Demand for relief required prior to suing nonprofit

Members of a public pension plan administered by the Minneapolis Police Relief Association (MPRA) must make a demand on the board of directors or demonstrate the futility of doing so before bringing a derivative suit over losses suffered by the plan, the Court of Appeals has ruled.

The MPRA lost nearly $15 million of pension funds after investing in a start-up company in which two of the MPRA’s board members and its executive director were involved. The plaintiffs, police officers and members of the MPRA, sued the two board members and the MPRA as a “nominal defendant,” alleging breaches of fiduciary duties and seeking damages and injunctive relief. While the lawsuit was pending, the plaintiffs filed charges with the MPRA, but were unsuccessful in having the board members removed.

The defendants moved to dismiss the lawsuit, arguing the plaintiffs failed to satisfy a condition precedent in Minn. R. Civ. P. 23.06, which requires a demand on the board of directors for relief or a demonstration of the futility of the demand prior to filing suit.

A Hennepin County District Court judge agreed, viewing the lawsuit as a corporation members’ derivative action subject to rule 23.06.

The Court of Appeals affirmed.

“The [plaintiffs] were aware of the derivative nature of the action when they initiated it. They brought the lawsuit ‘on behalf of’ the MPRA and they requested remedies ‘on behalf of’ the MPRA,” wrote Judge Gordon W. Shumaker. “Furthermore, their losses are not direct and are not separate, distinct, and independent from the MPRA’s losses. … Their claim is derivative and is subject to rule 23.06.”

The nine-page decision, Stocke, et al. v. Berryman, et al., is Minnesota Lawyer No. CA-892-01.

Minneapolis attorney Patrick J. McLaughlin, who represents the MPRA, told Minnesota Lawyer that the decision “confirms that nonprofit corporations that govern public pension funds are entitled to govern their own affairs rather than have their affairs governed through litigation.”

The plaintiffs never made the demand they were legally supposed to make, said McLaughlin, adding that if and when the plaintiffs do make a proper demand on the board, it will be considered at that time.

Once the plaintiffs jump through the hoops they need to, there is a whole other set of criteria that the court will need to look at in determining if a violation of the law exists, McLaughlin observed. “In my opinion, that is the issue we should have been litigating all along,” he said.

The plaintiffs’ attorneys did not return phone calls from Minnesota Lawyer prior to deadline.

Busting the fund

The plaintiffs, active Minneapolis officers, are all members of the Minneapolis Police Relief Association (MPRA), a nonprofit corporation organized under Minn. Stat. ch. 423B, which administers a defined benefit- pension plan for Minneapolis officers hired before June 15, 1980. The MPRA is governed by a board of nine members.

During 1996 and 1997, the MPRA invested $14.93 million in Technimar Industries, Inc., a start-up company engaged in the manufacture and sale of agglomerated stone blocks. Technimar’s prospectus warned of the risk inherent in purchasing its stock, stating: “The securities offered hereby are speculative and involve a high degree of risk and should be purchased only by persons who can afford the loss of their entire investment.”

By 1998, the MPRA had lost its entire investment in Technimar and the company was adjudged bankrupt in July of that year.

During the Technimar investment years, defendants Richard Nelson and Allen Berryman were MPRA board members. Nelson was the MPRA’s chief executive officer and Berryman was its secretary. Berryman and defendant Gerald Bridgeman also served on the board of Technimar. Although not an MPRA board member, Bridgeman was the MPRA’s executive director and, in that capacity, he participated in investment transactions with Technimar on behalf of the MPRA.

In February 1999, the plaintiffs sued the defendants “on behalf of nominal defendant” MPRA, alleging breaches of fiduciary duties and seeking damages and injunctive relief. The ad damnum clause in the complaint prayed for “judgment against [defendants] and on behalf of nominal defendant MPRA.”

While this lawsuit was pending, the plaintiffs filed charges with the MPRA against Berryman, Nelson, and all other board members. The MPRA bylaws provided that members would be entitled to vote on charges filed against directors. The members’ vote did not sustain the charges, and Berryman and Nelson remained on the board.

The defendants then made two dismissal motions in the lawsuit. The first was to dismiss or strike the plaintiffs’ demand for injunctive relief on the ground that the exclusive remedies for directors’ breaches of fiduciary duty are provided by Minn. Stat. ch. 423B and the MPRA bylaws. The District Court judge agreed that the plaintiffs had an adequate remedy under the MPRA bylaws and granted the motion.

The second motion sought the dismissal of the entire action on the grounds that the plaintiffs had failed to satisfy a condition precedent in Minn. R. Civ. P. 23.06 requiring an allegation with particularity of the efforts made to obtain relief from the MPRA board. The complaint contained only a general allegation in that regard. The District Court judge granted this motion as well, ruling that the lawsuit was a derivative action and was subject to the requirements of rule 23.06. The plaintiffs appealed.

Demanding a demand

The plaintiffs contended that they were not obligated by rule 23.06 of the Minnesota Rules of Civil Procedure to make a demand for board action because:

• their claims were brought under Minn. Stat. ch. 356A, the Public Pension Fiduciary Responsibility Act (PPFRA), which mirrors the federal Employee Retirement Income Security Act (ERISA);

• their claims are individual and not members’ derivative claims; and

• they sued as beneficiaries of the MPRA trust fund.

The PPFRA provides in part that the District Court has jurisdiction over a challenge of fiduciary action or inaction, Shumaker observed. “However,” he continued, “there is nothing in Minnesota law that exempts chapter 356A from the rules of civil procedure.”

The court also dispelled the notion that chapter 356A is a mirror of ERISA and that rule 23.06 does not apply to actions under ERISA. Shumaker noted that state governmental pension plans such as that administered by the MPRA are excluded from ERISA applicability.

Rejecting the plaintiffs’ final contention that they are, in effect, beneficiaries who are proceeding against trustees, Shumaker pointed out that there is a separate statute governing trusts, trustees, and beneficiaries.

“The MPRA and its fund are not established under trust law and, we see no reason to apply trust law to circumstances already regulated by directly applicable statutes and rules,” Shumaker observed.

The judge explained that generally a shareholder or member of a corporation may not individually assert a direct cause of action that belongs to the corporation. In deciding whether a claim is direct or derivative, the focus is on the alleged injury.

Where the injury is to the corporation and only indi
rectly harms the shareholder, the claim must be pursued as a derivative claim, Shumaker explained. To bring a direct action, a shareholder or member must be able to allege some injury or harm that is separate and distinct from the injury or harm to the corporation and that is not dependent on the harm to the corporation.

Shumaker asserted that the plaintiffs were aware of the derivative nature of the action when they initiated it, bringing suit and requesting remedies “on behalf of” the MPRA. The judge added that the plaintiffs’ losses are not direct and are not separate, distinct, or independent from the MPRA’s losses.

“Their financial tide under their pension rises and falls solely with the financial tide of the MPRA. The [plaintiffs] suffer no loss unless the MPRA first suffers a loss,” Shumaker observed, concluding that the claim was derivative and subject to rule 23.06.

The plaintiffs conceded they did not make the demand required under the rule. The Court of Appeals agreed with the District Court that the alternative course of showing why the demand would be futile also was not satisfied.

“The [plaintiffs’] general statement of futility does not satisfy the ‘particularity’ requirement of the rule,” Shumaker wrote.

Refusal to remove

The Court of Appeals also addressed the plaintiffs’ request that the defendants “be permanently enjoined from acting as a fiduciary with respect to MPRA.”

The District Court noted that the plaintiffs had already unsuccessfully tried to remove Berryman and Nelson through the removal procedure in MPRA bylaws and stated that it would not disregard the vote by the members of the MPRA or substitute its judgment for their judgment.

Shumaker explained that the MPRA is governed in part by Minn. Stat. ch. 423B, which contains the mandate that “[t]he affairs of the association must be regulated by its articles of incorporation and bylaws.” As a nonprofit corporation, the MPRA is also subject to Minn. Stat. ch. 317A, the Minnesota Nonprofit Corporation Act, which states that its procedures are to be followed “unless a different method of removal is provided for in the articles or bylaws.”

The MPRA bylaws do in fact provide a different method for the removal of directors, Shumaker pointed out. The bylaws state that charges of neglect of any duty or conduct detrimental to the corporation will be investigated, and if sustained, the seat held by the offending board member will be declared as vacant.

The plaintiffs argued that the removal procedure in the bylaws is only one of several available remedies, noting for example that Minn. Stat. sec. 356A.09, subd. 2, provides that “remedies available for a fiduciary breach by a fiduciary are those specified by statute or available at common law.” The plaintiffs argued that the removal procedure in the MPRA bylaws does not involve the necessary determination of whether the defendants breached their fiduciary duties.

Shumaker said that the bylaws allow the removal of a director for neglect of any duty or conduct detrimental to the interests of the corporation.

“A breach of fiduciary duties, such as those alleged and presented to the MPRA membership, surely fell within the stated reasons for removal of directors,” wrote Shumaker. “Thus, the remedy of removal of a director for breach of fiduciary duty was available under the MPRA bylaws.”

The Court of Appeals determined that this was an adequate remedy and, therefore, equitable relief through the courts was not available.

— Michelle Lore