Clark v. Lomas & Nettleton Financial Corp., 78-2973

• Decision Date: 28 August 1980
• Docket Number: No. 78-2973,78-2973
• Citation: 625 F.2d 49
• Parties: Gerald CLARK et al., Plaintiffs-Appellants, v. LOMAS & NETTLETON FINANCIAL CORPORATION et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 49

625 F.2d 49

Gerald CLARK et al., Plaintiffs-Appellants, v. LOMAS & NETTLETON FINANCIAL CORPORATION et al., Defendants-Appellees.

No. 78-2973.

United States Court of Appeals, Fifth Circuit.

Aug. 28, 1980.

Jay S. Fichtner, Douglas E. Yeager, Dallas, Tex., David Berger, Philadelphia, Pa., for plaintiffs-appellants.

Locke, Purnell, Boren, Laney & Neely, Stanley E. Neely, Stephen Philbin, Dallas, Tex., Beale Dean, Brown, Herman, Scott, Dean & Miles, Fort Worth, Tex., for Lomas & Nettleton Financial Corp., The Lomas & Nettleton Co., Lomas & Nettleton West, Inc., Jess T. Hay, Albert Rohnstedt, Dewitt T. Ray, John Sexton & James B. Gardner.

Saner, Jack, Sallinger & Nichols, Tim Kirk, Dallas, Tex., for NCS Computing Corp., now known as Booth, Inc.

Rain, Harrell, Emery & Doke, Stan McMurry, Dallas, Tex., for Guy W. Rucker, Martin T. Whitmer & Jack J. Booth.

Geary, Stahl, Koons, Rohde & Spencer, Joseph W. Geary, Gerald P. Urbach, Dallas, Tex., for Ernst & Ernst.

Jackson, Walker, Winstead, Cantwell & Miller, John Lancaster, III, Dallas, Tex., for Richard Rogers & Dan Busbee.

Appeal from the United States District Court for the Northern District of Texas.

Before SIMPSON, HILL and HATCHETT, Circuit Judges.

JAMES C. HILL, Circuit Judge:

NCS Computer Corp. (NCS), a Texas corporation, was formed in 1968 to develop and market computer software. The following year, Lomas & Nettleton Financial Corp. (LNFC) allegedly acquired "control" of NCS by inducing it to issue shares in consideration of a service contract that, it is alleged, LNFC never intended to perform. Once in "control," LNFC allegedly set about to "dismantle" NCS, installing its own slate of directors who allegedly permitted LNFC to dishonor its contract with NCS while LNFC developed internal data processing capability. By 1972, LNFC apparently was in a position to compete directly with NCS, whose active operations meanwhile had been drastically curtailed. Merger discussions began with Booth, Inc. (Old Booth), a closely held vendor of soft drink dispensers that was interested in NCS's liquid assets. In 1973, Old Booth and NCS agreed to merge in a stock/stock transaction, NCS surviving. The merger terms provided that LNFC would purchase NCS's computer related assets. The entity that was NCS took on the name Booth, Inc. (Booth), continuing the soft drink dispenser business inherited from Old Booth, and exiting altogether from the data processing field.

Within two months of the NCS-Old Booth merger, several Booth shareholders commenced the instant action. The original complaint, directed solely at pre-merger events, charged LNFC and related persons with various securities frauds, 15 U.S.C.A. §§ 78j, 78n (West 1971); 17 C.F.R. §§ 240.10b-5, 240.14a-9 (1979), and pendent state law omissions. Appellants sued both individually and derivatively on behalf of Booth. See Fed.R.Civ.P. 23.1. In respect of the derivative claims, although "demand" had not been made on them, ¹ Booth's directors evidently were content to allow appellants to proceed. The company, a nominal defendant, answered simply by stating that recovery under the derivative claims should accrue to it. Beyond that, the company apparently took no active part in the early litigation.

Following some eighteen months of discovery, and a second fruitless "demand" on Booth's directors, ² appellants sought to amend their complaint so as to attack the NCS-Old Booth merger, and specifically the sale of NCS's computer related assets to LNFC. The merger, appellants charged, resulted from proxy misstatements allegedly made by LNFC's "captive" NCS managers, and by which LNFC allegedly was enabled to obtain NCS's computer related assets at distress prices. To these new claims, all derivative in nature, Booth again answered neutrally that recovery thereunder should accrue to it. Actual pursuit continued as before through appellants' sole efforts, neither assisted nor opposed by Booth.

In 1976, appellants again sought to amend their complaint, this time to join certain Old Booth officials one of whom became and remains Booth's president and largest shareholder as aiders and abettors of LNFC. Then, three years into the litigation, appellants met their first resistance from Booth. In contrast with its response to appellants' second complaint, Booth now prayed that the district court deny leave to amend. Some months later, after amendment was permitted, Booth joined with the newly named individuals in moving to dismiss the counts against them. This motion also was denied. Appellants meanwhile continued to prepare for trial in January, 1978.

One week before trial was to begin, Booth once more entered the fray, this time to terminate all of the derivative claims by settling them. Without the presence or knowledge of appellants, Booth representatives met with the various defendants and reached an overall compromise within three days. In substance, the compromise provided that LNFC would tender to Booth all of its shares in that company; that LNFC would pay Booth $415,000 cash; and that various former NCS officials would waive indemnification claims against Booth. Booth's directors ratified the compromise, and over appellants' vigorous objections the district court "tentatively" approved it pending an evidentiary hearing on fairness and adequacy. As required by Rule 23.1, Booth shareholders were notified of the proposed settlement. None (other than plaintiffs) objected. The evidentiary hearing occurred, at which the parties argued principally over the value of appellants' chances of success on the merits and the disinterest of Booth's directors. "(A)fter a thorough review of the entire record," the district court determined both that the board was disinterested and that "the settlement amount and the terms are adequate, fair and reasonable." Clark v. Lomas & Nettleton Finance Corp., 79 F.R.D. 641, 652 (N.D.Tex.1978). This appeal followed.

As the district court apparently recognized, the threshold question is whether Booth's directors possessed authority, vel non, to determine that the corporation should compromise appellants' derivative claims. At first blush, it would seem anomalous that corporate directors could tardily and peremptorily intervene to extinguish shareholder derivative actions, over the plaintiffs' heads and despite their objections. But while the propriety of such intervention may be questioned, the power can not be. Appellants' action is "derivative" because the rights asserted belong not to them but to Booth, Inc. Corporate litigation policy whether to enforce corporate rights of action plainly constitutes part of the "business and affairs," Tex.Bus.Corp. Code § 2.31 (Vernon 1980), that corporate directors primarily manage. See Square 67 Development Corp. v. Red Oak State Bank, 559 S.W.2d 136, 138 (Tex.Civ.App.1977). ³ On this premise, which is neither extraordinary nor novel, courts have repeatedly held that corporate directors are empowered to abort putative shareholder derivative suits, when it is their business judgment that the cause ought not be enforced. See, e. g., United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64, 37 S.Ct. 509, 510, 61 L.Ed. 1119 (1917) (Brandeis, J.); Lewis v. Anderson, 615 F.2d 778, 781-82 (9th Cir. 1979); Abbey v. Control Data Corp., 603 F.2d 724, 729-30 (8th Cir. 1979), cert. denied, 444 U.S. 1017, 100 S.Ct. 670, 62 L.Ed.2d 647 (1980); Cramer v. General Telephone & Electronics Corp., 582 F.2d 259, 273-78 (3d Cir. 1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed.2d 90 (1979); Auerbach v. Bennett, 47 N.Y.2d 619, 631, 393 N.E.2d 994, 1000, 419 N.Y.S.2d 920, 927 (1979); Zauber v. Murray Savings Association, 591 S.W.2d 932, 936 (Tex.Civ.App.1979). Correlatively, corporate directors possess inherent authority to compromise such suits. See Saylor v. Lindsley, 456 F.2d 896, 899-900 (2d Cir. 1972) (Friendly, J.); Denicke v. Anglo California National Bank, 141 F.2d 285, 288 (9th Cir.), cert. denied, 323 U.S. 739, 65 S.Ct. 44, 89 L.Ed. 592 (1944).

As with other management functions, however, the power to control corporate litigation presupposes that the directors have no interest in its exercise. See Galef v. Alexander, 615 F.2d 51, 58-61 (2d Cir. 1980); Maldonado v. Flynn, 413 A.2d 1251, 1263 (Del.Ch.1980). See generally Note, The Business Judgment Rule in Derivative Suits Against Directors, 65 Cornell L.Rev. 600 (1980). We must further inquire, therefore, whether in negotiating the compromise Booth's directors stood "in a dual relation (that) prevent(ed) an unprejudiced exercise of judgment." United Copper Securities, 244 U.S. at 264, 37 S.Ct. at 510, quoted in Galef, 615 F.2d at 60. See, e. g., Ash v. International Business Machines, Inc., 353 F.2d 491, 493 (3d Cir. 1965), cert. denied, 384 U.S. 927, 86 S.Ct. 1446, 16 L.Ed.2d 531 (1966); Swanson v. Traer, 249 F.2d 854, 858-59 (7th Cir. 1957). In this connection, appellants point out that co-defendant Jack Booth one of the Old Booth officials joined in 1976 is president, a director and the largest Booth shareholder. Mr. Booth and LNFC together own a majority of Booth's outstanding shares. Booth's charter forbids cumulative voting, and it is undisputed that each and every director who ratified the compromise was elected by Jack Booth's and LNFC's combined vote. ⁴ A majority of those directors moreover, were insiders. Jack Booth and LNFC wielded power to strip them not only of directorates, but of officer and consultant positions as well. Nor can we ignore the possibility of "structural bias" in this case, see Note, supra, 65 Cornell L.Rev. at 619-22, suggested by Booth's sudden, hostile reaction to Mr. Booth's joinder.

The district court forthrightly confronted the conflicts question, but in the end did little more than state its conclusion that the new Booth board was disinterested:

The Board of Directors of Booth, Inc. that approved the settlement of the derivative action was...