Metropolitan News-Enterprise


Tuesday, September 23, 2008


Page 1


Court Tosses Policyholders’ Dividend Class Action Against State Farm


By STEVEN M. ELLIS, Staff Writer


This district’s Court of Appeal yesterday affirmed an order dismissing a nationwide class action by 50 million State Farm Mutual Automobile Insurance Company policyholders who contended the company breached a duty to pay billions of dollars in dividends from 1983-1998.

Holding that the Illinois-incorporated mutual insurance plan had no duty under that state’s law to provide dividends to policyholders, Div. Three ruled that the business judgment rule provided a defense to allegations that members of the company’s board of directors breached their duty of care by declining to do so, and affirmed Los Angeles Superior Court Judge Carolyn B. Kuhl’s grant of summary judgment in the company’s favor.

The plaintiffs brought suit in 1998, alleging that they had a right to dividends under their insurance policies and company bylaws, and that the board’s failure to pay dividends had created a surplus in excess of what the company needed to meet present and future insurance obligations, violating board members’ duty to act prudently in making dividend decisions.

Summary Judgment

State Farm moved for summary judgment based on the business judgment rule, which generally provides that courts will not review the financial decisions of corporate directors, and asserted that its board had made decisions on an informed basis, in good faith, and with the honest belief that it was acting in the company’s best interests.

Plaintiffs countered that the rule was inapplicable, arguing that the board had rubber-stamped management’s recommendations without adequately considering the matter or becoming sufficiently informed on the subject. They also contended that the board had engaged in fraudulent and dishonest practices by failing to disclose that it paid dividends from certain sources of income and did not sell invested assets for that purpose, and that the board’s ultimate dividend decisions were totally without merit.

However, Kuhl concluded that the business judgment rule applied as a matter of law and granted the motion, and—in an appeal in which the defendants were joined by a number of various state and national insurance trade associations, and the Illinois Division of Insurance, as amici curiae—the Court of Appeal agreed.

Examining Illinois’ substantive law, including its business judgment rule, which Div. One had previously held applicable to the case in a 2003 opinion, Div. One Presiding Justice Robert M. Mallano, sitting by assignment, wrote that the “plaintiffs, as policyholders of a mutual plan, did not have a right to any amount of dividends, but State Farm was obligated to consider from time to time whether dividends should be declared.”

In so doing, he said, “State Farm was bound by a duty of care, requiring the Board to make decisions in a prudent manner,” but Mallano rejected the plaintiffs’ assertions that the board’s actions fell within an exception to the business judgment rule.

‘Sufficiently Informed’

The jurist explained that the board could rely on information from State Farm’s management and actuarial department in its deliberative process, noting that the board itself was not required “to decide every underlying issue related to dividends,” and he opined that the “the Board was sufficiently informed—through written financial materials, oral presentations from company officers, and discussions during Board meetings—to make independent decisions about dividends.”

Mallano further concluded that State Farm had not engaged in fraud by failing to disclose to policyholders the source of possible dividends.

 “It had no duty to disclose that type of information,” he wrote. “Nor was there anything fraudulent about the financial information annually sent to policyholders; it was based on audited reports prepared by independent accountants in compliance with state regulatory principles of accounting.”

Mallano then rejected the plaintiffs’ argument that the board’s decisions not to pay dividends were without merit, pointing out that the merits of a decision was not an exception to the business judgment rule.

“[T]he rule focuses on whether the process used to reach the decision was tainted by fraud, oppression, illegality, or the like,” he wrote. “The very purpose of the rule is to preclude liability for a company’s mistakes, errors, and mere negligence. An exception that permitted consideration of the merits of a board’s decisions would swallow the rule.

Presiding Justice Joan D. Klein and Justice H. Walter Croskey joined Mallano in his opinion.

Counsel from Los Angeles law firm Robie & Matthai, and from international firms Heller Ehrman, and Skadden, Arps, Slate Meagher & Flom, represented State Farm in the action. Plaintiffs were represented by counsel from Gianelli & Morris and the Law Offices of Robert S. Gerstein, in Los Angeles; national firm Hennigan, Bennett & Dorman; and San Luis Obispo firm Ernst & Mattison.

The case is Hill v. State Farm Mutual Automobile Insurance Company, 08 S.O.S. 5247.


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