Court of Appeals refuses to exalt form over substance in shareholder derivative suit

In Gill v. Vorhes and Vorhes, Ltd., No. 15-0785 (July 27, 2016), the Iowa Court of Appeals decided a shareholder derivative suit in favor of the shareholder that brought the suit for the corporation. 

Vern and Irene Vorhes incorporated Vorhes, Ltd.; all interest in the corporation ultimately transferred to their children, Pete, Bill, Bernice, and Jean.

In April 2011, Bernice’s counsel sent a letter to Bill and Jean, the only other living shareholders, president and vice president, demanding that the corporation collect debts owed by Bill. The letter stated that if the corporation failed to act, Bernice would pursue a shareholder derivative suit.  Vorhes, Ltd. took no action.

In September 2011, Bernice filed a shareholder derivative suit against Bill, for unpaid rent and outstanding debts. Bill answered with affirmative defenses. Over two years later, on the eve of trial, the corporation moved to dismiss, alleging that Bernice did not supply an affidavit as required by Rule 1.279. The trial court denied the motion.

On the second day of trial, the parties entered a written stipulation, admitting that Vorhes, Ltd. loaned Bill money which remained unpaid, and that Bill owed the corporation for funds paid on Bill’s behalf. The remaining disputes were: farm rent from March 2000 forward; whether Bernice was entitled to attorney’s fees for bringing the derivative suit; and Bernice’s claim that the corporation be reimbursed for attorney’s fees that were loaned to Bill to defend the suit. At trial, Bill claimed that his mother relieved rent payment by two handwritten notes. The trial court found in favor of Bernice, and Bill appealed.

On appeal, the appellate court first ruled that even though Bernice was unable to speak because of a stroke, the corporation was adequately represented by counsel. Bernice was never deposed or listed as a witness, or subpoenaed.

The Court of Appeals also rejected the argument that Bernice’s failure to include an affidavit was fatal. Bill did not file a motion to dismiss, raise the deficiency in his answer, or join Vorhes, Ltd.’s motion to dismiss. Vorhes, Ltd. did not pursue the argument on appeal. Thus, Bill did not preserve the issue for appeal.

Further, there was “substantial compliance” with Rule 1.279. Bernice had standing to bring the action; made a written demand; and filed suit more than ninety days after the demand, as the Code required. No “useful purpose would be served by dismissing this action more than two years after suit was filed and on the eve of trial based on a lack of a supporting affidavit.”

Regarding Bill’s claim that his mother relieved his lease payments, the handwritten documents did not support his position.  Unclear on their face, it would be unnecessary to have two documents which permanently relieved Bill from paying rent. Also, Bill made no reference to either document until relatively late in the litigation. Further, the documents were unenforceable for lack of consideration; Vorhes, Ltd. gained nothing of benefit, and there was no detriment to Bill. Thus, neither document was given the effect that Bill urged at trial.

Regarding Vorhes, Ltd.’s appeal, the corporation argued that no attorney’s fees were available, because of 2013 amendments to Iowa Code section 490.746. The amended section was part of, “An Act Relating to Nonsubstantive Code Corrections and Including Effective Date Provisions.” Thus, the amendments were nonsubstantive. The Court of Appeals held that removal of the court’s authority to order the payment of attorney fees would be a substantive change. Also, the amendments added a new subsection, stating, “‘[e]xpenses’ means reasonable expenses of any kind that are incurred with a matter.” Thus, the court continued to have authority to award reasonable attorney’s fees, if the proceeding resulted in a substantial benefit to the corporation. As Bernice obtained a substantial benefit for Vorhes, Ltd., an award of $90,000 of fees was reasonable. Also, Bill owed Vorhes, Ltd. $45,000.00 for attorney’s fees incurred regarding the claim for unpaid rent.

Gill v. Vorhes and Vorhes, Ltd. is a lengthy opinion covering several issues of shareholder derivative suits. The court’s reasoning provides a detailed reminder that Iowa courts typically do not impose “onerous restraints in derivative actions.” For further information regarding Gill v. Vorhes and Vorhes, Ltd. or corporate litigation, contact Mollie Pawlosky.

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.