Second Circuit Allows Derivative Shareholder Lawsuit to Go Forward Even After Plaintiff Loses her Financial Stake in the Entity, Distinguishing Between Standing and Mootness

Case Name: Klein v. Cadian Capital Mgmt., LP – Second Circuit 

Date of Opinion: October 2, 2018

Opinion By: Judge Pooler (majority); Judge  Lohier (dissent)

Summary:

Appellant Terry Klein brought a derivative lawsuit suit as a shareholder of Qlik Companies. She alleged that a group of funds (referred to collectively as the “Cadian Group”) owned more than ten percent of Qlik and engaged in short-swing transactions in Qlik stock in 2014, in violation of Section 16(b) of the Securities Exchange Act. Subsequently, the action was stayed pending resolution of a motion in a related case. While the action was stayed, a private equity company bought out Qlik in an all-cash merger. As a result of that merger, Klein lost any financial interest in the litigation.

After the stay was lifted, Cadian Group moved to dismiss the action for lack of standing. Klein moved to substitute Qlik itself as a plaintiff under Rule 17(a)(3) of the Federal Rules of Civil Procedure. The United States District Court for the Southern District of New York granted the Cadian Group’s motion to dismiss and denied Klein’s motion to substitute. The District Court reasoned that Klein’s lack of continuing financial interest in the litigation caused her to lose standing, which made the case moot. In the alternative, the District Court found that Qlik could not be substituted under Rule 17(a)(3) because Klein had not made an “honest mistake” in failing to include Qlik as a plaintiff.

The Second Circuit disagreed, and vacated the ruling.  The court explained that Klein had already established her standing by virtue of the fact that she had a personal stake at the outset of the litigation.  The only question, therefore, was whether the case was now moot.  As the court put it, the standing doctrine “evaluates a litigant’s personal stake as of the outset of litigation,” while the mootness doctrine “determines what to do if an intervening circumstance deprives the plaintiff of a personal stake in the outcome of the lawsuit, at any point during litigation after its initiation.”

The court further reasoned that a district court has the constitutional power to substitute a real party in interest to avoid mooting a case, and that Rule 17(a)(3) is an appropriate procedural mechanism for doing so.  The court rejected the lower court’s ruling that Rule 17(a)(3) is only allowed in situations where there has been an “honest mistake in selecting the proper party,” which had not occurred here.  Instead, the Second Circuit held that Rule 17(a) substitution should be allowed as long as the substance of the action remains the same, there is no bad faith on the part of the old or new plaintiff, and there is no unfairness to defendants. Here, all of those conditions were satisfied.  Moreover, the court concluded that substituting Qlik was “necessary to avoid injustice, because a rule disallowing substitution in these circumstances would contravene the purpose of shareholder derivative suits.”  Accordingly, the court vacated the dismissal and remanded the case for further proceedings.

Judge Lohier dissented, arguing that the district court had correctly concluded that it lost jurisdiction once the plaintiff lacked a financial stake in Qlik, and that Rule 17(a) was not satisfied here.

To read the full opinion, please visit: http://www.ca2.uscourts.gov/decisions/isysquery/85283bd1-365c-4e90-9412-9ef4b04be969/2/doc/17-3218_complete_opn.pdf#xml=http://www.ca2.uscourts.gov/decisions/isysquery/85283bd1-365c-4e90-9412-9ef4b04be969/2/hilite

Summary Prepared By: Marcy J. Robles

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