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Special Litigation Committees — How Much Deference? — Minnesota Supreme Court Adopts New York’s Auerbach Standard Over Delaware’s Less Deferential Zapata Approach

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The Minnesota Supreme Court in In re UnitedHealth Group Inc. Shareholder Deriv. Litig.,2008 Minn. LEXIS 419 (Minn. S.Ct. Aug. 14, 2008), answering a certified question from the United States District Court for the District of Minnesota, adopted the highly deferential standard of Auerbach v. Bennett, 47 N.Y.2d 619, 393 N.E.2d 994, 999-1000, 419 N.Y.S.2d 920 (1979), rather than the less deferential standard of Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (Del. 1981), as the appropriate test for evaluating the reports of Special Litigation Committees set up by corporate boards to evaluate shareholder derivative litigation.

[T]he business judgment rule adopted in Auerbach requires a court to defer to the decision of an SLC if (1) the SLC is independent from the board of directors and (2) the SLC utilized appropriate investigative procedures and methodologies and pursued its investigation in good faith. A number of jurisdictions follow the Auerbach approach. See, e.g., Roberts v. Ala. Power Co., 404 So. 2d 629, 632 (Ala. 1981); Desaigoudar v. Meyercord, 108 Cal. App. 4th 173, 133 Cal.Rptr.2d 408, 418-19 (Cal. Ct. App. 2003); Hirsch v. Jones Intercable, Inc., 984 P.2d 629, 637-38 (Colo. 1999); Miller v. Bargaheiser, 70 Ohio App. 3d 702, 591 N.E.2d 1339, 1343, 8 Anderson's Ohio App. Cas. 135 (Ohio Ct. App. 1990); see also Atkins v. Hibernia Corp., 182 F.3d 320, 325 (5th Cir. 1999) (making "best Erie guess" that Louisiana courts would apply Auerbach).

***[Zapata] set forth a two-step process for reviewing the decision of an SLC.... The first step, similar to the Auerbach standard, requires evaluation of the "independence and good faith of the [SLC] and the bases supporting its conclusions." ... If the corporation demonstrates independence and good faith, then a court "may proceed, in its discretion," to the second step, in which the court "appl[ies] its own independent business judgment." .... In applying its own business judgment, a court considers "how compelling the corporate interest in dismissal is when faced with a non-frivolous lawsuit" and gives special consideration to "matters of law and public policy." ... A reviewing court may approve of the dismissal of a derivative suit "subject . . . to any equitable terms or conditions [it] finds necessary or desirable." *** A number of jurisdictions have adopted some form of the Zapata framework. See, e.g., Joy v. North, 692 F.2d 880, 891 (2d Cir. 1982) (applying Connecticut law); Abella v. Universal Leaf Tobacco Co., 546 F. Supp. 795, 799 (E.D. Va. 1982); Houle v. Low, 407 Mass. 810, 556 N.E.2d 51, 59 (Mass. 1990); Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323, 326 (N.C. 1987); House v. Estate of Edmondson, 245 S.W.3d 372, 382 (Tenn. 2008).

B. Auerbach is more compelling

***First, the New York Court of Appeals properly recognized that courts are not qualified to evaluate the business judgment of an SLC, explaining that "the business judgment doctrine, at least in part, is grounded in the prudent recognition that courts are ill equipped and infrequently called on to evaluate what are and must be essentially business judgments." ***

Second, even if courts were qualified to make business judgments, it is unclear how a court's "business judgment" should be defined for purposes of reviewing an SLC's decision. ***

Third, the very nature of a shareholder derivative suit is that the cause of action, although brought by a shareholder, belongs to the corporation. ***

Fourth, the Auerbach standard avoids the "lengthy and complicated" proceedings that characterize business judgment determinations under Zapata. ***

Fifth, allowing courts to second-guess the decision of an SLC undermines the SLC process itself, denying corporations a vital means of avoiding strike suits and other abusive derivative litigation. ***

Sixth, a court applying its "business judgment" is prone to act on its own biases and predilections. ***

Finally, the Zapata court's notion that a court may countermand the business judgment of an SLC based on "matters of . . . public policy" is indefensible.

Many thanks to my good friend, Judge George F. McGunnigle of the Hennepin County District Court, for calling my attention to this decision on the day it was rendered.

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New York Attorneys JHA handles range the gamut of complex financial and commercial litigation and arbitration, including securities, RICO, corporate and contract disputes, credit default swaps, derivatives, and class, mass, and derivative actions. The firm also represents law firms in major disputes.
New York Attorneys JHA handles range the gamut of complex financial and commercial litigation and arbitration, including securities, RICO, corporate and contract disputes, credit default swaps, derivatives, and class, mass, and derivative actions. The firm also represents law firms in major disputes.

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