In Sutherland v. Sutherland, 2007 WL 1954444 (Del. Ch., July 2, 2007), read opinion here, the Delaware Chancery Court denied in part a Motion for Protective Order, and allowed more discovery than usually allowed into the basis for the decision of a Special Litigation Committee to dismiss a derivative action. More factual details about the internecine warfare among the shareholders of the family-owned business involved in this case are provided in a prior decision of this court in a Section 220 action that preceded the current litigation and that was summarized on this blog here [ including a link to the full prior decision, the citation for which is Sutherland v. Dardanelle Timber Co., 2006 WL 1451531 (Del. Ch., May 16, 2006).] One of the reasons the court found (in the prior decision) a proper purpose and credible basis under Section 220, was that the directors–who were also the shareholders who controlled the corporation, approved their own compensation which was alleged to be excessive.
This opinion is full of useful insights into Delaware law regarding the selection of a Special Litigation Committee formed by a corporation as a response to a derivative action. The court noted that the corporation, in essence, lost its defense of the prior Section 220 action, but directors caused the company to spend "upwards of $500,000" in legal fees to defend the case. No indication in this opinion of the cost to the plaintiffs to pursue the Section 220 case, but this serves as an educational reminder of why those cases are not always simple affairs.
I need to attend to paying clients, so allow me to summarize a few key points in as pithy a manner as possible, while encouraging you to read the whole opinion at the above link.
1. The complaint in this case was filed in September 2006.
2. After a hearing in December 2006, the court stayed this case pending an investigation by the special litigation committee ("SLC").
3. Important aspects regarding the SLC in this case are as follows: (i) the board was originally comprised of the 3 relatives of the plaintiff who are also named defendants; (ii) after suit was filed, they expanded the board and added a fourth board member named Bryan Jeffrey; (iii) Mr. Jeffrey was then appointed as the sole member of the SLC with final and binding authority with respect to the claims in the lawsuit; (iv) at the hearing in December 2006, the Chancery Court expressed "significant concerns about the lack of adequate disclosure of Jeffrey’s background and bona fides" [see footnotes 9 and 10 describing concerns and noting that a single member SLC should be like Caesar’s wife and "above reproach" (citing Kahn v. Tremont Corp., 694 A.2d422, 430 (Del. 1997)).];
4. In March 2007 Jeffrey filed his report with the court as well as a motion to dismiss the litigation. Shortly thereafter the plaintiff served somewhat extensive discovery requests.
5. Relying on the Delaware Supreme Court’s seminal decision in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), the corporation sought to limit the scope of discovery sought and bar any inquiry into the merits of the underlying derivative claims, as opposed to simply examining the independence and good faith of the SLC (in this case Jeffrey alone).
6. The court acknowledged that the Zapata decision controlled the scope of permissible discovery that a derivative plaintiff may take following the investigation and motion to dismiss of an SLC (citing also to Kindt v. Lund, 2001 WL 1671438 at *1 (Del. Ch.)), and observed that the court’s limited role at that stage is to: "conduct both an inquiry into the independence and good faith of the committee’s members, and an examination of the objective reasonableness of the conclusions that the committtee ultimately reached in its report."
7. The court underscored its inherent equitable power to decide where to draw the line for "limited discovery" and based on the facts of this case a more expansive view of "limited discovery" was warranted–moreso "than might be appropriate in another context"–in light of the prior, expensive battle to obtain documents in the Section 220 case, and a modus operandi which the corporation seemed to be pursuing in this case with continuing efforts to bar access to data.
8. Thus, in conclusion, the court allowed the following discovery of the SLC (and provided a good roadmap for practitioners to follow, subject to the particular facts of this case): (i) same documents that the SLC or its counsel or advisors reviewed during the investigation; (ii) documents related to the "selection, retention and compensation of [the sole SLC member], as well as his attorneys and advisors"; (iii) the deposition of the SLC member, his consultant and "representatives of the attorneys who advised Jeffrey in his work"; and (iv) replies to interrogatories that related to the scope of his work or the substantive tasks entrusted to him. The court reasoned that this discovery related directly to the SLC’s diligence and independence. However, the court disallowed other requests that went directly to the merits of the derivative claims, which otherwise would result in a loss of the "perceived efficiencies generated by a committee’s investigation."