Sax v. World Wide Press, Inc., 85-4306

• Decision Date: 30 September 1986
• Docket Number: No. 85-4306,85-4306
• Citation: 809 F.2d 610
• Parties: Arnold J. SAX, Plaintiff-Appellant, v. WORLD WIDE PRESS, INC., a Montana corporation; Instant Ticket Factory, Inc., a Montana corporation; Zollie Kelman; Sidney Kelman; Richard C. Pachek; Sheldon C. Masnek; Irving Greenfield; George Robert Crotty, Jr.; and George Campenella, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 610

809 F.2d 610

Arnold J. SAX, Plaintiff-Appellant, v. WORLD WIDE PRESS, INC., a Montana corporation; Instant Ticket Factory, Inc., a Montana corporation; Zollie Kelman Sidney Kelman; Richard C. Pachek; Sheldon C. Masnek Irving Greenfield; George Robert Crotty, Jr.; and George Campenella, Defendants-Appellees.

No. 85-4306.

United States Court of Appeals Ninth Circuit.

Submitted Sept. 30, 1986 ^*.

Decided Feb. 5, 1987.

R.P. Ryan, Billings, Mont., for plaintiff-appellant.

Gregory H. Warner, Judith A. Bartram, Margaret M. Joyce Johnson and Richard F. Gallagher, Great Falls, Mont., for defendants-appellees.

Appeal from the United States District Court for the District of montana.

Before NELSON, HALL and KOZINSKI, Circuit Judges.

NELSON, Circuit Judge:

Arnold J. Sax appeals the district court's dismissal of his amended complaint in a diversity action. The district court concluded that Sax's claims for damages stated a derivative cause of action under Montana law and that he had failed to comply with Fed.R.Civ.P. 23.1. The district court also dismissed Sax's claim to liquidate World Wide Press, Inc. (World Wide), concluding that the claim could not be brought in the form of a direct shareholder action because Sax had not alleged acts that injured him personally but only acts that damaged World Wide. Sax contends that the counts seeking damages state grounds for a direct shareholder action because they allege conduct by the defendants that injured Sax personally. He also claims that under Montana law, World Wide can be liquidated in his direct shareholder action. We disagree. Accordingly, we affirm the district court's dismissal of Sax's amended complaint.

FACTS

World Wide, a Montana corporation, manufactures and markets punchboards and other gambling supplies and equipment. The individual defendants own more than half of the stock of World Wide. In 1972, World Wide hired Sax as its general manager for the purpose of creating a plant at Great Falls, Montana. The oral employment agreement gave Sax an option to purchase up to 75,000 shares of stock in World Wide. After Sax successfully started the business and had acquired approximately 5% of World Wide's outstanding stock, World Wide allegedly breached the option agreement by refusing to sell him further stock. Sax terminated his employment on June 30, 1976.

After he terminated his employment, Sax alleges that the individual defendants conspired to deplete World Wide's assets and depreciate the value of his stock, which "deprived [him] of income consisting of the going rate of interest of the value of his stock." He claims that the members of the conspiracy illegally sold punchboards and kept inadequate records of inventory. He also alleges that the conspirators diverted World Wide's assets to their own use by selling punchboards to their corporation, Instant Ticket Factory, Inc., at less than fair market value, by causing World Wide to make unsecured loans to themselves, and by using World Wide assets to secure personal investments. Furthermore, Sax claims that the conspirators published false and fraudulent annual statements concealing their personal interests and conflicts of interest.

On December 3, 1983, Sax filed a complaint as an individual shareholder seeking compensation for actual and punitive damages caused by the alleged wrongful conduct of the conspiracy. The complaint also sought the liquidation of World Wide. In response to the defendants' motions, the district court struck Sax's claims for actual and punitive damages under Fed.R.Civ.P. 12(f) but did not strike his claim for liquidation.

Sax filed an amended complaint in an attempt to comply with the district court's opinion and order. On July 19, 1985, the district court withdrew its earlier opinion and dismissed the counts seeking damages in the amended complaint on the ground that the claims stated a derivative cause of action and that Sax had failed to comply with Fed.R.Civ.P. 23.1. It reasoned that the alleged wrongful acts of the defendants did not injure Sax personally but rather damaged World Wide and that therefore the action must be brought derivatively. It also dismissed Sax's claim to liquidate World Wide. The district court concluded that, although Mont. Code Ann. Sec. 35-1-921(1)(a)(ii) allows a shareholder to liquidate a corporation in a direct action, the shareholder "must first identify illegal, oppressive, or fraudulent acts which have injured him personally" and that the amended complaint had failed to identify such acts. Furthermore, it concluded that Mont. Code Ann. Sec. 35-1-921(1)(a)(i), (iii), (iv) "contemplate injury to the corporation" and that, as with the damage claims, Sax had failed to follow Fed.R.Civ.P. 23.1. Accordingly, the district court dismissed Sax's complaint.

DISCUSSION

I. Standard of Review

We review de novo a dismissal for failure to state a claim pursuant to Fed.R.Civ.P. 12(b)(6). ¹ Shah v. County of Los Angeles, 797 F.2d 743, 745 (9th Cir.1986); Guillory v. County of Orange, 731 F.2d 1379, 1381 (9th Cir.1984). Our review is limited to the contents of the complaint. North Star Int'l v. Arizona Corp. Comm'n, 720 F.2d 578, 581 (9th Cir.1983). To uphold a dismissal of this type, it must appear to a certainty that the plaintiff would not be entitled to relief under any set of facts that could be proven. Halet v. Wend Inv. Co., 672 F.2d 1305, 1309 (9th Cir.1982). All allegations of material fact are taken as true and construed in the light most favorable to the nonmoving party. North Star, 720 F.2d at 580. In addition, "[w]hether state or federal law applies in a diversity action is a question of law, which we review de novo." Olympic Sports Prod. v. Universal Athletic Sales Co., 760 F.2d 910, 912 (9th Cir.1985), cert. denied, --- U.S. ----, 106 S.Ct. 804, 88 L.Ed.2d 780 (1986). Finally, the district court's construction of state law is also reviewed de novo. Id.; In Re McLinn, 739 F.2d 1395, 1403 (9th Cir.1984) (en banc).

II. The Claims for Damages

In diversity actions, the characterization of an action as derivative or direct is a question of state law. C. Wright, A. Miller & M. Kane, Federal Practice and Procedure Sec. 1821 (2d ed. 1986); see Lewis v. Chiles, 719 F.2d 1044, 1048-49 (9th Cir.1983) (citing state law in diversity action to determine the nature of the appropriate cause of action). Once state law characterizes the action as either derivative or direct, the applicable procedural rules are determined by federal law. Gadd v. Pearson, 351 F.Supp. 895, 900 (M.D.Fla.1972); see Hanna v. Plumer, 380 U.S. 460, 464-74, 85 S.Ct. 1136, 1140-45, 14 L.Ed.2d 8 (1965); Olympic Sports Prod., 760 F.2d at 913-16. In federal courts, derivative suits are subject to the procedural requirements of Fed.R.Civ.P. 23.1. See Greenspun v. Del E. Webb Corp., 634 F.2d 1204, 1208-10 (9th Cir.1980) (affirming district court's dismissal of derivative action for failure to comply with Fed.R.Civ.P. 23.1). Rule 23.1 governs derivative actions " 'to enforce a right of a corporation' when the corporation itself 'failed to enforce a right which may properly be asserted by it' in court." Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 533-34, 104 S.Ct. 831, 836-37, 78 L.Ed.2d 645 (1984) (quoting Fed.R.Civ.P. 23.1).

Under Montana law, a shareholder can enforce a corporate right in a derivative action if certain conditions are met. Mont.R.Civ.P. 23.1; see S-W Co. v. John Wight, Inc., 179 Mont. 392, 402-03, 587 P.2d 348, 354 (1978). As a general rule, an action enforces a corporate right "if the gravamen of the complaint is injury to the corporation, or to the whole body of its stock or property without any severance or distribution among individual holders." 12B W. Fletcher, Cyclopedia of the Law of Private Corporations, Sec. 5911 (rev. perm. ed. 1984) (footnotes omitted); see Annotation, Stockholder's Right to Maintain (Personal) Action Against Third Person as Affected by Corporations' Right of Action for the Same Wrong, 167 A.L.R. 279, 280 (1947) (cited by Mont.R.Civ.P. 23.1 comment). Therefore, if the corporate wrong decreases the value of the corporation's stock, it does not necessarily create a direct cause of action for shareholders. Lewis, 719 F.2d at 1049 (applying Oregon law); W. Fletcher, supra, Sec. 5913; Annot., 167 A.L.R. 279, 280 (1947). The general rule that a shareholder cannot enforce corporate rights in a direct action applies to actions arising out of either contract or tort law. Schaffer v. Universal Rundle Corp., 397 F.2d 893, 896 (5th Cir.1968) (applying Texas law). A direct action can be brought either when there is a special duty, such as a contractual duty, between the wrongdoer and the shareholder, or when the shareholder suffers injury separate and distinct from that suffered by other shareholders. W. Fletcher, supra, Sec. 5911; see Schaffer, 397 F.2d at 896.

Sax argues that the district court improperly dismissed the damage counts of his amended complaint. He contends that he has an individual cause of action to which Rule 23.1 does not apply because he "gave up his prior job in Indiana, moved to Montana, successfully started World Wide, was refused his contractual right to purchase additional stock and therefore resigned," and because he was unable to sell his stock as a result of the defendants' actions. He cites Jones v. H.F. Ahmanson & Co., 1 Cal.3d 93, 460 P.2d 464, 81 Cal.Rptr. 592 (1969) and Davis v. Ben O'Callaghan Co., 238 Ga. 218, 232 S.E.2d 53 (1977), as support for the argument that he has stated grounds for a direct action. We disagree. The damages sought by Sax for the loss of interest income on his stock investment are incidental to injuries to World Wide and, therefore, are not injuries to Sax personally. See W. Fletcher, supra p. 6, at Sec. 5913; Annot., 167 A.L.R. 279, 280 (1947).

Sax alleges that the conspiracy depleted World Wide's assets through corporate mismanagement and diversion of corporate assets. These...