Court Opinion

ID: 9847954
Source: CourtListenerOpinion
Date Created: 2023-09-24 04:10:30.817634+00
Date Added: 2024-06-11T09:17:50.490393
License: Public Domain

*318Justice MARTIN
dissenting.
The Court today has placed the corporate fox in charge of the shareholders’ henhouse. As stated by the Supreme Court of Delaware:
At the risk of stating the obvious, the problem is relatively simple. If, on the one hand, corporations can consistently wrest bona fide derivative actions away from well-meaning derivative plaintiffs through the use of the committee mechanism, the derivative suit will lose much, if not all, of its generally-recognized effectiveness as an intracorporate means of policing boards of directors. See Dent, [The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit?], 75 Nw. U.L. Rev. at 96 & n. 3, 144 & n. 241. If, on the other hand, corporations are unable to rid themselves of meritless or harmful litigation and strike suits, the derivative action, created to benefit the corporation, will produce the opposite, unintended result. For a discussion of strike suits, see Dent, supra, 75 Nw. U.L. Rev. at 137. See also Cramer v. General Telephone & Electronics Corp., 3d Cir., 582 F. 2d 259, 275 (1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed. 2d 90 (1979). It thus appears desirable to us to find a balancing point where bona fide stockholder power to bring corporate causes of action cannot be unfairly trampled on by the board of directors, but the corporation can rid itself of detrimental litigation.
Zapata Corp. v. Maldonado, 430 A. 2d 779, 786-87 (1981). Accord, e.g., Lewis v. Fuqua, 502 A. 2d 962 (Del. Ch. 1985), appeal refused, 504 A. 2d 571 (Del. 1986). See Abella v. Universal Leaf Tobacco Co., 546 F. Supp. 795 (E.D. Va. 1982). In my opinion, the majority’s rejection of a standard acknowledging the existence of structural bias because of its concern to “serve the best interests of all segments of the corporate community in North Carolina” (slip op. at 24) does so at the expense of the bona fide rights of well-meaning stockholder-plaintiffs. What is needed instead is a fair procedure which will protect the interests of both the corporation and of shareholders who seek to protect their own economic interests by bringing suit on behalf of the corporation. It is not for this Court to “serve the best interests of all segments of the corporate community in North Carolina” —a function perhaps proper*319ly performed by the governor and General Assembly — but to ensure that conflicts among litigants are fairly adjudicated in a way favoring neither “the corporate community” nor any other association or person bringing suits before this Court.
The majority’s adoption of the Auerbach standard mirrors those opinions
characterized both by insufficient attention to the commerciaj considerations which justify the business judgment rule’s application in general business transactions and by a marked insensitivity to the threat of structural bias. Courts persuaded by Auerbach’s articulation of the limited judicial review necessary in special litigation committee cases have in effect announced a substantial presumption that the committee has acted properly, so that its recommendation can be overturned only in extreme situations.
Cox & Munsinger, Bias in the Boardroom: Psychological Foundations and Legal Implications of Corporate Cohesion, 48 Law and Contemporary Problems, Summer 1985, at 83, 115-16, 126 (1985) (footnotes omitted) [hereinafter Bias in the Boardroom]. Cf, e.g., Hasan v. CleveTrust Realty Investors, 729 F. 2d 372, 376 (6th Cir. 1984). Enlightened courts do not need blindly to defer to the “business judgment rule.” See, e.g., Smith v. Van Gorkom, 488 A. 2d 858 (Del. 1985); Note, Directors Who Approve Sale of Corporation Without Sufficient Deliberation Not Entitled to Protection Afforded by Business Judgment Rule, 16 Seton Hall L. Rev. 242 (1986).
As at least one commentator has acknowledged, North Carolina accords even minority shareholders unusually strong protection. See R. Robinson, North Carolina Corporation Law § 14-1 (1983). It is therefore appropriate to begin by observing that our legislature has mandated that a shareholder’s derivative action
shall not be discontinued, dismissed, compromised or settled without the approval of the court. If the court shall determine that the interest of the shareholders or any class or classes thereof, or of the creditors of the corporation, will be substantially affected by such discontinuance, dismissal, compromise or settlement, the court, in its discretion, may direct that notice, by publication or otherwise, shall be given to *320such shareholders or creditors whose interests it determines will be so affected. If notice is so directed to be given, the court may determine which one or more of the parties to the action shall bear the expense of giving the same, in such amount as the court shall determine and find to be reasonable in the circumstances, and the amount of such expense shall be awarded as costs of the action.
N.C.G.S. § 55-55(c) (1982).1 This statute is a clear instantiation of the public policy of our state requiring thorough judicial review of suits initiated by shareholders on behalf of a corporation: under its plain language the court is directed to determine whether the interest of any shareholder will be substantially affected by the discontinuance, dismissal, compromise, or settlement of a derivative suit. This is also in accord with Rule 23(c) of the North Carolina Rules of Civil Procedure. In order to make such an assessment the court must of necessity evaluate the adequacy of materials prepared by the corporation which support the corporation’s desire to dismiss or settle a derivative suit. To rely blindly on the report of a corporation-appointed committee which assembled such materials on behalf of the corporation — as the majority of this Court would do by adopting an Auerbach-type rule — is to abdicate the judicial duty to consider the interests of shareholders imposed by N.C.G.S. § 55-55(c). This abdication is particularly inappropriate in a case such as this one, where shareholders allege serious breaches of fiduciary duties owed to them by the directors controlling the corporation.
Since Zapata Corp. v. Maldonado, 430 A. 2d 779, was handed down in May 1981 the trend among courts which have been faced with the choice of applying an Auerbach-type rule or a Zapata-type rule clearly has been to require judicial scrutiny of the merits of the report of a special litigation committee. Compare In re General Tire & Rubber Co. Sec. Litigation, 726 F. 2d 1075 (6th Cir.), modified on other grounds, Fed. Sec. L. Rep. 5 91,468, cert. denied, 469 U.S. 858, 83 L.Ed. 2d 120 (1984); Abramowitz v. Posner, 672 F. 2d 1025 (2d Cir. 1982) (Delaware law); Joy v. North, 692 F. 2d 880, 889 (2d Cir. 1982) (Connecticut law; rejecting Auer*321bach rule because it “effectively eliminate^] the fiduciary obligations of directors and officers”), cert. denied, 460 U.S. 1051, 75 L.Ed. 2d 930 (1983); Rosengarten v. Buckley, 613 F. Supp. 1493, 1500 (D.C. Md. 1985) (applying Maryland law, the court stated that it “agrees with [the] commentators [who] have found fault with the Auerbach approach because it does not acknowledge the structural bias inherent in a system which allows directors to judge the actions of their fellow directors”); Abella v. Universal Leaf Tobacco Co., 546 F. Supp. 795 (Virginia law); Zilker v. Klein, 540 F. Supp. 1196 (N.D. Ill. 1982) (indicating in dictum that court would have followed Zapata rule had parties not settled); Miller v. Register and Tribune Syndicate, Inc., 336 N.W. 2d 709 (Iowa 1983), with Gaines v. Haughton, 645 F. 2d 761 (9th Cir. 1981) cert. denied, 454 U.S. 1145, 71 L.Ed. 2d 297 (1982) (relying on Lewis v. Anderson, 615 F. 2d 778 (9th Cir. 1979), cert. denied, 449 U.S. 869, 66 L.Ed. 2d 89 (1980), a case which, interpreting California law, noted similarity between Delaware and California statutes and followed Auerbach-type rule enunciated in pre-Zapata federal case construing Delaware law); Roberts v. Alabama Power Co., 404 So. 2d 629 (Ala. 1981). I interpret this trend away from Auerbach as indicating growing concern with the deficiencies inherent in a rule giving great deference to the decisions of a corporate committee whose institutional symbiosis with the corporation necessarily affects its ability to render a decision that fairly considers the interest of plaintiffs forced to bring suit on behalf of the corporation.
The majority’s shift of the burden of proving on summary judgment2 that an executive “committee was composed of directors who were disinterested and independent and who conducted an appropriately thorough investigation” to the defendants to a derivative action is a step in the right direction. However, the majority’s shift of this burden only when a majority of the members of the board of directors of the corporation are accused of misconduct hardly goes far enough. It would be a rare occasion that a majority of a board would be so accused. Moreover, what the majority concedes with one hand it takes away by the other by adding to this Auerbach test an unwarranted presumption. Until today, no court has ever gone so far as to add a presumption of *322good faith to the Auerbach test “[i]f . . . the independence of the directors and the reasonableness of their investigation is established.” As the United States Court of Appeals for the Sixth Circuit stated when overruling a district court order which applied such a presumption:
Neither the Auerbach approach nor the Zapata approach allows a reviewing court to extend to the members of a special litigation committee the presumption of good faith and disinterestedness. As the Auerbach court recognized, the policies of the business judgment rule do not protect from judicial scrutiny the complexion and procedures of a special litigation committee. . . . The courts . . . are particularly well-equipped to evaluate the fairness of a committee’s makeup and procedures. In Auerbach, the court concluded:
As to the methodologies and procedures best suited to the conduct of an investigation of facts and the determination of legal liability, the courts are well equipped by long and continuing experience and practice to make determinations. In fact they are better qualified in this regard than are corporate directors in general.
419 N.Y.S. 2d at 929, 393 N.E. 2d at 1003. Thus although the policies of the business judgment rule may accord to the substantive business conclusions of a special litigation committee a presumption of soundness, those policies do not accord to the committee’s members a presumption of good faith.
The delegation of corporate power to a special committee, the members of which are hand-picked by defendant-directors, in fact, carries with it inherent structural biases. In their seminal article on the status of shareholder derivative actions, Coffee and Schwartz found in the members of a special litigation committee a strong potential for bias:
A derivative action invokes a response of group loyalty, so that even a ‘maverick’ director may feel compelled to close ranks and protect his fellows from the attack of the ‘strike suiter.’ As a result, an outside director independent enough to oppose a chief executive officer with re*323spect to a proposed transaction he thinks is unfair or unwise may still be unable to tell the same officer that he thinks the suit against him has sufficient merit to proceed ... a refusal to protect one’s peers once events have transpired is seen as disloyal treachery.
Coffee & Schwartz, The Survival of The Derivative Suit: An Evaluation and a Proposal for Legislative Reform, 81 Columbia L.Rev. 261, 283 (1981).
The problems of peer pressure and group loyalty exist a fortiori where the members of a special litigation committee are not antagonistic, minority directors, but are carefully selected by the majority directors for their advice. Far from supporting a presumption of good faith, the pressures placed upon such a committee may be so great as to justify a presumption against independence. See Dent, The Power of Directors to Terminate Shareholder Litigations: The Death of The Derivative Suit, 75 Northwestern L.Rev. 96 (1981).
Hasan v. CleveTrust Realty Investors, 729 F. 2d 372, 376-77.
The threshold guarantee of the integrity of an independent litigation committee is the requirement of its independence and freedom from influence of the defendants named in the derivative suit. Permitting defendants to choose committee members would ignore the fact that colleagues of the defendants cannot be impartial in evaluating the merits of claims against those who appointed them to the committee. E.g., Joy v. North, 692 F. 2d 880, 888; Bias in the Boardroom at 91-108, 132 (analyzing factors which lead individuals selected by board of directors to conform their decision-making behavior to the board’s normative view, which view usually disfavors derivative suits). Even permitting nondefendant directors to choose members of or to participate in an allegedly independent executive committee established to evaluate a derivative suit does not purge the committee of bias. Nondefendant board members continue to be part of the cohesive, loyal, conforming ingroup which favors outcomes that will not damage their colleagues’ esteem or judgment:
The directors called upon to evaluate a derivative suit against their colleagues are not, and generally have not been, isolated from the suit’s defendants. As members of the board *324of directors they continue to interact with the defendants, who usually remain directors or officers of the corporation. Even members of a special litigation committee who were appointed after the derivative suit was initiated are legally bound under the organic requirements for committee membership to serve as directors on the full board. The new special litigation committee members and the defendant directors therefore serve as colleagues on the same corporate board in addressing an array of nonderivative suit issues. Consequently, the judges and those to be judged associate on a regular basis in discharging their many tasks as corporate directors during the preliminary derivative suit skirmishes. In doing so, they share a mutual duty to serve the corporate interest, and they often adopt a common view of that corporate interest. Analogous studies suggest that the effect of these shared experiences is not only to bond the directors and the defendants together but also to form a basis upon which the [independent] directors can be expected to give greater weight to the defendant’s values, attitudes, and perceptions than to those of outgroup members like the plaintiff. . . .
More is involved in the dynamics of intergroup discrimination in the demand or special litigation committee context than the seemingly simple categorization of the nondefendant directors as “directors,” a category which also includes the defendants. As seen earlier, individuals place great value on their selection to and membership on a corporation’s board: They are attracted to their colleagues and value greatly the associations they reap from the directorship. The relative attractiveness and rewards of board membership to the non-defendant director are important considerations in the director’s ability to be an impartial arbitrator of a colleague’s behavior.
Bias in the Boardroom at 103-04 (footnotes omitted). See also, e.g., Brudney, The Independent Director: Heavenly City or Potemkin Village?, 95 Harv. L. Rev. 597 (1982).
Because of the potential for such structural bias, it is my opinion that a rule which permits a trial court to determine that a litigation committee chosen even by nondefendant directors is in*325dependent provides less than an empty prayer for the impartiality needed to ensure the integrity of a litigation committee. Cf. Miller v. Register and Tribune Syndicate, Inc., 336 N.W. 2d 709; Zapata Corp. v. Maldonado, 430 A. 2d 779, 787 (when independent directors are called upon to participate in executive committee established to evaluate litigation, “[t]he question naturally arises whether a ‘there but for the grace of God go F empathy might not play a role”); Bias in the Boardroom at 117. A judicial inquiry into the alleged independence, good faith, and reasonable investigation of a committee established under such circumstances is fatuous at best. Cf. ALI Principles of Corporate Governance and Structure: Restatement and Recommendations § 7.03(e) (Tent. Draft No. 1, 1982).
If the use of a special committee is to be the means for corporate evaluation of whether to go forward with a derivative suit when plaintiffs have alleged malfeasance of corporate directors, the only balanced way to proceed is for parties to the suit to petition the trial court to appoint a committee whose members have no connection with either the parties to the suit or the suit itself.3 This committee, rid of the structural bias inherent in the Auerbach approach, would review the allegations of the derivative suit with input from all litigants concerning, e.g., the legal merits of the suit and its practical impact on the corporation’s business and internal management, before submitting the committee report to the court for judicial review. Because such a report will have been prepared by a committee not sharing defendants’ biases, the court would then be able to focus on the legal and factual merits of the complaint, as well as the costs and/or benefits to the corporation resulting from a decision to prosecute or not to prose*326cute the suit, instead of focusing on potentially inherent biases of the committee which would otherwise frame the court’s analysis. See Bias in the Boardroom at 132-35. Such prophylactic rules are required to prevent the potential for structural bias inherent in the use of a litigation committee whose members are chosen by corporate officials who may share the majority of this Court’s evident, but unwarranted, presumption that many if not most derivative suits are merely strike suits. Bias in the Boardroom at 89 (“directors perceive the typical derivative suit [as being an] unscrupulous strike suit. Such a view of the derivative suit can only introduce a very solid source of decision bias to the choice between the suit’s continuance and its dismissal.”). See Miller v. Register and Tribune Syndicate, Inc., 336 N.W. 2d 709.
The majority’s assessment of the adequacy of the trial court’s evaluation of the evidence before it also exposes jurisprudential weakness in the standard of analysis applied.4 After noting that the special investigative committee interviewed sixteen people, reviewed numerous documents, and submitted interrogatories to some relevant persons before preparing its report, the majority then dismissively rejects plaintiffs’ objection to defendants’ motions for partial summary judgment because instead of identifying “false” items of information relied upon by the special committee, one of plaintiffs’ affiants identified only “erroneous or questionable” information which defendants provided to the committee. The majority goes on to state:
Because Mr. Anderson’s affidavit contains a challenge to the Committee’s judgment, not to its independence or good faith, and does not suggest any available information which the Committee did not consider, it raises no question regarding issues which we have said are appropriate for determination of the ruling on the motion for summary judgment.
*327In addition to drawing an opaque epistemological distinction between “false” information and “erroneous” information, the majority’s approach omits consideration of those parts of plaintiffs’ objection which clearly expose the need for neutral judicial review of the adequacy, scope, and conclusions of the special committee’s investigation.5 Besides alleging that defendants supplied the committee with critical false pieces of information, plaintiffs objected, inter alia, that:
2. The business judgment defense sought to be raised by AAA through the Special Committee does not apply because the claims alleged in the Complaint involve multiple conflicts of interest between the defendants, particularly the Shaw Group, and AAA, and the conflicts of interest alleged in the Complaint and confirmed by the Committee Report have not been resolved.
4. The business judgment defense sought to be raised by AAA through the Special Committee does not apply because the claims alleged in the Complaint result from the obvious and prolonged failure of the defendants to exercise oversight and supervision of AAA to the egregious detriment of AAA, and this failure to exercise the oversight and supervision required by the laws of North Carolina has not been corrected.
5. The business judgment defense sought to be raised by AAA through the Special Committee does not apply because the claims alleged involved no business purpose for AAA, and the defendants who caused AAA to engage in the wrongful and unlawful acts alleged in the Complaint and confirmed by the Committee Report are still in control of the business affairs of AAA.
7. The Committee Report is not sufficiently thorough to warrant the Court’s dismissal of plaintiffs [sic] claims and approval of the proposed $250,000 settlement.
*3288. The Committee Report is not thorough because it is based upon incomplete, insufficient and misleading information, a large part of which was gathered by counsel, not the Special Committee.
9. The Committee Report is not thorough because the information is unsworn and there was no opportunity for cross-examination by the Special Committee or counsel for the plaintiffs.
10. The Committee Report could not be sustained upon a trial of plaintiffs’ claims.
11. The Shaw Group supervised or participated in the organization and structure of the Special Committee.
12. Approval of the Committee Report and the proposed $250,000 settlement would be inequitable, unfair, unreasonable, prejudicial and contrary to the best interests of AAA, AAA’s shareholders (now or formerly), AAA’s policyholders and the public of North Carolina.
By rejecting a test that would require the trial court to examine and resolve these issues, the majority’s Auerbach-type approach permits defendants to seal from judicial review serious issues affecting plaintiffs’ rights as minority shareholders under North Carolina law. Cf. Meiselman v. Meiselman, 309 N.C. 279, 307 S.E. 2d 551 (1983). At the very least plaintiffs should be permitted to develop and present evidence in the neutral forum of superior court: (1) that the committee, though perhaps disinterested and independent, may not have been qualified to assess intricate and allegedly false tax and accounting information supplied to it by those in the corporate culture who would benefit from decisions not to proceed with litigation,6 (2) that, in fact, false and/or incomplete information was supplied to the committee because of the nonadversarial way in which it gathered and evaluated information, and therefore (3) in light of these and other problems which arise from the structural bias inherent in the procedures approved by today’s majority opinion, that the *329committee’s decisions with respect to litigation eviscerate plaintiffs’ opportunities as minority shareholders to vindicate their rights under North Carolina law. Cf. Dent, The Power of Directors to Terminate Shareholder Litigations: The Death of The Derivative Suit, 75 Nw. U.L. Rev. 96 (1981). Such is especially true in cases, like this one, where serious and complex allegations of breaches of fiduciary duty by defendant-directors caused minority shareholders to have to file a derivative suit on behalf of the corporation. The courts of this state should not participate in shielding from justice the possible wrongdoing of those against whom grievances have been lodged.
It is clear from the materials submitted by plaintiffs in support of their objections to defendants’ motions for summary judgment that material issues of fact exist surrounding the adequacy of the investigation conducted by and the conclusions reached by defendants’ litigation committee. Those accused of breach of fiduciary duties owed to a corporation and its shareholders should not be permitted to close the courthouse doors to plaintiffs merely by appointing a special committee which allows them to avoid the burden of proving challenged transactions to be fair and reasonable to those to whom the fiduciary duties are owed. The public policy of this state favoring derivative actions compels the conclusion that the approach espoused by the majority of this Court and the entry by the trial court of summary judgment in favor of defendants are inappropriate. N.C.G.S. § 55-55(c).
Moreover, I note that the majority’s capitulation to the decisions of an executive committee hand chosen by the corporation whose very refusal to sue caused the plaintiff-shareholder to bring suit constitutes an unconstitutional delegation of judicial power under our state constitution. Cf. State v. Matthews, 270 N.C. 35, 153 S.E. 2d 791 (1967). Although article IV, section 1 of the North Carolina Constitution is an express limitation of legislative power, it is clear that this Court cannot by its opinions establish a court. By adopting Auerbach and establishing a presumption of good faith, the majority has in effect created a court whose decisions affecting the substantive rights of the parties are unreviewable. Such procedure also violates article I, section 18 of the North Carolina Constitution. This section guarantees access to the courts for redress of injuries. Osborn v. Leach, 135 N.C. 628, 47 S.E. 811 (1904). The majority’s Auerbach procedure im*330pairs the right of persons to have their complaints resolved by the courts of this state. See Lamb v. Wedgewood South Corp., 308 N.C. 419, 302 S.E. 2d 868 (1983). Simply put, redress by an Auerbach-type committee is not redress within the meaning of article I, section 18 of our constitution. Presumably, the legislature had this in mind when it adopted N.C.G.S. § 55-55 (c).
By this dissent I paint no stains upon the character and integrity of the Honorable Francis Marion Parker, my valued friend of long standing, nor upon Mr. Follin. It is not the actions of Judge Parker and Mr. Follin that trouble me, but the adoption of the rule itself, which will be applied in all future cases.

. Although the majority recognizes this statute in a footnote, no attempt is made to reconcile the duties imposed upon the trial court by the statute with the majority’s analysis.

. The majority’s opinion does not make clear whether this burden would also shift at trial on the merits.

. As one court stated when discussing plaintiffs allegations that corporate directors diverted a corporate opportunity to themselves:
“If [plaintiffs allegation] is true, it is difficult to imagine a more egregious breach of fiduciary duty. In the present corporate litigation climate, a stockholder’s welfare rests almost solely on the judgment and independence of his directors. Any reasonably valid claim that the directors acted because of a conflict of interest involving their own selfish economic interest should bear close scrutiny by an impartial tribunal —not a one-man committee appointed by the alleged wrong doers.”
Lewis v. Fuqua, 502 A. 2d 962, 972 (Del. ch. 1985), appeal refused, 504 A. 2d 571 (Del. 1986).

. The majority first determines that the trial court properly found that the members of the special investigative committee were sufficiently uninvolved with the affairs of defendants so as to be genuinely disinterested in and independent of defendants and their corporate affairs. Although concerns regarding structural bias would normally require careful scrutiny of the independence and disinterestedness of the committee, plaintiffs in this case do not contest the disinterested independence of the committee members and therefore neither the trial court nor, a fortiori, the appellate division, is required to address this issue.

. Similarly the majority excerpts only a few general phrases from the detailed and lengthy affidavit of plaintiffs’ affiant.

. Such is suggested by plaintiffs’ affiant in this case. Under the majority’s “disinterested and independent” standard, a professor of philosophy who knew nothing about accounting or corporate law would be acceptable as a committee member.