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A special litigation committee (“SLC”) is a committee appointed by a corporation’s Board of Directors when challenged by a shareholder derivative action and is tasked with considering whether it is in the corporation’s best interest is to pursue or terminate the derivative litigation.
When is a SLC formed?
Where a disgruntled shareholder makes a demand upon a corporation to file a lawsuit against certain officers and directors, the Board of Directors may appoint a SLC, typically made up of two or more disinterested or independent directors. The SLC is charged with investigating the allegations made by the shareholders against the targeted officers and directors and determining if it is in the best interest of the company to pursue the claims against the officers and directors.
More commonly, a SLC is appointed where there is already a pending derivative lawsuit in which pre-suit demand on the board has been excused as futile by a court on a motion to dismiss under Rule 23.1. Even where a shareholder plaintiff has survived a motion to dismiss for failure to make pre-suit demand by showing reasonable doubt concerning the disinterest or independence of a majority of board members, that board can properly delegate its authority concerning litigation decisions on behalf of the corporation to an SLC consisting of disinterested and independent directors. The SLC is a last chance for a corporation to control a derivative claim when a court has determined that a majority of its directors cannot impartially consider the demand.
What Are the Requirements of a SLC?
After a SLC is formed, it must be given full authority and control to make its decisions. It must act independently and not under the influence or control of the board of directors despite the fact that the board appointed its members. The SLC’s procedures for investigating claims must be “adequate, appropriate, and pursued in good faith.”
The determination of whether the SLC’s procedures are proper depends on the nature of the particular investigation may include factors such as: the length and scope of the investigation; the SLC’s use of independent counsel or experts; the corporation or defendant’s participation, if any in the investigation; and the adequacy and reliability of the info supplied to the SLC.
The most important requirement of a SLC is its independence from the Board members who appointed them. The SLC member(s) must not have a relationship with any of the individual defendant or the derivative lawsuit itself that would impair an SLC member’s judgment. When reviewing the decision of a SLC, a Court finds the SLC lacked independence, the court may vacate the SLC’s recommendation despite the length, scope or thoroughness of its investigation.
Examples of when the members of a SLC will be found not to be independent include: if they are a defendant in the derivative lawsuit they are investigating; if a SLC member has a significant financial stake in the corporation they are advising; and, when the committee is simply advising the board of directors, most of whom are defendants in the derivative lawsuit, instead of acting with full power delegated by the board of directors.
Deference given to the recommendation of a SLC
The Board’s resolution establishing the SLC must delegate the board’s power to control the litigation. A mere advisory role of a SLC fails to bestow a sufficient legitimacy to warrant deference to the committee’s decision by the court. When a properly delegated SLC files a motion to dismiss a demand-excused derivative suit, the SLC has the burden of demonstrating the absence of genuine issues of material fact regarding the committee’s independence, meaning that SLC members are not given the benefit of the doubt as to their objectivity.
A court will examine the independence of the SLC and the process followed by the SLC in reaching its determination, and investigative lapses will undermine the court’s confidence in the SLC’s conclusion. The SLC must foreclose any reasonable basis to question whether non-merits factors operated in the SLC’s ultimate judgment. Generally, if the SLC recommends terminating the derivative suit, the court will defer to the recommendation if the committee shows that its members were independent, acted in good faith, and had a reasonable basis for their conclusions. As a result, a properly constituted SLC of disinterested and independent directors empowered by the board to investigate and determine whether the prosecution of derivative claims is in the best interests of the company can be a powerful aspect of a board’s management authority.
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(855) Tim-MLaw (855-846-6529)