California Court Reinforces Judicial Oversight in Derivative Litigation Settlements

In Norman v. Strateman, the California Court of Appeal ruled that a settlement resolving derivative claims among all shareholders of a closely held corporation was unenforceable because it lacked formal judicial approval.

Writing on Sheppard Mullin’s Corporate and Securities Law Blog, Joshua Hess says the decision affirms that procedural safeguards in derivative litigation must be followed regardless of whether all shareholders are involved in the case.

The ruling underscores the judiciary’s role in ensuring that corporate interests are properly protected, even in closely held companies.

The dispute arose from a failed cryptocurrency start-up jointly owned by three founders, who were also the only shareholders.

Following the company’s collapse, the CEO filed derivative claims alleging that other founders improperly shut down the business and excluded him from operations.

One founder countersued, also derivatively, claiming the CEO misused company funds.

During the trial, the parties settled for court-supervised talks and entered their terms into the record. They asked that the court retain jurisdiction to resolve future disputes.

Almost a year later, the CEO moved to invalidate the settlement, arguing that it required court approval because the claims were derivative. The trial court rejected this argument, noting all shareholders had agreed to the terms.

However, the appellate court reversed, holding that because some claims belonged to the corporation, judicial oversight was necessary.

Citing precedent, the court analogized derivative settlement review to class action procedures, requiring the trial court to assess the fairness, adequacy, and representation of the settlement.

The author writes that Norman presents “a number of cautions to counsel and parties in intra-company disputes.” They need to consider whether intra-company claims are derivative or direct and proceed accordingly. In derivative claims, even in litigation involving closely held companies, judicial approval of settlements must be sought.

Additionally, the California Court of Appeal raises practical issues about whether a company is adequately represented in derivative litigation if it does not have separate counsel.