Dansie v. City of HerrimanDansie v. City of Herriman
INTRODUCTION
¶ 1 The City of Herriman was added to the roster of Utah cities in 1999. Soon thereafter, Herriman decided that it would provide water to its residents through a municipal water system. At the time, Herriman owned no water, no wells, nor any delivery infrastructure, but the Herriman Pipeline and Development Co. (“Company”) did. The City, set about to acquire, the Company’s assets. It succeeded, much to the distress of a number of the Company’s shareholders, who sued the City and certain directors of the Company. Defendants filеd a succession of summary judgment motions that resulted in the dismissal of Plaintiffs’ claims. This appeal followed.
¶ 2 We affirm the district court on each of the four issues before us for review. First, we conclude that the district court correctly ruled that Plaintiffs’ ownership of shares in the Company entitled them to use Company water but gave them no ownership interest in Company assets. Next, we affirm the district court’s dismissal of several of Plaintiffs’ individual claims because they were derivative claims that must be prоperly advanced in the name of the Company. Third, we sustain the district court’s dismissal of the derivative claims that Plaintiffs did assert on behalf of the Company because Plaintiffs failed to make the requisite demand on the Company to remedy the alleged objectionable conduct. Finally, we turn back Plaintiffs’ claim for relief under the Utah Control Shares Acquisition Act,
ANALYSIS
I. PLAINTIFFS HAVE NO VESTED PROPERTY RIGHTS IN COMPANY ASSETS
¶ 3 Plaintiffs maintain that under the terms of the Company’s articles of incorporation, shareholders, like themselves, own an interest in Company assets. If they are right, they likely suffered injury when Company assets were transferred to the City. The district court ruled that Plaintiffs did not own Company assets. We conclude that the district court was correct. Our reasoning centers on interpretations of relevant statutes and the Company’s articles of incorporation.
¶4 Under the Utah Revised Nonprofit Corporation Act, effective as of 2001, “[a] member does not have a vested property right resulting from any provision in the articles of incorporation or the bylaws.”
¶ 5 Plaintiffs claim that Article 5 of the Company’s articles of incorporation conferred upon them ownership rights to Company assets. The relevant text states that the Company’s stock “shall evidence the interests of the stockholders in corporate assets, including water rights, pipelines, water control faсilities, and other property. The owner of each share of stock shall be entitled to participate on an equal basis in the use of water, pipelines, and other corporate assets.”
¶ 6 We assay this language for meaning using the same approach that we apply to the interpretation of contracts generally. We conclude that the unambiguous meaning of Article 5 may be extracted from the plain language of its text. That meaning does not cоnform to Plaintiffs’ preferred interpretation. The meaning of the word “interests” is key to our interpretive effort. To confer the rights claimed by Plaintiffs, the word “interests” must be read to grant shareholders something akin to fee simple ownership. This is certainly not the sole, inevitable connotation of the word. Indeed, as used in Article 5, “interests” tells us little more than that whatever a shareholder’s “interests” might be, the stock certificate is proof that he has them. If the articles of incorporatiоn said nothing more about the relationship between Company shareholders and Company assets, there could be little question that Article 5’s use of “interests” would be ambiguous. The obvious question, “just what ‘interests’ are evidenced by shares of Company stock?” would remain unanswered.
¶ 7 Black’s Law Dictionary has defined “interest” as “[t]he most general term that can be employed to denote a right, claim, title, or legal share in something.” Black’s Law Dictionary 812 (6th ed.1990). As the “most general” term in the property lexicon, “interest,” standing alone, mеans both everything and nothing. It is a word that leans heavily on other words for support.
¶ 8 That support appears in the second sentence of Article 5. Its text provides that the interest possessed by the members is the right “to participate on an equal basis in the use of water, pipelines, and other corporate assets.” Shareholders are promised equal participation, not in the ownership, but rather in the use of Company assets. This is the interest that stock ownership evidences. It is not the interest that Plaintiffs insist that their shares guaranteed, but it is an interest that survived intact the transfer of Company assets to the City. Thus, the plain language of the Articles defeats Plaintiffs’ claim to asset ownership.
II. THE DISTRICT COURT PROPERLY DISMISSED PLAINTIFFS’ CLAIMS BECAUSE THE CLAIMS WERE DERIVATIVE AND NOT INDIVIDUAL
¶ 9 A shareholder must bring an action to enforce a right of the corporation as a derivative action.
¶ 10 Not every grievance held by a sharеholder arising from actions by a corporation, its officers, or its directors must be brought through a derivative action. A shareholder may sue in his individual capacity in a direct action when he can “show that he ... was injured in a manner distinct from the corporation.”
Warner v. DMG Color, Inc.,
¶ 11 Plaintiffs’ core complaint is that the City used its voting control of the Company to approve an agreement that transferred Company assets to itself. According to Plaintiffs, this act of self-dealing enriched one class of shareholders, the City, at the expense of another class, the Plaintiffs. Because this case comes to us after a grant of summary judgment, we indulge Plaintiffs, as the nonmoving party, all reasonable inferences that may be derived from the factual record.
Hermansen v. Tasulis,
¶ 12 We are unable to uncover any behavior by Defendants that was animated by a desire to injure Plaintiffs in their individual capacities. To the contrary, the City acquired and voted Company shares for the sole purpose of acquiring a “turnkey” water system for Herriman. Indeed, Herriman appears to be wholly unapologetic about its intentions. However sinister one may view Herriman’s designs, the transfer of Company assets to a majority shareholder does not of itself endow dissenting shareholders with individual claims.
¶ 13 To think otherwise is to misunderstand the distinction between individual and corрorate injury. A shareholder does not sustain an individual injury because a corporate act results in disparate treatment among shareholders. Rather, the shareholder must examine his injury in relation to the corporation and demonstrate that the injury was visited upon him and not the corporation.
Arndt v. First Interstate Bank of Utah, N.A.,
¶ 14 Viewing the asset transfer from a second perspective, that of Herriman as a shareholder, reinforces the correctness of the district court’s ruling that Plaintiffs’ claims were derivative. While it is clear that Herri-man’s interests in creating a municipal water system were advanced by its acquisition of Company assets, the effect of the transfer on the City’s shares in the Company was the same as the consequences, whatever they may have been, that befell Plaintiff shareholders as a result of the asset transfer. We therefore affirm the district court’s dismissal of claims that should have been brought derivatively.
III. PLAINTIFFS’ CLAIMS ARE NOT ELIGIBLE FOR APPLICATION OF EXCEPTIONS TO THE DERIVATIVE ACTION REQUIREMENTS
¶ 15 We have acknowledged that circumstances may exist under which a shareholder may prosecute a claim that would normally belong to a corporation. We ratified one such exception to the derivative action rule in
Aurora Credit Services, Inc. v. Liberty West Development, Inc.,
the rationale for requiring an action to proceed derivаtively is often absent in a closely held corporation, where it is unlikely that there is a disinterested board because the majority shareholders are often the corporation’s managers. As well, the concept of a corporate injury that is distinct from any injury to the shareholders approaches the fictional in the case of a firm with only a handful of shareholders.
Id. at 1280-81 (citations omitted).
¶ 16 We justified our holding in part by aligning it with “a growing trend to allow minority shareholders of a closely held corporation to proceed directly against majority shareholders.” Id. at 1280. Spotting trends in the law is an inexact science. A phenomenon that has the hallmarks of a trend may prove to be nothing more than an aggrega *1145 tion of ad hoc events. Nor is it unusual for the momentum of a proven trend to overstretch its logical and conceptual capabilities, stopping the trend in its tracks or causing it to retreat. From our vantage point eight years after Aurora, we can see that our proclamation of a “growing trend” in recognizing an exception to the derivative action rule for closely held corporations may have overstated matters. Some jurisdictions have rejected the closely held corporation exception or severely limited it. Peter H. Donaldson, Breathing Life Into Aurora Credit Services, Inc. v. Liberty West Development, Inc., 2002 Utah L.Rev. 519, 532-33. Since Aurora, we have not had the opportunity to fully delineate the bounds of the exception in Utah. However, such a task must wait for another day because the Company in this case is not a closely held corporation, nor is its cast of shareholders and principals as small as that present in Aurora.
¶ 17 Although various statutes and courts have defined closely held corporations differently, Carol A. Jones
&
Britta M. Larsen,
Fletcher Cyclopedia of Private Corporations
§ 70.10 (perm, ed.2002), “[cjourts generally identify common law close corporations by three characteristics: (1) a small number of shareholders; (2) no ready market for corporate stock; and (3) active shareholder participation in the business.”
Id.
Today, we need only examine the first characteristic, the number of shareholders. According to its records, the Company had over 120 shareholders. This substantially exceeds the number of shareholders other jurisdictions permit in close corporations.
Id.
The number of shareholders is essential to evaluating the merits of the close corporation exception to the derivative action rule becausе of the risk that direct suits can work an injustice on other shareholders. Damages recovered by an individual shareholder from a corporation or in its stead leave uncompensated all other similarly injured shareholders and the value of the corporation potentially diluted. As we noted in
Aurora,
direct actions should not be allowed if doing so would “expose the corporation ... to a multiplicity of actions.”
IV. THE DISTRICT COURT PROPERLY DISMISSED PLAINTIFFS’ DERIVATIVE CLAIMS BECAUSE DEMAND ON THE COMPANY WAS REQUIRED
¶ 18 Although the trial court dismissed their individual claims, Plaintiffs were granted leave to refile them as derivative claims on behalf of the Company. However, the district court turned back the refiled derivative claims because Plaintiffs failed to make proper demand on the Company to correct their alleged misdeeds before filing suit, a condition precedent to bringing a derivative claim.
¶ 19 Both the Utah Rules of Civil Procedure and the Revised Nonprofit Corporation Act require that a derivative action must “allege with particularity” that demand was made on the directors and why the directors failed to act or why demand was not made.
¶ 20 The second amended complaint, where Plaintiffs first brought their derivative claims, does not allege that any demand was made or that the demand requirement was *1146 waived. In their briefs to this court, Plaintiffs now claim that, notwithstanding the deficiencies in their pleadings, they in fact made adequate demand or, in the alternative, demand was not required. We disagree.
A. Demand Was Not Made
¶21 This court has articulated the requirement that a party make a demand on the corporation. “The stockholder must show ... that a demand upon the board of directors or other managing body, to have an action brought and prosecuted in the name of the corporation to redress the grievances complained of, has been made and refused.”
Tripp v. Dist. Ct.,
¶ 22 Plaintiffs claim that our ease law offers ambiguous direction concerning the necessary features of a demand. We disagree. To the contrary, Tripp is quite explicit on this point. As noted, the demand must be “to have an action brought and prosecuted in the name of the corporation to redress the grievances complained of.” Id. Therefore, the demand must not merely remonstrate against a certain corporate policy. Rather, the communication must articulate legal claims that the corporation holds and insist that the corporation pursue them.
¶23 None of the communications from Plaintiffs tо the Company meet these standards. Several of them voice opposition to the proposed asset transfer, communicated both orally at Company meetings and in letters demanding certain analyses of corporate assets be undertaken prior to the transfer. Such expressions of disagreement fall short of the demand requirement because none of them insist that the corporation seek legal remedies. The interaction that comes closest to meeting the requirement occurred prior to the transfer of assets at a meeting of the board of directors at which Plaintiffs informed Company directors that they would pursue legal action if the corporation followed through with the asset transfer. However, this communication was inadequate for two reasons. First, it did not demand that the corporation pursue legal action. Second, it failed to outline the specific legal claims that Plaintiffs wanted rectified.
B. Thе Demand Requirement Was Not Waived by the Futility Exception
¶24 Both the Revised Nonprofit Corporation Act and the Utah Rules of Civil Procedure allow the demand requirement to be waived if a plaintiff alleges with particularity why demand was not made.
¶ 25 Before us, Plaintiffs allege that the continued antagonistic relationship between Plaintiffs and Herriman, as evidenced by this litigation, demonstrates that a perfectly crafted demand would have been futile. However, this is the first instance where they present such a claim. The second amended complaint, in which Plaintiffs brought their derivative claims, makes no mention of the futility exception and fails to address why demand would have been futile. This fact alone would be a sufficient basis for turning away Plaintiffs’ futility claims; however, even had Plaintiffs properly preserved their futility claims, a close analysis shows that they are insufficient to satisfy the exception and waive the demand requirement.
¶ 26 It is axiomatic that the right to seek the redress of corporate grievances belongs to the corporation to be exercised by corporate management.
See, e.g., In re Kauffman Mut. Fund Actions,
¶ 27 This presumption is further strengthened by the relative ease with which demand can be made. A potential litigant would, of necessity, have prepared and outlined the legal claims upon which his lawsuit will be based. The marginal cost for presenting these claims to corporate management and demanding that they take them up is so insignificant that to strip the corporation of its rights based solely on conjecture or a post hoc judicial determination would be unreasonable in most instances. Courts must not leave such determinations of futility to the subjective determination of the party upon which the law requires action; to do so unnecessarily risks stripping thе corporation of its rights. In fact, it will generally require less effort for the plaintiff to make a demand on the corporation than to satisfy rule 23.1’s stringent pleading requirements. For this reason, application of rule 23.1’s futility exception requires close scrutiny.
¶ 28 We can conceive of two instances in which the futility exception would be met. For the first, we borrow logic from
Jenkins v. Equipment Center, Inc.,
¶ 29 Neither instance is applicable in this case. The Company never explicitly stated that it would not pursue the specific claims raised in this derivative aсtion. Nor would there have been a detriment to Plaintiffs in making a demand. Herriman already knew that it was embroiled in litigation and presumably acted accordingly. Therefore, a demand prior to the filing of Plaintiffs’ second amended complaint would not have affected the Company’s behavior to Plaintiffs’ detriment.
V. THE UTAH CONTROL SHARES ACQUISITIONS ACT IS INAPPLICABLE BECAUSE IT WAS NOT RAISED AT THE DISTRICT COURT
¶ 30 Plaintiffs failed to raise claims based on the Control Shares Acquisition Act,
CONCLUSION
¶ 31 We affirm the district court on its conclusions that Plaintiffs had no vested property rights, that Plaintiffs’ original claims properly belonged to the corporation, that Plaintiffs failed to make proper demand on the corporation prior to bringing a derivative lawsuit, and that demand was not excused through the futility exception. Furthermore, we need not rule on Plaintiffs’ claim based on the Control Shares Act because such a claim was not raised below.