Charlene Hicks—Senior Attorney, National Legal Research Group
Corporate shareholders, individual members of a limited liability company, or residents of a homeowners' association often file derivative complaints on behalf of the entity to assert rights that the entity itself has failed to raise against third parties. Sometimes these derivative actions prompt the entity to file its own lawsuit against the same third parties, resulting in parallel proceedings.
In Star v. TI Oldfield Development, LLC, 962 F.3d 117, 131 (4th Cir. 2020), the Fourth Circuit considered for the first time the issue of "whether a plaintiff's derivative action on behalf of an entity is rendered moot by the entity's settlement of the same or similar claims in another action." As a matter of first impression, the court held that it may.
The evidence showed that the Board of Directors of Oldfield, a residential community in South Carolina, filed lawsuits related to Oldfield's development. Rob Star, an Oldfield resident, later filed a derivative action on Oldfield's behalf, alleging similar claims against the same defendants. After the Board settled the lawsuits that it brought, the defendants moved to dismiss Star's derivative action on the ground that the settlements rendered the derivative lawsuit moot, and, therefore, the court lacked jurisdiction. In opposition, Star alleged that the settlement agreement was invalid due to a conflict of interest by certain board members and that the derivative action alleged claims not included in the Board's lawsuits.
Citing the Third Circuit's opinion in Salovaara v. Jackson National Life Insurance Co., 246 F.3d 289 (3d Cir. 2001), the Star court determined that it was not required to accept the Board's settlement agreement in the other action at face value. Rather, the court overseeing the derivative case had the equitable power to examine the settlement agreement for reasonableness and to determine whether the settlement was in the company's best interest. Star, 962 F.3d at 132.
In conducting this analysis, the court noted that the benefits of settlement included the end of ongoing litigation, the recovery of a significant monetary sum, and the conveyance of valuable rights to the entity. Accordingly, the court reasoned that a settlement that is "in the best interests of the company, entered by a disinterested board," may serve to "moot a related derivative suit asserting identical or similar claims arising out of the same underlying facts." Id. at 133.
Evidence of "collusion in the negotiation of the settlement agreements or any cognizable conflict of interests on the part of the Board" may "trigger a need for further scrutiny" of the terms of the settlement agreement by the court. Id. However, the burden is on the derivative plaintiffs to demonstrate improper collusion or bad faith on the part of some or all Board members. Id.
Given the broad language of the release provision of the settlement agreement at issue, the Star court also concluded that the Board's settlement released all claims that the Board could have raised in its own lawsuits but did not assert. Id. at 134. Thus, the effect of the Board's settlement agreement reached beyond the claims asserted in the Board's own action and also barred Star's claims in the derivative lawsuit that could have been raised in the Board's separate actions but were not.