Siblings Michael (Mike) McGraw, John McGraw and Ann M. Morrical are coequal shareholders of a group of family corporations.
The primary issue presented in this appeal is whether an action brought under section 709, which allows the court to determine the validity of an election of corporate directors, may be based on an alleged breach of fiduciary duty or more specifically a violation of section 310, which governs corporate transactions with companies in which one or more corporate directors have a material financial interest. After reviewing the plain text of the statute, its statutory context, its legislative history, and the case law interpreting the statute, we conclude that section 709 permits a corporate electoral challenge on such grounds.
We also conclude, however, that the trial court erred in failing to require that the Brothers be joined in this action as indispensable parties. We therefore do not address the merits of the judgment entered, but reverse and remand for further proceedings.
From the 1970's to the early 1990's, Jack McGraw, the father of Mike, John and Ann, built the McGraw Group of Affiliated Companies (McGraw Group), companies that originally specialized in the sale of motorcycle and watercraft insurance and later expanded to other lines of insurance. The McGraw Group is comprised of three principal companies: McGraw Company (McGraw), which is the managing agent that sells the insurance and retains a share of premiums; Western Service Contract Corporation
Jack and his wife, Joan, eventually transferred ownership in the Companies to their three children, Ann, John and Mike (collectively the Siblings). The Siblings were the sole and equal shareholders of the Companies.
The Companies apparently have been successful.
In the mid-1990's, Mike took over as chief executive officer of the Companies. In about 2005, Mike moved to Southern California and became less involved in daily operations, which were left to the Companies' long-term management team: Tim Summers, Brian McSweeney, David Sacks, and six others. Sacks (then chief financial officer) resigned in 2009, complaining that Mike was misusing corporate funds for personal expenses. At the request of Ann and John, an audit was conducted, which in Ann's view showed there was substantial abuse of corporate funds by Mike for personal use. Jack and Joan attempted to negotiate a resolution of the Siblings' dispute and threatened to assign or sell their preemptive rights under section 7 of the Buy and Sell Agreement in order to pressure the Siblings to come to an agreement.
In November 2009, Ann and John voted to remove Mike as president and chief executive officer of the Companies and to remove Jack and two other
In February 2010, McGraw adopted phantom stock plans (PSP's) for nine of the Companies' managers (including McSweeney, Summers and Sacks),
Defendant Altamont Capital Management, LLP (Altamont Management), is affiliated with Altamont Capital Partners, which is represented to be a private equity firm with $500 million in capital that focuses on investing in middle-market businesses that have not reached their full potential. Defendants Jesse Rogers and Keoni Schwartz were cofounders and managing directors of Altamont Capital Partners, and defendant Gene Becker was an operating partner. Rogers had personal connections with Mike. Becker had personal connections to Mike and Jack and had served as a Pacific director until he was removed along with Jack in November 2009.
In August 2011, Altamont Management proposed an investment relationship with the Companies that would involve the purchase of one or more of the Siblings' shares in the Companies. About the same time, Altamont Capital Partners proposed a purchase of Mike's shares with investment funds it managed. In December, the Brothers discussed a sale of Mike's shares in the Companies to John that would be financed by Mike and an Altamont entity, with that entity receiving an interest in the appreciation of certain stock. All of these deals fell through.
The Brothers agreed to amend the bylaws and articles of incorporation of the Companies to increase the size of each board to eight directors and to adopt certain "shareholder protections." The protections required approval by holders of a majority of a Companies' stock before the Companies or its subsidiary could take certain actions, such as issuing new stock, incurring indebtedness greater than $25 million, or authorizing a merger or a sale of 40 percent or more of company assets outside of the McGraw Group.
Under a voting agreement, the Brothers agreed to vote their shares "to ensure that Altamont [Management] shall be entitled to designate five candidates to be elected as members of the Board of Directors of [the Companies]" and to maintain the size of each board at eight directors.
Indemnification agreements would be adopted for all directors.
Under a management agreement, Altamont Management would provide McGraw, Western, and Pacific with management, consulting, financial and other advisory services for a fee of $500,000 a year. Altamont Management promised to "devote such time and efforts to the performance of services contemplated hereby as [Altamont Management] deems necessary or appropriate." The agreement allowed Altamont Management and its affiliates to directly or indirectly engage in competing businesses and to withhold potential business opportunities from the McGraw Group and pursue those opportunities for its own or for other companies' benefit.
Altamont California Investment LLC (Altamont California) would loan $4 million and $2 million to Mike and John respectively. The Brothers would sign nonrecourse promissory notes promising to repay these amounts with interest by March 13, 2019, and would pledge McGraw stock as collateral for the notes.
Mike and John would give Altamont California cash settled stock option rights in exchange for payments of almost $2 million and $1 million respectively. Under these agreements, Altamont California would recover a percentage of the difference between the fair market value and the stated "exercise price" for certain shares of Western and McGraw owned by the Brothers. The exercise price was based on a valuation in excess of $300 million for the companies. The option rights could be exercised at the end of a seven-year term, which was extendable by up to three years at the Brothers' option.
Mike and John would pay Altamont California $1,805,000 and $645,000 respectively and amounts "equal to the fees and expenses reasonably incurred by [Altamont California] with respect to the [Promissory] Note[s]" (Expense Agreement).
Mike would offer to sell Western the Section 7 Assignment for $500,000 to be paid to a charitable foundation designated by Jack and Joan.
On March 12, 2012,
At a March 15, 2012 joint board meeting, the eight-member boards appointed Chu as chairman of each board (replacing John at Western and Ann at McGraw). Chu earned $200,000 a year for serving in this position, plus an annual bonus of $100,000 that was guaranteed the first year and awarded at the boards' discretion thereafter. Cohen signed Chu's contract.
At the same meeting, the directors created an executive committee of each board to deal with issues delegated to them by the full boards. Chu, Becker and Schwartz were appointed to these committees, which apparently functioned as a single body (hereafter the Executive Committee).
In April 2012, the Executive Committee decided to reimburse Mike for the legal fees he had incurred in the PSP Action since March 1, which covered the period after Mike said he wanted to dismiss the case. At the time of trial in the instant matter, no reimbursement had been made.
In May 2012, the Executive Committee removed McSweeney from his officer positions at McGraw and Western and terminated Sacks. McSweeney reached a settlement with the Companies regarding his rights under the PSP's, which apparently were terminated by the Executive Committee. At the time of trial, Cohen was also trying to negotiate a new contract with Summers that would replace the PSP's with a new management incentive plan.
Cohen was made chief executive officer of McGraw, Western and Pacific. In Ann's view, Cohen took over McSweeney's position. Cohen's base salary was set as the same level as Summers's salary ($550,000 a year), but his potential bonuses were greater and were guaranteed for the first year. Cohen also participated in a "Senior Management Incentive Program" that gave him a 4 percent interest in the McGraw Group if it was sold for more than $300 million. Chu signed Cohen's contract.
In May 2012, the Western board removed McSweeney and Summers as directors of Pacific and elected the Altamont Directors to the Pacific board.
According to Ann, the Executive Committee retained the Mayer Brown law firm and its partner, James Woods (a friend of Mike and Jack), to represent the Companies at a cost of $1 million.
On May 2, 2012, Ann (both individually as a shareholder and derivatively on behalf of McGraw and Western) sued Altamont Management and the Altamont Directors (collectively Altamont) pursuant to section 709 (Section
Altamont moved for judgment on the pleadings and argued, inter alia, for dismissal of the action because the Brothers had not been joined. The trial court (Hon. Barbara J. Mallach) denied the motion.
The court did not issue a statement of decision, noting that the parties had agreed on the record that one would not be required.
On November 8, 2012, we granted Altamont's petition for a writ of supersedeas and stayed enforcement of the trial court's judgment pending resolution of this appeal (Rogers v. Superior Court (Nov. 8, 2012, A137001)).
The primary issue on appeal is whether the conflict of interest and breach of fiduciary duties raised by Ann as the grounds for her challenge to the election are proper grounds for a section 709 action. Altamont argues the Legislature never intended that issues as complex as breach of fiduciary duty would be adjudicated in a summary section 709 proceeding and that doing so is a violation of due process rights. It argues the statute was intended to adjudicate only electoral process issues such as the adequacy of notice and the presence of a quorum at a board election, disputes over persons' rights to vote, and the validity of voting agreements.
Section 709 provides: "(a) Upon the filing of an action therefor by any shareholder or by any person who claims to have been denied the right to vote, the superior court of the proper county shall try and determine the validity of any election or appointment of any director of any domestic corporation ....
"(b) Upon the filing of the complaint, and before any further proceedings are had, the court shall enter an order fixing a date for the hearing, which shall be within five days unless for good cause shown a later date is fixed, and requiring notice of the date for the hearing and a copy of the complaint to be served upon the corporation and upon the person whose purported election or appointment is questioned and upon any person (other than the plaintiff) whom the plaintiff alleges to have been elected or appointed ....
"(c) The court may determine the person entitled to the office of director or may order a new election to be held or appointment to be made, may determine the validity, effectiveness and construction of voting agreements and voting trusts, the validity of the issuance of shares and the right of persons to vote and may direct such other relief as may be just and proper."
Section 709, subdivision (a), provides without limitation that the court "shall try and determine the validity of any election or appointment of any director of any domestic corporation." Altamont notes that the subdivision authorizes only a shareholder or "any person who claims to have been denied the right to vote" to initiate an action under the statute. (Ibid.) It argues that this language implies the action is limited to voting and similar electoral
Altamont argues the summary procedures set forth in subdivision (b) imply that the grounds for a section 709 proceeding must be restricted to technical or procedural issues. This is not a plain language argument but one which we address post.
Altamont argues that the placement of section 709 in chapter 7 of title 1, division 1, of the Corporations Code, which is entitled "Voting of Shares," indicates that section 709 was intended to remedy abridgements of the voting rights addressed in that chapter.
Altamont argues that the legislative history of section 709 and its predecessor statutes demonstrates that the Legislature intended proceedings under the statutes to be limited to procedural and technical challenges to the electoral process.
Altamont argues the legislative history "shows that lawmakers, over the decades, increasingly tightened the language and scope of the statute to focus on the corporate electoral process." It first notes that the earliest version of the statute allowed plaintiffs to challenge not only elections and appointments of directors, but also any "proceeding, act, or matter in or touching the same," whereas the current statute only permits challenges to elections and appointments of directors. (Compare Civ. Code, former § 315 [Stats. 1850-1853, ch. 58, § 15, p. 283 (authorizing action when any aggrieved person "complain[ed] of any election held by any corporate body, or any proceeding, act, or matter in or touching the same") & Stats. 1931, ch. 862, § 2, pp. 1763, 1779 (authorizing action to challenge "the election or appointment of a director at a meeting of shareholders or directors")] with § 709, subd. (a) [authorizing action to "determine the validity of any election or appointment of any director of any ... corporation"].) While these changes demonstrate an intent to limit the target of section 709 actions to elections and appointments of directors, they do not demonstrate any intent to limit the grounds on which such elections or appointments can be challenged as invalid. Because Ann's action is directed at an allegedly invalid election of directors, which is appropriate under the former and current versions of the statute, these changes also are not directly relevant to this action.
Altamont observes that early versions of the statute allowed any aggrieved person to bring an action, whereas the current statute only allows shareholders and those claiming they were denied their right to vote to bring an action. (Compare Civ. Code, former § 315 [Stats. 1850-1853, ch. 58, § 15, p. 283 (any aggrieved person) & Stats. 1931, ch. 862, § 2, pp. 1763, 1779 (shareholder)] with § 709, subd. (a) [shareholder or person claiming denial of right to vote].) Again, these changes limit standing to bring a section 709 action but do not limit the grounds on which an election can be challenged. And again, because Ann is a shareholder, these changes are not directly relevant to this action.
Finally, Altamont argues that the references to specific remedies in subdivision (c) of the current statute, section 709 (authorizing the court to
We are more persuaded by the following consistent features of the statute throughout its legislative history: (1) the court is empowered to determine the validity of a corporate election with no express restriction on the grounds on which the validity could be challenged; (2) the determination must be made promptly and in a summary procedure; and (3) the court's remedial powers are equitable and broad. (See Civ. Code, former § 315 [Stats. 1850-1853, ch. 58, § 15, p. 283; Code Amends. 1877-1878, ch. 639, § 1, p. 79; Stats. 1901, ch. 157, § 74, p. 348; Stats. 1905, ch. 416, § 9, p. 560; Stats. 1931, ch. 862, § 2, pp. 1763, 1779; Stats. 1933, ch. 533, § 23, p. 1371]; Corp. Code, former §§ 2236-2238 [Stats. 1947, ch. 1038, pp. 2347-2348]; Corp. Code, § 709 [Stats. 1975, ch. 682, § 7, pp. 1516-1570].) In our view, nothing in the legislative history implies a restriction on the grounds available for invalidating an election under the statute.
Another division of this court directly addressed the question of what issues may appropriately be raised in a section 709 summary proceeding in Columbia Engineering Co. v. Joiner (1965) 231 Cal.App.2d 837 [42 Cal.Rptr. 241] (Columbia). Based on its review of the case law under the predecessor statutes of section 709, the court concluded: "[A]lthough summary in nature, the actions provided for by [section 709 predecessor statutes] were not intended ... merely to determine [the] technical and procedural questions involved in a corporation election." (Columbia, at p. 844.) Rather, they provide "for a proceeding in equity to determine all questions which may affect the validity of a contested election." (Id. at p. 849, italics added.) The only restriction is that the court will not decide issues unrelated to the validity of the election: "Matters of corporate behavior, dealing with corporate management, general accounting, etc., cannot be considered unless they affect the validity of the election." (Ibid., italics added; see Braude, supra, 38 Cal.App.3d at p. 530.) We agree with the Columbia court's analysis.
In Boericke, the court held that a trial court may determine the validity of a voting trust agreement insofar as it affects an election, but may not decide "matters which relate solely and exclusively to the rights of the stockholders between themselves, or between themselves and third persons." (Boericke, v. Weise, supra, 68 Cal.App.2d at pp. 418-420 (Boericke).) Boericke also held that the equitable defenses of estoppel and unclean hands could properly be raised in the section 709 predecessor action because the statute was remedial and "obviously was intended to confer upon the superior court the power to determine in a summary proceeding whether or not a particular director or the entire board was or was not properly elected or appointed in order that the corporation can properly function." (Boericke, at p. 411; see Goss v. Edwards (1977) 68 Cal.App.3d 264, 271 [137 Cal.Rptr. 252] [court may decide issues of laches and estoppel; "[a]n action to defeat a corporate election is a broad-based equity action in which the court may examine the entire transaction without being limited to technical or procedural issues ..."].) Finally, the Supreme Court held in Lawrence that an action under a section 709 predecessor statute "is in the nature of an equitable proceeding in which the court will consider all matters necessary to a proper determination of the validity of the contested election ...." (Lawrence, supra, 15 Cal.2d at p. 227, italics added.)
Moreover, courts in exercising their equitable powers in section 709 or predecessor statute actions have decided similar issues. Lawrence involved issues of fraud and breach of fiduciary duty. (Lawrence, supra, 15 Cal.2d at pp. 226, 230.) In upholding a trial court order setting aside an election, the court held that a defendant "should not have so manipulated said stock certificates as to gain any personal advantage to himself to the detriment of either the corporation or its stockholders or the owners of said stock," citing a director's fiduciary duties. (Id. at p. 230.)
In Smith v. California Thorn Cordage, Inc. (1933) 129 Cal.App. 93, 98 [18 P.2d 393] (Smith), the court determined the legality of an underlying contract in order to resolve a section 709 predecessor action. (See Lawrence, supra, 15 Cal.2d at p. 227, citing Smith in support of statement that, in Civ. Code, former § 315 action, "the court will consider all matters necessary to a proper determination of the validity of the contested election ..."].) The court held, "A casual reading of the contract at once discloses that it is a bald attempt to usurp the powers and duties of the directors.... Such contracts are clearly illegal and unenforceable in law and in equity." (Smith, at pp. 98-99.)
In Kauffman v. Meyberg (1943) 59 Cal.App.2d 730, 733-734 [140 P.2d 210], the court looked behind an ostensible irregularity in the issuance of a
In Braude, supra, 38 Cal.App.3d at page 529, another division of this court ruled an election invalid under former section 2236 because the manner in which management solicited vote proxies and ran the nominating process were improper. "Incumbent directors may not use the corporate proxy machinery solely to perpetuate themselves in office. [Citations.] ... [L]imits on the board's use of the corporate proxy machinery are inherent in each director's fiduciary obligations to the members or shareholders. [Citation.]" (Braude, at p. 532.)
As explained in Boericke, section 709 (and its predecessors) "obviously was intended to confer upon the superior court the power to determine in a summary proceeding whether or not a particular director or the entire board was or was not properly elected or appointed in order that the corporation can properly function." (Boericke, supra, 68 Cal.App.2d at p. 411.) Altamont argues section 709 should be construed narrowly to exclude election challenges based on alleged breaches of fiduciary duty or conflicts of interest because adjudication of such issues in a summary proceeding may violate a defendant's procedural due process rights. We are not convinced that the narrow construction of section 709 urged by Altamont is necessary to avoid unconstitutionality under the due process clause.
Altamont further argues the summary nature of the section 709 proceeding implies a restriction on discovery that is incompatible with adjudication of issues like breach of fiduciary duty and conflict of interest and that threatens defendants' due process rights in those factual contexts. According to Altamont, questions about election notice, a board quorum, electoral process, stock ownership, and the validity of voting agreements are distinguishable (and thus do not raise due process concerns about summary § 709 proceedings) because they do not require development of a factual record or expert opinions. However, the case law belies this contention. Many of the cases
Altamont argues more specifically that it was wrongfully denied discovery in this action: "[T]he trial court ... overrul[ed] Defendants' request for even limited discovery. [Citation.] Thus, Defendants had no opportunity to request documents or propound interrogatories to explore Plaintiff's legal and factual theories. There were no depositions of experts.[
Altamont argues the judgment must be reversed because the Brothers were indispensable parties who were not joined in the action in violation of Code of Civil Procedure section 389. Altamont specifically argues the Brothers were indispensable parties under Code of Civil Procedure section 389, subdivisions (a)(2) and (b). We agree that joinder of the Brothers is required under the circumstances of this case.
"Whether a party is necessary and/or indispensable is a matter of trial court discretion in which the court weighs `factors of practical realities and other considerations.' [Citations.]" (Hayes v. State Dept. of Developmental Services (2006) 138 Cal.App.4th 1523, 1529 [42 Cal.Rptr.3d 363].) We review a trial court's determinations under Code of Civil Procedure section 389 for abuse of discretion. (Lungren, supra, 56 Cal.App.4th at p. 875.)
As noted ante, Altamont sought dismissal of the action because the Brothers had not been joined, albeit without significant discussion or elaboration on the issue until after the court had pronounced its judgment. The court denied the pretrial dismissal request without explanation.
Altamont argues the Section 709 Action would impair or impede the Brothers' ability to protect specific interests: the Brothers' interest in defending their March 2012 votes as directors, which authorized corporate changes that they believed would enhance the value of the companies; Mike's interest in the board's directive that the Executive Committee consider reimbursing
Ann counters that she sought no relief from her brothers, and since nothing in the court's judgment adjudicated their rights, they were not indispensable parties. But Ann ignores the theory upon which her case was grounded, the factual predicates necessary for the court to render judgment in her favor, and the consequences of the judgment.
Ann challenged the March 12, 2012 election on the ground that it was part of a series of transactions in which the Brothers breached their fiduciary duties as directors and majority shareholders toward the corporation and her, the minority shareholder. Ann's complaint alleged that the Brothers were disqualified from voting because they were "personally and materially financially self-interested in the subject matter of the [decision to expand the board, the election of the Altamont Directors, and the adoption of the management and indemnification agreements], and were thereby conflicted and disqualified with respect to the voting therefor." The self-interest allegedly arose from the provision of $4 million and $2 million loans, and payment under the CSSOA's of almost $2 million and $1 million, to Mike and John respectively. The complaint alleged that these financial benefits were conditioned on the Brothers' agreement to elect the Altamont Directors, adopt the management agreement, and allow Altamont to exercise control over the day-to-day operations of the Companies. Thus, the complaint alleged that the Altamont Transactions — including the amendments to the bylaws and articles of incorporation expanding the boards, the voting agreement, the indemnification and management agreements, the loans, and the CSSOAs — collectively rendered the election invalid. Specifically, Ann argued they rendered the election invalid under section 310.
Further, Ann's opening trial brief provided a "summary of basis for relief" in the action: "this statutory action under ... section 709 seeks (a) judicial invalidation of the `election' of a control block of Directors designated by a company (Altamont) that paid the aggregate sum of $9,000,000 to two ([Mike] and John) of the three existing Directors who then purported, in their sole votes, to elect the individuals designated by the payor of those sums
It was, therefore, the Brothers' alleged self-interest and breach of fiduciary duty to Ann and to the Companies that formed the necessary predicate for Ann's challenge to the election. And the trial court ultimately determined, in invalidating the election, that the Brothers had a disqualifying interest "due to financial dealings." Wholly aside from any reputational interest which the Brothers may have had at stake, the consequence of the court's finding was not only to invalidate the election of the Altamont Directors but to declare "invalid and unenforceable" the adoption of the management and indemnification agreements. While the court did not directly set aside the loans or pledge agreements, the CSSOA's, or the voting agreement, Ann's own complaint alleged the interrelationship of the Altamont Transactions and that the financial benefits of the loans and the CSSOA's were conditioned on the Brothers' agreement to elect the Altamont Directors, adopt the management agreement, and allow Altamont to exercise control over the day-to-day operations of the Companies. Under Ann's theory of the case, the consideration Altamont received for the financial benefits provided to the Brothers was rendered a nullity, impairing or impeding the Brothers' ability to protect their interests in the remaining Altamont Transactions (and leaving Altamont subject to a substantial risk of incurring inconsistent obligations by reason of the Brothers' claimed interests).
Because we find indispensable parties were not joined and reverse on that basis, we need not address the court's rulings on the merits of the controversy and express no opinion on those issues.
The judgment is reversed and the matter is remanded with instructions that the trial court require that plaintiff Ann Morrical name and serve Michael McGraw and John McGraw as parties to this action, or dismiss this action if she fails to do so. Each party shall bear its own costs on appeal.
Jones, P. J., and Needham, J., concurred.
In the meantime, Ann sued Mike, Altamont Capital Partners, and Altamont Management for breach of contract, breach of fiduciary duty, and interference with contract relations based in part on allegations that the Altamont Transactions violated the Buy and Sell Agreement and Mike's fiduciary duties (Morrical v. McGraw (Super. Ct. San Mateo County, 2012, No. CIV512421) (hereafter the Altamont Contract and Tort Action)).
