Forcing Plaintiff To Furnish A Bond In Derivative Lawsuits

By Ethan Watts

Corporations Code section 17501 permits a defendant or the limited liability company in a derivative action to make a motion to require the plaintiff to furnish security “for reasonable expenses, including attorneys' fees, that may be incurred by the moving party and the limited liability company in connection with the action.” Corporations Code § 17501(b) and (c). Section 800(c) of the Corporation Code is nearly identical and applies to derivative actions involving corporations. Corporations Code § 800(c). Such a motion, if successful, may prove to be a substantial impediment to plaintiff’s ability to continue to prosecute the action.

The first step in determining whether such a motion may be successfully brought is to determine whether the action is “derivative.” In determining whether an action is derivative, the court will examine whether “the gravamen of the complaint is injury to the corporation, or to the whole body of its stock or property without any severance of distribution among individual holders, or if it seeks to recover assets for the corporation or to prevent the dissipation of its assets.” Jones v. H.F. Ahmanson & Co. (1969) 1 Cal. 3d 93, 106-107. An individual cause of action exists only if damages to the shareholders were not incidental to damages to the corporation. Id. at 107.

For example, in Avikian v. WTC Financial Corp. (2002) 98 Cal. App. 4th 1108, the plaintiff shareholders alleged defendant officers and directors mismanaged or looted corporate assets and engaged in self-dealing to sell assets to third parties, culminating in the corporation's involuntary liquidation. Avikian, 98 Cal. App. 4th 1108, 1111, 1112, 1115. The court, in holding these claims were derivative in nature, explained that the plaintiffs’ “own damages, the loss in value of their investments in [the corporation], were merely incidental to the alleged harm inflicted upon [the corporation] and all its shareholders.” Id. at 1116.

If the action is derivative in nature, then the motion under Corporations Code section 800 (in the case of a corporation) or section 17501 (in the case of a limited liability company) may be made on the ground, among others, that there is “no reasonable possibility that the prosecution of the cause of action alleged in the complaint against the moving party will benefit the limited liability company or its members.” Corporations Code § 17501(b)(1). For derivative actions involving corporations, see Corporations Code section 800(c)(1). “If the court determines, after hearing the evidence adduced by the parties, that the moving party has established a probability in support of any of the grounds upon which the motion is based, the court shall fix the nature and amount of security, not to exceed fifty thousand dollars ($50,000).” Corporations Code § 17501(c).

Thus, if a defendant or limited liability company or corporation involved in a derivative action is able to establish a probability that there is no reasonable possibility that the prosecution of plaintiff’s derivative claims will benefit the limited liability company or its members, or the corporation or its shareholders, plaintiff will be required to post a bond (up to $50,000).

******************************************

The above discussion is intended to be a general commentary on legal issues. Each situation is different and this article is not intended as legal advice. Further, nothing in this article is intended to create an attorney-client relationship.