In a recent decision in a diversity case, the Seventh Circuit deferred to a state legislature’s “strongly pro-management version of the business judgment rule,” rejecting a derivative claim filed by shareholders in an Indiana corporation who had failed to make a demand on the corporation’s board of directors. In re: Biglari Holdings, Inc. Shareholder Derivative Litigation, No. 15-1828 (Feb. 17, 2016). The case is instructive for Wisconsin practitioners as to the Seventh Circuit’s deference to the business judgment rule embodied in many states’ corporations statutes. As emphasized in our Supreme Court’s decision in Data Key Partners v. Permira Advisers LLC, 2014 WI 86, Wisconsin, too, has a strong business judgment rule, see Wis. Stat. § 180.0828(1). And, like Indiana, Wisconsin looks for guidance to Delaware corporate-governance law when applying it.
In Biglari Holdings, shareholders alleged that the directors approved three transactions in order to entrench and enrich the company’s CEO and Chairman – Mr. Biglari himself – and perhaps to entrench the other board members as well. For this sort of challenge, shareholders normally first demand that the board address the matter by filing suit or otherwise, unless such a demand would be futile. In Indiana, demand is futile (and shareholders can file suit without making a demand) if a derivative claim poses a significant risk of personal liability for the board members. When is that risk significant such that directors would be unlikely to take up a demand? In Indiana, if no good reason is given to cast doubt on the disinterestedness and independence of the board, plaintiffs must show facts creating a reasonable doubt that a majority of the board had exercised reasonable business judgment.
The district court held that the plaintiffs had not demonstrated demand futility and dismissed the claims. The Seventh Circuit affirmed. Judge Richard Posner, writing for the panel, began by citing Delaware law to quickly reject the plaintiffs’ allegations that the directors acted to entrench themselves, or were not independent.
Next the court moved to detail the three challenged transactions. As pleaded, one could see the transactions raising suspicions. One provided that, if Mr. Biglari or the majority of the board were replaced, he would get a 2.5% royalty on products using his name, which plaintiffs said would have amounted to 81% of net earnings for 2012 and would prevent a changing of the guard. The second deal sold Biglari Capital Corporation back to Mr. Biglari for $1.7 million, three years after he had sold it to Biglari Holdings for $4.2 million. For the third, plaintiffs attacked a stock offering that allowed Mr. Biglari to (modestly) increase his percentage ownership in Biglari Holdings. Judge Posner took care to describe these facts and some of the explanations that the directors did, or might, provide.
Then the court wasted no time in disposing of the claims. Its summary analysis of the claims and their disposition took only one short paragraph, and required no analysis of the relevant cases or doctrines. The court clearly gave significant weight to the legislature’s decision to pass a stringent business judgment rule, creating a presumption that directors act in good faith believing their actions are in the company’s best interest. The Seventh Circuit set up a test consistent with the legislature’s decision: whether the transactions were “so obviously improper” that “the board cannot be thought to have been acting in [shareholders’] interest.” “Given the stringency of the Indiana standard of demand futility and the lack of strong support for the plaintiffs’ claims to demonstrate that futility, the three challenged transactions, whether examined individually or together, cannot be deemed so oppressive to shareholders as to create a substantial doubt that the transactions were the product of a valid exercise of business judgment by an unbiased and independent board.” (emphasis added).
The bottom line is that courts defer to the business decisions of corporate boards absent unusual circumstances. Part of that deference involves requiring shareholders to first route their complaints through the board. Would-be derivative plaintiffs would do well to remember that before adopting a “shoot first” approach to derivative litigation.