The requirements for a special litigation committee, in the alternative entity context, that seeks recognition of its legitimacy from the court was recently explained in the Delaware Court of Chancery decision styled: Wenske v. Blue Bell Creameries, Inc., C.A. No. 2017-0699-JRS (Del. Ch. Aug. 28, 2019).
Short Overview of Case:
This case involves a derivative action arising from the alleged failures of Blue Bell Creameries, Inc. (“BBGP”) as the sole general partner of the nominal defendant, Blue Bell Creameries LP (“Blue Bell” or the “Partnership”), to operate the Partnership in compliance with the governing standards of the limited partnership agreement (“LPA”). The court previously denied the motion to dismiss based on a finding that the plaintiff adequately pled demand futility. See Wenske v. Blue Bell Creameries, Inc., 2018 WL 3337531, at * 19 (Del. Ch. July 6, 2018), reargument denied, 2018 WL 5994971 (Del. Ch. Nov. 13, 2018). After the denial of the motion to dismiss, BBGP created a committee of its board of directors that, in turn, formed a special litigation committee to manage the claims against BBGP. As often happens, the special litigation committee moved to stay the derivative action to allow it time to conduct an investigation and make a determination. The court observed that when properly made, such requests are often granted. But, the court found that such a request in this case was “not proper.”
Highlights of Court’s Reasoning:
The court explained that in the context of this limited partnership structure, the sole general partner had already been determined to have a “disabling interest for pre-suit demand purposes.” Id. at * 18.
The court explained that “as a matter of agency law, a principal who delegates authority to an agent” will be deemed to maintain control over the conduct of that agent–regardless of whether the principal actually exercises control. Any conflict that disables the principal disables the agent.
Based on its prior ruling that BBGP, as principal, is not fit to decide how to manage the claims against the defendants, including against BBGP itself, the special litigation committee, as agent, is likewise disabled. Thus, the motion to stay was denied because it was brought by a special litigation committee with “no authority to bring it.” Slip op. at 2.
Important Legal Principles Recited by the Court:
This opinion is noteworthy for the many important statements of law it recites regarding the prerequisites for a properly functioning special litigation committee, not only in the corporate context, but–more importantly–in the less often addressed alternative entity context which does not enjoy as robust a body of case law compared to the corporate context on this issue.
The following bullet points provide a sample of the more notable legal nuggets:
- The court observed the important function that special litigation committees serve to respond to accusations of series misconduct by high officials and an impartial group of independent directors. (citing Biondi v. Scrushy, 820 A.2d 1148, 1156 (Del. Ch. 2003), aff’d, 847 A.2d 1121 (Del. 2004)).
- The court instructed that: “A well-functioning, well-advised special litigation committee, whose fairness and objectivity cannot reasonably be questioned, can serve to assuage concern among stockholders that the company’s litigation assets are being managed properly.” (internal citations omitted) (citing Id., and Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (Del. 1981)).
- The court noted that in the Biondi case, the court denied a motion to stay because the special committee was demonstrably not independent. See footnote 13.
- The court emphasized that a threshold issue is whether the committee was properly constituted.
- The court cited the seminal Zapata v. Maldonado case as involving a conflicted corporate board that wrested control of a derivative claim from a stockholder by establishing a committee of independent directors to investigate the claim and determine whether to prosecute it.
- Although the court noted that Section 141(c) allows a board to delegate all of its authority to a committee, for purposes of this case and based on a prior ruling in this case, the contrast with the context of an alternative entity was underscored by the following rationale: “. . . the delegation of management authority by a conflicted board to an independent committee of the board, is the delegation of authority by a conflicted group of principal decision makers to a subset of unconflicted principal decision makers. There is no principle/agent relationship created in this [corporate] context.”
- Although the Zapata special litigation committee framework may, as a general matter, serve its intended purpose in the partnership context, in this case the problem was that the court already determined that the sole general partner of the L.P. had a disabling conflict. See generally 6 Del. C. §§ 17-1011-103, and 17-403(c) (regarding the authority to determine whether to prosecute derivative actions, and unless otherwise restricted in the partnership agreement, a general partner has the power to delegate various rights).
- But the court reasoned that: “. . . just as the special litigation committee of a corporate board must be independent to be effective under Zapata, so too must a special litigation committee of a general partner of a limited partnership be independent if it is to perform its mandate properly and with binding effect.” See footnote 22.
- The problem in this case for the committee was that in the limited partnership context, the court “does not draw a distinction between a general partner and the members of its board of directors when assessing conflicts.”
- The court advised that a sole general partner cannot cleanse its disability by appointing new members to its board of directors, or by contracting out its authority to manage the litigation asset to third parties, because it no longer has that authority.
- The precise issue that the court had to resolve in this case was whether BBGP, as the exclusive general partner of the limited partnership, after already having been deemed unfit to consider a litigation demand, could avail itself of the Zapata framework by establishing a special litigation committee comprised of non-general partner actors. The Court’s answer: No.
- After distinguishing the facts in the case of Katell v. Morgan Stanley Gp., Inc. (Katell II), 1993 WL 205033, at * 2 (Del. Ch. June 8, 1993), the court reasoned that the problem for BBGP, unlike the limited partnership structure in the Katell case, was that the limited partnership in this case had no other general partner that was not conflicted. Cf. Obeid v. Hogan, 2016 WL 3356851, at * 11 (Del. Ch. June 10, 2016) (The fact that demand was excused or futile did not strip the board of its corporate power. Rather, the problem is one of member disqualification, not the absence of power in the board–in the corporate context.)
- The court compared the analogy in the corporate context of a sole conflicted director who would be disabled from serving or creating a special litigation committee. See Zapata, 43 A.2d 787.
- In the instant case, a defining feature of the principal-agent relationship is the principal’s inherent control over the conduct of the agent, and it is the existence of the right to control, not its exercise, which is decisive. Slip op. at 12-13.
- Although in the corporate context the effort by BBGP in this case to appoint independent members may have been effective, because the lone general partner, as an entity, in this case has been determined to be conflicted, “there is no non-conflicted principal decision maker who can properly delegate management authority” to a special litigation committee.