Joy v. North

United States District Court for the District of Connecticut · Corporations

CorporationsDerivative suitsBusiness judgment ruleSpecial litigation committeederivative actionindependent directorsdisinterested committeeConnecticut corporate law

Facts

The derivative suit, filed in 1977, alleged that officers and directors of Bancorp and Citytrust improperly authorized and extended loans for construction of a building by the Katz Corporation. After Burks v. Lasker, the board created a Special Litigation Committee composed of two directors, Marion S. Kellogg and Ernest C. Trefz, to determine whether continued prosecution served the corporations' best interests. The committee retained counsel, investigated for nine months, and issued a three-volume report recommending dismissal as to twenty-three defendants but continuation or settlement as to seven others. The plaintiff challenged both Connecticut's recognition of the business judgment rule in this context and the committee's independence, good faith, and procedures.

Issue

Whether, under Connecticut law and consistent with the National Banks Act, an independent and disinterested special litigation committee may invoke the business judgment rule to terminate a pending shareholder derivative suit, and whether this committee's investigation was sufficiently independent, in good faith, and thorough to warrant dismissal.

Rule

Under Burks, a federal court reviewing a special litigation committee's recommendation to dismiss a derivative action must determine: (1) whether state law permits such a dismissal and under what circumstances; (2) whether application of that state rule is consistent with the policy of the federal statute underlying the suit; and (3) whether the committee acted with independence, good faith, and thoroughness. Connecticut recognizes a broad business judgment rule derived from directors' statutory authority to manage corporate affairs, and that rule includes the power of a disinterested and independent committee to terminate a derivative suit, subject to limited judicial review of the committee's bona fides rather than the merits of the underlying claims.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Lakeshore Components, Inc., a Connecticut corporation based in Hartford, faces a shareholder derivative suit alleging that several directors breached fiduciary duties by approving a risky supplier arrangement. After the suit is filed, the board appoints two newer directors, Dana Mercer and Victor Lin, neither of whom participated in the arrangement, to investigate whether continuing the litigation serves the corporation’s interests. Their report recommends dismissal as to most defendants after a lengthy investigation.

A federal court hearing the derivative suit should first ask which question before considering the committee’s recommendation?

Explanation. Under the majority opinion’s Burks framework, the threshold inquiry is whether applicable state law permits dismissal by an independent committee and under what circumstances. Only after that does the court consider consistency with federal policy, if any, and the committee’s independence, good faith, and thoroughness. The court does not begin by adjudicating the merits of the underlying claims. (Derived from Joy v. North (n.d.).)