2013-00151906-CU-MC

Mitchell McClernon vs. McClernon General Engineering

Nature of Proceeding: Motion for Order Requiring Plaintiff to Furnish Security

Filed By: Kachmar, James

This matter was continued to this date for oral argument only. For ease of reference
the Court repeats it tentative ruling below.

Defendant McClernon General Engineering, Inc.’s (“Defendant” or “MGE”) motion for
order requiring Plaintiff Mitchell McClernon, individually and derivatively on behalf of
McClernon General Engineering (“Plaintiff”) to furnish security pursuant to Corp. Code
§800 is ruled upon as follows.

The Court did not consider Plaintiff’s “supplemental brief in opposition” and
“supplemental declaration.” The Court also will not rule on Plaintiff’s objections to the
declarations of Julia Brusby, Karen McClernon and Elizabeth McClernon, and
Defendant’s objections to Plaintiff’s “Improper Supplemental Declaration.” None of
these additional filings were permitted by the CCP, Local Rules, or the Court.

Plaintiff’s verified complaint is for involuntary dissolution, wrongful termination, breach
of fiduciary duty to minority shareholder, and shareholder derivative action for: (1)
breach of fiduciary duty, (2) waste, (3) gross mismanagement, and (4) accounting.

The essential purpose of the Corp Code sec. 800 bond statute is to create a deterrent
to unwarranted shareholder derivative lawsuits by providing a mechanism for securing
a prevailing defendant’s expenses up to $ 50,000. (Donner Management Co. v.
Schaffer (2006) 142 Cal. App. 4th 1296, 1308.)

The defendant in a derivative action may move that a security bond be required of the
plaintiff on either of the following grounds: (1) That there is no reasonable possibility
that the continuation of the lawsuit will benefit the corporation or its shareholders; or
(2) that the moving party, if other than the corporation, did not participate in the
transaction complained of in any capacity. (Corp Code §800(c).)

Corp Code § 800(d) provides that “the court shall consider such evidence, written or
oral, by witnesses or affidavit, as may be material (1) to the ground or grounds upon which the motion is based, or (2) to a determination of the probable reasonable
expenses, including attorneys’ fees, of the corporation and the moving party which will
be incurred in the defense of the action. If the court determines, after hearing the
evidence adduced by the parties, that the moving party has established a probability in
support of any of the grounds upon which the motion is based, the court shall fix the
amount of the bond, not to exceed fifty thousand dollars ($50,000), to be furnished by
the plaintiff for reasonable expenses, including attorneys’ fees, which may be incurred
by the moving party and the corporation in connection with the action, including
expenses for which the corporation may become liable pursuant to Section 317. A
ruling by the court on the motion shall not be a determination of any issue in the action
or of the merits thereof. ”

The burden of establishing the statutory condition that “That there is no reasonable
possibility that the prosecution of the cause of action alleged in the complaint against
the moving party will benefit the corporation or its shareholders” under Code § 800(c)
(1) is on the party moving for security. (Muller v. Tanner (1969) 2 Cal. App. 3d 445,
466; Burt v. Irvine Co. (1965) 237 Cal. App. 2d 828, 868.)

The Court in Marble v. Latchford Glass Co. (1962), 205 Cal. App. 2d 171, 175 holds
that if the plaintiffs’ chances of success in overcoming defendant’s possible defenses
are “slight”, the moving party has met his burden.

Alternatively, the test is whether the moving party has established a probability in
support of the proposition that there is no reasonable possibility that the prosecution
will benefit the corporation or its security holders. (Burt v. Irvine Co., supra, 237 Cal.
App. 2d 828, 868.)

Therefore, this Court must assess the corporate benefit, by assessing possible
defenses that plaintiff must overcome to prevail at trial.

Defendants moves for Plaintiff to furnish security on the grounds that there is no
reasonable probability that the derivative claims will be of any benefit to MGE or its
shareholders because: (1) Plaintiff failed to make a demand on MGE to investigate the
alleged wrongdoing or provide MGE with a copy of the complaint before filing it, (2) at
the March 2013 shareholder meeting, Plaintiff was unable to identify any transaction
that was wrongful or any individual alleged to be involved, and (3) Plaintiff is unable to
allege in the complaint any specific misconduct by any individual defendant that would
support his derivative claims.

Demand on MGE

Corp. Code §800(b)(2) requires that Plaintiff alleges in the complaint with particularity
Plaintiff’s “efforts to secure from the board such action as plaintiff desires, or the
reasons for not making such effort, and alleges further that plaintiff has either informed
the corporation or the board in writing of the ultimate facts of each cause of action
against each defendant or delivered to the corporation or the board a true copy of the
complaint which plaintiff proposes to file.”

“It is well settled that such demand need not be alleged if the facts pleaded show that
such a demand would have been futile.” (Fairchild v. Bank of America Nat’l Trust &
Sav. Asso, (1961) 192 Cal. App. 2d 252, 259.) In support of the motion, Defendant proffers the declaration of Karen McClernon,
MGE’s employee and corporate secretary since 1995. Ms. McClernon states that on
March 26, 2013, MGE held a special meeting of the shareholder and directors of MGE,
which involved the removal of Plaintiff as a director of MGE. (Declaration of Karen
McClernon, ¶ 4.) At the meeting, Plaintiff submitted a notice to the board stating “I
demand in writing the reason for removing me from the board. I have requested a
copy of the bylaws and have not received them. I’m making a formal request to
dissolve MGE and distribute all assets.” (Id. Ex. C.) Ms. McClernon is unaware of
Plaintiff “ever submitting to MGE any written demand of alleged wrongdoing by MGE’s
directors, officers and/or employees. (Id. ¶ 6.) She is also unaware of Plaintiff ever
submitting a copy of his draft complaint to MGE prior to filing it with the Court. (Id.)

In opposition to the motion, Plaintiff argues that he has sufficiently alleged that his
demands for financial documents and information and that further demand upon MGE
is futile. The complaint alleges “At the shareholder’s meeting held on March 26, 2013,
after the meeting was called to order but before voting on Plaintiffs removal as director.
Plaintiff presented a written demand for a statement of the “cause” for his termination,
demanded a copy of the bylaws of MGE (I[n] response to which JULIA stated none
existed), and for dissolution of MGE.” (Complaint, ¶ 29.) It also alleges “any further
attempt to make a formal demand on the Board of Directors is and would have been
futile, as the majority of the board, namely JULIA and MATHEW, together with all
CONTROLLING DEFENDANTS, and each of them, are the perpetrators of the
wrongdoing, and have engaged in a concerted effort to carry on and conceal their
breaches over the course of many months.” (Id. ¶ 30.)

Here, the Court agrees with Plaintiff that he has sufficiently alleged futility in making a
demand.

Acts of Misconduct

Defendants argue that there is no reasonable probability that the suit will benefit MGE
or its shareholders because the allegations of misconduct are based on Plaintiff’s
“information and belief” and that he has not alleged with any specificity what
misconduct MGE’s directors/officers engaged.

In opposition to the motion, Plaintiff proffers the declaration of Mitchell McClernon. Mr.
McClernon states he received from Karen McClernon the MGE checking account
statements for the months of July through September 2012. (Declaration of Mitchell
McClernon, ¶5.) When he looked through the bank statements, he saw some
improper transactions. (Id, ¶ 6.) He asked for more bank statements, but they were
not provided. (Id.) He then went to the bank and obtained more statements, which
reflected an “extended history of misuse of corporate funds.” (Id.) He states that
reflected in the statements are payments made for utility accounts for the personal
residences and cell phones for Julia, Matthew and Mark, payments of MGE corporate
funds for credit cards issued to these individuals for personal expenses. (Id. ¶9.) He
states that he never voted for or authorized the use of such funds. (Id.) He also states
that he did not vote or authorize Mark or Matthew to loan MGE funds which appear as
liabilities on MGE’s balance sheets. (Id. ¶10.)

In reply, Defendant proffers the declaration Karen McClernon. Ms. McClernon’s
declaration provides the following: (1) MGE also paid utilities for Plaintiff’s residence because he used part of his home (as do Karen, Julia and Mark) as home offices and
to store MGE equipment. Plaintiff was both aware of, and authorized this arrangement
throughout his time as an MGE director; (2) Plaintiff would charge his home’s utility
bills to his MGE issued credit card, MGE would pay the balance, and Plaintiff never
reimbursed MGE for he charges; (3) Plaintiff also used his MGE issued credit card to
pay his divorce attorneys; (4) the items identified by Plaintiff as payments for “personal
expenses” were for MGE-related business purposes or other properly reimbursable
expenses; (5) MGE pays for the cellphone services for its employees and its officers
and Plaintiff also had a MGE-paid cellphone while employed at MGE; and (6) Plaintiff
also participated in the loan program to MGE. To the extent Plaintiff argues that
Defendants moved the corporate account to a new account but was not provided with
the name or location of the new bank, Ms. McClernon states that Plaintiff knew of the
new account and was a signer on the new account.

The Court finds that for the purposes of this motion only, Defendants have failed to
satisfy their burden to show that there is no reasonable possibility that the prosecution
will benefit the corporation or its security holders. While Defendants assert that
Plaintiff knew of, acquiesced in, and/or participated in the purported wrongful conduct,
Defendants have failed to analyze why Plaintiff’s purported actions are a defense to
the complaint and that due to Plaintiff’s own actions there is no reasonable possibility
that the prosecution will benefit the corporation or its security holders.

Accordingly, the motion is DENIED.

Defendants’ objections to evidence are ruled upon as follows. The Court notes that it
has numbered the objections 1 through 17.

Sustained: 4, 5, 6, 7, 8, 9

Overruled: 1, 2, 3, 10, 11, 12, 13, 14, 15, 16, 17

Plaintiff’s objections to evidence are OVERRULED.

The minute order is effective immediately. No formal order pursuant to CRC Rule
3.1312 or further notice is required.