Joy v. North

• Decision Date: 10 August 1981
• Docket Number: Civ. No. B-77-385.
• Citation: 519 F. Supp. 1312
• Parties: Athalie Doris JOY, Plaintiff, v. Nelson L. NORTH, et al., Defendants.
• Court: U.S. District Court — District of Connecticut

519 F. Supp. 1312

Athalie Doris JOY, Plaintiff, v. Nelson L. NORTH, et al., Defendants.

Civ. No. B-77-385.

United States District Court, D. Connecticut.

August 10, 1981.

COPYRIGHT MATERIAL OMITTED

Arthur A. Hiller, A. Reynolds Gordon, Gordon & Hiller, Bridgeport, Conn., for plaintiff.

John S. Murtha, John C. Yavis, Jr., Francis J. Brady, Murtha, Cullina, Richter & Pinney, Hartford, Conn., for Conn. Financial Services Corp.

Doris B. Shiller, D. S. Maclay, Marsh, Day & Calhoun, Bridgeport, Conn., for Conn. Financial Services Corp. and Citytrust.

William S. Secor, Jr., Donald McPartland, Waterbury, Conn., James L. Ackerman, Hartford, Conn., for Kellogg and Miller.

Peter K. Leisure, Whitman & Ransom, New York City, Richard F. Lawler, Whitman & Ransom, Stamford, Conn., for Nelson North.

J. Daniel Sagarin, William B. Barnes, Harrigan, Hurwitz, Sagarin & Rutkin, Milford, Conn., Neil P. Coughlan, Day, Berry & Howard, Hartford, Conn., for P. Sagarin.

MEMORANDUM OF DECISION

EGINTON, District Judge.

This shareholder's derivative action was instituted in 1977 on behalf of Citytrust Bancorp., Inc., (then known as Connecticut Financial Services Corporation), against numerous officers and directors of Bancorp and its wholly owned subsidiary Citytrust (collectively, the "Corporations"). Plaintiff alleges that the defendants violated the National Banks Act, 12 U.S.C. § 21 et seq., and common law fiduciary duties, by authorizing and extending a series of loans for the construction of a building by the Katz Corporation.

During the pendency of the litigation, the Supreme Court held in Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979), that federal courts should as a matter of federal law, apply state law governing the authority of independent directors to discontinue derivative suits, even when the cause of action arises under a federal statute. The Supreme Court reversed the Second Circuit Court of Appeals, which had found that as a consequence of a federal statute disinterested directors did not have the power to foreclose the continuation of nonfrivolous litigation brought by shareholders against majority directors for breach of their fiduciary duties. Id. at 475, 99 S.Ct. at 1835. The Supreme Court rejected that the existence of federal question jurisdiction rendered state law irrelevant, particularly in the area of corporate law. To the contrary, the Burks decision emphasized the importance of state corporation law, "which is the font of corporate directors' powers," as distinct from federal law in this area, which is "largely regulatory and prohibitory in nature — it often limits the exercise of directorial power, but only rarely creates it." Id. at 478, 99 S.Ct. at 1837.

Based on the Burks decision, a federal court confronted with a recommendation by a disinterested panel of directors to dismiss a derivative action must as a threshold matter determine whether state law permits such a dismissal and under what circumstances. If so, the next inquiry mandated by Burks is whether the state rule is consistent with the policy of the federal statute upon which the derivative suit is based. Finally, even if state and federal law permit an independent committee to initiate a business judgment dismissal, then the federal court must assure itself of the integrity of the committee by reviewing the independence, good faith and thoroughness of the decision. If all three prongs of the Burks test have been satisfied, then the committee's recommendation will be upheld.

Immediately following the Supreme Court's decision in Burks, the Board of Directors of the Corporations in the instant case authorized the establishment of the Special Litigation Committee (hereinafter the "Committee"), to determine whether the continued prosecution of the derivative suit would serve the best interests of the Corporations. In appointing the Committee, the directors relied on Burks and its progeny, and selected two directors, Ms. Marion S. Kellogg and Mr. Ernest C. Trefz, claimed to be independent and disinterested in the derivative litigation.¹ The Committee thereafter retained the law firm of Murtha, Cullina, Richter and Pinney to assist in conducting the investigation. By resolution dated August 15, 1979, the full board delegated to the Committee the power to review, investigate and analyze the circumstances surrounding the pending derivative action. Nine months later, counsel to the Committee submitted a three-volume report, which contained the unanimous recommendation that the suit be dismissed against twenty-three designated defendants, but continued or settled as to the remaining seven defendants.²

When plaintiff failed to voluntarily withdraw the claims against the defendants in accordance with the Committee's determination, the Corporations filed motions, first to dismiss and thereafter for summary judgment. This Court repeatedly denied the motions, without prejudice and subject to renewal, to enable plaintiff to conduct limited discovery into the "good faith, motivation and thoroughness" of the Committee's investigation. At the conclusion of the stipulated discovery schedule, the Corporations renewed their motion for summary judgment on the grounds that the business judgment rule was available under state law and had been properly invoked to terminate the derivative suit. Plaintiff, in opposing the motion, contends that even if Connecticut recognizes the business judgment rule (which she vigorously disputes), the Corporations may not foreclose prosecution of claims involving alleged fraud and breach of trust. In addition to a full scale attack on the business judgment rule and the concept of a special litigation committee, plaintiff also challenges every phase of the Committee's investigation, from the procedures employed in its formation to the ultimate substantive conclusions.

I BUSINESS JUDGMENT RULE

The power of a corporation to manage daily internal affairs without interference by the courts has long been recognized. The so-called business judgment rule is based on the premise that directors of a corporation have the requisite expertise to resolve the daily business matters which form an integral part of corporate life, an expertise that cannot be matched by courts or shareholders. So long as directors render an unbiased judgment in carrying out their responsibilities, they will not be held liable for honest errors. Nor will the board's decisions be subject to review by outside interests, absent proof of bad faith or prejudice. Galef v. Alexander, 615 F.2d 51, 57 (2d Cir. 1980), citing 3A Fletcher, Cyclopedia of the Law of Private Corporations, § 1039 (perm. ed. 1975).

Since 1917, the Supreme Court has recognized the power of directors to invoke the business judgment rule to determine whether or not to enforce in the courts claims available to the corporation. In United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64, 37 S.Ct. 509, 510-11, 61 L.Ed. 1119 (1917), the Supreme Court held:

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.

This analysis by the Supreme Court dealing with the initiation of a derivative action has been not only followed but expanded. In its most recent decision involving a derivative suit, Burks v. Lasker, supra, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979), the Supreme Court noted that it is only consistent with such reasoning to extend directors' discretionary power to include decisions to terminate an ongoing derivative suit. Id. at 485, 99 S.Ct. at 1840. Whether in a given case a committee of disinterested directors may rely upon the business judgment rule to terminate a suit found to be detrimental to the interests of a corporation depends on the particular state law governing the status and scope of that rule. Id. at 480, 99 S.Ct. at 1838.

II STATE LAW

Accordingly, the Court's first inquiry under Burks relates to the status of the business judgment rule under applicable state law. In this case, where both Bancorp and Citytrust are incorporated in Connecticut, it must be determined whether Connecticut's corporation law embraces the rule, and if so, whether the scope is sufficient to encompass a decision by an independent committee to terminate a pending derivative suit. Absent any direct statutory or judicial authority for guidance, this Court finds support for the rule in sources including, but not limited to, state court opinions, state statutory scheme, specific statutory provisions, concepts of modern corporate law, and by analogy to other state law schemes.

Connecticut courts have long consistently observed the basic tenet of corporation law that the discretion to manage the daily affairs of a corporation rests with its directors. See, e. g. Osborne v. Locke Steel Chain Co., 153 Conn. 527, 218 A.2d 526 (1966). That discretion, however, is not without its limits. In the earliest Connecticut decision setting forth the doctrine, Pratt v. Pratt, Read & Co., 33 Conn. 446 (1866), the Supreme Court dealt with a request for injunctive relief brought by a group of stockholders seeking to prevent a corporation from devoting surplus funds to the erection of a new building, and to compel distribution of those funds to the stockholders. The court noted that the directors acted without malice, improper motive or fraud, and exercised sound and reasonable judgment and discretion. Id. at 451. In refusing to interfere with the directors' proposal, the court nevertheless noted...