Maher v. Zapata Corp.

• Decision Date: 27 May 1980
• Docket Number: Civ. A. No. H-79-234.
• Citation: 490 F. Supp. 348
• Parties: John F. MAHER et al., Plaintiffs, v. ZAPATA CORPORATION et al., Defendants.
• Court: U.S. District Court — Southern District of Texas

490 F. Supp. 348

John F. MAHER et al., Plaintiffs, v. ZAPATA CORPORATION et al., Defendants.

Civ. A. No. H-79-234.

United States District Court, S. D. Texas, Houston Division.

May 27, 1980.

Jess Hall, Jr., Liddell, Sapp, Zivley & Brown, Houston, Tex., for plaintiffs.

Robert A. Hall, Woodard, Hall & Primm, John L. McConn, Jr., Butler, Binion, Rice, Cook & Knapp, John C. Held, Baker & Botts, Houston, Tex., for defendants.

MEMORANDUM AND ORDER:

NORMAN W. BLACK, District Judge.

Plaintiffs filed this shareholders' derivative suit pursuant to the federal securities laws, the Texas Business Corporation Act and the common law. Plaintiffs have not made demand upon Zapata or its Directors to bring this suit. Plaintiffs argue that the demand would have been futile since all of the present members of the Board (not including the special committee, infra) are defendants in the action. (Second Amended Complaint at § 34).

Allegations

Defendants have violated § 14(a) of the Securities Exchange Act of 1934 (the "Act"), (15 U.S.C. § 78n) and Rule 14a-9, 17 C.F.R. 240.14a-9 (1978) promulgated thereto through material misstatements and material omissions made in Zapata's proxy statements and materials circulated therewith dated January 27, 1977, December 27, 1977, and December 21, 1978. The material omissions herein referred to rendered the few factual statements actually made in those proxy materials false and misleading insofar as they did not adequately inform the stockholders of, among other matters, the lack of independence on the Board and the degree of domination of Zapata and the Board by Flynn and the abuse of Zapata's assets permitted thereby. (Second Amended Complaint at § 18).

Defendants have violated § 13(b)(2) of the Act as amended by the Foreign Corrupt Practices Act of 1977 (15 U.S.C. § 78m(b)(2)) in that Zapata, through its Board and management, has failed to make and keep books, records, and accounts to accurately reflect the transactions and dispositions of the assets of Zapata. (Second Amended Complaint at § 21).

Defendants have violated § 13(a) of the Act (15 U.S.C. § 78m(a)), by failing to disclose material information necessary to make required statements in its form 10-K Annual Report filed December 21, 1978, not misleading in light of the circumstances under which they were made. (Second Amended Complaint at § 25).

Defendants have violated Article 2.02 A(6) of the Texas Business Corporation Act ("T.B.C.A.") made applicable to Defendants by Article 8.02 A, T.B.C.A. by making loans to its officer—directors and officers. (Second Amended Complaint at § 28).

Defendants have breached the fiduciary duties imposed upon them by law by their failure to diligently superintend and oversee the affairs of Zapata, by their failure to exercise independent judgment, by their sacrificing the welfare of Zapata and its stockholders to the self-serving desires of Flynn and others and by their failure and refusal to set up adequate controls to prevent the waste of the assets of Zapata. (Second Amended Complaint at § 31).

Special Committee

On June 25, 1979, the Board of Directors of Zapata established a Committee, pursuant to 8 Del.C. § 141(c), to investigate the allegations made by Plaintiffs in this suit and to decide whether the action should be maintained on behalf of the corporation. The members of the Committee were F. Arnold Daum and George A. Lorenz, outside directors who are not defendants in this case. Both men were elected to the Board after the commencement of this suit.

The Board invested the Committee with unrestricted, unreviewable authority to conduct the investigation and, if advisable, to assert claims against present or former officers and directors of Zapata. The resolution establishing the Committee provided in pertinent part:

RESOLVED, that the Committee shall

(1) conduct or cause to be conducted such review, analysis and further investigation of the circumstances surrounding all matters referred to, or which may be referred to, in the action of John F. Maher and Robert L. Easton v. Zapata Corporation, et al., or any other action which is based in whole or in part upon a common nucleus of operative facts, as the Committee deems necessary or desirable to determine whether or not the Corporation shall undertake any litigation against one or more of the present or former directors or present or former officers of the Corporation or against anyone else in respect of such matters or take any other action in respect thereof;

(2) make the determination contemplated in (1) above; and

(3) undertake and supervise any action necessary or appropriate to implement any such determination.

The Committee retained the New York law firm of Cahill Gordon & Reindel to act as its Special Counsel. The law firm has allegedly not represented the corporation or any of the Defendants prior to this time.

From June 25, 1979, until September 21, 1979, the Committee conducted an investigation of the allegations made by Plaintiffs in this suit and other related matters. The Committee interviewed witnesses, reviewed the transcripts of depositions, and examined interview notes and documents.

On September 21, 1979, the Committee issued a report of its investigation in which it decided, "in the exercise of its business judgment", that the "continued maintenance of the action is inimical to the Company's best interests . . ." (Report at 23.) Specifically, the Committee reached the following conclusions:

It is our considered business judgment that further legal action by or on behalf of the Company against the present defendants or any other present or former officers or directors is not in the Company's best interest because (i) the claims asserted appear to be without merit; (ii) litigation costs would be inordinately high in view of the unlikelihood of success and would be further exacerbated by the probable right of indemnification by the defendants from the Company if the defendants are successful; (iii) the time and talents of the Company's senior management would be wasted on lengthy pretrial and trial proceedings; (iv) continuing publicity about past events could be damaging to the Company's ongoing and future business; (v) there does not appear to have been any material injury to the Company; (vi) further legal action against the present defendants (other than Messrs. Flynn, Naess or Wolcott) could significantly impair their ability to manage the Company's affairs; (vii) litigation is unnecessary as a policing action as the possibility of recurrence is slight in light of new internal controls and new top management; (viii) none of the present defendants obtained any improper personal benefit from the conduct alleged; (ix) certain of the practices alleged were a continuing business practice at the time and were intended to serve the business interests of the Company; (x) there is a serious legal question whether the New York and Texas Complaints state a cause of action under the federal securities laws and whether the Company has standing to assert such a claim; (xi) the continuation of these actions will undermine employee morale, as will any attempt to revoke options already granted and/or exercised or to call any loans currently outstanding; and (xii) the likely adverse effects on the relationship between the Company and the defendants, on the one hand, and the Company and its suppliers and customers, on the other, far outweigh any potential recovery.

(Report at 21-22) (footnote omitted). Based upon these conclusions, the Committee in the exercise of its business judgment directed counsel for Zapata to move this Court for a dismissal of this action. (Report at 22-23). Presently pending before the Court is Defendants' motion to dismiss, or, in the alternative for summary judgment, based upon the business judgment determination by the special committee.

Business Judgment Rule

It is well settled that the management of a corporation is entrusted to its board of directors, and that business judgments made by the board are not subject to review unless they are made in bad faith. The business judgment rule extends to decisions of boards of directors to pursue or abandon litigation. The principle was articulated by Mr. Justice Brandeis in United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-264, 37 S.Ct. 509, 510, 61 L.Ed. 1119 (1917):

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. . . . (emphasis added).

More recently, the Supreme Court in Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979), established a two-step inquiry: (1) Does the applicable state law (in this case, Delaware, since Zapata is a Delaware corporation—see Abbey v. Control Data Corp., 603 F.2d 724, 728 (8th Cir. 1979), cert. denied, 444 U.S. 1017, 100 S.Ct. 670, 62 L.Ed.2d 647 (1980)) permit independent directors to terminate a derivative action against other board members; and, if so, (2) whether such a state law rule is consistent with the policies of the federal securities act.

While the Delaware Supreme Court has not precisely addressed the first issue, the Court of Appeals in Abbey v. Control Data Corp., supra at 729-730, concluded, after examining Delaware law, that the law permitted a derivative action to be terminated by disinterested, independent directors. Also See Maldonado v. Flynn, United States District Court, Southern District of New York, 485 F.Supp. 274, 278 (1980).

This Court does not concur with that...