Court Orders Discovery In Derivative Action Challenging Racial Diversity

Last year, the City of Pontiac General Employees' Retirement System filed a derivative suit against the Board of Directors and Chief Executive Officer of Cisco Systems, Inc.  The gist of the complaint was that the "Defendants publicly misrepresented Cisco's success as an industry leader in top leadership diversity and as a company that effectively promotes diversity throughout its ranks". 

Cisco responded by bringing two motions - a motion to dismiss under Rule 23.1 and a motion to terminate.   Cisco's motion to terminate was based on its claim that Cisco's board performed a reasonable and good faith investigation and that the board's resulting decision to reject plaintiff's demand is entitled to deference under the business judgment rule.

The plaintiff sought discovery.   Because the motion to dismiss was a pleadings motion, U.S. Magistrate Judge Thomas S. Hixson ruled that no discovery was necessary for the plaintiff to respond.   Judge Hixson, however, ruled that discovery was needed with respect to the motion to terminate because it was based on the special litigation defense:

The absence of a written Committee report, combined with a Board Resolution that is a complete black box that provides no meaningful assessment of what the investigation found, necessitates discovery.  The only way for Plaintiff to have any meaningful opportunity to oppose the motion to terminate is discovery.  Otherwise, the investigation would remain essentially a mystery, with Plaintiff knowing only that one occurred, but having no information about whether it was done in good faith.

City of Pontiac Gen. Emples. Ret. Sys. v. Bush, 2021 U.S. Dist. LEXIS 119066, 2021 WL 2588979.  

Cisco was a California corporation until its reincorporation into Delaware this year.   California follows the New York approach to the review of special litigation committee decisions to terminate derivative suits:

While the substantive aspects of a decision to terminate a shareholders' derivative action against defendant corporate directors made by a committee of disinterested directors appointed by the corporation's board of directors are beyond judicial inquiry under the business judgment doctrine, the court may inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee.

Auerbach v. Bennett,  393 N.E.2d 994, 996 (1979).   The California Court of Appeal adopted Auerbach in Desaigoudar v. Meyercord, 108 Cal. App. 4th 173, 188 (2003).  Delaware adds a second step to Auerbach in which the court applies its own business judgment to the committee's conclusion.   Zapata Corp. v. Maldonado 430 A.2d 779, 787–789 (Del. 1981).