Case Brief: Potter v. Cozen & O’Connor Analyzes the Shareholder Standing Rule

Andrew Schwartz, Class of 2023

In a recent case, the Court of Appeals for the Third Circuit held that shareholder standing is not a jurisdictional issue but rather affects prudential standing. Therefore, it is not proper to dismiss a shareholder suit under Rule 12(b)(1) for lack of subject matter jurisdiction simply because the suit of a derivative nature.

Background

Adam Potter and Moxie HC LLC (“Moxie”) are the sole shareholders of two entities sold to The Institutes, LLC in 2018 for $20 million.[1] A team of lawyers from Cozen O’Connor represented The Institutes in negotiating the price of this transaction.[2] One of the lawyers on that team, Anne Blume, was on the board of directors and served as general counsel for one of the entities sold to The Institutes.[3] Potter was not aware of this and relied on the advice of Blume in accepting the $20 million offer negotiated by the attorneys from Cozen.[4] Potter subsequently learned that the sale price was “substantially below . . . market value” and that Blume had shared confidential information about the entities.[5]

Potter filed suit against Cozen O’Connor for breach of fiduciary duty and professional malpractice, naming himself and Moxie as plaintiffs even though the harm alleged was to the entities purchased.[6] Cozen filed a motion to dismiss under Fed. R. of Civ. Proc. 12(b)(6) for failing to state a claim by seizing on the fact that the plaintiffs cannot “bring claims of the corporate entities in their own names” under the shareholder standing rule.[7] Potter responded by characterizing the motion as “a facial attack on the court’s subject matter jurisdiction” that should be analyzed under Rule 12(b)(1).[8] The district court split the baby by adopting Potter’s framework and dismissing the complaint pursuant to Rule 12(b)(1).[9]

Discussion

The issue before the Third Circuit is whether the shareholder standing rule is jurisdictional or prudential.[10] The court first describes the differences between jurisdictional and prudential standing and then applies the shareholder standing rule to that framework of analysis.

Jurisdictional standing is established by meeting three criteria grounded in Article III of the Constitution: (1) “‘injury in fact’ which is ‘concrete and particularized’ and ‘actual or imminent’”; (2) “the injury is ‘fairly traceable to the challenged action of the defendant’”; (3) “it is likely ‘that the injury will be redressed by a favorable decision.’”[11] In contrast, prudential standing rules are made by judges “to help courts ‘avoid deciding questions of broad social import where no individual rights would be vindicated.’”[12] The key distinction is that a prudential standing issue “implicat[es] only a plaintiff’s power to bring claims, not the Court’s power to hear them.”[13]

The Third Circuit determined that the shareholder standing rule is an issue of prudential standing and, thus, not an attack on the court’s subject matter jurisdiction that can cause a suit to be dismissed under Rule 12(b)(1).[14]

First, the court looked to Supreme Court precedent third-party standing. That review revealed that the Supreme Court has described third-party standing and the shareholder standing rule as an “equitable restriction” not based in Article III.[15] Additionally, the Supreme Court has recognized that third-party standing deficiencies can be waived, whereas Article III standing can never be waived.[16]

Next, the court looked to its own precedent to analogize shareholder standing to plaintiff standing in antitrust cases. In antitrust cases, the court looks to whether the “plaintiff’s alleged injury . . . is of the type that the antitrust statute was intended to forestall” and then uses that standard to determine whether the plaintiff has a chance to succeed on the merits of the case.[17] Subject matter jurisdiction is not implicated in this analysis.[18]

Finally, the Third Circuit considered the nature of a derivative shareholder lawsuit. The requirements of jurisdictional standing are met, even if it is not prudent for a court to hear a case.[19] The facts of this case follow the formula.[20] Potter is alleging that the value of his interests in the entities sold to The Institutes were diminished by Blume’s breach of fiduciary duty and that monetary damages are sufficient to remedy that harm.[21]

Conclusion

Now that the Third Circuit has rejected the idea that shareholder standing can be challenged as an issue of subject matter jurisdiction under Rule 12(b)(1), the district court will have to reconsider the defendant’s motion to dismiss. However, the burden of proof has now shifted: instead of the plaintiff needing to show that the district court has jurisdiction as it did under Rule 12(b)(1), the defendant will have to show that there is no set of facts that would entitle Potter to relief.

On a broader scale, this decision is clarifies idea that shareholder derivative suits do not have exceed some jurisdictional hurdle beyond requirements of the underlying company. There are ample safeguards in place to protect against rogue shareholders; onerous jurisdictional hurdles do not need to be added.

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[1] Potter v. Cozen & O’Connor, No. 21-2258, 2022 WL 3642107, at *1 (3d Cir. Aug. 24, 2022).

[2] Id.

[3] Id.

[4] Id.

[5] Id. at *2.

[6] Id.

[7] Id.

[8] Id.

[9] Id.

[10] Id. at *3.

[11] Id. (quoting Lujan v. Defs. Of Wildlife, 504 U.S. 555, 560–61 (1992)).

[12] Id. (quoting Freeman v. Corzine, 629 F.3d 146, 154 (3d Cir. 2010)).

[13] Id. at *4.

[14] Id. at *6.

[15] Id. at *4 (quoting Franchise Tax Bd. of Cal. v. Alcan Aluminum Ltd., 493 U.S. 331, 336 (1990)).

[16] Id. at *5

[17] Id. (quoting Hartig Drug Co. v. Senju Pharm. Co., 836 F.3d 261, 269 (3d Cir. 2016)).

[18] Id.

[19] Id. at *6

[20] Id.

[21] Id.