Opinion ID: 2034219
Heading Depth: 1
Heading Rank: 3

Heading: The Effect of Alleged Director Wrongdoing on the Directors' Authority to Select a Litigation Committee.

Text: In the absence of the special litigation committee device, it would not be possible for the business judgment rule to be invoked at the instance of a board of directors if the majority of the board are alleged to be involved in the self-dealing. United Copper Sec. Co. v. Amalgamated Copper Co., 244 U.S. 261, 264, 37 S.Ct. 509, 512, 61 L.Ed. 1119, 1122 (1917); Lewis v. Anderson, 615 F.2d 778, 764 (9th Cir.1979), cert. denied, 449 U.S. 869, 1015 S.Ct. 206, 66 L.Ed.2d 89 (1980); Nussbacher v. Chase Manhattan Bank, 444 F.Supp. 973, 977 (S.D. N.Y.1977). It is tacitly, if not expressly, conceded by the defendant corporation and the defendant directors in the present case that the board itself could not seek dismissal of the action against the majority of its own members by invoking the business judgment rule. The question which naturally arises is whether, given this circumstance, the board has the power to delegate to a committee the authority to do that which it may not do itself. The litigation committee device has alarmed many commentators, who argue the trend of the decisions toward liberality in litigation committee powers is wrong and that the powers should be more circumscribed. These writings include Block and Prussin, The Business Judgment Rule and Shareholder Derivative Actions: Via Zapata?, 37 Bus.Law. 27 (1981); Brown, Shareholder Derivative Litigation and the Special Litigation Committee, 43 U.Pitt.L.Rev. 601 (1982); Cox, Searching for the Corporation's Voice in Derivative Suit Litigation: A Critique of Zapata and the ALI Project, 1982 Duke L.J. 959; Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit?, 75 Nw.U.L.Rev. 96 (1980); Elfin, An Evaluation of a New Trend in Corporate Law: Dismissal of Derivative Suits by Minority Board Committees, 20 Am.Bus.L.J. 179 (1982); Note, A Procedural Treatment of Derivative Suit Dismissals by Minority Directors, 69 Calif.L.Rev. 885 (1981); Note, Zapata: Delaware's Judicial Business Judgment RuleA Ship Without a Rudder?, 19 Cal.W.L.Rev. 189 (1982); Note, The Business Judgment Rule in Derivative Suits Against Directors, 33 U.Fla.L.Rev. 589 (1981); Note, Special Litigation Committees: An Unwelcome Solution to Shareholders Demands, 1981 U.Ill.L.Rev. 485; Recent Development, Shareholder Derivative Suits, 8 J.Corp.L. 145 (1982). Most of the attacks which have been launched against the use of litigation committees appointed by boards of directors whose members are tainted by self-interest have not approached the problem in terms of a limitation on the board's powers of delegation. The thrust of such attacks has been directed toward the matter of the committee's independence. The central theme of these concerns has been focused on the structural bias approach, which suggests that it is unrealistic to assume that the members of independent committees are free from personal, financial or moral influences which flow from the directors who appoint them. The argument is made that this is all the more so where, as in the present federal derivative action, the members of the special committee are fellow directors. If the certified question clearly included the element of committee independence under the certified facts we would be forced to carefully scrutinize the transaction presented for the effects of structural bias on the committee. We are only asked, however, to pass on the extent of the board's powers of delegation. We believe, however, that the form in which the certified question is cast requires us to do more than determine the extent of the powers of delegation of the board of directors as an institution. It requires us to pass upon the power of the board of directors under the certified facts in this case. Within this context, any theoretical differences between lack of power on the part of the directors to appoint a litigation committee and the inability to exercise such power as a result of a self-interest disqualification appear to be a distinction of purely semantic significance. Several courts which have considered this question have concluded or at least assumed that the board of directors does possess the power to delegate to the special litigation committee the power to invoke the business judgment rule even where a majority of the board is personally interested in the litigation. Abbey, 603 F.2d at 729; Gall, 418 F.Supp. at 519-20; Zapata, 430 A.2d at 785-86. In Zapata the court reasoned that the only legal effect of the self-interest taint is to disable the board from properly exercising its authority in a manner worthy of judicial deference. The court reasoned that such circumstance does not preclude the board from delegating to an independent body the power to exercise that same authority in a manner worthy of judicial deference. As one commentator has suggested, however, this approach leaves unanswered or at least fails to analyze the question of why, if the director interest is a disqualification to participation in the decision to recommend dismissal of a derivative action, is it not also a disqualification to participation in the selection of the litigation committee empowered to make the same decision. Note, Special Litigation CommitteesAn Expanding and Potent Threat to Shareholder Derivative Suits, 2 Cardozo L.Rev. 169, 201 (1980). The American Law Institute has recently undertaken a project in this area of the law which differs somewhat from the usual restatements of the law, in that both restatements and recommendations of law are made. This format is explained in the Foreword: Where there is no judicial authority, or where the cases are unsatisfactory by modern standardseither because of their antiquity, or the absence of compelling analysis, or because today they just seem wrongresort must be had to other sources. These may include the literature on the subject, the better corporate practice in the view of those experienced in the field, not limited to lawyers, and ultimately the judgment of the Institute, aided by the Reporter and his Advisers. Where the project is not in fact restating the cases, the Institute's views should take the form of recommendations, which may include recommended statutory provisions, state or federal. Principles of Corporate Governance and Structure: Restatement and Recommendations, Foreword viii (Tent.Draft No. 1, April 1, 1982) (herein referred to as Corporate Governance). The Institute deals with problems such as those presented in the present case in section 7.03 of Corporate Governance. Section 7.03 provides that derivative actions shall be dismissed upon recommendation of a litigation committee under the conditions in section 7.03(c), but not otherwise. Section 7.03(c) requires that section 7.03(b) be substantially complied with. One of the requirements of section 7.03(b) is that the litigation committee be appointed by independent directors. Directors who are defendants in the derivative suit are ordinarily not to be considered independent directors within the Institute's definition. § 7.03(e)(iv). This limitation is qualified by a provision which states that being a defendant in the action shall not alone disqualify a director from serving on or selecting a litigation committee if the court finds that the inclusion of the director as a defendant was without merit. Id. The approach taken by the American Law Institute in its Corporate Governance guidelines does not articulate its recommendations in terms of a limitation on the board's powers of delegation. We believe, however, that by opting to make the decision of a special committee inoperative if the committee is appointed by directors who are parties to the litigation the recommendations of the Institute do imply a limitation on the powers of the board to invoke the business judgment rule within the context of the certified question in the present case. Director disqualification based on structural bias was explored in Clark v. Lomas & Nettleton Financial Corp., 625 F.2d 49, 52-54 (5th Cir.1980). There the court held that seemingly independent directors were disqualified from settling a derivative action when a majority of the board was elected by a stockholder who was a defendant in the suit. In so ruling, the court stated: Jack Booth [the principle shareholder and a defendant in the case] wielded power to strip them not only of directorates, but of officer and consulting positions as well. Nor can we ignore the possibility of structural bias in this case. Clark, 625 F.2d at 53. The issue in the present case involves the potential for structural bias of the litigation committee appointed by directors who are defendants in the action, whereas Clark involved the structural bias of directors appointed by a controlling stockholder who was a defendant. Despite this distinction we conclude that the applicable principles are similar. We believe that the potential for structural bias on the part of a litigation committee appointed by directors who are parties to derivative actions is sufficiently great and sufficiently difficult of precise proof in an individual case to require the adoption of a prophylactic rule. We conclude that we should prevent the potential for structural bias in some cases by effectively limiting the powers of such directors in all cases. In this case of first impression in this jurisdiction we hold that directors of Iowa corporations organized under chapter 491, or any other corporate enabling legislation, who are parties to a derivative action may not confer upon a special committee of the type described in the certified question the power to bind the corporation as to its conduct of the litigation. [3] We accordingly answer the certified question in the negative. This decision does not render an Iowa corporation powerless to utilize the litigation committee device when a majority of its directors are parties to the action. Under Iowa law, equity has broad powers to make appointments to enable corporate functions to be carried out. See Rowen v. LeMars Mutual Insurance Co., 230 N.W.2d 905, 916 (Iowa 1975) (court appointment of separate counsel for corporations); Hali Rest, Inc. v. Treloar, 217 N.W.2d 517, 527 (Iowa 1974) (court appointment of fiscal agent for corporation). Consistent with these decisions, we conclude that a corporation may apply to the court for appointment of a special panel to make an investigation and report on the pursuit or dismissal of a stockholder derivative action, which panel may be invested for these purposes with the powers of the board of directors. The clerk is directed to proceed in accordance with Iowa Rule of Appellate Procedure 458. CERTIFIED QUESTION ANSWERED.