Diamond Post
Business & Commercial Newsletter
Staving off Shareholder Suits: New South Carolina Decision Supports Corporations
In the wake of the financial crisis facing the United States economy, the number of shareholder derivative actions brought against corporations are increasing and are anticipated to continue to increase as the Great Recession wears on.  These types of actions require corporations to invest time and money to defend their business decisions, despite the long-standing business judgment rule protecting rational business decisions made by corporate boards. In addition, since the enactment of Sarbanes-Oxley, some courts have begun to look differently at decisions made in the board room and found ways to make it easier for shareholders to pursue derivative suits. However, a recent decision by the Business Court of Richland County, Covan v. Blue Cross and Blue Shield of South Carolina, et al., C.A. No.: 08-CP-40-5794, reiterated the basic principles in South Carolina favoring corporate governance and control, and is a good example of courts' traditional deference to business decisions made by corporate boards and the limitations on shareholders' ability to individually interfere with management's authority.
First, it is noteworthy that in September 2007, the Supreme Court of South Carolina implemented a pilot program creating a Business Court system in South Carolina. These business courts, existing in Greenville, Richland and Charleston Counties, were designed to handle "complex business, corporate, and commercial matters" by judges with experience in these types of cases. Another advantage is that since there is one judge for each business court, he or she presides over the entire case, like other circuit court cases designated complex. S.C. Sup. Ct. Order No. 2007-09-07-01. The Covan lawsuit, which sought to compel dividends to policyholders of Blue Cross, was precisely the type of case that our Supreme Court envisioned being handled by the business courts.
In Covan, GWB shareholders Howard Boyd and Luanne Runge, with assistance from associates Paul Greene and Mary Giorgi, represented the defendants, Blue Cross Blue Shield of South Carolina and its Board of Directors. The plaintiffs, Blue Cross policyholders, alleged that the defendants breached fiduciary duties by failing to declare a dividend to policyholders while premiums increased and the company's surplus grew, and requested that the Honorable J. Michelle Childs, circuit judge for the Business Court in Richland County, compel a dividend. Significantly, prior to filing this lawsuit, the policyholder-plaintiffs failed to ask the Board to declare a dividend, and the lawsuit was the board's first notice that any policyholder was seeking a dividend.
We moved to dismiss the policyholder-plaintiffs' complaint on multiple grounds, and Judge Childs ruled in favor of Blue Cross and its Board, dismissing the complaint with prejudice. While Judge Childs' Order addresses numerous corporate law issues and should be read in full by those responsible for corporate management, below are three tips gleaned from this decision for you to note for your business.
1. Corporate boards must be given the opportunity to address shareholder concerns prior to suit by an unhappy shareholder.
Because the policyholder-plaintiffs' cause of action for dividends was derivative in nature, Judge Childs applied South Carolina's applicable procedural rules which require that before such a suit can be filed, a demand for this action must be made on the board or otherwise, a plaintiff will have to adequately plead that making such a demand would have been futile. She held that "demand futility" can only be adequately pled with specific facts prior to the filing of the complaint to show demand would be futile. This rule of corporate governance supports a corporation's management and control of its actions - and the policy of the courts to allow business leaders to run the business, rather than the courts - by allowing a board to have the first opportunity to resolve a shareholder complaint without involving the courts. In Covan, the plaintiffs' claim failed because the board had no opportunity to address the issue prior to litigation, thus thwarting the fundamental principles of corporate law. Judge Childs concluded that it also failed because no particularized facts were pled to show demand futility. For example, Judge Childs found the policyholder-plaintiffs' allegations that the Board was "interested" insufficient to excuse demand because the complaint did not "contain particularized allegations specific to any Director that he or she received or may receive a personal benefit from the failure to issue dividends, or has engaged in self-dealing or fraud."
2. Shareholders may not make conclusory, speculative allegations of Board misconduct.
Judge Childs concluded that the policyholders-plaintiffs had not alleged sufficient facts in support of their claims. She explained that a plaintiff cannot merely re-allege the elements of a cause of action in a conclusory and speculative fashion and force a corporation into expensive and time-consuming litigation. For shareholders to maintain a derivative action against a corporation, they must state specific facts to show that the conduct complained of is actionable. In Covan, the Court found that the policyholder-plaintiffs did not sufficiently plead how or why the failure to declare a dividend was wrongful and held mere boiler-plate allegations of control by one inside director that was also the CEO, financial interest in the surplus funds, and corporate waste, with no specific facts alleged to support them, were insufficient. This ruling favors corporate control of litigation, imposing restrictions on shareholders from filing lawsuits without any factual support.
3. Shareholders cannot bring a direct action against a corporation to compel directors to declare dividends.
In South Carolina, "a shareholder's suit to compel directors to declare dividends is the right of the corporation" and must be brought as a derivative action. There are two schools of thought among jurisdictions whether an action for the declaration of dividends is a direct or derivative action. Although the most recent South Carolina law on this point was decided in the 1950's and there are more recent decisions to the contrary from other jurisdictions, Judge Childs followed existing South Carolina case law, and ruled that the policyholder-plaintiffs' action for dividends was derivative in nature and could not be brought as a direct action. Further, Judge Childs noted that only in rare situations can a cause of action be both derivative and direct, and it is generally one or the other. Judge Childs ruled that since policyholder-plaintiffs' sole cause of action was for breach of fiduciary duty for failure to declare dividends, their cause of action did not fall into one of those rare situations and therefore, they could only assert their claim as a derivative suit.
While Judge Childs' order dismissing this lawsuit is not an appellate decision and has no precedential value, it may be persuasive in similar cases in the future, and ultimately, should be helpful to companies faced with lawsuits challenging board action or inaction, and assist with corporations' efforts to govern and control their business without interference from dissident shareholders. If you would like to discuss this decision further with GWB attorneys involved in the litigation, please contact Howard Boyd at hboyd@gwblawfirm.com or Luanne Runge at lrunge@gwblawfirm.com. |
