Zapata Corp. v. Maldonado

• Citation: 22 A.L.R.4th 1190,430 A.2d 779
• Parties: ZAPATA CORPORATION, Defendant Below, Appellant, v. William MALDONADO, Plaintiff Below, Appellee.
• Decision Date: 31 December 1980
• Court: United States State Supreme Court of Delaware

Page 779

430 A.2d 779

22 A.L.R.4th 1190

ZAPATA CORPORATION, Defendant Below, Appellant, v. William MALDONADO, Plaintiff Below, Appellee.

Supreme Court of Delaware.

Submitted Dec. 31, 1980 ^*.

Decided May 13, 1981.

Upon appeal from the Court of Chancery. Reversed and Remanded.

Robert K. Payson, (argued) of Potter, Anderson & Corroon, Wilmington, and Thomas F. Curnin, Thomas J. Kavaler, P. Kevin Castel and Edward P. Krugman of Cahill, Gordon & Reindel, New York City, of counsel, for defendant-appellant.

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

Irving Morris and Joseph A. Rosenthal of Morris & Rosenthal, Wilmington, Sidney L. Garwin (argued), and Bruce E. Gerstein of Garwin, Bronzaft & Gerstein, New York City, of counsel, for plaintiff-appellee.

Arthur G. Connolly, Jr. of Connolly, Bove & Lodge, Wilmington, for amici curiae.

Before DUFFY, QUILLEN and HORSEY, JJ.

QUILLEN, Justice:

This is an interlocutory appeal from an order entered on April 9, 1980, by the Court of Chancery denying appellant-defendant Zapata Corporation's (Zapata) alternative motions to dismiss the complaint or for summary judgment. The issue to be addressed has reached this Court by way of a rather convoluted path.

In June, 1975, William Maldonado, a stockholder of Zapata, instituted a derivative action in the Court of Chancery on behalf of Zapata against ten officers and/or directors of Zapata, alleging, essentially, breaches of fiduciary duty. Maldonado did not first demand that the board bring this action, stating instead such demand's futility because all directors were named as defendants and allegedly participated in the acts specified. ¹ In June, 1977, Maldonado commenced an action in the United States District Court for the Southern District of New York against the same defendants, save one, alleging federal security law violations as well as the same common law claims made previously in the Court of Chancery.

By June, 1979, four of the defendant-directors were no longer on the board, and the remaining directors appointed two new outside directors to the board. The board then created an "Independent Investigation Committee" (Committee), composed solely of the two new directors, to investigate Maldonado's actions, as well as a similar derivative action then pending in Texas, and to determine whether the corporation should continue any or all of the litigation. The Committee's determination was stated to be "final, ... not ... subject to review by the Board of Directors and ... in all respects ... binding upon the Corporation."

Following an investigation, the Committee concluded, in September, 1979, that each action should "be dismissed forthwith as their continued maintenance is inimical to the Company's best interests ...." Consequently, Zapata moved for dismissal or summary judgment in the three derivative actions. On January 24, 1980, the District Court for the Southern District of New York granted Zapata's motion for summary judgment, Maldonado v. Flynn, S.D.N.Y., 485 F.Supp. 274 (1980), holding, under its interpretation of Delaware law, that the Committee had the authority, under the "business judgment" rule, to require the termination of the derivative action. Maldonado appealed that decision to the Second Circuit Court of Appeals.

On March 18, 1980, the Court of Chancery, in a reported opinion, the basis for the order of April 9, 1980, denied Zapata's motions, holding that Delaware law does not sanction this means of dismissal. More specifically, it held that the "business judgment" rule is not a grant of authority to dismiss derivative actions and that a stockholder has an individual right to maintain derivative actions in certain instances. Maldonado v. Flynn, Del.Ch., 413 A.2d 1251 (1980) (herein Maldonado). Pursuant to the provisions of Supreme Court Rule 42, Zapata filed an interlocutory appeal with this Court shortly thereafter. The appeal was accepted by this Court on June 5, 1980. On May 29, 1980, however, the Court of Chancery dismissed Maldonado's cause of action, its decision based on principles of res judicata, expressly conditioned upon the Second Circuit affirming the earlier New York District Court's decision. ² The Second Circuit appeal was ordered stayed, however, pending this Court's resolution of the appeal from the April 9th Court of Chancery order denying dismissal and summary judgment.

Thus, Zapata's observation that it sits "in a procedural gridlock" appears quite accurate, and we agree that this Court can and should attempt to resolve the particular question of Delaware law. ³ As the Vice Chancellor noted, 413 A.2d at 1257, "it is the law of the State of incorporation which determines whether the directors have this power of dismissal, Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979)". We limit our review in this interlocutory appeal to whether the Committee has the power to cause the present action to be dismissed.

We begin with an examination of the carefully considered opinion of the Vice Chancellor which states, in part, that the "business judgment" rule does not confer power "to a corporate board of directors to terminate a derivative suit", 413 A.2d at 1257. His conclusion is particularly pertinent because several federal courts, applying Delaware law, have held that the business judgment rule enables boards (or their committees) to terminate derivative suits, decisions now in conflict with the holding below. ⁴

As the term is most commonly used, and given the disposition below, we can understand the Vice Chancellor's comment that "the business judgment rule is irrelevant to the question of whether the Committee has the authority to compel the dismissal of this suit". 413 A.2d at 1257. Corporations, existing because of legislative grace, possess authority as granted by the legislature. Directors of Delaware corporations derive their managerial decision making power, which encompasses decisions whether to initiate, or refrain from entering, litigation, ⁵ from 8 Del.C. § 141 (a). ⁶ This statute is the fount of directorial powers. The "business judgment" rule is a judicial creation that presumes propriety, under certain circumstances, in a board's decision. ⁷ Viewed defensively, it does not create authority. In this sense the "business judgment" rule is not relevant in corporate decision making until after a decision is made. It is generally used as a defense to an attack on the decision's soundness. The board's managerial decision making power, however, comes from § 141(a). The judicial creation and legislative grant are related because the "business judgment" rule evolved to give recognition and deference to directors' business expertise when exercising their managerial power under § 141(a).

In the case before us, although the corporation's decision to move to dismiss or for summary judgment was, literally, a decision resulting from an exercise of the directors' (as delegated to the Committee) business judgment, the question of "business judgment", in a defensive sense, would not become relevant until and unless the decision to seek termination of the derivative lawsuit was attacked as improper. Maldonado, 413 A.2d at 1257. Accord, Abella v. Universal Leaf Tobacco Co., Inc., E.D.Va., 495 F.Supp. 713 (1980) (applying Virginia law); Maher v. Zapata Corp., S.D.Tex., 490 F.Supp. 348 (1980) (applying Delaware law). See also, Dent, supra note 5, 75 Nw.U.L.Rev. at 101-02, 135. This question was not reached by the Vice Chancellor because he determined that the stockholder had an individual right to maintain this derivative action. Maldonado, 413 A.2d at 1262.

Thus, the focus in this case is on the power to speak for the corporation as to whether the lawsuit should be continued or terminated. As we see it, this issue in the current appellate posture of this case has three aspects: the conclusions of the Court below concerning the continuing right of a stockholder to maintain a derivative action; the corporate power under Delaware law of an authorized board committee to cause dismissal of litigation instituted for the benefit of the corporation; and the role of the Court of Chancery in resolving conflicts between the stockholder and the committee.

Accordingly, we turn first to the Court of Chancery's conclusions concerning the right of a plaintiff stockholder in a derivative action. We find that its determination that a stockholder, once demand is made and refused, possesses an independent, individual right to continue a derivative suit for breaches of fiduciary duty over objection by the corporation, Maldonado, 413 A.2d at 1262-63, as an absolute rule, is erroneous. The Court of Chancery relied principally upon Sohland v. Baker, Del.Supr., 141 A 277 (1927), for this statement of the Delaware rule. Maldonado, 413 A.2d at 1260-61. Sohland is sound law. But Sohland cannot be fairly read as supporting the broad proposition which evolved in the opinion below.

In Sohland, the complaining stockholder was allowed to file the derivative action in equity after making demand and after the board refused to bring the lawsuit. But the question before us relates to the power of the corporation by motion to terminate a lawsuit properly commenced by a stockholder without prior demand. No Delaware statute or case cited to us directly determines this new question and we do not think that Sohland addresses it by implication.

The language in Sohland relied on by the Vice Chancellor negates the contention that the case stands for the broad rule of stockholder right which evolved below. This Court therein stated that "a stockholder may sue in his own name for the purpose of enforcing corporate rights ... in a proper case if the corporation on the demand of the stockholder refuses to bring suit." 141 A. at 281 (emphasis added). The Court also stated that "whether ("(t)he right of a stockholder to file a bill to litigate corporate...