## Facts

- Shareholders of a registered investment company brought a derivative action alleging that the fund’s directors and its registered investment adviser caused the fund to purchase commercial paper in violation of the Investment Company Act of 1940 (ICA), the Investment Advisers Act of 1940 (IAA), and state fiduciary duties.
- After the suit was filed, five non-affiliated, non-defendant directors (a quorum under the bylaws) reviewed the claims and concluded continued litigation was contrary to the company’s and shareholders’ best interests.
- The independent directors moved to dismiss the derivative action based on their business judgment under applicable corporate governance rules.
- The district court found no evidence the independent directors acted other than independently and in good faith and granted summary judgment dismissing the derivative claims.
- The Second Circuit reversed, holding the ICA prevented disinterested directors from terminating nonfrivolous shareholder litigation against majority directors for breach of fiduciary duty.

## Issues

1. In a derivative suit alleging ICA and IAA violations, must federal law categorically bar independent directors from terminating nonfrivolous litigation, or may state corporate law supply the standard for dismissal authority?
2. To what extent should federal courts apply state law on independent directors’ authority to discontinue derivative suits, and when must that law be displaced as inconsistent with the ICA/IAA or their policies?

## Decision

- The Supreme Court reversed the Second Circuit and remanded.
- Federal courts should apply state law governing independent directors’ authority to discontinue derivative suits, but only to the extent the state law is consistent with the policies of the ICA and IAA.
- Congress did not require an absolute federal rule forbidding director termination of all nonfrivolous derivative actions involving registered investment companies.
- On remand, the lower courts were to determine, under relevant state law, whether the independent directors had authority to seek dismissal and whether exercising that authority would conflict with federal statutory policy.

## Legal Principles

- When enforcing assumed implied derivative causes of action under the ICA/IAA, state corporate law does not control “of its own force”; it is applied as part of the federal rule of decision only insofar as consistent with federal law and policy.
- The ICA primarily imposes controls and restrictions on investment company management; it does not generally replace state-law allocations of board authority.
- State law governing dismissal of derivative litigation is displaced if it (1) permits conduct prohibited by the ICA/IAA, or (2) would be inconsistent with the federal policy underlying the federal cause of action.
- There is no categorical federal prohibition preventing independent directors from deciding to terminate nonfrivolous derivative litigation; permissibility depends on state law filtered through the federal consistency test.

## Conclusion

The Court held that independent directors’ power to terminate derivative litigation alleging ICA/IAA violations is governed by applicable state corporate law incorporated into federal law, unless that state rule authorizes what the federal Acts forbid or conflicts with the federal policies those Acts serve, and it remanded for application of that standard.


Burks v. Lasker, 441 U.S. 471 (1979)