Opinion
NOT TO BE PUBLISHED IN THE OFFICIAL REPORTS
APPEAL from a judgment of the Superior Court of Fresno County. Ct. No. 05CECG03554 Mark W. Snauffer and Adolfo M. Corona, Judges.
Law Offices of Walter W. Whelan and Walter W. Whelan for Plaintiffs and Appellants.
Lang, Richert & Patch, Victoria J. Salisch, Val W. Saldana and Tamara L. Lyles for Defendant and Respondent RCO Ag Credit, Inc.
Coleman & Horowitt, Darryl J. Horowitt and Christine J. Levin for Defendant and Respondent Ranchers Cotton Oil.
OPINION
Kane, J.
Plaintiffs West Hills Farms, Inc. (WHF) and California Pistachio, LLC (CP) (collectively plaintiffs) are minority shareholders in defendant corporation RCO Ag Credit, Inc. (RCO). When plaintiffs discovered that RCO was paying substantial sums of money in unnecessary fees to defendant Ranchers Cotton Oil (Ranchers), to the detriment of RCO’s shareholders, plaintiffs initiated this action against both Ranchers and RCO. Plaintiffs sought to recover the unnecessary fees from Ranchers for the benefit of RCO. Because of the derivative nature of such claims, plaintiffs’ standing to sue as shareholders depended on whether they made a demand on RCO’s board of directors to take action, unless such a demand was futile. RCO and Ranchers interposed a series of demurrers that were sustained on the ground that the factual allegations were insufficient to show either a demand or futility. After several amendments failed to cure the defect, the trial court sustained the demurrers to the third amended complaint without leave to amend. A judgment of dismissal followed. Plaintiffs appeal, contending the third amended complaint adequately alleged that it would have been futile to make the required demand on RCO’s board of directors. We disagree and accordingly affirm the judgment.
As we discuss later, the necessity of such a demand (unless futile) as a condition for having standing to maintain a derivative action arises under section 800, subdivision (b)(2), of the Corporations Code and the case law interpreting that section.
Motions to strike by RCO and Ranchers were also granted on the same ground without leave to amend.
FACTS AND PROCEDURAL HISTORY
The Parties
RCO was originally organized in 1991 by Ranchers to provide loans to growers who were members of certain cotton gins that were shareholders of Ranchers. Later, RCO began extending loans to other growers (such as plaintiffs) who had no affiliation with Ranchers or the cotton gins. In providing such loans, if the borrower was not an RCO shareholder, the loan might be conditioned on the borrower’s purchase of shares of RCO stock in an amount equal to a percentage (e.g., 3 percent) of the loan.
Ranchers was incorporated in 1950 as an agricultural cooperative. Over the years, Ranchers built a successful cottonseed oil processing and marketing business, and also sold whole cottonseed on behalf of its member cotton gins. In 1991, Ranchers founded RCO as a separate company and provided necessary investment capital, loans and loan guarantees for the new entity. Ranchers and RCO share expenses, including some employees, office space and general overhead. A 1998 audit report indicated that these entities had “common management.” At all relevant times, Ranchers has been a “major” RCO shareholder but not a majority shareholder. As of October 2003, Ranchers owned approximately 17.59 percent of RCO stock, Ranchers member cotton gins owned about 9.66 percent, and the remaining shares were held by various growers who were also RCO’s borrowers.
Plaintiffs were growers who obtained crop financing from RCO and, in connection therewith, were required to purchase shares of RCO stock. Plaintiffs purchased a total of 105 shares of RCO stock, which is less than 1 percent of the 14,295 shares of RCO stock outstanding at the time of the 1998 audit report.
The Pleadings and Demurrers
On November 14, 2005, plaintiffs filed their original complaint. The complaint alleged that WHF began obtaining crop loans from RCO in 1999. In 2000, when WHF sought to obtain new crop financing from RCO, RCO imposed a requirement that WHF acquire stock in RCO equivalent to 3 percent of the loan amount. WHF agreed to these terms and entered a stock subscription agreement whereby it acquired 105 shares of RCO stock at a cost of $100 per share. In 2001, in connection with another loan agreement with RCO, WHF transferred 26 of its shares in RCO to CP. Plaintiffs’ shareholder status was therefore as follows: WHF 79 shares, CP 26 shares.
Concurrent with the above sale of stock to plaintiffs, RCO provided a copy of a 1999 private placement memorandum. The private placement memorandum, a copy of which was attached to the complaint, disclosed that “‘office space and accounting services for [RCO] are provided by [Ranchers] currently at no cost to [RCO]’” and “‘[i]t is anticipated that a similar arrangement could continue with the possibility that [RCO] will begin paying Ranchers for services in the future.’” Additionally, an audit report attached to the private placement memorandum stated “‘[RCO] has a line of credit from a stockholder, [Ranchers], in the amount of $2,500,000[,]’” and further reported “‘[t]he amounts outstanding as of December 31, 1998 and 1997 were $2,500,000 and $2,400,000, respectively.’” The same audit report disclosed the following: “‘[RCO] and Ranchers have common management and share office space. [RCO] reimburses Ranchers for employee and related costs. During the years ending December 31, 1998 and 1997, [RCO] reimbursed Ranchers for employee and related expenses in the amount of $361,121 and $279,964, respectively.’”
The complaint alleged that said disclosures were “incomplete, misleading and inaccurate” because RCO failed to disclose a substantial “‘loan risk fee’” was being paid to Ranchers over and above the interest charged, and also failed to disclose other excessive fees were being paid by RCO to Ranchers, including a substantial “‘facility fee’” and “administrative fees.”
The complaint further alleged that in January 2003, plaintiffs, through their principal, Brad Gleason, met with RCO’s president, Mitchell Metzler, to review financial information of RCO that Mr. Gleason had previously requested. In reviewing the limited records provided, the existence of a “‘loan risk fee’” was first discovered. When other records were not provided by RCO, in 2004 plaintiffs filed a lawsuit to obtain access to RCO’s accounting records and shareholder list pursuant to sections 1600 and 1601 of the Corporations Code (hereafter the records lawsuit). Plaintiffs thereby discovered the extent of the loan risk fees, facility fees and administrative fees “that were being funneled to Ranchers by RCO to the detriment of all shareholders of RCO other than Ranchers itself.”
Damage allegations in plaintiffs’ complaint alleged that the unnecessary and undisclosed loan risk fees, facility fees and administrative fees paid by RCO to Ranchers were in excess of $2,680,045, thereby causing plaintiffs’ ownership interest in RCO, along with all other shareholders, to be “detrimentally diminished” by the allegedly fraudulent and improper payments. Although such injury was to the entire body of RCO stock due to the alleged depletion of corporate assets, the complaint failed to allege that plaintiffs had presented a demand to RCO’s board of directors (i.e., that RCO take appropriate action itself to remedy the situation), nor were any specific facts alleged to demonstrate that such a demand would have been futile. RCO and Ranchers separately filed demurrers to the complaint. On March 17, 2006, prior to the scheduled hearing on the demurrers, plaintiffs filed a first amended complaint.
The first amended complaint attempted to plead facts showing both demand and futility of demand as a basis for standing to assert the derivative claims. Plaintiffs alleged that the demand requirement was satisfied because they mailed a copy of the first amended complaint to one of RCO’s attorneys. Plaintiffs alternatively alleged that it was futile to make a formal demand based on two circumstances: (1) RCO’s vigorous defense of the records lawsuit by plaintiffs to obtain financial and accounting records of RCO, and (2) RCO’s continuing practice of paying the allegedly improper fees to Ranchers. The trial court found these allegations inadequate to plead either demand or futility, and therefore the demurrers by RCO and Ranchers to the first amended complaint were sustained with leave to amend.
Plaintiffs’ second amended complaint was filed on August 6, 2006. The second amended complaint continued to claim that a proper demand had been made on RCO’s board of directors, relying again on the fact that plaintiffs mailed a copy of the first amended complaint to one of RCO’s attorneys. Plaintiffs added that they did not realize the derivative nature of their claims until after the original complaint was filed. Plaintiffs further alleged that the demand requirement was satisfied by a March 24, 2003 letter sent to RCO’s counsel by an attorney for WHF (i.e., Michael Farley), together with certain conversations between Mr. Gleason and Glen Janzen related thereto. At the time, Mr. Janzen was allegedly both CEO and chairman of the board of RCO, as well as president of Ranchers. The second amended complaint also continued to claim, alternatively, that a formal demand on RCO’s board of directors was futile. In support of the claim of futility, plaintiffs alleged that futility was shown by RCO’s defense of the records lawsuit and by RCO’s failure to take any action after receiving a copy of the first amended complaint. In addition, plaintiffs alleged the conclusions that Ranchers is “a dominant and controlling major shareholder of RCO,” and similarly that “Ranchers is a majority shareholder having effective control over the management of both RCO and Ranchers through shared management of those entities.”
These allegations regarding Mr. Janzen were removed from the third amended complaint.
RCO and Ranchers demurred to the second amended complaint. The trial court sustained the demurrers with leave to amend on the ground that the second amended complaint failed to adequately plead demand or futility of demand regarding the derivative causes of action. In so ruling, the trial court noted in its order that “[p]laintiffs in their opposition to the demurrers concede that the letter of March 24, 2003 and the conversations between Mr. Janzen and Mr. Gleason did not ‘[constitute] a formal demand.’” (Italics added.) The trial court expressly found that such concession was “fatal to any allegations that a proper demand was made prior to the initiation of this action.” Thus, “[p]laintiffs must therefore rely exclusively upon futility of such a demand in order to establish their standing to maintain their … causes of action.” Further, the trial court found that the allegations of futility were inadequate because plaintiffs were required to allege facts specific to each director from which the court would be able to conclude that that particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff. Plaintiffs’ conclusory, general allegations against all directors were insufficient to establish demand futility; therefore, the demurrers to the second amended complaint were sustained with leave to amend.
Of course, the mailing of the first amended complaint could not have satisfied the demand requirement under Corporations Code section 800, subdivision (b)(2), because the wording of that subdivision clearly indicates the demand is to be made before the filing of the initial complaint containing the derivative claims. (See Shields v. Singleton (1993) 15 Cal.App.4th 1611, 1618 [describing “the prefiling demand requirement”].)
Plaintiffs filed their third amended complaint on May 16, 2007. As relevant to this appeal, the third amended complaint included the following derivative claims: (1) conspiracy to breach fiduciary duty (against Ranchers and RCO -- labeled as third cause of action); (2) aiding and abetting in breach of fiduciary duty (against Ranchers and RCO -- labeled as fourth cause of action); and (3) constructive trust (against Ranchers and RCO -- labeled as fifth cause of action). The aiding and abetting claim was entirely new. Plaintiffs have acknowledged that all other causes of action were either properly eliminated by demurrer or were voluntarily dismissed and are no longer in dispute.
We note the third amended complaint also added “loan guarantee fees” to the list of allegedly unnecessary and excessive fees paid by RCO to Ranchers.
In substance, the third amended complaint attempted to show, on the basis of specific factual allegations, that it was futile for plaintiffs to make a formal demand on the RCO board of directors because, allegedly, Ranchers had control over RCO and individual RCO directors were financially interested in the transactions referred to in the allegations. The additional allegations were primarily set forth in paragraphs 4, 23 and 24 and largely focused on the relationship between the two entities and the alleged financial ties to Ranchers of the individual RCO board members.
Paragraph 4 of the third amended complaint alleged that “[Ranchers] has been and is a dominant and controlling major shareholder of RCO.” Said domination and control allegedly arose from “the intertwined histories of the two entities and the close financial relationship that has come to exist between them.” Plaintiffs then recited several diverse facts in an effort to substantiate this alleged domination and control. It was stated that Ranchers founded RCO, provided capital and loans for its operations, and was still heavily invested in RCO “to the tune of $6.3 million.” This figure allegedly included stock ownership, loans and a continuing guarantee by Ranchers of RCO’s primary line of credit. As to stock ownership, it was alleged that as of October 2003, Ranchers owned approximately 17.5 percent of RCO stock, with Ranchers member gins owning an additional 9.66 percent. After Ranchers sold its processing plant in 2004, Ranchers and RCO together relocated to a new office in Fresno, but Ranchers was the only party on the lease and RCO was a subtenant. Finally, paragraph 4 alleged that RCO president, Mr. Metzler, had been required to attend Ranchers board meetings to report on RCO’s financial condition.
Paragraphs 23 and 24 of the third amended complaint alleged that it would have been futile for plaintiffs to have requested, pursuant to Corporations Code section 800, that RCO take action to recover the unnecessary fees from Ranchers. Allegedly, “[t]his is so because the RCO board then consisted of a majority of persons who have had a close personal and financial affiliation with Ranchers now and historically so as to render them not disinterested directors regarding claims or potential claims against Ranchers.” As to the individual RCO board members, consisting of John Walth, David Alderete, Fred Cook, Vincent Sola, Richard Schultz, Glen Janzen, and Darin Lundquist, plaintiffs set forth the following facts:
John Walth. John Walth was chairman of the RCO board of directors and was serving concurrently as president of Ranchers. Mr. Walth received an annual salary from Ranchers of $130,000, plus other employee benefits. When a special litigation committee for evaluation of this lawsuit was established by RCO’s board, Mr. Walth decided to abstain from the vote because he “‘felt it was the right thing to do.’”
David Alderete. David Alderete had served as an RCO board member since 1992 and was also “the gin manager of the Kern Delta Weedpatch Cotton Ginning Company, which is a Ranchers member gin.” Allegedly, “[t]his means that the millions that will be returned by Ranchers to RCO if this lawsuit is successful will have to be paid back, in part, from Mr. Alderete’s employer, from which Mr. Alderete receives his primary income.” Plaintiffs added, by way of further explanation, that “[b]ecause Ranchers is a cooperative, its net revenue is not retained as profit but is distributed out to the owner member gins.” Mr. Alderete was also selected to serve on the special litigation committee of the RCO board to review and evaluate the present litigation.
Fred Cook. Fred Cook was on the RCO board of directors and had served in that capacity since 2005. Mr. Cook was also the manager for the Westside Farmers Cotton Gin, a Ranchers member gin. “Mr. Cook receives a substantial salary from Westside Farmers Cotton Gin which could be jeopardized financially if it, as a gin member of Ranchers, had to disgorge funds obtained from RCO which were distributed out to the Ranchers member gins.”
Vincent Sola. Vincent Sola had served as a member of RCO’s board of directors since 1997. He was a cotton famer who had a long history of selling cotton through Ranchers member gins, including the Tule River Cooperative Ginning Company. Allegedly, as a member of a gin that, in turn, was a member of Ranchers, Mr. Sola had, in effect, an interest in Ranchers.
Richard Schultz. Richard Schultz had been an RCO director since 1992. Although Mr. Schultz was not currently farming cotton, he had a history of farming cotton going back before the inception of RCO. In addition, he had served on the board of the Raisin City Gin Corporation, a Ranchers member gin, and had sold cotton to other Ranchers member gins. Mr. Schultz was selected to serve on the special litigation committee of the RCO board to review and evaluate the present litigation.
No specific information was provided in the third amended complaint concerning directors Glen Janzen and Darin Lundquist. Finally, plaintiffs noted that structurally the RCO board of directors was required (apparently under the RCO bylaws) to consist of two growers, two processor managers and one Ranchers officer.
Ruling on Demurrers to Third Amended Complaint
RCO and Ranchers demurred to the third amended complaint, once again on the ground that plaintiffs failed to adequately allege facts showing that a demand was made under Corporations Code section 800, subdivision (b)(2) or that such a demand was futile. RCO and Ranchers also separately moved to strike the new fourth cause of action on the same ground, and also because the new cause of action was added without leave of the court.
On August 31, 2007, the trial court issued its written order sustaining the demurrers and granting the motions to strike regarding the third amended complaint. The trial court expressly held that plaintiffs’ allegation that they mailed a copy of the first amended complaint to RCO’s attorney was insufficient to constitute a formal demand in compliance with Corporations Code section 800, subdivision (b)(2), because the demand must be made prior to filing the original complaint. Further, the trial court reiterated that plaintiffs previously conceded that the letter of March 24, 2003, and the conversations between Mr. Janzen and Mr. Gleason did not constitute a formal demand. Accordingly, the trial court held that plaintiffs “must … rely exclusively upon futility of such a demand in order to establish their standing to maintain this action.”
On the issue of futility, the trial court held the allegations of the third amended complaint still failed to indicate that the RCO board members were financially interested or could not be expected to fairly assess the claims of the plaintiffs. One possible exception was Mr. Walth, since he was an officer of Ranchers and Ranchers paid his salary. However, plaintiffs failed to set forth an adequate factual basis for concluding that any other RCO directors were potentially interested or could not fairly consider the plaintiffs’ claims. The trial court found that merely because certain directors may have been employed by one of Ranchers member cotton gins or may have utilized one of Ranchers member cotton gins as a grower did not mean such directors had a financial or personal interest in preventing Ranchers from paying back money to RCO. Such remote connections did not show a direct financial interest and were too tenuous to establish demand futility. Accordingly, the trial court sustained the demurrers and granted the motions to strike.
On the issue of leave to amend, the trial court noted this was plaintiffs’ fourth attempt to properly allege their claims and plaintiffs conceded at the hearing that it was their final and best pleading (i.e., no further amendment could be made). Accordingly, the demurrers were sustained and the motions to strike granted without leave to amend. On November 8, 2007, the trial court dismissed the action and entered a judgment of dismissal. Plaintiffs timely appealed.
DISCUSSION
Plaintiffs argue on appeal that the trial court erred in sustaining the demurrers to the third amended complaint because, according to plaintiffs, the pleading adequately set forth facts of futility as a basis for excusing the demand requirement under Corporations Code section 800, subdivision (b)(2). As we proceed to explain, we disagree and conclude that the trial court correctly sustained the demurrers.
Because the motions to strike were granted on grounds that included those raised in the demurrers, for convenience sake we shall refer to the underlying motions as simply the demurrers.
I. Standard of Review
“In reviewing the sufficiency of a complaint against a general demurrer, we are guided by long-settled rules. ‘We treat the demurrer as admitting all material facts properly pleaded, but not contentions, deductions or conclusions of fact or law. [Citation.] We also consider matters which may be judicially noticed.’ [Citation.] Further, we give the complaint a reasonable interpretation, reading it as a whole and its parts in their context. [Citation.] When a demurrer is sustained, we determine whether the complaint states facts sufficient to constitute a cause of action. [Citation.] And when it is sustained without leave to amend, we decide whether there is a reasonable possibility that the defect can be cured by amendment: if it can be, the trial court has abused its discretion and we reverse; if not, there has been no abuse of discretion and we affirm. [Citations.] The burden of proving such reasonable possibility is squarely on the plaintiff. [Citation.]” (Blank v. Kirwan (1985) 39 Cal.3d 311, 318.)
II. The Demurrers Were Correctly Sustained Based on Plaintiffs’ Failure to Allege Facts Showing Demand Futility
We begin with an overview of some of the basic legal principles implicated in a derivative lawsuit. “Because a corporation is a legal entity separate from its shareholders [citation], when a corporation has suffered an injury to its property the corporation is the party that possesses the right to sue for redress. [Citation.]” (Desaigoudar v. Meyercord (2003) 108 Cal.App.4th 173, 183.) “If a corporation fails to pursue redress of an injury, a shareholder may file a derivative action on behalf of the corporation. The ‘derivative’ action is so called because the rights of the plaintiff shareholders derive from the primary corporate right to redress wrongs against it. [Citation.]” (Ibid.) Thus, “‘“[a] corporation which suffers damages through wrongdoing by its officers and directors must itself bring the action to recover the losses thereby occasioned, or if the corporation fails to bring the action, suit may be filed by a stockholder acting derivatively on behalf of the corporation.”’” (Nelson v. Anderson (1999) 72 Cal.App.4th 111, 124.) A shareholder cannot sue individually on his own behalf on the theory that the alleged wrongdoing “‘decreased the value of his or her stock (e.g., by reducing corporate assets and net worth).’” (Schuster v. Gardner (2005) 127 Cal.App.4th 305, 312.) Rather, in such cases, “‘[t]he corporation itself must bring such an action, or a derivative suit may be brought [by the shareholder] on the corporation’s behalf.’ [Citations.]” (Ibid.)
An action is derivative if “‘the gravamen of the complaint is injury to the corporation, or to the whole body of its stock and property without any severance or distribution among individual holders, or it seeks to recover assets for the corporation or to prevent the dissipation of its assets.’ [Citations.]” (Jones v. H.F. Ahmanson & Co. (1969) 1 Cal.3d 93, 106-107.) In the present case, there is no dispute that the plaintiffs’ lawsuit was derivative in nature, since it alleged injury to the corporation (RCO) itself and to the entire body of RCO stock as a result of dissipation of assets in the form of unnecessary fees paid to Ranchers. The issue here is not whether the action was derivative (it was), but whether plaintiffs complied with the standing requirements for maintaining a derivative action as shareholders.
Since a derivative action “impinges on the managerial freedom of directors, the law imposes certain prerequisites to the exercise of this remedy.” (Pogostin v. Rice (Del. 1984) 480 A.2d 619, 624.) In particular, Corporations Code section 800, subdivision (b), provides that “[n]o action may be instituted or maintained” by a shareholder “in right of any … corporation” unless “[t]he 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.” (Corp. Code, § 800, subd. (b)(2), italics added.) The complaint must state further “that plaintiff has either informed the corporation or the board in writing of the ultimate facts of each cause of action against each defendant or delivered to the corporation or the board a true copy of the complaint which plaintiff proposes to file.” (Corp. Code, § 800, subd. (b)(2).)
Pursuant to these statutory provisions, “in order for a shareholder to bring a derivative suit on behalf of the corporation, he must allege ‘with particularity’ either (1) that he made a demand on the board of directors, which the board wrongfully refused, or (2) that such a demand would have been futile.” (Shields v. Singleton, supra, 15 Cal.App.4th at pp. 1616-1617.) “The shareholder must show exhaustion of all practical means to force the corporation to act and must therefore allege a demand on the directors to act, and their refusal, unless a demand would have been useless.” (9 Witkin, Summary of Cal. Law (10th ed. 2005) Corporations, § 172, p. 944.) Failure to comply with the requirements of the statute deprives a litigant of standing and the complaint is subject to demurrer. (Shields v. Singleton, supra, at p. 1619; Nelson v. Anderson, supra, 72 Cal.App.4th at p. 127.) Any other rule would “authorize multitudinous litigation and ignore the corporate entity.” (Sutter v. General Petroleum Corp. (1946) 28 Cal.2d 525, 530.)
The “demand” requirement in Corporations Code section 800, subdivision (b)(2), obliges the shareholder who contemplates filing a derivative suit to first “give the board of directors the opportunity to consider and act upon the proposed litigation by presenting to the board the ‘ultimate facts of each cause of action’ and the action which plaintiff wishes the board to take to remedy the alleged wrongdoing.” (Shields v. Singleton, supra, 15 Cal.App.4th at p. 1618, fn. omitted.) “‘The purpose of this [demand] requirement is to encourage intracorporate resolution of disputes and to protect the management freedom of those to whom the responsibility of running the business is delegated. This policy is merely an extension of the business judgment rule, which dictates that judicial interference with corporate decision-making should be limited.’ [Citation.]” (Id. at p. 1619.)
In its order sustaining demurrers to the third amended complaint, the trial court held, based on the relevant allegations thereof and plaintiffs’ own concessions, that no proper “demand” was made on the RCO board of directors, and plaintiffs do not challenge that aspect of the trial court’s ruling. Instead, plaintiffs’ sole contention on appeal is that they adequately alleged that such a demand would have been futile under the circumstances. We shall therefore focus our analysis on the question of demand futility.
Since plaintiffs did not raise the issue of whether a sufficient demand was made, we treat the issue as abandoned. (Christoff v. Union Pacific Railroad Co. (2005) 134 Cal.App.4th 118, 125; Reyes v. Kosha (1998) 65 Cal.App.4th 451, 466, fn. 6.)
The case of Oakland Raiders v. National Football League (2001) 93 Cal.App.4th 572 sets forth the recognized test for demand futility as follows: “The 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 of business judgment.” (Id. at p. 587, citing Aronson v. Lewis (Del. 1984) 473 A.2d 805, 814.) “[G]eneral, conclusory facts are insufficient” to meet this burden, and “facts relating to the structural bias common to corporate boards throughout America are also insufficient. [Citations.]” (Oakland Raiders v. National Football League, supra, at p. 587.) “The proof must be of ‘facts specific to each director from which [the trier of fact] can [find a reasonable doubt] that that particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff.’ [Citations.]” (Ibid.)
The court in Oakland Raiders v. National Football League, supra, 93 Cal.App.4th 572, was willing to rely on Delaware law concerning this issue since “it is identical to California corporate law for all practical purposes.” (Shields v. Singleton, supra, 15 Cal.App.4th at p. 586, fn. 5.)
In Shields v. Singleton, supra, 15 Cal.App.4th 1611, the plaintiffs alleged that demand on the board of directors of the corporation (Teledyne, Inc.) “would have been futile and was therefore excused” because all the board members were named as defendants in the suit, they were allegedly responsible for the wrongdoing of employees of a subsidiary corporation (Teledyne Electronics) who committed criminal and fraudulent acts on behalf of their employer, and they personally benefited from those criminal and fraudulent acts. (Id. at p. 1621.) The trial court found such general allegations were insufficient to support demand futility, and sustained the demurrers without leave to amend. The Court of Appeal affirmed, pointing out that “the complaint does not allege a single fact which would indicate that the directors had any knowledge of, much less participated in, any criminal or fraudulent activities, nor does it allege that they benefitted directly from the wrongdoing or were otherwise disabled from exercising independent business judgment.” (Ibid.) Such general allegations were inadequate because, as the Court of Appeal explained, “in order to evaluate the demand futility claim, 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.” (Id. at p. 1622.) The case serves to highlight the necessity that allegations made in support of demand futility must be set forth with particularity. (Corp. Code, § 800, subd. (b)(2).)
The court further explained: “‘The task of demanding action … is not onerous. No policy recommends eviscerating the demand requirement as [the] plaintiff would have us do.’ [Citation.]” (Shields v. Singleton, supra, 15 Cal.App.4th at p. 1622.)
A. The Third Amended Complaint Failed to State Facts Showing a Reasonable Doubt Whether a Majority of Directors Were Disinterested or Independent
We now consider plaintiffs’ allegations of demand futility in the third amended complaint. We begin with the question of whether the alleged facts “show a reasonable doubt that … the directors are disinterested and independent.” (Oakland Raiders v. National Football League, supra, 93 Cal.App.4th at p. 587, italics added.) Specifically, the plaintiff must allege particular facts, specific to each director, creating a reasonable doubt whether a majority of the directors could be disinterested or independent with respect to the plaintiff’s claims. (See Aronson v. Lewis, supra, 473 A.2d at pp. 814-815; Shields v. Singleton, supra, 15 Cal.App.4th at p. 1622; Oakland Raiders v. National Football League, supra, at p. 589.) That is, the alleged facts must be sufficient to show that the individual directors could not be expected to fairly evaluate the claims of the shareholder plaintiff. (Shields v. Singleton, supra, at p. 1622.)
A director’s lack of disinterestedness exists “whenever divided loyalties are present, or a director either has received, or is entitled to receive, a personal financial benefit from the challenged transaction which is not equally shared by the stockholders.” (Pogostin v. Rice, supra, 480 A.2d 619, 624, citing Aronson v. Lewis, supra, 473 A.2d at p. 812.) “Directorial interest also exists where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders.” (Rales v. Blasband (Del. 1993) 634 A.2d 927, 936 (Rales).)
A director’s lack of independence exists when his decision in regard to a transaction is not based on the corporate merits of the subject matter before the board but on extraneous considerations or influences that sterilize his ability to fairly exercise discretion in the performance of his duties with respect to the transaction. (Aronson v. Lewis, supra, 473 A.2d at pp. 814, 816; Pogostin v. Rice, supra, 480 A.2d at p. 624.)
Although we separately address the issues of disinterestedness and independence, we recognize there is often considerable overlap in these concepts.
Plaintiffs’ allegations were insufficient to create a basis for reasonable doubt as to a majority of the RCO directors’ disinterestedness. With the exception of director John Walth, who was allegedly serving as President of Ranchers and receiving a salary paid by Ranchers, there is no indication of any direct financial benefit or detriment to the other directors in connection with the plaintiffs’ derivative claims.
Directors David Alderete and Fred Cook were allegedly employed and received salaries as managers for Kern Delta Weedpatch Cotton Ginning Company and Westside Farmers Cotton Gin, respectively, both of which companies were Ranchers member gins. The allegations further stated that, as a cooperative, Ranchers distributed net revenue out to its owner member gins. Such facts were insufficient to show that these directors were not disinterested. We fully concur with the trial court’s analysis on this point: “[E]ven if Alderete was a manager in a Ranchers member gin, this does not mean that he had a financial or personal interest in preventing Ranchers from paying back money to RCO. Plaintiffs do not allege that Alderete had an ownership interest in Ranchers or even in the member cotton gin. He is merely employed by the gin as a manager. There is no reason to conclude from the allegations of the complaint that his salary will be affected by the plaintiffs’ claims. Therefore, plaintiffs have failed to allege a sufficient interest to show that Alderete would not have fairly evaluated plaintiffs’ claims.” The same analysis applies with equal force to Mr. Cook and the trial court so held. Moreover, the highly speculative conclusion recited in the third amended complaint that these directors’ salaries would somehow be adversely impacted if plaintiffs’ claims were successful was insufficient to meet the particularity requirements for pleading demand futility.
As to directors Vincent Sola and Richard Shultz, their status as growers who had a history of selling cotton through Ranchers member gins was simply too remote to show any reasonable ground for concluding these men were not disinterested or could not fairly evaluate plaintiffs’ claims. The vague elaboration that Mr. Sola’s participation in the Tule River Cooperative Ginning Company, a Ranchers member gin, somehow meant that Mr. Sola “‘in the past had, in effect, an “ownership interest” in Ranchers’” (italics added) was without any rational basis in the allegations and was little more than artful but conclusory pleading. Furthermore, as the trial court correctly pointed out, “[e]ven if [Mr. Sola] was at one time a member of Ranchers, plaintiffs do not allege any facts showing that he had a financial interest in Ranchers sufficient to prevent him from fairly evaluating plaintiffs’ claims at the time plaintiffs would have made their demand. Therefore, the alleged connection between Sola and Ranchers is too tenuous to show that he was an interested board member.” Similarly, the allegations that Mr. Schultz at one time served on the board of the Raisin City Gin Corporation, a Ranchers member gin, and that in the past he sold cotton to other Ranchers member gins, are too tenuous and remote to show that Mr. Schultz was not disinterested or could not be expected to fairly evaluate plaintiffs’ claims.
Finally, plaintiffs argue that because the board of directors was alleged to have actively participated in wrongdoing -- that is, concealing or failing to disclose the nature and extent of the unnecessary fees in breach of fiduciary duties and/or conspiring with and aiding and abetting Ranchers -- they were not disinterested directors. We reject plaintiffs’ argument for the same reasons the court did in Shields v. Singleton, supra, 15 Cal.App.4th 1611. Namely, such broad and conclusory allegations of fraud, conspiracy or other wrongdoing on the part of the board of directors is insufficient to show demand futility or to overcome the presumption that the directors were capable of fairly evaluating the plaintiffs’ claims. (Id. at pp. 1621-1622.)
For all of these reasons, plaintiffs have failed to allege particularized facts indicating a reasonable doubt that a majority of RCO’s board was disinterested.
(2) Independence
Plaintiffs contend that the history, relationships and/or entanglements between RCO and Ranchers created a structural bias that prevented the RCO board of directors from retaining its independence regarding the subject of plaintiffs’ claims. As we noted previously, independence means that “a director’s decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.” (Aronson v. Lewis, supra, 473 A.2d at p. 816.) However, “facts relating to the structural bias common to corporate boards throughout America are … insufficient” to show demand futility. (Oakland Raiders v. National Football League, supra, 93 Cal.App.4th at p. 587). Instead, there must be “facts, specific to each director, from which the trier of fact could conclude that a particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff.” (Id. at p. 589.) Apart from such a specific factual showing, allegations of structural bias alone are insufficient. (Id. at pp. 587, 589.)
A lack of independence may be shown by particularized allegations that a party who was interested in the disputed corporate transaction (e.g., an interested director or controlling shareholder) could control or dominate individual directors on the board, in which case the affected directors would be under such considerable extraneous influence that they could not be expected to act independently. (See, e.g., Oakland Raiders v. National Football League, supra, 93 Cal.App.4th at pp. 587-590 [cases summarized]; Rales, supra,634 A.2d at pp. 936-937 [interested directors had positions of substantial influence over other directors’ employment and salary]; Clark v. Lomas & Nettleton Financial Corp. (5th Cir. 1980) 625 F.2d 49 [controlling shareholder defendant dominated majority of board]; Koshaba v. Koshaba (1942) 56 Cal.App.2d 302 [director defendant had control of entire board by virtue of share ownership].)
Here, the third amended complaint set forth a number of facts that allegedly showed a general structural bias existed in the relationship between Ranchers and RCO. Ranchers founded RCO, it owned 17.59 percent of outstanding RCO stock and was heavily invested in RCO, including the provision of loans and loan guarantees. The two entities had a close financial relationship and shared some employees and expenses. Additionally, a provision of the RCO bylaws indicated that the board of directors of RCO was to include two growers, two processor managers and one Ranchers officer. Mr. Walth was both president of Ranchers and chairman of the board of directors of RCO. Other RCO directors were either managers of cotton gins that were members of Ranchers or cotton growers who utilized the member gins. Plaintiffs argued these intertwined and symbiotic relationships reflected that RCO’s board could not make an independent and impartial assessment of plaintiffs’ claims. We disagree. Even though the allegations showed a number of structural and economic connections between Ranchers and RCO, they did not establish, by themselves, that the individual directors on RCO’s board could not have independently or impartially evaluated plaintiffs’ claims. (Oakland Raiders v. National Football League, supra, 93 Cal.App.4th at pp. 587, 589 [structural bias alone insufficient to show demand futility].)
The share ownership of Ranchers allegedly made them “a dominant and controlling major shareholder of RCO.” However, although Ranchers was no doubt an important and influential shareholder, the allegations fail to show that Ranchers was able to effectively dominate or control the individual board members of RCO.
Plaintiffs further argue that two individual directors, namely Mr. Alderete and Mr. Cook, could not have independently evaluated the matters alleged in the derivative claims because Ranchers “exerts control and influence” over the cotton gins that employed them and paid their salaries. In this regard, plaintiffs rely heavily on Rales, supra, 634 A.2d 927. In Rales, two interested directors (brothers Steven and Mitchell Rales) were in positions to exert substantial influence over two other directors on the corporate board. Specifically, the Rales brothers’ positions as chairman of the board and chairman of its executive committee gave them considerable power over the employment and salary of one director, a Mr. Sherman, who was employed as president and chief executive officer of the corporation. The other director, a Mr. Ehrlich, was employed by and received his salary from a separate corporation that was controlled by the Rales brothers as majority stockholders and directors thereof. Considering the financial stake that directors Sherman and Ehrlich would have in continuing their employment and salaries, the court held that they were “beholden” to the Rales brothers or so under the Rales brothers’ influence that there was reasonable doubt as to their independence. (Id. at pp. 936-937.)
The Rales brothers also owned 44 percent of the outstanding stock in the subject corporation. (Rales, supra, 634 A.2d at p. 930.)
We reject plaintiffs’ argument that the present case is analogous to Rales. Here, unlike in Rales, there are no specific facts alleged to show the existence of control or significant influence by Ranchers over the cotton gin entities that paid Mr. Alderete and Mr. Cook their salaries. Nor is this a case in which an interested director (or interested controlling shareholder) was allegedly able to exert control over the employment or salaries of noninterested directors. Additionally, as noted in our discussion on disinterestedness, there are no particularized facts alleged in the instant case that are adequate to show that the salaries of Mr. Alderete and Mr. Cook would be jeopardized if fees paid to Ranchers were recovered by RCO. The law is well established that conclusory or speculative allegations are wholly incapable of establishing demand futility. (Oakland Raiders v. National Football League, supra, 93 Cal.App.4th at p. 587; Shields v. Singleton, supra, 15 Cal.App.4th at p. 1622.) We conclude that Rales is clearly inapplicable and does not support the plaintiffs’ claim of demand futility.
We likewise reject plaintiffs’ argument that the two directors who happened to be growers of cotton utilizing the member cotton gins were somehow beholden to or under the influence of Ranchers. That assertion is a mere conclusion that is entirely unsupported in the allegations.
Finally, plaintiffs alleged that the two RCO directors who were appointed to serve on the special litigation committee, namely Mr. Alderete and Mr. Schultz, were thereby “compromised” and not independent or disinterested because the committee was allegedly being “controlled and advised by Stockton attorney William Parrish,” who was handpicked by RCO’s current legal counsel and had a “close relationship” with him. It was further alleged that the committee was established in July of 2006, but as of January 2007 no interviews or investigations had yet occurred. Plaintiffs alleged that Mr. Alderete and Mr. Schultz would probably follow the advice given to them by Attorney Parrish and it was assumed by plaintiffs that Mr. Alderete and Mr. Schultz would have a “cavalier” attitude to the matter of plaintiffs’ litigation.
Plaintiffs’ argument that these allegations demonstrate a lack of directorial independence on the part of Mr. Alderete or Mr. Schultz is a non sequitur. Simply because months after the derivative lawsuit was filed, a special litigation committee was established by RCO’s board and two directors were selected to serve on that committee does not create a reasonable inference that those two directors could not have fairly evaluated plaintiffs’ claims if a presuit demand had been made. And even if Mr. Alderete and Mr. Schultz, as of January 2007, had not yet actively pursued an investigation through the committee, that fact does not support a conclusion that they were not disinterested or independent directors. Of course, futility is to be determined on the basis of circumstances existing before the shareholder files the derivative suit, since that is the time the demand would have been made. (See Friedman, Cal. Practice Guide: Corporations (The Rutter Group 2007) ¶ 6:626.1, p. 6-138.5; Aronson v. Lewis, supra, 473 A.2d at p. 810 [“futility is gauged by the circumstances existing at the commencement of a derivative suit”].) But even if postlitigation conduct could be considered as evidence of prelitigation state of mind for purposes of showing demand futility, the allegations are inadequate to do so here.
Suffice it to say there could be any number of reasons for a delay in a special litigation committee’s investigation that would have nothing to do with whether directors on the committee were interested or lacked independence. What may be inferred from the allegation in terms of the directors’ ability to evaluate plaintiffs’ claims is at best speculation.
We conclude that plaintiffs’ third amended complaint failed to allege particularized facts showing a reasonable doubt whether a majority of the board was disinterested or independent.
B. The Third Amended Complaint Failed to State Facts Showing a Reasonable Doubt Whether the Challenged Transaction Was An Exercise of Valid Business Judgment
We now turn to the second prong of the demand futility test -- namely, whether the complaint alleged particular facts showing a reasonable doubt that the challenged transaction was a product of a valid exercise of business judgment. (Oakland Raiders v. National Football League, supra, 93 Cal.App.4th at p. 587.) Preliminarily, the parties disagree over whether both prongs of the demand futility test must be shown in order to establish demand futility. We find it is unnecessary to resolve that question because it is clear that plaintiffs failed to plead a sufficient factual basis to support either prong.
Although we do not decide the issue, we note the Delaware Supreme Court has taken the approach that if either prong is shown by the allegations, demand futility is adequately alleged. (White v. Panic (Del. 2001) 783 A.2d 543, 551; Rales, supra, 634 A.2d at p. 933; Brehm v. Eisner (Del. 2000) 746 A.2d 244, 256.) Aronson v. Lewis, supra, 473 A.2d at page 814, originally referred to the two prongs of the demand futility test using the word “and,” but the above Delaware Supreme Court cases subsequently clarified that the two prongs are in the disjunctive (“or”) instead of conjunctive (“and”). When the California case of Oakland Raiders v. National Football League, supra, 93 Cal.App.4th at page 587, set forth the demand futility test in reliance on Delaware law, it appears to have simply restated the wording in Aronson v. Lewis, supra, at page 814, and it did not consider or decide the issue of whether both prongs were necessary to establish demand futility.
Under this second prong, unless the alleged facts cast reasonable doubt on directorial disinterest or independence (which was not the case here), the plaintiff shareholder has the difficult task of overcoming the presumption of the business judgment rule. (See, e.g., White v. Panic, supra, 783 A.2d at p. 551; Brehm v. Eisner, supra, 746 A.2d at p. 264, fn. 66; Pogostin v. Rice, supra, 480 A.2d at pp. 624-625; Aronson v. Lewis, supra, 473 A.2d at pp. 812, 814-815.) This “second” inquiry on the question of whether demand futility has been adequately alleged focuses on the substantive nature of the challenged transaction and the board’s approval thereof. (Pogostin v. Rice, supra, at p. 624; Aronson v. Lewis, supra, at pp. 814-815.) “The business judgment rule is premised on the notion that management of the corporation is best left to those to whom it has been entrusted, not to the courts. [Citation.] The rule requires judicial deference to the business judgment of corporate directors so long as there is no fraud or breach of trust, and no conflict of interest exists. [Citations.]” (Desaigoudar v. Meyercord, supra, 108 Cal.App.4th at p. 183.)
Plaintiffs’ third amended complaint failed to allege particularized facts to overcome the presumption of the business judgment rule. Plaintiffs’ pleading effort was primarily directed at alleging a basis for lack of disinterestedness or independence on the part of the RCO board. As explained herein above, that effort failed. No other specific facts were alleged to demonstrate how approval of the disputed fees was outside the scope of the business judgment rule. Calling the fees excessive, unnecessary or wasteful, were merely conclusions. Further, there are no specific facts to establish the fees were approved by RCO’s board based on fraud, self-dealing or other improper motives. We conclude that plaintiffs have failed to allege particularized facts showing a reasonable doubt that the approval of the allegedly unnecessary fees was not a valid exercise of business judgment.
III. Leave to Amend and Other Issues
Because plaintiffs failed to adequately allege demand or demand futility, plaintiffs lacked standing to pursue their derivative claims and the trial court correctly sustained the demurrers to the third amended complaint. On the question of the leave to amend, plaintiffs failed to indicate any reasonable possibility that they would be able to cure the defective pleading, and indeed plaintiffs admitted that the third amended complaint was their best effort. The trial court, therefore, rightly sustained the demurrers without leave to amend. (Blank v. Kirwan, supra, 39 Cal.3d at p. 318.)
Because the entirety of the third amended complaint was properly disposed of on the grounds that the applicable causes of action were derivative in nature but plaintiffs failed to allege facts essential for shareholder standing to assert the derivative claims, we find it unnecessary to reach any additional pleading issues raised in the appeal, including issues relating to the trial court’s detailed rulings on defendants’ motions to strike.
DISPOSITION
The judgment is affirmed. Costs on appeal are awarded to RCO and Ranchers.
WE CONCUR: Vartabedian, Acting P.J., Cornell, J.