# Appendix — Citytrust v. Joy

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URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385010_0411%3A2

## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1983
- **Citation:** 460 U.S. 1051

## Text

ang r —

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APPENDIX A

UNITED STATES COURT OF APPEALS
For Tue Seconp Circuit

No. 1050 — August Term, 1981

(Argued April 23, 1982 Decided November 4, 1982)

Docket No. 81-7729

ATHALIE Doris Joy,
Plaintiff-A ppellant,

—Y=

NELSON L. Nortu, Ropert C. BALDWIN, HERMAN K.

BACH. IR. EDWARD M. BLESER, PHILIP H. BURDETTE,
CAMERON CLARK, JR. WALTER M. GopDARD, RICHARD F.
GRETSCH, WILLIAM A, Haist, IR. EDWARD E. HARRISON,
WILLIAM C. KeaTor, CHARLES T. KELLOGG, Dr. HENRY W.
LITTLEFIELD, HUBERT T. MANDEVILLE, P. DoUGLAS MAR.
TIN, HORACE MERWIN, FREDERICK R. MILLER, WILLIAM R.
Moopy, Hoyt O. Perry, IR. WILLARD E. Rosperts, PHILIP
H. SAGARIN, NORMAN ScCHAFF, IR, CHARLES E. SPENCER,
III. Ret C. Spencer, HAROLD P. SPLAIN, FRANCIS W.
Srossk. DANIEL F. WHEELER, Ropert H. WHITNEY, Co-
NECTICUT FINANCIAL SERVICES, Corp., CITYTRUST, and
HAROLD H. GRISWOLD,

Defendants,

NELSON L. Nortu, Ropert C. BALDWIN, HERMAN K.

Beach, IR, Epwarp M. BLESER, Pümur H. BURDETTE,
CAMERON CLARK, IR. WALTER M. GopDArRD, RICHARD F.
Gretscu, WILLIAM A. Haist, IR. EDWARD E. HARRISON,
WILLIAM C. KeaTtor, CHARLES T. KELLOGG, DR HENRY W.
LITTLEFIELD, HUBERT T. MANDEVILLE, P. DoUGLAS Mak.

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TIN, WILLIAM R. Moopy, Hoyt O. Perry, IR. WILLARD E.
Roperts, Piu H. SAGARIN, CHARLES E. SPENCER, III.
HAROLD P. SPLAIN, DANIEL F. WHEELER, Ropert H.
WHITNEY, CONNECTICUT FINANCIAL SERVICES, CorpP.,
Citytrust, and HAROLD H. GRISWOLD,

Defendants-A ppellees.
Before:
OAKES, CARDAMONE, and WINTER,
Circuit Judges.

Appeal from a grant of summary judgment by the
United States District Court for the District of Connecticut
(Eginton, Judge), dismissing a shareholder's derivative suit
as to certain of the defendants on the basis of the report of a
special litigation committee and a decision to impose a pro-
tective order on the contents of the special litigation com-
mittee report.

Reversed and remanded.

A. REYNOLDS GorDON, Bridgeport, Connecticut (Arthur
A. Hiller, Lucille J. Becker, Gordon & Hiller, Bridge-
port, Connecticut, of counsel), for Appellant.

FRANCIS J. BRADY. Hartford, Connecticut (John S. Mur-
tha, Murtha, Cullina, Richter and Pinney, Hartford,
Connecticut, of counsel), for Appellees Citytrust and
Citytrust Bancorp, Ine.

Rall C. Dixon, Hartford, Connecticut (James L. Acker-
man, Felix J. Springer, Day, Berry & Howard, Hart-
ford, Connecticut, of counsel), for the nineteen
individually named Appellees.

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RicHarD F. LAWLER, Stamford, Connec.icut (Whitman
& Ranson, Stamford, Connecticut, of counsel), for
Appellee North.

J. DANIEL SAGARIN, Milford, Connecticut (Harrigan, Hur-
witz, Sagarin & Rutkin, Milford, Connecticut, of coun-
sel), for Appellee Sagarin.

Davip Mac.ay, Bridgeport, Connecticut, for Appellees
Connecticut Financial Services Corporation and City-
trust.

WILLIAM Secor, Waterbury, Connecticut, for Defendants
Miller and Kellogg.

WINTER, Circuit Judge:

This is an appeal from a grant of summary judgment for
defendants by the District Court for the District of Con-
necticut, Eginton, Judge, dismissing a derivative action
against certain directors and officers of Citytrust upon a
recommendation of a special litigation committee and plac-
ing that report under seal. 519 F.Supp. 1312 (D. Conn.
1981).

We reverse.

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BACKGROUND

In October of 1977, Dr. Athalie Doris Joy brought this
shareholder’s derivative suit on behalf of Connecticut
Financial Services Corporation (now Citytrust Bancorp,
Inc.) against its wholly-owned banking subsidiary, City-
trust,! and the officers and directors of Citytrust. Both cor-
porations are incorporated in Connecticut. The complaint
alleged diversity of citizenship, common law breach of
trust and of fiduciary duty as well as violations of the
National Bank Act, 12 U.S.C. § 84 (1976), which limits
aggregate loans to a single person or entity to 10% of a
bank’s combined stockholder equity and capital. The alle-
gations concern loans made by Citytrust to the Katz Corpo-
ration (“Katz”) for construction of an office building in a
redevelopment area of Norwalk, Connecticut. Plaintiff
seeks a $6 million recovery plus interest and attorney’s fees.

The underlying transactions need only be briefly sum-
marized at this point. In 1967, Citytrust entered into a 20-
year term lease agreement for approximately 9% of an
office building which Katz was planning to build in Nor-
walk. Katz, then a respected developer, signed a $4 million
construction mortgage for a one-and-a-half year term on
January 12, 1971. Although the mortgage was written
through and recorded in the name of Citytrust, Chase Man-
hattan Bank provided the bulk of the financing, $3.5 mil-
lion, with Citytrust participating to the extent of $500,000.
At this time, Katz had already borrowed, largely in unse-
cured form, an additional $250,000 from Citytrust to
finance construction of the office building. As the building
neared completion in early 1972, Katz had drawn down the
full value of the $4 million mortgage. At its expiration in
June, 1972, the Chase mortgage was replaced by a $4.5
million mortgage by First National City Bank, with
Citytrust both issuing the mortgage and participating to

1. Citytrust became a federal bank on June 30, 1971. It became a
state bank again on January 1, 1977.

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the extent of $90,000. Meanwhile, Katz continued to receive
unsecured loans from Citytrust. By December, 1972, that
unsecured debt reached $900,000, for a total of $990,000 in
Citytrust loans related to the building.

In June, 1973, with the building only half rented, the
First National City mortgage was extended for a year.
Katz’s unsecured debt to Citytrust had by now climbed to
$1,840,000. In November, in conjunction with the issuance
of yet another loan to Katz, Citytrust obtained a blanket
second mortgage on the building and on other Katz proper-
ties to secure what was now a total loan balance of
$2,140,000. Shortly thereafter, the First National City
mortgage was extended to August, 1975, and Citytrust lent
Katz another $300,000. Just prior to this extension of credit,
the National Bank Examiners classified the Katz loans.

In April, 1975, a refinancing plan was completed with
Lincoln National Life Insurance Company providing a $6
million loan to a Katz-related partnership which had taken
title to the building. The loan was secured by a first mort-
gage on the building and was used to consolidate Katz’s
debt. As a condition of the new financing, Citytrust was
required to take a 30-year master lease on the still largely
unrented building at a rental equaling the mortgage pay-
ments to Lincoln National, in effect guaranteeing Katz’s $6
million obligation to Lincoln. In addition to undertaking
the master lease, Citytrust had by now extended $2,665,000
in loans to Katz.

In May, 1975, the National Bank Examiners classified $2
million of the Katz loans as doubtful and required a charge
off of $665,000. On August 18, 1976, in an apparent effort to
salvage what was left of its position, Citytrust’s Board of
Directors authorized loans which exceeded the 10% federal
statutory limit. After these loans were consummated,
Katz’s total indebtedness to Citytrust reached $3,545,000.
On October 20, 1976, Citytrust charged off the $2 million
remaining on the second mortgage.

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On June 13, 1977, the Katz-related partnership relin-
quished title to the building to Citytrust in exchange for a
release from its obligation to Lincoln National and a release
of personal guarantees previously assumed by members of
the Katz family. Citytrust thus directly assumed the $6
million Lincoln National mortgage. In October, 1977,
Second Nutmeg Financial purchased the building for
$9,600,000 which consisted of its assumption of the $6 mil-
lion Lincoln National mortgage and a $3,600,000 note to
Citytrust secured by a second mortgage. There is an indica-
tion in the District Court record that an affiliate of Second
Nutmeg which later acquired the building has defaulted
and Citytrust once again owns it, along with the concurrent
obligations. There is no indication that rental income is now
adequate to meet those obligations, and we appear free to
assume that the other Katz properties covered by the
second mortgage are not of any significant value.

In October, 1977, Joy commenced this action after mak-
ing an unsuccessful demand on the Directors of Citytrust.
During the pendency of this case, the Supreme Court
decided Burks v. Lasker, 441 U.S. 741 (1979), holding that
federal courts must apply state law in determining the
authority of a committee of independent directors to discon-
tinue derivative suits even in many cases which arise under
federal law. Immediately following the Burks decision, the
Board of Directors of Citytrust and Connecticut Financial
Services Corporation authorized the establishment of a
Special Litigation Committee to determine whether con-
tinued prosecution of this derivative action would be in the
best interests of the corporation. The Committee consisted
of two Board members, Marion S. Kellogg and Ernest C.
Trefz.2 Kellogg was elected to the Board of Directors on

2. Alexander L. Stott was also named to the Committee. However, he
resigned on March 3, 1980.

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July 21, 1976 and commenced service on September 15,
1976. Trefz was elected to the Board on December 15, 1976
and commenced service on January 3, 1977. Neither is a
defendant in this action.*

By resolution dated August 15, 1979, the full Board of
Directors, a majority of whom were defendants, voted to
delegate to the Committee the power to review, investi-
gate and analyze the circumstances surrounding the
pending derivative action. The Committee retained inde-
pendent counsei, John Murtha, Esquire, to assist its
investigation.

Nine months later, the Committee issued a Report
recommending that the suit be discontinued as to 23
defendants, 20 of whom were outside directors of either
Citytrust or Connecticut Financial Services and three of
whom were either officers or directors or both. (The 23
will hereafter be referred to as the “outside defendants”).
The Committee concluded there was “no reasonable possi-
bility” that the outside defendants would be found liable.
Its Report also recommended that settlement be
considered with regard to seven defendants who were the
senior officers most directly involved in the Katz loans.
(These seven will hereafter be referred to as the “inside
defendants”). As to them, the Committee found there was
a “possibility” that one or more might be found to have
been negligent. Counsel for the Committee made it clear
to the District Court, however, that the decision to pursue
settlement was not necessarily a decision to press the lit-
igation against the inside defendants. If settlement is not
reached, the Committee will reconsider whether to recom-
mend termination of that portion of the action also.

3. Trefz and Kellogg did, however, vote to refuse plaintiff's demand
that the corporation bring suit against those involved in the Katz
transaction.

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When plaintiff declined to withdraw the action as to the
outside defendants, the corporation filed a motion to dis-
miss the case as to them. The District Court permitted
discovery on the limited issue of the Committee’s “bona
fides, motivation and thoroughness.” 519 F.Supp. at 1315.
Portions of the Committee Report, consisting of a sum-
mary and a detailed presentation of the Committee’s fac-
tual findings, supplemented by expert opinion letters and
counsel’s memorandum of law, were produced. These doc-
uments were put under seal pursuant to a protective
order. Plaintiff was also allowed to depose a variety of
persons involved in the underlying transactions and in
preparation of the Report, to pose interrogatories to oth-
ers, and to see various documents relating to the Report.

After discovery, Judge Eginton granted the defendants’
motion for summary judgment, the protective order
remaining in force. Concluding that no dispositive
Connecticut case or statute exists, Judge Eginton referred
to the weight of authority in cases reported elsewhere. He
held that Connecticut law permits the use of a Burks com-
mittee and that the business judgment rule limits judicial
scrutiny of its recommendations to the good faith, inde-
pendence and thoroughness of the Committee. 519 F. Supp.
at 1325. He resolved these issues favorably to the Commit-
tee and, therefore, entered summary judgment in favor of
the 23 outside defendants. Plaintiff appeals from the rul-
ing. We reverse as to both the grant of summary judgment
and the sealing of the Committee report.‘

4. The notice of appeal does not mention the protective order sealing
the Report although appellant has challenged it in her brief. Since
documents filed in this Court are being kept under seal pursuant to the
order, our power to vacate it is clear.

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DISCUSSION

The grounds of liability asserted are common law claims
of negligence and breach of fiduciary duty, as well as viola-
tion of the National Bank Act. We agree with Judge Egin-
ton for the reasons stated in his opinion that the Special
Litigation Committee may seek dismissal of both the state
common law and federal claims if Connecticut law autho-
rizes it to do so. 519 F. Supp. at 1318-22; Burks, supra. We
also agree with him that the Connecticut statutory and case
law cited by the parties is not dispositive. Our task, there-
fore, is to predict what the Connecticut Supreme Court
would do in a case such as the one before us.

Appellees assert that, since a board of directors can dele-
gate all its powers to a committee, Conn. Gen. Stat. Ann.
§ 33-318(a) (West 1982), a special litigation committee of
independent directors can decide whether a derivative
action should be dismissed or continued. They further
argue that, when an appropriate motion is made, courts
must defer to the committee’s recommendation under the
so-called business judgment rule, even though the delega-
tion of power is made by directors who are defendants in
the action. Judge Eginton adopted that position and limited
his inquiry to the Committee’s good faith, independence
and thoroughness. Appellees also assert that the Committee
Report in question may be kept under seal, any public use
being in violation of the District Court’s order. Appellant
claims an absolute right to maintain a derivative action
once begun and challenges the protective order on constitu-
tional and non-constitutional grounds.

An examination of these claims requires a discussion of
some underlying principles of corporate law. Our opinion
first addresses the nature and function of the business judg-
ment rule, which played a large role in persuading the
District Court to dismiss this action. It turns then to the
legal oddity known as the derivative action, thought by
many to be an endangered species as a consequence of the

A-10

evolution of special litigation committees. See Comment,
Special Litigation Committees — An Expanding and Potent
Threat to Shareholder Derivative Suits, 2 Cardozo L. Rev.
169 (1980); Note, The Business Judgment Rule in Derivative
Suits Against Directors, 65 Cornell L. Rev. 600 (1980);
Dent, The Power of Directors to Terminate Shareholder Lit-
igation: The Death of the Derivative Suit, 75 Northwestern
L. Rev. 96 (1980). Finally, it discusses the general princi-
ples applicable to attempts by special litigation committees
to terminate particular derivative actions, and their rele-
vance to the present case.

A. The Liability of Corporate Directors and Officers and
the Business Judgment Rule

While it is often stated that corporate dii eetors and offi-
cers will be liable for negligence in carrying out their cor-
porate duties, all seem agreed that such a statement is
misleading. See generally, Lattin, Corporations, 272-75
(1971). Whereas an automobile driver who makes a mistake
in judgment as to speed or distance injuring a pedestrian
will likely be called upon to respond in damages, a corpo-
rate officer who makes a mistake in judgment as to eco-
nomic conditions, consumer tastes or production line
efficiency will rarely, if ever, be found liable for damages
suffered by the corporation. See generally, Symposium,
Officers’ and Directors’ Responsibilities and Liabilities, 27
Bus. Lawyer 1 (1971); Fever, Personal Liabilities of Corpo-
rate Officers and Directors, 28-42 (2d ed. 1974). Whatever
the terminology, the fact is that liability is rarely imposed
upon corporate directors or officers simply for bad judg-
ment and this reluctance to impose liability for unsuccess-
ful business decisions has been doctrinally labelled the
business judgment rule. Although the rule has suffered
under academic criticism, see, e.g., Cary, Standards of Con-
duct Under Common Law, Present Day Statutes and the
Model Act, 27 Bus. Lawyer 61 (1972), it is not without
rational basis.

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First, shareholders to a very real degree voluntarily
undertake the risk of bad business judgment. Investors
need not buy stock, for investment markets offer an array
of opportunities less vulnerable to mistakes in judgment by
corporate officers. Nor need investors buy stock in particu-
lar corporations. In the exercise of what is genuinely a free
choice, the quality of a firm’s management is often decisive
and information is available from professional advisors.
Since shareholders can and do select among investments
partly on the basis of management, the business judgment
rule merely recognizes a certain voluntariness in undertak-
ing the risk of bad business decisions.

Second, courts recognize that after-the-fact litigation is a
most imperfect device to evaluate corporate business deci-
sions. The circumstances surrounding a corporate decision
are not easily reconstructed in a courtroom years later,
since business imperatives often call for quick decisions,
inevitably based on less than perfect information. The
entrepreneur’s function is to encounter risks and to con-
front uncertainty, and a reasoned decision at the time made
may seem a wild hunch viewed years later against a back-
ground of perfect knowledge.

Third, because potential profit often corresponds to the
potential risk, it is very much in the interest of shareholders
that the law not create incentives for overly cautious corpo-
rate decisions. Some opportunities offer great profits at the
risk of very substantial losses, while the alternatives offer
less risk of loss but also less potential profit. Shareholders
can reduce the volatility’ of risk by diversifying their hold-
ings. In the case of the diversified shareholder, the seem-
ingly more risky alternatives may well be the best choice
since great losses in some stocks will over time be offset by

5. For purposs of this opinion, “volatility” is “the degree of dispersion
or variation of possible outcomes.” Klein, Business Organization and
Finance 147 (1980).

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even greater gains in others.“ Given mutual funds and sim-
ilar forms of diversified investment, courts need not bend
over backwards to give special protection to shareholders
who refuse to reduce the volatility of risk by not diversify-
ing. A rule which penalizes the choice of seemingly riskier
alternatives thus may not be in the interest of shareholders
generally.

6. Consider the choice between two investments in an example
adapted from Klein, Business Organization and Finance 147-49
(1980):

INVESTMENT A

Estimated Outcome
Probability Profit or
of Outcome Loss Value
A +15 6.0
A +1 A
_2 -13 20
1.0 3.8
INVESTMENT B
Estimated Outcome
Probability Profit or
of Outcome Loss Value
A +6 2.4
4 +2 8
4 4 st
1.0 3.4

Although A is clearly “worth” more than B, it is riskier because it is
more volatile. Diversification lessens the volatility by allowing inves-
tors to invest in 20 or 200 A's which will tend to guarantee a total result
near the value. Shareholders are thus better off with the various firms
selecting A over B, although after the fact they will complain in each
case of the 2.6 loss. If the courts did not abide by the business judgment
rule, they might well penalize the choice of A in each such case and
thereby unknowingly injure shareholders generally by creating incen-
tives for management always to choose B.

A-13

Whatever its merit, however, the business judgment rule
extends only as far as the reasons which justify its exis-
tence. Thus, it does not apply in cases, e.g., in which the
corporate decision lacks a business purpose, see Singer v.
Magnavox, 380 A.2d 969 (Del. Supr. 1977), is tainted by a
conflict of interest, Globe Woolen v. Utica Gas & Electric
Co., 224 N.Y. 483, 121 N.E. 378 (1918), is so egregious as to
amount to a no-win decision, Litwin v. Allen, 25 N.Y.S.2d
667 (N.Y. Co. Sup. Ct. 1940), or result from an obvious and
prolonged failure to exercise oversight or supervision,
McDonnell v. American Leduc Petroleums, Lid., 491 F.2d
380 (2d Cir. 1974); Atherton v. Anderson, 99 F. 2d 883 (6th
Cir. 1938). Other examples may occur.

B. Shareholder Derivative Actions

Whereas ordinary lenders may and will sue directly to
enforce their rights and debentureholders look to indenture
trustees to enforce obligations to them, direct actions by
individual shareholders for injuries to the value of their
investment would be an inefficient and wasteful method of
enforcing management obligations. The stake of each
shareholder in the likely return is usually too small to jus-
tify bringing a lawsuit and a multiplicity of such actions
would result in corporate and judicial waste. Moreover, the
costs of organizing a large number of geographically
diverse shareholders to bring an action are usually prohibi-
tively high. If an alternative remedy were not available,
therefore, the fiduciary obligations of corporate manage-
ment, however limited, might well be unenforceable.
Moreover, state or federal law may impose other duties
upon directors and officers which are designed to protect
shareholders through procedural or other requirements,
e.g. proxy rules. Enforcement of such obligations by share-
holders, even where monetary recovery by the corporation
is doubtful, may be desirable. J.J. Case Co. v. Borak, 377
U.S. 426 (1964); Mills v. Electric Auto-Lite, 396 U.S. 375
(1970).

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The derivative action is the common law’s inventive solu-
tion to the problem of actions to protect shareholder inter-
ests. In its classic form, a derivative suit involves two
actions brought by an individual shareholder: (i) an action
against the corporation for failing to bring a specified suit
and (ii) an action on behalf of the corporation for harm to it
identical to the one which the corporation failed to bring.
See Ross u. Bernhard, 397 U.S. 531 (1970). The technical
structure of the derivative suit is thus quite unusual.
Moreover, the shareholder plaintiffs are quite often little
more than a formality for purposes of the caption rather
than parties with real interest in the outcome. Since any
judgment runs to the corporation, shareholder plaintiffs at
best realize an appreciation in the value of their shares. The
real incentive to bring derivative actions is usually not the
hope of return to the corporation but the hope of handsome
fees to be recovered by plaintiffs’ counsel. As two leading
commentators state:

[The derivative action constitutes a major bulwark
against managerial self-dealing. As a practical matter
this means that the rules governing plaintiffs’ legal fees
are critical to the =} of the corporate system:
Since very few shareholders would pay an attorney’s fee
out of their own pocket to finance a suit that is brought
on the corporation’s behalf and normally holds only a
slight and indirect benefit for the plaintiff, very few
derivative actions would be brought if the law did not
allow the plaintiff's attorney to be compensated by a
contingent fee payable out of the corporate recovery.

Cary and Eisenberg, Corporations 938 (5th ed. 1980).
However, there is a danger in authorizing lawyers to
bring actions on behalf of unconsulted groups. Derivative
suits may be brought for their nuisance value, the threat of
protracted discovery and litigation forcing settlement and
payment of fees even where the underlying suit has modest
merit. Such suits may be harmful to shareholders because
the costs offset the recovery. Thus, a continuing debate sur-
rounding derivative actions has been over restricting their

A-15

use to situations where the corporation has a reasonable
chance for benefit.

C. Termination of Derivative Suits Special Litigation
Committees

In the normal course of events a decision whether to
bring a lawsuit is a corporate economic decision subject to
the business judgment rule. United Copper Securities Co. v.
Amalgamated Copper Co., 244 U.S. 261 (1917). Thus, share-
holders upset at a corporate failure to bring actions for, say,
non-payment of a debt for goods sold and delivered, may
not initiate a derivative suit without first making a demand
upon the directors to bring the action. Where the directors
refuse, and the derivative action challenges that refusal,
courts apply the business judgment rule to the action of the
directors. In a demand-required case, therefore, the direc-
tors’ decision will be conclusive unless bad faith is proven.

Different rules apply, however, in the cases which prim-
arily concern us here. When there is a conflict of interest in
the directors’ decision not to sue because the directors them-
selves have profited from the transaction underlying the
litigation or are named defendants, no demand need be
made and shareholders can proceed directly with a deriva-
tive suit. Note, Demand on Directors and Shareholders as a
Prerequisite to a Derivative Suit, 73 Harv. L. Rev. 746, 753-
56 (1960). It is in demand-not-required cases that the spe-
cial litigation committee plays its role.

Appellees argue that, because special litigation commit-
tees are composed of “independent” directors—usually
newly-elected directors who are not defendants—courts
should treat their recommendations as the equivalent of a
board refusal to bring an action in demand-not-required
cases. If that proposition were accepted, the business judg-
ment rule would apply in full force to the recommendation,
and judicial scrutiny would be limited to the good faith,
independence and thoroughness of the committee, as it is in

A-16

the case of everyday business decisions. Appellant argues,
on the other hand, that such committees are transparent
devices enabling implicated directors to avoid liability and
that derivative actions in demand-not-required cases are
immune from termination whatever the recommendation
of special litigation committees. We disagree with both
parties.

We believe Connecticut would not adopt appellees’ con-
tention that the business judgment rule should play a major
role where a special litigation committee recommends ter-
mination of an action in a demand-not-required case, such
as the one before us.’ As a practical matter, new board
members are selected by incumbents. The reality is, there-
fore, that special litigation committees are appointed by the
defendants to that litigation. It is not cynical to expect that
such committees will tend to view derivative actions
against the other directors with skepticism. Indeed, if the
involved directors expected any result other than a recom-
mendation of termination at least as to them, they would
probably never establish the committee.“ The conflict of
interest which renders the business judgment rule inappli-
cable in the case of directors who are defendants is hardly
eliminated by the creation of a special litigation committee.

7. Demand was made in the present case but was not required as a
condition of bringing the action.

8. We do not regard the Committee's failure to recommend dismissal
as to the seven inside defendants as affecting this conclusion. First, most
of the seven appear to have severed their relationship with Citytrust.
Second, the Committee will reconsider their recommendation if settle-
ment efforts fail. Finally, the facts here are such that the Committee
might reasonably have feared that such a recommendation at this stage
would have destroyed its credibility.

A-17

It is here that we part company with Judge Cardamone.
While he recognizes that the business judgment rule has
never applied to corporate decisions tainted by a conflict of
interest, he argues that the conflict in the defendants’ crea-
tion of a committee to determine whether this action should
be terminated is wholly cured by a judicial finding that the
committee acted independently and in good faith. This view
is a major departure from the traditional scrutiny courts
have given to the underlying fairness of corporate decisions
which benefit directors. Lattin, Corporations at 293; see
also Ferris v. Polycast Technology Corp., 180 Conr.. 199,
208-09, 429 A.2d 850, 854 (1980) and cases cited therein. To
be sure, Judge Cardamone is correct in anticipating diffi-
culties in judicial review of the recommendations of special
litigation committees. These difficulties are not new, how-
ever, but have confronted every court which has scrutin-
ized the fairness of corporate transactions involving a
conflict of interest.

Moreover, the difficulties courts face in evaluation of bus-
iness decisions are considerably less in the case of recom-
mendations of special litigation committees. The relevant
decision—whether to continue litigation—is at hand and
the danger of deceptive hindsight simply does not exist.
Moreover, it can hardly be argued that terminating a law-
suit is an area in which courts have no special aptitude.
Citytrust’s Special Litigation Committee concluded that
there was “no reasonable possibility” that 23 outside defen-
dants would be held liable. A court is not ill-equipped to
review the merits of that conclusion. Even when the Com-
mittee recommendation arises from the fear of further
damage to the corporation, for example, the distraction of
key personnel, the cost of complying with discovery, and
the possible indemnification of defendants out of the corpo-
rate treasury, courts are not on unfamiliar terrain. The
rule we predict Connecticut would establish emphasizes
matters such as probable liability and extent of recovery.

A-18

For these reasons we hold that the wide discretion afforded
directors under the business judgment rule does not apply
when a special litigation committee recommends dismissal
of a suit.

We think Connecticut would reject appellees’ argument
for a second reason. Limiting judicial scrutiny in cases such
as the one before us to the good faith, thoroughness and
independence of the special litigation committee would
effectively eliminate the fiduciary obligation of directors
and officers. As adumbrated further below, the present
action involves classic allegations and substantial evidence
of mismanagement and perhaps deliberate wrongdoing
resulting in a loss exceeding 10% of the shareholders’ capi-
tal and equity. The traditional fiduciary obligations of
directors and officers under Connecticut law can hardly be
said to exist if the sole enforcement method can be elim-
inated on a recommendation of the defendants’ appointees.
Other well-understood principles of corporate law would
also be altered. For example, the requirement of a demand
upon directors before initiating a derivative suit does not
apply to a case such as the present one, where the corporate
directors and officers are defendants. One reason—the
other being futility—underlying the rule is that directors
and officers cannot render a fair judgment on allegations of
their own misconduct. Appellees would have us substan-
tially modify this by allowing the defendants to appoint a
committee to evaluate these allegations and impose their
conclusions on the plaintiffs. In derivative actions, the
plaintiffs have always controlled the action subject to judi-
cial findings of adequate representation of shareholders
and approval of settlements. See Conn. Gen. Stat. Ann.
§ 52-572j (West 1982). Appellees’ view essentially vests
power in defendants’ appointees to bring about their
dismissal.

A-19

We are aware that Auerbach v. Bennett, 47 N.Y.2d 619,
393 N.E.2d 994 (1979), held that the business judgment rule
limits judicial scrutiny of the recommendations of special
litigation committees to their good faith, thoroughness and
independence. Because we believe that test would work a
major transformation of Connecticut corporate law, we pre-
dict that Connecticut would not adopt it. While the ongoing
debate over the legal obligations of corporate management
has spawned literature from Connecticut commentators
calling for less judicial scrutiny of corporate transactions,
Wolfson, A Critique of Corporate Law, 34 Miami L. Rev. 959
(1980), the special litigation committee, as envisioned in
Auerbach, seems a rather blunt instrument to accomplish
that end, since it appears to allow dismissals in actions for
deliberate looting as well as in nuisance suits.

We detect no signals that Connecticut law is moving
away from the enforcement of directors’ and officers’ tradi-
tional fiduciary obligations. Connecticut legislation govern-
ing indemnification of directors and officers for expenses
incurred in litigation supports the view we take here. Conn.
Gen. Stat. Ann. § 33-320a(b) (West 1982). Although that
provision has no direct application to this case, attitudes
toward indemnification are relevant to the issue before us.
By its terms, the Connecticut statute is exclusive and can-
not be varied by corporate by-laws. It calls for indemnifica-
tion without court approval only in circumstances in which
the defendant directors and officers secure a judgment in
their favor. This legislation adopts the middle ground
between no indemnification and permissible indemnifica-
tion without regard to outcome and thus does not bespeak a
negative attitude toward enforcement of fiduciary obliga-
tions through meritorious derivative litigation.

We also disagree with appellant that recommendations of
special litigation committees should be ignored by courts in
which derivative actions are pending. The incentives
underlying derivative litigation are such that actions may

A-20

well be brought which cannot be dismissed on motion but
which also are unlikely to lead to net benefits to the corpora-
tion. At least where the effectuation of an overriding fed-
eral policy is not at stake, cf. Galef v. Alexander, 615 F.2d
51, 62 (2d Cir. 1980) (“serious questions” whether a special
litigation committee can seek dismissal of an action alleg-
ing federal proxy violations), a corporation can play a legiti-
mate role in aiding a court to determine whether the
maintenance of an action in its name is in fact in its inter-
est. Surviving a motion to dismiss and for summary judg-
ment establishes only that a claim for relief has been stated
and that there is a scintilla of evidence to support it. It does
not establish that continued prosecution of the action is
actually in the corporation’s interest.

Appellant argues that Connecticut recognizes an abso-
lute right to bring and continue a derivative action. The
statute relied upon, however, Conn. Gen. Stat. Ann. § 52-
5723.“ clearly of a procedural nature directing how and

9. Section 52-572j reads in part:

(a) Whenever any corporation or any unincorporated association fails
to enforce a right which may properly be asserted by it, a derivative
action may be brought by one or more shareholders or members to
enforce such right, provided such shareholder or member was a share-
holder or member at the time of the transaction of which he complained
or his membership thereafter devolved on him by operation of law. Such
action shall be begun by a complaint returnable to the superior court for
the county or judicial district in which an office of the corporation or
association is located. The derivative action may not be maintained if it
appears that the plaintiff does not fairly and adequately represent the
interests of the shareholders or members similarly situated in enforcing
the right of the corporation or association. The action shall not be dis-
missed or compromised without the approval of the court, and notice of
the proposed dismissal or compromise shall be given to shareholders or
members in such manner as the court directs.

(b) In any action brought pursuant to this section, process shall also
be served on the corporation or association as in other civil actions, and
notice of such service of process after its having been served shall be
given to the board of directors and such other interested persons as the
court deems proper, and it shall not be necessary to make shareholders

A-21

where such actions may be brought in a state court. It has
no apparent substantive effect. Appellant also relies upon
Conn. Gen. Stat. Ann. § 33-323 (West 1982)'° which renders
transactions between the corporation and directors void-
able if unfair to the corporation. She argues that creation of
the Committee is thus a voidable corporate act since a
majority of those voting were defendants. Since our deci-
sion permits dismissal of this action only after an indepen-
dent judicial finding that it will not benefit the corporation,
the statutory fairness requirement is satisfied.

The Connecticut statute permitting indemnification with
court approval of a director’s expenses incurred in defend-
ing litigation even when the settlement calls for payment to
the corporation, Conn. Gen. Stat. Ann. § 33-320a(b), sug-
gests a recognition by the General Assembly of the fact that
some derviative actions may in the end not benefit the cor-
poration. We believe Connecticut law allows a court before

or members parties thereto. The costs of such action or part thereof,
which shall include but not be limited to witness’ fees, court costs and
reasonable attorney's fees, may be charged by the court, in its discre-
tion, against the corporation.

10. Section 33-323 reads in part:

(a) A contract or transaction between a corporation and a director
thereof, or a member of his immediate family, or between a corporation
and any other corporation, firm or other organization in which a direc-
tor of the corporation and members of his immediate family have an
interest, shall not be voidable and such director shall not incur any
liability, merely because such director is a party thereto or because of
such family relationship or interest, if: (1) Such family relationship or
such interest, if it is a substantial interest, is fully disclosed, and the
contract or transaction is not unfair as to the corporation and is autho-
rized by (i) directors or other persons who have no substantial interest
in such contract or transaction in such a manner as to be effective
without the vote, assent or presence of the director concerned or (ii) the
written consent of all of the directors who have no substantial interest in
such contract or transaction, whether or not such directors constitute a
quorum of the board of directors.

A-22

which a derivative action is pending to entertain a motion
for judgment by a defendant corporation based on a recom-
mendation of a special litigation committee. Before grant-
ing such a motion, however, it should apply far more
vigorous scrutiny to that recommendation than occurs
under the good faith, independence and thoroughness test.
While those qualities are necessary even to consideration of
the merits of such a motion, they are by no means sufficient
to determine whether it should be granted. The reason for
entertaining such a motion stems from the nature of the
incentives underlying derivative litigation. Because they
encourage actions which are not subject to pretrial dismis-
sal but which also may not benefit the corporation, the
device of the special litigation committee affords an oppor-
tunity for a judicial second look at the underlying litigation.
There is no reason, however, to treat the recommendation
of such a committee as having presumptive weight or to
accord it deference beyond its inherent persuasiveness. The
function of judicial scrutiny of a committee’s recommenda-
tion is to determine independently whether the action is
likely to harm the corporation rather than help it.

We strongly disagree with the implications of the dissent-
ing opinion that by not according the recommendations of
special litigation committees conclusive weight we are
somehow embarking on a new course of “stricter corporate
accountability” which will lead to “more derivative law-
suits.” Such committees are very recent creations. Indeed,
Auerbach, the first decision of a state high court to address
these issues, was decided only three years ago. Our failure
to accord the recommendations of such committees conclu-
sive weight can hardly be regarded as overregulation. And
our holding that the recommendations of such committees
may be considered by a court and provide the basis for
dismissal of a derivative action will hardly lead to an
increase in the number of such actions brought.

A-23

The Auerbach decision gives excessive weight to the
recommendations of special litigation committees. In re-
jecting Auerbach and concluding that Connecticut would
adopt a rule limiting the role of such committees, we are
not without eminent judicial support. In Zapata Corp. v.
Maldonado, 430 A.2d 779 (Del. Supr. 1979), the Delaware
Supreme Court, which has unique experience in the area,
laid down the following rule: Where a derivative suit can-
not be brought without prior demand upon the directors
followed by refusal, the directors’ decision will stand absent
a demonstration of self-interest or bad faith; but where
such a demand is excused (for reasons of futility, etc.) and a
derivative action is properly brought, an independent com-
mittee of directors may obtain a dismissal only if the trial
court finds both (a) that the committee was independent,
acted in good faith and made a reasonable investigation;
and (b) that in the court’s independent business judgment
as to the corporation’s best interest, the action should be
dismissed. We believe Connecticut would adopt a similar
rule.

Independent judicial scrutiny of a special litigation com-
mittee’s recommendation is apt to be difficult and in an
effort to ease that task we establish some guidelines. We
emphasize that what we say here applies to cases involving
allegations of direct economic injury to the corporation
diminishing the value of the shareholders’ investment as a
consequence of fraud, mismanagement or self-dealing. This
is not a case involving allegations of ultra vires acts or acts
illegal under domestic or foreign laws which do not have as
a major purpose protection of the corporate shareholder’s
investment interest. Compare Gall v. Exxon Corp., 418
F.Supp. 508 (S.D.N.Y. 1976). Nor is it a case in which the
relief sought may benefit the corporation but in ways not
entailing a direct financial return. Mills v. Electric Auto
Life, supra (action for misleading proxy statement where
no monetary recovery by the corporation may result); Bosch

A-24

v. Meeker Cooperative Light & Power Assn., 275 Minn. 362,
101 N.W.2d 423 (1960) (invalidation of directors’ elections).
The guidelines we establish here are limited to cases involv-
ing allegations of acts resulting in direct financial harm to
the corporation and a consequent diminishing of the value
of shareholders’ investment. We express no views on the
appropriate calculus to be applied to recommendations of
special litigation committees where the derivative action
alleges violations of law not designed principally to protect
shareholders or, which, if successful, may benefit the corpo-
ration in ways other than the recovery of compensatory

damages.

In cases such as the present one, the burden is on the
moving party, as in motions for summary judgment gener-
ally, to demonstrate that the action is more likely than not
to be against the interests of the corporation. This showing
is to be based on the underlying data developed in the
course of discovery and of the committee’s investigation
and the committee’s reasoning, not simply its naked conclu
sions. The weight to be given certain evidence is to be deter-
mined by conventional analysis, such as whether testimony
is under oath and subject to cross-examination. Finally, the
function of the court’s review is to determine the balance of
probabilities as to likely future benefit to the corporation,
not to render a decision on the merits, fashion the appro-
priate legal principles or resolve issues of credibility.
Where the legal rule is unclear and the likely evidence in
conflict, the court need only weigh the uncertainties, not
resolve them. The court’s function is thus not unlike a lawy-
er's determining what a case is “worth” for purposes of
settlement.

Where the court determines that the likely recoverable
damages discounted by the probability of a finding of liabil-
ity are less than the costs to the corporation in continuing
the action, it should dismiss the case. The costs which may
properly be taken into account are attorney’s fees and other

oF a

?

A-25

out-of-pocket expenses related to the litigation and time
spent by corporate personnel preparing for and participat-
ing in the trial. The court should also weigh indemnifica-
tion which is mandatory under corporate by-laws, private
contract or Connecticut law, discounted of course by the
probability of liability for such sums. We believe indemnifi-
cation the corporation may later pay as a matter of discre-
tion should not be taken into account since it is an avoidable
cost. The existence or non-existence of insurance should not
be considered in the calculation of costs, since premiums
have previously been paid. The existence of insurance is
relevant to the calculation of potential benefits.

Where, having completed the above analysis, the court
finds a likely net return to the corporation which is not
substantial in relation to shareholder equity, it may take
into account two other items as costs. First, it may consider
the impact of distraction of key personnel by continued lit-
igation. Second, it may take into account potential lost prof-
its which may result from the publicity of a trial.

Judicial scrutiny of special litigation committee recom-
mendations should thus be limited to a comparison of the
direct costs imposed upon the corporation by the litigation
with the potential benefits. We are mindful that other less
direct costs may be incurred, such as a negative impact on
morale and upon the corporate image. Nevertheless, we
believe that such factors, with the two exceptions noted,
should not be taken into account. Quite apart from the elu-
siveness of attempting to predict such effects, they are quite
likely to be directly related to the degree of wrongdoing, a
spectacular fraud being generally more newsworthy and
damaging to morale than a mistake in judgment as to the
strength of consumer demand.

We do recognize two exceptions, however. First, where
the likely net return is not substantial in relation to share-
holder equity, the court can consider the degree to which
key personnel may be distracted from corporate busi‘iess

A-26

by continuance of the litigation. We appreciate that litiga-
tion can disrupt the decision-making process and thereby
impose unforeseen and undetected costs. These are not
measurable and we limit consideration of them to cases
where the likely return to the corporation is not great.
Where that is the case and many of the key directors and
officers will be heavily involved in the litigation, a court
may take such potential costs into account.

Second, where the corporation deals with the general
public and its level of business is dependent upon public
identification and acceptance of the corporate product or
service, we believe the court ought to take potential busi-
ness lost as a consequence of a trial into account when the
likely net return to the corporation is not substantial in
relation to total shareholder equity. In such a case, there is
less likelihood of a direct relationship between impact on
business and degree of misconduct. Where the likely return
to the corporation from the litigation is higher, however, we
believe the uncertainty as to the kind of publicity which
will attend a trial precludes consideration of that impact.
Moreover, when potential lost profits are taken into
account, the basis for calculating them must be something
more solid than the conclusory opinions of the alleged
experts, e., verifiable examples in similar firms.

D. Procedural Issues

Review of special litigation committee reports also raises
a number of procedural issues. First, documents used by
parties moving for, or opposing, summary judgment should
not remain under seal absent the most compelling reasons.
Fed. R. Civ. P. 26(c) authorizes protective orders in the
course of discovery, “[a]n important purpose of [which] is to
preserve the confidentiality of materials which are
revealed in discovery but not made public at trial.”
National Polymer Products v. Borg-Warner Corp., 641 F.2d

A-27

418, 424 (6th Cir. 1981). Protective orders are useful te pre-
vent discovery from being used as a club by threatening
disclosure of matters which will never be used at trial. Dis-
covery involves the use of compulsory process to facilitate
orderly preparation for trial, not to educate or titillate the
public. Private matters which are discoverable may, upon a
showing of cause, be put under seal under Rule 26(c), in the
first instance. Martindale v. International Tel. & Tel. Corp.,
594 F.2d 291 (2d Cir. 1979), says no more than that.

At the adjudication stage, however, very different consid-
erations apply. An adjudication is a formal act of govern-
ment, the basis of which should, absent exceptional
circumstances, be subject to public scrutiny. We simply do
not understand the argument that derivative actions may
be routinely dismissed on the basis of secret documents. We
cannot say what the effect on investor confidence would be
if special litigation committees were routinely allowed to do
their work in the dark of night. We believe, however, that
confidence in the administration of justice would be
severely weakened. Indeed, any other rule might well
create serious constitutional issues. See Globe Newspaper
Co. v. Superior Court, 50 U.S.L.W. 4759 (U.S. June 23,
1982).

We do not say that every piece of evidence, no matter how
tangentially related to the issue or how damaging to a party
disclosure might be, must invariably be subject to public
scrutiny. An exercise of judgment is in order. The impor-
tance of the material to the adjudication, the damage disclo-
sure might cause, and the public interest in such materials
should be taken into account before a seal is imposed.

Second, if the special litigation committee recommends
termination and a motion for judgment follows, the com-
mittee must disclose to the court and the parties not only its
report but all underlying data. To the extent that communi-
cations arguably protected by the attorney-client privilege
may be involved in that data, a motion for judgment based

A-28

on the report waives the privilege.'' See In re John Doe
Corporation, 675 F.2d 482 (2d Cir. 1982). The work-product
immunity will apply to the documents usually included
within its terms to the extent that they are working papers
of the committee’s counsel and are not communicated to the
committee. Once communicated, the immunity may not be
claimed, since the papers may be part of the basis for the
committee’s recommendations.

E. The Present Case

Given the principles outlined above, we reverse the order
putting the Citytrust Committee’s Report under sea! and
restricting its use. The showing of good cause was merely
that it and the accompanying documents were protected by
the attorney-client privilege and work-product immunity
and involved a candid assessment of the bank’s internal
operations which, if made public, would adversely affect

the two corporations in the banking industry and the

Bridgeport community. This showing is patently inade-
quate. First, the submission of materials to a court in order
to obtain a summary judgment utterly precludes the asser-
tion of the attorney-client privilege or work-product
immunity. Second, a naked conclusory statement that pub-
lication of the Report will injure the bank in the industry
and local community falls woefully short of the kind of
showing which raises even an arguable issue as to whether
it may be kept under seal. The Report is no longer a private
document. It is part of a court record. Since it is the basis
for the adjudication, only the most compelling reasons can
justify the total foreclosure of public and professional seru-
tiny. The potential harm asserted by the corporate defen-
dants is in disclosure of poor management in the past. That
is hardly a trade secret. The argument that disclosure of
poor management is so harmful as to justify keeping the

11. Whether or to what extent the attorney-client privilege applies to
material relating to creation of the Special Litigation Committee is an
issue we do not decide.

A-29

Report under seal proves too much since it is a claim which
grows stronger with the degree of misconduct. Were out-
right looting of Citytrust disclosed by the Report, for exam-
ple, the harm of publication would be even greater.
Moreover, Citytrust is a publicly owned company and this
litigation directly concerns management's obligations to
shareholders. We believe that foreclosing public scrutiny of
the grounds for this adjudication is wholly unjustifiable.

We turn now to the contents of the Special Litigation
Committee’s Report. We emphasize that this recitation is
the Committee’s version of the facts. The record suggests
that a trial might reveal sharply differing versions of the
same events from various witnesses as well as sharply
differing inferences drawn from that testimony.

According to the Report, Nelson L. North was City-
trust’s Chief Executive Officer and Norman Schaff, Jr.
was its Chief Lending Officer during the period in ques-
tion. The management of Citytrust was completely domi-
nated by North. Bank officers who did not temper
themselves to his regime had a short tenure at the bank.
North also exercised strong control over the activities of
the Board of Directors. Board members were given
neither materials nor agendas prior to meetings and
requests for long range planning documents were left
unanswered. North’s control is illustrated by the fact that
contrary to the recommendation of Citytrust’s outside
auditors, the bank’s Audit Committee was not composed
solely of outside directors but instead counted among its
members Mr. North and one other officer. Minutes of the
Audit Committee between 1971 and 1974 are largely
incomplete.

Mr. North apparently brought the initial proposal for
the Katz loan to Citytrust. From 1971 to 1976, North’s son
was employed by Katz, and he apparently deemed this a
sufficient conflict of interest to preclude his voting on the
Katz transactions in Executive Committee meetings. This

A-30

fastidiousness appears to have been limited to the formal-
ity of voting, for the Report strongly suggests that North
was deeply involved in the Katz transactions, although the
full degree of his involvement is left uncertain. The
Report also adds that Mr. North has destroyed his
records.

Katz appears to have been experiencing financial diffi-
culties as early as 1971. Chase Manhattan in fact opposed
financing the Katz building in part because of a $1.6 mil-
lion shortfall between the building cost and available
lending; it was North who persuaded Chase to make the
initial mortgage loan. By 1972, Katz was falling behind in
its loans and by December of that year owed Citytrust
$990,000 with respect to the building. The Report con-
cludes that by then Citytrust was effectively a joint ven-
turer with Katz in the building, sharing the risk of loss
but entitled at best only to interest and principal if things
went well. There is also some indication that a portion of
the unsecured advance made by Citytrust was being ap-
plied to the Chase mortgage.

Notwithstanding the increasingly evident peril in City-
trust’s transactions with Katz, no appraisals of the build-
ings were undertaken until 1976, and no rentability study
until 1974. Although Katz had suggested that a public
offering would alleviate the situation, no professional
review of the preliminary prospectus was undertaken.
From 1972 through 1973, only one meeting of the Board of
Directors or Executive Committee considered the Katz
loans. The Senior Loan Committee did meet on the Katz
matter late in 1972 and may have adopted a very cautious
attitude toward further credit extension. Despite this, and
despite the absence of Executive Committee and Board
support, senior management extended almost a million
dollars in loans to Katz between 1972 and 1973.

From 1973 through 1974, the number of Board meet-
ings at which the Katz loans were considered increased to

=, ee

A-31

five. This is roughly contemporaneous with the recom-
mendation of the outside auditors that a 50% special fund
be set up for the Katz loans and the National Bank Exam-
iners’ classification of the total outstanding Katz
indebtedness as substandard. It is, as the Report notes,
“unsettling” that neither Schaff nor Citytrust’s Comp-
troller recall being advised of the recommendation as to
the special reserve. Moreover, it is not established that the
Directors were advised of this recommendation.

By late 1974, the Katz loans were so clearly a problem
that they were extensively considered by the Board and
the Executive Committee. In fact, the Report notes that
these loans were discussed at a minimum of 25 Board and
Executive Committee meetings. Nevertheless, when, on
August 18, 1976, the Board was presented with the
request to go over the 10% limit, there was no prior men-
tion of the issue on the agenda nor was opinion of counsel
presented to the Board or even sought. Indeed, copies of
the Comptroller’s letter suggesting that Directors might
wish to consult their personal counsel were not distrib-
uted to the Board.

The Report estimates a loss of $5.1 million to Citytrust.
As stated earlier, there is an indication in the record that
since the Report was issued, the new owner has defaulted
and Citytrust again owns the building. If so, $5.1 million
may be considerably less than the actual loss. In any
event, a loss exceeding 10% of shareholder equity seems
quite likely.

A-32

The Report contains the opinions of two experts. One con-
cluded that the impact on morale of bank personnel, on the
image of Citytrust among the banking public, upon persons
who might be asked to become directors and upon potential
new customers would offset even a recovery of $5.5 mil-
lion.'? The other reached a different conclusion, stating that
a recovery of even $2 million would be worth pursuing not-
withstanding speculation about the public impact. It stated
that this opinion would stand whether or not the outside
directors continue as defendants, “as long as the insurance
carrier is obligated through the ‘D and O policy’.” This last
phrase might have given the Committee some pause since
the letter requesting the opinion indicated that the insur-
ance carrier had raised a question as to its liability.

As to exceeding the federal statutory limit, the Commit-
tee concluded that under the compelling circumstances sur-
rounding the vote, it is possible that no net damage to
Citytrust resulted. It also concluded that even if damage
did occur, the maximum recovery would be $376,000 plus
interest, a sum too small in the Committee’s view to justify
continuance of the action.

As to the claims of breach of fiduciary duty, the Commit-
tee recommended that the suit be discontinued as to the
outside defendants because there is “no reasonable possibil-
ity” that they might be found liable. As to the others, it
concluded merely that

there is a possibility that a finding of negligence could

be rendered against any one or more of the senior loan
officers who participated in the Katz Corporation loans.

12. This opinion was not substantiated by verifiable historical evi-
dence or other factual material. As such, we believe it is entitled to no
weight in the determination whether a suit such as this should be
dismissed.

13. If in fact the potential recovery was limited to $376,000, the
analysis described above might well lead to a dismissal.

A-33

Although it is emphasized that there is no evidence
whatsoever of any self-dealing or of deliberate
impropriety, there is some indication that the most pru-
dent lendin lags 4 were not adhered to during the
evolution of those loans.

Applying the standard of review set out above to the
Committee’s recommendation, we look first to potential lia-
bility generally without regard to which defendants are
responsible. As to that liability, we find that plaintiff's
chances of success are rather high. The loss to Citytrust
resulted from decisions which put the bank in a classic “no
win” situation. The Katz venture was risky and increas-
ingly so. By continuing extensions of substantial amounts of
credit the bank subjected the principal to those risks
although its potential gain was no more than the interest it
could have earned in less risky, more diversified loans. In a
real sense, there was a low ceiling on profits but only a
distant floor for losses. It is so similar to the classic case of
Litwin v. Allen, supra (bank purchase of bonds with an
option in the seller to repurchase at the original price, the
bank thus bearing the entire risk of a drop in price with no
hope of gain beyond the stipulated interest) that we cannot
agree with the Committee’s conclusion that only a “possibil-
ity of a finding of negligence” exists.

The issue as to which defendants are responsible is less
clear. The Committee concluded that there is “no reason-
able possibility” of the outside defendants being found lia-
ble because they had neither information nor reasonable
notice of the problems raised by the Katz transactions. We
note first that members of the inside defendants may con-
tradict that version and, if so, a possibility of liability in
the outside group exists. Moreover, lack of knowledge is
not necessarily a defense, if it is the result of an abdication
of directorial responsibility. McDonnell, supra; Atherton,
supra. Directors who willingly allow others to make
major decisions affecting the future of the corporation
wholly without supervision or oversight may not defend

*

ive

A-34

on their lack of knowledge, for that ignorance itself is a
breach of fiduciary duty. The issue turns in large part
upon how and why these defendants were left in the dark.
See Graham v. Allis Chalmers Mfg. Co., 41 Del. Ch. 78, 188
A.2d 125 (1963). An individual analysis of each outside
defendant’s role may show that some are blameless or
even that they all were justified in not acting before they
did, but neither is an inexorable conclusion on the basis of
the present record.

The Report concluded as to the inside defendants that
there was a “possibility” of liability. This conclusion is a
considerable understatement and not entirely consistent
with the Report’s finding as to the outside defendants. The
outsiders’ best defense may well be that the inside group
actively concealed the Katz problem. Given the fact that
exoneration of the outside defendants may show culpabil-
ity of the insiders and our conclusion that the probability
of liability somewhere is high, we think the exposure of
the inside group is considerably more than a “possibility.”
Nor do we agree that “there is no evidence whatsover” of
deliberate impropriety. Not only is there the problem of
North’s apparently inconsistent behavior with respect to
the appropriateness of his participation in the considera-
tions of Katz transactions, but his failure to keep the
Board of Directors informed may well entail more than a
negligent omission.

A precise estimate of potential damages is not possible
since the trier must determine at what point liability be-
gins. We think, however, that on the present record, a
trier might easily find liability extending back to early
1972 or before (assuming no statute of limitations prob-
lem), resulting in a return of several million dollars to
Citytrust, or perhaps 10% or more of the shareholder
equity. This far exceeds the potential cost of the litigation
to the corporation.

A-35

CONCLUSION

Applying the analysis described above, we conclude that
the probability of a substantial net return to the corpora-
tion is high. We reject, therefore, the recommendation of
the Special Litigation Committee. The grant of summary
judgment is reversed, the protective order is vacated, and
the case is remanded. Since we have been unable to explain
our reasoning in this opinion without extensive reference to
materials under seal, the mandate shall issue forthwith as
to the lifting of the protective order.“

CARDAMONE, C.J., concurring, in part,! and dissenting in
part.

As the majority correctly concludes Connecticut law con-
trols the question of the defendant corporation’s right to
terminate Joy’s derivative suit. Since Connecticut’s courts
have not yet addressed the issue now before us, we are
relegated to predicting what the Connecticut Supreme
Court would decide in this case. Because it is an “iffy” busi-
ness to prophesy what view a state’s highest court will take
in the future, and since Connecticut's Supreme Court could
at any time render what we say here irrelevant, the discus-
sion should be as simple as possible.

The highest courts of only two states have addressed the
question currently before us. In Auerbach w. Bennett, 47
N. V. 24 619 (1979), New York’s Court of Appeals held that
the substantive merits of an independent director commit-
tee’s decision to terminate derivative litigation against
defendant corporate directors are beyond judicial scrutiny

14. We do not disturb that portion of the protective order which pro-

tects the confidentiality of the Committee’s evaluation of the settlement
value of the litigation. It is not relevant to the issues before us.

1. I concur with the majority insofar as it vacates the order placing the
independent committee report under seal.

A-36

and that a court’s role in such cases is limited to determin-
ing whether the committee acted independently, tho-
roughly and in good faith. In so holding, the A uerbuch court
recognized and applied the business judgment doctrine
which it stated “bars judicial inquiry into actions of corpo-
rate directors taken in good faith and in the exercise of
honest judgment in the lawful and legitimate furtherance
of corporate purposes.” Id. at 629. In Zapata Corp. v. Mal-
donado, 430 A. 2d 779 (Del. 1981), the Delaware Supreme
Court expressly refused to adopt the business judgment
rationale. Instead it fashioned a two-step analysis. Under
the first, which mirrors Auerbach, the corporation seeking
dismissal must establish the independence, good faith and
thoroughness of the investigative efforts of the committee of
the board reaching the decision to terminate the litigation.
As a second step the trial court in its discretion may apply
its own “independent business judgment” in determining
whether to accept the board’s decision to terminate the
derivative suit.

Faced with these opposing views, the majority has con-
cluded that Connecticut would not adopt the “business judg-
ment” doctrine of Auerbach, but would adopt the
“independent business judgment” test of Maldonado. In
fact, the majority goes beyond Maldonado by requiring
that the court must proceed to apply its own business judg-
ment, rather than leaving the decision to resort to the
second step within the trial court’s discretion. I respectfully
dissent from that conclusion and propose, first, to set forth
briefly what I perceive to be the inherent deficiencies in
Maldonado and the adoption of its rationale by the majority
and, then, to indicate why I believe the Connecticut
Supreme Court will take a position similar to Auerbach.

Under Maldonado two-step analysis and the majority
position unanswered questions abound. For example,

A-37

reasonable inquiry could be made with regard to the follow-
ing: under what circumstances can the trial court conclude
that the director’s decision satisfied the step one criteria,
but not the “spirit” of those criteria as required by step two
of Maldonado; will evidence be considered by the court that
was not before the independent committee; in the exercise
of its “business judgment” will the court consider facts not
in the record; will the court need to appoint its own experts?

The majority proposes a calculus in an attempt to resolve
additional issues engendered by its analysis. This calculus
is so complicated, indefinite and subject to judicial caprice
as to be unworkable. For example, how is a court to deter-
mine the inherently speculative costs of future attorneys’
fees and expenses related to litigation, time spent by corpo-
rate personnel preparing for trial, and mandatory indemni-
fication “discounted of course by the probability of liability
for such sums.” How is a court to quantify corporate good-
will, corporate morale and “the distraction of key person-
nel” in cases in which it “finds a likely net return to the
corporation which is not substantial in relation to share-
holder equity?” Should a court also take into account the
potential adverse impact of continuing litigation upon the
corporation’s ability to finance its operations? Should
future costs be discounted to present value and, if so, at
what rate? Must the income tax ramifications of expected
future costs be considered and, if so, how? This veritable
Pandora’s box of unanswered questions raises more prob-
lems than it solves.

Even more fundamentally unsound is the majority's
underlying premise that judges are equipped to make busi-
ness judgments. It is a truism that judges really are not
equipped either by training or experience to make business
judgments because such judgments are intuitive, geared to
risk-taking and often reliant on shifting competitive and
market criteria. Auerbach, 47 N.Y.2d at 630 (courts are
“ill-equipped” to make essentially business judgments).

on

A-38

Reasons of practicality and good sense strongly suggest
that business decisions be left to businessmen. Whether to
pursue litigation is not a judicial decision, rather, it is a
business choice. Burks v. Lasker, 441 U.S. 471, 487 (1979)
(Stewart, J., concurring) (“A decision whether or not a cor-
poration will sue an alleged wrongdoer is no different from
any other corporate decision ....”). As perceptive com-
mentators have observed, if Maldonado’s statement is true
that “{uJnder our system of law, courts and not litigants
should decide the merits of litigation,” Maldonado at 789
n.13 (quoting Maldonado v. Flynn, 413 A.2d 1251, 1263
(Del. Ch. 1980)), then its corollary “that boards, and not
courts, are entitled to exercise business judgment” is
equally true. Coffee and Schwartz, The Survival of the
Derivative Suit: “An Evaluation and a Proposal for Legisla-
tive Keform, 81 Colum. L. Rev. 261, 329 (1981).

Public policy concerns also strongly militate against the
second step of the majority’s two-tiered analysis. The sud-
den urge for stricter corporate accountabilty under judicial
aegis arises, one Connecticut commentator suggests, not
from corporate misconduct, which he asserts is no greater
now than at previous times in history but, rather, because
of an anti-business bias present in our society amidst an
atmosphere of pervasive government regulation. Wolfson,
A Critique of Corporate Law, 34 U. Miami L. Rev. 959,
988-89 (1980). In a land weary of overregulation and the
kind of judicial activism embodied in the second step of
Maldonado, there may well be a strong inclination fer busi-
ness to incorporate in states more hospitable to them. See,
e.g., Genzer v. Cunningham, 498 F. Supp. 682, 688 (E.D.
Mich. 1980).

Moreover, when one considers that even a meritorious
lawsuit can have a detrimental effect upon a company’s
stockholders due to the significant and rising costs of litiga-
tion, disruption of corporate work force and adverse public-
ity, it becomes piain how wasteful it will become for

ea a

i
*

A- 39

corporations not to believe it worthwhile to move to dismiss
a nonmeritorious case. The Business Round Table, a group
of over one hundred chief executive officers of America’s
largest corporations has publicly stated that a view like the
one adopted by the majority will lead to more derivative
lawsuits being brought, make it more difficult for corpora-
tions to have them dismissed, discourage risk-taking and
make fewer candidates willing to serve on boards of direc-
tors. N.Y. Times, June 10, 1982, at D6. Such real fears
overcome in large measure what the majority implicitly
assumes to be the advantages of limiting directors’ control
over the pursuit of the derivative suit.

Review of Connecticut law lends support to a belief that
something closer to the business judgment rule of Auerbach
is more likely to be adopted by Connecticut’s highest court
than the independent judgment rule of Maldonado. Under
Connecticut law a director is not civilly liable for the conse-
quences of his official actions if in the exercise of his duties
as a director he acts prudently and in good faith. Conn. Gen.
Stat. Ann. §§ 33-313(d),? 33-321(b\2) 33-455(bX2) and 33-
447(d) (West Supp. 1982). See Davenport v. Lines, 77 Conn.
473, 59 A. 603 (1905). Liability has been confined to cases in
which a director has not performed (dereliction of duty),
cases in which a director has used his fiduciary position for

|

2. § 33-313(d) provides in relevant part:

A director shall perform his duties as a director, including his duties
as a member of any committee to the board upon which he may serve, in
good faith, in a manner he reasonably believes to be in the best interests
of the corporation and with such care as an ordinarily prudent person in
a like position would use under similar circumstances. . . A person who
performs his duties in accordance with this subsection shall be presumed
to have no liability by reason of being or having been a director of the

corporation.
Conn. Gen. Stat. An. § 33-131(d) (West Supp. 1982).

Sa an
ss

A-40

personal advantage (breach of a duty of loyalty), and con-
flict of interest cases. S. Cross, Corporation Law in Connect-
icut, at 298 (1972). Business decisions honestly made are
treated as discretionary, even when the interests of stock-
holders are adversely affected. Carter v. Spring Perch Co.,
113 Conn. 636, 155 A. 832 (1931).

Because these statutory standards provide that a director
may avoid liability when he acts in good faith and with
prudent care, they lend support to the rationale underlying
the business judgment rule, i.e., courts should not second-
guess the merits of business decisions honestly and pru-
dently made.

Additionally, independent committees similar to the one
appointed by defendants in this case are recognized and
approved under Connecticut law. See Conn. Gen. Stat. Ann.
§ 33-318(b) (West Supp. 1982). Therefore, I believe the
Supreme Court of Connecticut would refrain from review-
ing the recommendation of independent committees sanc-
tioned under state laws.

IV

My colleagues advance two arguments as to why they
believe Connecticut would not adopt the Auerbach test.
First, they contend that director committees simply cannot
be expected to act independently. Where a special litigation
committee does not act independently and in good faith, its
decision to terminate derivative litigation will not survive
judicial scrutiny under Auerbach. Thus the contention that
director committees will not act independently and in good
faith does not support the conclusion that the Auerbach
standard is inadequate to protect shareholder rights.
Second, the majority argues that limiting judicial review to
the Auerbach test would effectively eliminate the fiduciary
obligations of directors and officers because the sole
method of enforcing these obligations, shareholder deriva-
tive suits, could be eliminated upon the recommendation of

A-41

persons appointed by the officers and directors whose con-
duct is being challenged. Een if shareholder derivative
suits are the only effective method of enforcing the fidu-
ciary obligations of officers and directors, this second objec-
tion to Auerbach again assumes that director committees
reviewing derivative litigation will not act independently
and in good faith. Since Auerbach will require judicial
intervention if the director committees do not so act this
second objection to the use of the Auerbach standard is sim-
ilarly without merit. All this, as well as the majority's dis-
tinction between “demand-excused” cases and
“demand-required” cases, serves only to reveal the true ra-
tionale underlying its opinion — it simply does not believe
that special litigation committees will act independently
and in good faith.

Our Court has been down this path before. When Burks
was before us we took the same position that the majority
now does, i.e., that directors could never be wholly disinter-
ested in deciding whether to pursue claims against fellow
directors. Lasker v. Burks, 567 F.2d 1208, 1212 (2d Cir.
1978). On appeal that view was rejected by the Supreme
Court which concluded that lack of impartiality of disinter-
ested directors is not a determination to be made as a mat-
ter of law. Burks, 441 U.S. at 485 n.15.

Plainly Connecticut’s Supreme Court will be influenced
to some degree by the number of cases that have followed
Auerbach teaching that an unbiased board’s power to ter-
minate derivative litigation is essentially unreviewable.*

*See Gaines +. Haughton, (1981 Transfer Binder] Fed. Sec. L. Rep.
(CCH) 7 98,000 (9th Cir. 1981); H. M. Greenspun v. Del E. Webb Corp..
634 F. 2d 1204 (9th Cir. 1980); Lewis rv. Anderson, 615 F.2d 778 (9th Cir.
1979), cert. denied, 449 U.S. 869 (1980); Abbey v. Control Data Corp.
603 F. 2d 724 (8th Cir. 1979), cert. denied, 444 U.S. 1017 (1980); Joy rv.
North, 519 F.Supp. 1312 (D. Conn. 1981); Abramowitz vr. Posner, 513
F.Supp. 120(S.D.N.Y. 1981), aff'd, 672 F.2d 1025 (2d Cir. 1982); Genzer
„ Cunningham, 498 F.Supp. 682 (E.D. Mich. 1980); Maldonado r.
Flynn, 485 F.Supp. 274 (S. D. N. V. 1980), modified, 671 F.2d 729 (2d

A-42

Applying the Auerbach analysis to the facts in this case,
the district court correctly found that the Committee's
recommendation should be adopted, The committee would
be deemed “independen'” under Connecticut law because
none of the directors had any of the relationships pr hibited
unde Section 33-319 of the Connecticut General Statutes.
For the reasons stated in Judge Eginton’s extensive opinion
below, I believe that the committee acted thoroughly and in
good faith when it recommended termination of the litiga-
tion against some, but not all, of the defendants. Moreover,
a district judge’s interpretation of the law of the state in
which he sits should be accorded substantial deference.

Based upon the foregoing, | would therefore affirm the
grant of summary judgment dismissing the derivative suit
as to the 23 defendants and its continuance as to the others
as recommended by the independent committee.

Cir, 1982); Ronengarten v, International Telephone & Telegraph Corp.
466 F Supp. 817 (8.D.N.Y, 1979); Siegal N Merrick, 84 F. R. D. 106
(8.D.N.Y. 1979); Our own Court eschewed second-guessing by the
courts of what is the responsibility of a corporate board of directors
and, until today, may properly have been included in the above group.
Galef v, Alexander, 616 F.2d 61 (2d Cir, 1980); Abramowits, anpra,

B-1

UNITED STATES DISTRICT COURT,
D. CONNECTICUT,

ATHALIE Doris Joy, PLAINTIFF,
V.
NELSON L. Nortu, et al., DEFENDANTS.

Civ. No, B-77-885.
Aug. 10, 1981.
MEMORANDUM OF DECISION
EGINTON, District Judge.

This shareholder's derivative action was instituted in
1977 on behalf of Citytrust Bancorp., Inc., (then known as
Connecticut Financial Services Corporation), against
numerous officers and directors of Bancorp and its wholly
owned subsidiary Citytrust (collectively, the “Corpora-
tions”). Plaintiff alleges that the defendants violated the
National Banks Act, 12 U.S.C, § 21 et seq., and common law
fiduciary duties, by authorizing and extending a series of
loans for the construction of a building by the Katz
Corporation.

During the pendency of the litigation, the Supreme
Court held in Burka u Lasker, 441 U.S. 471, 99 S.Ct. 1831,
60 L.Ed.2d 404 (1979), that federal courts should as a mat-
ter of federal law, apply state law governing the authority
of independent directors to discontinue derivative suits,
even when the cause of action arises under a federal stat-
ute. The Supreme Court reversed the Second Circuit
Court of Appeals, which had found that as a consequence
of a federal statute disinterested directors did not have the
power to foreclose the continuation of nonfrivolous litiga-
tion brought by shareholders against majority directors
for breach of their fiduciary duties. /d. at 475, 99 8.Ct. at
1835, The Supreme Court rejected that the existence of
federal question jurisdiction rendered state law irrelevant,

wedi Pied Whe
iS
Wye
j 0

particularly in the area of corporate law. To the contrary,
the Burks decision emphasized the importance of state cor-
poration law, “which is the font of corporate directors’
powers,” as distinct from federal law in this area, which is
“largely regulatory and prohibitory in nature—it often
limits the exercise of directorial power, but only rarely
creates it.” Jd. at 478, 99 S.Ct. at 1837.

I Based on the Burks decision, a federal court con-
fronted with a recommendation by a disinterested panel of
directors to dismiss a derivative action must as a threshold
matter determine whether state law permits such a dismis-
sal and under what circumstances. If so, the next inquiry
mandated by Burks is whether the state rule is consistent
with the policy of the federal statute upon which the deriva-
tive suit is based. Finally, even if state and federal law
permit an independent committee to initiate a business
judgment dismissal, then the federal court must assure
itself of the integrity of the committee by reviewing the
independence, good faith and thoroughness of the decision.
If all three prongs of the Burks test have been satisfied,
then the committee’s recommendation will be upheld.

Immediately following the Supreme Court's decision in
Burks, the Board of Directors of the Corporations in the
instant case authorized the establishment of the Special
Litigation Committee (hereinafter the Committee“), to
determine whether the continued prosecution of the deriva-
tive suit would serve the best interests of the Corporations,
In appointing the Committee, the directors relied on Burks
and its progeny, and selected two directors, Ms. Marion 8.
Kellogg and Mr. Ernest C. Trefz, claimed to be indepen-
dent and disinterested in the derivative litigation.' The
Committee thereafter retained the law firm of Murtha,
Cullina, Richter and Pinney to assist in conducting the

I. The Committee's third original member, Alexander IL. Stott,
resigned on March 3, 1980.

B-3

investigation. By resolution dated August 15, 1979, the full
board delegated to the Committee the power to review,
investigate and analyze the circumstances surrounding the
pending derivative action. Nine months later, counsel to the
Committee submitted a three-volume report, which con-
tained the unanimous recommendation that the suit be dis-
missed against twenty-three designated defendants, but
continued or settled as to the remaining seven defendants.’

When plaintiff failed to voluntarily withdraw the claims
against the defendants in accordance with the Committee’s
determination, the Corporations filed motions, first to dis-
miss and thereafter for summary judgment. This Court
repeatedly denied the motions, without prejudice and sub-
ject to renewal, to enable plaintiff to conduct limited discov-
ery into the “good faith, motivation and thoroughness” of
the Committee's investigation. At the conclusion of the stip-
ulated discovery schedule, the Corporations renewed their
motion for summary judgment on the grounds that the bus-
iness judgment rule was available under state law and had
been properly invoked to terminate the derivative suit.
Plaintiff, in opposing the motion, contends that even if Con-
necticut recognizes the business judgment rule (which she
vigorously disputes), the Corporations may not foreclose
prosecution of claims involving alleged fraud and breach of
trust. In addition to a full scale attack on the business judg-
ment rule and the concept of a special litig tion committee,
plaintiff also challenges every phase of the Committee’s
investigation, from the procedures employed in its forma-
tion to the ultimate substantive conclusions.

2. Of the twenty-three who seek dismissal, twenty include outside
directors of either Citytrust or the Bancorp, while the remaining three
are either officers or directors of the Corporations.

B-4

I
BUSINESS JUDGMENT RULE

2. 3] The power of a corporation to manage daily inter-
nal affairs without interference by the courts has long been
recognized. The so-called business judgment rule is based
on the premise that directors of a corporation have the req-
uisite expertise to resolve the daily business matters which
form an integral part of corporate life, an expertise that
cannot be matched by courts or shareholders. So long as
directors render an unbiased judgment in carrying out
their responsibilities, they will not be held liable for honest
errors. Nor will the board’s decisions be subject to review
by outside interests, absent proof of bad faith or prejudice.
Galef u Alexander, 615 F.2d 51, 57 (2d Cir. 1980), citing 3A
Fletcher, Cyclopedia of the Law of Private Corporations, §
1039 (perm. ed. 1975).

[4] Since 1917, the Supreme Court has recognized the
power of directors to invoke the business judgment rule to
determine whether or not to enforce in the courts claims
available to the corporation. In United Copper Securities
Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64, 37
S. Ct. 509, 510-11, 61 L.Ed. 1119 (1917), the Supreme Court
held:

Whether or not a corporation shall seek to enforce in the
courts a cause of action for damages, is, like other busi-
ness questions ordinarily a matter of internal man
ment, and is left to the discretion of the directors, in the
absence of instruction by vote of the stockholders.
Courts interfere seldom to control such discretion intra
vires the corporation, except where the directors are
guilty of misconduct equivalent to a breach of trust, or
where they stand in a dual relation which prevents an
unprejudiced exercise of judgment.

This analysis by the Supreme Court dealing with the initia-
tion of a derivative action has been not only followed but
expanded. In its most recent decision involving a derivative
suit, Burks v. Lasker, supra, 441 U.S. 471, 99 S.Ct. 1831, 60

B-5

L.Ed.2d 404 (1979), the Supreme Court noted that it is only
consistent with such reasoning to extend directors’ discre-
tionary power to include decisions to terminate an ongoing
derivative suit. /d. at 485, 99 S.Ct. at 1840. Whether in a
given case a committee of disinterested directors may rely
upon the business judgment rule to terminate a suit found
to be detrimental to the interests of a corporation depends
on the particular state law governing the status and scope
of that rule. Id. at 480, 99 S.Ct. at 1838.

1
STATE LAW

Accordingly, the Court's first inquiry under Burks
relates to the status of the business judgment rule under
applicable state law. In this case, where both Bancorp and
Citytrust are incorporated in Connecticut, it must be deter-
mined whether Connecticut's corporation law embraces the
rule, and if so, whether the scope is sufficient to encompass
a decision by an independent committee to terminate a
pending derivative suit. Absent any direct statutory or judi-
cial authority for guidance, this Court finds support for the
rule in sources including, but not limited to. state court
opinions, state statutory scheme, specific statutory provi-
sions, concepts of modern corporate law, and by analogy to
other state law schemes.

Connecticut courts have long consistently observed the
basic tenet of corporation law that the discretion to manage
the daily affairs of a corporation rests with its directors.
See, e.g. Osborne v. Locke Steel Chain Co., 153 Conn. 527,
218 A.2d 526 (1966). That discretion, however, is not with-
out its limits. In the earliest Connecticut decision setting
forth the doctrine, Pratt v. Pratt, Read & Co., 33 Conn. 446
(1866), the Supreme Court dealt with a request for injunc-
tive relief brought by a group of stockholders seeking to
prevent a corporation from devoting surplus funds to the
erection of a new building, and to compel distribution of

B-

those funds to the stockholders. The court noted that the
directors acted without malice, improper motive or fraud.
and exercised sound and reasonable judgment and discre-
tion. Id. at 451. In refusing to interfere with the directors’
proposal, the court nevertheless noted that it would not hes-
itate to intervene through its equity powers based on a
showing that the directors had exceeded their powers as
bestowed by the corporate charter. Id. at 455.

The parameters set forth in Pratt have been followed in
the Connecticut decisions of this century. See, e.g. Van Tas-
sel v. Spring Perch Co,, 118 Conn. 636, 646-47, 155 A. 832
(1931); Carten v. Carten, 153 Conn. 603, 615, 219 A.2d 711
(1966). These decisions wherein the state court has
refrained from second-guessing directors’ good faith deci-
sions concerning the corporation’s best interests represent
an implicit acceptance of the business judgment doctrine in
Connecticut, with the limitation that not all decisions are
insulated from judicial scrutiny on a blanket basis.

[5] This Court’s finding that the business judgment rule
exists as a matter of law in Connecticut is not supported
merely by the cases just cited, but finds support also in a
review of the state’s corporate law scheme and its legisla-
tive history. Although no single provision of Connecticut
law expressly refers to the business judgment rule, it is
derived from the power of the board of directors to manage
the corporation, pursuant to C.G.S. § 33-313(a), which
states:

Subject to any provisions pertaining thereto contained
in the certificate of incorporation, the business, prop-
erty and affairs of a corporation shall be managed by or
under the direction of its board of directors.

In interpreting a state law provision analogous to this Con-
necticut statute which invests directors with the power to
manage the corporation, the Delaware Supreme Court
explained:

B-7
ba: ead ms vaed fount of directorial powers. The ‘busi-

1 certain circumstances, in a board’s
vam defensively, it does not create author-
It is ly used as a defense to an attack on

the he decision’ soundness. The board’s managerial deci-
pec i ee er, however, comes from [the statute].
The judic — 4. and * grant are rela
because the business judgment' rule evolved to ae
recognition and deference to directors’ business ex
ee 1 exercising their managerial power under the

Zapata Corp. v. Maldonado, 430 A.2d 779, at 782 (Del. Sup.
1981), rev'’g Maldonado v. Flynn, 413 A.2d 1251 (Del. Ch.
1980). Although the Connecticut Supreme Court has not as
yet so specifically equated the managing power statute to
the existence of a Connecticut business judgment rule, the
cases leave no doubt that the rule is a judicial creation, the
source of which is found in the legislative grant of authority
conferred upon corporate directors by C.G.S. § 33-313(a).

Further support for the existence of the business judg-
ment rule in Connecticut is found in the legislative history
of the state’s corporate law scheme. One commentator has
examined the evolution of corporate law‘ Connecticut and
concluded that the comprehensive revision of the statutes in
1959 to conform to the ALI—ABA Model Business Corpo-
ration Act, “brought Connecticut’s corporation law into line
with, and in some respects well ahead of, the modern
trend.” S. Cross, Corporate Law in Connecticut 38 (1972).
Amendments subsequently enacted by the legislature
which correlate with changes in the Model Act reflect a
continual expansion of the discretionary powers available
to directors. The legislative history of one such amendment
confirms that the supporters of the proposed addition to
C.G.S. § 33-313(d) specifically intended to incorporate the
business judgment rule. As one Senator explained:

B-8

The Bill changes the t duty of care ining to
Directors of ions from the duly diligent exer-
cise of the duties of his office to the business judgment
rule as has been expressed by the Courts.

Senate Reports, Vol. 18, part 3, p. 1418 (May 1, 1975). The
constant revision of Connecticut statutes in this area evin-
ces an intention by the legislature to adopt as part of the
state’s corporation law a broad range of powers associated
with the business judgment rule.

[6] Having thus found that the business judgment rule
exists on a broad basis as a matter of Connecticut law, this
Court must determine whether the scope of the doctrine is
sufficient to encompass a decision by disinterested direc-
tors to dismiss a pending derivative suit. This exact ques-
tion has never been addressed by a Connecticut court, nor
for that matter has a Connecticut court ever addressed the
question of the discretionary power of a corporation to
initiate and maintain a derivative action. Nonetheless, both
of these issues are relevant since, as previously noted, the
Supreme Court has held that the power to discontinue an
action is a logical extension of the power to institute the
action. Burks, supra, 441 U.S. at 485, 99 S.Ct. at 1840.

In predicting how a state court would rule if presented
with this precise question, this Court finds sparse guidance
in the previously cited judicial decisions using the business
judgment rationale in unrelated contexts, even though the
language of the opinions was expansive. This Court primar-
ily relies on the extensive weight of judicial authority in
other jurisdictions, wherein courts have found that when
state law embraces the business judgment rule, its scope
includes a decision by a disinterested and independent com-
mittee of directors to terminate a derivative suit, subject to
limited review of the committee’s good faith and integrity.’

3. See, e. g. Gaines v. Haughton, 645 F. 2d 761 (C.A.9), 1981; Clark v.
Lomas & Nettleton Financial Corp., 625 F.2d 49 (5th Cir. 1980), cert.
denied. U.S. . 101 S.Ct. 1738, 68 L.Ed.2d 224 (1981); Lewis u.

ea

5494

B- 9

PLAINTIFF'S INTERPRETATION
OF STATE LAW

Notwithstanding the ample percent permitting directors
to use a state business judgment rule as authority to termi-
nate an ongoing derivative suit, plaintiff contends that
when the action is based on breach of trust or other fidu-
ciary wrongs, Connecticut law requires a different result.
To support her position, plaintiff relies on specific statutory
provisions and corporate law concepts which are generally
applicable to decisions rendered by directors. Once again,
no Connecticut court has addressed whether the authority
upon which plaintiff relies is relevant in the particular con-
text of a business judgment dismissal of a derivative suit.
However, derivative plaintiffs in other jurisdictions have
unsuccessfully presented arguments similar to the four
made by the instant plaintiff. Those courts confronted with
challenges based on analogous laws and concepts have
rejected such authority as inapplicable to the specific issues
raised when an independent committee votes to terminate a
pending derivative suit.

Anderson, 615 F.2d 778 (9th Cir. 1979), cert. denied, 449 U.S. 869, 101
S.Ct. 206, 66 L.Ed.2d 89 (1980); Galef v. Alexander, 615 F.2d 51 (2d Cir.
1980); Abbey v. Control Data Corp., 608 F.2d 724 (8th Cir. 1979), cert.
denied, 444 U.S. 1017, 100 S.Ct. 670, 62 L.Ed.2d 647 (1980); Cramer v.
GE Corp., 582 F.2d 259 (3d Cir. 1978), cert. denied, 439 U.S. 1129, 99
S.Ct. 1048, 59 L.Ed.2d 90 (1979); Abramowitz v. Posner, 513 F.Supp. 120
(S.D.N.Y.1981); Maldonado , Flynn, 485 F.Supp. 274 (S.D.N.Y.1980),
appeal docketed, No. 80-7221 (2d Cir. 1980); Rosengarten v. Interna-
tional Tel. & Tel. Corp., 466 F. Supp. 817 (S.D.N.Y.1979); Zapata Corp.
„ Maldonado, 430 A.2d 779 (Del.Sup.1981), rev'd, Maldonado v. Flynn,
413 A.2d 1251 (Del.Ch.1980); Lewis v. Adams, Civ. No. 77-266C
(N.D.Okla. 11/15/79); Genzer v. Cunningham, 498 F.Supp. 682
(E.D.Mich.1980); Gall v. Exxon Corp., 418 F. Supp. 508 (S.D.N.Y.1976);
Auerbach u. Bennett, 47 N.Y.2d 619, 419 N. V. S. 2d 920, 393 N.E.2d 994
(1979).

e

B- 10

7, 8] First, plaintiff denies that directors charged with
common law breach of trust have power to terminate a suit
against themselves. This argument might have merit if the
defendants actually charged with violation of trust sought
on their own to dismiss the action. Indeed, the Supreme
Court has held that directors guilty of misconduct equiva-
lent to breach of trust lack the power under certain circum-
stances to exercise their business judgment. United Copper
Securities Co., supra, 244 U.S. at 264, 87 S.Ct. at 510. How-
ever, once an independent committee has been appointed,
the fate of the derivative suit is no longer in the hands of the
defendant directors charged with wrongdoing, but rather
is under the exclusive control of a disinterested committee.
The focus thus shifts from those accused of breach of trust
over to the committee members. So long as the committee
consists of directors who are not personally responsible for
the breach of trust, or otherwise involved in the alleged
illegality, they have the power, properly exercised, to
absolve those directors claimed to have breached their fidu-
ciary duties.

[9] Second, plaintiff contends that the right conferred on
a shareholder to initiate a lawsuit under the state deriva-
tive suit statute, C.G.S. § 52-572j, necessarily confers an
absolute right to maintain the action undisturbed by direc-
tors in the exercise of their business judgment. Virtually
every court faced with this claim has categorically rejected
that the right to bring a derivative suit supports an unres-
tricted right to continue to control it. As the Ninth Circuit
held in Lewis v. Anderson, 615 F.2d 778, 783 (9th Cir. 1979),
cert. denied, 449 U.S. 869, 101 S.Ct. 206, 66 L.Ed.2d 89
(1980):

To allow one shareholder to incapacitate an entire
board of directors merely by leveling charges inst
them gives too much leverage to dissident shareholders.

ala

B-11

More recently, the Delaware Supreme Court elaborated
upon this distinction in Zapata v. Maldonado, supra, at
784-785:

We see no inherent reason why the ‘two phases’ of a
derivative suit, the stockholder’s suit to compel the cor-
poration to sue and the corporation's suit should auto-
matically result in the placement in the hands of the
litigating stockholder sole control of the corporate right
throughout the litigation. To the contrary, it seems to us
that such an inflexible rule would recognize the interest
of one —_ or group to the exclusion of all others
within the corporate entity.

This Court agrees that placing continuous control of the
corporate cause of action in the exclusive hands of the lit-
igating shareholder would elevate the interests of an iso-
lated group over those of the corporate entity, in a manner
neither contemplated by the legislature in enacting the
derivative suit statute nor evident in the legislative history.

Even a cursory glance at the derivative suit statute,‘
reveals that the legislature intended to set up a mechanism
to formalize a shareholder’s power to bring derivative
actions on behalf of the corporation. The legislature specifi-
cally included limits on a shareholder’s power by providing

4, Whenever any corporation or any unincorporated association fails
to enforce a right which may properly be asserted by it, a derivative
action may be brought by one or more shareholders or members to
enforce such right, provided such shareholder or member was a share-
holder or member at the time of the transaction of which he complained
or his membership devolved on him by operation of law. Such action
shall be begun by a complaint returnable to the superior court for the
county or judicial district in which an office of the corporation or associ-
ation is located. The derivative action may not be maintained if it
appears that the plaintiff does not fairly and adequately represent the
interests of the shareholders or members similarly situated in enforcing
the right of the corporation or association. The action shall not be dis-
missed or compromised without the approval of the court, and notice of
the proposed dismissal or compromise shall be given to shareholders or
members in such manner as the court directs.

— ae
=)
2

3-12

that under certain eireumstances, a court had the power to
approve disrnissal or compromise of a derivative action,
even after it had commenced. That power defeats plaintiff's
claim that the statute creates a substantive, indefeasible
right in a shareholder to litigate a derivative suit to its
conclusion without interference. Moreover, this Court finds
no indication that the legislature intended by the derivative
suit statute to grant a shareholder unbridled discretion to
proceed with a suit in the face of opposition by an indepen-
dent committee which has found the suit detrimental to the
corporation. This Court accordingly finds no substance in
plaintiff's reliance on C. G. S. § 52-572) as the source of any
absolute right to prosecute the instant suit to verdict.

Plaintiff's third ground for opposing dismissal is based
on the alleged inapplicability of the business judgment rule
to “non-ratifiable” wrongs. Plaintiff cites numerous deci-
sions in other jurisdictions which hold that neither the
board of directors nor a majority of shareholders may by
ratification validate a wrong which the corporation itself
lacks the power to remedy. According to plaintiff's analy-
sis, by seeking to dismiss claims relating to the alleged
wrongful extension of certain loans, the directors are
impermissibly attempting to ratify the original (non-
ratifiable) conduct. The flaw in tlus argument was noted by
a district court in Laseſ inirks, 404 F.Supp. 1172, 1180
(S.D.N.Y.1975), rev'd on other grounds, 441 U.S. 471, 99
S.Ct. 1831, 60 L.Ed.2d 404 (1979):

The court must also reiect plaintiffs’ argument that the
decision not to sue was tantamount to an illegal ratifica-
tion. Although it can be argued that derivative suits
should be allowed when the Board has refused to sue on
a non-ratifiable wrong, the question of business dra,
ment is separate from the question of ratification, Many
of the cases which established the business judgment
rule and its relation to derivative suits have involved
claims which were arguably non-ratifiable.

B-13

Accord, Gall v. Exxon, 418 F.Supp. 508, 518 n. 18
(S.D.N.Y.1976).

10] To ratify a corporate act involves a limited decision
by the directors as to the propriety of certain actions under-
taken by those charged with managing the corporation.
The directors’ concern in a ratification context is therefore
primarily whether the underlying conduct being reviewed
is legal. If it is concluded that the conduct may expose the
corporation to liability, then such wrongful activity may
not be ratified. In contrast to a ratification situation, the
exercise of business judgment in the context of a derivative
suit involves a broader focus, wherein the legality of the
underlying claims is only one of numerous factors consid-
ered by the board, including but not limited to ethical, com-
mercial, promotional, public relations and fiscal concerns.
Auerbach v. Bennett, 47 N.Y.2d 619, 419 N.Y.S.2d 920, 928,

898 N.E.2d 994, 1002 (1979). Whether the conduct is

regarded as legal or not, the directors’ pa amount concern
is whether the prosecution of the suit wili harm or benefit
the corporation. If, after reviewing the impact on the corpo-
ration, the directors determine that the Jitigation should be
disposed of, “the conclusive effect of such a judgment can-
not be affected by the alleged illegai nature of the initial
action which purportedly gives rise to the cause of action.”
Gall v. Exxon, supra, 418 F.Supp. at 518; accord, Rosen-
garten v. ITT, 466 F.Supp. 817, 824 (S.D.N.Y.1979).

[11] Directors possess the power to terminate an action
which may be meritorious from a legal standpoint, despite
objection of shareholders or the public, because a derivative
suit is unique. As a mechanism for correcting corporate
wrongs as opposed to public wrongs, a derivative suit con-
cerns rights belonging exclusively to the corporation, and
any judgment inures to the sole benefit of the corporation.
Therefore, whatever interest a shareholder or the public
may have in rectifying unlawful conduct must yield to the
business judgment of directors who have in good faith con-

B-14

cluded that the corporation ultimately gains rather than
loses rights by discontinuing the action.

This does not mean, however, that directors may engage
in illegal activity with impunity, relying on the prospect
that a disinterested committee will seek dismissal on their
behalf. To the contrary, when unlawful acts have been com-
mitted, there are other mechanisms available to the public
or shareholders to enforce any rights infringed as a result
of illegal corporate activities. The government may either
prosecute alleged wrongdoers, which serves the public
interest by punishing illegal conduct, or a shareholder may
bring a direct action, which enables those personally
harmed by the conduct to seek redress. These suits are not
subject to dismissal at the instance of directors. As such,
they provide adequate safeguards against directors who
attempt to ratify conduct not capable of ratification. There-
fore, plaintiffs reliance on the allegedly non-ratifiable
nature of the defendants’ conduct in the instant case is mis-
placed in the context of this derivative suit.

12 Finally, plaintiff contends that from the Commit-
too formation through the consequent motions to dismiss
the suit against the corporation's own directors, there exists
a successive chain of self-dealing transactions outside the
scope of the business judgment rule. For this proposition,
plaintiff relies on C.G.S. § 33-828, pertaining to the void-
ability of transactions between interested directors and the
corporation, According to plaintiff, the fact that thirteen
out of a total sixteen directors who appointed the Commit-
tee were also named as defendants automatically taints
both phases of the Committee process—the formation stage
and the final determination. She contends that by allowing
interested directors to participate in the vote appointing
the Committee, the Corporation insured the selection solely
of members certain to recommend dismissal. Based on this
premise, plaintiff concludes that an independent Commit-
tee, free of self-dealing, is structurally impossible so long as
the members owe their appointment to interested directors.

B-15

With respect to plaintiff's claims of self-dealing in the
formation phase, other courts faced with analogous argu-
ments have conceded the potential for self-dealing or struc-
tural bias“ in the establishment of a special committee. Asa
New York court noted in Auerbach, supra:

The ible risk of hesitancy on the part of the
mem of any committee . . to investigate the activi-
ties of fellow members of the board where personal lia-
bility is at stake is an inherent, inescapable, given
aspect of the pres redicament, 419 N. V. S. 2d
at 928, 393 N. E. 2d at 1002

This “predicament” exists in the nature of the corporate
organization, wherein only the existing board of directors
has authority under state law to establish a special commit-
tee and to delegate the power to act on behalf of the entire
board. Notwithstanding the potential for bias, the same
court held that:

To assign responsibility of the dimension here involved
to individuals wholly separate and apart from the board
of directors would, except in the most extraordinary
circumstances, itself be an act of default and breach of
the nondelegable fiduciary duty owed by the members
ot te to the corporation and to its shareholders.

No decision which plaintiff has cited to this Court has held
that this unique relationship between defendant directors
and the directors they chose to determine the fate of the
derivative suit is grounds, standing alone, either to dissolve
the Committee or invalidate its results. In fact, to take this
position would compel this Court to find self-dealing by the
directors even though they followed procedures prescribed
by statute and corporate bylaws in appointing an indepen-
dent Committee. Moreover, to find these procedures infirm

5. Structural bias is inherent prejudice against all derivative suits by
virtue of the composition of the board and relationship between direc:
tors, whereas actual bias resulta from a particular director's personal
involvement in the specific transactions underlying the suit.

B-16

and voidable under the statute would place in jeopardy the
concept of a litigation committee at a time when such com-
mittees have become widely accepted, useful tools for dis-
posing of detrimental derivative actions.

As to plaintiff's claims of bias during the Committee's
deliberative stage, she accuses the Committee members of

continued acts of self-dealing by virtue of their frequent

contact with interested directors at board meetings and
other functions throughout the period of the investigation.
It is this ongoing relationship between the directors on the
Committee and the director defendants which plaintiff
claims is fatal to the Committees power to render a busi-
ness judgment dismissal, This is because, according to
plaintiff, these affiliations rendered the decision to dismiss
a foregone conclusion. If this Court accepted plaintiff's
“conspiracy” argument, it would be compelled to declare
the Committee's final recommendation to be a voidable self-
dealing transaction, pursuant to C.G.S. § 33-323, In the
absence of state judicial or statutory authority applying the
self-dealing statute in this context, this Court must predict
whether a state court would find that all interaction
between defendant directors and non-defendant Committee
members rises to the level of a self-dealing transaction suf-
ficient to nullify the Committee's exercise of its business
judgment.

This Court has examined the self-dealing statute, as the
state court would do, and conc\udes that the legislature
enacted C. G. S. § 33-323 to prohibit directors from reaping
personal financial gain at the corporation’s expense by
exploiting their insider status. Under the terms of the stat-
ute, any transaction which results from a director's abuse
of his fiduciary position is rendered voidable at the option of
the entire board. There is no authority for plaintiff's expan-
sive interpretation of the self-dealing statute as compelling
the invalidation of the Committee's final decision merely
because its members continued to interact with the director

B-17

defendants. Absent such authority, this Court declines to
construe the statute so broadly, particularly when plaintiff
has not uced any evidence of actual self-dealing, as
distinct mere speculation. Only proof of actual self-
dealing during either the formation or deliberative phase
of the Committee’s investigation would warrant a finding
that the entire process must be voided.

[13] Having thus rejected the last of four grounds which
plaintiff raised as state statutory impediments to the appli-
cation of the business judgment rule in the context of a
derivative suit dismissal, this Court finds no remaining
barrier under state law to the Committee's exercise of its
judgment in the instant case.

ia ot hie
9 —

B-18

IV
FEDERAL LAW

14] Once having found that a Connecticut business judg-
ment rule exists and that it permits an independent com-
mittee to seek dismissal, this Court must determine
whether approval of the Committee’s recommendation
would conflict with federal law. Burks v. Lasker, supra, 441
US. at 480, 99 S8. Ct. at 1838. When a derivative suit rests in
whole or in part on a federal law, in this case the National
Banks Act, such law does not render state law irrelevant.
To the contrary, the indisputable mandate of Burks is that
unless federal law directly conflicts with the state scheme
or unless application of state law “would be inconsistent
with the federal policy underlying the cause of action,”
state law prevails. Id. at 479, 99 S.Ct. at 1837, citing John-
son v. Railway Express Agency, 421 U.S. 454, 465, 95 S.Ct.
1716, 1722, 44 L.Ed.2d 295 (1975). This mandate remains
true even if the application of state law would cause a deriv-
ative plaintiff to lose litigation based on meritorious federal
claims. /bid. In fact, the Supreme Court held that federal
law would preempt relevant state law only if Congress spe-
cifically intended federal law to replace the entire corpus of
state corporate law. Id. at 478, 99 S.Ct. at 1837. Congress
will evince such an intention either by enacting a compre-
hensive federal scheme which permits of no state variation,
or by including an express statutory provision which pre-
vents the corporation from invoking its state powers. Id. at
479, 484, 99 S.Ct. at 1837, 1840. Absent an unequivocal
message from Congress that federal law supplies the exclu-
sive rule of decision, or that compelling federal interests
override powers conferred by state law, state corporate law
must control.

[15] In the context of the instant derivative suit, so long
as the National Banks Act is not found by this Court to be

Pi

B-19

inconsistent with state law, the Connecticut business judg-
ment rule will dictate whether the Committee may termi-
nate the action. Plaintiff contends that both the letter and
the spirit of the National Banks Act, 12 U.S.C. § 21 et seq.
(hereinafter, the Act“), conflict with the Committee's
power to compel dismissal. She relies on four sections of the
Act to support claims of inconsistency between state and
federal law: Sections 24 (corporate powers of associations);
§ 73 (violation of oath of office by directors); § 84 (overline
loan); § 93 (director liability for violation of the Act). After
listing these provisions, plaintiff concludes, without analy-
sis, that permitting the directors to dismiss would be con-
trary to and frustrate the purposes of the Act. This Court
finds these conclusory remarks insufficient to satisfy
Burks, which requires a federal court to carefully review
the federal law before rendering a decision as to the degree
of conflict or consistency between state and federal law.
This Court has conducted such a review, and for the follow-
ing reasons rejects plaintiffs claims of inconsistency.

In support of plaintiff's claim based on § 84, pertaining to
overline loans, she contends that the Committee concluded
in its report that the directors might be liable for an over-
line violation with respect to the Katz loans. Based on that
alleged finding, plaintiff claims that termination of the suit
would conflict with this provision of the Act. However,
after reviewing the Committee’s report, this Court has
found no such admission of liability contained therein.
Rather, the figure discusssed in the report merely reflects
the Committee’s valuation of the magnitude of the loans. In
fact, the Committee expressed serious doubt in its report as
to whether liability could be found based on the uncertainty
of damages suffered by the corporation. Plaintiff has there-
fore misinterpreted the Committee’s conclusion regarding
the Katz loans.

[16] Even assuming arguendo that the directors had
authorized an overline loan and plaintiff could prove that

\ ch ded

B-20

such loans violated federal law, Burks makes it plain that
simply by enacting a federal law, Congress did not require
that states, or federal courts, absolutely forbid director ter-
mination of all nonfrivolous actions. Burks, supra, 441 U.S.
at 486, 99 S.Ct. at 1841. The proper inquiry is therefore not
whether the federal claims of overline loans have merit, but
whether any single provision of the federal statute, such as
§ 84, specifically prohibits dismissal in accordance with the
state’s business judgment rule. This court finds no indica-
tion that Congress intended § 84 of the Act to prevent board
action from cutting off detrimental derivative suits.

[17] With respect to claims of conflict based on Section
24, relating to corporate powers of associations, plaintiff
has offered only conclusory statements that applying state
law would pose Aa] significant threat to any identifiable
federal policy or interest.” Burks, supra, 441 U.S. at 479, 99
S.Ct. at 1838. This section simply sets forth the general
corporate powers of associations. It does not provide that
the powers therein are meant to preempt state law. Yet by
relying on this provision of the Act, plaintiff attempts to
persuade this Court that the mere existence of a broad fed-
eral statute requires that state laws governing corporate
affairs be displaced. This position has been rejected by the
Supreme Court in Burks;

Corporations are creatures of state law, and it is state
law which is the font of corporate directors’ powers. By
contrast, federal law in this area is largely regulatory
and prohibitory in nature — it often limits the exercise
of directorial power, but only rarely creates it . . Con-
gress has never indicated that the entire corpus of state
corporation law is to be replaced * because a
plaintiff's cause of action is based upon a federal statute.
441 U.S. at 478, 99 S.Ct. at 1837.

The National Banks Act belongs in this category of laws
which are primarily regulatory. As the Supreme Court
held in Anderson National Bank v. Luckett, 321 U.S. 233,
248, 64 S.Ct. 599, 607, 88 L.Ed. 692 (1943), notwithstanding

B-21

that national banks derive their powers from the federal
statute, they remain subject to the laws of the state. This
Court therefore finds no basis to plaintiff's claim of conflict
between § 24 and state law in the case at bar.

Plaintiff also relies on Section 73 of the Act to support a
possible conflict between state and federal law. That provi-
sion requires each director to take an oath that he will dili-
gently and honorably administer the corporation’s affairs.
State law imposes the identical obligation on all directors
as fiduciaries, to conduct the business of the corporation in
an honest and unprejudiced manner; the two bodies of law
coincide rather than conflict. Plaintiff's claims of inconsis-
tency between federal and state law under Section 73 of the
Act is therefore without basis.

Finally, Section 93 provides that in the event of a judicial
determination of liability in a suit filed by the Comptroller
of Currency, a director responsible for violating the statute
may be exposed to liability. Plaintiff contends that in the
absence of any express language in the federal statute au-
thorizing an independent committee to invoke the state bus-
iness judgment rule in the face of such a finding of liability,
no such power exists. It is the statute’s silenc

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385010_0411%3A2. Public record. Not legal advice.