Jeffrey Klobucar, Bassford Remele, P.A.
Contributing Editor: Alexander J. Beeby, Larkin Hoffman Daly & Lindgren Ltd.
In Sears v. Sears (In re AFY, Inc.), 902 F.3d 884 (8th Cir. 2018), the Eighth Circuit agreed that the Nebraska Bankruptcy Court had jurisdiction and authority to consider the merits of a shareholder derivative action. The Eighth Circuit also agreed that the shareholder-standing rule barred the shareholders’ claim.
The debtor, Ainsworth Feed Yards Company, Inc., filed for bankruptcy in 2010. In 2007, the appellees (three relatives) sold their shares of the debtor in exchange for promissory notes. The appellants (two other relatives) were the sole remaining shareholders of the debtor. In approving, over the appellants’ objection, the appellees’ $2.6 million claim, the bankruptcy court determined that the appellees did not breach the sale agreement, which included fiduciary obligations.
After the trustee paid the claim, the appellants sued the appellees in state court alleging that the appellees breached their obligations to AFY and unfairly abused and benefited from the bankruptcy process. The appellees removed the case to the bankruptcy court, which dismissed the case based on the shareholder-standing rule and claim preclusion. The BAP affirmed.
Before addressing the merits of the dismissal, the Eighth Circuit considered the bankruptcy court’s subject matter jurisdiction, the propriety of the case’s removal, and the bankruptcy court’s authority to enter a final order. The Circuit held that the case at least satisfied the requirements of “related to” jurisdiction because the outcome could effectively redistribute the estate and, therefore, alter the handling and administration of the estate. Id. at 888 (citing Specialty Mills, Inc. v. Citizens State Bank, 51 F.3d 770, 774 (8th Cir. 1995); In re Dogpatch U.S.A., Inc., 810 F.2d 782, 786 (8th Cir. 1987)).
The Court also held that removal is appropriate because the well-pleaded complaint rule is inapplicable to a removal based on 28 U.S.C. § 1334 bankruptcy jurisdiction, rather than § 1331 federal question jurisdiction. Id. at 889 (citing Am. Nat’l Red Cross v. S.G., 505 U.S. 247, 258 (1992); In re KSRP, Ltd., 809 F.3d 263, 268 n.3 (5th Cir. 2015)). The Court further noted that the case’s relatedness is clear on the face of the complaint.
The Court also found that the appellants had implicitly consented to the bankruptcy court’s authority to enter a final order. The Court determined that the appellants’ failure to timely object to the bankruptcy court’s authority constitutes implicit consent. Id. at 889–90 (citing Wellness Int’l Network, Ltd. v. Sharif, 135 S.Ct. 1932, 1944–45 (2015) (permitting waiver of Article III adjudication); Abramowitz v. Palmer, 999 F.2d 1274, 1280 (8th Cir. 1993) (permitting implicit consent under 28 U.S.C. § 157(c)(2))). The Court noted that the appellant’s decision to not elect to appeal to the district court, rather than the BAP, supports the implicit consent conclusion.
Turning to the merits of the bankruptcy court’s dismissal of the case, the Court agreed that the shareholder standing rule bars the appellants’ claims. The shareholder standing rule prohibits derivative actions unless management refuses, without good-faith business judgment, to pursue the claims. Id. at 890 (citing Franchise Tax Bd. of Cal. v. Alcan Aluminum Ltd., 493 U.S. 331, 336 (1990)). Because the appellants only alleged derivative claims and injuries, the Court agreed that the claims were barred and affirmed the bankruptcy court’s dismissal of the case without reaching the court’s claim preclusion determination.