Alford v. Shaw

Decision Date07 October 1986
Docket NumberNo. 132PA85,132PA85
Citation349 S.E.2d 41,318 N.C. 289
CourtNorth Carolina Supreme Court
Parties, 55 USLW 2246 Frank O. ALFORD, Wilkie P. Beatty, as Executrix of the Estate of Paul B. Beatty, Carson Insurance Agency, Inc., Patricia A. Edlund, Stanley Edlund, James M. Gilfillin, Larry G. Goldberg, Raquel T. Goldberg, Betty F. Rhyne, Robert R. Rhyne and Norman V. Swenson, derivatively in the right of All American Assurance Company, Plaintiffs, v. Robert T. SHAW, American Commonwealth Financial Corporation, Great Commonwealth Life Insurance Company, ICH Corporation, Charles E. Black, S.J. Campisi, Roy J. Broussard, Truman D. Cox, Fred M. Hurst, C. Fred Rice, and Peggy P. Wiley, Defendants, and All American Assurance Company, Beneficial Party.

Petree, Stockton, Robinson, Vaughn, Glaze & Maready by Ralph M. Stockton, Jr. and Daniel R. Taylor, Jr., Winston-Salem, for plaintiff All American Assur. Co.

Cansler & Lockhart, P.A. by Thomas Ashe Lockhart and Bruce M. Simpson, Charlotte, for plaintiff-appellees.

Adams, Kleemeier, Hagan, Hannah & Fouts by Daniel W. Fouts and Bruce H. Conners, and Peter G. Pappas, Greensboro, for defendant-appellants Charles E. Black, S.J. Campisi, Roy J. Broussard, Fred M. Hurst, Peggy P. Wiley and Truman D. Cox.

BILLINGS, Chief Justice.

The sole issue on appeal is whether, in North Carolina, the business judgment rule may be applied to a special litigation committee's decision not to pursue derivative claims based upon charges of fraud and self-dealing by a majority of the members of the board of directors of the corporation asserted by minority shareholders. The Court of Appeals concluded that the business judgment rule, "traditionally used by our courts as a defense on the merits to allegations of fraud," could not be invoked as "a procedural device to dispose of derivative litigation," 72 N.C.App. at 548, 324 S.E.2d at 886, and reversed the order of the trial judge granting summary judgment on all but two claims and approving settlement of the remaining claims. We reverse.

I.
A.

As a result of certain demands made on behalf of a number of minority shareholders of All American Assurance Company ("AAA"), that company's board of directors adopted a resolution establishing a "Special Investigative Committee." The Committee was authorized, "in their independent discretion and judgment," to conduct an investigation into the matters about which complaint had been made and "to determine in their independent judgment based upon such investigation whether in the best interest of AAA and its shareholders any claim or demand shall be made or asserted ... or whether any legal action shall be initiated against any person or other entity."

Prior to completion by the special litigation committee of its investigation, plaintiffs filed a shareholder's derivative suit in Superior Court, Mecklenburg County. The allegations in the complaint, for the most part, paralleled the claims made earlier which were then under investigation by the Committee. Included in the complaint were allegations of "wrongful, unlawful and fraudulent transactions" undertaken by defendants 1 "to the enormous loss and detriment of All American."

Within a year after the complaint was filed, the special litigation committee completed its investigation and filed its report. The Committee recommended that all except two of the claims investigated 2 not be asserted and that the two remaining claims be settled.

Based on the recommendations of the special litigation committee, defendant AAA moved for summary judgment on all claims except the two which were the subject of a settlement agreement and for approval of the settlement agreement. In addition, defendants Wiley, Campisi, Hurst, Broussard, Black and Cox moved for summary judgment.

Judge Snepp granted the motions, reasoning that:

The Court is of the opinion that the business judgment rule controls the disposition of this case and, therefore, that the only issues before it are whether the Special Committee was composed of disinterested, independent directors who acted in good faith, and whether the scope of the investigation and the procedures adopted and followed were appropriate.... [and] that there is no genuine issue of a material fact as to the disinterestedness, independence and good faith of the Special Committee, or as to the scope of the investigation or the appropriateness of the procedures adopted and followed by the Special Committee in investigating the claims asserted....

The Court of Appeals reversed, holding that "directors of North Carolina corporations who are parties to a derivative action may not confer upon a special committee of the board of directors the power to bind the corporation as to its conduct of the litigation." 72 N.C.App. at 547, 324 S.E.2d at 886. In reaching this conclusion, the Court of Appeals considered each of three prevailing views, rejected both the view first articulated in the landmark case of Auerbach v. Bennett, 47 N.Y.2d 619, 393 N.E.2d 994, 419 N.Y.S.2d 920 (1979), and the view as represented by Zapata Corp. v. Maldonado, 430 A.2d 779 (Del.1981), both of which recognize the authority of the courts to rely, with different degrees of deference, upon litigation decisions made by special litigation committees of the corporation's board of directors, and adopted the rule enunciated in Miller v. Register And Tribune Syndicate, Inc., 336 N.W.2d 709 (Iowa 1983). 3 The claims made on behalf of certain minority shareholders of AAA were first asserted by letter dated 28 October 1981, from Attorney Thomas A. Lockhart and directed to the board of directors of All American Assurance Company. The letter questioned the propriety of certain transactions undertaken by the officers and directors of AAA in conducting business for the corporation. These included failing to exercise an option to purchase shares of AAA stock from Great Commonwealth Life Insurance Company (GCL) and failing to exercise a "put" to sell shares of AAA stock to American Commonwealth Financial Corporation (ACFC); paying excessive amounts to affiliated companies for administrative expenses; entering into certain allegedly improper reinsurance and coinsurance agreements; redeeming certain 8% debentures held by affiliated companies; releasing American Bank and Trust Company (ABTC) of Baton Rouge, Louisiana, from an obligation to purchase an office building; and engaging in other allegedly improper transactions with affiliates, including unsecured loans and joint ownership of airplanes. 4 By letter dated 11 May 1982, Mr. Lockhart, as attorney for the minority shareholders of AAA, made the following demands of the board of directors with regard to the earlier claims: recovery from GCL of 232,678 AAA shares purchased at $5.00 per share when AAA had a "put" option to sell 51,774 shares at $10.00 per share to ACFC; recovery of all loans and advances to affiliates; recovery of all investments, amounting to at least $4,259,149.00, in National American Life Insurance Company (NAL); and demand that the company refrain from coinsurance and reinsurance treaties and transactions with affiliates which had not been approved by the North Carolina Department of Insurance.

The complaint in the present action, filed on 4 November 1982, asserted liability on the part of the defendants based on the transactions described above and the failure of AAA's directors to take action.

B.

As one commentator recently noted, this case "clearly presents policy choices of major significance in the corporation law of North Carolina." R. Robinson, North Carolina Corporation Law and Practice, § 14-15 (3d ed. 1983 and Supp.1985). We therefore deem it appropriate to approach the issue from a historical and economic as well as a legal perspective.

The shareholder derivative action, codified in N.C.G.S. § 55-55, traces its roots to English common law as first described in the case of Foss v. Harbottle, 2 Hare 461, 67 Eng.Rep. 189 (1843).

The Supreme Court of the United States, after a brief encounter with the propriety of derivative actions in Dodge v. Woolsey, 59 U.S. 331, 18 How. 331, 15 L.Ed. 401 (1855), fully recognized and set out the common law requirements for derivative actions in Hawes v. Oakland, 104 U.S. 450, 14 Otto 450, 26 L.Ed. 827 (1882). With respect to the right of the shareholder to bring a derivative action, the Court observed:

That the vast and increasing proportion of the active business of modern life which is done by corporations should call into exercise the beneficent powers and flexible methods of courts of equity, is neither to be wondered at nor regretted; and this is especially true of controversies growing out of the relations between the stockholder and the corporation of which he is a member. The exercise of this power in protecting the stockholder against the frauds of the governing body of directors or trustees, and in preventing their exercise, in the name of the corporation, of powers which are outside of their charters or articles of association, has been frequent, and is most beneficial, and is undisputed.

Id. at 453, 26 L.Ed. at 829.

A derivative action brought by the shareholder against the corporation and others for wrongdoing, however, was subject to two requirements: (1) an exhaustion of intra-corporate remedies, and (2) ownership of shares in the corporation at the time of the complained-of transaction. In this regard, Justice Miller relied on the decisions of the English courts, quoting with approval MacDougall v. Gardiner, 1 Ch. D. 13 (1875):

"[N]othing connected with internal disputes between shareholders is to be made the subject of a bill by some one shareholder on behalf of himself and others, unless there be something illegal, oppressive, or fraudulent; unless there is something ultra vires on the part of the company qua company, or on the part of the majority of the company, so that they are not fit persons to determine it, but that every...

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    ... ... North Carolina, for example, after temporarily adopting Auerbach's inquiry, changed course and endorsed the Zapata approach. Compare Alford v. Shaw, 318 N.C. 289, 349 S.E.2d 41, 52, 56 (1986) (adopting Auerbach approach), with Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323, 324 (1987) ... ...
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