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August 16, 1982


The opinion of the court was delivered by: Aspen, District Judge:


Plaintiffs, Caryn J. Mills and Susan M. Mills, brought this derivative action on behalf of Esmark, Inc. ("Esmark") against the corporation, its directors and certain of its officers. Plaintiffs allege that the assignment and award of restricted Esmark common stock and performance units to key employees of the corporation in 1979 and 1980 violated Esmark's Long Term Growth Plan ("LTGP"), the Delaware Constitution and the fiduciary duty owed shareholders by Esmark's officers and directors. Plaintiffs also allege that the circumstances under which the defendants obtained shareholder approval of the LTGP in 1979 and awarded restricted stock to key Esmark employees in 1980 violated the Securities Exchange Act of 1934. Plaintiffs allege further that the award of $1,000,000 to defendant Jack A. Vickers in 1980 was improper and a waste of corporate assets. Plaintiffs assert finally that Esmark's Corporation Committee and Board of Directors violated the purpose of the corporation's Management Incentive Plan by declaring an award for the 1981 fiscal year in 1980. Presently before the Court are certain defendants' motions to dismiss plaintiffs' second amended complaint with prejudice or, in the alternative, for summary judgment.

The crux of plaintiffs' charges were contained in a letter of demand received by the Esmark Board of Directors on March 31, 1981.*fn1 Plaintiffs subsequently filed a complaint which this Court dismissed to afford time for Esmark's Special Litigation Committee ("SLC") to respond to plaintiffs' allegations. Mills v. Esmark, 91 F.R.D. 70 (N.D.Ill. 1981). The SLC ultimately concluded that litigation involving the charges raised in the initial complaint would not be in the best interest of Esmark. SLC Report, pp. 10-12. Upon receipt of the SLC's Report, plaintiffs filed an amended complaint asserting the original claims and adding further claims against the defendants for breach of fiduciary duty and violation of the federal securities laws. Plaintiffs have since filed a second amended complaint advancing still further claims for breach of the LTGP and the Management Incentive Plan and for violation of the Delaware Constitution. Plaintiffs also allege that the SLC failed to exercise independent and good faith business judgment in evaluating their substantive claims. Defendants now seek dismissal of this action on the merits in light of the SLC's recommendation.

I. The Special Litigation Committee Report

The Supreme Court held in Burks v. Lasker, 441 U.S. 471, 480, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979), that the authority of disinterested directors to terminate shareholder derivative actions is a matter properly resolved with reference to the applicable state law. See also Abramowitz v. Posner, 672 F.2d 1025, 1026 (2d Cir. 1982). In the present case, therefore, this Court must look to the law of Delaware, the state of Esmark's incorporation, to determine the effect of the SLC's conclusion that it is not in the best interest of the corporation to pursue this litigation.*fn2

A. The Standard for Reviewing Findings of a Special Litigation

The effect of a decision by a committee of independent directors not to pursue derivative claims asserted by shareholders in a demand was addressed by the Delaware Supreme Court in Zapata Corporation v. Maldonado, 430 A.2d 779 (Del.Supr. 1981). The Zapata Court made clear that, as a general rule, "a board decision to cause a derivative suit to be dismissed as detrimental to the company, after demand has been made and refused, will be respected unless it was wrongful." Id. at 784. The Court reasoned that the decision of disinterested directors not to pursue derivative claims "falls under the `business judgment' rule and will be respected if the requirements of the rule are met."*fn3 Id. at n. 10. See also United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64, 37 S.Ct. 509, 61 L.Ed. 1119 (1917); Galef v. Alexander, 615 F.2d 51, 57-58 (2d Cir. 1980). Accordingly, shareholders who initiate an action purportedly on behalf of the corporation cannot maintain that action in derivative context once a committee of independent and disinterested directors determine that litigation is not in the best interests of the corporation. Swanson v. Traer, 249 F.2d 854, 859-60 (7th Cir. 1957).

This Court's review of the SLC's report, therefore, is limited to an inquiry into the disinterested independence of the members of the SLC and the appropriateness and sufficiency of the committee's investigative procedures. Zapata, supra, 430 A.2d at 784. Cf. Galef, supra, 615 F.2d at 59; Auerbach, supra, 47 N.Y.2d at 623-24, 419 N.Y.S.2d 920, 393 N.E.2d 920. The "second step" of the trial court's inquiry under Zapata, a complete and independent review of the substantive basis of the shareholder plaintiffs' claim, is not appropriate in a case such as this where a special litigation committee, established by the board in response to a proper shareholder demand, has determined that litigation would not advance the best interests of the corporation.*fn4 Abramowitz, supra, 672 F.2d at 1030; Maldonaldo v. Flynn, 671 F.2d 729, 731 (2d Cir. 1982) (per curiam).

The limited scope of inquiry permitted in this context under Delaware law and the business judgment rule does not, however, bar all substantive review of the SLC's conclusions and recommendations. In cases where, as here, the shareholder plaintiffs articulate specific grounds on which to question the good faith of a special litigation committee's investigation, the Court must examine the committee's treatment of the merits of the shareholders' underlying claims in order to determine the appropriate weight to be given to the committee's recommendations. To shield our eyes entirely from the merits would prevent us from evaluating the underlying independence of the committee.

     B. Assessment of the Good Faith and Independence of the
               Esmark Special Litigation Committee

In the present case, Esmark's Board of Directors appointed two "outside" directors, Dr. Archie R. Dykes and Admiral Elmo R. Zumwalt, Jr. (Retired) to head the Special Litigation Committee. Although Dr. Dykes and Admiral Zumwalt were each named as defendants in this action, neither is alleged to have participated in the decisions of the Esmark Compensation Committee or to have received any payment or benefit challenged by plaintiffs in this lawsuit. The disinterested independence of Dr. Dykes and Admiral Zumwalt is not impaired merely because they were named as nominal defendants in this case.*fn5 Cf. Klotz v. Consolidated Edison Co. of New York, Inc., 386 F. Supp. 577, 580-82 (S.D.N.Y. 1974). To hold otherwise would allow a small number of shareholders to "incapacitate an entire board of directors" merely by naming the entire board as defendants. Zapata, supra, 430 A.2d at 785.

Dr. Dykes' and Admiral Zumwalt's status as nominal defendants for the purpose of evaluating plaintiffs' state law claims does not, however, establish their disinterested independence for the purpose of evaluating plaintiffs' claims under section 14 of the Securities Exchange Act of 1934. As Esmark directors, Dr. Dykes and Admiral Zumwalt each participated in the alleged wrongdoing by approving the alleged misrepresentations concerning the LTGP contained in the 1979 Esmark Proxy Statement. As a practical matter, neither Dr. Dykes nor Admiral Zumwalt can be expected to exercise truly independent judgment in evaluating the propriety of their own decision to approve the proxy statement.*fn6 Accordingly, the SLC's conclusions as to plaintiffs' section 14 claim will not be afforded deference under the business judgment rule.*fn7

Plaintiffs assert a variety of alternative theories to cast doubt upon the independence or disinterestedness of the SLC in its evaluation of the state law claims asserted in the complaint. For example, plaintiffs allege that Dr. Dykes and Admiral Zumwalt earn more money each year from their directors' fees than their limited number of shares of Esmark stock. This fact does not, however, establish any particular bias against shareholders' interests or improper affiliation with management.*fn8 Similarly, Dr. Dykes and Admiral Zumwalt's consistent participation in unanimous decisions on a variety of issues by the Esmark Board of Directors does not establish any lack of independence from management.*fn9 Indeed, several of the Board's decisions at issue in this case deviated from management's initial recommendations. Plaintiffs cannot avoid application of the business judgment rule by advancing generalized charges of bias or lack of independence.

Plaintiffs assert that the SLC's lack of independence is also evidenced by its failure to disclose a variety of facts and documents favorable to the claims advanced in their complaint. The viability of this argument as a means of invalidating the SLC's recommendations requires the Court to engage in some substantive analysis of the significance of the "undisclosed" facts and documents in relationship to the underlying allegations of wrongdoing in plaintiffs' complaint. For example, one of the claims raised in plaintiffs' "Presentation to the Special Litigation Committee" and reiterated in the second amended complaint is that the value of each share of restricted Esmark stock awarded to key Esmark employees in 1979 and 1980 under the LTGP was excessive because the total number of outstanding shares of Esmark was cut in half during that period as the result of the restructuring of Esmark and the disposition of the Trans Ocean Oil, Inc. to Mobil Oil Corporation. "Consequently," plaintiffs argue, "the retirement of [54% of Esmark's shares] approximately doubled the earnings per share on the remaining shares [including those restricted shares awarded under the LTGP], doubled the proportion of voting percentage of [those] remaining shares and had the effect of substantially increasing the market value of [those] shares." Second Amended Complaint, ¶ 44.A. Plaintiffs allege that, under these circumstances, the Esmark Board of Directors should have exercised its power to reduce the number of restricted shares awarded under the LTGP to reflect the increased "value" of each share.

The "fact" purportedly favorable to plaintiffs which was not disclosed in the SLC's report was that the Esmark Board of Directors increased the number of shares awarded to key employees under the LTGP when Esmark declared a 5 for 4 stock split in 1981. Presumably, this undisclosed fact is viewed by plaintiffs as evidence of the Board's inconsistency in the administration of the LTGP or simply as evidence of the Board's power to alter the number of shares awarded under the LTGP. In either event, however, we do not view the SLC's failure to address this fact as material evidence of its lack of independence. The SLC's report does distinguish in general terms between the equity effect of a stock split and the kind of corporate restructuring involved in this case.*fn10 SLC Report, p. 110. Given the entirely different nature of each transaction, the SLC's failure to specifically distinguish one from the other is not evidence of bias or domination.

Plaintiffs also argue that the SLC should have disclosed that defendant Jack A. Vickers, a member of the Esmark Board of Directors, voted favorably on a resolution which included a provision which compensated him in the amount of $1,000,000 for his role in the Esmark restructuring. Although the SLC report defends the reasonableness of such compensation, it does not discuss the implications of Vicker's vote in his own favor.*fn11 The SLC's failure to consider these implications reflects the fact that this allegation was not fully developed until after the SLC report was issued and that Admiral Zumwalt had a personal recollection that Vickers did not vote on his own compensation. Zumwalt Dep. at p. 12. Neither of these considerations, however, cast doubt upon the SLC's ability to independently evaluate plaintiffs' underlying claim that the payment of $1,000,000 to Vickers was a waste of corporate assets. Second Amended Complaint, ¶ 47. The "fact" undisclosed in the SLC report supports neither a separate cause of action against Vickers under Delaware law, 8 Del.Corp.Code § 144(a)(1), nor an inference that the SLC was biased or dominated by those accused of wrongdoing.

Plaintiffs also contend that the SLC failed to disclose various documents purportedly favorable to their claim. One of those documents was a legal opinion, authored by lawyers in the firm of Mayer, Brown & Platt, which expressed some doubt over Esmark's assessment of the tax benefits arising from the corporate restructuring program.*fn12 Second Amended Complaint, ¶ 50.I. The underlying significance of plaintiffs' tax liability claim was not, however, fully developed until after the SLC report was issued.*fn13 Moreover, the SLC's discussion of the tax issue with Howard J. Doherty, a partner of Arthur Young & Co., manifests that the committee analyzed the merits of plaintiffs' allegation in some detail.*fn14 The absence of any specific reference to the Mayer, Brown & Platt opinion reflects the generalized nature of plaintiffs' claim at the time of the investigation rather than the lack of independence of the SLC.

Plaintiffs also suggest that the SLC should have disclosed the existence of a corporate insurance policy which would indemnify key employees of Esmark in the event of the successful prosecution of this suit. Second Amended Complaint, ¶ 50.I. The existence of such an insurance policy no doubt would, to some extent, dilute the morale problem of Esmark executives cited by the SLC as one of several reasons for not pursuing this litigation. Although we do not agree with Dr. Dykes' subsequent assertion that the insurance issue is irrelevant to consideration of the wisdom of pursuing this lawsuit, Dykes Deposition at pp. 61-62, neither do we agree that the SLC's failure to address this issue evidences any lack of independence or disinterestedness.*fn15 Indeed, if the SLC's intention was to conceal all facts and documents inconsistent with its ultimate conclusion, it would not have included a summary or discussion of the variety of substantive criticisms launched against Esmark's restructuring and handling of the LTGP by sources other than the plaintiffs.*fn16

The final nondisclosure cited by plaintiffs as evidence of the SLC's lack of independence is the fact that the Esmark Compensation Committee deviated from its prior formula in determining the number of restricted shares of Esmark stock to be awarded under the LTGP in 1981. This purported deviation, and the resulting higher number of shares awarded, forms the basis of "Plaintiffs' First Claim" in the second amended complaint. The SLC's failure to address this issue in detail does not, however, evidence any lack of independence or good faith. The propriety of the formula used in calculating the 1981 grant of restricted stock was not raised as an issue in this lawsuit until plaintiffs filed their first amended ...

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