Opinion by
This appeal involves a derivative lawsuit by limited partners challenging the sale of partnership property to a general partner at a price allegedly far below fair market value. Derivative lawsuits, whether filed by limited partners (as here) or by corporate shareholders, are two suits in one: the first against controlling officials to assert the entity's rights and the second on behalf of the entity. The entity may try to defeat the first suit and avoid the second by appointing a special litigation committee (SLC). Colorado courts do not review the substance of SLC business judgments but do ensure the judgments were reached independently after adequate investigation.
Because the general partners were involved in the sale to a fellow insider, a one-person SLC was appointed to evaluate the sale's fairness. After the SLC concluded the partnership should not pursue derivative claims challenging the sale, the court deferred to that determination and dismissed the lawsuit. We reverse because the SLC's investigation-which never sought independently to value the property at the time of the insider sale-was patently inadequate to reach an informed decision as to the merits of the derivative claims.
I. Background
The entity at issue is HMC, Ltd., a Colorado limited partnership formed to invest in real property in the Garfield County Town of Parachute. Investors hoped a referendum would allow gambling in the nearby City of Rifle. But the referendum failed. Some of the partnership's properties were sold in pri- or transactions that are not challenged.
Two limited partners, Judith Day and Bryan Barnes, brought the derivative claims against general partners Hayden C.W. Rad-er, Michael P. Stascavage, and Chalmers I. Morse. The claims involve the sale of the remaining partnership lots (the property) to general partner Rader. The contract was signed in November 2005, and the sale closed in September 2007. Rader paid $258,000 and also assumed obligations of $66,000.
The limited partners alleged that the sale price was far below the property's fair market value. Though Garfield County had assessed the property at $258,000, the limited partners alleged this tax assessment was for-mulaically discounted and based on outdated information. They alleged the property was worth well in excess of $1 million and perhaps as much as $4 million.
The limited partners asserted several derivative claims, including breaches of fiduciary duty and civil theft, Each verified claim alleged that the property had been sold to Rader for less than its fair market value. The limited partners alleged it would be "futile" to demand that the general partners pursue the claims, as "it is the wrongdoing of the general partners which is at issue."
The general partners responded by agreeing to a court order appointing an SLC. Ultimately, a Vail, Colorado, lawyer served as the SLC to decide whether the partnership should pursue the claims asserted in the derivative lawsuit. The lawyer's investigation spanned ten weeks, totaling some thirty
Relying on the SLC report, defendants moved to dismiss the derivative claims. To respond to that motion, the limited partners were allowed to depose the SLC.
The court concluded the attorney SLC (1) was "independent and disinterested" and (2) followed "appropriate" investigative procedures. Accordingly, as the SLC had recommended, the court dismissed the limited partners' derivative claims. The court issued a C.R.C.P. 54(b) certification allowing immediate appeal.
II. Discussion
A. Overview of Derivative Actions
Derivative actions provide shareholders an equitable remedy "to protect the interests of the corporation from the misfeasance and malfeasance of 'faithless directors and managers" Kamen v. Kemper Fin. Servs., Inc.,
Derivative suits raise two distinct issues: "first, the plaintiffs right to sue on behalf of the [entity] and, second, the merits of the [entity] claim itself." Ross v. Bernhard,
There are prerequisites-including making a demand (or showing futility of a demand) on directors or general partners-to such actions. § 7-62-1001; see also C.R.C.P. 28.1 (shareholder derivative pleading requirements). The limited partners here indisputably complied with these procedures, and no one challenged their allegation regarding the futility of a demand.
The question in this case is whether the SLC's report required dismissal of the derivative claims. Under Colorado law, which follows the New York rather than Delaware approach, a "court may not second-guess [the SLC's] business judgment in deciding not to pursue the derivative litigation." Hirsch,
B. Burden of Persuasion
The parties disagree regarding who should bear the burden regarding the SLC's independence and investigation. Neither Hirsch nor Curtis addressed that issue. Most other courts have placed the burden of persuasion on those seeking dismissal of properly-pled derivative claims. See In re UnitedHealth Group Inc. Shareholder Derivative Litigation,
Consistent with the majority view, we will impose the burden of persuasion on those seeking dismissal based on an SLC's report. Such a motion is not, strictly speaking, a summary judgment motion because it does not address the merits of the claims. See Strougo ex rel. Brazil Fund, Inc. v. Padegs,
The moving party has the "ultimate burden of persuasion" in showing that "there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Continental Air Lines, Inc. v. Keenan,
We do not agree with the general partners that Auerbach dictates placing the burden on the limited partners. They quote one court's comment that "Awerbach placed the burden of proof on the plaintiff to show 'facts sufficient to require a trial of any material issue of fact as to the adequacy or appropriateness of the modus operandi of [the] committee."" Strougo ex rel. Brazil Fund, Inc. v. Padegs,
As the Sixth Cireuit has explained, "Inleither the Awerback approach nor the Zapata approach allows a reviewing court to extend to the members of a special litigation committee the presumption of good faith and disinterestedness." Hasan v. CleveTrust Realty Investors,
Finally, whatever Auerbach might suggest regarding burdens under New York law, we are not bound by that aspect of the case. Hirsch followed Auerbach instead of Zapata on one specific point; that a court will not second-guess an SLC's substantive judgments. Hirsch,
C. Standard of Appellate Review
The standard of appellate review of orders dismissing derivative claims depends on whether there was an evidentiary hearing. Where, as here, the trial court resolves the motion as a matter of law without an eviden-tiary hearing, appellate review is de novo. Cf. West Elk Ranch, L.L.C. v. United States,
D. Review of the SLC's Investigation 1. The SLC was independent.
The record shows that the SLC was independent of the general partners charged with the wrongdoing. Independence requires that the SLC be delegated "full and final authority" to act on the entity's behalf. See Hirsch,
The stipulated order of appointment gave the SLC the full "authority of the General Partners" in investigating the derivative claims. This case is different from GreenField, where the "committee [was] given only
An SLC must also be free from a disqualifying conflict of interest. One court wrote that the "yardstick" for measuring an SLC's independence "must be 'like Caesar's wife'-'above reproach'" Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart,
The undisputed facts here showed the SLC attorney was independent and capable of impartially evaluating the partnership's best interests. He was not implicated in any wrongdoing and had no prior involvement with the partnership or principals involved in this case. There was no genuine factual issue that would require an evidentiary hearing regarding the SLC attorney's independence.
2. The investigation was inadequate.
The issue thus is whether the SLC's investigation was sufficiently thorough to support his conclusion. The undisputed facts of this case show the investigation was legally inadequate.
The "cornerstone of a court's review of the SLC's procedures" is "the thoroughness of that committee's investigation." Curtis,
Here, the SLC was charged with evaluating the essential fairness of a self-dealing transaction between the partnership and a general partner. Under Colorado law, such a transaction is not categorically precluded, but it must be "demonstrate[d] that the transaction took place in good faith, was fair to the [entity], and was accompanied by full disclosure." Kim v. Grover C. Coors Trust,
There is no dispute that the critical issue in evaluating whether pursuing the derivative claims was in the partnership's best interests was the value of the partnership property sold in the insider transaction. The derivative claims alleged that the general partners had sold the property to one of their own for much less than the property's fair market value. The SLC's report recognized that the focus should be on the transaction's "fairness" and "whether full value was received in the transaction." And the district court ree-ognized "[the key factor" in evaluating fairness was "the price" at which the property was sold.
Despite spending some thirty hours (including general legal research) and writing a fourteen-page report (including general legal discussion), the SLC conducted no independent investigation into this critical point. In a case that cried out for an expert appraisal of the property's value, cf. Curtis,
The district court wrote that the SLC "did not have the Property appraised because such an appraisal would reflect today's value, and not the value ... in November 2005" when two general partners agreed to sell it to the other. That reasoning ignores the
The SLC simply accepted, without any independent serutiny or any expert opinion, the general partners' reliance on the tax assessment. The limited partners, however, presented the SLC with information that this assessed value was significantly lower than the property's actual fair market value because it was outdated and based on a statutory formula artificially discounting the value of vacant land. Again, the SLC was not required to credit those contentions. But neither could he blithely accept the tax assessment as a fair appraisal of then-current market value.
The SLC admittedly made no effort to investigate whether the county's tax assessment accurately depicted the property's fair market value at the time of sale. He was unfamiliar with a possible statutory discount ing formula, and he never contacted the Garfield County Assessor's Office to investigate this issue.
It is not our role to consider whether in fact the property was worth more than general partner Rader paid for it. But "courts are well equipped to evaluate the methodology and procedures best suited" to an SLC investigation. Curtis,
The SLC's final reason for recommending against pursuing the derivative claims was that a derivative suit challenging the sale to Rader would not be warranted in light of post-sale developments. In particular, the SLC noted that Wells Fargo Bank has now financed Rader's entity's development of the property.
This final reason suffers from the same procedural infirmity as the rest of the SLC report: it is not founded on independent investigation. The SLC specifically chose not to contact Wells Fargo (to avoid "stirring up the pot") and never investigated what had happened to the property after the partnership sold it to Rader. (The limited partners contend that such an investigation would have revealed that Rader resold one piece of the property just a few months later for about $500,000 more than he paid the partnership for the entire property.) The SLC's investigation was procedurally inadequate because it did not investigate the property's current status or whether it would be beneficial for the partnership to seek damages or even a remedy that might allow it to stand in Rader's shoes with respect to the property.
E. Consequences of an Inadequate SLC Investigation
Because the SLC did not employ reasonable investigative procedures, the SLC's conclusion that the partnership should not pursue the derivative claims is not entitled to deference. Accordingly, the limited partners' derivative suit may now proceed. 13 Fletcher, supra, § 6019.50, at 250 (result of deficient SLC investigation is that "[the shareholder-plaintiff may then resume immediate control of the litigation with a view toward prosecuting it to a conclusion regardless of the position taken by the committee appointed by the board"); see also Janssen v. Best & Flanagan,
The Minnesota Supreme Court in Janssen, seeking to "strike a balance between allowing corporations to control their own destiny and permitting meritorious suits by shareholders," held that an entity is allowed just "one opportunity to exercise its business judgment." Id. at 890. We need not now decide whether to adopt such an invariable rule. If a stay is sought to allow further SLC investigation, the district court should balance the interests of the limited partners in expeditiously pursuing derivative claims against the interests of the partnership in exercising independent business judgment. Cf. Curtis,
IIL Conclusion
The order dismissing the derivative claims is reversed, and the case is remanded for further proceedings consistent with this opinion.