Keith Paul Bishop writes:
California follows the New York approach to the review of special litigation committee decisions to terminate derivative suits:
While the substantive aspects of a decision to terminate a shareholders' derivative action against defendant corporate directors made by a committee of disinterested directors appointed by the corporation's board of directors are beyond judicial inquiry under the business judgment doctrine, the court may inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee.
Auerbach v. Bennett, 393 N.E.2d 994, 996 (1979). The California Court of Appeal adopted Auerbach in Desaigoudar v. Meyercord, 108 Cal. App. 4th 173, 188 (2003). Delaware adds a second step to Auerbach in which the court applies its own business judgment to the committee's conclusion. Zapata Corp. v. Maldonado 430 A.2d 779, 787–789 (Del. 1981).
Not quite. In addition to adding a second step, Delaware also modified the first step of Auerbach. As I explain in my book Corporate Law:
In Zapata, the Delaware supreme court specifically rejected Auerbach’s conclusion that the business judgment rule applies to a SLC’s recommendations. Instead, the court laid out a new set of procedures to be followed in such cases. After an “objective and thorough investigation,” the committee may cause the corporation to file a motion to dismiss the derivative action. The motion should include a written record of the committee’s investigation and its findings and recommendations. Each side is given a limited opportunity for discovery with respect to the court’s mandated areas of inquiry.
In deciding whether to dismiss the action, the court is to apply a two-step test: (1) The court should inquire into the independence and good faith of the committee. The court also should inquire into the bases supporting the committee’s recommendations. The corporation will have the burden of proving independence, good faith, and a reasonable investigation. (2) If the first step is satisfied, the court may but need not go on to apply its own business judgment to the issue of whether or not the case is to be dismissed.
The first step differs from Auerbach in that the Delaware court looks not only at the procedures used, but also at the reasonableness of the basis for the committee’s decision—something Auerbach expressly forbids.
