Improved Review Blog Court of Chancery Reminds of Usefulness of Properly Trained SLCs in Resolving Pending Derivative Claims
For more than 40 years, Delaware courts have recognized the Special Litigation Committee (“SLC”) as an effective means of judging the corporate interest served by a derivative action when the board of directors is otherwise off. out of personal interest. However, with this recognition came a long-standing skepticism about the structural biases that can affect SLC members. In the flagship case of Zapata Corp. vs. Maldonado, 430 A.2d 779 (Del. 1981), the Delaware Supreme Court warned that courts should âbe aware that directors make judgments on other directors of the same company. . . . The question naturally arises as to whether an empathy âthere but for the grace of God will Iâ cannot play a role. And the further question arises as to whether an investigation of independence, good faith and a reasonable investigation is a sufficient safeguard against abuse, perhaps unconscious abuse. “
Recently in Diep vs. Sather, the Delaware Court of Chancellery allowed a SLC motion to dismiss a derivative lawsuit raising allegations of insider trading, providing a useful model for boards of directors and future ad hoc litigation committees to overcome the skepticism of the courts with regard to the impartiality of directors. In this case, shareholders of the El Pollo Loco restaurant chain (the âCompanyâ) accused certain directors, as well as an acquisition vehicle of the private equity firm that took the chain public, of d ‘selling around $ 130 million in stock shortly after an earnings call. during which alleged false statements were made about the Company’s lagging performance and outlook in the first quarter.
After the court dismissed the defendants’ motions to dismiss lead plaintiff Kevin Diep’s insider trading complaint, the company formed an SLC to investigate and assess the allegations and issues raised in the lawsuit, as well as the lawsuits. and shareholder demands. The company appointed three of its independent directors to the SLC, and the court stayed the lawsuit pending the results of the SLC investigation.
After conducting a thorough document review and several interviews, and meeting regularly with lawyers and as a committee, the SLC released a 377-page report concluding that the Company should dismiss the lawsuit in light of the costs of litigation for the Company, distraction from business operations, and unnecessary focus of public relations efforts on what it determined to be baseless claims. After filing its report, the SLC decided to dismiss the lawsuit. The day before oral argument, however, the parties filed a settlement clause regarding the individual defendants, leaving the acquisition vehicle and the majority shareholder as the only remaining defendant. The settlements, however, did not prevent the court from concluding that the SLC had discharged its onus by requesting the referral. In resolving the SLC’s motion, the court applied Zapatathe two-part test of:
First, the tribunal assessed the independence of the SLC members, their good faith and the basis for their recommendation, which required the SLC to provide a detailed report of its investigation, proceedings and findings. See Zapata, 430 A.2d at 788â89. Since none of the SLC members were on the board of directors of the company at the time of the suspicious transactions or had a financial interest in the transactions at issue, the tribunal’s analysis focused on the issue. whether the relations of the SLC members with the defendants were such that they could have considered factors other than the best interests of the company in the decision to request the referral.
The court was primarily concerned about the SLC members’ relationship with David Keller, director and one of the managing members of Trimaran Capital, LLC, who was the managing member of the defendant’s acquisition vehicle. The court finally recognized, among other things, that participation in other boards, the innocuous statements about the litigation years earlier and the social relations based largely on children did not mar the independence. administrators. Because the SLC members did not have stakeholder relationships that significantly exceeded some sort of thin social circle friendship, they remained independent for the purposes of the derivative lawsuit.
Second, having implicitly concluded that the case concerned non-frivolous claims, see id. at 789, the court exercised its independent judgment to determine whether or not the company’s interest would be served by the continuation of the derivative lawsuit. After rejecting the plaintiff’s disputes on the merits and scope of the SLC’s investigation, the court quickly concluded that a disinterested and independent decision-maker of the Company, not acting under any constraint and for the benefit of the information available to them. the SLC, could reasonably accept the recommendation of the SLC to dismiss the plaintiff’s claims. Therefore, the court granted the SLC’s motion.
The El Pollo decision is an important reminder to companies about the usefulness of SLCs in resolving ongoing derivative disputes, while highlighting potential pitfalls. First, companies should consider having multiple members on an SLC, or risk going against the often repeated guidelines in Lewis vs. Fuqua, 502 A.2d 962 (Del. Ch. 1985) that when an SLC is composed of one member, that member should “like Caesar’s wife be above reproach. Second, companies should prioritize scrutiny of any conflict of interest in order to ensure the independence of SLC members. Finally, companies should empower the SLC to conduct a thorough and well-documented complaint investigation sufficient to meet the âreasonable scope good faith investigationâ standard. Properly constituted, SLCs can offer a business significant power in determining the outcome of derivative claims.