Sutherland v. Sutherland, 2009 WL 750287 (Del. Ch., March 23, 2009).

Professor Larry Ribstein, a nationally recognized expert on LLCs, provides an analysis of this Chancery Court opinion which demonstrates how one can waive duties in the LLC format but such waivers are more limited in the corporate context.

Following is an excerpt from the good professor’s post.

The court refused to apply the provision  [in the parties agreement] to treat interested directors as disinterested for purposes of immunizing interested transactions from Delaware’s entire fairness analysis. The court said (emphasis added):

The question * * * is whether such a far-reaching provision would be enforceable under Delaware law. It would not. If the meaning of the above provision were as the defendants suggest, it would effectively eviscerate the duty of loyalty for corporate directors as it is generally understood under Delaware law. While such a provision is permissible under the Delaware Limited Liability Company Act and the Delaware Revised Uniform Limited Partnership Act, where freedom of contract is the guiding and overriding principle, it is expressly forbidden by the DGCL. Section 102(b)(7) of the DGCL provides that a corporate charter may contain a provision eliminating or limiting personal liability of a director for money damages in a suit for breach of fiduciary duty, so long as such provision does not affect director liability for “any breach of the director’s duty of loyalty to the corporation or its stockholders….

In other words, if you want to completely opt out, you have to use an uncorporation. In corporations, freedom of contract is not, by negative implication, the "guiding and overriding principle."

This is not form over substance because there are meaningful differences between uncorporations and corporations. Here’s more on that.

Read the whole post, and links to Professor Ribstein’s related writings on the topic, here.

Six other Chancery Court decisions involving the same (or affilated) parties as in this case, are collected and summarized here.

Sutherland v. Sutherland, 2008 WL 3021024 (Aug. 5, 2008).

This is an example of the Chancery Court’s practical side which allows it to cut to the chase and avoid unnecessary procedural entanglements. In this case, despite a Motion to Dismiss that was pending, and in light of the multiple proceedings that ensued after the motion was filed, in order to promote efficiency, the court allowed the plaintiff to amend his complaint.  Apparently a Brief was filed by the plaintiff in reply to the Motion to Dismiss and Chancery Court Rule 15(aaa) gives one a binary choice in light of a Motion to Dismiss: either amend the complaint or respond to the Motion to Dismiss. However, the rule also gives the Court flexibility to amend anyway when  (as here) dismissal "would not be just under the circumstances".

In the meantime, the court cited to several cases that address the procedural impact on a pending complaint based on actions taken by a special litigation committee, especially in terms of arguments about demand excusal under Chancery Court Rule 23.1.

There have been no less than five (5) prior decisions of substance that I previously summarized in this case, which provide the extensive background details regarding this intra-family, internecine warfare, and which are available here.

In Sutherland v. Sutherland, 2008 WL 2221770 (Del. Ch., May 29, 2008), read opinion here, the Delaware Chancery Court denied a motion to reargue its May 5 decision, pursuant to Chancery Rule 59(f), in which it rejected the report of a one-person Special Litigation Committee (SLC). The prior decision sought to be reargued was summarized on this blog here. In addition to the foregoing decisions, several other prior Chancery decisions involving these parties, which provide more background on this case, have been summarized on this blog and are linked here.

In the course of repelling the request by the nominal defendant company that the court second-guess its opinion, the Chancery Court recited well-settled law regarding the standard of review used by the court to evaluate the SLC’s conclusions and investigations as articulated in the seminal decision of Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), and the court provided examples of what an SLC should NOT do as well as reiterating precatory practices.

Initially the court quoted from its prior decision to emphasize that the SLC seeking to dismiss derivative litigation has the burden of proof, akin to a motion for summary judgment under Rule 56, as follows:

The SLC is not entitled to any presumptions of independence, good faith, or reasonableness. Rather, the corporation has the burden of proof under Rule 56 standards, which require the corporation to establish the absence of any material issue of fact and its entitlement to relief as a matter of law. In addition, as the court in Kaplan v. Wyatt noted, the motion must be supported by a thorough record. It seems … that what the Committee did or did not do, and the actual existence of the documents and the persons purportedly examined by it, should constitute the factual record on which the decision as to the independence and good faith of the Committee, and the adequacy of its investigation in light of the derivative charges made, must be based. Each side has the opportunity to make a record on the motion. If the court is satisfied with the SLC’s independence and good faith, and the reasonableness of its inquiry, the court may nonetheless exercise its own business judgment and deny the motion to dismiss. FN6

FN6. Sutherland v. Sutherland, 2008 WL 1932374, at *3 (Del. Ch. May 5, 2008) (citations omitted)[emphasis added].

Citing to prior cases (FN 7) comparing the need for a one-person SLC to be "above reproach, like Caesar’s wife",  the court noted that this rubric also applied to the evaluation of the SLC’s independence as well as its good faith and the reasonableness of its investigation and conclusions.

It did not help the SLC’s argument that the one-person SLC apparently "destroyed its original interview notes, after using them to prepare cursory and incomplete summaries of the interviews it conducted, which undermined the court’s confidence in the good faith and reasonableness of the SLC’s investigation."

NOTE TO FUTURE SLCs: Consider carefully, in light of this opinion, whether it is a good idea to destroy notes of interviews.

ANOTHER SUGGESTION: Don’t be too quick to omit reference to information about claims even if the SLC thinks the company has good defenses to assert against those claims.

The foregoing "suggestion" comes directly from the court’s criticism of the SLC’s omission from its report  of payments that related to the claims that the executives were using company assets for their personal benefit–inappropriately. The court reasoned that even if the SLC thought that there was a good statute of limitations defense to claims relating to that information: " a good faith effort to deal with the King payments issue necessarily required that the report both disclose the facts relating to the payments and present analysis of  Perry’s [the executive involved] defense".

LAST NOTE: Provide documentation to support the most important factual conclusions of the SLC’s investigation.  The court was not impressed, to say the least, with the lack of documentary support for key representations by the SLC that certain disputed benefits for the company executives were included in their W-2s. Compounding the inability of the company to satisfy its burden of proof was an incomplete review of the company ledger that admittedly failed to capture two large payments at issue in the case. [In the court’s prior opinion, the court noted that on the one day that the company’s record’s were reviewed, the review started late in the day, was interrupted by a leisurely lunch, and ended before the normal end of normal business hours.]


Sutherland v. Sutherland, 2008 WL 1932374 (Del. Ch., May 5, 2008), read opinion here.

[This is one of four opinions issued on May 5 by the Chancery Court, two of which were written by the same vice-chancellor. I hope to post on the other 3 opinions issued on May 5 by tomorrow.]

Factual background details can be obtained from the three prior decisions by the Chancery Court involving these parties, and summarized on this blog here, here and here. This latest opinion in this ongoing internecine Sutherland family squabble denied a motion to dismiss, despite the great weight often given to the recommendation of the Special Litigation Committee (SLC), on which the defendant companies relied for their motion to dismiss. The reason for rejecting the SLC’s conclusions: After having considered the briefs, affidavits, limited discovery and arguments of the parties, the Chancery Court reasoned that:

"the special litigation committee [consisting of one man] has not satisfied the court that it acted in good faith and conducted a reasonable investigation."

The opinion also discusses the issue of independence, the third requirement that the SLC needs to satisfy pursuant to the decision in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), as well as closely scrutinizing whether the SLC satisfied the other requirements of good faith and reasonable investigation.

One lesson from this opinion that can be learned by "negative example" is how "not to constitute"" an SLC (if one wants to have maximum "protection") , and how "not to conduct an SLC investigation" (if one wants to increase the odds of not  having the court disregard the SLC’s conclusions.)

The court noted that the SLC has the burden of establishing its good faith, reasonable investigation and independence, based on Rule 56 standards, although the review has some aspects of a Rule 12(b)(6) motion. The court also referred to the decision in Kaplan v. Wyatt , 484 A.2d 501, (Del. Ch. 1984), that requires the SLC’s conclusions to be supported by a "thorough record". The court may also apply its own business judgement to the conclusion of the SLC even if the SLC satisfied all other prerequisites.

A central theme in the complaint was that the directors were allegedly using the company’s assets for their own personal benefit via such things as personal use of the corporate jet, lavish personal expenses charged to the company for chartered private railroad cars, private parties, club memberships, expensive hotels, rental cars, and other examples of opulence not required by their position at the company.

The court provided reasoning and examples of why the one-man committee’s investigation was not adequate. He only spent  less than one full-day at the company’s office reviewing records. He arrived at 8:30 and then met with various accounting and management personnel before reviewing records. He took a one-hour lunch and then left at 3:30. The following quote from the opinion provides more details:

Perhaps more notable than what Jeffrey did is what Jeffrey [the one-man committee] did not do. Jeffrey testified at his deposition that, although he is a certified public accountant, he did not arrive at the companies’ offices with a plan for how he was going to conduct the review. He did not take any notes. Thus, there is no written record of what he did. Jeffrey testified that he did not review a statistically significant number of invoices when testing whether the accounting records were accurate. He did not verify that the vendor number he asked the accounting department to run was Perry’s only vendor number. And he conducted no search for payments the companies may have made to third parties on Perry’s behalf. For instance, if Perry used Maysville and Maysville then invoiced the companies rather than Perry, Jeffrey’s investigation would not have found the check sent to Maysville on Perry’s behalf.FN33  Nor, as Jeffrey testified, would he have found checks the companies made to credit card issuers on Perry’s behalf. Indeed, Jeffrey testified that his review of the ledgers would have failed to capture the two large payments made to King on Perry’s behalf.

In Sutherland v. Sutherland, 2008 WL 571253 (Del Ch., Feb. 2008), read opinion here, the Delaware Chancery Court examined the format and content of the report of a Special Litigation Committee (SLC) — noting the paucity of citation to source documents, for example, and observed the inauspiciousness of the SLC being composed of only one person (which of course makes it a greater challenge for the SLC to establish its independence, good faith and reasonableness under the Zapata standard.) This short letter opinion refused to allow the SLC to supplement the record with an appendix to the report due in large measure to the prejudice that would be suffered by the plaintiff in light of the lateness of the supplementation in terms of the amount of work and expense incurred to date based on discovery, briefing and argument that focused on the initial SLC report.

Two prior decisions in the case, that can be accessed here, provide more factual background.

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."