Master Delaware Supreme Court establishes a two-step judicial review for special litigation committee motions to dismiss derivative suits when demand is excused. with this comprehensive case brief.
Zapata Corp. v. Maldonado is the foundational Delaware case that defines how courts evaluate a corporation’s attempt—through a board-appointed special litigation committee (SLC)—to dismiss a shareholder derivative action where pre-suit demand has been excused. The decision balances two competing concerns: on the one hand, the need to prevent meritless strike suits that drain corporate resources; on the other, the risk that a board accused of wrongdoing may deploy an ostensibly independent committee to protect insiders and quash meritorious claims.
Rejecting the purely deferential approach taken by some jurisdictions, the Delaware Supreme Court crafted a two-step framework that preserves meaningful judicial oversight. Under this test, courts first scrutinize the SLC’s independence, good faith, and the reasonableness of its investigation; then, even if those criteria are met, courts may apply their own independent business judgment to decide whether dismissal is in the corporation’s best interests. Zapata thus remains a cornerstone of Delaware corporate jurisprudence and a staple of corporate law courses addressing derivative litigation, demand futility, and board authority.
Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981)
A Zapata Corporation shareholder, Maldonado, filed a derivative action in the Delaware Court of Chancery alleging that certain Zapata directors and officers breached their fiduciary duties and committed corporate waste, naming a majority of the then-sitting board as defendants. Maldonado made no pre-suit demand, alleging demand futility because the board was interested and incapable of impartially evaluating a demand. The Court of Chancery determined that demand was excused. After the suit was filed and while it was pending, Zapata’s board appointed two new outside directors and created a Special Litigation Committee (SLC) composed solely of those new directors, delegating to the SLC full authority under 8 Del. C. § 141(c) to investigate the derivative claims and determine the corporation’s litigation posture. The SLC retained independent counsel, conducted an investigation, and concluded that pursuing the claims was not in the corporation’s best interests; it recommended dismissal. Relying on the SLC’s recommendation, Zapata moved to dismiss. The Chancery Court confronted whether, and to what extent, it should defer to an SLC’s decision to terminate litigation where demand had been excused because the board was interested.
When demand is excused in a shareholder derivative suit, what standard governs a court’s review of a special litigation committee’s decision to terminate the litigation, and may a court exercise its own business judgment to deny dismissal even if the committee is independent and acted in good faith after a reasonable investigation?
Delaware adopts a two-step test for SLC motions to dismiss when demand is excused: (1) The corporation bears the burden to prove that the SLC was independent, acted in good faith, and had reasonable bases for its conclusions after a reasonable investigation. Limited discovery may be permitted on these issues. If the corporation fails at this step, the motion is denied. (2) If the corporation meets step one, the court may, in its discretion, apply its own independent business judgment to determine whether the motion to dismiss should be granted, i.e., whether dismissal is in the corporation’s best interests. This approach departs from purely deferential standards by authorizing substantive judicial review even when the SLC satisfies procedural and independence requirements.
A board of directors may delegate to an SLC the authority to decide whether to pursue or dismiss a derivative action even where demand has been excused, but the trial court must apply a two-step analysis: first, assess the SLC’s independence, good faith, and reasonableness of investigation; second, if that showing is made, exercise its own business judgment to determine whether dismissal is in the corporation’s best interests. The case was remanded for application of this standard.
The Delaware Supreme Court recognized the structural tensions inherent in derivative litigation. Although boards generally enjoy business judgment deference, derivative suits exist precisely because boards may be conflicted or unwilling to sue themselves. Where demand is excused due to board interest, allowing that same board to extinguish the suit through a committee poses risks of bias, yet providing no avenue to terminate weak claims would unduly expose corporations to costly, meritless litigation. To address these competing concerns, the Court rejected the New York Court of Appeals’ approach in Auerbach v. Bennett, which largely confined judicial review to assessing a committee’s independence, good faith, and the adequacy of its procedures, without second-guessing its substantive decision. Delaware instead crafted a two-step framework that preserves corporate autonomy while ensuring meaningful judicial oversight. At step one, the corporation—bearing the burden—must demonstrate that the SLC was truly independent, acted in good faith, and conducted a reasonable investigation that provides a reasonable factual basis for its conclusions. The court may permit limited discovery, focused on committee independence and investigative rigor, recognizing that conclusory affidavits or superficial inquiries are insufficient. At step two, even if the SLC passes the procedural and independence thresholds, the court has discretion to apply its own independent business judgment to determine whether dismissal would serve the corporation’s best interests. This discretionary, substantive review acknowledges the risk of subtle structural bias and the gravity of dismissing claims that may vindicate corporate rights. The court may weigh factors including the strength of the claims, likely recoveries versus costs, potential collateral consequences, and the corporation’s policies and governance interests. By reserving this gatekeeping function to the judiciary, Delaware ensures that SLCs do not become mere instruments for insulating fiduciaries from accountability. Because the Chancery Court did not have the benefit of this articulated standard, the Supreme Court remanded the case for application of the two-step test to the record developed regarding the SLC’s composition, process, and conclusions.
Zapata is the definitive Delaware authority on special litigation committees in the demand-excused context. It delineates the burden of proof (on the corporation), authorizes limited discovery into independence and investigative adequacy, and—critically—permits courts to exercise independent business judgment to deny dismissal even when an SLC appears procedurally sound. The case remains central to understanding derivative litigation strategy, the interplay with demand futility doctrine, and the limits of the business judgment rule when board members are potential defendants. For law students, Zapata frames how Delaware reconciles board managerial authority with the need for accountability, and it provides the analytic template later applied and refined in cases evaluating SLC independence and effectiveness.
An SLC is a committee of disinterested directors empowered by the board (under 8 Del. C. § 141(c)) to determine the corporation’s position in derivative litigation, including whether to pursue, settle, or dismiss claims. In Zapata, after demand was excused because most directors were named defendants, the board appointed two new outside directors to an SLC to investigate the claims and decide if continuing the suit was in the corporation’s best interests.
Step one asks whether the corporation has proven the SLC’s independence, good faith, and the reasonableness of its investigation and conclusions. Courts may allow limited discovery focused on these issues. If the corporation meets this burden, step two authorizes the court, in its discretion, to exercise independent business judgment to decide whether dismissal is in the corporation’s best interests, weighing factors like claim strength, litigation costs, potential recoveries, and broader corporate impacts.
Auerbach (New York) generally confines review to process—independence, good faith, and investigative adequacy—eschewing substantive second-guessing of the committee’s decision. Zapata adds a second step: even if the SLC passes process scrutiny, Delaware courts may apply their own business judgment and deny dismissal if they conclude continuation is in the corporation’s best interests. This preserves a judicial check against structural bias.
The corporation bears the burden at step one to prove SLC independence, good faith, and a reasonable investigation with a reasonable basis for its conclusions. The court may permit limited discovery tailored to those points (e.g., the SLC’s composition, relationships, counsel selection, scope and depth of inquiry, and materials reviewed). Broader merits discovery is generally inappropriate at this stage.
Zapata’s two-step framework was developed for the demand-excused setting, where the board’s structural interest is pronounced. If demand is made and refused, a different deference framework typically applies because the board has exercised its business judgment in response to a demand. Nonetheless, principles of independence and good faith remain relevant whenever a committee evaluates corporate litigation.
Courts look at whether committee members are newly added or outside directors; the absence of personal, financial, or social ties to interested fiduciaries; the SLC’s freedom to retain independent counsel; the breadth and depth of its inquiry; and the manner in which authority was delegated. Even subtle ties or structural dependencies can undermine independence.
Zapata v. Maldonado sets the modern Delaware template for judicial oversight of SLC decisions to terminate derivative suits in demand-excused cases. By imposing a corporation-side burden to prove independence and investigative rigor and authorizing courts to exercise independent business judgment, the decision strikes a pragmatic balance between deterring meritless litigation and preventing conflicted fiduciaries from insulating themselves from accountability.
For students and practitioners, Zapata underscores that process is necessary but not sufficient: independence, good faith, and reasonableness open the door, but the court retains the final say on the corporation’s best interests. Mastery of Zapata’s two-step test is essential to evaluating derivative litigation strategy, designing effective SLC processes, and understanding Delaware’s unique blend of deference and judicial review in corporate governance.