Reprinted with permission from the March 24, 2015 edition of the The Legal Intelligencer.
You’re the chairman or CEO of a major corporation. Unfortunately, your company has had some negative press recently. Maybe it’s lower-than-expected earnings, heightened regulatory scrutiny, a controversial merger negotiation, a securities class action lawsuit, or even some corporate scandal. Whatever the cause, the result is that your team has been scrambling to recover.
And now, adding insult to injury, you’ve just received a letter demanding that the board bring suit against many of the very same officers and directors who are currently guiding the company through this storm.
You’re appalled. Your first instinct may be to tear the letter up and toss it in the trash – why, it even names you as a potential defendant. But, of course, you know you can’t do that.
So your second instinct may be to fire off a snappy comeback rejecting the allegations. That may be even more tempting. But you shouldn’t do it either. The result of your rejecting a derivative demand will be to free the writer of the letter to file suit.
So what to do? In response to a serious demand letter, the better approach may be to form a committee of independent board members and task it with deciding how to address the allegations.
How could it possibly be better, you may ask, to surrender the fate of your company to people who may know nothing at all about the issues?
The answer is that forming a Special Litigation Committee, or SLC, cleanses the conflict of interest that would otherwise arise from having corporate directors evaluate claims against themselves. As a result, a court adjudicating those claims will now likely defer to the business judgment of an independent and diligent SLC as to how those claims should be handled — just as it would relative to any other business decision.
Moreover, at least one statistical analysis, Minor Myers’ “The Decisions of the Corporate Special Litigation Committees: An Empirical Investigation,” from the Indiana Law Journal, suggests that SLCs are often sympathetic with the corporation that appointed them. According to that analysis, a review of 97 matters involving SLCs between 1993 and 2006 revealed the following SLC determinations: 60 percent dismissal, 30 percent settlement, and 10 percent claim pursuit.
But, you may ask, what if your SLC is in the minority that actually decides to pursue claims?
The answer is that it likely beats the alternative anyway. Even if your SLC’s investigation does not result in a clean dismissal, as you may have hoped, the resolution of the dispute will nonetheless likely be faster, cheaper and more favorable than fighting it out with the plaintiff from filing to verdict. If there is bad news that must be faced, in other words, an SLC can help your company face it in a reasoned and cost-effective manner.
Should you elect to form an SLC, here are the steps that would typically follow:
The Board Must Select the SLC Members
You need at least two SLC members, and three are preferable so as to break any ties. Depending on the current composition of your board, it may well be necessary to appoint new board members having no connection to the derivative allegations. You should select people whose judgment and reputations inspire confidence. More importantly, they absolutely must be both independent and disinterested. Certainly you can pick a distinguished member of the business community who (you may hope) will see matters “the right way” – but not if he or she is in your regular golf foursome. Likewise, he or she must not have any financial interest in the outcome of the litigation.
The Board Must Prepare a Resolution
The next step is for the board to prepare a “hand-off” resolution. What’s scary about this step is that the resolution must give the SLC real independence and authority. The SLC should have the power to independently investigate and act upon the derivative allegations with the assistance of such professional advisers (paid for by the company) as the SLC alone deems fit. This is critical, because a court will not likely defer to the decisions of an SLC that operates under the thumb of a conflicted board.
The good news is that your work is now done. You just need to sit back, stay out of the way, give the SLC whatever support it requests, and pay its bills.
But the SLC itself is just getting warmed up. The remaining steps apply to it alone.
The SLC Must Hire Independent Counsel
The SLC must engage qualified and independent legal counsel. It cannot rely on the company’s usual in-house or outside counsel, who may be viewed as conflicted. The SLC must select and hire this counsel itself. The first role of the SLC’s counsel will be to interview the SLC members thoroughly to ensure they are independent and disinterested.
The SLC Must Investigate
With the assistance of its new counsel, the SLC should promptly conduct a thorough investigation of the derivative allegations. Courts will often stay any discovery during this process. The investigation will likely entail identifying and reviewing key documents, as well as interviewing witnesses. The SLC may also wish to interview the lawyers who wrote the derivative demand letter to better understand their allegations. On occasion, the SLC may even decide there are good reasons for not investigating certain topics, which it will need to be prepared to justify particularly well – for example, an investigation may undermine the company’s defense of a parallel litigation involving higher stakes. In the course of its investigation, the SLC may also need to engage other professional advisers, such as accountants or investment bankers.
The SLC Must Decide on a Course of Action
Following its investigation, the SLC should decide how it wishes to proceed relative to the derivative allegations. Typically, this would involve dismissing, prosecuting or settling the claims. There may sometimes be reasons to temporize instead, such as by seeking a stay or tolling agreement. One virtue of having an SLC conduct this analysis is that the SLC may decide to afford weight to factors that are of importance to the corporation – but that might otherwise be overlooked by a plaintiffs lawyer – such as the realistic likelihood of success, the cost of litigating, the collectability of any resulting judgment, the distraction to management, and the impact of the proceeding on other legal or business matters.
The SLC Must Write A Report
Everything an SLC does – from screening its members, to conducting its investigation, to chronicling its own activities – must be calculated to survive judicial scrutiny if challenged in court. As a result, it will usually be necessary for the SLC (with the assistance of counsel) to write a detailed report describing its investigation, analysis and conclusions.
Such a report can then be used in several ways. For one, it can be sent to the lawyer who wrote the demand letter, which will then obligate that lawyer to articulate a compelling basis for overriding the SLC’s conclusions if the lawyer still wishes to pursue a complaint anyway. If a complaint has already been filed, the SLC’s report may form the basis for a motion to dismiss. Or, the SLC’s report may drive all interested parties to reach an early settlement by virtue of its careful analysis of the disputed issues.
By appointing an SLC using these simple steps, you may well achieve a resolution of the derivative claims that is preferable to any other alternative available to your company.
Reprinted with permission from the March 24, 2015 edition of the The Legal Intelligencer. Copyright 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For further information, contact 877-257-3382 – [email protected] or visit www.almreprints.com.