Zapata Corp. v. Maldonado

Brief Fact Summary.

A derivative suit was initiated by Maldonado (Plaintiff), which charged officers and directors of Zapata (Defendant) with breaches of fiduciary duty. Four years later an “Independent Investigation Committee†of two disinterested directors made a recommendation to dismiss the action.

Synopsis of Rule of Law.

Where the making of a prior demand upon the directors of a corporation to sue is excused and a stockholder brings forth a derivative suit on behalf of the corporation, the board of directors or an independent committee appointed by the board can move to dismiss the derivative suit as detrimental to the best interests of the corporation, and the court should apply a two-step test to the motion: (1) Has the corporation proved independence, good faith, and a reasonable investigation, and (2) Does the court believe, when applying its own independent business judgment, that the motion should be granted?

Facts.

At the time Maldonado (Plaintiff) began a derivative suit against Zapata (Defendant), he was excused from making a prior demand on the board of directors because they were all defendants (Maldonado [Plaintiff] asserting a breach of fiduciary duty on the part of officers and directors of Zapata [Defendant]).  The board had changed membership when, four years later, it appointed an “Independent Investigation Committee,†consisting of two new directors, to investigate the litigation.  The committee recommended dismissing the action, calling its continued maintenance “inimical to the Company’s best interests. . . .â€Â  In an interlocutory appeal before the Supreme Court of Delaware, the primary focus was on whether or not the aforementioned Committee had the power to dismiss the action.

Issue.

Where a stockholder acted properly in bringing forth a derivative suit on behalf of the corporation without first making a demand on the board of directors to sue, can the board of directors or an independent committee they appoint move to dismiss the suit as detrimental to the best interests of the corporation?

Held.

(Quillen, J.)  Yes.  In this case, a stockholder acted properly in bringing a derivative suit without first demanding the directors file suit (i.e., where such a demand is “excusedâ€), the board of directors or an independent committee they appoint has the power to choose not to pursue the litigation as it would not be in the best interests of the corporation.  The fact that a majority of the board may have been tainted by self-interest is not per se a legal bar to the delegation of the board’s power to an independent committee made up of disinterested board members.  Therefore, a committee, such as the one involved here, can properly act for the corporation to move to dismiss derivative litigation that is believed to be detrimental to the best interests of the corporation.  When the court is faced with this type of motion, it should give each side an opportunity to make a record on the motion.  The party bringing the motion to dismiss should be prepared to meet the normal burden of showing that there is no genuine issue as to any material fact and that it is entitled to dismiss as a matter of law.  A two-step test should be applied to the motion by the court.  First, it should inquire into the independence and good faith of the committee and the bases supporting its conclusions.  Limited discovery may be ordered to assist in such inquiries.  If the court determines either that the committee is not independent or has not shown reasonable bases for its conclusions, or if the court is not satisfied for other reasons relating to the process, including but not limited to the committee’s good faith, the corporation’s motion shall be denied by the court.  It must be remembered that the corporation carries the burden to prove independence, food faith, and reasonableness.  If the court is satisfied that the committee was independent and showed reasonable bases for good faith findings and recommendations, the court may use its discretion and proceed to the second step.  The second step provides the essential key in striking the balance between legitimate corporate claims as conveyed in a derivative stockholder suit and the best interests of a corporation as conveyed by an independent investigating committee.  The court should apply its own independent business judgment and determine whether the motion should be granted.  This second stop is intended to prevent instances where corporation actions meet the criteria of step one, but the result does not appear to satisfy the spirit, or where corporate actions would simply prematurely terminate a stockholder grievance that indicates, in the best interest of the corporation, further consideration is called for.  Of course, the court must carefully consider and weigh how compelling the corporate interest in dismissal is when faced with a non-frivolous lawsuit.  It should, when appropriate, give special consideration to matters of law and public policy as well as to the best interests of the corporation.  If, after all of this, the court’s independent business judgment is satisfied, it may proceed to grant the motion, subject, of course, to any equitable terms or conditions it finds necessary or desirable.  Reversed and remanded for further proceedings.

Discussion.

Other courts have chosen to treat this type of situation as one where the “business judgment†rule is applicable.  They look to see if the committee to whom the board of directors delegated the responsibility of determining if the litigation at issue should be continued was composed of independent and disinterested members and if it conducted a proper review of the matters prior to reaching a good faith business judgment about whether or not to continue the litigation.  If it did, the decision of the committee stands.  This court found that approach too one-sided, as inclined to take genuine derivative actions away from well-meaning derivative plaintiffs and robbing the shareholders of an effective intra-corporate means of policing boards of directors.