Setting up a Special Litigation Committee (“SLC”) is a great way to deal with a conflict of interest in a company. A Special Litigation Committee allows the company to keep control of legal claims and address issues in a way that puts the best interests of the company first. The main idea behind a Special Litigation Committee is to move a decision from the Board of Directors/Managers to people who are independent and disinterested.
A special litigation committee is a committee appointed by the Board of Directors of a corporation that has been tasked with deciding whether to sue on a corporate claim or whether to continue an already commenced lawsuit against directors or officers of the corporation.
When appointing an SLC, the board of directors should be aware of certain requirements. Once an SLC is formed, it is to act independently, meaning it is not under the control of the board of directors despite the fact that the board appointed them. The SLC must be given full authority and control to make its decisions. The SLC’s procedures investigating claims must be “adequate, appropriate, and pursued in good faith.” Whether an SLC’s procedures are proper depends on the nature of the particular investigation and other factors including
Once an SLC has reached a decision as to the course of action for the corporation, it is not allowed to improve or amend their investigation in any way. Depending on the jurisdiction you are in, decisions made by an SLC—and the process used to reach those decisions—are usually granted significant deference by a reviewing court. This essentially means that SLC’s decisions are binding, under the business judgment rule, barring a finding by a reviewing court that the SLC acted unlawfully or was not disinterested.
Tantamount to an SLC is its independence from the Board members who appointed them. The SLC member(s) must not have a relationship with the individual defendant or the suit itself that would impair an SLC member’s judgment. If a court reviewing the decision of an SLC finds the SLC lacked independence, the court may vacate the SLC’s recommendation. For example, SLC members will not be deemed independent if they are a defendant in the suit at hand. Independence can also be challenged if the SLC member has a significant financial stake in the corporation they are advising. See Hasan v. CleveTrust Realty Investors, 729 F.2d 372 (6th Cir. 1984). SLC recommendations lack independence when the committee is simply advising an entire board of directors, most of whom are defendants in the suit at hand, instead of acting with full power delegated by the board of directors. See Par Pharmaceuitcal Inc. Derivative Litig.¸750 F. Supp. 641 (S.D.N.Y. 1990).
SLCs are permitted to hire attorneys to represent the SLC. The SLC’s attorney may advise the SLC on compliance with the law. The SLC’s attorney may also conduct due diligence and investigations for the SLC, including interviews with witnesses, such as employees or past employees of the business.
The framework of a Special Litigation Committee is specifically provided in the Minnesota Statutes.
Nonprofit organizations are usually corporations, so the statutes for corporations apply. (See below.)
For corporations, the Special Litigation Committee framework is provided in Minnesota Statutes section 302A.241, subdivision 1: “Committees may include a special litigation committee consisting of one or more independent directors or other independent persons to consider legal rights or remedies of the corporation and whether those rights and remedies should be pursued.”
In Minnesota, Minnesota Statutes section 302A.241 governs some of the basic rules regarding SLCs. Members of the SLC must be natural persons (they may not be another corporation); committees must contain at least two or more members; the makeup of an SLC can only be approved by a majority vote of the directors present (unless the articles or bylaws say otherwise); and the SLC has the power to appoint subcommittees.
For limited liability companies (LLCs), the Special Litigation Committee framework is provided in Minnesota Statutes section 322C.0905:
Subdivision 1. Committee authorization. If a limited liability company is named as or made a party in a derivative proceeding, the company may appoint a special litigation committee to investigate the claims asserted in the proceeding and determine whether pursuing the action is in the best interests of the company. If the company appoints a special litigation committee, on motion by the committee made in the name of the company, except for good cause shown, the court shall stay discovery for the time reasonably necessary to permit the committee to make its investigation. This subdivision does not prevent the court from enforcing a person’s right to information under section 322C.0410 or, for good cause shown, granting extraordinary relief in the form of a temporary restraining order or preliminary injunction.
Subdivision 2. Committee composition. A special litigation committee may be composed of one or more disinterested and independent individuals, who may be members.
Subdivision 3. Requirements for appointment of committee. A special litigation committee may be appointed:
(1) in a member-managed limited liability company:
(i) by the consent of a majority of the members not named as defendants or plaintiffs in the proceeding; and
(ii) if all members are named as defendants or plaintiffs in the proceeding, by a majority of the members named as defendants;
(2) in a manager-managed limited liability company:
(i) by a majority of the managers not named as defendants or plaintiffs in the proceeding; and
(ii) if all managers are named as defendants or plaintiffs in the proceeding, by a majority of the managers named as defendants; and
(3) in a board-managed limited liability company:
(i) by a majority of governors not named as defendants or plaintiffs in the proceeding; and
(ii) if all governors are named as defendants or plaintiffs in the proceeding, by a majority of the governors named as defendants.
Subdivision 4. Determinations of committee. After appropriate investigation, a special litigation committee may determine that it is in the best interests of the limited liability company that the proceeding:
(1) continue under the control of the plaintiff;
(2) continue under the control of the committee;
(3) be settled on terms approved by the committee; or
(4) be dismissed.
Subdivision 5. Committee procedures. After making a determination under subdivision 4, a special litigation committee shall file with the court a statement of its determination and its report supporting its determination, giving notice to the plaintiff. The court shall determine whether the members of the committee were disinterested and independent and whether the committee conducted its investigation and made its recommendation in good faith, independently, and with reasonable care, with the committee having the burden of proof. If the court finds that the members of the committee were disinterested and independent and that the committee acted in good faith, independently, and with reasonable care, the court shall enforce the determination of the committee. Otherwise, the court shall dissolve the stay of discovery entered under subdivision 1 and allow the action to proceed under the direction of the plaintiff.
A properly formed Special Litigation Committee must be independent and disinterested.
Independence means the SLC does not report to the board. The SLC has total authority, without needing any subsequent approval from the Board of Directors.
Disinterested means the SLC members have no conflict of interest. This means the individual SLC members have nothing to benefit or lose from the outcome of the SLC’s actions.
This includes people with close ties to SLC members including their:
The Minnesota LLC Act provides that “[a] special litigation committee may be composed of one or more disinterested and independent individuals, who may be members.” See Minn. Stat. § 322C.0905, subdiv. 2. This codifies the common law (what courts have established is required for a Special Litigation Committee).
The Minnesota Corporations Act is older, so it does not expressly include the term “disinterested.” The Minnesota Corporations Act uses “independent directors or other independent persons.” Under the common law, courts have held that “independent” includes “disinterested.”
Attorneys interested in additional information regarding special litigation committee legal issues might consider reading the case of In re UnitedHealth Group, Inc. S’holder Derivative Litig., 754 N.W.2d 544, 548 (Minn. 2008), and the law review article, Finessing Well-Plead Derivative Lawsuits: The Implications of the Minnesota Supreme Court’ s Selection of Auerbach over Zapata (2009).
What is a special litigation committee? My name is Aaron Hall. I’m an attorney in Minneapolis, Minnesota, and I’ve represented a number of businesses, business owners, and nonprofits that have dealt with a special litigation committee. I’m here to explain how that works. A special litigation committee is a committee typically appointed by the board of directors of a company or non-profit organization, and it’s appointed because the existing board of directors has a conflict of interest in some sort of legal matter.
The existing board is considered conflicted rather than disinterested. The organization needs disinterested board members who are able to resolve some legal issues that they’re facing, and so in order to do that, Minnesota law allows a company through its board to appoint a group of people called a special litigation committee to make decisions regarding some sort of legal matter. Now, the key with that special litigation committee is they need to be disinterested. They can’t have a conflict of interest. That’s the whole idea for why they were set up separate from the board.
The board has a conflict of interest, or at least some of the members do, so this special committee is set up. Now, who can be on that special litigation committee? You can have disinterested board members on the special litigation committee of course, but not conflicted ones. You have to think through as well what with the … whatever the legal issue is, who is implicated by it and who do they report to? Let’s say the existing board has a couple members who are potentially at risk or implicated in the issue. Maybe the president is involved and then of course the employees report to the president. In order to have a special litigation committee that’s truly disinterested, all of those people who are conflicted or suspect can’t be on there nor can there family members or people who they report to or who report to them or those who are just way too close.
For example, in one case I was working on, I wanted to demonstrate that a board … that a special litigation committee member was too closely affiliated with one of the defendants in the lawsuit. In a deposition I asked them, when did you meet them? I found out it was at quite a young age. Have you ever gone to a social parties with them? I found out that that person had just been at their birthday party. Bingo. That’s what I was looking for. You’re going to somebody’s birthday party, the likelihood … or it raises questions about whether that person can be objective in dealing with legal claims against a person who’s conflicted or can be objective in making decisions.
As you can see here, you’re typically going to have an attorney on the other side trying to see if there’s too close a connection between the disinterested person on the special litigation committee and the conflicted people within the organization. You want to make sure that you have that objectivity, that disinterest. There’s no contractual relationship. There’s no fiduciary relationship. There’s no close social relationship. That that person truly can be objective and has the credentials to do the job.
Then a special litigation committee is given the benefit of the business judgment rule. The business judgment rule quite simply says, because they’re disinterested, a court will defer to their business judgment as long as they did a basic job of analyzing the issues and making a decision. That decision might be bad, it might have poor consequences later. It might look like a breach of the duty of care, but as long as they’re disinterested and they’re operating in good faith, none of those things matter. They’ve essentially fulfilled their fiduciary duty of care.
That is why it’s so important to get that special litigation committee right and to have then good counsel who can walk the special litigation committee through the process. There’s a lot more we could talk about with special litigation committees, but that gives you at least a general idea of what they are, when they’re used, and who can sit on a special litigation committee. I’m Aaron Hall, a business attorney in Minneapolis, Minnesota. For additional information, see the materials below.