What Is A Special Litigation Committee?

A truly independent “Special Litigation Committee” or “SLC” wields enormous power in the context of derivative claims (more on these claims below). The SLC will either validate a derivative claim and recommend that it be pursued or settled or will recommend that it be dismissed.  Since the company or corporation must adhere to the SLC’s determinations, and because of the deference provided to an SLC’s determinations by Minnesota courts, the SLC will either be your best friend or worst enemy, depending on which side of the determination you fall. As a result, you must be adequately prepared if an SLC is appointed in a matter you are handling.

To understand why it is necessary to prepare for the SLC properly, one must first understand the appointment of the SLC, the role of the SLC, and the deference granted to the SLC. The practitioner must also understand the difference between a derivative claim and a direct claim and the trends in the law as it relates to SLC determinations and recommendations. Armed with this background information, counsel can understand the importance of preparing for and dealing with the SLC.

Direct vs. Derivative Claims:

In determining whether a claim is direct or derivative, Minnesota courts have “focused the inquiry to whether the complained of injury was an injury to the shareholder directly, or to the corporation.” Wessin v. Archives Corp., 592 N.W.2d 460, 464 (Minn. 1999). The focus by the courts is not on the theory in which the claim is “couched, but instead on the injury itself.” Id. “Where the injury is to the corporation and only indirectly harms the shareholder, the claim must be pursued as a derivative claim.” Id. Minnesota has “long adhered to the general principle that an individual shareholder may not directly assert a cause of action that belongs to the corporation.”  Id. “When a shareholder asserts a cause of action belonging to the corporation, the shareholder must seek redress in a derivative action on behalf of the corporation rather than in a direct action by the individual shareholder.”  Id. “A shareholder derivative suit is a creation of equity in which a shareholder may, in effect, step into the corporation’s shoes and seek in its right the restitution he could not demand on his own.”  Blohm v. Kelly, 765 N.W.2d 147, 153 (Minn. Ct. App. 2009) (quotation omitted).

Appointing an SLC:

The board may form an SLC when a shareholder has alleged a derivative claim.   Id. An SLC may be appointed under statute by a corporation, limited liability company, nonprofit company, or co-op. Minn. Stat. § 302A.241, subd. 1 (corporations); Minn. Stat. § 322C.0905 (limited liability companies); Minn. Stat. § 317A.241 (nonprofit companies); Minn. Stat. § 308B.451 (cooperative associations).  A properly appointed SLC should consist of one or more independent persons to consider the legal rights or remedies of the corporation and whether those rights and remedies should be pursued. In re UnitedHealth Group Shareholder Derivative Litig., 754 N.W.2d 544, 550 (Minn. 2008); Minn. Stat. § 322C.0905, subd. 2. Every member of a properly appointed SLC must be independent. UnitedHealth Group, 754 N.W.2d at 550. Following the appointment, the SLC is not subject to the control of the board. UnitedHealth Group, 754 N.W.2d at 550.

The benefits of whether to appoint an SLC depend on which side of the derivative claim you find yourself on. From the company’s perspective, the SLC can save the company significant time and expense in investigating the derivative claim before protracted litigation. From the shareholder’s perspective, the SLC’s determination/recommendation will either give credence to the derivative claim or maybe the demise of the claim. Either way, the SLC’s determination/recommendation early in the derivative action may also save the derivative plaintiff and individual defendant significant sums in litigation expenses.

If you are in the role of advising on the appointment of the SLC, it is imperative to emphasize the independence of the SLC. Factors on the independence of the SLC include, but are not limited to: whether the members of the SLC are defendants in the litigation; whether the members of the SLC are exposed to direct and substantial liability; whether the members of the SLC are outside, non-management directors; whether the members were on the board when the alleged wrongdoing occurred; whether the members of the SLC participated in the alleged wrongdoing; whether the members of the SLC approved conduct involving the alleged wrongdoing; whether the members of the SLC had business dealings with the company other than as governors or directors; whether the members of the SLC had business or social relationships with one or more of the defendants; whether the SLC received advice from an independent counsel or other independent advisors; the severity of the alleged wrongdoing; and the size of the SLC and whether the board retains the right to change the number of SLC members during the SLC’s investigation. UnitedHealth Group, 754 N.W.2d at 560 n.11.

Following the appointment of the SLC, if there are questions surrounding the independence of the SLC, it is best to raise these questions immediately. Because of the costs involved in retaining an SLC—most often a lawyer or retired judge experienced in this area of law—and the costs of the SLC investigation, no party benefits from a protracted investigation followed by a challenge to the independence of the SLC. It is best to ensure that the SLC is independent of the start rather than restart the process if the SLC is later found to be biased. Moreover, you run the risk of simply looking like a disgruntled participant if you challenge the independence of the SLC after their determination (most likely against your client). During this equitable process, perception in the eyes of the court is important.

SLC’s Investigation:

The independent SLC should be delegated the board’s power to control the derivative action and should not have a limited scope placed on its investigation.  Janssen v. Best & Flanagan, 662 N.W.2d 876, 888 (Minn. 2003).   The SLC provides for an independent evaluation of a derivative action. They balance the rights and duties of the board and the dissenting shareholder by providing a corporation with ‘an important tool to rid itself of meritless or harmful litigation’ while preventing directors from using the committee to ‘wrest control of bona fide derivative claims away from well-meaning plaintiffs.’  Janseen v. Best & Flanagan, 645 N.W.2d 495, 498- 99 (Minn. Ct. App. 2002), aff’d, 662 N.W.2d 876 (Minn. 2003) (internal quote omitted).

An SLC and its investigation after appointment are protected by the business judgment rule. UnitedHealth Group, 754 N.W.2d at 550-51. The business judgment rule is a presumption to protect a company’s board from derivative claims that the board made an unprofitable business decision. Id. A director will not be liable for company losses if the director is uninterested, makes an informed business decision, and acts in good faith under the business judgment rule.  Janssen, 662 N.W.2d at 884. The business judgment rule prevents judges from second-guessing a board’s well-intentioned decision. UnitedHealth Group, 754 N.W.2d at 551.

Whether the SLC has investigated in good faith depends on the nature of the particular investigation and the SLC’s procedures and methods. Drilling v. Berman, 589 N.W.2d 503, 507 (Minn. Ct. App. 1999). The length and scope of the SLC’s investigation, the SLC’s use of independent counsel or experts, the corporation’s or defendant’s involvement in the SLC’s investigation, and the adequacy and reliability of the information supplied to the SLC are all factors relevant to the adequacy of the SLC’s investigation. Id.

Preparing for the SLC:

Following their appointment, the independent SLC will request information from all sides of the dispute during their investigation. Most often, the SLC will meet with the parties and their attorneys to discuss the factual basis surrounding the derivative claim early in the investigation. As applicable in most areas, you do not get a second chance to make an excellent first impression. Thus, it is important to have factual support, or factual defense, for the derivative claim before meeting with the SLC. Evidentiary support for the positions should come via financial statements, witness statements, emails, etc. Do not make the mistake of being unprepared for a meeting with the SLC. Instead, look at the meeting with the SLC as a trial; you must convince the SLC that your position has evidentiary support on which the SLC can base their determination.

Following the initial meeting, the parties often have additional opportunities to provide the SLC with further evidentiary support. Do not make the SLC do unnecessary research or digging to support your view of the derivative claim. If you have the evidentiary support, or come across additional evidentiary support, provide it as soon as possible to the SLC. The SLC investigation should not be a game of hide-and-seek between you and the SLC. If you believe the other side of the claim has additional information which is not in your possession, inform the SLC as such and request that the SLC obtain such information. Unlike the unfortunate trend in litigation of simply objecting to object to discovery requests in hopes of ‘hiding the ball,’ if the SLC asks for information from your client, it is best to provide it. It will be disingenuous to later object to the adequacy of the SLC’s investigation if you or your client refuses to provide relevant information to the SLC.

If you believe that the SLC has conducted an improper or inadequate investigation, it is best to raise this complaint as soon as possible. Again, because perception is important during this equitable process, questioning the SLC’s investigation following its determination against you raises whether you are simply raising this issue because the SLC recommended against your client or if there was an issue with the adequacy of the investigation.

Power of the SLC:

After completing its investigation, the SLC must decide whether it is in the company’s best interests to pursue the derivative claims, settle the derivative claims, or seek dismissal of the derivative claims.  Janssen, 662 N.W.2d at 883.  This determination “involves the weighing and balancing of legal, ethical, commercial, promotional, public relations, fiscal and other factors familiar to the resolution of many if not most corporate problems.”  Id. The SLC should consider the long-term and short-term interests of the company and its members and the company’s employees, customers, suppliers, and creditors.

In considering these factors as it relates to litigation, costs, at times, even non-frivolous derivative claims, “may not be worth pursuing when the likelihood of victory is compared with the time, money, and hostility necessary to win.”  Janssen, 662 N.W.2d at 883.  Whether the company should ultimately pursue a cause of action is a matter of internal management and is left to the discretion of the SLC. Black v. NuAire, Inc., 426 N.W.2d 203, 210 (Minn. Ct. App. 1988) (internal citations and quotations omitted).

[I]t must be remembered that the dismissal of meritorious litigation may be justifiable, such as when pursuit of the claim will prove more costly than beneficial. As to the settlement of a meritorious claim, it is a fact of modern legal practice that settlements are commonplace and the rule rather than the exception; moreover, it is broadly acknowledged that settlements are favored because they conserve judicial resources and minimize litigation expenses. It seems to us of little concern that, under the standard we set forth today, a substantial number of cases may end in settlement rather than adversarial litigation.

UnitedHealth Group, 754 N.W.2d at 559.

Once the SLC determines whether to pursue, settle or dismiss the derivative claim, they must follow this determination. Suppose the derivative plaintiff disagrees with the SLC’s determination. In that case, the board of directors must establish that the SLC was independent and that the SLC’s investigation was adequate, appropriate, and pursued in good faith. Id. at 561. If the board establishes both criteria, the court must defer to the SLC’s decision and enter an order accordingly. Id. at 559; Minn. Stat. § 322C.0905, subd. 5. If the board fails to establish either of these criteria, the court need not defer to the SLC’s decision, and the plaintiff’s derivative claim(s) may move forward on its merits with no opportunity to rectify the SLC’s deficiencies.  Janssen, 662 N.W.2d at 889.

A review of recent Minnesota cases reveals a trend by SLCs to dismiss or not pursue derivative claims. Often, SLCs recommended the derivative claims be dismissed or not pursued. Many factors were cited for dismissing/not pursuing the claims, including the frivolous derivative claims, lack of benefit to the company, and costs of pursuing the claims to the company.

The SLC can either be your best friend or your worst enemy. Knowing the role of the SLC and being properly prepared in dealing with the SLC will help ensure the appointment of an independent SLC and the adequacy of the SLC’s investigation. Knowing the role of the SLC and being properly prepared to deal with the SLC will also, hopefully, result in an SLC determination favorable to your client.

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