In Norman v. Strateman, No. A170356, 2025 WL 1802786 (Cal. App., 1st Dist., June 20, 2025), the California Court of Appeal held that a settlement of derivative claims reached among all shareholders of a close corporation was not enforceable because the settlement was not vetted by the trial court through a formal settlement approval process. This ruling confirms that the procedural requirements for derivative litigation must followed even for closely held companies where all shareholders are also individual parties to the litigation.
The case centered on a start-up cryptocurrency exchange that was founded by three individuals, who were also the company’s sole shareholders. Eventually, the company ceased operating after one founder closed its bitcoin exchange. Another founder (the company’s CEO) filed derivative claims against the other founders, claiming that the bitcoin exchange was closed without the consent of the other shareholders and the other shareholders were excluded from the company’s operations. One of the defendant founders, in turn, filed a derivative cross-complaint against the CEO for abdicating his duties and liquidating the company’s bank account for his own use.
During trial in San Francisco Superior Court, the parties participated in court-supervised settlement discussions, ultimately reaching a resolution in principle. As is typical, the settlement judge requested the terms of the settlement be put on the record. Additionally, the parties confirmed on the record their agreement to the terms of the settlement, that they did not have any questions about the settlement after conferring with counsel, and they did not request any additional information from the court other than that the court retain jurisdiction to resolve future disputes. The parties also confirmed on the record that the settlement was immediately enforceable. The trial judge was informed of the settlement, adjourned the trial, and set an order to show cause hearing regarding dismissal.
Plaintiff sought to continue the hearing on the order to show cause while the settlement was documented. Nearly a year later, plaintiff filed a motion to “confirm [the] absence of an enforceable settlement in [this] derivative action and/or in the alternative, to set aside [the] settlement on various grounds.” Defendant filed a motion to enforce the settlement that was entered into the record. Plaintiff argued that because all of the asserted claims were derivative, any settlement required judicial approval, although he conceded the issue had not been raised before. The trial court denied plaintiff’s motion and granted defendant’s motion to enforce. The trial court found that derivative lawsuits were designed to protect shareholders, but, in this case, all of the company’s shareholders were parties to the case, so the settlement agreement “clearly [went] right to that issue,” and there was no objection from any shareholder to the settlement put in the record, all of whom were present.
The Court of Appeal reversed. The Court confirmed that at least some of the claims at issue belonged to the company. Citing Jones v. H.F. Ahmanson & Co., 1 Cal.3d 93, 460 P.2d 464 (1969), the Court noted that “the stockholders derive no benefit [from the derivative litigation] except the indirect benefit resulting from a realization upon the corporation’s assets.” Because the settlement purported to resolve all claims, the determination that at least some, if not all, claims were derivative was sufficient to determine if judicial approval of the settlement was warranted. To that end, the court observed that a “shareholder plaintiff in a derivative action must obtain court approval before settling and dismissing the corporation’s cause of action.” The Court of Appeal analogized the judicial review of derivative settlements to those for class action settlements. Specifically, the Court stated that trial courts evaluating derivative settlements “should consider all relevant factors, which may include, but are not limited to the strength of [the] plaintiff’s case, the risk, expense, complexity and likely duration of further litigation, . . . the amount offered in settlement, the extent of discovery completed and the stage of proceedings, the experience and views of counsel, the presence of a governmental participant, and the reaction of the class members to the proposed settlement” (cleaned up).
Reviewing the record on appeal, the Court of Appeal determined that no such review was conducted. With respect to the settlement judge who oversaw the negotiations, the Court held that he merely had the parties read the agreement into the record and ensured there were no questions, but did not inquire into any of the factors annunciated above.
Significantly, although the trial court noted that there was no objection to the settlement even though all of the company’s shareholders were parties to the litigation, there was no evidence that the trial judge “independently assessed whether the settlement was fair and reasonable by considering other relevant factors.” The Court of Appeal did acknowledge that concerns of fairness were less pressing in this case because all shareholders were parties to it, but that fact did “not negate the importance of courts following appropriate procedural steps to review and approve derivative claim settlements.” Additionally, the Court instructed on remand that the trial court “also consider whether [the company] was adequately represented,” noting that in the prior litigation the company was not separately represented by counsel.
Norman presents a number of cautions to counsel and parties in intra-company disputes. First, even in litigation involving closely held companies where all shareholders are represented, parties and counsel will need to remain mindful of whether intra-company claims are derivative or direct. If such claims are derivative, then courts will require parties to follow the procedural formalities in proceeding with derivative litigation on a company’s behalf, including establishing demand futility and seeking judicial approval of settlements. Second, the Court of Appeal’s concern about whether a company is adequately represented in derivative litigation if it does not have separate counsel poses important practical issues. Although the Court did not conclusively determine whether the lack of separate counsel in this case was inadequate, and did not provide much guidance on how a trial court should determine that, the fact that it raised the question where all of the company’s senior management and all of its shareholders were parties strongly suggests that companies embroiled in derivative litigation should obtain separate representation.