Auerbach v. Bennett, 47 N.Y.2d 619 (1979)

The business judgment rule protects decisions by a special litigation committee (SLC) to terminate a derivative suit, provided the committee members are disinterested, independent, and their investigative procedures are adequate and appropriate.

Summary

A shareholder derivative action was brought against directors of General Telephone & Electronics Corporation (GTE) for alleged illegal payments. The board formed a special litigation committee (SLC) of disinterested directors to determine if pursuing the lawsuit was in the company’s best interest. The SLC concluded it was not and moved to dismiss the suit. The court addressed the extent to which the SLC’s decision was protected by the business judgment rule. The Court of Appeals held that while the substance of the SLC’s decision is protected, courts can review the SLC’s disinterestedness, independence, and the adequacy of its investigation. Finding no issues with these factors in this case, the Court reinstated the dismissal of the derivative action.

Facts

GTE’s management initiated an internal investigation into potentially questionable payments to foreign officials. The audit committee, with the assistance of outside counsel and auditors, investigated worldwide operations from 1971 to 1975. Their report revealed possible bribes and kickbacks totaling over $11 million, involving some directors. A shareholder, Auerbach, filed a derivative action against GTE’s directors and its auditor, Arthur Andersen & Co. The board then created a special litigation committee (SLC) comprised of three disinterested directors who joined the board after the transactions in question.

Procedural History

The SLC determined that pursuing the derivative action was not in the corporation’s best interest and directed dismissal. The corporation and the defendant directors moved to dismiss the complaint. The Supreme Court, Special Term, granted the motions and dismissed the complaint. When Auerbach didn’t appeal, another shareholder, Wallenstein, appealed. The Appellate Division reversed the Special Term’s order and denied the defendants’ motions for summary judgment. The Court of Appeals granted defendants’ motion for leave to appeal.

Issue(s)

1. Whether the business judgment rule bars judicial inquiry into the decision of a special litigation committee of disinterested directors to terminate a shareholder derivative action.

2. Whether the court can inquire into the disinterestedness and independence of the committee members and the appropriateness of their investigative procedures.

Holding

1. Yes, the business judgment rule generally protects the substantive decision of a special litigation committee to terminate a derivative suit because courts are ill-equipped to evaluate business judgments.

2. Yes, because the court can inquire into the disinterested independence of the committee members and the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee, but absent evidence of bad faith or fraud, the court should respect the SLC’s determinations.

Court’s Reasoning

The Court reasoned that derivative claims belong to the corporation, and the decision to pursue them lies within the board’s judgment. The business judgment rule protects directors’ decisions made in good faith and with honest judgment. The Court acknowledged that courts are not equipped to evaluate business decisions. The Court emphasized that the business judgment rule shields the decisions of the SLC only if its members are disinterested and independent. The court can examine the committee’s investigative procedures to ensure adequacy and appropriateness, but it cannot delve into the committee’s substantive evaluation or the weight given to various factors. The court stated, “Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision…and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.” The Court found no evidence to challenge the disinterestedness of the SLC members or the adequacy of their investigation, which included engaging special counsel, reviewing prior reports, interviewing directors and employees, and obtaining legal advice. The court also addressed the intervener’s argument for further discovery, finding it speculative and not a basis to postpone summary judgment. The disclosure proposed by Wallenstein would only go to particulars as to the results of the committee’s investigation and work. Therefore, the Court modified the Appellate Division’s order and reinstated the Special Term’s dismissal of the complaint.