Maldonado v. Flynn

• Decision Date: 18 March 1980
• Citation: 413 A.2d 1251
• Parties: William MALDONADO, Plaintiff, v. William H. FLYNN et al., Defendants.
• Court: Court of Chancery of Delaware

Page 1251

413 A.2d 1251

William MALDONADO, Plaintiff, v. William H. FLYNN et al., Defendants.

Court of Chancery of Delaware, New Castle County.

Submitted Jan. 11, 1980.

Decided March 18, 1980.

Irving Morris, and Joseph A. Rosenthal, Morris & Rosenthal, P. A., Wilmington, and Bruce E. Gerstein, and Sidney L. Garwin, Garwin & Bronzaft, New York City, for plaintiff.

Charles F. Richards, Jr., Richards, Layton & Finger, Wilmington, for individual defendants.

Robert K. Payson, Potter, Anderson & Corroon, Wilmington, for defendant Zapata Corp.

Thomas F. Curnin, Cahill Gordon & Reindel, New York City, special counsel to the Independent Investigative Committee of Zapata Corp.

HARTNETT, Vice Chancellor.

Plaintiff ("Maldonado") brought this stockholder's derivative action against Zapata Corporation ("Zapata") and individual defendants who are, or were, officers or directors of Zapata, alleging a breach of fiduciary duty by the individual defendants. Zapata now seeks, by motion, to compel the dismissal of this action as to all defendants because an ostensibly independent committee of the directors of Zapata, after this suit was commenced, concluded, in the exercise of business judgment, that the pendency of the suit was not in the best interests of Zapata. For the reasons discussed, I find that Zapata cannot compel the termination of this suit at this stage of the proceedings and the business judgment rule is irrelevant to that issue.

I

The relevant facts, construed most favorably to Maldonado, show that in 1970 Zapata's board of directors adopted a stock option plan under which certain of Zapata's officers and directors were granted options to purchase Zapata common stock at $12.15 per share. The plan provided for the exercise of the options in five separate installments, the last of which was to occur on July 14, 1974. In 1971 this plan was ratified by Zapata's stockholders. As the date for the exercise of the final options grew near, however, Zapata was planning a tender offer for 2,300,000 of its own shares. Announcement of the tender offer was expected to be made just prior to July 14, 1974, and it was predicted that the effect of the announcement would be to increase the then market price of Zapata stock from $18-$19 per share to near the tender offer price of $25 per share.

Zapata's directors, most of whom were optionees under the 1970 plan, were aware that the optionees would incur substantial additional federal income tax liability if the options were exercised after the date of the tender offer announcement and that this additional liability could be avoided if the options were exercised prior to the announcement. This was so because the amount of capital gain for federal income tax purposes to the optionees would have been an amount equal to the difference between the $12.15 option price and the price on the date of the exercise of the option: $18-$19 if the options were exercised prior to the tender offer announcement, or nearly $25 if the options were exercised immediately after the announcement.

In order to reduce the amount of federal income tax liability the optionees would incur in exercising their options, Zapata's directors accelerated the date on which the options could be exercised to July 2, 1974. On that day the optionees exercised their options and the directors requested the New York Stock Exchange to suspend trading in Zapata shares pending "an important announcement". On July 8, 1974 Zapata announced the tender offer. The market price of Zapata stock promptly arose to $24.50.

In 1975 Maldonado brought this stockholder's derivative suit on behalf of Zapata and its stockholders, alleging that the actions of the directors of Zapata in accelerating the time for the exercise of their stock options constituted a breach of the fiduciary duty owed to Zapata and its stockholders by the directors. He claimed that the acceleration of the exercise date of the options deprived Zapata of a federal tax deduction in an amount equal to that saved by the optionees because the options were exercised on July 2, 1974, when the price of Zapata stock was $18.8125, rather than on July 14, 1974, when the price of Zapata stock was at or near $24.50. Defendants deny these allegations and also assert that, in any case, any resulting tax deduction for Zapata would have been minimal or nonexistent due to operating and capital loss carrybacks which were available to the corporation for income tax purposes.

In 1979, four years after this suit was commenced, Zapata's directors formed and appointed an Independent Investigative Committee ("the Committee") composed of two outside newly appointed directors who were ostensibly independent of management. The Committee was authorized to investigate the claims asserted in this and two companion actions in the federal courts and to take any course of action it deemed appropriate in view of its findings. After an investigation, the Committee determined that this litigation and the federal litigations were contrary to Zapata's best interests and instructed counsel for Zapata to seek dismissal of all the pending suits.

Pursuant to the Committee's directive, Zapata moved for dismissal of this action or in the alternative for summary judgment in its favor. In support of its motions Zapata asserts that a disinterested Committee of directors, appointed after a stockholder's derivative suit is filed on behalf of the corporation, can compel the dismissal of the suit when, in the Committee's business judgment, it concludes that discontinuance of the action is in the best interests of the corporation. Zapata also asserts that Maldonado has the burden to rebut the alleged independence and disinterest of the Committee. Maldonado disputes the independence of the Committee and its right to terminate this litigation. He also disagrees that he has any burden to show the lack of independence or disinterest of the Committee.

II

Zapata's argument in support of its motions is based on the well settled and salutary doctrine of corporate law that the board of directors of a corporation, as the repository of the power of corporate governance, is empowered to make the business decisions of the corporation. The directors, not the stockholders, are the managers of the business affairs of the corporation. 8 Del.C. § 141(a).

When stockholders are dissatisfied with a decision of the directors with respect to the corporation, their recourse is to bring a stockholder's derivative suit (that is, an action derived from the corporation). In the suit the corporation is named as a nominal defendant and is an indispensable party, Levine v. Milton, Del.Ch., 219 A.2d 145 (1966), but does not normally exercise control over the suit. Slutzker v. Rieber, N.J.Ch., 28 A.2d 528 (1942); Solimine v. Hollander, N.J.Ch., 19 A.2d 344 (1941).

When a stockholder's derivative suit, however, challenges the propriety of a decision of the directors, the business judgment rule protects the directors from liability by a presumption that the decision is proper. Warshaw v. Calhoun, Del.Supr., 221 A.2d 487 (1966). In order to overcome this presumption and successfully assail the directors' decision, the derivative plaintiff must first show facts which, if true, would remove the directors' decision from the protection of the rule, such as self-dealing, lack of good faith, failure to exercise due care, or the like. Warshaw v. Calhoun, supra.

Zapata cites these fundamental principles of corporate law and argues that a decision to litigate a corporate right is solely within the directors' discretion and that even a decision not to continue a suit asserting the corporate right to prosecute a claim against the directors themselves, if made by disinterested directors acting in good faith and on reasonable inquiry, is protected by the business judgment rule and cannot be challenged by a stockholder. Applying its theory to the facts of the present case, Zapata argues that the Committee was independent; that the Committee's decision to seek dismissal of this action was a good faith exercise of business judgment; and that the Committee's decision is therefore binding on all of Zapata's stockholders and precludes Maldonado from further pursuing this suit.

Zapata, as will be seen, misconstrues the applicability of the business judgment rule. To ascertain why this is so, it is necessary to analyze the business judgment rule and nature of the derivative suit.

III

The business judgment rule is a defensive rule, the effect of which is to permit corporate directors to exercise their discretion in managing the corporation's business affairs in the manner they deem in the corporation's best interests in accordance with their power to govern the corporation pursuant to 8 Del.C. § 141(a). ¹

In Bodell v. General Gas & Elec. Corp., Del.Supr., 140 A. 264 (1927), the Delaware Supreme Court stated the broad outlines of business judgment rule:

If in the particular case there is nothing to show that the directors did not exercise their discretion for what they believed to be the best interest of the corporation, certainly an honest mistake of business judgment should not be reviewable by the court.

See also, Warshaw v. Calhoun, supra; Gimbel v. Signal Companies, Inc., Del.Ch., 316 A.2d 599 (1974); Chasin v. Gluck, Del.Ch., 282 A.2d 188 (1971); Getty Oil Co. v. Skelly Oil Co., Del.Ch., 255 A.2d 717 (1969), rev'd., Del.Supr., 267 A.2d 883 (1970); Davis v. Louisville Gas & Elec. Co., Del.Ch., 142 A. 654 (1928); Fletcher, Cyclopedia of Corporations, § 1039.

The rule has been variously stated by Delaware Courts, at times perhaps overbroadly. ARSHT, The Business Judgment Rule Revisited, 8 Hofstra L.Rev. Pg. --- (1980). But its character as a purely defensive rule has never been seriously challenged. The rule, however, is not of universal application, nor without exception. It does not irrevocably shield all corporate transactions. Gimbel v. Signal...