Holmstrom v. Coastal Industries, Inc.

• Decision Date: 23 October 1986
• Docket Number: No. C80-670A.,C80-670A.
• Citation: 645 F. Supp. 963
• Parties: Peter G. HOLMSTROM, Plaintiff, v. COASTAL INDUSTRIES, INC., et al., Defendants.
• Court: U.S. District Court — Northern District of Ohio

645 F. Supp. 963

Peter G. HOLMSTROM, Plaintiff, v. COASTAL INDUSTRIES, INC., et al., Defendants.

No. C80-670A.

United States District Court, N.D. Ohio, E.D.

March 6, 1984.

On Motion for Summary Judgment November 29, 1984.

On Motion to Withdraw Jury Demand October 23, 1986.

Marvin L. Karp, Cleveland, Ohio, Robert B. Block, Pomerantz, Levy, Haudek & Block, New York City, for plaintiff.

Steven E. Sigalow, Joseph C. Weinstein, Buckingham, Doolittle & Burroughs, John M. Glenn, Akron, Ohio, for Reid, Champion Investments and Cascade Industries.

Tom Parker, Richard E. Guster, Roetzel & Andress, Akron, Ohio, for Coastal Industries.

Oscar A. Hunsicker, Brouse & McDowell, Akron, Ohio, for Predler and Forty-Four Forty, Inc.

Hugh M. Stanley, Jr., Arter & Hadden, Cleveland, Ohio, for Ryder, Kelley, Nelson, Siff and Reese.

Robert A. Downing, Sudley & Austin, Chicago, Ill., for Harbor Ins. Co.

MEMORANDUM OPINION

DOWD, District Judge.

By this action the plaintiff prosecutes a derivative shareholder's action against a number of the directors of Coastal Industries, Inc. on behalf of Coastal Industries.

At issue is the motion for summary judgment filed by Coastal Industries, Inc., whereby the plaintiff's complaint would be dismissed. For the reasons which follow, the motion for summary judgment is denied.

The motion for summary judgment prosecuted by the nominal defendant Coastal Industries, Inc. is predicated upon the report of the Litigation Oversight Committee appointed by the Board of Directors of Coastal Industries following the commencement of this action by the plaintiff.

The plaintiff's complaint focuses upon the majority decision of a divided Board of Directors of Coastal Industries to purchase a substantial portion of its own stock at approximately 100% premium. The stock purchased was held by a subsidiary of Coastal Industries, Cascade Industries, Inc., which, as alleged by the plaintiff, was threatening to take control of Coastal's Board.

According to the position of the plaintiff, the purchase of Cascade Industries stock at the 100% premium had a two fold purpose, first to perpetuate the control by Coastal's management and secondly to serve the interest of defendant director James Pedler, now deceased, who, at the time of the purchase, was a major Coastal shareholder, and who had previously guaranteed a Cascade loan which was in default. The proceeds realized by Cascade from the purchase by Coastal of its stock were used by Cascade to pay off the loan personally guaranteed by Pedler. Hence, Pedler received a benefit by the transaction and, according to the plaintiff, was motivated by that self interest to vote for the challenged transaction.

The purchase of the shares of Coastal, held by Cascade, was approved by a minority of the Board of Directors, consisting of nine directors. The action to purchase the stock was approved by four members of the Board, two members of the Board voted no and two abstained. The ninth member was absent. Following the commencement of the lawsuit, new members were elected to the Board of Directors. Those members, i.e., J. Robert Wilson, Robert J. Himelright, Jr., and Morris B. Jobe,¹ were designated to serve as the Litigation Oversight Committee (LOC) to review the question of whether it was in the best interest of Coastal Industries to have plaintiff's litigation pursued or terminated.

The concept of the litigation oversight committee flows from the business judgment rule which, in short, constitutes judicial recognition of the fact that a private corporation should, generally speaking, have the right to control its destiny respecting the prosecution of claims held by the corporation.

The LOC hired independent counsel, then conducted an investigation and concluded that it was in the best interests of Coastal Industries, Inc., to terminate the instant litigation. Hence, the motion of the defendant, Coastal Industries, Inc., for summary judgment.

Nearly every analysis of the application of the business judgment rule in the context of derivative suits by corporate shareholders begins with reference to the decision in United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 37 S.Ct. 509, 61 L.Ed. 1119 (1917), where Justice Brandeis, in considering the question of whether the business judgement rule could be employed to insulate the conclusions of management regarding corporate prosecution of a derivative suit from judicial scrutiny declared:

Whether or not a corporation shall seek to enforce in the courts a cause of action for damages is, like other business questions, ordinarily a matter of internal management and is left to the discretion of the directors, in the absence of instruction by vote of the stockholders. Courts interfere seldom to control such discretion intra vires the corporation, except where the directors are guilty of misconduct equivalent to a breach of trust, or where they stand in a dual relation which prevents an unprejudiced exercise of judgment.

With the proliferation of shareholder derivative actions, the use and reliance upon the litigation oversight committee composed of independent directors has developed. Frequently, the courts have granted the dismissal of derivative shareholders' lawsuits when the independent or disinterested directors have recommended against a continuation of the litigation brought by the derivative shareholder, e.g. Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979); Clark v. Lomas and Nettleton Financial Corp., 625 F.2d 49 (5th Cir.1980); Lewis v. Anderson, 615 F.2d 778 (9th Cir.1979); Abbey v. Control Data Corp., 603 F.2d 724 (8th Cir.1979); Genzer v. Cunningham, 498 F.Supp. 682 (E.D.Mich.1980); Maldonado v. Flynn, 485 F.Supp. 274 (S.D.N.Y.1980); Rosengarten v. International Telephone Telegraph Corp., 466 F.Supp. 817 (S.D.N.Y.1979).

As an additional application of the business judgment rule in the setting of a recommendation to dismiss made by a litigation oversight committee composed of independent directors, the courts have chosen to abide by the recommendation of the special litigation committee that the action be dismissed when the committee is composed of independent or disinterested directors and their recommendation is the product of a good faith and a thorough study of the issues regarding it is in the best interest of the corporation to pursue or to terminate the litigation. A component of the traditional view has been that the court should not assess independently the merits of the derivative suit as to do so would defeat the purpose of the business judgment rule which is premised on the expertise of the directors to render important business decisions without interference by the courts or shareholders. See Joy v. North, 519 F.Supp. 1312 (Conn.1981).

However, in recent years, some courts have begun to draw back from the traditional view and have begun to re-examine the idea that the judgment of the litigation oversight committee should prevail as long as it is comprised of disinterested directors and their recommendation has been reached as the result of a good faith, thorough effort in examining the issues from the perspective of the best interests of the corporation. The decision of the Delaware Supreme Court in Zapata Corp. v. Maldonado, 430 A.2d 779, (Del.S.Ct.1981), signaled the re-examination of the traditional view. The decision of the Zapata court is designed to steer a middle course between those decisions which yield to the independent judgment of a board committee and those which permit unbridled plaintiff stock-holder control over derivative actions. In steering the so-called middle course, the Zapata court decision is premised on the judicial declaration that the Court should apply its own business judgment in determining whether a motion for summary judgment should be granted because of a committee decision. In effect, the Zapata court decision calls for independent judicial review of the merits of the independent litigation committee's decision and requires a judicial assessment of: 1) the procedural propriety of a complaining shareholder's initiation of suit, 2) whether the board committee is endowed with the requisite corporate power to seek the dismissal of the derivative suit, 3) whether the movants have adequately demonstrated the disinterest, independence and good faith of committee members, the basis' for the conclusions of such members, and the appropriateness and sufficiency of their investigative techniques, and 4) whether in the court's view, exercising its own independent business judgment, dismissal of the derivative action is warranted.

Ohio Courts have long recognized the business judgment rule. Wadsworth v. Davis, 13 Ohio St. 123 (1862); Goff v. Emde, 32 Ohio App. 216, 167 N.E. 699 (1928); McDonald v. Medical Mutual of Cleveland, 41 Ohio Misc. 158, 324 N.E.2d 785 (1974); Rice v. Wheeling Dollar Savings and Trust Co., 71 Ohio Law Ab. 205, 130 N.E.2d 442 (1954), aff'd in part and rev'd in part on other grounds, 163 Ohio St. 606, 128 N.E.2d 16 (1955); Gruber v. Chesapeake & Ohio Ry. Co., 158 F.Supp. 593 (N.D. Ohio 1957). However, no reported Ohio decision addresses the nature of the scrutiny a court should give to a recommendation of a litigation oversight committee which recommends that the corporation move to dismiss a derivative shareholder's action which is directed to claims of corporate directors' mismanagement or self dealing to the alleged detriment of the best interests of the shareholders.

Ohio courts have held that the corporation's directors should decide questions of corporate policy as long as they are not acting ultra vires and they had no involvement in the acts which form the basis of the complaint. Rice, supra, 71 Ohio Law Ab. at 211-13, 130 N.E.2d 442. "In the absence of usurpation, fraud or gross negligence, courts of equity will not interfere at the suit of a dissatisfied minority of shareholders merely to overrule and...