Lewis v. Anderson

• Decision Date: 29 October 1979
• Docket Number: No. 79-3021,79-3021
• Citation: 615 F.2d 778
• Parties: Fed. Sec. L. Rep. P 97,153 Harry LEWIS and Sylvia Baker, Plaintiffs-Appellants, v. William H. ANDERSON, S. Clark Beise, Shirley T. Black, Roy E. Disney, Ronald W. Miller, Richard T. Morrow, Donn B. Tatum, E. Cardon Walker, Raymond L. Watson, Walt Disney Productions, George L. Bagnall and Gordon E. Youngman, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 778

615 F.2d 778

Fed. Sec. L. Rep. P 97,153

Harry LEWIS and Sylvia Baker, Plaintiffs-Appellants, v. William H. ANDERSON, S. Clark Beise, Shirley T. Black, Roy E. Disney, Ronald W. Miller, Richard T. Morrow, Donn B Tatum, E. Cardon Walker, Raymond L. Watson, Walt Disney Productions, George L. Bagnall and Gordon E. Youngman Defendants-Appellees.

No. 79-3021.

United States Court of Appeals Ninth Circuit.

Oct. 29, 1979.

Rehearing Denied April 8, 1980.

Sidney L. Garwin, New York City, for plaintiffs-appellants.

Seth M. Hufstedler, Los Angeles, Cal., for defendants-appellees.

Appeal from the United States District Court for the Central District of California.

Before WRIGHT and GOODWIN, Circuit Judges, and SOLOMON, Senior District Judge. ^*

EUGENE A. WRIGHT, Circuit Judge:

Two minority shareholders of Walt Disney Productions appeal from partial summary judgment barring their derivative action against certain directors. The district court ruled that the board may appoint a "special litigation committee" to determine whether maintaining the action is in the corporation's best interests. So long as the committee exercises its best business judgment, its decision to dismiss the action will be honored by the courts. The court reserved for trial the question whether the committee did exercise good faith business judgment. We granted review under 28 U.S.C. § 1292(b) and Rule 5 of the Federal Rules of Appellate Procedure.

FACTS

The essential facts are not in dispute. In 1973, Walt Disney Productions (Disney) adopted a stock option plan for key employees. In November, 1974, the board-appointed "stock option committee" granted new options, allegedly more favorable to defendant directors. Appellants contend that the issuance of the new options, and management's behavior in seeking shareholder approval of the new option plan, violated federal securities laws.

This court need not decide the validity of any of these contentions, for the only issue before us is whether the special litigation committee appointed by the directors had authority to dismiss the action.

When appellants filed this action in February, 1976, Disney's board of directors delegated to a "special litigation committee" the authority to decide whether the action should be maintained. The committee consisted of two outside directors, appointed to the board after the challenged transactions, and one director who is a named defendant, but who did not benefit from the challenged transactions.

The committee met nine times, and retained independent legal counsel. It decided that it would not be in Disney's best interests to pursue the litigation. The committee's counsel moved for summary judgment on the issue of its authority to dismiss the action. The trial court granted the motion, holding that if the committee exercised its business judgment in deciding to terminate the action, that decision could not be challenged derivatively, but reserved for a court trial the factual determination of whether the committee actually made a good faith determination. We limit our review to the legal question whether a good faith determination by the committee bars any further action by a shareholder on behalf of the corporation.

DISCUSSION

In answering the question, we are aided, as the district court was not, by the recent decision in Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979). It gives added weight to the decision below.

In Burks the Court held that whether a special committee of disinterested directors may dismiss a derivative action brought against other board members, depends on the relevant state law. In that case, the derivative action charged the directors with violations of the Investment Company and Investment Advisers Acts. As in the present case, members of the board who were not involved in the alleged violations comprised a "special litigation committee" and independently decided that the action was not in the corporation's best interests.

The Supreme Court held that the role of the federal court in such a case is limited to two inquiries: whether the relevant state law allows the board to delegate power to dismiss the action to a special litigation committee, and whether such state laws are consistent with relevant federal law.

In light of Burks, we must determine (1) whether California law requires the dismissal of an action once a duly delegated committee determines that the action is not in the corporation's best interests, and (2) whether such a rule is consistent with the Securities Exchange Act of 1934. We answer both questions in the affirmative.

THE APPLICABLE LAW

Because Disney is a California corporation, California law controls. Our search for the applicable state law follows the guidelines established by the Supreme Court:

(T)he State's highest court is the best authority on its own law. If there be no decision by that court then federal authorities must apply what they find to be the state law after giving "proper regard" to relevant rulings of other courts of the State. In this respect, it may be said to be, in effect, sitting as a state court.

Commissioner of Internal Revenue v. Estate of Bosch, 387 U.S. 456, 465, 87 S.Ct. 1776, 1783, 18 L.Ed.2d 886 (1967), quoting Bernhardt v. Polygraphic Co., 350 U.S. 198, 76 S.Ct. 273, 100 L.Ed. 199 (1956).

We accord "substantial deference" to the district judge's interpretation of the law of the state in which he sits. United States v. Valley National Bank, 524 F.2d 199, 201 (9th Cir. 1975).

The California Supreme Court has never faced the issue presented here; we therefore "sit as a state court" and look for guidance from intermediate appellate courts in California, and from courts in other jurisdictions which have recently considered the question.

THE BUSINESS JUDGMENT RULE

California law has long recognized the "business judgment rule," holding that directors' decisions in the day to day management of the corporation may not be attacked by shareholders so long as the directors exercised their best "business judgment" in making those decisions. This rule applies to the courts as well:

Neither the court nor minority shareholders can substitute their judgment for that of the corporation "where its board has acted in good faith and used its best business judgment in behalf of the corporation."

Marsili v. Pacific Gas and Electric Company, 51 Cal.App.3d 313, 324, 124 Cal.Rptr. 313, 320 (1975), citing Olson v. Basin Oil Co., 136 Cal.App.2d 543, 559-60, 288 P.2d 952, 960 (1955).

The business judgment rule applies to all discretionary decisions by the board, including the decision not to pursue a cause of action:

Where a board of directors, in refusing to commence an action to redress an alleged wrong against a corporation, acts in good faith within the scope of its discretionary power and reasonably believes its refusal to commence the action is good business judgment in the best interest of the corporation, a stockholder is not authorized to interfere with such discretion by commencing the action.

Findley v. Garrett, 109 Cal.App.2d 166, 174, 240 P.2d 421, 426 (1952).

The same rule was stated by Justice Brandeis:

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; . . .

United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-4, 37 S.Ct. 509, 510, 61 L.Ed. 1119 (1917).

Appellants claim this rule does not apply when a majority of the board is charged with wrongdoing in the very action sought to be dismissed. The application of the rule to such a case would be improper. But here, the directors who are accused of wrongdoing have not decided to dismiss the case. They have appointed a committee of disinterested directors to make an independent determination of the merits of the action. Several recent cases have extended the business judgment rule to such situations.

Abbey v. Control Data Corp., 603 F.2d 724 (8th Cir. 1979), is the first federal case to decide the issue since Burks v. Lasker, supra, was decided. Following the two-step approach mandated by Burks, the Eighth Circuit held that under Delaware law the business judgment rule extends to the decision of a special litigation committee to dismiss a derivative action against board members. The court also held that this interpretation of Delaware law is consistent with federal securities laws.

Abbey is particularly helpful here, not only because it is the first post-Burks decision by a federal court of appeals, but also because the Delaware statute construed is almost identical to the California statute. ¹ Each authorizes a corporate board of directors to appoint committees to act for the board. We agree with the Eighth Circuit that the business judgment rule

applies to any reasonable, good faith determination by an autonomous board of directors that the action is not in the best interests of the corporation.

603 F.2d p. 727.

We also draw guidance from a recent decision by New York's Court of Appeals. In Auerbach v. Bennett, 47 N.Y.2d 619, 419 N.Y.S.2d 920, 393 N.E.2d 994 (1979), that court held:

(T)he substantive aspects of a decision to terminate a shareholders' derivative action against defendant corporate directors made by a committee of disinterested directors appointed by the corporation's board of directors are beyond judicial inquiry under the business judgment doctrine, . . .

47 N.Y.2d at 623, 419 N.Y.S.2d at 922, 393 N.E.2d at 996. The court appropriately noted that the fact that the independent...