By Jeremy Root
Absent evidence of bad faith, Rule 17(a) substitution of plaintiffs should be liberally allowed when the change is merely formal and in no way alters the original complaint’s factual allegations as to the events or the participants.
Klein vs. QLIK Technologies, Inc., No. 17-3218-cv (2nd Cir., 10/2/18).
Section 16(b) of the Securities Exchange Act requires corporate insiders to disgorge “short-swing” profits made from buying and selling a security based on the company’s stock within a six-month period. The Cadian Group allegedly owned more than ten percent of Qlik Technologies and allegedly engaged in short-swing transactions in 2014. Appellant Terry Klein purchased stock in Qlik and made the statutory demand upon Qlik to sue the Cadian Group. When Qlik refused to initiate the suit, Klein filed a complaint against the Cadian Group. While the case was pending, a private equity company bought out Qlik in an all-cash merger, extinguishing all shares including Klein’s.
The Cadian Group moved to dismiss for lack of standing, Klein sought to substitute Qlik under Rule 17(a)(3) which allows joinder of the real party in interest. The District Court concluded that Klein’s standing terminated when her shares were purchased, so the case was moot. The District Court also found that Rule 17(a)(3) was inapplicable to these facts, because there was no “honest mistake” about the real party in interest at the time of filing. Klein appealed the dismissal for lack of standing and the denial of her motion to substitute parties. The Second Circuit, in a 2-1 decision, vacates and reverses.
The District Court should not have hesitated to substitute Qlik for Klein. It has the constitutional power to substitute a real party in interest to avoid mooting a case and Rule 17(a)(3) is an appropriate procedural mechanism for doing so. Since Klein had power to initiate the suit, the question becomes what the court has power to do when Klein’s financial interest in Qlik ended. Over a stirring dissent, the Second Circuit concludes that the District Court continued to have constitutional power to substitute parties, despite the Plaintiff’s absence of a personal stake in the controversy.
The majority writes: “A legal controversy is not like an electrical circuit, such that a court’s power switches off as soon as the personal stake of all of the named parties on either side of the controversy drops below the legally adequate threshold.” While the District Court was correct that Klein lost her personal stake in the litigation, it was incorrect to conclude it could not consider her motion to substitute Qlik. “So long as a proposed substitution does not come long after the claims of the named plaintiff were dismissed, and does not alter the substance of the action, it should be considered as an alternative to dismissal.”
The District Court likewise erred in concluding that substitution of parties was not appropriate here under Rule 17(a), because there was no “honest mistake in selecting the proper party.” Rule 17(a) substitution of plaintiffs should be liberally allowed when the change is merely formal and in no way alters the original complaint’s factual allegations as to the events or the participants, unless it is proposed in bad faith or to deceive or prejudice the defendants. Klein’s proposed substitution would not alter the factual allegations of the complaint, nor is there any evidence of bad faith or unfairness to the Cadian Group.
(J. Root: This opinion carefully analyzes the boundaries between standing and mootness and serves as a good guide on those issues for Second Circuit practitioners at least. Given the strength of the dissent (which contends that the majority is inconsistent with recent Supreme Court decision in United States v. Sanchez-Gomez, 138 S.C.t. 1532 (2018)), this could also be revisited.)
(SOLA Ref. No. 2018-44-02)
NOTICE: The court decision synopsis published above represents an abbreviated description of the actual decision and is re-printed here for its educational value. The author's effort is to report concisely the substance of the decision or a selected portion of the decision; commentary or analysis is generally reserved for the italicized section at the bottom of the summary. Subscribers to SAC's Online Litigation Alert (SOLA), from which this synopsis is excerpted, have immediate access to the full decision, in addition to the synopsis.
Like what you see here?
Twice a week we present blog posts consisting of one write-up from each of our two flagship weekly online Alert services. Consider a subscription to these publications to receive the full array of coverage right on your desktop every week. Give it a try and sign up for a free trial to the Securities Arbitration Alert and the Securities Litigation Alert.