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MILLS v. ESMARK

September 6, 1983

CARYN J. MILLS AND SUSAN MILLS, NOT INDIVIDUALLY BUT DERIVATIVELY ON BEHALF OF ESMARK, INC., A DELAWARE CORPORATION, PLAINTIFFS,
v.
ESMARK, INC., A DELAWARE CORPORATION; DONALD P. KELLY; ROGER T. BRIGGS; EDWARD J. HARRISON; WILLIAM P. CARMICHAEL; GEOFFREY C. MURPHY; ROBERT E. PALENCHAR; JAY D. PROOPS; PHILIP L. THOMAS; EARL J. GRIMM; JACK A. VICKERS; SAMUEL B. CASEY, JR.; LESTER CROWN; ARCHIE R. DYKES; JEROME C. EPPLER; WILLIAM B. JOHNSON; JAMES J. O'CONNOR; RICHARD TERRELL; AND ELMO R. ZUMWALT, JR., DEFENDANTS.



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

MEMORANDUM OPINION AND ORDER

I. Remaining Claims

Three major allegations remain unresolved. First, plaintiffs allege that the 1981 grant to key Esmark employees was a departure from provisions of the Long-Term Growth Plan ("LTGP") as approved by shareholders, and that the actions of Esmark's Compensation Committee and Board of Directors in approving and ratifying the 1981 grant were without corporate purpose, a waste of corporate assets, a gift of corporate assets and a violation of fiduciary duty. Second, plaintiffs allege that the 1980 grant violated Article IX, § 3 of the Delaware Constitution, which provides that no corporation shall issue stock except in return for valid consideration. Third, plaintiffs allege that the proxy statement seeking shareholder approval of the LTGP was false and misleading in that: (1) it did not state that awards could be made on the basis of extraordinary, non-recurring capital gains; and (2) it stated that the LTGP was based upon the recommendations of compensation consultants. It is alleged that these misstatements and omissions were made in violation of § 14 of the Securities Exchange Act of 1934, 15 U.S.C. § 78n and Rule 14a-9 thereunder.

II. Standard of Review

The authority of disinterested directors to terminate a shareholder derivative action is a matter properly resolved with reference to the applicable state law. Burks v. Lasker, 441 U.S. 471, 480, 99 S.Ct. 1831, 1838, 60 L.Ed.2d 404 (1979). In this case, we look to the law of Delaware, the state of Esmark's incorporation, to govern the issue.

In Zapata Corporation v. Maldonado, 430 A.2d 779 (Del.Supr. 1981), the Supreme Court of Delaware enunciated the standards to be applied in reviewing the decision of disinterested directors not to pursue the claims of shareholders. When shareholders, after making demand and having their suit rejected, attack the board's decision as improper, the board's decision falls under the "business judgment" rule and will be respected if the requirements of the rule are met. Id. at 784, n. 10. The issues for judicial inquiry are thus limited to independence, good faith and reasonable investigation. Id. at 787. Where, as in Zapata, demand was excused due to futility, the situation may call for judicial caution beyond adherence to the business judgment rule. Id. In such a case, the court may, in its discretion, proceed to a "second step" and apply its own independent business judgment. The purpose of the second step is to thwart instances where corporate actions meet the criteria of the business judgment rule, but the result does not seem to satisfy its spirit. Id. at 789. Thus, where demand has not been made due to futility, the corporation bears the initial burden of establishing its good faith and independence in seeking termination of the suit, and even then its judgment is subject to the court's objective scrutiny. Abramowitz v. Posner, 672 F.2d 1025, 1031 (2d Cir. 1982).

In this case, plaintiffs made a demand on the board of directors of Esmark in March of 1981 that suit be brought by Esmark against 29 directors and officers to recover the increase in "cash and cash equivalent remuneration" received by those individuals in 1980. Plaintiffs filed this lawsuit on April 3, 1981, before Esmark had responded to the demand letter. On June 18, 1981, this Court granted defendants' motion to dismiss the action without prejudice pending the board's response to plaintiffs' demand. The board then established a Special Litigation Committee ("1st SLC") comprised of two outside directors to investigate the matter. On July 31, 1981, the 1st SLC issued its report, which concluded that the challenged payments and awards were reasonable, proper and lawful, and that legal challenge to them would not be in the corporation's best interests. Plaintiffs then filed an amended complaint, reasserting the original claims and adding claims for breach of fiduciary duty and violation of the federal securities laws. In February of 1982, plaintiffs filed a second amended complaint, further modifying their claims against defendants. Defendants then moved for dismissal with prejudice or summary judgment on the basis of the 1st SLC's report.*fn1

In considering defendants' motion, this Court applied a test of good faith, independence and reasonable investigation to those claims reviewed by the 1st SLC upon demand by plaintiffs. Mills v. Esmark, 544 F. Supp. 1275 (N.D.Ill. 1982). With respect to the claims that had not been presented as a demand on Esmark's board, however, we stated as follows:

    With possible exception of plaintiffs' claim under
  section 14(a) of the Securities Exchange Act of 1934,
  those issues which remain after the SLC's inquiry
  were not presented to the board of directors in the
  form of a proper demand as required by Rule 23.1.
  Fed.R.Civ.P. Although we earlier enforced the demand
  requirement in response to plaintiffs' initial
  complaint, Mills v. Esmark, 91 F.R.D. 70 (1981), we
  decline to do so again at this later stage of the
  litigation. A further demand and further
  investigation would likely prolong rather than cut
  short this dispute. Moreover, because the defendant
  directors have now taken a clear and unequivocal
  position on the merits of this entire controversy in
  their motion for summary judgment, a further demand
  on the board would not be fruitful. Cf. Nussbacher v.
  Continental Illinois Bank & Trust Co., 518 F.2d 873,
  879 (7th Cir. 1975), cert. denied, 424 U.S. 928, 96
  S.Ct. 1142, 47 L.Ed.2d 338 (1976).

Despite excused demand, Esmark established a 2nd SLC, appointing outside director Julia M. Walsh as the committee's sole member. Mrs. Walsh had no affiliation with or connection to Esmark until being elected to its board of directors in March of 1982; it is undisputed that she was not involved in any of the matters giving rise to this litigation. The 2nd SLC conducted an extensive investigation into the remaining charges and submitted a lengthy report which recommends that it is in Esmark's best interest to seek dismissal of the claims.*fn2

III. Plaintiffs' Challenges to 2nd SLC Report

Plaintiffs' challenges are largely in the form of alleged omissions from the report purportedly suggesting that the committee's recommendation was wrongful. Plaintiffs' contentions require us to analyze objectively the significance of undisclosed and/or unscrutinized "facts" ...


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