Angel Investors, LLC v. Garrity

• Decision Date: 21 July 2009
• Docket Number: No. 20080111.,20080111.
• Citation: 216 P.3d 944,2009 UT 40
• Parties: ANGEL INVESTORS, LLC, a Utah limited liability company, suing derivatively on behalf of XanGo, LLC, Plaintiffs and Appellants, v. Aaron GARRITY, Bryan Davis, Gary Hollister, Gordon Morton, Joseph Morton, and Kent Wood, Defendants and Appellees.
• Court: Utah Supreme Court

216 P.3d 944

2009 UT 40

ANGEL INVESTORS, LLC, a Utah limited liability company, suing derivatively on behalf of XanGo, LLC, Plaintiffs and Appellants, v. Aaron GARRITY, Bryan Davis, Gary Hollister, Gordon Morton, Joseph Morton, and Kent Wood, Defendants and Appellees.

No. 20080111.

Supreme Court of Utah.

July 21, 2009.

Rehearing Denied July 27, 2009.

Mary Anne Q. Wood, Richard J. Armstrong, Salt Lake City, for plaintiffs.

Mark F. James, Phillip J. Russell, Salt Lake City, for defendants.

AMENDED OPINION^*

DURRANT, Associate Chief Justice:

INTRODUCTION

¶ 1 In the district court, Angel Investors, LLC, brought a derivative suit on behalf of XanGo, LLC, against Aaron Garrity, Bryan Davis, Gary Hollister, Gordon Morton, Joseph Morton, and Kent Wood, who are the managing members and majority owners of XanGo (collectively, the "Majority Owners"). Prior to initiating the derivative suit, Angel Investors brought a direct suit against XanGo, seeking the dissolution of the company, among other relief. In the derivative suit, the district court ruled that Angel Investors lacked standing to bring the action because Angel Investors could not "fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing" XanGo's rights, as required by Utah Rule of Civil Procedure 23A.¹ The district court reached this conclusion after finding that (1) Angel Investors is similarly situated to other minority shareholders and (2) Angel Investors cannot fairly and adequately represent the interests of those similarly situated shareholders because (A) the shareholders each indicated that they do not support Angel Investors as a derivative plaintiff and (B) Angel Investors' direct suit causes a conflict of interest.

¶ 2 Angel Investors requested time to conduct discovery in order to demonstrate that it is not similarly situated to any other XanGo shareholder. The district court denied Angel Investors' request.

¶ 3 Angel Investors now challenges the district court's rulings on appeal, arguing that it should be allowed to proceed with the derivative action as a class of one and that the district court erred in denying its request to conduct discovery.

¶ 4 The Majority Owners argue that we should affirm the district court, if not on the original grounds then on the alternative grounds that Angel Investors cannot be a fair and adequate representative because it never signed the operating agreement or because Angel Investors stands to gain relatively little from the derivative suit given its small, one percent, interest in XanGo. We find the Majority Owners' arguments unpersuasive.

¶ 5 Particularly, we hold that (1) Angel Investors is not similarly situated to any other XanGo shareholders and, therefore, qualifies as a class of one; and (2) the Majority Owners have not met their burden of proving that Angel Investors is an inadequate representative under rule 23A. We address the Majority Owners' fair and adequate representation arguments as follows. We first determine that the dissent of dissimilar shareholders is not relevant to the fair and adequate representation inquiry when a derivative plaintiff qualifies as a class of one. We next determine that Angel Investors' direct and derivative suits are not in actual conflict and, therefore, the direct suit does not disqualify Angel Investors as a derivative plaintiff. Finally, we decline to address the Majority Owners' alternative grounds for affirming the district court's determination because they were not preserved in the district court. We also do not address the district court's ruling on Angel Investors' discovery request because our standing determination grants Angel Investors all of the relief it seeks in this appeal.

BACKGROUND

¶ 6 Angel Investors is a limited liability company that owns one percent of XanGo, which is also a limited liability company. The Majority Owners own eighty-six percent of XanGo. In addition to Angel Investors, there are nineteen individual entities that have an ownership interest in XanGo.

¶ 7 Prior to initiating a derivative suit on behalf of XanGo, Angel Investors brought a direct suit against XanGo. In the direct suit, Angel Investors alleged that (1) XanGo loaned funds to the Majority Owners so that they could personally acquire minority interests in XanGo and (2) XanGo denied Angel Investors the right to inspect XanGo's financial records. In the direct action, Angel Investors sought both monetary damages from XanGo and the dissolution of XanGo.

¶ 8 While the direct suit was pending, Angel Investors initiated a derivative suit against the Majority Owners. The derivative suit is the subject of this appeal. In the derivative suit, Angel Investors alleged that the Majority Owners had taken millions of dollars in personal loans from XanGo; purchased minority interests in XanGo with the loaned funds, thus appropriating to themselves opportunities belonging to XanGo and all of its shareholders; and paid themselves excessive compensation while wasting corporate assets.

¶ 9 The Majority Owners responded to Angel Investors' complaint by filing a motion to dismiss pursuant to Utah Rule of Civil Procedure 12(b)(1). In their motion to dismiss, the Majority Owners argued that Angel Investors lacked standing to bring a derivative suit. To support their argument, the Majority Owners attached affidavits from each of XanGo's minority shareholders, other than Angel Investors. All of the affiants stated that they did not support Angel Investors as a representative of XanGo in the derivative suit.

¶ 10 Angel Investors, in opposition to the motion to dismiss, requested time to conduct discovery and argued that it met the standing requirements of Utah Rule of Civil Procedure 23A. Angel Investors contended that through discovery it could prove that it was not similarly situated to any other XanGo shareholder. Specifically, Angel Investors alleged that it is the only minority owner "`which is not in a position to be coerced or bribed by [the Majority Owners].'"

¶ 11 The district court heard oral argument on the motion to dismiss. Two months later, the court issued its ruling, wherein the court granted the motion to dismiss, stating first that Angel Investors is not a class of one because there are other XanGo owners that are similarly situated. Describing the situation of the remaining nineteen XanGo owners, the court stated:

[S]ix of the nineteen [owners] are the Defendants and two have a family relationship with a Defendant.... Seven other [owners] are employees of XanGo. Only four of the [owners] do not have an employee or family relationship to the Defendants or the company of which the Defendants are the majority owners. While Defendants, their family members, and the XanGo employees may not be similarly situated to [Angel Investors], the Court finds that the four remaining [owners] are similarly situated....

The four remaining owners that the court found to be similarly situated to Angel Investors were among the affiants declaring their opposition to the derivative suit.

¶ 12 The court further stated that Angel Investors cannot fairly and adequately represent the interests of these similarly situated XanGo owners because "there may be some actual conflict between [Angel Investors' interests] in the Direct Lawsuit and its representation in the derivative suit" and because the other XanGo owners have asserted by affidavit that they oppose the derivative suit. The court observed that the minority shareholders "are independent actors and have the ability and right to take a position that may be against their best interests." Accordingly, the district court concluded that Angel Investors "would not be a fair and adequate representative of the non-defendant owners in the derivative suit."

¶ 13 We now review the district court's standing rulings on appeal. We have jurisdiction pursuant to Utah Code section 78A-3-102(3)(j) (2008).

STANDARD OF REVIEW

¶ 14 A standing determination "`is primarily a question of law, although there may be factual findings that bear on the issue.'"² Therefore, we review the district court's legal determinations for correctness but review its factual determinations with some deference to its findings.³

ANALYSIS

¶ 15 Utah Rule of Civil Procedure 23A(a) permits "a derivative action [to be] brought by one or more shareholders or members to enforce a right of a corporation or of an unincorporated association."⁴ But rule 23A(b) prevents the maintenance of a derivative action "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." Rule 23A further requires a court to dismiss a derivative action if the defendant demonstrates that the plaintiff does not meet the rule's requirements.⁵

¶ 16 If, as in this case, the plaintiff's pleadings allege that the plaintiff fairly and adequately represents the interests of similarly situated shareholders, then "the burden is on the defendant to show that the plaintiff is an inadequate representative under rule 23.1 ... and, therefore, does not have standing."⁶ We reverse the district court's determination that the Majority Owners met their burden. Specifically, we hold that (1) Angel Investors is not similarly situated to any other XanGo owner and may proceed as a class of one, and (2) the Majority Owners have not met their burden of proving that Angel Investors is an inadequate representative under rule 23A.

I. ANGEL INVESTORS QUALIFIES AS A CLASS OF ONE

¶ 17 The district court found that there are other XanGo shareholders who are similarly situated to Angel Investors. The court, relying in part on a Sixth Circuit decision,⁷ considered the following factors in determining that Angel Investors is similarly situated to other shareholders: the benefit that the suit could confer, familial relationships between the defendants...