In Villari v. Mozilo, 208 Cal. App. 4th 1470 (August 30, 2012), the court affirmed the dismissal of the plaintiff’s second amended complaint, holding that the trial court had correctly found the plaintiff to have lost standing to maintain shareholder derivative claims on behalf of Countrywide Financial Corporation (“Countrywide”) following the merger with Bank of America Corporation (“BofA”).
In January 2008, Countrywide announced that it was planning to merge with BofA. The plaintiff, Joseph Villari (“Plaintiff”) and others filed their first complaint the same day. BofA completed its acquisition of Countrywide in July 2008, and Countrywide was reorganized as Countrywide Financial Corporation, a BofA subsidiary (“New Countrywide”). The Second Amended Complaint, filed after the merger, alleged that Countrywide and several former officers and directors engaged in mismanagement and fraud and alleged that the acquisition was “part of a single, inseparable fraud.” Plaintiff also filed a double derivative action against BofA, New Countrywide, and several directors and officers of those corporations.
The trial court dismissed the claims. The court ruled that Plaintiff failed to meet the continuous ownership rule required for a derivative action as a result of the merger. Plaintiff brought the immediate appeal, claiming that he had adequately pled the fraud exception to the continuous ownership rule Plaintiff did not challenge the dismissal of the double derivative claims.
Under Delaware law, shareholder derivative claims are subject to the continuous ownership rule. In order to bring a derivative action, a shareholder must have been an owner at the time of the alleged wrong, at the time the action was commenced and throughout the entire duration of the litigation. A plaintiff who loses shareholder status due to a merger also loses standing to continue the action. The fraud exception to this rule allows a plaintiff to retain standing if “(1) the merger itself is the subject of a claim of fraud; [or] (2) where the merger is in reality a reorganization which does not affect plaintiff’s ownership of the business enterprise.” In order for a plaintiff to maintain a suit under the first prong of the exception, the plaintiff must show that the merger was done solely to eliminate derivative claims.
Plaintiff argued that the fraud exemption was not limited to mergers solely designed to deprive shareholders of standing, but also to situations “where the directors’ fraudulent conduct and breach of fiduciary duty prior to a merger impaired the corporation’s financial condition to such an extent that a merger became a practical necessity.” The court, however, rejected the argument, finding that there was “no compelling need to justify a broadening of the fraud exception to the continuous ownership rule” and that the “expansion of the fraud exception to the continuous ownership rule that would effectively swallow that rule.” The court noted that had Plaintiff pursued the double derivative claims that were brought in the second amended complaint, the continuous ownership rule would have been irrelevant and the case could have proceeded.
The primary materials for this case may be found on the DU Corporate Governance website.