Appeal from a judgment of the United States District Court for the Southern District of New York, Charles Haight, Judge, dismissing appellant's shareholder derivative suit after the corporation on whose behalf it was brought, by unanimous vote of its disinterested directors, rejected appellant's demand pursuant to Fed. R. Civ. P. 23.1 to bring the action itself. Affirmed.
Before Meskill and Kearse, Circuit Judges, and Metzner, District Judge.*fn*
In Burks v. Lasker, 441 U.S. 471, 480, 99 S. Ct. 1831, 1838, 60 L. Ed. 2d 404 (1979), the Supreme Court held that the authority of disinterested directors to terminate shareholder derivative litigation is governed by applicable state law, provided that such law is consistent with the policies of the federal acts upon which the action is based.*fn1 Our present task is to determine whether the district court properly dismissed appellant Ida Abramowitz's derivative suit after the corporation, by unanimous vote of its disinterested directors, declined to sue on its own behalf. We hold that the district court decision comports with Delaware law as recently set forth in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del.1981), that Delaware law does not offend relevant federal policy, and that the district court's findings are supported in the record. Accordingly, we affirm.
We assume familiarity with the underlying facts, which are discussed at length in the district court's opinion, Abramowitz v. Posner, 513 F. Supp. 120 (S.D.N.Y.1981). We repeat only those facts necessary for an understanding of the issues raised on this appeal.
At the time this action was commenced, the individual defendants were five of the seventeen directors of NVF Company (NVF), a Delaware corporation listed on the New York Stock Exchange.*fn2 These five individuals were among the defendants named by the Securities and Exchange Commission (SEC) in a civil action alleging that corporate perquisites had been abused. SEC v. Sharon Steel Corp., No. 77-1631 (D.D.C. filed September 20, 1977).*fn3 The SEC obtained a consent decree in which the defendants agreed to entry of a final judgment which granted permanent injunctive and other ancillary relief. The judgment, entered September 20, 1977, called for the Posner defendants to repay $600,000 to NVF and other companies in which they held controlling interests, and required NVF to create a three-member Audit Committee with responsibilities, set forth in part in Paragraph VIII of the judgment:
(e) to examine the matters alleged in the Commission's Complaint, and such other similar matters as each Audit Committee may deem appropriate, in order to recommend whether, in the best interests of the corporation, any action should be undertaken against any person, including the institution of any action permitted by Paragraph VI hereof, and to make recommendations with respect thereto to the Board of Directors of the respective corporations; provided that no person who is a subject of any such recommendation by an Audit Committee who serves on the Board of Directors of any such corporation shall vote upon any such recommendation; (f) within 120 days from the appointment of the Audit Committee, or such additional time as the Commission may reasonably agree, to submit to the Board of Directors and to file with the Commission in the public files of the corporation, a report or reports of its findings and recommendations pursuant to Subparagraphs (a) through (e) above, including a description of the scope of their investigation.
Two members of the Committee, James J. Needham, a former member of the SEC and a former Chairman and Chief Executive Officer of the New York Stock Exchange, and Mark A. White, Esq., a former Vice President and General Counsel of the National Association of Securities Dealers, were also appointed independent directors of NVF with the SEC's approval. The Committee's third member, Armer E. White, had been an outside director of NVF and was not a defendant in either the SEC action or the present litigation.
The Audit Committee, with the assistance of the Washington law firm of Arnold & Porter and the national accounting firms of Price Waterhouse & Co. and Arthur Anderson & Company, immediately began investigating improprieties in NVF's management.*fn4 Meanwhile, several NVF shareholders, including Abramowitz, brought separate but related suits based on substantially the same matters addressed by the SEC action.*fn5 Abramowitz based her complaint on theories of common law waste, conversion, and fraud, alleging that the defendants had damaged NVF through their abuses and misappropriations of corporate assets. The complaint also asserted that defendants had violated section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78a et seq. (1976) (the Act), and Rule 10b-5 promulgated thereunder, by making misleading disclosures in connection with transfers of stock from NVF to the defendants.
Abramowitz had never made a demand on the NVF Board pursuant to Fed.R.Civ.P. 23.1*fn6 because she felt that such an attempt would have been futile. See Elfenbein v. Gulf & Western Industries, Inc., 590 F.2d 445, 450 (2d Cir. 1978). The court below disagreed, however, dismissing the complaint for failure to satisfy Rule 23.1, but giving Abramowitz leave to replead within sixty days.
By the time Abramowitz made her demand on NVF to sue the defendants in its own name, the Audit Committee had issued its findings and recommendations. The Committee recommended that the company seek repayment from the defendants of an additional $1,021,445 over the $600,000 already received pursuant to the SEC consent decree. The Committee found, however, that further legal action was not in the company's best interests as an initial strategy and should be pursued only in the event that the defendants refused to consent to the additional reimbursement. In conclusion, the Committee stated:
the Audit Committees further believe that the corrective measures already being taken by the companies, and the policies, procedures and controls adopted by the Audit Committees, should prevent recurrence of these matters.
The Committee's findings referred to the injunctive provisions of the final judgment entered in the SEC action and recognized the profitability and substantial growth in sales achieved by NVF and related companies during the period in which the defendants served as directors. While the Committee conceded that a greater sum than $1,021,445 might be recovered through court action, it concluded that the sum recommended was both "fair and equitable." Id. at 328.
The Committee's report was unanimously accepted by the NVF board and was filed publicly with the SEC, which made no objection to the recommendations. Subsequently, full reimbursement was made in accordance with the report. On July 31, 1979, the board of NVF, including the two independent directors appointed with the approval of the SEC, unanimously rejected Abramowitz's demand for further proceedings against the defendants as not in NVF's or its shareholders' best interests. The individual defendants in this action did not vote on the matter.
On August 30, 1979, Abramowitz filed an amended complaint stating that "(n)o response to this demand has been received from the Board of Directors and accordingly the plaintiff has no recourse but to initiate this action." Amended Complaint, P 13. Shortly thereafter, Abramowitz received notice of NVF's rejection of her demand, but refused to withdraw the complaint. At that point, defendants moved to dismiss this action, arguing that "a determination by a board of directors in the exercise of its business judgment that proposed litigation is not in the corporation's best interests is conclusive and bars maintenance of a derivative action, absent a showing of bad faith not made here." 513 F. Supp. at 125. Abramowitz opposed the motion to dismiss, on the grounds that "relevant state law does not permit invocation of the business judgment rule in the manner put forward by defendants and that, even if state law gave the Board the authority to terminate a derivative action, condoning the exercise of that authority herein would be contrary to the policies underlying Section 10(b) of the Act and Rule 10b-5." Id.
District Judge Haight was forced to decide this case at a time when Delaware law was unclear on the application of the business judgment rule to termination of shareholder derivative suits. Several courts, including the Delaware Chancery, had addressed the issue of "whether (under Delaware law) the business judgment rule should be extended to permit noninterested members of the board of directors of the nominal corporation to dismiss a stockholder derivative suit brought against interested members of the board(,)" 513 F. Supp. at 125, with two courts answering in the affirmative, see Abbey v. Control Data Corp., 603 F.2d 724, 729-30 (8th Cir. 1979), cert. denied, 444 U.S. 1017, 100 S. Ct. 670, 62 L. Ed. 2d 647 (1980); Maldonado v. Flynn, 485 F. Supp. 274, 278-81 (S.D.N.Y.1980), rev'd, 671 F.2d 729 at 730 (2d Cir. Feb. 9, 1982), and ...