Opinion
G042017
08-15-2011
RONALD D. SHAPIRO et al., Plaintiffs and Appellants, v. PARKER KENNEDY et al., Defendants and Respondents.
Schubert Jonckheer Kolbe & Kralowec, Robert C. Schubert, Willem F. Jonckheer, for Plaintiffs and Appellants. Gibson, Dunn & Crutcher, Robert E. Palmer, Meryl L. Young, Kelly A. Roosevelt and Lauren A. Deeb, for Defendant and Respondent The First American Corporation.
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.
(Super. Ct. No. 07CC01241)
OPINION
Appeal from a judgment of the Superior Court of Orange County, Gail Andrea Andler, Judge. Affirmed.
Schubert Jonckheer Kolbe & Kralowec, Robert C. Schubert, Willem F. Jonckheer, for Plaintiffs and Appellants.
Gibson, Dunn & Crutcher, Robert E. Palmer, Meryl L. Young, Kelly A. Roosevelt and Lauren A. Deeb, for Defendant and Respondent The First American Corporation.
Latham & Watkins, Pamela S. Palmer, Matthew D. Williamson and Shadi Ghaffarzadeh; Latham & Watkins, Michael J. Weaver and Colleen C. Smith, for Defendants and Respondents Parker Kennedy, D.P. Kennedy, George Argyros, Gary Beban, J. David Chatham, James L. Doti, William G. Davis, Frank E. O'Bryan, Roslyn B. Payne, Lewis W. Douglas, Jr., D. Van Skilling, Virginia M. Ubberroth, Herbert B. Tasker, Mary Lee Widener, Craig I. DeRoy and Gary Kermott.
* * *
INTRODUCTION
This derivative action comes to us after a demurrer was sustained without leave to amend because of lack of specificity in the allegations of demand futility and because of failure to state causes of action against individual directors and officers. In addition, the shareholder-appellants appeal from the trial court's refusal to permit them to conduct the discovery they claim is necessary to establish demand futility.
The appellants, shareholders of First American Company (First American), are suing First American's board and three of its officers mainly because of the misdeeds of one of First American's subsidiaries. Appellants alleged the board and the officers either knew about these misdeeds and failed to stop them or created and implemented illegal "business strategies" the subsidiary then followed. Appellants are suing First American's directors and officers on behalf of First American for breaching their fiduciary duties toward First American.
We were troubled by the implications of shareholders of a parent company suing the parent company's board for misdeeds of a subsidiary and its board. To us, this appeared to violate the venerable rule that stockholders must own stock in the company being mismanaged in order to have standing to bring suit. (See Corp. Code § 800, subd. (b)(1).) At oral argument, however, counsel for the defendants assured us that they did not contest standing on that basis, so we are assuming appellants' standing as stockholders of the parent corporation for purposes of this appeal. This opinion should not be interpreted as endorsing the ability of stockholders of a parent corporation to bring suit for breaches of duty of the board of wholly owned subsidiary.
We affirm the judgment of the trial court. The appellants have not alleged demand futility with the particularity required under California law. We also do not agree with appellants' theory of discovery: file a complaint and then conduct discovery to find out if there is a factual basis for it. Because appellants have not explained how they could amend the second amended complaint to be any more specific about demand futility, we agree that the demurrer was properly sustained without leave to amend. We therefore do not reach the issue of whether the complaint stated causes of action against the individual defendants.
FACTS
Because this appeal arises from the sustaining of a demurrer without leave to amend, we take the facts mainly from the allegations of the second amended complaint. In addition, appellants' counsel informed us at oral argument that appellants were seeking redress only for misdeeds taking place between 2005 and 2007. Allegations of misconduct outside that time period were included to establish a "culture" of wrongdoing and inattention to duty, as well as conflicts destroying the directors' ability to consider the stockholders' charges disinterestedly, had they made a demand.
Appellants in this action are two shareholders in First American, a California corporation. First American in turn has several subsidiaries. The two chiefly involved in this action are First American Title Insurance Company (Title) and First American eAppraiseIT (eAppraiseIT). Another subsidiary, First American Title Company - not to be confused with First American Title Insurance Company, although how could it not be? - apparently also played a role in the events leading up to the lawsuit.
Appellants have alleged that the director and officer defendants have breached their duties of good faith and due care to First American for the most part based on misconduct by Title and eAppraiseIT. Appellants allege a series of encounters by Title with state officials, mainly insurance regulators, stretching back to 1999. These encounters have generally concerned violations of state anti-kickback laws affecting the title insurance industry, although other kinds of violations were also involved. The complaint also alleges violations of federal anti-kickback laws and actions by the federal Department of Housing and Urban Development (HUD) over these violations. A brief summary follows:
The first incident, a run-in with California's insurance commissioner in 1999, was alleged to have occurred in connection with First American Title Company.
I. Pre- 2005 Allegations of Misconduct
In 1999, California's insurance commissioner accused either Title or First American Title Company (depending on which allegation is credited) with violating an Insurance Code statute forbidding inducements for referrals of title insurance business. The offending company settled the matter by paying a fine and agreeing to a cease and desist order.
Also in 1999, Title, along with other title insurance companies, was a defendant in a class action filed by California's insurance commissioner and its controller regarding unlawful business practices. This action, and two private class actions alleging some of the same unlawful practices, was settled by cash payments to consumers and the state in 2002.
In 2000, two of Title's customers in Michigan sued it for overcharging for title insurance, in violation of a federal law. Ultimately this case and some similar ones turned into a class action, which was settled in 2006.
During 2001 and 2002, First American entered into two settlements with HUD regarding alleged violations of the federal Real Estate Settlement Procedures Act (RESPA). The first settlement involved "flood determination and tax realty settlement services." The second involved providing free "virtual tours" to real estate brokers in Texas. First American paid a fine to settle the first proceeding; the complaint does not allege any fine associated with the second, merely a cessation of the free virtual tours.
The purpose of RESPA is twofold: to inform real estate buyers of the nature and costs of charges
tacked on to real estate purchase, such as title searches and credit reports (called "settlement services" in the statute), and to prevent practices such as kickbacks that drive up these costs. (12 U.S.C. §§ 2601, 2602, subd. (3).) Section 2607 of the United States Code, subdivision (a), prohibits giving or accepting any fee, kickback, or "thing of value" with the understanding that real estate "settlement services" will be referred in return.
In 2004, Colorado's Division of Insurance began an investigation into Title's captive reinsurance practices, some of which had begun in 2000. Title settled this matter in 2005 by means of a fine and a stipulated cease and desist order.
In 2005, California's insurance commissioner began an investigation into title insurance practices in California, Title's among them, to which he had been alerted in the fall of 2004. The commissioner alleged the title insurance industry was engaging in illegal kickbacks, thereby inflating the cost of title insurance. The commissioner also complained of illegal captive reinsurance practices similar to the ones leading to the Colorado investigation. Title settled this matter in 2005 by paying a fine and penalties.
The complaint alleges that these practices took place in California between 1997 and 2004.
In 2006, California's insurance commissioner began another investigation of Title and First American Title Company, again for illegal rebate activities commencing in 2003. First American settled this action in 2007 by paying a fine.
In 2005, Title settled a HUD investigation into RESPA violations in Tennessee that HUD had begun in 2002. Title paid a fine to the U.S. Treasury, which represented the benefits Title had gained between May 2002 and December 2004.
In 2004, the office of the New York Attorney General began an investigation into Title's referral practices. This matter was settled in 2006 by means of an "Assurance of Discontinuance"; it is not alleged that Title paid any fine.
In 2007, Title settled with HUD over RESPA violations in Florida that had commenced in 2003. Title paid a penalty.
II. Allegations of Misconduct between 2005 and 2007
Washington State's insurance commissioner released a report in 2006 charging Title with obtaining market share in Washington by means of illegal inducements. This was basically a continuation of the 2004 Colorado investigation, although the insurance commissioner did not charge Title with providing sham reinsurance. As a result of the Washington investigation, several consumers filed a class action against Title in Washington, which was still pending in 2008.
In 2007, Title settled a HUD investigation into RESPA violations in Minnesota by paying a fine. It is not alleged when the violations took place.
In 2007, the New York Attorney General sued eAppraiseIT (another subsidiary) and First American regarding inflated home appraisals. According to the New York Attorney General's press release, eAppraiseIT gave into pressure from Washington Mutual (WaMu) to use appraisers who inflated home values. Allegedly the reason for caving into this pressure was to secure additional WaMu business for First American.
III. The Derivative Action
Appellants brought a derivative action on behalf of First American with First American as nominal defendant and 14 board members and two officers as actual defendants. One board member is also a First American officer. Appellants alleged that demand on the board to bring the action would be futile.
Appellants accuse the board of two types of misconduct. The first is actively adopting unlawful business strategies or practices, e.g., the kickbacks. The second is failing to implement internal controls and ignoring "red flags" - the governmental enforcement actions and private lawsuits - signaling pervasive violations of state and federal laws by Title.
First American demurred three times, each time on the ground that appellants had not properly alleged demand futility. This aspect of the complaint must be pleaded "with particularity," and appellants failed to do so. The trial court sustained the demurrer each time on this ground. The third time (second amended complaint), it sustained the demurrer without leave to amend. The trial court also sustained the individual defendants' demurrers to all of the causes of action: breach of fiduciary duty, gross negligence, breach of contract, waste, and unjust enrichment.
Shortly after serving the initial complaint, appellants served document production requests on both First American and the directors. Respondents objected to all of them on the ground, among others, that plaintiffs in derivative suits were not entitled to discovery until they had established standing. Respondents moved for a protective order, and appellants moved to compel further responses. Both motions were heard at the same time. The court denied the motion to compel and granted the protective order, entering an order for a 60-day stay. This stay was later extended. In the meantime, appellants whittled down the categories of documents until only one remained. Appellants also suspended their discovery requests to the individual directors.
Although appellants argued their need for discovery to flesh out their complaint to meet the particularity requirement for demand futility, they amended their pleading twice without getting any documents from First American. The trial court refused to allow appellants to engage in discovery "fishing expeditions" and sustained the demurrer to the second amended complaint without leave to amend.
Judgment was entered on March 18, 2009. In this appeal, appellants challenge both the sustaining of the demurrers and the trial court's refusal to permit the discovery appellants asserted would have allowed them to plead demand futility with more specificity.
DISCUSSION
We review de novo a judgment of dismissal after a demurrer has been sustained without leave to amend. Our task is to determine whether, accepting all factual allegations as true, the complaint states facts sufficient to constitute a cause of action. (Bader v. Anderson (2009) 179 Cal.App.4th 775, 786 (Bader).) We affirm the trial court's decision to sustain a demurrer if it is correct on any theory; we review the outcome, not the way it was obtained. (Orange Unified School Dist. v. Rancho Santiago Community College Dist. (1997) 54 Cal.App.4th 750, 757.)
I. A Director's Duty under California Law
Corporations Code section 309, subdivision (a), defines the duty of directors under California law: they must act "in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances." A director who acts in good faith and with due care "shall have no liability based on any alleged failure to discharge the person's obligations as a director." (§ 309, subd. (c).) The statute is based upon the common-law business judgment rule.
All further statutory references are to the Corporations Code.
II. The Derivative Suit under California Law
The derivative action arose in response to the increasing size and complexity of American corporations. "As business enterprise increasingly sought the advantages of incorporation, management became vested with almost uncontrolled discretion in handling other people's money. The vast aggregate of funds committed to corporate control came to be drawn to a considerable extent from numerous and scattered holders of small interests. The director was not subject to an effective accountability. That created strong temptation for managers to profit personally at expense of their trust. The business code became all too tolerant of such practices. Corporate laws were lax and were not self-enforcing, and stockholders, in the face of gravest abuses, were singularly impotent in obtaining redress of abuses of trust. [¶] Equity came to the relief of the stockholder, who had no standing to bring civil actions at law against faithless directors and managers. Equity, however, allowed him to step into the corporation's shoes and seek in its right the restitution he could not demand in his own. It required him first to demand that the corporation vindicate its own rights, but when, as was usual, those who perpetrated the wrongs also were able to obstruct any remedy, equity would hear and adjudge the corporation's cause through its stockholder with the corporation as a defendant, albeit a rather nominal one. This remedy, born of stockholder helplessness, was long the chief regulator of corporate management and has afforded no small incentive to avoid at least the grosser forms of betrayal of stockholders' interests. It is argued, and not without reason, that without it there would be little practical check on such abuses." (Cohen v. Beneficial Industrial Loan Corp. (1949) 337 U.S. 541, 547-548 (Cohen).)
Of course, no good deed goes unpunished. As Justice Jackson observed, "Unfortunately, the remedy itself provided opportunity for abuse, which was not neglected. Suits sometimes were brought not to redress real wrongs, but to realize upon their nuisance value. They were bought off by secret settlements in which any wrongs to the general body of share owners were compounded by the suing stockholder, who was mollified by payments from corporate assets. These litigations were aptly characterized in professional slang as 'strike suits.' And it was said that these suits were more commonly brought by small and irresponsible than by large stockholders, because the former put less to risk and a small interest was more often within the capacity and readiness of management to compromise than a large one." (Cohen, supra, 337 U.S. at p. 548.)
This was the climate in 1949, when the California Legislature enacted former section 834, the predecessor of the present statute governing derivative suits, section 800. Section 834 codified California's existing common-law derivative action and aligned California with other commercial states, such as New York, New Jersey, and Pennsylvania, that had already enacted tough statutes to curb strike suits. (See Work of the 1949 California Legislature (1949) 23 So.Cal. L.Rev.1, 19; Henry W. Ballantine, Abuses of Shareholders Derivative Suits: How Far Is California's New "Security for Expenses" Act Sound Regulation? (1948-1949) 37 Cal. L.Rev. 399, 400, 402.)
California's statute, however, was not as draconian as the other states', largely because of compromises worked out between the friends of minority shareholders, such as Professor Henry Ballantine, and the lawyers defending corporations in the trenches, such as Graham Sterling. (See Beach Vasey, Legislative Memorandum re Assembly Bill No. 428 to Governor Warren, June 1, 1949, at pp. 2-3.) Most of the wrangling concerned the security that a stockholder might have to post to go forward with a derivative suit. But the newly-enacted statute also made another important change. Any derivative complaint now had to allege a demand on the board, or explain why it had not been made, "with particularity." Since 1949, this requirement has remained largely unchanged and has been uniformly enforced, even as the Corporations Code itself has undergone significant mutations.
These two evidently resolved their differences well enough to write one of the premier treatises on California corporation law.
Pre-1949 law had required derivative plaintiffs to allege demand on the board (or demand futility), but they were allowed to make this allegation in conclusory terms. (See., e.g., Koshaba v. Koshaba (1942) 56 Cal.App.2d 302, 308.) Sometimes, the court did it for them. (See Parrott v. Byers (1871) 40 Cal. 622, 623.)
The requirements of section 834 were deliberately left alone by the Corporations Code revisers in 1977 in order to keep from reopening the controversies settled by the 1949 law. (2 Marsh's California Corporate Law (4th ed. 2005 supp.) § 15.11, pp. 15-58 to 15-59.)
III. Demand Futility
Appellants alleged two general kinds of misconduct against First American's directors and officers. On the one hand, appellants allege director inaction -doing nothing about the "red flags" signaling illegal activity. On the other hand, appellants allege the active creation of "business strategies" and "business practices" "designed to evade the law, not comply with it." The difference is important, because of the effect on pleading demand futility.
When a complaint alleges improper transactions, "[t]he test for proving demand futility is whether the facts show a reasonable doubt that (1) the directors are disinterested and independent, and (2) the challenged transaction was otherwise the product of a valid exercise in business judgment. [Citation.]" (Oakland Raiders v. National Football League (2001) 93 Cal.App.4th 572, 587 (Oakland Raiders).)The aim of this test is to protect the business judgment rule. (Aronson v. Lewis (Del. 1984) 473 A.2d 805, 812 (Aronson). "A director will be deemed not to be disinterested if the facts alleged 'demonstrat[e] a potential personal benefit or detriment to the director as a result of the decision.' [Citations] The personal benefit must arise out of the transaction being challenged. [Citation.]" (Bader, supra, 179 Cal.App.4th at p. 792.)
When a complaint alleges board inaction, however, there is no "challenged transaction" and thus no business judgment to protect. (Rales v. Blasband (1993) 634 A.2d 927, 933 (Rales).) The test then becomes "'whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations. Thus, a court must determine whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.' [Citation.]" (Bader, supra, 179 Cal.App.4th at pp.791-792 (quoting Rales, supra, 634 A.2d at p. 934).) As one court has observed, courts do not lightly excuse demand on the board: "the bar is high, the standards are stringent, and the situations where demand will be excused are rare." (Pirelli Armstrong Tire Corp. Retiree Medical Benefits Trust v. Raines (D.C. Cir. 2008) 534 F.3d 779, 782-783 (Pirelli)[applying Delaware law].)
California courts often rely on Delaware law to analyze demand futility. (See Oakland Raiders, supra, 93 Cal.App.4th at p. 586, fn. 5; Bader, supra, 179 Cal.App.4th at p. 797; see also Shields v. Singleton (1993) 15 Cal.App.4th 1611, 1621 (Shields)[Delaware and California law identical on this issue].)
It is not enough to plead generally that demand on the board was futile. Section 800, subdivision (b)(2), requires that the "plaintiff alleges in the complaint with particularity plaintiff's efforts to secure from the board such action as plaintiff desires, or the reasons for not making such effort . . . ." (Italics added.) Several California cases have discussed the "particularity" requirement. For one thing, it means allegations of specific wrongdoing, not conclusory allegations. (Bader, supra, 179 Cal.App.4th at pp. 797-798.) For another, it means "the court must be apprised of facts specific to each director from which it can conclude that that particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff." (Shields, supra, 15 Cal.App.4th at p. 1622, italics added; see also Oakland Raiders, supra, 93 Cal.App.4th at p. 587.) What are not sufficient are allegations of "structural bias common to corporate boards throughout America" (ibid.), "general allegations . . . indiscriminately level[ed] against all directors of the Company[,]" (Shields, supra, 15 Cal.App.4th at p. 1622), or "the mere threat of personal liability for approving a questioned transaction, standing alone . . . ." (Aronson, supra, 473 A.2d at p. 815.)
We are handicapped in our analysis by appellants' strategy of framing their allegations as extensive quotations from government press releases and from newspaper articles. These documents presumably reflect the viewpoints of the officials who investigated Title and eAppraiseIt. They do not, however, identify the "challenged transaction" that could form the basis of a claim against individual directors for active mismanagement. They also do not shed light on the board's ability to exercise its independence in responding to a demand if appellants' claim is based on inattention.
Furthermore, press releases do not tell us when the challenged board transactions or lack of attention took place. They reveal when the government officials decided to investigate or when the officials claim the practices occurred, which would presumably be after board approval. Nearly all of the allegedly illegal activities commenced before 2005, placing them outside the date range appellants identified as significant.
A. Demand Futility for Approval of Transactions
Appellants speak of a "culture" of kickbacks, sham reinsurance, and a "culture of noncompliance," for which they seek to hold First American's directors liable. But a breach of a director's or an officer's fiduciary duty cannot be based on a "culture." "The elements of a cause of action for breach of fiduciary duty are: (1) the existence of a fiduciary duty; (2) the breach of that duty; and (3) damage proximately caused by that breach. [Citation.]" (Mosier v. Southern Cal. Physicians Ins. Exchange (1998) 63 Cal.App.4th 1022, 1044.) There must be a specific breach that caused damage.
With respect to the directors, there must also be a "challenged transaction" about which the shareholders complain. And, as stated above, the shareholder-plaintiff must plead "facts specific to each director" showing that a demand would be futile, because of fraud, conflict of interest, or other such infirmity. None of appellants' allegations meets these criteria.
Let us look at one example. Appellants allege that the Washington State Insurance Commissioner issued a report in October 2006 regarding Title's violations of state insurance laws prohibiting "illegal incentives and inducements." Appellants quote extensively from the insurance commissioner's report, which suggests the investigation itself was ongoing in December 2005. Leaving aside the question of whether First American stockholders can sue First American's board for business decisions of Title's board and the question of whether actual director misconduct occurred before 2005, we are still left in the dark concerning the transaction about which there can be a reasonable doubt as to the directors' objectivity. Did the First American board devise or approve an illegal kickback scheme for Washington? Or is the Washington kickback scheme part of a larger, nationwide scheme? If so, did the First American directors devise or approve it? Did they approve of some business plan or strategy that mutated into or spawned the kickback scheme?
We agree with the only published California opinion to consider this issue that such a suit could probably not meet the contemporaneous ownership requirement of section 800, subdivision (b), since the shareholders would have to allege that they owned shares in both the parent and the subsidiary. (Gaillard v. Natomas Co. (1985) 173 Cal.App.3d 410, 419-420, disapproved on other grounds, Grosset v. Wenaas (2008) 42 Cal.4th 1100, 1119, fn. 16.)
Once we have a handle on the "transaction," we can move on to demand futility. What specific facts raise a reasonable doubt that, for example, director William Davis would be disinterested and independent if a demand were made upon him regarding the creation or approval of the business plan or strategy? What facts specific to him establish a reasonable doubt that his approval of whatever led to the scheme was a valid exercise of business judgment? What personal benefit or detriment accrued to Davis as a result of his decision? (See Bader, supra, 179 Cal.App.4th at p. 792.) What facts suggest that Davis would rather risk his reputation than risk his relationship with an interested director? (See Ibid.)And which interested director? These are the kinds of questions appellants' allegations must answer in order to plead demand futility. Appellants allege and acknowledge that directors must act in the best interests of the corporation and the shareholders "so as to benefit the shareholders equally and not in furtherance of their personal interest or benefit." Nowhere in the complaint, however do appellants allege any "personal interest or benefit" served or gained by any director as a result of any of the alleged misconduct.
Appellants allege that Davis has been a director since 1992, is a lawyer with a Canadian law firm, and holds First American stock. They also allege that because First American's subsidiaries have hired his law firm, "[h]e would not take a position adverse to the directors." "A director's association with a company that does business with the corporation does not in and of itself establish a lack of independence." (Katz, supra, 22 Cal.App.4th at p. 1368.) Appellants further allege that all the directors, presumably Davis among them, receive compensation for being directors, so they would not jeopardize this by suing the board. This is likewise insufficient; "[t]he personal benefit must arise out of the transaction being challenged. [Citation.]" (Bader, supra, 179 Cal.App.4th at p.792; see also In re Sagent Technology, Inc., Derivative Litigation (N.D. Cal. 2003) 278 F.Supp.2d 1079, 1089).) Moreover, appellants have alleged nothing to suggest that losing their compensation would be so devastating a financial blow that the directors would be willing breach their fiduciary duties in order to keep it. (See Johnson v. Glassman (N.J.App. 2008) 950 A.2d 215, 241.)
The same analysis applies to all the directors. Appellants have failed to allege facts "specific to each director from which [a court] can conclude that that particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff." (Shields, supra, 15 Cal.App.4th at p. 1622, italics added.) Appellants' focus on government press releases and newspaper articles leaves the transactions alleged to be breaches of the directors' fiduciary duty cloaked in obscurity. No wonder, then, that appellants' allegations of demand futility are similarly vague.
B. Demand Futility for Failure to Act
Appellants also allege the First American board is liable to the corporation for ignoring "red flags," that is, warnings in the form of fines, penalties, government actions, and private lawsuits that Title was constantly breaking the law. When a breach of duty stemming from inaction is the gravamen of the complaint, the plaintiffs must allege facts creating a reasonable doubt that, "„as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.' [Citation.]" (Bader, supra, 179 Cal.App.4th at pp.791-792.)
Once again, we find ourselves handicapped by appellants' failure to identify the events to which the board was supposed to pay attention, but did not. (See Johnson v. Glassman, supra, 950 A.2d at p. 242.) As we understand appellants' theory, at some point after 1999 - when the California Insurance Commissioner first investigated Title - the directors saw a pattern of noncompliance, not just isolated incidents, and should have taken action to stop the pattern, but did nothing. Presumably anything that happened afterward would have been attributable to the directors' breach of their duty of care. What was the tipping-point, after which incidents ceased to be "red flags" and became breaches of fiduciary duty? Appellants told us at oral argument that they were complaining only of events taking place between 2005 and 2007; the only event taking place in that timeframe was eAppraiselt's capitulation to WaMu's pressure regarding appraisal values, as alleged by New York's attorney general. But this event was utterly unlike the other instances of kickbacks and sham reinsurance, and even involved a different subsidiary. The prior examples of kickbacks and reinsurance, all of which appear to have started several years earlier, could not have presaged the eAppraiseIt situation.
Regardless of what events the board should have halted, appellants must allege facts raising a reasonable doubt that, when they filed their complaint April 2007, First American's board could have properly exercised its independent and disinterested business judgment in responding to a pre-suit demand. These facts must be pleaded "with particularity," i.e., they must be "facts specific to each director from which it can conclude that that particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff." (Shields, supra, 15 Cal.App.4th at p. 1622.)
Appellants allege four reasons for doubting the directors' independence and objectivity. First, six of the 14 directors served on First American's audit committee. While they were on the committee, First American became embroiled with backdated options, leading to the company's restating five years of financial statements. As a result, First American is now involved in a lawsuit alleging insider trading and Security and Exchange Commission (SEC) violations. Appellants allege this failure of oversight of the directors on the audit committee shows a widespread lack of internal controls at First American, in breach of the directors' fiduciary duty of due care.
It could just as easily be argued that when the backdated options tsunami hit, First American examined its own books - without any prompting from the SEC or from derivative suits - cleaned house, and set things right, thereby demonstrating its board's ability and willingness to fulfill its duty to the corporation. It's all in the point of view.
Next, appellants allege that four other directors and two members of the audit committee formed the compensation committee, which awarded bonuses to certain First American executives. Since appellants seek recovery of these bonuses as part of this action, these directors could not evaluate the claims because the directors would be liable for having approved the bonuses. Appellants also claim the existence of an action under the Employee Retirement Income Security Act (ERISA), filed in November 2007, which named all the current board members as individual defendants, presented a conflict, because the ERISA action alleged the same misconduct as this action. The board's investigation of appellants' claims would expose it to personal liability in the ERISA action.
The ERISA plaintiffs' motion for class certification was denied in July 2009. (In re First American Corp. ERISA Litigation (C.D. Cal. 2009) 258 F.R.D. 610.)
Finally, appellants allege a complex web of relationships between and among members of the board that, according to appellants, precludes the members' independence and disinterest. For example, one director is on the faculty of Chapman University. Another director is a Chapman alumnus, has donated money to the school, and serves on its board of trustees. Other board members have also donated money to Chapman. Two board members serve together on the board of another, unrelated company. Another board member is chairman of the Bowers Museum, to which some board members have donated money.
None of these allegations suffices to excuse demand on the board. The audit committee's alleged failure to spot backdated options does not lead inexorably to the conclusion that it failed in other areas, and even if it did, the board could form a special litigation committee that did not include the audit committee members to evaluate appellants' claims and present them to the entire board. "Mere membership on a committee . . ., without specific allegation as to defendants' roles and conduct, is insufficient to support a finding that directors were conflicted. [Citation.]" (In re CNET Networks, Inc., Shareholder Derivative Litigation (N.D. Cal. 2007) 483 F.Supp.2d 947, 963.) The same holds true for the compensation committee. In addition, the mere threat of personal liability for approving a questioned transaction does not establish lack of director independence. (Bader, supra, 179 Cal.App.4th at p. 797.)
At the time the complaint was filed, the First American board had 14 members. Four directors were on neither the compensation committee nor the audit committee. Only two directors were on both committees.
As for the ERISA action, it was not filed until November 2007. Appellants filed their complaint in April 2007. Obviously the ERISA action could not have influenced the directors' consideration of a demand made on them in late 2006 or early 2007. (See Bader, supra, 179 Cal.App.4th at p. 797 [independence assessed "as of the time the complaint is filed"]; In re VeriSign, Inc., Derivative Litigation (N.D. Cal. 2007) 531 F.Supp.2d 1173, 1189.) Moreover, the existence of another lawsuit naming the directors as defendants does not establish lack of independence in the absence of specific facts showing board resistance. (Lewis on Behalf of National Semiconductor Corp. v. Sporck (N.D. Cal. 1985) 612 F.Supp. 1316, 1323.)
Finally, the allegations regarding the personal relationships between and among the various directors are insufficient to establish the kind of lack of independence and of disinterestedness that would excuse a demand on the board. Courts routinely refuse to find sinister implications in allegations that board members are friends, sit on other boards together, attend the same social functions, have outside business relationships, or even get to use the company jet. (See, e.g., In re Morgan Stanley Derivative Litigation (S.D.N.Y. 2008) 542 F.Supp.2d 317, 325-326 and cases cited; Beam v. Stewart (Del. 2004) 845 A.2d 1040, 1051-1053 (Beam) and authorities cited; Pirelli, supra, 534 F.3d at pp. 793-794.) The personal relationships must be "of a bias-producing nature." (Beam, supra, 845 A.2d at p. 1050.) They must be of the kind that would induce a director to risk his or her reputation rather than the relationship. (Bader, supra, 179 Cal.App.4th at p. 792.) Appellants have alleged no relationships of this kind.
To summarize, appellants have not alleged facts sufficient to excuse them from making a demand on the board with respect to the allegations of their complaint, either as to improper transactions or as to inattention. The trial court properly dismissed the second amended complaint without leave to amend.
IV. Additional Discovery
Appellants also appeal from the trial court's refusal to lift a discovery stay and permit discovery purportedly needed to fill in the holes in their pleading. Specifically, appellants sought "board minutes, board agendas, and board packages containing information regarding the investigations, actions and settlements alleged in the amended complaint" and "board minutes, board agendas, and board packages containing information regarding the business practices that are the subject of the investigations, actions and settlements alleged in the amended complaint." We review discovery orders for abuse of discretion. (Manela v. Superior Court (2009) 177 Cal.App.4th 1139, 1145; Lipton v. Superior Court (1996) 48 Cal.App.4th 1599, 1612.) "The trial court's determination will be set aside only when it has been demonstrated that there was 'no legal justification' for the order granting or denying the discovery in question. [Citations.]" (Ibid., quoting Carlson v. Superior Court (1961) 56 Cal.2d 431, 438.)
The California Supreme Court in Melancon v. Superior Court (1954) 42 Cal.2d 698, upheld a discovery stay in a derivative action, preventing the shareholder plaintiff from deposing the defendants until he had complied with the procedural requirements of section 834, the predecessor to section 800. In Melancon, the procedural requirement was the posting of security. (Id. at p. 707.) The plaintiff claimed he needed this discovery to oppose the motions for security. (Id. at p. 704.)
In the present case, the procedural requirement is alleging with particularity the reasons for not making demand on the board. (§ 800, subd. (b)(2).) Appellants claim they need their discovery to oppose a demurrer for failure to plead demand futility with specificity. Melancon supports the trial court's refusal to allow the discovery sought in this appeal, and we have been provided no convincing reason to depart from its rule.
We should also point out that section 1601 permits stockholders to inspect board minutes of both the parent company and its subsidiaries upon a written request at any reasonable time during normal business hours. The stockholder may designate his or her attorney to make the inspection and has the right to make copies. No explanation is provided in the record as to why appellants did not make use of this procedure to review the board minutes they seek in discovery. (See Bezirdjian v. O'Reilly (2010) 183 Cal.App.4th 316, 328.) Under the circumstances, we cannot say that the court abused its discretion in refusing to allow discovery to drag this matter out.
Because we affirm the court's dismissal of the second amended complaint on the basis of inadequate allegations to support demand futility, we do not reach the demurrers to the individual causes of action.
The individual defendants have asked us to take judicial notice of a large stack of documents. Because these documents are not necessary to our decision, we deny the request.
DISPOSITION
The judgment is affirmed. Respondents are to recover their costs on appeal.
BEDSWORTH, J. WE CONCUR: RYLAARSDAM, ACTING P. J. MOORE, J.