Levine v. Smith

HORSEY, J.

These separate shareholder suits, consolidated on appeal, challenge once again the business judgment rule's application to action of the General Motors Board of Directors which this Court addressed three years ago in Grobow v. Perot, . . . (hereinafter "Grobow I"). The appeals highlight the differing legal standards controlling shareholder standing to pursue derivative claims depending on whether the shareholder asserts a claim of demand futility or wrongful refusal of demand. In the Grobow appeal (hereinafter "Grobow II"), a derivative claim premised on futility of demand, the Grobow plaintiffs again contend that they have now met their burden of pleading, by their "Second Amended Complaint," particularized facts sufficient to excuse demand. Concurrently, shareholder Morton Levine, appealing the Court of Chancery's dismissal of his original suit, contends that his Amended Complaint pleads particularized facts sufficient to create a reasonable doubt that the General Motors directors wrongly refused Levine's presuit demand.

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I. FACTS

Each of these derivative suits challenges General Motors Corporation's ("GM") repurchase on December 1, 1986 from H. Ross Perot, then GM's largest shareholder, of all his GM Class E stock and contingent notes and those of Perot's close associates of Electronic Data Systems Corporation ("EDS"), a wholly owned GM subsidiary. The facts underlying this transaction have been previously set forth at length in this Court's Opinion in Grobow I and in the reported decision of the Court of Chancery from which the Grobow I appeal was taken. . . . Therefore, we recite those facts only in a summary fashion, including such other facts as are pertinent to these consolidated appeals.

Both derivative actions are brought on behalf of GM and GM's wholly owned subsidiary, EDS, which was founded by Perot. The named defendants in both actions are all twenty-one members of GM's Board of Directors, Perot, and three of Perot's close EDS associates. [I]n 1984, GM acquired by merger 100 percent of EDS' stock. By the terms of the merger, Perot, then EDS' chairman and largest shareholder, exchanged EDS stock for cash, GM Class E stock and a contingent note package. The transaction made Perot GM's largest shareholder with 0.8 percent of GM voting stock. Perot remained chairman of EDS and became a member of the GM Board of Directors. GM and EDS agreed that EDS, although a wholly owned subsidiary of GM, would be allowed to operate with a "substantial degree of autonomy" and would retain "significant control over its internal affairs."

While the GM-EDS merger proved to be largely successful, numerous disputes arose between GM and Perot regarding the management and operation of EDS. By mid-1986, Perot became increasingly critical of GM management concerning issues involving EDS and unrelated to EDS, including the quality of GM products. Perot's criticism received wide media attention, with Perot being quoted in Business Week as having criticized GM for "producing second-rate cars." Perot also believed that GM was not acting in accordance with agreements the parties had reached. By the summer of 1986, Perot made demands upon GM's chairman that GM either buy him out or else allow him to operate EDS as he saw fit. Perot also threatened to sue GM.

In the fall of 1986, GM and Perot entered into negotiations for GM to repurchase Perot's interest in GM. This followed an aborted effort by GM to sell EDS to American Telephone and Telegraph. By November 30, 1986, the terms of a definitive agreement had been reached; and on that date, the Oversight Subcommittee of the GM Board's Audit Committee met to discuss the proposed agreement. The members of the three-person Subcommittee were all outside, non-management directors. Other directors participated in the lengthy meeting, although the full Board was not present. The Oversight Subcommittee unanimously recommended that the GM Board approve the terms of the repurchase. At the time, GM's twenty-one member Board consisted of but seven inside, or management, directors and fourteen outside directors, excluding Perot. The next day, December 1, the full GM Board (excluding Perot) met and unanimously approved the transaction.

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On December 11, 1986, ten days after the GM Board's approval of the Perot repurchase agreement, GM shareholder Levine made written demand upon the GM Board to rescind the Perot repurchase transaction. Levine also requested that the Board allow him to appear and speak in support of his position at its next meeting. Although the Board promised of his position at its next meeting. Although the Board promised to consider the demand at its next regularly scheduled meeting, it did not hear from Levine in person. On January 5, 1987, the GM Board met and voted unanimously to reject demand. GM notified Levine's counsel on January 9, 1987 that the Board had reviewed the December 11 demand letter and had unanimously decided that legal action would not be "in the best interests of the Corporation." On February 3, 1987, Levine filed suit in the Court of Chancery; . . . On November 27, 1989, the Court of Chancery granted defendants' motion and dismissed the Levine Amended Complaint. . . .

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In Levine, the first issue we address is whether, in a demand refused case, a shareholder plaintiff suing derivatively is entitled to discovery prior to responding to a Rule 23.1 motion to dismiss. . . . [P]laintiff Levine, shortly after filing suit in February 1987, initiated discovery of defendants by written interrogatories and requests for production of documents. Defendant then moved to dismiss the complaint under Rule 23.1 and sought a protective order barring discovery pending disposition of its motion to dismiss. Levine characterizes the discovery sought as "limited." Following briefing and argument, the Court of chancery, in December 1987, granted defendants' motion for a protective order staying discovery. The court held that a shareholder plaintiff, alleging that a pre-litigation demand has been wrongfully refused, is not entitled to discovery prior to responding to a Rule 23.1 motion to dismiss. The court ruled that a derivative plaintiff's standing to sue, whether suit is based on demand refused or demand excused, must be determined on the basis of the well-pleaded allegations of the complaint.

On appeal, Levine contends that the Court of Chancery erred as a matter of law in denying him "limited discovery" to substantiate his complaint's averments that his presuit demand on the GM Board was wrongfully refused. The decisional law on which Levine relies is limited to this Court's approval of discovery in Zapata, . . . and the federal district court's ruling in In re Continental Illinois Securities Litigation, . . .

Levine recognizes that Zapata was a "demand excused" case. He is also well aware of Aronson's post-Zapata ruling that, unless a special committee of the board has moved to dismiss, the issue of demand futility must be determined on the basis of the shareholder's derivative complaint. . . . Notwithstanding Aronson, Levine urges this Court to adopt the reasoning of the court in Continental Illinois, decided before Aronson, to extend the discovery permitted in Zapata to cases of demand refused. The court in Continental Illinois ruled that a derivative claimant in a demand refused case should be allowed limited discovery. The court reasoned that the burden of proof of the propriety of refusal should fall upon the board. . . . Levine also makes a "policy" argument: without discovery the court of Chancery has "unjustly tilted the scales [in favor of the board] and permitted a corporate board to simply refuse a shareholder's demand for action with impunity." Finally, Levine argues that the burden of proof of the propriety of a refused demand should logically fall upon the defendant board. The board has "better access to the relevant facts" and, having raised the defense, the board should have "the burden of proving that defense." . . .

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The rationale for allowing discovery in a demand excused-Zapata context has no application in the case of either demand refused or demand excused, absent the Zapata context. The issue in Zapata was whether an impliedly interested board could delegate its power to dismiss a derivative suit to a special committee of outside disinterested directors. . . . This Court found that it could, if, among other things, the corporation could prove the Committee was independent, operated in good faith, and made a reasonable investigation. . . . As the court below pointed out, the act of establishing a special litigation committee constitutes an implicit concession by a board that its members are interested in the transaction and that its decisions are not entitled to the protection of the business judgment rule. . . . However, as we stated in Spiegel, a board of directors concedes demand futility when it is both interested and establishes a special litigation committee to resolve the derivative plaintiff's suit. . . . Therefore, demand is excused and discovery is allowed. There is no basis for such presumptions to be extended to a demand refused case.

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We next address the question of whether the trial court applied the proper pleading standard in determining the sufficiency of the Levine complaint to withstand dismissal under Rule 23.1. At issue is the form of pleading and degree of particularity required for a complaint based on wrongful refusal of demand to be sustained. Levine makes two alternative arguments. First, he contends that, assuming the pleading standards controlling a claim of wrongful refusal of demand are those set forth in Aronson and Grobow I, the Court of Chancery committed legal error by applying to his complaint a pleading standard that was "heightened" and "far more stringent" than that required by mule 23.1, as interpreted in Aronson and Grobow. In the alternative, Levine argues that a more lenient pleading standard should be applied under Rule 23.1 to sustain a claim of wrongful refusal of demand which alleges "legally sufficient reasons" for questioning the validity of a board's exercise of its business judgment.

In Aronson, this Court formulated the "reasonable doubt" pleading standard for determining the sufficiency of a complaint based on demand excused to withstand a Rule 23.1 motion. This Court stated:

In our view demand can only be excused where facts are alleged with particularity which create a reasonable doubt that the directors' action was entitled to the protections of the business judgment rule.

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In sum the entire review is factual in nature. The Court of Chancery in the exercise of its sound discretion must be satisfied that a plaintiff has alleged facts with particularity which, taken as true, support a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. Only in that context is demand excused.

Levine does not dispute the applicability of the Aronson reasonable doubt test to a claim of wrongful refusal of demand. The reasons underlying the adoption in Aronson of the "reasonable doubt" test to a claim of demand futility have equal application to standing of a derivative plaintiff to maintain a claim of wrongful refusal of demand. . . .

We think it clear from the record and the decision below that the court applied the "reasonable doubt" pleading standard to Levine's claim of wrongful refusal of demand. In addressing the issue of the appropriate pleading standard, the court stated, "The Rule 23.1 demand requirement, and the implementing form of judicial scrutiny required by Aronson v. Lewis and Grobow v. Perot, . . . are procedures to which this court must adhere in determining whether the board is so disabled." In properly rejecting plaintiff's contention that the court should apply the more lenient Rule 12(b)(6) "notice pleading" standard, the court reasoned that a notice form of pleading would "contravene the policy underlying Rule 23.1 and the clear mandate of Aronson." It is patently clear that the court considered the reasonable doubt standard of Aronson as controlling its ultimate determination of the sufficiency of Levine's complaint under Rule 23.1.

Alternatively, Levine argues that a derivative complaint based on a claim of demand refused should be found to comply with Rule 23.1 when a plaintiff "alleges legally sufficient reasons to call into question the validity of the Board of Directors' exercise of business judgment." . . .

Rule 23.1's command that a derivative complaint "allege with particularity the efforts . . . made by the plaintiff to obtain the action he desires from the directors . . . and the reasons for his failure to obtain the action . . ." cannot be parsed to permit conclusory reasons alone to suffice. The requirements of particularity apply both to plaintiff's efforts to obtain the desired action and the reasons for failing to secure redress. Allison cannot be fairly read as intending any departure from Aronson's and Grobow I's requirement of well-pleaded allegations of fact which create a reasonable doubt that a board of directors decision is protected by the business judgment rule. . . .

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We next address the issue of whether the Court of Chancery applied the correct legal standard for determining the sufficiency of Levine's Amended Complaint to withstand defendant's Rule 23.1 motion to dismiss. The trial court ruled that the legal standard governing Rule 23.1 motions to dismiss "demand refused" cases is the same standard that governs dismissal of a "demand futility" case, that is, the Aronson two-part inquiry into board disinterest and independence as well as application of the tradition business judgment rule to the Board's refusal of the demand. The court thereby committed legal error.

The focus of a complaint alleging wrongful refusal of demand is different from the focus of a complaint alleging demand futility. The legal issues are different; therefore, the legal standards applied to the complaints are necessarily different. A shareholder plaintiff, by making demand upon a board before filing suit, "tacitly concedes the independence of a majority of the board to respond. Therefore, when a board refuses a demand, the only issues to be examined are the good faith and reasonableness of its investigation." . . . When a shareholder files a derivative suit asserting a claim of demand futility, hence demand excused, the basis for such a claim is that the board is (1) interested and not independent; and (2) that the transaction attacked is not protected by the business judgment rule. . . . In contrast, Levine's complaint based on wrongful refusal of demand not only tacitly concedes lack of self-interest and independence of a majority of the Board, but expressly concedes both issues. Thus, the first part of the Aronson test did not come into play and the trial court was only required to address the application of the business judgment rule to the Board's refusal of Levine's demand.

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We turn to Levine's final argument: that the Court of Chancery erred in finding his Amended Complaint to fail to allege particularized facts sufficient to overcome the business judgment rule presumption accorded the GM Board's refusal of his pre-suit demand. The standing of shareholder Levine to exercise "legal managerial power" and assert a derivative claim hinges upon his ability to establish that the GM Board's rejection of his demand was wrongful. . . . As we stated in Spiegel, "the effect of a demand is to place control of the derivative litigation in the hands of the board of directors"; and therefore, the board's refusal is subject to "judicial review according to the traditional business judgment rule." . . . Levine, by electing to make demand upon the GM Board before filing suit, tacitly conceded the independence of a majority of the GM Board to respond to his demand. . . . Levine also does not challenge the GM Board's good faith in rejecting his demand. Therefore, under the traditional business judgment rule, the only issue remaining to be resolved is the reasonableness of the GM Board's investigation of Levine's demand. . . . Reasonableness implicates the business judgment rule's requirement of procedural due care; that is, whether the GM Board acted on an informed basis in rejecting Levine's demand. . . .

Levine's complaint may be summarized as asserting essentially three allegations in support of his claim that the GM Beard failed to exercise due care and to reach an informed business judgment in refusing his demand. Levine asserts: (1) that the Board declined to permit plaintiff's counsel to make an oral presentation to the Board concerning his demand; (2) that the Board failed to undertake any investigation of his demand for rescission of the Perot buyout; and (3) that GM's Board "did nothing" following receipt of his demand. Levine contends that these allegations are sufficient to create a reasonable doubt that the GM Board acted in an informed manner in refusing Levine's demand.

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While a board of directors has a duty to act on an informed basis in responding to a demand such as Levine's, there is obviously no prescribed procedure that a board must follow. We find no abuse of discretion in the Vice Chancellor's rejection of Levine's contention that the GM Board's failure to permit Levine to make an "oral presentation" to the Board evidenced a lack of due care or unreasonable conduct. Indeed, the court found the argument insufficient as a matter of law, stating:

“A board of directors is not legally obligated to permit a demanding shareholder to make an oral presentation at a meeting. Corporate directors normally have only limited available time to deliberate, and a determination of what matters will (and will not) be considered must necessarily fall within the board's discretion. . . . A ruling that, as a practical matter, would require GM'S Board to hear the plaintiff's oral presentation, would place directors in the untenable position of having to entertain presentations by any shareholder who threatens to file a derivative action. It would also be an unwarranted intrusion upon the board's authority to govern the corporation's affairs conferred by 8 Del. C. § 141.”

We fully agree.

Plaintiff's remaining allegations, that GM's Board, after receiving Levine's demand letter "did not undertake an investigation" and "did nothing," represent conclusory allegations that are in fact contrary to the pleading record. Levine's allegation that the Board "did nothing" is contradicted by the Board's letter of reply rejecting Levine's demand. The letter, attached to plaintiff's Amended Complaint, states, "following review of the matters set forth in your December 11, 1986 letter, the Board . . . unanimously determined that an attempt to rescind, or litigation . . . concerning [the repurchase agreement] is not in the best interests of the corporation." As the trial court points out, GM's letter reply "is inconsistent with, and thus diminishes the force of, plaintiff's allegation that the Board 'did nothing.'" Further, the Board's letter response refusing Levine's demand "following review of the matters" which were the subject of Levine's demand letter of December 11, 1986 reflects on its face the GM Board's consideration of Levine's demand. The only reasonable inference to be drawn from this document is that the GM Directors did act in an informed manner in addressing Levine's demand. The business judgment rule accords directors the presumption that they acted on an informed basis. . . . The trial court was clearly correct in dismissing Levine's Amended Complaint for failure to plead particularized facts sufficient to create a reasonable doubt that the GM Board's rejection of Levine's demand was wrongful because reached in an uninformed manner.

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