Auerbach v. Bennett

New York Court of Appeals · 1979 · Corporations

CorporationsShareholder derivative suitsBusiness judgment ruleSpecial litigation committeesbusiness judgment rulespecial litigation committeederivative actiondirector independence

Facts

Following an internal investigation, the audit committee of General Telephone & Electronics Corporation reported evidence of bribes and kickbacks and indicated that some individual directors had been personally involved in certain transactions. A shareholder then brought a derivative action against directors, Arthur Andersen & Co., and the corporation. The board later created a special litigation committee composed of three directors who had joined the board after the challenged transactions and had no prior affiliation with the corporation, and delegated to it authority to determine the corporation's position on the derivative claims. After conducting its own investigation with outside counsel, the committee concluded that continuation of the derivative action would not be in the corporation's best interests and directed counsel to seek dismissal.

Issue

When a board-appointed committee of disinterested directors decides that a corporation should terminate a shareholder derivative action, to what extent may a court review that decision under the business judgment doctrine? Also, was the intervening shareholder properly allowed to appeal from the dismissal when the original plaintiff declined to do so?

Rule

The substantive decision of a special litigation committee of disinterested and independent directors to terminate a shareholder derivative action is protected by the business judgment doctrine and is not subject to judicial review. A court may inquire only into the disinterested independence of the committee members and the adequacy, appropriateness, and good-faith pursuit of the committee's investigative procedures. If the committee is independent and its procedures are not shown to be sham, pretextual, or otherwise deficient, the courts may not examine the merits of its substantive balancing of corporate interests.

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Cascade Devices, Inc., a New York corporation based in Buffalo, faces a shareholder derivative suit alleging that several directors approved improper overseas consulting payments in 2022. After the suit is filed, the board creates a two-director committee to decide the corporation's position; one member joined the board in 2024 with no prior ties to the company, but the other served on the board in 2022 and voted for the challenged contracts.

If the defendants move for summary judgment based on the committee's recommendation to dismiss the suit, which is the strongest reason a court may decline to defer under the business judgment doctrine?

Explanation. Judicial review is limited to the committee members' disinterested independence and the adequacy and good-faith nature of their procedures. If a committee member was on the board during the challenged conduct and voted for the transactions, that raises a proper independence concern. By contrast, courts may not review the committee's substantive balancing of the corporation's interests, and the mere fact that some directors are defendants does not automatically disable the board from acting through disinterested directors. (Derived from Auerbach v. Bennett (1979).)