Gabriel v. Preble

United States Court of Appeals
For the First Circuit

No. 04-1744

ANNE GABRIEL,

Plaintiff, Appellant,

v.

EDWARD G. PREBLE ET AL.,

Defendants, Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Rya W. Zobel, U.S. District Judge]

Before

Selya, Circuit Judge,

Campbell, Senior Circuit Judge,

and Lipez, Circuit Judge.

Cornelius J. Moynihan, Jr., with whom Nixon Peabody LLP was on
brief, for appellant.
Allen V. Farber, with whom Robert D. Hillman, Deutsch
Williams, Brooks, DeRensis & Holland, P.C., and Gardner, Carton &
Douglas, LLP were on brief, for appellee Edward G. Preble.
George A. Berman, with whom Marjunette deMagistris and Peabody
& Arnold LLP were on brief, for appellee James L. Ackerman.

January 19, 2005
 SELYA, Circuit Judge. In this diversity case, we are

called upon to determine the proper alignment of the parties to a

shareholder's derivative action. We conclude that the corporation

must be aligned as a defendant. Because that alignment destroys

complete diversity, we affirm the dismissal of the action for want

of federal subject matter jurisdiction.

When an appeal turns on the existence vel non of subject

matter jurisdiction and there has been no evidentiary hearing, we

accept at face value the facts alleged in the operative pleading

(here, the amended complaint), drawing all reasonable inferences in

the plaintiff's favor. See Valentin v. Hosp. Bella Vista, 254 F.3d

358, 363 (1st Cir. 2001). This is such an instance.

On October 20, 1999, Richard Gabriel and Edward Preble

formed a Virginia corporation, Stratin Consulting Inc. Stratin's

business was to provide management consulting services. Each

founder held a fifty percent ownership interest. Gabriel served as

president; Preble served as vice-president-treasurer; and the two

men comprised the entire membership of the board of directors.

At the start, Stratin maintained its principal place of

business in Virginia, where Gabriel lived and worked. Preble, a

citizen of New Hampshire, worked principally from Massachusetts.

Gabriel passed away in 2001. His widow, plaintiff-

appellant Anne Gabriel, inherited his equity interest in the

corporation. She claims that after her husband's death Preble took

-2-
several steps designed to give him total control of Stratin, drain

its assets, and "freeze [her] out." She alleges, among other

things, that Preble, with the connivance of the company's lawyer,

James L. Ackerman, covertly appointed a "straw" to the vacancy on

the board of directors caused by Gabriel's death; that Preble

refused to furnish the plaintiff with information concerning the

company's finances; that Preble and Ackerman neglected to hold an

annual meeting as required by the bylaws; and that the board

arbitrarily increased Preble's salary to ensure that there would be

no profits remaining for distribution to the shareholders.

The plaintiff responded to this course of conduct by

filing suit in the United States District Court for the District of

Massachusetts against Preble and Ackerman. She charged breach of

fiduciary duty and wrongful diversion of corporate assets, sought

an accounting, and prayed for damages of $1.5 million. The

defendants answered the complaint and moved to dismiss for failure

to state a claim upon which relief could be granted. See Fed. R.

Civ. P. 12(b)(6). The motion pointed out that, under Virginia law,

a shareholder could not directly sue a corporate officer or

director for breach of fiduciary duty; rather, such a suit must be

brought as a derivative action on behalf of the corporation.

Because the motion to dismiss was untimely, see Fed. R.

Civ. P. 12(b) (requiring that such a motion be filed before the

movant has answered the complaint), the district court treated it

-3-
as a motion for judgment on the pleadings, see Fed. R. Civ. P.

12(c). The court concluded that Virginia law required the suit to

be brought as a derivative action. It therefore dismissed the

complaint with leave for the plaintiff to join Stratin and file an

amended "derivative action" complaint.

The plaintiff served her amended complaint within the

time allotted. In it, she purported to sue "derivatively on behalf

of Stratin Consulting Inc." She did not, however, formally

denominate Stratin as a party.

The defendants moved to dismiss the amended complaint

for, among other things, lack of subject matter jurisdiction. See

Fed. R. Civ. P. 12(b)(1). They posited that the corporation was an

indispensable party to the suit; that it should be aligned as a

defendant; and that the plaintiff's assertion of diversity

jurisdiction could not survive such an alignment. The district

court granted the motion to dismiss without opinion. This appeal

ensued.

We review de novo the legal basis of a dismissal for want

of subject matter jurisdiction. Valentin, 254 F.3d at 365. We may

affirm the order of dismissal on any ground fairly presented by the

record. See Houlton Citizens' Coalition v. Town of Houlton, 175

F.3d 178, 184 (1st Cir. 1999).

The district court's order did not state its reason for

dismissing the amended complaint. The defendants labor to fill

-4-
this void, offering a salmagundi of possible reasons. We think it

best to cut through this asseverational array and focus on their

principal argument: that the corporation must be aligned as a

defendant, thereby destroying complete diversity.

The parties agree that this case is controlled, in the

first instance, by the substantive law of Virginia. See Lexington

Ins. Co. v. Gen. Accid. Ins. Co., 338 F.3d 42, 46 (1st Cir. 2003)

(noting that in diversity cases a district court must apply the

choice of law principles of the forum state); Harrison v.

NetCentric Corp., 744 N.E.2d 622, 628 (Mass. 2001) (reaffirming

that Massachusetts adheres to the "internal affairs doctrine,"

which applies the law of the state of incorporation to cases

involving corporate governance). The parties also agree that

Virginia law requires bringing the suit as a shareholder derivative

action.1 See Simmons v. Miller, 544 S.E.2d 666, 675 (Va. 2001)

(holding that, under Virginia law, a shareholder may not directly

bring suit against an officer or director for breach of fiduciary

duty). Thus, the plaintiff's suit is properly characterized as a

derivative action.

1
Virginia's rule in this respect accords with the majority
view. That view, however, is not universally held. Some
jurisdictions allow a shareholder to bring suit directly against an
errant officer or director (at least when a close corporation is
involved). See, e.g., Donahue v. Rodd Electrotype Co., 328 N.E.2d
505, 515-16 (Mass. 1975). In such a jurisdiction, a suit against
an officer or director may be maintained without joining the
corporation as a party.

-5-
 This characterization has consequences. Pertinently, it

means that the corporation is an indispensable party within the

meaning of Fed. R. Civ. P. 19 (which requires the joinder of

parties "needed for just adjudication"). See Koster v. (Am.)

Lumbermens Mut. Cas. Co., 330 U.S. 518, 522-23 & n.2 (1947)

(holding that the corporation is a necessary party in a derivative

suit). This procedural point supplies the foundation on which the

defendants construct their principal argument.

We assume arguendo that Mrs. Gabriel, in conformity with

the district court's ukase, amended her complaint to reflect that

she was bringing a derivative suit on behalf of Stratin. If the

corporation were properly positioned as a plaintiff (as Mrs.

Gabriel contends), this would arguably be a sufficient, if

inelegant, way of effecting a joinder. We therefore proceed

directly to the question of whether the district court had

jurisdiction over the suit once the corporation was included as a

party. We conclude that it did not.

The only colorable basis for federal jurisdiction over

this case is diversity. See 28 U.S.C. § 1332(a) (conferring

jurisdiction on federal courts to hear and determine suits between

citizens of different states, as long as the amount in controversy

exceeds $75,000). Diversity jurisdiction exists only when there is

complete diversity, that is, when no plaintiff is a citizen of the

same state as any defendant. Strawbridge v. Curtiss, 7 U.S. (3

-6-
Cranch) 267, 267 (1806); Am. Fiber & Finishing, Inc. v. Tyco

Healthcare Group, LP, 362 F.3d 136, 139 (1st Cir. 2004). Here, the

plaintiff is a citizen of Virginia. The defendants Preble and

Ackerman are citizens of New Hampshire and Massachusetts,

respectively. There is thus complete diversity among these

litigants.

But the case encompasses more than these three

individuals; the corporation is an indispensable party. See

Koster, 330 U.S. at 522-23 & n.2; see also Fed. R. Civ. P. 19. It

therefore must be aligned on one side or the other. This addition

threatens to unbalance the jurisdictional equation because Stratin,

which is incorporated under the laws of Virginia, is deemed a

citizen of that state for diversity purposes. See 28 U.S.C. §

1332(c) (ordaining that, for jurisdictional purposes, "a

corporation shall be deemed to be a citizen of any State by which

it has been incorporated").2 Consequently, the existence of

2
Arguably, the corporation also may be a citizen of
Massachusetts. In her amended complaint, the plaintiff alleged
that the individual defendants moved most of Stratin's funds to a
bank account in Massachusetts, shifted payroll administration
there, and changed the principal office address to a Massachusetts
location. If these facts are true, a good case likely can be made
that Stratin had its principal place of business in Massachusetts
when the plaintiff sued. That would make Stratin a citizen of both
Virginia and Massachusetts, see 28 U.S.C. § 1332(c) (providing,
inter alia, that a corporation also shall be deemed a citizen "of
the State where it has its principal place of business"), would
place Massachusetts citizens on each side of the case and, thus,
destroy complete diversity even if Stratin were aligned as a
plaintiff.

-7-
complete diversity (and, thus, of federal jurisdiction) depends, in

the first instance, on whether the corporation should properly be

aligned as a plaintiff or a defendant: if as a plaintiff, complete

diversity exists (subject, however, to the caveat limned in note 2,

supra); if as a defendant, there will be Virginia citizens on

opposing sides of the case and, thus, incomplete diversity.

As a formal matter, corporations generally are styled as

defendants in derivative suits. See 7C Charles Alan Wright, Arthur

R. Miller & Mary K. Kane, Federal Practice and Procedure § 1822

(1986) (collecting cases). When determining whether diversity

jurisdiction exists, however, courts are not bound either by

formalistic styling or by the alignment specified in the pleadings.

Rather, an inquiring court should look beyond these formalities and

attempt to determine, to the extent practicable, the actual

interests of the parties. See City of Indianapolis v. Chase Nat'l

Bank, 314 U.S. 63, 69-70 (1941). Only after the parties have been

realigned to match their actual interests can a decision be made as

to whether complete diversity exists. Id.

Against this backdrop, the plaintiff argues that because

a derivative suit is prosecuted on behalf of the corporation and

any recovery will accrue to it, the corporation should be deemed a

plaintiff. The general rule is to this effect. See Koster, 330

U.S. at 522-23.

-8-
 Like almost every general rule, this rule is littered

with caveats. A century ago, the Supreme Court created a prominent

exception. The Court held that when the corporation is adverse to

the plaintiff's derivative suit, the ordinary presumption bursts

and the corporation should be aligned as a party defendant. See

Doctor v. Harrington, 196 U.S. 579, 587 (1905). A corporation is

deemed adverse to a derivative suit when, regardless of the reason,

the corporation's management opposes the maintenance of the action.

Smith v. Sperling, 354 U.S. 91, 96-97 (1957).

This prominent exception has both theoretical and

practical implications. Conceptually, it will often be the case

that management does not believe a derivative suit is in the

corporation's best interests and, therefore, chooses to resist it.

When management takes such a tack, the corporation and the

plaintiff are actually adverse. Id. at 97-98; Doctor, 196 U.S. at

587-88. After all, it is the prerogative of management — the board

of directors and the ranking officers — to set policy for the

corporation.

From a pragmatic standpoint, the exception frequently has

the effect of preserving diversity jurisdiction. More often than

not, the directors and ranking officers (who are the real

defendants in a derivative suit) will be citizens of the same state

as the corporation. If corporations were invariably aligned as

plaintiffs in derivative suits, complete diversity would evaporate

-9-
in a large number of cases and federal courts would be inaccessible

in those situations. See Doctor, 196 U.S. at 587; see also 7C

Wright, Miller & Kane, supra § 1822.

The Supreme Court has admonished courts to attempt to

determine whether the corporation is adverse from the face of the

pleadings, as opposed to launching an extended evidentiary inquiry.

Sperling, 354 U.S. at 95-97. Limiting the adversity inquiry to the

pleadings has the salutary effect of ensuring predictability and

efficiency in jurisdictional determinations. It simultaneously

relieves district courts of the burden of engaging in prolonged

proceedings — oftentimes necessarily touching on the merits of the

dispute — merely to determine whether federal jurisdiction exists.

Id. at 97.

In most cases, it will be possible to heed the Sperling

Court's admonition because the Civil Rules require a derivative

suit plaintiff to describe what efforts she has made "to obtain the

action the plaintiff desires from the directors . . . and the

reasons for the plaintiff's failure to obtain the action or for not

making the effort." Fed. R. Civ. P. 23.1. This case is well

within the mine-run. Based on the facts contained in the

pleadings, we conclude, without serious question, that the

corporation must be aligned as a party defendant.

The two named defendants, Preble and Ackerman, are the

only officers and effectively control the operation of the

-10-
business. Preble and an ally are the sole directors. And the

plaintiff, in an apparent effort to fulfil her obligations under

Rule 23.1, has attested that she did not ask either the defendants

or Stratin's board of directors to take any ameliorative action

before filing suit because she realized that any attempt to do so

would be futile.

To cinch matters, Preble and Ackerman have, from the

inception of the litigation, fought the suit tooth and nail. The

reason is not hard to fathom: the entire theory of the plaintiff's

case is that these two men have acted wrongfully to minimize the

plaintiff's role in the corporation's activities and to devalue her

equity interest. Under these circumstances, we are constrained to

conclude that Stratin is hostile to the suit. It must, therefore,

be aligned as a party defendant.

The plaintiff's only response to this reasoning is that

the usual rules for aligning corporations in derivative suits

should not be given effect in a case involving a close corporation

with two fifty percent shareholders. It would be "highly

artificial," she argues, to apply these rules to what is

essentially a contretemps between two equal partners. The

plaintiff's argument founders on three shoals.

First, even if we were to view this case as a dispute

between the two shareholders, the corporation is an indispensable

party and, given its separate legal personality, must be treated

-11-
independently from the two shareholders. Consequently, the

corporation must be aligned somewhere. Yet the plaintiff never

satisfactorily explains why we should align the corporation on her

side of that dispute rather than on Preble's.

Second, the plaintiff overlooks the fact that, although

she owns half of Stratin, its management is firmly in the

opposition camp. While we have no reason to doubt the sincerity of

the plaintiff's claim that she is looking out for the corporation's

best interests, we are similarly without reason to doubt the

defendants' claim that it is they, rather than the plaintiff, who

have the welfare of the corporation at heart. And it is the

individual defendants who, as the current management, enjoy the

prerogative of deciding what is in the best interests of the

company at the moment. See Sperling, 354 U.S. at 96-97. So long

as they consider the plaintiff's suit contrary to those interests,

the plaintiff and the corporation are adverse for the purposes of

determining the existence vel non of diversity jurisdiction. Id.

Last — but far from least — the Sperling Court gave no

indication that it might be willing to carve out a separate

jurisprudence for close corporations. Other courts have refused to

do so, see, e.g., Frank v. Hadesman & Frank, Inc., 83 F.3d 158,

161-62 (7th Cir. 1996); Ono v. Itoyama, 884 F. Supp. 892, 900-01

(D.N.J. 1995), aff'd 79 F.3d 1138 (3d Cir. 1996), and we deem

ourselves bound by Sperling. A straightforward application of the

-12-
principles set forth therein requires that Stratin be aligned as a

party defendant.3

We need go no further. It is incumbent on the federal

courts, as courts of limited jurisdiction, to be scrupulous in

applying the tenets that define the limits of their subject matter

jurisdiction. This suit falls outside those boundaries.

Accordingly, given the want of federal subject matter jurisdiction,

we affirm the district court's dismissal of the case. That

dismissal operates, of course, without prejudice to the plaintiff's

right to pursue her action in a state court of competent

jurisdiction.

Affirmed.

3
We are cognizant of the Sperling Court's admonition that it
was not laying down a mechanical rule as to the alignment of
parties in derivative suits. 354 U.S. at 97. We leave open the
possibility that other cases may present sufficiently unusual facts
to justify departing from the conventional paradigm. Here,
however, we find no compelling reason to deviate from standard
practice.

-13-