Appeals court flattens shareholders' suit vs Caterpillar execs for misbegotten Chinese deal

By Dan Churney | May 13, 2019

A Chicago federal appeals panel has upheld a decision by a downstate federal judge, who gave no traction to a lawsuit brought by a pair of Caterpillar shareholders over Caterpillar executives' allegedly ill-advised decision to buy a Chinese company, saying the company officers acted in what they believed to be Caterpillar's best interests.

Chief Judge Diane Wood, of the U.S. Court of Appeals for the Seventh Circuit, penned the May 9 ruling, with agreement from Circuit Judges Ilana Rovner and Daniel Manion. The ruling upheld a decision laid down by U.S. District Judge Sara Darrow, of the Central District of Illinois in Springfield. Both rulings favored four current and former Caterpillar corporate officers in a suit against them by shareholders Robert Lowinger and Issek Fuchs, both of New York.

Wood observed the shareholders were "between the proverbial rock and a hard place" in trying to win their action.

The officers included Chief Executive Officer Douglas Oberhelman; Chief Financial Officer and Group President Edward Rapp; Group President Steven Wunning; and Mining Product Vice President Luis de Leon. Caterpillar, which is headquartered in Peoria, makes construction and mining equipment.

The case stems from Caterpillar's purchase in 2012 of the Chinese companies ERA Mining Machinery and its subsidiary, Zhengzhou Siwei Mechanical & Electrical Equipment Manufacturing. After the $690 million acquisition, Caterpillar learned the companies allegedly engaged in accounting practices that overstated profit and improperly recognized revenue, according to court papers. As a consequence, Caterpillar took a $580 million loss.

The two shareholders asked Caterpillar's Board of Directors to sue the four officers for allegedly not adequately investigating the Chinese companies before the purchase. The board penalized some officers and sued the companies, but declined to sue the officers. The board based its decision on a study it commissioned by the Cleveland-based Jones Day law firm, which reported the risks of suing the officers outweighed the advantages.

In lieu of the board doing so, the shareholders then sued the officers in 2015. However, their suit was dismissed on grounds the officers were shielded by Delaware's "business judgment rule," which presumes a company's directors act in the company's best interests, unless their conduct is shown to have been "egregious." Delaware law applied, because Caterpillar is incorporated in that state.

The shareholders appealed, but Chief Judge Wood would not upset the lower court's dismissal order.

Wood noted the shareholders centered much of their case on the contention Jones Day had conflicts of interest, because the firm represents the four officers under suit by the shareholders, as well as two other corporations that were possible defendants in litigation involving the Chinese companies.

Wood was not impressed with the argument.

"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. They (plaintiffs) allege nothing that would suggest that Jones Day did not independently investigate and analyze everything discussed in its report," Wood said.

Wood continued, saying: "These plaintiffs might come to a different conclusion about the strategic importance of the acquisition" and "the risk that litigation might cause disruption and excessive cost for Caterpillar." She added: "But those types of business and investigative choices are exactly what the  business judgment rule protects." 

As a final note, Wood said, "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."

Lowinger and Fuchs are represented by the following: Kantrowitz, Goldhamer & Graifman, of Montvale, N.J.; Abraham, Fruchter & Twersky, of New York; and Winstein, Kavensky & Cunningham, of Rock Island.

Besides Sidley Austin, the Caterpillar officers are represented by Heyl, Royster, Voelker & Allen, of Peoria.

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Jones Day Sidley Austin LLP U.S. Court of Appeals for the Seventh Circuit U.S. District Court for the Central District of Illinois Winstein and Kavensky

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