In the fall of 2011, Caterpillar Inc. began making serious inquiries about the possible acquisition of a Chinese mining company, ERA Mining Machinery Ltd., and its wholly owned subsidiary, Zhengzhou Siwei Mechanical & Electrical Equipment Manufacturing Co., Ltd. (Siwei). Caterpillar completed that acquisition in June 2012. Only after the closing did Caterpillar gain access to Siwei’s physical inventory. What it found was unsettling. An inspection of the inventory revealed that Siwei had overstated its profits and improperly recognized revenue. As a result, Caterpillar took a $580 million goodwill impairment charge just months after the acquisition was completed. Plaintiffs Robert Lowinger and Issek Fuchs (the Lowinger Plaintiffs), both Caterpillar shareholders, brought a shareholder derivative suit alleging that several former Caterpillar officers breached their fiduciary duties by failing to conduct an adequate investigation of the Siwei acquisition. That failure, they contend, caused Caterpillar’s loss. The Lowinger Plaintiffs made a demand that the Caterpillar Board sue Siwei; the Board refused based on opinions from law firms Jones Day and Sidley Austin that the suit would likely fail. The Lowinger Plaintiffs argue that the Board’s refusal was improper, and the Board argues that its actions are protected under the business judgment rule.
CHIEF JUDGE WOOD The question we face is a narrow one. It is not whether the Siwei acquisition was good or bad for Caterpillar. Nor are we concerned with whether Caterpillar’s board made the right decision by not bringing litigation against its former officers. Instead, our review is confined to whether the Board’s decision not to litigate is protected by the wide bounds of the business judgment rule, or if the Lowinger Plaintiffs have managed to allege with particularity facts suggesting that the Board’s decision was irrational or the result of a grossly negligent process. The plaintiffs can meet their burden by pleading facts that show that the Board’s decision “cannot be attributed to a rational business purpose” or that the Board reached its “decision by a grossly negligent process that includes the failure to consider all material facts reasonably available.”
The Lowinger Plaintiffs’ most serious allegation is that Jones Day could not independently evaluate Caterpillar’s claims because that firm also represented E&Y and Citigroup, two of the possible defendants in any litigation about the Siwei acquisition. Moreover, plaintiffs note, Jones Day also relied on Sidley’s investigation of the Siwei acquisition, but Sidley was conflicted because it represented the corporate officers in both this case and the Demand Futility Action.
It is true that conflicts can undermine the business judgment rule. But these plaintiffs have not alleged with particularity any potentially disqualifying conflicts. Their only reference to Jones Day’s representation of E&Y and Citigroup is that Jones Day “regularly represents and works together with both of those entities.” This is not enough to give us the information that we would need to decide whether Jones Day was actually conflicted. The mere fact that a law firm represented a client on some other matter does not automatically disqualify the firm whenever that client may be involved as an opposing party in future litigation. The Lowinger Plaintiffs simply have not provided enough information about Jones Day’s representation of Citigroup and E&Y to reveal with particularity any conflict that creates a reasonable doubt about the Board’s business judgment.
The Lowinger Plaintiffs’ other arguments fall into two buckets: the Board’s allegedly improper lack of response to their demand, and perceived inadequacies in Jones Day’s investigation. The Board’s decision to delay responding to their demand while the Demand Futility Action was pending does not create a reasonable doubt with respect to the Board’s business judgment. If anything, that was a prudent business decision. If the Demand Futility Action had been successful, then the Board would be disqualified from responding to a demand, and so any resources spent responding to the Lowinger Plaintiffs’ demand would have been wasted.
The Lowinger Plaintiffs counter that the Board risked making certain claims time-barred by delaying a response. They contend that the Board could have mitigated this risk by entering into tolling agreements, but that it refused to do so. That failure to mitigate, Lowinger Plaintiffs contend, raises a reasonable doubt about their business judgment. But as the Lowinger Plaintiffs’ complaint illustrates, they made this argument about the statute of limitations to Sidley, the Board’s counsel, and it disagreed. The only reasonable inference to draw from this exchange is that the Board relied on its counsel’s legal advice when deciding to delay a response without tolling agreements. That advice was not so erroneous that relying on it was grossly negligent. Indeed, the district court believed that Sidley’s advice on the statute of limitations was correct.
The Lowinger Plaintiffs finally attempt to create doubt about the Board’s judgment by attacking various parts of Jones Day’s legal and factual analysis, and the choices it made about whom and whom not to interview. But these arguments all amount to “cavils about the types of documents reviewed, or the choice of persons to be interviewed” that “will not support a finding of gross negligence.” These plaintiffs might come to a different conclusion about the strategic importance of the acquisition, the risk that litigation might cause disruption and excessive cost for Caterpillar, or the need to interview Siwei’s former CEO. But those types of business and investigative choices are exactly what the business judgment rule protects. More to the point, nothing about Jones Day’s process, or its legal or factual analysis, was so egregiously deficient that the Board was grossly negligent to rely on it. And it is egregiousness that Delaware requires to rebut the business judgment rule’s protections.
CRITICAL THINKING:
Are there words or phrases in the court’s argument that are ambiguous? Why are these ambiguous words important?
ETHICAL DECISION MAKING:
Suppose you were on the board of directors in this case. The universalization test guides your ethical decisions. Would you have made a different decision?