his office is “subject to the control of the Board of Directors…” and “the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of its Board of Directors.”?The president did not have the power to enter into contracts or execute other instruments?or render the corporation “liable for any purposes or any amount” without Board authorization.?From this the court concluded that “there is no power to institute litigation in the corporate name against the other 50 percent shareholder.”

???????????The appellate court did note that “[i]n general, the issue of the president’s power in the face of a corporate deadlock is unsettled, and has not been the subject of a great deal of case law.”?“There is a conflict in the decisions as to the right of the president of a corporation, in the event of a deadlock or division of the directors, to initiate litigation in the corporation’s name.”?Despite the inconsistency in rulings, one commentator noted that “it is clear that the scope of such permissible action is extremely limited and clearly does not exist with respect to any major corporate decision.”

???????????The court discussed another California case entitled Sealand Investment Corporation v. Emprise Incorporated.?In that case the secretary-treasurer and another director, who held 50% of the shares, filed a suit in the name of the corporation against the other two corporate directors, who also held 50% of the shares.?And one of those defendants was the president of the corporation.

???????????The Sealand court had a little different scenario in that it examined whether the secretary-treasurer had executive power (or only ministerial power).?The court found that the secretary had no power to institute a suit on behalf of the corporation and affirmed dismissal of the lawsuit.?The Anmaco court noted that the Sealand court discussed the powers of a corporate president under California law and stated that the president has no greater power than any other director.?After reviewing some New York cases as well, the Anmaco court “found no presumptive or implied authority in the president to institute litigation in the name of the corporation against a co-director and equal shareholder.?Pressing the corporation into litigation as a plaintiff is inappropriate where the other shareholder-director could claim equal authority to bring suit in the corporate name.”?In Anmaco, while Mr. Pearlman was president, Mr. Bohlken was Chief Executive Officer.?The court concluded that “The proper vehicle for such a suit, when the gravamen of the complaint is injury to the corporation, is a shareholders’ derivative action.”

Does A Lawsuit Of This Type Circumvent The Derivative Action Laws?

???????????The Sealand court had a few other observations of note.?At the beginning of the analysis, the court noted that the two directors who filed suit “are in our opinion seeking judicial-legislation so as to enable them to circumvent the available statutory remedy of a derivative action under Corporations Code section 834.

Can Derivative Actions Protect A Corporation In Case Of Emergency?

???????????However, in reviewing out-of-state cases, the opinion pointed out a Louisiana case in which “It is idle to contend that a president of a corporation can be permitted, through adverse interest, to block every effort of a corporation to save its property from being sacrificed at forced sale during a public economic emergency, to the detriment of the corporation, its stockholders and creditors, and thereby enrich himself, and that, although the corporation ay have a clear legal right to demand a moratorium, yet it is merely a right without a remedy, either at law or in equity, for its enforcement.”?In that case the court allowed the secretary-treasurer of the corporation had the right and authority to institute a lawsuit in the name of the corporation.?The Sealand court, however, concludes that “Unlike the situation in the [Louisiana[ case, there is a remedy available in the case at bar, namely:?a stockholder’s derivative action and furthermore we are not presently confronted with a public economic emergency.”

???????????If the court is suggesting an ‘emergency’ exception, it fails to explain why an emergency situation could not be handled in a corporate derivative lawsuit just as well as in a lawsuit brought in the name of the corporation.

Does A President’s Prior Course Of Action Allow Him To Ignore The Derivative Action Laws?

???????????Some courts have found that ordinarily a 50% shareholder and CEO cannot initiate suit in the name of the corporation against the other 50% shareholder/director.?However, exceptions can occur even if the Board of Directors is divided if the president is granted such powers in the bylaws or not precluded from instituting such action by the bylaws.?Sealand also indicates that a president might be able to initiate a lawsuit if they “had previously conducted the affairs of the corporation without intervention,” or if there was an “emergency involved in the case in the sense that if the action was not filed and prosecuted as was attempted all would be lost forever for the corporation.”

???????????The problems I see with these two arguments is that the filing of a lawsuit in the normal course of business to, for example, recover from a vendor or the like is not at all equivalent to filing a lawsuit in the corporate name (and using corporate money) to sue the other shareholder.?Moreover, I cannot see why the solution should not be the normal corporate derivative action.?The director/shareholder deadlock often means that there is a corporate dissolution action and it seems that a shareholder dispute in that situation should be handled as a derivative action that is part of the dissolution.?For sure one shareholder should not be able to use the corporation’s money to attack the other shareholder.

???????????Any attempt to create an ‘emergency’ exception or ‘I have filed lawsuits before’ exception to the normal rule that a 50% director/shareholder may not sue the other 50% shareholder/director only leads to confusion.?Every lawsuit will involve an emergency.?However, all of the pre-judgment remedies available in every type of business litigation are available in derivative actions.?The law needs a rule that everyone can rely on.

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Laine T. Wagenseller is a corporate litigation attorney in Los Angeles.?He is the founder of Wagenseller Law Firm in downtown Los Angeles and focuses on real estate and business litigation.?He can be contacted at [email protected] or (213) 286-0371.