Served Today, Trial Tomorrow

Served Today, Trial Tomorrow

You could be in trial tomorrow on a case that was filed last week. This has been a surprising reality for clients – and lawyers. A special provision in the California Corporations Code Section 709, requires a trial to begin within five days once an action to determine the validity of a shareholder election or the appointment of a director is filed. I have handled many of these Section 709 Actions, and I have yet to appear before any judge that has ever even heard of them.

Section 709 Actions do not simply challenge a vote count. Rather, courts are given wide discretion to consider all matters relevant to determining who the directors should be, not just technical or procedural issues.

The provision refers to both the “shareholder” filing the action, and “any person who claims to have been denied the right to vote.” Courts have granted standing to those who merely assert they are entitled to vote, considering the merits of the action without first determining whether the plaintiff did in fact have a legal right.

The facts leading to Section 709 Actions are diverse.

Some examples are as follows:

• Two self-appointed boards of directors were created when certain stock transactions lacked clear documentation and effective dates. A purported shareholder who had acquired stock through one of the suspect transactions brought a Section 709 Action to invalidate the other board.
• A Section 709 Action sought to validate the election of a board of directors, rather than to invalidate it, to ensure that subsequent actions by the board could not be challenged over questionable authority.
• Two competing shareholder factions claimed their representative director held the decisive fifth seat on an otherwise evenly divided board of directors. A special meeting of the shareholders was called by one faction, and only they showed up to the meeting. Because there was no quorum, the meeting was adjourned until immediately before the next shareholder or board of directors meeting. At that new meeting, defendants were able to elect their representative as the fifth director. A Section 709 Action determined whether the “adjournment” leading to the election was proper.
• A board had seven seats with three vacancies. The four directors were deadlocked. The bylaws provided a certain process for shareholders to elect directors at annual meetings. No annual meeting had been held for years. The bylaws provided that a majority of directors, although less than a quorum, could fill the vacancies and any directors so chosen could hold office until the next election of directors at an annual shareholders’ meeting. Two of the directors held a special directors meeting, filled all of the vacant seats, then appointed new officers and management of the company.
• A shareholder brought a Section 709 Action to determine the validity of the board.

A shareholder brought a Section 709 Action challenging the election of the company’s directors by written consent. The dispute was whether such an election required the signatures of a simple majority of shareholders, or all of the shareholders.

Clearly, the plaintiff in a Section 709 Action has a tremendous advantage during litigation. Typically, the plaintiff has fully prepared for trial before they have even filed the action. The defendant, however, is left with only a few days–or even hours–to prepare a defense.

There are ways, however, that the defense could slow the process down, including challenging jurisdiction, removing to federal court, demurring, asserting an arbitration provision, or commencing the trial within the five days and then continuing it.

Section 709 Actions have no specific statute of limitations, but since they are equitable claims, they are subject to laches. I have seen these lawsuits survive six months to a year after the challenged election has occurred. When successful, the actions taken by the errant board may be unwound.

To prevent these problems, a prescient draftsman could attempt to contractually waive the right to a Section 709 Action. For example, a venture capital firm could insert the anti-Section 709 provision into its financing agreements so that it never finds itself trying a case within five days of filing. No reported case has dealt with whether this statute can be waived, but it may be worth the attempt, particularly for venture capital firms who are likely targets of these types of actions.

Mark S. Adams, a partner in the Litigation Department of JMBM’s Orange County office, focuses his practice on domestic and international business litigation including, contracts, products liability, corporate and partnership disputes, and employment litigation. He has tried numerous cases in state courts, federal courts, and in domestic and international arbitrations under the auspices of the International Chamber of Commerce. Contact him at MarkAdams@JMBM.com or 714.429.3064.

To view a PDF of this article, click here.