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Members Lose Standing to Sue When They Withdraw, Start Competitor

Members Lose Standing to Sue When They Withdraw, Start Competitor

Court finds requirement for continuous membership, absence of conflict of interest, to pursue derivative action

Members of a Masonic/Scottish Rite organization lost their standing to bring a derivative suit on behalf of the organization against several of its officers when the members lost their membership rights and started a competing organization.  An appellate court in Tennessee has ruled that the plaintiffs could not fairly represent the interests of the remaining members of the original organization when they had started a new one.

Several members who also served as officers of the United Supreme Council, 33 Degree of the Ancient and Accepted Scottish Rite of Freemasonry, Prince Hall Affiliation, Southern Jurisdiction of the United States (“Council I”), sued various officers and directors for breach of fiduciary duty, including embezzlement and misappropriation of corporate funds.  They sought an accounting and injunctive relief to prevent the defendants from participating in the management of the organization. 

After several of the defendants filed motions to dismiss, the trial court ordered a new election of officers.  Several of the defendants won elections against several of the plaintiffs.  The plaintiffs, no longer officers of Council I, formed a rival corporation with a similar, but not identical name, (“Council II”) and moved to transfer some of the subordinate entities of Council I to Council II.

Attorneys for Council I filed a motion to intervene and sought to have the case dismissed on the ground that the plaintiffs had lost their membership in Council I and could not adequately represent the interests of the remaining membership because they had an “openly hostile relationship.”  The trial court agreed and granted summary judgment against the plaintiffs.  The trial court said they had “voted with their feet” and left the Council and because they had formed a rival organization they could not “fairly and adequately” represent the rights of Council I in the case.

On appeal, the Court of Appeals said it was bound by the Tennessee nonprofit corporation law and its Rule of Civil Procedure on derivative suits.  The statute provides that a member bringing a derivative suit must be a member “at the time of bringing the proceeding.”  It does not deal with what happens when the member loses membership status.  The Rule provides that a derivative action “may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association.”

On the statutory issue, the Court found that an “overwhelming majority” of other state courts had found a requirement for “continuous ownership” in for-profit corporation derivative cases.  Quoting one opinion from California, it said that “if successful, a derivative claim will accrue to the direct benefit of the corporation and not to the stockholder who litigated it.  Because a derivative claim does not belong to the stockholder asserting it, standing to maintain such a claim is justified only by the stockholder relationship and the indirect benefits made possible thereby, which furnish the stockholder with an interest and incentive to seek redress for injury to the corporation.  Once this relationship ceases to exist, the derivative plaintiff lacks standing because he or she no longer has a financial interest in any recovery pursued for the benefit of the corporation.”

The Court said the rational was “equally appropriate” in the context of a derivative action brought on behalf of a nonprofit corporation.  “To hold otherwise, under the circumstances of this case, would produce the ‘anomalous result’ that Plaintiffs — who have absolutely ‘no dog in the hunt’ — are permitted to pursue a right of action that belongs solely to” Council I, the Court wrote.

The Court also agreed that the plaintiffs had a conflict of interest so that they could not fairly and adequately represent the interests of Council I and its members because they had formed a rival and competing organization.  It said its research into for-profit cases found cases dealing only with shareholders bringing derivative and individual claims simultaneously.  But it concluded that the “underlying principle — that a conflict of interest may disqualify a shareholder from maintaining a derivative action — is nevertheless applicable to the present case.”

It found that “an overriding antagonistic relationship” between the plaintiffs and Council I was such that they “cannot fairly and adequately represent the interests of the members” of Council I “and, thus, lack standing.”  (United Supreme Council AASR SJ et al. v. McWilliams, Ct. of App, TN, at Jackson, No. W2018-00116-COA-R3-CV, 3/21/19.)

YOU NEED TO KNOW

While this case seems to follow the general rule for shareholders of a for-profit corporation, you should know that a court in California recently rejected a requirement for “continuous directorship” when a director was removed from the board involuntarily after filing a derivative suit on behalf of a nonprofit corporation.  (See: “Director Retains Standing to Sue Even After Removal From Board”)

Jurisdiction: 
Ct. of App. TN

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