United States District Court, Northern District of Illinois, E.D
May 6, 1983
IN RE CONTINENTAL ILLINOIS SECURITIES LITIGATION.
The opinion of the court was delivered by: Grady, District Judge.
DECISION ON STANDARD TO BE USED IN RULING ON MOTION TO DISMISS
Certain defendants have moved for dismissal of some of the
derivative claims on the basis that a special committee appointed
by the Board of Directors of Continental Illinois Corporation
("CIC") has determined that pursuit of these claims would not be
in the best interest of the corporation. Awaiting resolution by
the court is the question of what weight and effect is to be
given these determinations of the Special Committee. Defendants
argue that the court is limited to an examination of whether the
committee was independent, whether it acted in good faith, and
whether it made a reasonable investigation. Plaintiffs, on the
other hand, argue that the court should go beyond this and make
an independent inquiry into the factual bases for the committee's
recommendation. The parties agree that the law of Delaware
governs and that the controlling case is Zapata Corp. v.
Maldonado, 430 A.2d 779 (Del. 1981). The parties offer
conflicting views as to what the case holds.
Defendants' argument is based on the proposition that the
instant case is a "demand required" situation. Defendants
apparently concede that the court must conduct some inquiry into
the questions of independence, good faith and reasonable
investigation, if only to determine whether the corporate
decision based upon the committee recommendation was "wrongful."
Zapata, 430 F.2d at 784. What separates the parties is really a
dispute as to the depth of the inquiry the court should conduct.
I believe defendants have misread Zapata. While the opinion
does mention the distinction between the case where a demand on
the board is required and the case where the demand is excused
(430 A.2d at 784), it is not the holding of Zapata that the court
is barred from examining a corporate decision not to prosecute in
a situation where a demand is required. In fact, it does not seem
to me that the demand versus no-demand discussion in Zapata has
much to do with the instant case. If the plaintiffs had not made
a demand upon CIC before bringing this suit, we would have to
address the question whether the suit was subject to dismissal
for that failure. Because shareholders' suits are brought on
behalf of the corporation and not for the personal benefit of the
shareholder plaintiffs, the corporation should be given the first
opportunity to institute and control the suit. The way to
guarantee the corporation that opportunity is to dismiss a
shareholder's suit instituted without demand on the corporation
to institute the suit itself. However, an exception has to be
made for the situation where the directors of the corporation are
themselves so connected with the alleged wrongdoing that they
would be unlikely to favor the suit. In this kind of situation,
a demand is said to be "futile" and is therefore excused.
The question of whether the directors have the kind of bias
which should excuse a demand is, of course, one which might
itself require judicial resolution in a case where a suit is
filed without a demand. This, however, is not such a case.
Whether plaintiffs were required to make a demand or not, they
did. In Zapata, there was no demand, so the court discussed the
significance of that fact. I do not interpret that discussion
(430 A.2d at 784) read in the context of the entire opinion, as
holding that the merits of the corporate decision are beyond
judicial review in a case where a demand is not excused. So
simplistic a view is inconsistent with the tenor of the court's
discussion at pp. 787-789 of the opinion. For instance, the
court's discussion of the possibility of a "`. . . there but for
the grace of God go I'" attitude on the part of even innocent
directors (p. 787) seems applicable to any decision on whether to
bring suit against fellow directors, including the
demand-required situation. The court goes on to reject the view
that the "business judgment" of a committee of disinterested
directors must be accepted. Describing the position of the courts
which had followed this "business judgment" rule, the court
The issues become solely independence, good faith and
reasonable investigation. The ultimate conclusion of
the committee, under that view, is not subject to
judicial review. (emphasis added).
The court went on immediately to say:
We are not satisfied, however, that acceptance of the
`business judgment' rationale at this stage of
derivative litigation is a proper balancing point.
Id. Defendants in the instant case quote the first passage as
indicating the adoption of the business-judgment rule by the
Zapata court, whereas it seems clear that the court is doing
precisely the opposite. The passage is introduced by the words,
"As we noted, the question has been treated by other courts as
one of the `business judgment' of the board committee." Id.
(emphasis added). It is the rationale of those "other courts"
that Zapata does not accept "at this stage of derivative
litigation as a proper balancing point." The phrase "at this
stage of derivative litigation" appears to refer to the stage of
legal development our society has reached. In other words, says
Zapata, if that has been the rule, it is time to change it.
Zapata then goes on to discuss what role the court must play
even in the case where the corporate decision not to prosecute is
based upon the recommendation of an apparently disinterested
committee of directors. In the instant case, we are dealing with
a decision made by an allegedly independent committee of
directors. Thus, it seems to me, the issue is the same. The fact
that there was no demand in Zapata, and that the court regarded
the case as one where the demand was excused, is not a
significant distinction, because in Zapata, as here, the question
is what effect is to be given the corporate decision recommended
by directors who are not alleged to have participated in the
wrongdoing. Our inquiry, moreover, is not limited to whether the
Zapata holding applies precisely to the facts of this case.
Rather, the inquiry is what the Supreme Court of Delaware would
do in this case. Zapata leads me to the conclusion that the
Supreme Court of Delaware would apply the same two-step test to
this case that it applied in Zapata itself. I hold, therefore,
that the two-step test applies.
The first step (430 A.2d 788-789) is an inquiry into "the
independence and good faith of the committee and the bases
supporting its conclusions." Three times in the paragraph
describing Step One the court uses the phrase "the bases
supporting its conclusions." Therefore, it is clear that in Step
One the inquiry is not simply whether the committee used adequate
investigative procedures, such as retaining counsel, interviewing
numerous witnesses and examining relevant documents, but, to a
limited extent, the inquiry is into the merits of the committee
conclusions based on that investigation. Defendants have
submitted an affidavit which describes the procedures the Special
Committee used but contains no hint of what facts were disclosed
by the investigation. That affidavit is therefore of little
significance in the necessary Step One inquiry.
The burden of proof is on the defendants, and "limited
discovery" should be allowed. 430 A.2d at 788.
If, after inquiry, the court is not satisfied that the Step-One
tests have been met, the motion to dismiss must be denied. But
even if the court should be satisfied that the Special Committee
was independent, acted in good faith and had reasonable bases for
its conclusions, the court still has discretion to proceed to
Step Two, which would involve the court's using "its own
independent business judgment" in determining whether the motion
to dismiss should be granted. 430 A.2d at 789. In that stage of
the inquiry, the court can even consider "matters of law and
public policy in addition to the corporation's best interests."
Plaintiffs argue that the motion to dismiss should not be
decided until substantially all the merits discovery in the case
is concluded, for only then will the court be able to determine
whether there were reasonable bases for the committee decision.
I reject that approach because it would delay
for too long a decision which should be made early in the case.
Zapata's reference to "limited discovery" reflects the fact that
the inquiry at this stage is to be relatively summary. The
question is not whether the derivative action should be dismissed
at the point of trial after a long period of discovery but
whether it should be maintained at all.
The next question is the procedure to be followed in carrying
out Step One of the inquiry. It seems clear that there should be
an evidentiary hearing. Defendants have the burden of proof. I
believe the most efficient way of conducting the inquiry would be
to have defendants put on their case and then see whether any
particular discovery is needed by the plaintiffs. Considerable
information is already in plaintiffs' possession, and it may be
that they need nothing more at this point. In any event, at the
conclusion of defendants' presentation, we will be in a position
to order the precise kind of discovery that may be necessary.
This case is set for May 12, 1983, at 4:00 p.m. for the purpose
of setting an early date for the Step One evidentiary hearing.
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