Zapata Corp. v. Maldonado

Supreme Court of Delaware
430 A.2d 779 (1981)

ELI5:

Rule of Law:

When an independent committee of disinterested directors moves to dismiss a stockholder derivative suit where demand on the board was excused as futile, a court must apply a two-step test. The court first inquires into the committee's independence, good faith, and the reasonableness of its investigation, with the burden on the corporation, and then, in its discretion, the court applies its own independent business judgment to determine if dismissal is in the corporation's best interests.

Facts:

William Maldonado, a stockholder of Zapata Corporation, believed that ten of its officers and directors had breached their fiduciary duties to the company.
Maldonado initiated a derivative action on behalf of Zapata without first demanding that the board of directors bring the suit, alleging that such a demand would be futile because all directors were named as defendants.
Four of the original defendant-directors later left the board, and the remaining directors appointed two new, outside directors.
The Zapata board then created an 'Independent Investigation Committee' composed solely of the two new directors.
This Committee was given the final and binding authority to investigate Maldonado's claims and determine whether the corporation should continue the litigation.
After conducting an investigation, the Committee concluded that the continued maintenance of the derivative action was 'inimical to the Company's best interests' and should be dismissed.

Procedural Posture:

William Maldonado filed a derivative action in the Delaware Court of Chancery (trial court) on behalf of Zapata Corporation against ten of its officers and directors.
Zapata formed an Independent Investigation Committee, which concluded the suit should be dismissed.
Zapata filed a motion to dismiss or for summary judgment in the Court of Chancery.
The Court of Chancery denied Zapata's motions, holding that a stockholder has an independent right to maintain a derivative action and the business judgment rule does not grant authority to dismiss it.
Zapata, as the appellant, filed an interlocutory appeal of the Court of Chancery's denial to the Supreme Court of Delaware.

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Issue:

Does a committee of independent and disinterested directors have the power under Delaware law to cause the dismissal of a stockholder's derivative lawsuit when demand on the full board of directors was properly excused as futile?

Opinions:

Majority - Quillen, Justice

Yes, an independent committee of directors has the power to move for dismissal of a derivative suit, but its decision is not granted the full deference of the business judgment rule and is instead subject to a special two-step judicial inquiry. The court rejected the lower court's finding that a stockholder has an absolute right to control a derivative suit once it is properly initiated. The court also rejected a pure business judgment rule approach, which would defer entirely to the committee's decision, due to the risk of structural bias when directors pass judgment on their peers. To balance the corporation's need to dismiss detrimental litigation against the shareholder's right to police the board, the court established a new two-step test. First, the court must review the committee's independence, good faith, and the reasonableness of its investigation, placing the burden of proof on the corporation. Second, if the first step is satisfied, the court should apply its own independent business judgment to determine whether, in the corporation's best interest, the suit should be dismissed. This approach allows judicial oversight into the substance of the committee's decision.

Analysis:

This landmark decision establishes the 'Zapata two-step' test, creating a new standard of judicial review for motions to dismiss derivative suits by special litigation committees when demand is excused. It carves out a middle ground between giving shareholders unfettered control of derivative litigation and giving boards unchecked power to terminate such suits through the business judgment rule. The second step of the test, allowing the court to substitute its own business judgment, was a significant departure from the more deferential approach used in other jurisdictions, like New York. This ruling profoundly shapes corporate governance by providing a judicial check on the potential for structural bias within corporate boards, ensuring that meritorious shareholder claims are not improperly dismissed.

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