Accordingly, "a court will defer to the decision of an SLC only if the board properly delegates its authority to act to the [SLC]. Janssen, 662 N.W.2d at 884. In other words, the SLC and its investigation must satisfy the requirements of the business judgment rule."In Minnesota, a board of directors may create a special litigation committee ?consisting of one or more independent directors or other independent persons to consider legal rights or remedies of the corporation and whether those rights and remedies should be pursued.? Minn. Stat. ? 302A.241, subd. 1. ?Committees other than special litigation committees . . . are subject at all times to the direction and control of the board.? Id. By implication, then, an SLC is not subject to a board?s direction and control.
Interestingly, the court decided to adopt the Auerbach rather than the Zapata approach to judicial review of SLCs, holding that:
Among the grounds the court advanced for doing so was the argument that:The Minnesota business judgment rule requires a reviewing court to defer to a special litigation committee?s decision to settle a shareholder derivative action if the proponent of that decision demonstrates that (1) the members of the committee possessed a disinterested independence and (2) the committee?s investigative procedures and methodologies were adequate, appropriate, and pursued in good faith.
I'm always pleased to be cited, but my view on the specific issue at bar is that Zapata makes much more sense than Auerbach. In Corporation Law and Economics (at 400-404), I explained that:... a court applying its ?business judgment? is prone to act on its own biases and predilections. Ironically, then, Zapata simply replaces the danger of bias on the part of the corporate directors and the SLC with the danger of bias on the part of the court. The business judgment rule should eliminate bias to the greatest extent possible, not simply reallocate it from one professional to another. As one commentator has observed, any danger of bias in the SLC process is likely to be corrected by natural market forces. See Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 Vand. L. Rev. 83, 122 (2004). Competition between firms provides even the most self-interested directors with a strong incentive to make good (i.e., profitable) decisions; directors who prove themselves incapable of making profitable decisions will inevitably be replaced by others who are more capable. Whereas ?[m]arket forces work an imperfect Darwinian selection on corporate decision makers, . . . no such forces constrain erring judges.? Id. As a result of the relative inability of the market to rectify a court?s erroneous business decision, ?rational shareholders will prefer the risk of director error to that of judicial error.? Id.
In contrast, check out the Minnesota court's argument that structural bias shouldn't drive the law in this area.The Zapata court correctly identified the basic issue: If the corporation can consistently defeat bona fide derivative actions through procedural devices, much of the derivative suit?s supposed utility in punishing and deterring managerial misconduct will evaporate. On the other hand, the underlying cause of action belongs to the corporation and the corporation should be able to rid itself of nonmeritorious or even harmful litigation. Subsequent decisions have recognized an even more serious concern: ?the derivative action impinges on the managerial freedom of directors.? Due regard therefore must be given ?the fundamental precept that directors manage the business and affairs of corporations.? In other words, shareholder derivative litigation presents the same tension between authority and accountability we have pervasively encountered throughout corporate law. Consequently, the question to be resolved is whether the derivative suit process deserves what the Zapata court referred to as its ?generally recognized effectiveness as an intra-corporate means of policing boards of directors.?
The significance of accountability concerns depends, at least in the first instance, on the nature of the defendant and of the claim. A board decision not to sue a supplier for breach of contract, for example, really is no different from a decision to enter into the contract in the first place. On the other hand, a board decision not to sue a fellow board member who has, for example, usurped a corporate opportunity is qualitatively different.
In supplier-type cases, accountability concerns have little traction. Consequently, it ought to be quite easy for the board to regain control over cases in which the shareholder-plaintiff sues some corporate outsider on a derivative basis. If the shareholder-plaintiff sues the board for breach of the duty of care, it likewise should be easy for the board to regain control over the litigation. If the board decided not to sue the supplier, for example, there probably was a reasonable justification for that decision. Even if there was not, the policies against judicial second-guessing of board conduct underlying the business judgment rule remain compelling. Indeed, in light of those policies, one could plausibly argue that shareholders should have no standing to bring derivative suits based on such claims.
In cases in which a director allegedly violated the duty of loyalty, however, accountability concerns seem more pressing.
? As illustrated by Zapata?s concern that SLC members will have a ?there but for the grace of God go I? empathy for the defendants, concerns about structural bias pervade the law in this area. If structural bias is the main concern, Delaware law seems to get at the problem more directly than, say, does New York. Under Delaware law, demand will be excused where a majority of the board is either interested in the transaction or otherwise failed to validly exercise business judgment. Once demand is excused, Delaware courts take a close look at the merits of allowing the litigation to go forward, while New York courts are barred from doing so.
To be sure, Delaware law in this area could stand a good tweaking. The Aronson/Zapata framework continues to rely unduly on bizarrely worded standards that often fail to grapple with the real issue. The Delaware courts would do well to adopt a simpler standard, which asks whether the board of directors is so clearly disabled by conflicted interests that its judgment cannot be trusted. If so, the shareholder should be allowed to sue. If not, the shareholder should not.