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CALIFORNIA CORPORATE & SECURITIES LAW

Compromising and Settling of Derivative Suits In California

When a shareholder sues derivatively, the shareholder is seeking relief not for itself, but for the corporation.  Therefore, it should be expected that the shareholder is not free to compromise or dismiss the suit absent court oversight.  For example, Rule 23.1 of the Federal Rules of Civil Procedure provides:

A derivative action may be settled, voluntarily dismissed, or compromised only with the court’s approval.  Notice of a proposed settlement, voluntary dismissal, or compromise must be given to shareholders or members in the manner that the court orders.

Rule 23.1 of the Nevada Rules of Civil Procedure includes a similar prohibition on extra judicial compromises and voluntary dismissals:

The action shall not be dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs.

The Delaware Court of Chancery also proscribes compromises and most, but not all, voluntary dismissals without court approval:

The action shall not be dismissed or compromised without the approval of the Court, and notice by mail, publication or otherwise of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the Court directs; except that if the dismissal is to be without prejudice or with prejudice to the plaintiff only, then such dismissal shall be ordered without notice thereof if there is a showing that no compensation in any form has passed directly or indirectly from any of the defendants to the plaintiff or plaintiff’s attorney and that no promise to give any such compensation has been made.

Del. Ch. Ct. Rule 23.1(c).  What about California?  Section 800 of the California Corporations Code includes a number of particular requirements about what a derivative plaintiff must allege, but it is silent on the question of the need to obtain court approval of compromises or voluntary dismissals.  However, the California Supreme Court addressed that question long before the enactment of the current General Corporation Law:

But the stockholder acts in purely a representative capacity. He is a guardian ad litem by virtue of statutory authority, empowered to do precisely what a guardian ad litem appointed by a court may do. He has gone into equity seeking redress for a corporation under disability to obtain relief itself, precisely as the guardian ad litem goes into court to obtain like redress for a client under disability by reason of incompetency or nonage. The principles governing the conduct of a guardian ad litem are in full strictness applicable to the conduct of such a plaintiff stockholder. Not only should a plaintiff in such a fiduciary capacity be willing to take no act that did not first receive the sanction of the court of equity to which he has appealed, but, more than this, he is not permitted to take any act without such sanction.

Whitten v. Dabney, 171 Cal. 621, 631 (1915).  The Court of Appeal was more succinct last year in Kennedy v. Kennedy, 235 Cal. App. 4th 1474, 1485 (2015):

Dismissal of a derivative claim requires court approval.

 

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