Shoen v. SAC Holding Corp.

Citations: 137 P.3d 1171; 122 Nev. 621; 122 Nev. Adv. Rep. 57; 2006 Nev. LEXIS 77Docket: 41563

Court: Nevada Supreme Court; July 13, 2006; Nevada; State Supreme Court

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The case involves multiple appellants, including Paul F. Shoen, Alan Kahn, and Glenbrook Capital Limited Partnership, against various respondents, primarily SAC Holding Corporation and a series of related self-storage corporations, as well as several individuals including Edward J. Shoen, Mark V. Shoen, and AMERCO. The Supreme Court of Nevada issued a ruling on July 13, 2006, under case number 41563. The legal representation for appellants includes firms from Las Vegas, San Francisco, New York, and San Diego, while the respondents are represented by firms from Reno, Los Angeles, and Phoenix. The document outlines the extensive list of parties involved, indicating a complex legal battle with multiple entities and individuals on both sides.

The court clarifies the conditions under which a shareholder's demand for corrective action on a company's board before filing a derivative suit can be deemed futile. Appellants—shareholders of AMERCO, a Nevada holding company—filed four derivative suits against current and former directors and associated self-storage entities, alleging improper dealings that harmed shareholder interests. The district court dismissed their complaints, stating they did not adequately demonstrate that a demand would be futile. 

The court establishes that when a shareholder's demand is made to a board that has already voted on the action in question, the shareholder must provide specific facts raising doubt about the directors' independence or their protection under the business judgment rule. Conversely, if the board has not made a definitive business decision regarding the action, a shareholder can be excused from making a demand only if they demonstrate that over fifty percent of the directors would be unable to act impartially. 

As the court refines the criteria for assessing demand futility, it reverses the district court's dismissal of the shareholders' complaints and remands the case for further proceedings. Background information reveals that AMERCO, founded in 1969 and originally led by Leonard Samuel Shoen, has been involved in disputes among family members over control, which includes the appellants, who have historical ties to the board of directors.

In 1994, Joe and James transferred their shares in the SAC entities to Mark prior to filing for personal bankruptcy, making Mark the sole shareholder of the SAC entities. Appellants claim that Joe, James, and Mark constitute an 'insider group' that has used board control to pursue their own interests at the expense of AMERCO shareholders, specifically by establishing a competing business through unfair transfers of AMERCO's self-storage assets to the SAC entities. As a result, appellants filed derivative suits seeking to reverse these transactions but did not make a pre-suit demand on the AMERCO board, alleging that such demand would be futile due to board members' involvement in the alleged misconduct and the dominance of the 'insider group.'

In district court proceedings, after Paul and Ron Belec filed individual derivative actions, respondents moved to dismiss these actions for failure to meet pre-suit demand requirements. The court denied the motions but noted that demand futility had not been adequately demonstrated and permitted amendments to their complaints. Paul later filed an amended complaint, but respondents sought dismissal again, claiming insufficient pleading of demand futility, failure to state a claim, and untimely filing. The district court consolidated Paul’s and Belec’s suits but noted it could not merge their complaints. 

Subsequently, shareholders Glenbrook Capital, L.P. and Alan Kahn filed their own derivative complaints. A court notice scheduled a hearing for May 6, 2003, to address dismissal issues, notifying Paul and Belec but not Glenbrook Capital and Kahn. On May 5, 2003, the four parties agreed to consolidate their cases, appointing Paul’s and Belec’s attorneys as lead co-counsel and intending to file a superseding consolidated complaint. However, this stipulation was not filed before the hearing. Paul’s counsel filed a notice of intent to submit a proposed consolidated complaint, which alleges eight causes of action for breaches of fiduciary duties and violations of corporate and tort laws, claiming AMERCO's focus on self-storage opportunities has shifted to benefit Mark and the SAC entities instead.

The proposed consolidated complaint alleges that Mark and the SAC entities improperly profited in three main ways. First, it claims that AMERCO sold self-storage properties to the SAC entities at unfairly low prices, calculated at 'acquisition cost plus capitalized expenses,' determined by Joe, without accounting for additional value from AMERCO’s lease agreements and the properties' strategic locations. Second, it alleges that AMERCO financed these transactions with over $400 million in nonrecourse loans, retaining financial risk while the SAC entities gained benefits like appreciation and tax advantages. Specific transactions from 1995 and 1996 are highlighted, including a $54 million loan for properties purchased at a loss. The SAC entities allegedly competed with U-Haul through these acquisitions. Third, the complaint asserts that the SAC entities utilized AREC's employee resources for property-related activities without appropriate compensation, and these dealings were not approved by AMERCO's board. It is claimed that AMERCO's financial statements failed to adequately disclose the SAC entities' involvement, leading to misleading public disclosures. The external auditor later required clearer disclosure, which resulted in negative financial implications for AMERCO. Additionally, in 2002, the SAC entities began encroaching on U-Haul’s core business by acting as independent dealers. The complaint also alleges that AMERCO's board members breached their fiduciary duties by allowing these practices to occur without proper oversight, participating in the planning and sanctioning of the alleged illegal conduct.

The proposed complaint alleges that each respondent director was aware of and participated in the wrongful acts attributed to AMERCO or neglected their responsibilities regarding these acts. Appellants claim that the former board's signing of misleading financial statements and the current board's failure to clarify them constitute a conspiracy to defraud. Although the proposed consolidated complaint was not filed, during a May 6 hearing, the district court addressed motions to dismiss Paul's amended complaint. Appellants raised the issue of consolidating the complaints, suggesting that if approved, the motions to dismiss would become moot. The court decided to proceed with the dismissal motions, focusing on Paul's amended complaint and the proposed consolidated complaint, which were argued to be similar regarding the demand futility sections. Ultimately, the district court found both the amended and proposed consolidated complaints insufficient in alleging demand futility, leading to the dismissal of all four lawsuits, including those of Paul, Belec, Glenbrook Capital, and Kahn, without leave to amend, prompting an appeal.

Nevada corporate law grants the board of directors full control over corporate affairs, governed by duties of care and loyalty. The duty of care requires informed decision-making, while the duty of loyalty mandates prioritizing the corporation's and shareholders' interests. The business judgment rule, codified in 1991 at NRS 78.138, presumes directors act in good faith and in the company's best interests. Shareholders can file derivative suits to compel the corporation to take legal action against directors or third parties when the board fails to act appropriately.

Shareholders must make a demand on the board of directors before filing a derivative lawsuit, which serves to inform directors of concerns and allows them the opportunity to address issues without litigation. This demand requirement acknowledges that certain actions might be ratified by a majority of shareholders, potentially negating the need for a lawsuit. It also aims to protect the discretion of directors and corporate assets by discouraging frivolous shareholder claims. 

Under NRCP 23.1, a derivative complaint must specify the demand made and the reasons for any failure to obtain action, or justify the absence of a demand. The Delaware Supreme Court emphasizes that shareholders must provide detailed factual statements regarding their demands, with mere conclusory assertions being insufficient. A failure to adequately plead compliance with this demand requirement can lead to dismissal of the complaint for lack of standing.

Dismissals under NRCP 23.1 are reviewed rigorously by courts, which must accept the truth of the allegations and draw favorable inferences for the nonmoving party. Furthermore, in cases like Johnson v. Steel, it is noted that if a board is involved in wrongful acts, a demand may not be necessary. However, allowing demand excuses based solely on participation could undermine the demand requirement and the business judgment rule. Therefore, a balanced approach is advocated, recognizing the presumption of director action's validity.

Johnson's suggestion that the demand requirement is excused simply because a shareholder derivative complaint alleges that a majority of directors participated in wrongful acts is overruled. The business judgment rule applies only to directors whose conduct is protected under certain conditions, specifically in the context of valid interested director actions or disinterested directors exercising business judgment in line with their fiduciary duties. Shareholder derivative complaints may not always involve business decisions made by the directors, and the directors to whom a demand must be made are not necessarily the same as those accused of wrongdoing. 

The Delaware Supreme Court has established two analyses to determine whether the board considering a demand is either potentially protected by the business judgment rule or capable of being disinterested and independent in evaluating the demand for corrective action. In the 1984 case Aronson, the court ruled that mere allegations of wrongdoing do not automatically excuse the demand requirement. The court emphasized that even poor business decisions are usually protected by the business judgment rule, as long as disinterested directors can claim its protections. 

Plaintiffs challenging business decisions must demonstrate that either the board cannot invoke the protections of the business judgment rule (e.g., due to financial interests) or that the rule is unlikely to protect the decision due to possible breaches of due care. Approval of a transaction by a majority of disinterested directors typically strengthens the presumption that the decision was made with due care, placing a significant burden on the plaintiff to avoid pre-suit demand. Thus, a two-pronged demand futility analysis is necessary to assess whether a complaint raises reasonable doubt about the disinterestedness and independence of the directors or their entitlement to the protections of the business judgment rule.

Determining demand futility involves assessing whether a reasonable doubt exists regarding the disinterest and independence of directors or the validity of the business judgment in a challenged transaction. Under the Aronson test's first prong, if the allegations in the complaint suggest that the business judgment rule does not apply due to the directors' interests or control by interested parties, the demand requirement is excused without further inquiry. An "interested" director may have divided loyalties or stand to gain financially from the transaction, while "control" refers to influences affecting directors' decision-making. 

The second prong of the Aronson test applies only if the board majority is deemed disinterested or independent. It involves reviewing the facts to determine if the challenged transaction constitutes a valid exercise of business judgment. If the alleged wrongs are not business decisions, the analysis focuses on whether the board would have been entitled to business judgment protection regarding the act. The business judgment rule may not apply if board members change or if the act is not a business decision. However, demand is not automatically excused based on the applicability of the business judgment rule.

In Rales v. Blasband, a different analysis for demand futility is applied when the board considering the demand was not involved in the challenged transaction. It examines whether a majority of the directors had a disqualifying interest or were unable to act independently at the time the complaint was filed. This approach focuses on the ability of the board addressing the demand to impartially consider it, free from improper influences. Independence issues may arise if directors are unduly influenced or beholden to those who may be liable, impacting their ability to consider a demand on its merits.

To establish interestedness, a shareholder must demonstrate that a majority of the board would be materially affected by a board decision in a way that is not shared with the corporation or its shareholders. Mere allegations of potential liability are insufficient to bypass the demand requirement, except in rare cases of egregious misconduct that create a substantial likelihood of director liability. The business judgment rule does not shield directors and officers from gross negligence or breaches of duty of loyalty involving intentional misconduct or violations of law. This high threshold for demonstrating interestedness through potential liability aligns with Delaware's framework for analyzing demand futility, which is applicable under Nevada law.

In evaluating demand futility, Nevada courts must determine if specific facts indicate a reasonable doubt about the directors' disinterestedness regarding challenged transactions or if the board can impartially consider a demand when board action is absent or when the board has changed since the transactions. The appellants allege that the AMERCO board failed to prevent or address wrongdoings and knowingly issued misleading public statements. Since these allegations primarily concern a lack of supervision rather than specific business decisions, the Rales test applies, which assesses whether the board can impartially evaluate a demand.

The appellants contend that their claims create reasonable doubt about the current board's ability to exercise independent judgment. However, the district court is deemed the appropriate venue to resolve these shareholder demand disputes initially. Thus, the matter is remanded for the district court to analyze if the appellants have presented sufficient specific facts to demonstrate demand futility. Additionally, the appellants argue that the demand requirement should be excused due to allegations that the AMERCO-SAC entities' transactions are ultra vires and therefore void and not subject to ratification.

Appellants argue that demand is excused in their proposed consolidated complaint due to allegations that AMERCO's transactions with the SAC entities are ultra vires acts, meaning they exceed the powers granted by state law or the corporation's articles of incorporation. The definition of ultra vires acts is not clearly defined, especially regarding acts performed without authority but still within corporate powers. In derivative actions challenging a board's ultra vires act, demand on shareholders may be excused because such acts, if proven true, are void and cannot be ratified by shareholders. However, the board has a duty to correct any potentially void transactions, and the rationale for demand becomes stronger when the board has not affirmatively approved the acts in question. The district court did not adequately consider whether demand on AMERCO's board was excused based on this rationale. Therefore, the court's dismissal of the cases is reversed, and the matter is remanded for reconsideration of the demand requirement under the Aronson and Rales tests. The court clarifies that shareholders must plead with particularity to show reasonable doubt regarding directors' independence and disinterest to excuse demand. Additionally, if the contested transaction did not arise from director action, the focus shifts to whether a majority of directors had a disqualifying interest. The district court's examination of this issue may extend beyond the pleading stage.

If the district court finds sufficient particularized facts indicating demand futility, it must hold an evidentiary hearing to assess whether this affects the shareholder's standing to sue. As the parties have not fully addressed the demand requirement following this opinion, the dismissal order by the district court is reversed, and the case is remanded for further proceedings on demand futility. Appellants are permitted to amend and file their complaints, reflecting the adoption of the Aronson and Rales tests for evaluating demand futility claims.

Additionally, M.S. Management, Inc. withdrew from the appeal after participating in the district court proceedings. A prior 1994 Arizona lawsuit related to corporate disputes resulted in substantial damages against Joe and James, leading to their bankruptcy. M. Frank Lyons was named in Belec's complaint but not in Paul's. The district court initially dismissed the cases for insufficient pleading of fraudulent misrepresentation but later amended its dismissal to assert failure to plead demand futility adequately. Despite the proposed consolidated complaint not being filed, the dismissal motions were addressed concerning it; since demand futility was equally applicable, there was no basis to file the proposed consolidated complaint if it was not sufficiently alleged. 

Various legal precedents and statutes, including NRS 78.120(1) and NRS 78.138(3), are referenced regarding the expectations of directors and the requirements for pleading demand futility in derivative suits.

Aronson v. Lewis established a two-pronged test for evaluating demand futility in shareholder derivative suits, requiring plaintiffs to show either that a demand on the board would be futile or that a majority of the board is disinterested and independent. This analysis was reaffirmed and later modified in Rales v. Blasband, which replaced the conjunctive "and" with a disjunctive "or," indicating that satisfying either prong is sufficient. Delaware's NRCP 23.1 mandates particularized pleading regarding efforts to obtain desired actions from directors, paralleling the heightened pleading requirements for fraud. The Brehm decision clarified that the NRCP 23.1 standard is more rigorous than NRCP 12(b)(5), and if a complaint meets the former, it typically satisfies the latter. Courts accept allegations as true and draw reasonable inferences favorably when reviewing NRCP 23.1 issues, but this acceptance does not reflect on the merits of the claims. The excerpt also emphasizes the importance of demonstrating the merit of claims through detailed factual allegations, as outlined in Grobow v. Perot and Rales v. Blasband.

A plaintiff must allege specific facts that create a reasonable doubt regarding the directors' impartiality to establish demand futility in derivative actions, as outlined in Pogostin v. Rice and further refined by the Aronson and Rales tests. The trial court must exercise discretion to determine if these facts warrant concluding that demand is futile, thereby ending inquiry. The Rales test applies under certain conditions, such as a majority of directors being replaced or the subject matter not being a board business decision. Familial relationships among directors may create a reasonable doubt about their impartiality; however, mere familial ties are insufficient without particularized allegations demonstrating how these relationships affect disinterestedness. Legal precedents emphasize the need for detailed pleadings to support claims of partiality based on family connections, as established in cases like Harbor Finance Partners v. Huizenga and In re Oracle Corp. Derivative Litigation.

Directors facing lawsuits for failing to supervise their subordinates may have a disabling interest if the potential for liability is significant, rather than merely theoretical. In McCall v. Scott, it was determined that specific facts raised reasonable doubt regarding the disinterestedness of directors due to a substantial likelihood of liability. Under Nevada law (NRS 78.138(7)), this principle applies only to claims post-June 15, 2001, although AMERCO’s articles of incorporation reflect a similar limitation. When fiduciary transactions are questioned, the interested fiduciary bears the burden to demonstrate good faith and fairness of the transaction, as highlighted in various case laws. In derivative actions asserting demand futility based on substantial liability likelihood, shareholders must allege specific facts to support their claims without needing to prove unfairness. The tests for determining disinterestedness and independence often yield similar results, focusing on whether a director's interest affects their impartiality. Notably, on an even-numbered board, disinterested directors’ votes can be overridden by half the board, impacting demand considerations. Additionally, in cases of nonfeasance or willful blindness, particularized facts must connect a majority of directors to concerted inaction before the Aronson test is relevant, as evidenced in various court interpretations.

Appellants claim that respondent directors engaged in wrongful conduct through their roles in various committees and as officers of subsidiaries. However, they fail to demonstrate that a majority of directors participated in any specific transaction, which undermines their assertion of concerted board action. The district court noted that Nevada law on demand futility was not entirely applicable and directed appellants to Delaware law, requesting detailed information on the transactions in question. The current board's ability to impartially address a demand for corrective action is in question, but their entitlement to business judgment protections regarding the alleged improper transactions remains unaffected. 

On remand, the court should reassess the demand futility in light of the clarified analysis. Director Lyons was not named as a defendant, but appellants allege he lacks independence. Additionally, the familial ties of the Shoen brothers to another director suggest that they are interested parties regarding demand futility. The court should evaluate these allegations concerning Lyons and the other five board members.

Furthermore, legal precedents differentiate between void and voidable acts, emphasizing that corporate articles define the authority of the directors. Acts beyond this authority cannot be ratified by shareholders, and the business judgment rule may not apply to ultra vires acts that significantly deviate from corporate purposes. Lastly, Belec, Glenbrook Capital, and Kahn argued their due process rights were violated when their suits were dismissed without notice. The court's dismissal should be reversed, and the matter remanded for further proceedings, as the lack of a dismissal motion or notice violated procedural due process rights.