Special Committees: Law and Practice

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Author: Gregory Varallo | Srinivas Raju | Michael Allen

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SPECIAL COMMITTEES

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SPECIAL COMMITTEES LAW AND PRACTICE

GREGORY V. VARALLO SRINIVAS M. RAJU MICHAEL D. ALLEN

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1 Oxford University Press, Inc., publishes works that further Oxford University’s objective of excellence in research, scholarship, and education. Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Mexico City Nairobi New Delhi Shanghai Taipei Toronto

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Copyright © 2011 by Oxford University Press, Inc. Published by Oxford University Press, Inc. 198 Madison Avenue, New York, New York 10016 Oxford is a registered trademark of Oxford University Press Oxford University Press is a registered trademark of Oxford University Press, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press, Inc. ______________________________________________________________ Library of Congress Cataloging-in-Publication Data Varallo, Gregory V., 1959Special committees : law and practice / Gregory V. Varallo, Srinivas M. Raju, Michael D. Allen. p. cm. Includes bibliographical references and index. ISBN 978-0-19-973513-6 (hardback : alk. paper) 1. Directors of corporations—Legal status, laws, etc.—United States. 2. Corporate internal investigations—United States. 3. Management committees—United States. I. Raju, Srinivas M. II. Allen, Michael D. III. Title. KF1423.V37 2011 346.73’0664—dc22 2010035416 ______________________________________________________________ 1 2 3 4 5 6 7 8 9 Printed in the United States of America on acid-free paper. Note to Readers This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is based upon sources believed to be accurate and reliable and is intended to be current as of the time it was written. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Also, to confirm that the information has not been affected or changed by recent developments, traditional legal research techniques should be used, including checking primary sources where appropriate. (Based on the Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.)

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This book is dedicated to our wives and children (who put up with us and our constant absence from hearth and home in pursuit of our profession). Catherine, Danielle, Peter and Michael Varallo Seetha, Anand, Sanjay and Priya Raju Becky, Andrew, Jack and Hailey Allen The authors also wish to thank our colleagues Aaron Stewart, Esq. and Robert Burns, Esq. for their tireless efforts in assisting in the research and production of this book.

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Contents

Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv Chapter 1

The Special Committee and the Circumstances in Which It Is Used—Or, What Makes a Special Committee so Special? . . . . . . . . . . . . . . . . . . . . . . . . . . 1 a. Common Circumstances in Which Special Committees Are Used . . . . . . 2 i. Investigating Potential Corporate Wrongdoing . . . . . . . . . . . . . 2 ii. Investigating Stockholder (Member) Demands . . . . . . . . . . . . . 3 iii. Addressing Pending Litigation . . . . . . . . . . . . . . . . . . . . . 3 iv. Corporate Transactions . . . . . . . . . . . . . . . . . . . . . . . . . 4 1. Controlling Stockholder Transactions . . . . . . . . . . . . . . . . 4 2. Conﬂicted Board Transactions . . . . . . . . . . . . . . . . . . . . 5 v. Other Situations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 b. Circumstances in Which a Committee May Not Be Advisable . . . . . . . . 7 Chapter 2

The Role of the Special Committee and the Legal Consequences of Its Use . . . . . . . . . . . . . . . . . . . . 11 a. The Role of the Special Committee and the Legal Consequences of Its Use in Stockholder Litigation . . . . . . . . . . . . . . 12 i. The Demand Requirement . . . . . . . . . . . . . . . . . . . . . . . 12 ii. The Role of the Demand Committee and the Legal Consequences of Its Use . . . . . . . . . . . . . . . . . . . . . 14 iii. The Role of the Special Litigation Committee and the Legal Consequences of Its Use . . . . . . . . . . . . . . . . . . . 16 vii

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b. Role of a Non-Demand Investigative Committee and the Legal Consequences of Its Use . . . . . . . . . . . . . . . . . . . 17 c. The Role of a Transactional Committee and the Legal Standards Applicable to Its Work . . . . . . . . . . . . . . . . . . . . . . 17 i. Legal Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 1. Fiduciary Duties—Duty of Care . . . . . . . . . . . . . . . . . . . 19 2. Fiduciary Duties—Duty of Loyalty. . . . . . . . . . . . . . . . . . 21 d. The Legal Beneﬁts of Using Special Committees in Conﬂict of Interest Transactions. . . . . . . . . . . . . . . . . . . . . . 22 e. The Legal Beneﬁts of Using a Committee in Conﬂict Transactions: Limited Partnerships and Limited Liability Companies. . . . . . . . . . . . . . . . . . . . . . . . . 25 f. De Facto Special Committees . . . . . . . . . . . . . . . . . . . . . . . . 28 Chapter 3

Forming the Special Committee . . . . . . . . . . . . . . . . . . . . . 31 a. The Size of the Special Committee . . . . . . . . . . . . . . . . . . . . . 31 b. The Composition of the Special Committee . . . . . . . . . . . . . . . . . 32 i. Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 ii. Disinterest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 iii. Willingness to Serve in a Vigorous Manner . . . . . . . . . . . . . . . 37 c. Case Study: The Thrust-Upon Conﬂict . . . . . . . . . . . . . . . . . . . . 37 d. The Committee Charter . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 i. The Form of the Charter . . . . . . . . . . . . . . . . . . . . . . . . 41 ii. Restrictions on Delegations to Committees . . . . . . . . . . . . . . . 42 iii. Recommend Versus Take Action . . . . . . . . . . . . . . . . . . . . 44 iv. The Power to Negotiate and Just Say No— Transactional Committees . . . . . . . . . . . . . . . . . . . . . . . 46 v. Do’s and Don’ts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 vi. Forms of Committee Charters . . . . . . . . . . . . . . . . . . . . . 53 e. The Retention of Advisors . . . . . . . . . . . . . . . . . . . . . . . . . . 53 i. Who retains the advisors? . . . . . . . . . . . . . . . . . . . . . . . 53 ii. Who do the advisors represent? . . . . . . . . . . . . . . . . . . . . 54 iii. The Use of Experienced Company Advisors . . . . . . . . . . . . . . 55

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CONTENTS

iv. Interviewing Potential Advisors . . . . . . . . . . . . . . . . . . . . . 56 1. Conﬂicts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 2. What is the lawyer’s direct experience? . . . . . . . . . . . . . . . 56 3. Am I comfortable with this lawyer? . . . . . . . . . . . . . . . . . 57 f. Case Study: Meet your new lawyer! . . . . . . . . . . . . . . . . . . . . 57 g. Compensation of Committee Members. . . . . . . . . . . . . . . . . . . 60 h. APPENDIX A: Sample Special Litigation Committee Charter . . . . . . . . 62 i. APPENDIX B: Sample Investigatory Special Committee Charter. . . . . . . 64 j. APPENDIX C: Sample Negotiating Special Committee Charter . . . . . . . 66 k. APPENDIX D: Sample Conﬂict Transaction Special Committee Charter. . . 69 l. APPENDIX E: Sample Special Committee Guidelines and Procedures . . . 72 m. APPENDIX F: Recent Special Committee Fees . . . . . . . . . . . . . . . 74 Chapter 4

Getting Ready: Director Indoctrination. . . . . . . . . . . . . . . . . . 83 a. What Are We Trying to Do and for Whom Are We Trying to Do It? . . . . . 84 b. What Does It Mean to Simulate Arm’s-Length Bargaining? . . . . . . . . . 85 c. Inquisitor? Thoughts on the Role of the Forensic Committee . . . . . . . . 89 d. Understanding the Role of In-House and Other Counsel . . . . . . . . . . 92 e. Dealing with Actors Who Do Not Understand (Or Respect) the Role of the Committee . . . . . . . . . . . . . . . . . . . . . . . . . 93 f. Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 i. It’s fair, so we approved it . . . . . . . . . . . . . . . . . . . . . . . 93 ii. The One-Person Negotiating Committee . . . . . . . . . . . . . . . . 95 g. APPENDIX A: Sample Bidding Procedures . . . . . . . . . . . . . . . . . 99 h. APPENDIX B: Sample Bidding Procedures—Competing Superior Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 Chapter 5

The Committee’s First Steps . . . . . . . . . . . . . . . . . . . . . . 107 a. Investigative Committees . . . . . . . . . . . . . . . . . . . . . . . . . 107 i. Identifying the Subject and Goal of the Investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

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CONTENTS

ii. Conﬁrming the Independence and Disinterestedness of the Committee Members and the Authority of the Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 iii. Establishing the Role of Counsel . . . . . . . . . . . . . . . . . . . 109 iv. Initial Document Requests . . . . . . . . . . . . . . . . . . . . . . 110 v. Organizing Interviews . . . . . . . . . . . . . . . . . . . . . . . . 110 vi. Demonstrating Commitment to the Investigation . . . . . . . . . . . 111 b. Transactional Committees . . . . . . . . . . . . . . . . . . . . . . . . . 112 i. Starting with the End in Mind . . . . . . . . . . . . . . . . . . . . 112 1. Formulating Basic Strategy for Negotiations . . . . . . . . . . . . 115 2. Keeping in Mind the Ultimate Disclosure . . . . . . . . . . . . . 118 ii. Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 1. The Role of Management . . . . . . . . . . . . . . . . . . . . . 120 2. The Role of Traditional Outside Counsel . . . . . . . . . . . . . 122 iii. Case Study: Stacking the Deck . . . . . . . . . . . . . . . . . . . . 123 Chapter 6

Getting Down to Work (Investigative Committees) . . . . . . . . . . 125 a. Issues and Considerations Regarding Legal Privileges . . . . . . . . . . . 125 i. The Attorney–Client Privilege . . . . . . . . . . . . . . . . . . . . 126 ii. The Work Product Doctrine . . . . . . . . . . . . . . . . . . . . . 127 iii. The Joint Defense Privilege . . . . . . . . . . . . . . . . . . . . . . 128 b. Steps to Preserve Privilege . . . . . . . . . . . . . . . . . . . . . . . . 129 c. Reviewing the Relevant Documents . . . . . . . . . . . . . . . . . . . . 130 d. Fact Gathering from Persons with Relevant Information . . . . . . . . . . 131 i. Identifying Interviewees and Conducting the Interviews . . . . . . . 133 ii. Warnings to Non-Client Interviewees . . . . . . . . . . . . . . . . 133 iii. Protecting Employees’ Rights . . . . . . . . . . . . . . . . . . . . . 135 iv. Methods of Recording Interviews. . . . . . . . . . . . . . . . . . . 137 e. Documenting the Committee Process . . . . . . . . . . . . . . . . . . . 139 Chapter 7

Getting Down to Work (Transactional Committees) . . . . . . . . . . 141 a. The Power to Say No and Its Importance . . . . . . . . . . . . . . . . . 141

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CONTENTS

b. The Use of Experts (Bankers and Others) . . . . . . . . . . . . . . . . . 144 i. Fairness Opinions . . . . . . . . . . . . . . . . . . . . . . . . . . 147 c. Communicating with the Committee and Conﬁdentiality . . . . . . . . . 149 d. Meetings of the Committee and Documenting Proceedings . . . . . . . . 151 i. Committee Meetings . . . . . . . . . . . . . . . . . . . . . . . . . 151 ii. Minutes and Documenting Proceedings . . . . . . . . . . . . . . . 154 iii. Practice Pointers . . . . . . . . . . . . . . . . . . . . . . . . . . . 157 iv. Notes and Document Retention . . . . . . . . . . . . . . . . . . . 158 e. Understanding the Required Disclosures of the Committee’s Work . . . . 159 f. Case Study: The Emailing Director . . . . . . . . . . . . . . . . . . . . . 162 g. Avoiding Falling into the Deal Mentality . . . . . . . . . . . . . . . . . . 164 Chapter 8

Drafting the Forensic Committee’s Report . . . . . . . . . . . . . . . 167 a. The Importance of a Written Report of the Committee . . . . . . . . . . 167 b. The Scope of the Written Report . . . . . . . . . . . . . . . . . . . . . 170 c. Deciding What to Include in Writing . . . . . . . . . . . . . . . . . . . 170 i. Rule One: Avert not thine eyes . . . . . . . . . . . . . . . . . . . . 171 ii. Rule Two: Speak truth to power . . . . . . . . . . . . . . . . . . . 173 iii. Rule Three: Separate the wheat from the chaff . . . . . . . . . . . . 174 iv. Rule Four: Avoid the gratuitous . . . . . . . . . . . . . . . . . . . . 174 v. Rule Five: Draft to build consensus . . . . . . . . . . . . . . . . . . 175 d. A Sample Report Outline . . . . . . . . . . . . . . . . . . . . . . . . . 175 i. A Description of the Committee and its Work . . . . . . . . . . . . 175 ii. An Executive Summary of Findings and Recommendations . . . . . 175 iii. Facts Found by the Committee . . . . . . . . . . . . . . . . . . . . 176 iv. An Overview of the Law as Understood by the Committee . . . . . 176 v. Speciﬁc Factors Considered by the Committee in Making Its Decision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 vi. The Committee’s Conclusions . . . . . . . . . . . . . . . . . . . . 177 vii. Recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . 177 e. Working with the Committee to Finalize the Report . . . . . . . . . . . . 177 f. Final Steps of the Forensic Committee . . . . . . . . . . . . . . . . . . . 178

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CONTENTS

Chapter 9

Negotiating the Transaction Documents . . . . . . . . . . . . . . . . 181 a. The Need for an Informed and Active Committee . . . . . . . . . . . . . 181 b. The Role of the Committee Counsel . . . . . . . . . . . . . . . . . . . 185 c. The Role of Regular Outside Counsel to the Corporation . . . . . . . . . 192 d. Interaction with the Full Board . . . . . . . . . . . . . . . . . . . . . . 194 e. A Word about Substance . . . . . . . . . . . . . . . . . . . . . . . . . 197 Chapter 10

What to Do? (The Forensic Committee) . . . . . . . . . . . . . . . . 199 a. The Decision that Further Proceedings Should Not Be Pursued . . . . . . 199 i. The Demand Committee . . . . . . . . . . . . . . . . . . . . . . 199 ii. The Special Litigation Committee . . . . . . . . . . . . . . . . . . 201 iii. The Transactional Committee . . . . . . . . . . . . . . . . . . . . 205 b. The Decision to Pursue Claims . . . . . . . . . . . . . . . . . . . . . . 206 i. The Demand Committee . . . . . . . . . . . . . . . . . . . . . . 206 ii. The Special Litigation Committee . . . . . . . . . . . . . . . . . . 207 c. The Decision to Attempt to Reach a Settlement . . . . . . . . . . . . . . 208 i. The Demand Committee . . . . . . . . . . . . . . . . . . . . . . 208 ii. The Special Litigation Committee . . . . . . . . . . . . . . . . . . 209 d. Conclusion of an Internal Investigation . . . . . . . . . . . . . . . . . . 210 e. Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211 i. Let’s get rid of this case . . . . . . . . . . . . . . . . . . . . . . . 211 ii. Pay up! . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215 Chapter 11

Controlling Fallout from the Committee Process . . . . . . . . . . . . 221 a. The Transactional Committee—Expect to Waive the Privilege . . . . . . . 221 b. Investigative Committees—Preserve Legal Privileges if Possible . . . . . . 222 i. The Attorney–Client Privilege . . . . . . . . . . . . . . . . . . . . 223 ii. The Work Product Doctrine . . . . . . . . . . . . . . . . . . . . . 223 iii. The Waiver of Privilege. . . . . . . . . . . . . . . . . . . . . . . . 224 c. Discovery Requests by Derivative Plaintiffs in Response to Decisions Made by a Special Litigation Committee . . . . . . . . . . . 225 xii

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d. Consequences of Disclosing the Investigative Committee’s Report . . . . 226 i. Criminal Conduct: Dealing with Organizational Fallout from Findings Implicating Criminal Conduct . . . . . . . . . 227 ii. Federal Sentencing Guidelines . . . . . . . . . . . . . . . . . . . . 229 iii. Department of Justice’s Principles of Federal Prosecution of Business Organizations . . . . . . . . . . . . . . . . 230 iv. Potential Libel Claims . . . . . . . . . . . . . . . . . . . . . . . . 232 e. Case Study: Announcing Investigation Results to the Full Board . . . . . . 233 Chapter 12

The In-House Lawyer’s Role: What to Expect and How to Cope . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 a. Understanding the Potential Appearance of Conﬂict of the In-House Lawyer . . . . . . . . . . . . . . . . . . . . . 237 b. Understanding How the Appearance of Conﬂict Shapes the Role of In-House Counsel in the Committee Process . . . . . . . . . . . . . . . . . . . . . . . . . . 238 c. Helping the Special Committee Get Started . . . . . . . . . . . . . . . . 239 i. Selection of Counsel . . . . . . . . . . . . . . . . . . . . . . . . . 240 ii. Dealing with Billing and other Mechanics of the Committee’s Representation by Outside Counsel . . . . . . . . . 241 iii. Providing Internal Support to the Committee . . . . . . . . . . . . . 242 iv. Supporting the Transactional Committee . . . . . . . . . . . . . . . 243 d. Avoiding Common Pitfalls . . . . . . . . . . . . . . . . . . . . . . . . . 244 i. Controlling the Process: Give It Up! . . . . . . . . . . . . . . . . . 244 ii. Staying Away from Meetings . . . . . . . . . . . . . . . . . . . . . 245 iii. Acting as the Board Interface . . . . . . . . . . . . . . . . . . . . . 245 iv. Controlling Curiosity and the Urge to Meddle . . . . . . . . . . . . 247 v. Preparing and Debrieﬁng Witnesses . . . . . . . . . . . . . . . . . 248 e. Case Study: Don Quixote and the Meddling General Counsel . . . . . . . 250 Chapter 13

The Role of the Controlling Stockholder and Management: What to Expect and How to Cope . . . . . . . . . . . . 253 a. Commitment to Process . . . . . . . . . . . . . . . . . . . . . . . . . . 254 b. The Selection of Committee Members and Advisors . . . . . . . . . . . 255 xiii

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c. The Scope of Authority Given to the Committee . . . . . . . . . . . . . 256 d. The Appropriate Role for Management . . . . . . . . . . . . . . . . . . 258 e. Resisting the Urge to Meddle . . . . . . . . . . . . . . . . . . . . . . . 259 f. Negotiating with the Record in Mind . . . . . . . . . . . . . . . . . . . 259 i. Playing Hardball . . . . . . . . . . . . . . . . . . . . . . . . . . . 260 ii. Controlling the Stockholder’s Duty of Candor . . . . . . . . . . . . 261 iii. The Rights of Controlling Stockholders Qua Stockholders . . . . . . 263 g. The Interested Party Typically Suffers the Consequences of a Flawed Special Committee Process . . . . . . . . . . . . . . . . . . 264 h. Case Studies: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265 i. Fostering Communication . . . . . . . . . . . . . . . . . . . . . . 265 ii. The Disappearing Bid . . . . . . . . . . . . . . . . . . . . . . . . 268 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271 Table of Authorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

xiv

Foreword

Board committees are undoubtedly familiar to every director who sits on the governing body of a public or private company, as most every board of directors does its work between meetings through various committees. The special committee, however, is often not as well known. Those who have accepted the invitation to participate in the work of such a committee quickly learn just how different the role of a special committee director can be. Special committees are typically used to address conflict situations, such as the negotiation of a transaction with a controlling stockholder; the investigation of potential wrongdoing in which a majority of the board may be implicated; or the review of pending litigation in which some or all of the existing directors are defendants, to determine whether the litigation should continue. In each of these classic examples, some significant number (often a majority) of existing directors are faced with a potential or actual conflict of interest. The special committee is chartered to address the conflict, either by attempting to simulate arm’s-length bargaining or by making an independent arm’s-length review of the potential wrongdoing or existing litigation. When used correctly, a special committee may resolve troublesome litigation; ameliorate or avoid litigation arising from a conflict of interest transaction; and, in certain circumstances, add additional protection to a transaction if the transaction itself is later attacked in court. As it has evolved in modern practice, the properly functioning special committee is an important tool which serves to reinforce the primacy of the board in corporate governance and to allow the board to reassert the role assigned to it by statute under certain circumstances where that role may have been (or could be) set aside as a result of potential conflicts of interest. The notion of a properly functioning special committee is the key to a successful outcome. As shown in detail in the following chapters, a poorly functioning special committee is often worse than no committee at all, and only the truly properly functioning committee is likely to protect a transaction or allow the board to discharge its role in conflict situations. How a special committee functions properly and thus how it can achieve its purpose is the subject of this book. Because the role of the special committee is to simulate arm’s-length bargaining or conduct an independent and arm’s-length review if the full board is not otherwise able to do so, the work of the special committee must be thorough and rigorous. xv

FOREWORD

Moreover, the role of the director sitting on the special committee is, almost of necessity, quite different than the director’s role if he participates on any other committee. Simulating arm’s-length bargaining in a transaction setting involves direct and potentially adversarial negotiations with the controlling stockholder or other interested parties. Likewise, investigating potential wrongdoing is a serious undertaking, and the investigation is pursued wherever it leads, even if it leads to a finding that one or more key insiders or other board members have harmed the company. Similarly, since special committees are often used to address conflict situations, the review of the work of such committees in court is often subject to a different and higher standard than the director-friendly business judgment rule used to review many other decisions of the board. Instead, the courts have evolved a body of law that calls for more searching review of the work of many special committees. So, the director who agrees to participate in the work of a special committee is expected to stand ready to come into conflict with other board members, is required to conduct a rigorous and unflinching process, and then is judged more harshly by a reviewing court than is typical in any routine decision making. This role is, indeed, a different animal; the director who steps into the role of special committee member must possess a full and complete understanding of what he is being asked to do and how that role is different than typical committee service before embarking on this unusual journey. So too, the committee’s advisors. Counsel have often undertaken special committee work lacking the understanding that the work is a specialized area of practice, perhaps because the field has not yet been broadly recognized as such. But special committee practice is and has been a highly evolved specialty for some time. Advising a special committee means, first and foremost, fully understanding the nature of the role directors are asked to play as committee members, and then communicating that role at the outset of the representation and repeatedly throughout the process. Counsel’s role is likely to be uncomfortable at times, as it ultimately falls to counsel to help steer the special committee past social and other ties and to help the committee understand the critically important difference between being independent on paper and being willing to act independently of the conflicted parties. Moreover, given the close scrutiny a special committee often faces in court, as well as the panoply of different issues that can arise during the course of a special committee assignment, counsel advising a special committee needs to clearly grasp how the process should unfold; what key issues are most likely to be litigated later; and in certain circumstances, what disclosure and other issues may be implicated in different factual contexts. Indeed, as we set forth below, even criminal issues occasionally arise during the work of a special committee charged with investigating alleged wrongdoing. In short, special committee practice, both from the perspective of the director and the perspective of the committee’s counsel, has emerged as a high-stakes specialty. If done correctly, a well-run special committee process can be of enormous value to the company and all its constituencies. If done poorly, or even with good motives but nonetheless incompetently, it can magnify whatever issues the company is facing. In the chapters that follow, we address the role of the director and the process he must be prepared to follow as a member of an independent special committee. xvi

FOREWORD

Each step in the special committee process is considered in detail, from committee formation to the conclusion of a transaction or investigation. Finally, a word about the case studies we have used in this book. Some will be familiar to the experienced reader because they are based on court decisions that have reviewed the work of transactional and forensic committees. Others are based upon or contain similarities to the authors’ experiences counseling special committees and may never have been litigated in court. Still others are purely illustrative. We trust that the case studies used here will elucidate and underline the points we make throughout and will be a helpful guide to the reader.1

1

Portions of this volume ﬁrst appeared in Varallo, Dreisbach & Rohrbacher, Fundamentals of Corporate Governance: A Guide for Directors and Corporate Counsel (2d ed. ABA 2009), and are reprinted with permission. xvii

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Chapter 1

The Special Committee and the Circumstances in Which it is Used—Or, What Makes a Special Committee so Special?

As a general matter, the board of directors of a company is responsible for managing the business and affairs of the company. The board is permitted to delegate various responsibilities to the management of the company and form committees of the board to carry out various functions. Any such committees serve at the pleasure of the board, which retains the ultimate responsibility to manage the company. Hence, in many ways, a special committee is just like any other committee of the board. Special committees, however, are different in one very important respect—namely, the reason for forming a special committee is almost always a material conflict of interest that has been identified, a conflict that either disables or makes it inadvisable for the board and/ or senior management of the company to address the issue directly. Such conflict of interest situations typically pose a host of challenges to all involved, including the board, the senior management of the company, and outside advisors. Although the board ultimately retains the authority to direct the business and strategy of a company, it is fair to say that, in most companies, senior management typically “runs the show” on a daily basis. Nor is there anything wrong with this. As long as the board is not abdicating its statutory and fiduciary duties, it is sensible for the board to rely upon the recommendations of management as to the business and operations of the company. The special committee situation, however, is far from ordinary. If a special committee is formed and given its task, then it is the special committee that is in charge with respect to the delegated task. The special committee is certainly free to consult with the board, members of senior management, or anyone else who may aid the special committee in its work, but must give independent consideration to the issues presented and then make an independent decision on behalf of the company. Such a situation, in which neither the board nor senior management has any real influence, often puts tremendous stress on all parties involved. The members of the special committee, typically independent directors, often experience significant stress in having to devote far 1

THE SPECIAL COMMITTEE AND THE CIRCUMSTANCES IN WHICH IT IS USED

more time than they likely anticipated to the work of the committee. Given its point of view, senior management often is severely stressed by its lack of control over the process and the delay and inefficiencies created by delegating what likely is a matter of significant corporate importance to outside, independent directors who are less knowledgeable about the company. The special committee is required under law to conduct its work in an independent, informed, and thorough manner without undue influence by senior management or the board, which invariably adds to these stresses. There are many different types and variations of special committees and many different names used for such committees, including special committee, special transaction committee, special investigative committee, special litigation committee (SLC), independent committee, and conflicts committee. One constant with respect to all these special committees is that they are formed to address a matter as to which the board and/or senior management of the company has an actual or perceived conflict of interest. In this book, special committees are divided into two broad categories: negotiating or transactional committees and investigative or forensic committees. Negotiating or transactional committees are those special committees formed to consider a potential transaction involving the company. Typical examples of negotiating committees include committees formed if a company is considering a goingprivate transaction (in which members of senior management are part of the acquiring group), a sale of the company or financing transaction in which there are conflicts of interest, or an acquisition of or sale of assets that involve a conflict of interest. Forensic or investigative committees are those special committees formed to investigate (rather than negotiate). Such committees may be formed to investigate potential or alleged wrongdoing or failures on the part of the company and/or its directors, officers, or employees. Forensic committees include those formed by the board to investigate particular corporate actions or problems. They also include those committees formed to consider a stockholder demand that the board initiate litigation to redress alleged wrongdoing, as well as those formed to consider whether the company should take control of existing stockholder derivative litigation. We address the more typical situations in which special committees are used in greater detail below.

A. COMMON CIRCUMSTANCES IN WHICH SPECIAL COMMITTEES ARE USED There are many circumstances in which special committees are formed in practice. What follows are common examples of those circumstances.

i. Investigating Potential Corporate Wrongdoing One situation in which a special committee is often used is to investigate potential wrongdoing either by or involving the company. Potential wrongdoing can come in many forms, including the failure to comply with internal corporate policies and/or failure to comply with state, federal, or other applicable laws. Often, members of senior 2

COMMON CIRCUMSTANCES IN WHICH SPECIAL COMMITTEES ARE USED

management are heavily involved in investigating such potential mismanagement. However, if the nature of the potential wrongdoing is such that it is possible that senior management may have been involved in or aware of the potential wrongdoing, then a special committee of outside directors may be tasked with investigating the potential wrongdoing. Typically, the special committee, once the investigation is complete, will set out its findings in a written report that describes the investigation, the committee’s findings and conclusions as a result of the investigation, and recommendations as to what should be done. The board or one of its committees, such as the audit committee, may initiate this kind of internal investigation. Likewise, these investigations are sometimes initiated as a result of whistleblower allegations or tips made to corporate compliance hotlines that work their way up through the corporate compliance structure.

ii. Investigating Stockholder (Member) Demands In addition to internally generated complaints, boards are often called upon to investigate stockholder or member grievances. Special committees of independent directors can be used effectively by boards in circumstances where a stockholder or member has made a demand upon the board to initiate litigation. After the receipt of such a demand letter, a board may form a special committee to investigate the allegations of the demand and recommend a course of action to the board. In such a situation, the special committee should conduct a thorough investigation of the allegations and then make a recommendation as to the action(s) it believes would best serve the interests of the company. If the special committee finds none of the allegations in the demand to have merit, then the special committee could decide to recommend that the company not take further action and not initiate litigation with respect to such allegations. On the other hand, if the special committee were to find that one or more of the allegations in the demand have merit, then the special committee could well decide to recommend that the company take action to redress the wrong (including through the initiation of litigation) and take steps to ensure that such wrongs or issues do not arise in the future.

iii. Addressing Pending Litigation Special committees can also be used by a company to attempt to take control of existing stockholder or member-initiated derivative litigation. The principle underlying this use of a special committee is quite simple. A derivative claim is one brought on behalf of the company (or other entity); consequently, any recovery obtained would go directly to the company. Hence, a derivative claim is a claim belonging to the company and, therefore, potentially an asset of the company. Given that it is the board (or a duly authorized committee thereof), rather than stockholders, that manages the company’s business and affairs, the law recognizes the right of a special committee of independent directors to investigate and, subject to court approval, take control of a derivative 3

THE SPECIAL COMMITTEE AND THE CIRCUMSTANCES IN WHICH IT IS USED

litigation initiated by a stockholder. If stockholder derivative litigation has been initiated, the board may opt to appoint an SLC to investigate the stockholder’s allegations, consider the merits of the allegations, and determine whether the litigation is in the best interests of the company and its stockholders. As appropriate, such a committee would either seek to terminate all or a portion of the derivative suit, seek to prosecute all or a portion of the derivative suit, or determine to settle the suit. The use of SLCs is addressed in detail throughout this volume.1

iv. Corporate Transactions2 Special committees are also commonly used in transactional settings, to carry out the task of considering a potential transaction by the company that implicates a conflict of interest. The types of transactions and the potential conflicts of interest come in many forms. A few examples are discussed in the following sections.

1. Controlling Stockholder Transactions Special committees are often very useful in controlling stockholder transactions. For example, the controlling stockholder may wish to effect a cash-out merger of the minority stockholders. Delaware law typically subjects a controlling stockholder cash-out merger to the entire fairness standard.3 The use of a special committee can be particularly helpful in these situations. First, there are benefits with respect to the how the legal standard is applied if an effective special committee process is used. Second, the effective functioning of a special committee often provides evidence that the minority stockholders have been treated fairly regardless of what legal standard is ultimately applied. The classic interested transaction is one in which a controlling stockholder of a company seeks to take the company private by cashing out the public stockholders. This is an interested transaction because the controlling stockholder is on both sides of the transaction, i.e., both the buy side as well as (through its control of the company) the sell side. In such a situation, a special committee should be strongly advised to negotiate the potential cash-out merger from the perspective of the public stockholders of the company. Another form of interested transaction occurs if a company with a controlling stockholder is being sold to a third party, but the controlling stockholder receives consideration that is different (whether in the amount of per share consideration or in the form 1

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The law draws an important distinction between direct and class actions, on the one hand, and derivative actions, on the other. The SLC is available to address derivative, but not direct or class, actions. This is because the derivative action is a species of corporate asset, whereas the direct or class action belongs instead to the aggrieved plaintiffs. Although we refer here to “corporate” transactions, as made clear in succeeding chapters, special committees are widely used (and useful) in noncorporate settings such as limited partnerships and limited liability companies. The entire fairness standard of review, if applicable, is often difficult to meet and requires proof of both “fair dealing” and “fair price.” Weinberger v. UOP, Inc., 457 A.2d 701, 703, 711 (Del. 1983).

COMMON CIRCUMSTANCES IN WHICH SPECIAL COMMITTEES ARE USED

of consideration received) than what the public stockholders are to receive. For example, all the public stockholders may be getting cash for their stock, but it is contemplated that the controlling stockholder is going to get a mix of cash and equity of the surviving company for its shares. In this situation, the controlling stockholder is not really on both sides of the transaction, because the company is being sold to a third party.4 Nevertheless, there is a conflict of interest with respect to how the consideration being paid for the company is allocated among the stockholders of the company. A third party that is interested in acquiring a company will obviously focus on the total price of the acquisition. But, the third-party acquirer typically has no vested interest in how that total price is allocated among the various stockholders of the target corporation. The controlling stockholders and the public stockholders of the corporation, on the other hand, will care deeply about how the total consideration being paid is allocated among the stockholders. With respect to maximizing the total price to be received in a sale, the controlling stockholder and the public stockholders should be aligned. There will be a conflict, however, to the extent that consideration is to be allocated other than by providing equal consideration per share to all stockholders. In addition, in light of the controlling stockholder’s ability to shape the terms of the transaction, including the terms of the different consideration for it, the creation of a special committee to negotiate with the third party should be strongly considered. Controlling stockholders are sometimes required by an arm’s-length, third-party acquirer to take equity in the post-merger enterprise to allow for a recapitalization accounting treatment or for other reasons specific to a particular transaction. Even in these situations, in which the controlling stockholder is at best a reluctant participant in rather than the architect of the disparate consideration, the use of an independent special committee is highly recommended.

2. Conﬂicted Board Transactions Conflict of interest transactions can also occur outside the controlling stockholder context if a majority (or a significant percentage) of the members of a board have a conflict of interest with the corporation or its stockholders. Such conflicts can arise in numerous contexts, such as transactions with directors or the affiliates of directors, consulting agreements or other compensation or employment arrangements with members of the board, or a management-sponsored going-private transaction. These types of conflicts can be just as significant as in conflicted controlling stockholder situations. As an example, consider the significant conflicts in a management-sponsored going-private transaction in which representatives of senior management also sit on the board. Usually in the absence of a controlling stockholder, a managementsponsored proposal has significant financial backers (typically, private equity firms or other investors). These financial backers usually incorporate mechanisms to incentivize 4

But see In re LNR Props. Corp. S’holders Litig., 896 A.2d 169, 178 (Del Ch. 2005) (denying motion to dismiss as to allegations that a controlling stockholder acted as a seller and not a buyer when negotiating a merger transaction in which he would receive cash consideration equivalent to the public stockholders for 75 percent of his shares, but rolled over the remaining 25 percent of his shares into a 20-percent interest in the surviving corporation). 5

THE SPECIAL COMMITTEE AND THE CIRCUMSTANCES IN WHICH IT IS USED

senior management to maximize performance following the going private transaction. Performance incentives in the form of future cash bonuses and/or stock or option grants are frequently based on performance relative to corporate projections. Given that these same projections are also very important for purposes of determining the value of the corporation and thus the price that has to be paid to acquire the corporation in the going-private transaction, the potential conflicts of interest become clear. On the one hand, senior management should try to extract top dollar from any potential acquirer in connection with a sale of the corporation. This can be done in significant part by convincing the acquirer of all the upside scenarios in the corporation’s projections for future performance. On the other hand, senior management has a direct incentive to take a conservative approach in preparing the corporation’s projections to build in a cushion for future outperformance and thereby maximize their own financial incentives post acquisition. Of course, such a conservative approach to projections is likely to result in a lower price for the stockholders in the going-private transaction. This is just one example of how the conflicts of interest in a conflicted board situation can be every bit as real as in a controlling stockholder situation.

v. Other Situations There are a countless number of conflict of interest transactions that arise and could potentially benefit from the use of a special committee. In addition to being used to address conflict and controlling stockholder situations, there may be practical benefits to using a special committee outside the classic interested transaction. For example, it may be worthwhile to consider a special committee in circumstances where there is a conflict of interest that affects only a minority of the board. Assume a proposed transaction in which the senior management of the corporation has interests that are different from those of the public stockholders of the corporation. Assume that two out of five directors of the corporation are members of senior management and the other three directors are independent directors. Even though the majority of the board is disinterested, there are real practical benefits to using a special committee in this situation. First, having discussions relating to the transaction with the full board is, at a minimum, awkward and may be problematic. Given that two out of the five directors have a conflict of interest, their presence at board meetings could have a chilling effect on whether the three independent directors have a full and frank discussion of the merits of the transaction from the point of view of the corporation and its stockholders. Hence, as a matter of process, some steps should be taken to permit the independent directors to have deliberations outside the presence of the two insiders. Informal steps in this regard can be taken, such as asking the two insiders to leave for certain portions of the board meetings or having the independent directors meet in executive session. Nevertheless, the formal step of creating and delegating authority to a special committee may sometimes be the best option. In addition, in the situation we have assumed, the corporation’s outside advisors may be put in a difficult situation if no committee is formed. Since outside counsel typically will report to and have long-term relationships 6

CIRCUMSTANCES IN WHICH A COMMITTEE MAY NOT BE ADVISABLE

with senior management, practical issues often arise if no committee is formed and the independent board members continue to look to corporate counsel for assistance. Were the board to form a committee, however, and were that committee to retain independent counsel, these potential issues evaporate. Second, having a special committee formally created, empowered, and involved in a conflict transaction often provides some degree of assurance to public stockholders that their interests are being protected. If a stockholder vote is required for the transaction, then the involvement of a special committee will often be a significant factor in leading stockholders to believe that their interests are being protected and increasing the support for the transaction among public stockholders. Even if a stockholder vote is not required for a given transaction, the active involvement of a special committee in a conflicted transaction, and the confidence engendered from that process, can have important investor relations benefits.

B. CIRCUMSTANCES IN WHICH A COMMITTEE MAY NOT BE ADVISABLE There are several circumstances under which a special committee may not be advisable. First, a special committee is typically not advisable if a large majority of the board has no conflict of interest. For example, suppose a board is considering a matter in which only two out of nine directors on the board have a material conflict of interest and the other seven directors are both independent and disinterested. Depending upon the matter under consideration, it may not make sense to set up a special committee to consider the matter. Rather, it may be simpler and more efficient for the board to consider and address the matter while the two interested directors recuse themselves whenever the matter at issue is being considered.5 One of the most important considerations of a board setting up a special committee is to make sure it is committed to letting the special committee process run its course. There are many ways to address a conflict of interest. There is no legal requirement, particularly in a transaction setting, that requires that a special committee be formed. Rather, the effective use of a special committee provides significant legal benefits to the corporation, which are discussed further in Chapter Two, “The Role of the Special Committee and the Legal Consequences of Its Use.” Hence, even in a conflict of interest situation, the board has a choice as to whether to set up a special committee. In many conflict of interest situations, the best and prudent choice is to set up and delegate full authority to the special committee to address the conflicted matter. A less

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As noted above, however, if only a bare majority of the members of the board (e.g., five out of nine directors) is believed to disinterested and independent, there may be good reason to set up a special committee. In addition to the reasons noted above, in this situation, there would be little margin for error in the assessment that a majority of the board is independent and disinterested. If a court were to disagree with the corporation’s assessment as to any one of the five directors, then the corporation could be stuck with a situation in which a majority of the board is deemed to be interested and has not used a special committee. 7

THE SPECIAL COMMITTEE AND THE CIRCUMSTANCES IN WHICH IT IS USED

desirable but nevertheless possible choice might be for the board to address the matter despite the conflicts but make every effort to do so by ensuring that its process and the matter’s resolution are demonstrably fair to the corporation and its stockholders. Often the worst possible choice, and one that should be avoided at all costs, is for a board to set up a special committee without realizing the implications of this action, only to watch as senior management or other interested parties somehow undercut the special committee process. In this situation, not only are the benefits of effectively using a special committee likely lost, but the actions taken to neuter or obstruct the special committee may cast the board and/or senior management in a very bad light and be seen as evidence of a lack of fairness to the corporation or its stockholders. In sum, a board should carefully consider whether to delegate a matter to a special committee in the first instance, but if it chooses to make such a delegation, it should do so with conviction and be prepared to remain committed to that decision. Another significant reason not to use a special committee is if some suspicion exists that the special committee members do not clearly understand or are not prepared to discharge vigorously their role and the special responsibility of special committee members. Special committee work can be very difficult, time-consuming, and quite different than the typical work of a corporate director. A board often operates within a collegial atmosphere. Although significant issues need to be considered and significant decisions need to be made, there is a presumption among corporate directors and senior management that “everyone is on the same team” and committed to pursuing common goals. Consequently, although directors may have different viewpoints and opinions as to how the business of the corporation should be run, discussions rarely become adversarial and decisions are usually made by consensus. Given the conflicts of interest within the board or with senior management that precipitate the use of the special committee in the first instance, there is a real chance that the work of the special committee will lead to unpleasant and sometimes even hostile discussions with other members of the board and/or senior management. Although outright hostility is the exception rather than the norm, the possibility that a situation could become very tense and border on hostile cannot be ignored. Therefore, the members of the special committee need to have the conviction, the commitment, and the intestinal fortitude to carry out their responsibilities and fulfill their obligations regardless of how others outside the special committee may react. If the special committee members are not up to the task, then it probably makes sense not to establish a special committee or at least to carefully consider how it should be populated. These issues are considered in greater detail in Chapters Three, “Forming the Special Committee,” and Four, “Getting Ready: Director Indoctrination.” A final reason not to establish a special committee is if there are no clearly independent directors and the board determines not to expand itself to add outside and unconflicted members. Public companies are obviously subject to federal law and the standards promulgated by federal agencies and national stock exchanges, which typically require the presence of independent directors on corporate boards. Still, it is important to note that the standard of independence required under common law is not necessarily the same as that applied under federal law and the regulations of the national stock exchanges. Thus, an otherwise independent director may find herself 8

CIRCUMSTANCES IN WHICH A COMMITTEE MAY NOT BE ADVISABLE

confronted with an unanticipated conflict in the specific case that renders the director “interested.” One other factor to consider is whether the transaction will be conditioned on the approval of a majority of the outstanding shares held by disinterested stockholders. The approval of a transaction by an effectively functioning special committee is considered a cleansing mechanism that provides some legal benefits if an otherwise interested transaction is challenged. The law has recognized that the informed approval of a majority of the outstanding shares held by disinterested stockholders is another effective cleansing mechanism in many situations. Therefore, if there is confidence that the transaction will be subject to the approval of a majority of the unaffiliated shares, then consideration may be given to whether the formation of a special committee is necessary. This, of course, may be difficult to know at the outset of a potential transaction. Even if such majority of the disinterested stockholder approval will be sought, special committees are often used because, among other things, the use of a special committee is perceived as a positive factor that will help obtain the stockholder approval being sought. Indeed, in the authors’ experience, third-party acquirers often suggest that a special committee be formed to negotiate if a conflict of interest is clearly apparent or it is desirable to assure arm’s-length bargaining. In the next chapter, we explore the role of the special committee in greater detail, as well as provide a more nuanced discussion of the legal consequences of its use.

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Chapter 2

The Role of the Special Committee and the Legal Consequences of Its Use

As made clear in the Chapter One, “The Special Committee and the Circumstances In Which It Is Used—Or,What Makes a Special Committee So Special?” a special committee can be used in a variety of contexts. Depending on the context in which it is used, an effectively functioning special committee can result in significant legal benefits to the corporation. In this chapter, we provide a brief overview of (1) the role and functioning of special committees in some common litigation and transactional contexts, and (2) the legal benefits and implications of effectively functioning special committees in each of these contexts.1 The various special committee contexts discussed in detail in this chapter include the use of (1) a special committee to consider a demand by a stockholder wishing to initiate derivative litigation; (2) a special litigation committee (SLC) to consider whether to take over or terminate stockholder initiated derivative litigation; (3) an investigative committee to investigate alleged or suspected wrongdoing or noncompliance with law or corporate policies; (4) a special committee to consider conflict of interest transactions involving the corporation; and (5) a special committee to consider conflict of interest transactions in non-corporate entities such as limited partnerships and limited liability companies.

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Although the role, responsibility, and functioning of a special committee is entirely dependent on the context in which it is used and the circumstances presented, one universal and critical requirement needs to be emphasized at the outset. For a special committee effectively to carry out its mission, the special committee members must be independent with respect to the subject matter being considered by the special committee. Courts will look beyond the résumé of the individuals on the special committee and carefully consider whether the special committee members are truly independent. Independence is addressed at greater length in Chapter Three, “Forming the Special Committee.”

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THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

A. THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE IN STOCKHOLDER LITIGATION It is well recognized that the authority of the board to manage the business and affairs of the corporation encompasses the decision to initiate or abstain from initiating litigation.2 The law also recognizes that, once litigation is commenced, the role of the board is to oversee and manage that litigation just as if it were any other asset or liability of the corporation. But the law treats different types of corporate litigation differently, depending on who initiates the action and based upon whether the board is sufficiently disinterested and independent to make unbiased judgments about whether or not to continue litigation once brought. For example, the law recognizes that, in certain circumstances, stockholders of the corporation may be empowered to bring litigation on behalf of the corporation.3 In general, however, this is only permitted if the stockholder is able to demonstrate that a majority of the board or governing body lacked independence (i.e., could not be trusted to bring the case itself), or the stockholder first made a demand to sue upon the board and the board “wrongfully” rejected that demand. Finally, the law also recognizes that even if the stockholder has established the right to bring a corporate action (called a derivative action because the stockholder is suing derivatively on behalf of the company), the board may, after unsuccessfully challenging the stockholder action in court, reassert control over the action by appointing an independent SLC. Thus, in order to bring an action on behalf of a Delaware company, a stockholderplaintiff must first satisfy the so-called demand requirement set forth in court rules.4 Although much of the discussion herein focuses on Delaware law,5 many other jurisdictions have case law relating to stockholder derivative litigation that is often (but not always) consistent with that of Delaware.

i. The Demand Requirement Although Rule 23.1 is a procedural rule of the Delaware Court of Chancery, the demand requirement is regarded as a substantive rule of law governing the internal affairs of Delaware companies.6 Accordingly, under the internal affairs doctrine, even courts

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8 Del. C. § 141(a); Spiegel v. Buntrock, 571 A.2d 767, 773 (Del. 1990) (“The decision to bring a law suit or to refrain from litigating a claim on behalf of a corporation is a decision concerning the management of the corporation.”). For convenience, references in this chapter to stockholder and board are generally intended to include interest owners in a non-corporate entity and the governing body thereof, as applicable. See, e.g., Ch. Ct. R. 23.1 (Rule 23.1); see also Fed. R. Civ. P. 23.1. Throughout this book, we refer primarily (although not exclusively) to Delaware law. Delaware is home to more than half of the Fortune 500 and its judiciary has issued most of the decisions on which we rely. Braddock v. Zimmerman, 906 A.2d 776, 784 (Del. 2006).

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

outside of Delaware will apply Delaware law with respect to the demand requirement in matters concerning Delaware companies.7 Under Rule 23.1, a stockholder’s ability to prosecute a derivative action is expressly “limited to situations where the stockholder has demanded that the directors pursue the corporate claim and they have wrongfully refused to do so or where demand is excused because the directors are incapable of making an impartial decision regarding such litigation.”8 If no pre-suit demand has been made, the stockholder’s complaint is subject to dismissal unless the stockholder is able to plead with particularity why making the demand would have been futile. If the stockholder initiates derivative litigation without first making a demand on the board, then, under Delaware law, the court looks to determine whether the plaintiff was excused from making a demand.9 The court examines: “(1) whether threshold presumptions of director disinterest or independence are rebutted by well-pleaded facts; and, if not, (2) whether the complaint pleads particularized facts sufficient to create a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment.”10 Whether the board could exercise its independent and disinterested business judgment in responding to a demand requires a court to determine whether a majority of the board could exercise such judgment.11 Thus, a plaintiff meets his burden of showing that a demand would have been futile by demonstrating that at least one-half of the defendant company’s board members are either interested or cannot act independently of those directors that are interested.12 Special committees are used in two separate contexts involving stockholder derivative litigation. The first context occurs if a stockholder actually makes a demand on the company to initiate litigation. Committees in this context are often referred to as demand committees. The second context occurs if a stockholder has initiated derivative litigation and then the board employs an SLC to attempt to reassert its control of the litigation. The respective roles and legal consequences of using a demand committee and an SLC are discussed further below.

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See Rales v. Blasband, 634 A.2d 927, 932 n.7 (Del. 1993) (“The United States Supreme Court has recognized that the demand requirements for a derivative suit are determined by the law of the state of incorporation.”); see also Vantagepoint Venture P’rs 1996 v. Examen, Inc., 871 A.2d 1108, 1113 (Del. 2005) (noting that “[t]he internal affairs doctrine applies to those matters that pertain to the relationships among or between the corporation and its officers, directors, and shareholders”). Rales, 634 A.2d at 932. If a purported derivative complaint challenges a particular transaction, the complaint will be analyzed under the test first articulated by the Delaware Supreme Court in Aronson v. Lewis, 473 A.2d 805 (Del. 1984). Levine v. Smith, 591 A.2d 194, 205 (Del. 1991), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). See Conrad v. Black, 940 A.2d 28, 37 (Del. Ch. 2007). See id. at 40–41 (excusing demand where the plaintiff’s complaint raised a reasonable inference that five members of the defendant corporation’s ten-person board were interested). Interest and independence are addressed at greater length in Chapter Three. 13

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

ii. The Role of the Demand Committee and the Legal Consequences of Its Use One of the common uses of a special committee is to consider a stockholder demand made on the board that the company obtain remedial relief with respect to alleged wrongdoing. Generally, a board should not ignore a demand letter. Under established Delaware law, a board may not “assume a position of neutrality and take no position in response to the demand.”13 Once a potential claim is brought to the board’s attention, the board has a fiduciary duty to undertake an appropriate investigation of the claim.14 The board is, of course, permitted to delegate this task to a special committee. A board or duly authorized committee is obliged to “affirmatively object to or support” the institution of derivative litigation by a stockholder.15 Normally, after a stockholder makes a demand on the board, the stockholder loses the ability to initiate a derivative suit, absent a showing of wrongful refusal of that demand by the board or its committee. By making the demand, the stockholder is said to have conceded that a majority of the board is capable of considering it.16 Thus, it is typically not open to a stockholder who has made a demand to later argue that the board lacked independence or was otherwise interested. 17 Although a board’s proper investigation and disposition of a demand typically ends the matter, a board’s failure to respond to the demand may be considered a “wrongful refusal,” justifying a suit by the demanding stockholder.18 When is a board said to have “failed to respond” to a demand? A board or committee generally is entitled to a reasonable amount of time to investigate a demand.19 Although a court may construe lengthy inaction on a demand as constructive refusal of that demand, it is generally the case that the stockholder who has made a demand may not file a derivative suit while the special committee’s investigation is continuing.20 Delaware courts have declined to set an outside time limit on investigation of stockholder demands.21 The amount of

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Scattered Corp. v. Chi. Stock Exch., Inc., 701 A.2d 70, 78 (Del. 1997), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). 13 William Meade Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations § 5967, at 96 (perm. ed., rev. vol. 2004). Spiegel v. Buntrock, 571 A.2d 767, 775 (Del. 1990) (quoting Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 731 (Del. 1988)). Spiegel, 571 A.2d at 777. This outcome is reinforced by the fact that a valid demand on a board concedes the board’s independence and disinterestedness. A board’s subsequent decision to refuse demand is thus protected by the business judgment rule. Id. Rubin v. Posner, 701 F. Supp. 1041, 1045–46 (D. Del. 1988) (finding that a board’s failure to respond to a demand constituted a refusal of the demand and thus plaintiff’s filing of suit one month after making demand was not premature). Abbey v. Computer & Commc’ns Tech. Corp., 457 A.2d 368, 371 (Del. Ch. 1983). Charal Inv. Co. v. Rockefeller, 1995 WL 684869, at *2 (Del. Ch. Nov. 7, 1995) (stating that “[u]ntil the board has responded, the shareholder generally may not move forward with a derivative action”). BTZ, Inc. v. Nat’l Intergroup, Inc., 1993 WL 133211, at *3 (Del. Ch. Apr. 7, 1993) (noting that there is no “magical period of time” by which to measure amount of time required to review demand).

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

time needed to review a demand will vary in direct proportion to the complexity of the legal issues raised by the demand letter.22 There is, therefore, no exact rule to determine the amount of time within which a board or committee may consider a demand. In one case, the court found that an incomplete investigation that had been going on for five months did not constitute a constructive refusal of the demand.23 The plaintiff had challenged a transaction involving hundreds of millions of dollars and accused several of the directors of selfdealing.24 The court stated that the five-month investigatory period was not excessive due to the complexity of the issues and because the special committee had established a schedule for completing its investigation. The court also noted that there are numerous examples of cases in which the investigations were of similar length.25 Thus, the amount of time that a board will need to evaluate fully a demand varies. The complexity of the issues implicated by the demand is the primary factor used by courts to determine whether the lengthy time taken to consider a demand constitutes wrongful refusal of the demand.26 A finding of wrongful refusal of the demand by the board or a committee will enable a plaintiff-stockholder to maintain a derivative action against the board.27 In order to show wrongful refusal, the plaintiff must prove that the directors did not validly exercise their business judgment. A plaintiff may accomplish this by shouldering the burden to show that a board was not disinterested or independent or that it failed to act with due care in considering a demand.28 In a case in which a board ignores a demand, however, a plaintiff could likely show that the board did not exercise due care because it made no effort to consider the demand.29 On the other hand, by conducting a good faith investigation into a demand, a board or a committee of the board can secure for itself the presumptions of the business judgment rule if it ultimately decides to refuse the demand. Hence, as a general matter, assuming the board or a duly authorized committee thereof undertakes an appropriate process in good faith to consider and investigate the allegations of the demand, the substantive determination by the board or

22 23 24 25 26

27 28

29

Allison v. Gen. Motors Corp., 604 F. Supp. 1106, 1117–18 (D. Del. 1985), aff’d, 782 F.2d 1026 (3d Cir. 1985) (TABLE). Charal, 1995 WL 684869, at *1, *3. Id., at *3. Id. (citing Kaplan v. Wyatt, 1984 WL 8274 (Del. Ch. Jan. 18, 1984); Mount Moriah Cemetery v. Moritz, 1991 WL 50149 (Del. Ch. Apr. 4, 1991)). Allison, 604 F. Supp. at 1117–18 (holding that the “amount of time needed for a response will vary in direct proportion to the complexity of the technological, quantitative, and legal issues raised by the demand”). Grimes v. Donald, 673 A.2d 1207, 1219 (Del. 1996), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Id. at 1219. Note that although making the demand typically concedes the independence and disinterest of a majority of the board, that concession can be rebutted if the committee creates evidence, through its actions or inactions, sufficient to cast doubt on its own independence and disinterestedness. Scattered, 701 A.2d at 75. Kahn v. Tremont Corp., 694 A.2d 422, 430 (Del. 1997) (denying business judgment rule protection to decision not to pursue demand where two of the committee members considering the demand did not attend the meetings to discuss the demand). 15

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

committee will be protected by the business judgment rule and, therefore, will not be second guessed by a court.

iii. The Role of the Special Litigation Committee and the Legal Consequences of Its Use In the event that a stockholder fails to make a demand before suing and the board challenges that failure and loses, i.e., the court concludes that a majority of the board is not sufficiently independent to have fairly considered and acted on a demand, that initial loss does not deprive the board for all time of the ability to assert control over the lawsuit. Most courts that have considered the issue agree that even if the board is originally found to be unable to consider the demand, it can still delegate full authority to an SLC of independent, disinterested directors to determine whether it is in the best interests of the company to pursue claims brought on its behalf. In the leading case, Zapata Corp. v. Maldonado,30 the Delaware Supreme Court reasoned that a board retains all of its statutory managerial authority with respect to litigation decisions even though a majority of its members are determined to be unable to respond to a demand to sue, because of either an interest in the challenged transaction or a lack of independence.31 Such inability merely disqualifies the disabled directors from participating in the decision-making process with regard to those claims, and the board can legally delegate such authority to a committee of independent, disinterested directors. After a full investigation, the SLC can determine to seek dismissal of the stockholder suit, intervene to take control over it, or seek to settle it. Any of these steps is subject to court approval. Under Delaware law, the court inquires into the independence and good faith of the committee and its investigation and, in its discretion, may also apply its own business judgment to the review. This is a different and more rigorous test than that typically used to review disinterested director action.32 Used correctly, the SLC mechanism allows a board, the majority of which has been found to be disqualified from asserting control over corporate litigation, to take over the control and direction of that litigation through a truly independent committee, potentially displacing the stockholder and the stockholder’s counsel in the process. In order to achieve this rather remarkable result, however, the SLC must submit its work to a searching and non-deferential review in court. In the chapters that follow, we elaborate at length, inter alia, on how the SLC is likely to maximize its chances of running this judicial gauntlet.

30 31 32

16

430 A.2d 779 (Del. 1981). Id. at 785–86. Courts outside Delaware do not uniformly utilize this rigorous test, with some states applying a more deferential form of review. See, e.g., Auerback v. Bennett, 393 N.E.2d 994 (N.Y. 1979).

THE ROLE OF A TRANSACTIONAL COMMITTEE AND THE LEGAL STANDARDS APPLICABLE TO ITS WORK

B. ROLE OF A NON-DEMAND INVESTIGATIVE COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE Sometimes the need for an independent investigation by a committee of the board arises outside the context of formal litigation or stockholder demand. These situations can result from allegations or suspicions of wrongdoing or other noncompliance with applicable laws; or failure to comply with internal corporate policies in a wide variety of contexts, including potential whistleblower communications, concerns articulated by in-house officers or employees, or concerns communicated by outside consultants or accountants. If these issues arise, it is incumbent upon the board to consider whether an investigation should be conducted. If the allegations and/or suspicions of wrongdoing are sufficiently credible and material to the company, boards will often delegate the task of investigating the matter to a special committee. In these situations, the committee needs to investigate and consider the matter and determine how best to address any issues that are discovered. The substantive work of a special committee in this context is very similar to that of a committee considering a stockholder demand or an SLC. Nevertheless, there are some important differences. Unlike stockholder litigation or stockholder demands, typically there is no formal adversary. In light of this contextual difference, the committee may be able to do much of its work without public disclosure or court proceedings. Of course, depending on the conclusions reached by the committee, court proceedings and/or public disclosure may well result. Given that the committee’s work may at some point be subject to public disclosure and/or judicial scrutiny in litigation, the committee should take care to do its work in a careful, thorough, and independent manner.

C. THE ROLE OF A TRANSACTIONAL COMMITTEE AND THE LEGAL STANDARDS APPLICABLE TO ITS WORK A transactional committee is typically used if a material conflict of interest exists between the interests of the company on the one hand, and members of the board or a controlling stockholder of the company, on the other. In these situations, the role of a transactional committee is to conduct arm’s-length, independent negotiations to protect the unaffiliated stockholders in the otherwise interested transaction. An effectively functioning special committee can result in significant legal benefits to the company. We first discuss the legal standards that apply to interested transactions and the legal benefits of an effectively functioning special committee to explain the role and context of a transactional committee.

i. Legal Standards Directors of Delaware companies stand in a fiduciary relationship to the company they serve and all of the company’s stockholders, not just to the stockholders that 17

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

elected them.33 Therefore, if a particular decision poses a conflict, directors must be particularly sensitive to such conflicting interests and may, in appropriate circumstances, deem it advisable to “totally abstain from participation in the matter.”34 Under ordinary circumstances, board decisions to act, or conscious decisions not to act, are made under the presumptions of the business judgment rule. The business judgment rule reflects the recognition by the Delaware courts that businesspeople— not judges or stockholders—run companies. The rule provides an important defense that ordinarily will sustain a well-reasoned, informed, and good faith business decision by a board. If applicable, the rule is said to give rise to evidentiary presumptions that the board acted in good faith, with due care, and in the honest belief that the action taken was in the best interests of the company.35 Directors are ordinarily entitled to these presumptions unless a person challenging the directors’ decision can establish that a majority of the directors who took the challenged decision had a personal and conflicting interest in the decision or otherwise failed to act with care or in the honest belief that the action was in the best interests of the company. If the presumptions of the business judgment rule are rebutted, “the burden shifts to the defendant directors, the proponents of the challenged transaction, to prove to the trier of fact the ‘entire fairness’ of the transaction. . . .”36 The entire fairness standard generally also applies to transactions in which a majority of the board has a conflict of interest37 and transactions negotiated between a controlling stockholder and the controlled company.38

33

34 35 36 37

38

18

See Weinberger v. UOP, Inc., 457 A.2d 701, 710–11 (Del. 1983); Phillips v. Insituform of N. Am., Inc., 1987 WL 16285, at *10 (Del. Ch. Aug. 27, 1987) (stating that the “law demands of directors . . . fidelity to the corporation and all of its shareholders and does not recognize a special duty on the part of directors elected by a special class to the class electing them”). 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations and Business Organizations § 4.16[E][2], at 4–149 (3d ed. 1998) (quoting Weinberger, 457 A.2d at 710–11). In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 52 (Del. 2006). Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993). See, e.g., Weinberger, 457 A.2d at 710 (“When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.”); In re Tele-Commc’ns, Inc. S’holders Litig., 2005 WL 3642727, at *6 (Del. Ch. Dec. 21, 2005) (“A demonstration of fairness is also appropriate in evaluating transactions . . . when the directors of the corporation . . . own significant nonmajority stakes of the corporation’s voting shares and have personal interests that significantly diverge from those of other equity holders.”); Orman v. Cullman, 794 A.2d 5, 22 (Del. Ch. 2002) (stating that the entire fairness standard applies when the plaintiff “plead[s] facts demonstrating ‘that a majority of the director defendants have a financial interest in the transaction or were dominated or controlled by a materially interested director’”). See, e.g., Kahn v. Lynch Commc’n Sys., Inc., 669 A.2d 79, 85 (Del. 1995); see also Tremont, 694 A.2d at 428 (“[W]hen a controlling shareholder stands on both sides of the transaction the conduct of the parties will be viewed under the more exacting standard of entire fairness as opposed to the more deferential business judgment standard.”). A developing body of law suggests that if freeze-outs are structured to include independent committee approval and are approved by a majority of minority shares, they may be subject to the business judgment standard of review. In re CNX Gas Corp. S’holders Litig., C.A. No. 5377 (Del. Ch. May 25, 2010). At press time, this case had not been reviewed by the Delaware Supreme Court. That is significant

THE ROLE OF A TRANSACTIONAL COMMITTEE AND THE LEGAL STANDARDS APPLICABLE TO ITS WORK

The entire fairness standard embodies two elements—“fair dealing” and “fair price.”39 The standard has been explained as follows: The concept of fairness has two basic aspects: fair dealing and fair price. The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained. The latter aspect of fairness relates to the economic and financial considerations of the proposed [transaction], including all relevant factors. . . . However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.40

In determining whether there has been fair dealing, courts have looked at elements such as whether: (1) the company was financially injured by the timing of the transaction and whether the controlling stockholder or interested directors gained from the timing that which the company lost;41 (2) the transaction was structured to maximize benefits to the fiduciaries at the expense of corporate profits;42 (3) the transaction was negotiated by an independent committee of disinterested directors (or otherwise approved by a majority of the “disinterested members of the board”) or whether procedural safeguards were in place to protect the interests of disinterested stockholders;43 and (4) the directors were informed of all available material information.44 The fair price aspect of the entire fairness standard involves consideration of “all relevant factors,” with a conclusion based on “proof of value by any techniques or methods which are generally considered acceptable in the financial community.”45 Of course, any determination of fair price will depend on the facts underlying the given transaction or decision. In the context of self-dealing transactions, however, the judicially constructed intrinsic or entire fairness standard is intended closely to approximate what arm’s-length bargaining might produce.46

1. Fiduciary Duties—Duty of Care Directors have the duty to make decisions regarding the company with due care. In Smith v. Van Gorkom, the Delaware Supreme

39 40 41 42 43 44

45 46

since the unified standard discussed in CNX departs from the holding of the Supreme Court’s decision in Kahn v. Lynch. See, e.g., Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1162–63 (Del. 1995); Weinberger, 457 A.2d at 703. Weinberger, 457 A.2d at 711 (citations omitted); see also Cinerama, 663 A.2d at 1162–63. See Van de Walle v. Unimation, Inc., 1991 WL 29303, at *11–12 (Del. Ch. Mar. 7, 1991). See, e.g., Summa Corp. v. Trans World Airlines, Inc., 540 A.2d 403, 407 (Del. 1988); Van de Walle, 1991 WL 29303, at *11–12. See, e.g., Rosenblatt v. Getty Oil Co., 493 A.2d 929, 937 (Del. 1985); Weinberger, 457 A.2d at 710. See, e.g., Smith v. Van Gorkom, 488 A.2d 858, 872–73 (Del. 1985), overruled on other grounds, Gantler v. Stephens, 965 A.2d 695 (Del. 2009). Indeed, in the CNX case, the court made clear, at least in the context of that case, that the inability of the committee to negotiate with the same power as the full board, due to restrictions in its charter, would trigger entire fairness. CNX, C.A. No. 5377, at 32. Weinberger, 457 A.2d at 713. Getty Oil Co. v. Skelly Oil Co., 267 A.2d 883, 886–87 (Del. 1970). 19

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

Court explained this duty as the duty “to act in an informed and deliberate manner in determining whether to approve [a transaction].”47 In determining whether a board (or a committee thereof) has met its duty of care, the board (or committee thereof) must avail itself of all reasonably available material information concerning the subject of its decision.48 The directors’ fiduciary duty of care is not limited to decision making. Directors also have a duty to exercise care in overseeing and investigating the conduct of corporate employees.49 The following practical guidelines relating to a special committee’s duty of care can be distilled from Delaware court decisions:50 • Committee members should avoid not only haste, but also the appearance of haste, in making decisions.51 Major decisions should be made only after the committee has had a full opportunity to digest all available material information, which often may require several meetings. • Members of the committee should review and consider carefully all available material information. Pertinent information should be distributed to the committee as far in advance of the meeting as reasonably possible. The committee should carefully review all relevant documents prior to approving them or authorizing their execution. • Committee members should ask questions and actively probe and test all information presented to them, actively judge the reliability and accuracy of such information, understand such information fully, and review in detail all issues important to the committee’s final determinations. • The committee should consider whether it may need the advice of outside advisors or experts, such as outside legal advisors, investment bankers, or other financial advisors. • The committee may consider the advice of corporate officers and employees who would be expected to have relevant information on the subject of the committee’s decision and should seek the advice of corporate officers or employees if the committee believes that those officers or employees may possess pertinent information. • The committee should consider whether individuals or entities providing information or advice to it are potentially biased due to compensation or other arrangements. The committee should be convinced that its advisors are competent, were chosen with reasonable care, and are providing reliable advice. • The committee’s deliberations should be documented carefully and completely. 47 48 49

50 51

20

Van Gorkom, 488 A.2d at 873 (emphasis added). Id. at 872. See, e.g., Stone v. Ritter, 911 A.2d 362, 369–70 (Del. 2008); Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 129-31 (Del. 1963); In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967–70 (Del. Ch. 1996). See 1 Balotti & Finkelstein, supra note 40, § 4.15, at 4-100 to 4-112. In approving the settlement of litigation in the context of a going-private transaction sponsored by a controlling stockholder, the court noted with some degree of concern the fact that the special committee, faced with a long delay by its counterparty, countered and then split the difference to arrive at a final deal all within twenty-four hours. Brinckherhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370, 393 (Del. Ch. 2010).

THE ROLE OF A TRANSACTIONAL COMMITTEE AND THE LEGAL STANDARDS APPLICABLE TO ITS WORK

The foregoing principles elaborate the hallmarks of a fully informed, deliberative board, and are directly applicable in the special committee environment.

2. Fiduciary Duties—Duty of Loyalty In addition to the duty of care discussed above, directors owe a duty of loyalty to the company and its stockholders. The duty of loyalty requires directors to make decisions based on the best interests of the company, untainted by conflicting personal interests. Directors may not maintain their impartiality if they appear on both sides of a transaction, have a material personal financial interest in the decision that is separate from that to be received by other stockholders, or are dominated by a controlling person who has such an interest. A director or other person acting in a fiduciary capacity is deemed to have a personal financial interest in a transaction if she receives, or is entitled to receive, a personal financial benefit not shared equally with other stockholders.52 Thus, a director may be viewed as having a self-interest in a transaction if she serves as an officer or employee of the company, is a member of a firm receiving substantial revenue from the company, or receives a benefit from a transaction not received on an equivalent basis by all stockholders of the company. A director may also be interested if a corporate decision will have a materially detrimental impact on the director, but not on the company or the stockholders generally.53 In all events, the conflict of interest between the director and the company or its stockholders must be actual and imminent, and not speculative and remote.54 Moreover, the director’s financial interest will not be disqualifying unless it is substantial.55 In assessing a director’s independence, a court will apply “a subjective ‘actual person’ standard to determine whether a particular director’s interest is material and debilitating or that he lacks independence because he is controlled by another.”56 There is no bright-line dollar amount at which a benefit becomes material, so the materiality of a benefit will depend on the particular individual.57

52 53 54 55

56 57

See, e.g., Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Rales, 634 A.2d at 936. See Smith v. Good Music Station, Inc., 129 A.2d 242, 247 (Del. Ch. 1957). Cinerama, 663 A.2d at 1169; see also Orman, 794 A.2d at 25 n.50 (stating that a disabling interest occurs “when (1) a director personally receives a benefit (or suffers a detriment), (2) as a result of, or from, the challenged transaction, (3) which is not generally shared with (or suffered by) the other shareholders of his corporation, and (4) that benefit (or detriment) is of such subjective material significance to that particular director that it is reasonable to question whether that director objectively considered the advisability of the challenged transaction to the corporation and its shareholders”). Orman, 794 A.2d at 24; see also Cinerama, 663 A.2d at 1167; McMullin v. Beran, 765 A.2d 910, 923 (Del. 2000). State law in this regard is different from the stock exchange regulations, which provide a bright-line amount. See, e.g., Orman, 794 A.2d at 29 (holding that an allegation that a director was beholden to a controlling stockholder for a $75,000-per-year consulting agreement was sufficient to establish a lack of independence of that director for purposes of a motion to dismiss). Independence and disinterestedness are addressed in greater detail in Chapter Three. 21

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

D. THE LEGAL BENEFITS OF USING SPECIAL COMMITTEES IN CONFLICT OF INTEREST TRANSACTIONS If one or more directors may be deemed to be interested or lack independence with regard to a particular transaction, the board risks losing the presumptions of the business judgment rule in the event of a challenge to its decision. Nevertheless, the mere presence of a single conflicted director or a single act of disloyalty by one director does not deprive the entire board of the business judgment rule’s presumption of loyalty unless a challenging plaintiff can show that the self-interested directors either (1) constituted a majority of the board, (2) controlled and dominated a majority of the board, or (3) failed to disclose their interest in the transaction to the whole board and a reasonable board member would have regarded the existence of their material interests as a significant fact in the evaluation of the proposed transaction.58 Transactions approved by directors with a conflict of interest generally are not entitled to the protections of the business judgment rule, but rather will be closely scrutinized under the exacting entire fairness standard. Under the entire fairness test, the burden of proof initially lies with the transaction’s proponent. Because the entire fairness standard of judicial review is so demanding, the application of the test usually (but not always) is outcome determinative.59 Nevertheless, if properly utilized, a special committee of independent directors provides valuable protection against potential legal challenges to a conflict transaction. A properly authorized and functioning special committee may serve to preserve the integrity of the board’s decision-making process, even if a majority of the directors have a disqualifying self-interest or lack independence, by providing an opportunity for arm’s-length negotiations on any issue raising a conflict between the company and the directors. Hence, the effective use of a special committee results in a cleansing of the conflict of interest, which in many conflict of interest transaction situations results in changing the applicable standard of review with respect to such transaction from entire fairness back to the business judgment rule. This is certainly true in conflict situations in which there is no controlling stockholder with a conflict of interest. Cases have held that, in transactions between a company and interested directors (as opposed to controlling stockholders), such mechanisms may remove the transaction from entire fairness scrutiny and result in business judgment review.60 If the conflict of interest is with the controlling stockholder of a company, however, the use of the special committee may only result in a shift in the burden of proof within the entire fairness standard of review, rather than the invocation of business judgment review.61 58 59 60

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1 Balotti & Finkelstein, supra note 40, § 4.16[A], at 4-126 to 4-127. See, e.g., Mills Acq. Co. v. MacMillan, Inc., 559 A.2d 1261, 1279 (Del. 1988). See In re Walt Disney Co. Deriv. Litig., 731 A.2d 342, 368 (Del. Ch. 1998), aff’d in part, rev’d in part on other grounds sub nom. Brehm v. Eisner, 746 A.2d 244 (Del. 2000); Orman, 794 at 20–22; Kohls v. Duthie, 765 A.2d 1274, 1286 (Del. Ch. 2000); In re Wheelabrator Techs., Inc. S’holders Litig., 663 A.2d 1194, 1204 (Del. Ch. 1995); see also Fletcher, supra note 20, at § 931. See, e.g., Kahn v. Lynch commc’n Sys., Inc., 638 A.2d 1110, 1117 (Del. 1994); Rosenblatt v. Getty Oil Co., 493 A.2d 929, 937–38 (Del. 1985); In re LNR Prop. S’holders Litig., 896 A.2d

THE LEGAL BENEFITS OF USING SPECIAL COMMITTEES IN CONFLICT OF INTEREST TRANSACTIONS

For example, in the context of a merger between a company and its controlling stockholder, the effect of a cleansing mechanism, such as a special committee, is solely to shift the burden of proof of entire fairness from defendants to plaintiffs.62 As the Delaware Supreme Court explained: The initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction. However, an approval of the transaction by an independent committee of directors . . . shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholderplaintiff. Nevertheless, even when an interested cash-out merger transaction receives the informed approval of . . . an independent committee of disinterested directors, an entire fairness analysis is the only proper standard of judicial review.63

The rationale for not permitting business judgment review in these situations is that, even if the special committee functions well and independently, there is always a threat (either implied or implicit) of retaliation by the controller if the controlling stockholder is on both sides of a transaction.64 Courts often take a broad view of when the entire fairness analysis will be invoked in cases involving controlling stockholders. In In re John Q. Hammons Hotels Inc. Shareholder Litigation,65 the court applied the entire fairness standard to review the acquisition of a company by a third party. The company had a controlling stockholder who controlled approximately 76 percent of the total vote of the company through

62

63 64

65

169, 178 n.52 (Del. Ch. 2005); In re Emerging Commc’ns, Inc. S’holder Litig., 2004 WL 1305745, at *10 (Del. Ch. May 3, 2004). It has been noted that the failure to use a special committee (or similar safeguard) itself may be evidence of the absence of fair dealing. See 1 David A. Drexler et al., Delaware Corporate Law and Practice § 15.05[5], at 15–33 (2009) (citing Seagraves v. Urstadt Prop. Co., 1996 WL 159626 (Del. Ch. Apr. 1, 1996). But see Drexler, supra (stating that “other decisions have acknowledged that a committee is not a legal requirement and that the failure to use a committee does not of itself establish unfairness”). Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110, 1116 (Del. 1994); But see In re Cox Commc’ns, Inc. S’holders Litig., 879 A.2d 604, 606–07 (Del. Ch. 2005) (noting that business judgment review potentially could be applicable if a proposal in the corporate context is conditioned from the outset on both special committee approval and approval by a majority of the disinterested stockholders). Kahn, 638 A.2d at 1117 (citations omitted). The mere presence of a substantial stockholder does not necessarily require the application of the entire fairness standard of review. In In re Western National Corp. Shareholders Litigation, 2000 WL 710192 (Del. Ch. May 22, 2000), the plaintiffs challenged an acquisition of Western National Corporation by American General Corporation, which held 46 percent of Western National’s outstanding common stock. Despite its significant ownership interest, the court concluded that, given a standstill agreement limiting American General to two nominees on the eight-member board of Western National and the fact that American General had not used its power of nomination to control the Western National board, American General did not exercise actual control over the business and affairs of Western National. As a result, the court held that the effective special committee process resulted in a change in the standard of review from entire fairness to the business judgment rule. In re John Q. Hammons Hotels Inc. S’holder Litig., 2009 WL 3165613 (Del. Ch. Oct. 2, 2009). 23

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

ownership of 5 percent of the Class A common stock and of all of the non-public Class B common stock. Here, the controlling stockholder was not on both sides of the transaction in the classic sense; i.e., the controlling stockholder was not buying the company from the public, but rather was essentially a seller similarly situated to the rest of the stockholders. A special committee was formed and negotiated the acquisition with the prospective acquirer on behalf of the minority stockholders of the company. The controlling stockholder negotiated with the prospective acquirer on his own behalf for his non-public Class B common stock. The special committee and its financial advisor considered, among other things, the relative consideration being received by the minority stockholders for their Class A common stock and that received by the controlling stockholder for his Class B common stock. The special committee concluded that the allocation of the consideration between the controlling stockholder and the minority stockholders was reasonable. Based on the special committee’s recommendation, the board voted to approve the acquisition. After noting that the controlling stockholder was not on both sides of the transaction, the court nevertheless held that entire fairness applied because the controlling stockholder was in a sense competing with the minority stockholders for the merger consideration.66 To achieve the legal cleansing effect—either a change in the standard of review from entire fairness to the business judgment rule or a shift in the burden of proof within the entire fairness standard, a special committee should have certain characteristics. Its members should be: (1) thoroughly independent, (2) vested with adequate authority to veto a transaction proposed by interested directors or a controlling stockholder, and (3) willing to act independently in a vigilant and diligent manner. The special committee should also be assisted by independent financial and legal advisors. Ultimately, both the composition and the functioning of the committee are critical to its success.67 When a special committee’s process is perceived as reflecting a good faith, informed attempt to approximate aggressive, arm’s-length bargaining, it will be accorded substantial importance by the court. When, on the other hand, it appears as artifice, ruse or charade, or when the board unduly limits the committee or when the committee fails to correctly perceive its mission—then one can expect that its decision will be accorded no respect.68

Likewise, the court applied a new unified standard to its review of a committee’s work in the context of a controlling stockholder freeze out, in which the court made clear that any restrictions on the right of the committee to bargain aggressively with the controller, such as the inability to adopt and deploy a poison-pill rights plan against 66

67 68

24

The court held that business judgment review would only apply if the transaction were (1) recommended by a disinterested and independent special committee and (2) approved by stockholders in a non-waivable vote of the majority of all the minority stockholders. See W. Nat’l, 2000 WL 710192, at *17–18, *21–27. See William T. Allen, Independent Directors In MBO Transactions: Are They Fact or Fantasy?, 45 BUS. LAW. 2055, 2060 (1990); see also Freedman v. Rest. Assoc. Indus. Inc., 1990 WL 135923, at *7 (Del. Ch. Sept. 21, 1990) (“[W]here a special committee is passive or its charter from the board unduly restricts it, the work of the committee may be accorded no effect.”).

THE LEGAL BENEFITS OF USING A COMMITTEE IN CONFLICT TRANSACTIONS

the controller, would be enough to trigger entire fairness (rather than business judgment) review.69 Courts will carefully scrutinize the actions and deliberative process of the special committee to determine whether that process should be given legal respect in terms of cleansing the transaction. This subject is addressed at length throughout the chapters that follow.

E. THE LEGAL BENEFITS OF USING A COMMITTEE IN CONFLICT TRANSACTIONS: LIMITED PARTNERSHIPS AND LIMITED LIABILITY COMPANIES Special committees can also be used outside the corporate context, in entities such as limited partnerships or limited liability companies. Indeed, although the law relating to how a special committee should perform its duties is likely the same in both the corporate and alternative entity arenas, the beneficial result of the special committee process may be enhanced in the alternative entity area. Moreover, limited partnership provisions addressing who has the authority to act as a special committee have also been upheld. Though this broad flexibility to impact the process and result may not be entirely without limits, it is extremely useful and makes special committee use in the alternative entity context particularly valuable.70 Under Delaware law, the fiduciary duties of those managing a limited partnership or a limited liability company have been analogized to those of a director of a company. Delaware courts have imposed fiduciary duties upon those who act for the benefit of another.71 Hence, as a default matter, a general partner owes fiduciary duties to a limited partnership and the limited partners of the limited partnership, and a person controlling a limited liability company and its property owes fiduciary duties to the limited liability company and its members.72

69

70 71

72

In re CNX Gas Corp. S’holders Litig., C.A. No. 5377, at 32 (Del. Ch. May 25, 2010). As noted elsewhere, at press time CNX had not yet been reviewed by the Delaware Supreme Court and thus the final word on its new unified standard of review remains to be written. We have included sample provisions for use in an alternative entity agreement in Chapter Three, section d, “The Committee Charter.” In In re USACafes, L.P. Litig., 600 A.2d 43, 48 (Del. Ch. 1991), the court stated that “the principle of fiduciary duty, stated most generally, [is] that one who controls property of another may not, without implied or express agreement, intentionally use that property in a way that benefits the holder of the control to the detriment of the property or its beneficial owner.” In interpreting the Delaware limited partnership statute, courts have found that traditional fiduciary duties attach by default to the general partner of a Delaware limited partnership. “Absent a contrary provision in the [limited partnership agreement], the general partner of a Delaware limited partnership owes the traditional fiduciary duties of loyalty and care to the Partnership and its partners.” Gotham P’rs, L.P. v. Hallwood Realty P’rs, L.P., 2000 WL 1476663, at *10 (Del. Ch. Sept. 27, 2000). Courts and commentators alike have noted the similarities between the Delaware statute for limited partnerships and the Delaware statute for limited liability companies, and have indicated that analogy to cases concerning Delaware limited partnerships should prove an apt tool in deciding limited liability company cases. In short, fiduciary duty 25

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

Delaware cases addressing fiduciary duties in the limited partnership or limited liability company context generally look to fiduciary principles gleaned from the corporate arena. In particular, Delaware courts have considered the duties owed by a director of a Delaware company to determine the fiduciary duties owed by a person managing or controlling a limited partnership or a limited liability company. In In re Boston Celtics Ltd. Partnership Shareholders Litigation,73 the Delaware Court of Chancery found traditional fiduciary duties of care and loyalty were owed. The court stated, in pertinent part: [T]he fiduciary duty of fair dealing by a general partner to a limited partner is no less than that owed by a director to a shareholder. The form of the enterprise does not diminish the duty of fair dealing by those in control of the investments. As a result, Delaware law requires the general partners of limited partnerships to exercise due care and to act in the best interest of the partnership and the limited partners.74

Although the authority to modify default fiduciary duties is helpful in many contexts, it is particularly useful in the context of establishing procedures for addressing so-called interested transactions. Absent a modification of default fiduciary duties, courts will apply the entire fairness standard to scrutinize interested transactions in the limited partnership context. Delaware cases confirm that the drafters of partnership agreements have broad latitude to implement mechanisms to enable the limited partnership to engage in interested transactions without implicating fiduciary duties or imposing upon the general partner the burden to demonstrate that the transaction was entirely fair.75 Another option that can be considered by the drafters of partnership agreements is to establish procedures for an independent committee to consider and/or review interested transactions. Given the flexibility inherent in the limited partnership statute, all aspects of the committee process, including the procedures for using such a committee and the legal effect of obtaining approval by such committee, can be defined in the partnership agreement itself. Hence, as a practical matter, the use of independent

73 74

75

26

analyses will be very similar, if not identical, in both the limited partnership and limited liability company contexts. In re Boston Celtics Ltd. P’ship S’holders Litig., 1999 WL 641902, at *4 (Del. Ch. Aug. 6, 1999). Id., at *4 (citing Boxer v. Husky Oil Co., 429 A.2d 995 (Del. Ch. 1981)); see also U.S. W., Inc. v. Time Warner Inc., 1996 WL 307445, at *22–23 (Del. Ch. June 6, 1996) (analogizing limited partnership fiduciary duties to corporate fiduciary duties, focusing on the corporate opportunity doctrine). See Sonet v. Timber Co., L.P., 722 A.2d 319, 324–26 (Del. Ch. 1998) (holding that a limited partnership agreement had set up a structure that effectively supplanted default fiduciary duties); Gelfman v. Weeden Investors, L.P., 792 A.2d 977, 986–87 (Del. Ch. 2001) (holding that the language of a partnership agreement displaced traditional fiduciary duties in lieu of a “subjective bad faith standard” for the general partner’s actions).

THE LEGAL BENEFITS OF USING A COMMITTEE IN CONFLICT TRANSACTIONS

committees in the limited partnership setting could be perhaps even more useful than in the corporate setting.76 A good example of how a committee process can effectively be used in the limited partnership context for considering interested transactions is provided in the court’s decision in Brickell Partners v. Wise.77 In Brickell Partners, a limited partner brought a derivative action on behalf of the limited partnership challenging the partnership’s acquisition of an entity that was affiliated with the general partner. The plaintiff alleged that the general partner had caused the limited partnership to overpay for this entity and that the excess consideration had accrued to the benefit of the general partner. The general partner argued that a particular provision of the limited partnership agreement supplanted default fiduciary duties that may have otherwise existed at law. The relevant provision stated, in pertinent part: Unless otherwise expressly provided in this Agreement . . . whenever a potential conflict of interest exists or arises between the General Partner or any of its Affiliates, on the one hand, and the Partnership, . . . on the other hand, any resolution or course of action in respect of such conflict of interest shall be permitted and deemed approved by all Partners, and shall not constitute a breach of this Agreement, . . . or of any duty stated or implied by law or equity, if the resolution or course of action is or, by operation of this Agreement, is deemed to be, fair and reasonable to the Partnership. The General Partner shall be authorized . . . to seek Special Approval of a resolution of such conflict or course of action. Any conflict of interest and any resolution of such conflict of interest shall be conclusively deemed fair and reasonable to the Partnership if such conflict of interest or resolution is (i) approved by Special Approval . . . . 78

Special Approval was defined in the agreement to mean the “approval of a majority of the members of the Conflicts and Audit Committee of the Partnership.”79 The general partner argued that the plaintiff’s claim must be rejected because such Special Approval had been obtained for the challenged transaction. The plaintiff argued that the conflicts and audit committee process was flawed because the two members of the conflicts and audit committee were current directors of the corporate general partner and thus had a clear conflict of interest. Rejecting the plaintiff’s arguments, the court noted that neither member of the conflicts and audit committee was alleged by the

76

77 78 79

For example, in the corporate context, the effect of a validly functioning special committee depends on the type of transaction that the special committee is considering. In most instances, special committee approval of an interested transaction will enable such a transaction to be scrutinized under the deferential business judgment rule rather than under an entire fairness standard. If the interested transaction at issue, however, involves a transaction between a corporation and its controlling stockholder (or in certain other controlling stockholder transactions), even approval by a validly functioning special committee may not result in the transaction being insulated from entire fairness review. Rather, in this scenario, the benefit of special committee approval likely is to shift the burden to those challenging the transaction to demonstrate that the transaction was not entirely fair. See Kahn, 638 A.2d at 1116–17. Brickell P’rs v. Wise, 794 A.2d 1 (Del. Ch. 2001). Id., at *2–3 (emphasis omitted). Id., at *3. 27

THE ROLE OF THE SPECIAL COMMITTEE AND THE LEGAL CONSEQUENCES OF ITS USE

plaintiff to be a current member of management of the general partner and that the plaintiff had failed to allege that the Special Approval process had been tainted by fraud or otherwise. Therefore, despite the obvious structural conflicts of interest faced by the members of the conflicts and audit committee, the court concluded that there was no basis to examine the validity of the transaction under fiduciary duty principles.80

F. DE FACTO SPECIAL COMMITTEES An interesting question sometimes arises about whether a group of corporate directors acting as a special committee can avail themselves of the same protections granted to special committees designated by a formal board resolution. There is some limited precedent for the proposition that a group of corporate directors may act as a de facto special committee without formal board authorization and may be able to shift the burden of fairness, even though they were not explicitly designated as such by a board resolution. In Emerald Partners v. Berlin, the plaintiffs argued that the board’s failure to designate the three chief negotiators/board members as a special committee to consider a merger proposal constituted a lapse of process.81 The court conceded that “the board did fail to do that in the formal sense (i.e., by failing to adopt a formal resolution to that effect).”82 But the court did not find this failure to be of consequence, holding “that at all relevant times those three directors acted de facto in an independent negotiating committee capacity.”83 In holding that the three disinterested directors acted “in an independent negotiating committee capacity,” the court also found that a special committee was never required because the disinterested directors constituted a majority of the board and observed many of the procedural safeguards that are associated with special negotiating committees: Emerald cites as a process failure the fact that the . . . board of directors never formally constituted . . . a special committee of independent directors to negotiate the proposed merger. That this did not occur is undisputed. In this case, however, that omission is of no practical or legal significance. Special negotiating committees are typically constituted because a majority of the board have a disabling conflict. That was not the case here. The three non-affiliated directors constituted the majority of [the] board, and, for purposes of the merger proposal, they regarded themselves as a special negotiating committee whose role was to protect the

80

81 82 83

28

But see Brinckerhoff v. Tex. E. Prods. Pipeline Co., LLC., 986 A.2d 370, 384–85 (Del. Ch. 2010) (applying corporate standard in which partnership agreement used slightly different language than that used in the relevant partnership agreement in Bricknell Partners). Emerald P’rs v. Berlin, 2001 WL 115340 (Del. Ch. Feb. 7, 2001), vacated and remanded, 787 A.2d 85 (Del. 2001). Id., at *27 n.68. Id.

DE FACTO SPECIAL COMMITTEES

interests of [the corporation’s] minority stockholders. The real issue, therefore, is whether those directors adequately discharged that role.84

Emerald is, perhaps best read in light of the court’s conclusion that no committee was necessary ab initio. It would, we suggest, be preferable to avoid the mistakes made by the Emerald “committee,” including the failure to empower the committee by delegating the authority of the board and the failure to observe such basic tenents of committee practice as keeping the controlling stockholder at arm’s length (the Emerald committee allowed the controller to attend its meetings and have access to its banker’s analysis).85 The Emerald court relied on the substance of the committee’s work to justify a demonstrated lack of legal formality, but it does not follow that a properly constituted committee will see the court defer to its work upon compliance with legal formalities. In Kahn v. Tremont Corp.,86 a three-member committee was appointed to negotiate an interested transaction.87 The Delaware Supreme Court observed, however, that one of the committee’s members conducted all of the negotiations regarding the terms of the transaction, while the other two members “abdicated their responsibility.”88 Concluding that the committee was a de facto committee of one, the court examined only the one member’s independence. After holding that the one member “was arguably the one most beholden,” receiving $325,000 from interested parties, the court remanded the case for an entire fairness review.89 Hence, although there is some legal support for the proposition that a group of independent directors functioning as a special committee on a de facto basis ought to be given legal respect, anyone wishing to ensure that they obtain the legal benefits of a well-functioning special committee would be well advised to have the board formally constitute and authorize such a special committee at the outset. Having briefly outlined the taxonomy of committees and the legal consequences of their use, we turn now to the nuts and bolts of how to form a committee, including whom to include in its membership, how it can be compensated, and other practical aspects of initiating the committee process.

84 85

86 87 88 89

Emerald P’rs v. Berlin, 2003 WL 21003437, at *22 (Del. Ch. Apr. 28, 2003), aff’d, 840 A.2d 641 (Del. 2003) (TABLE) (citation omitted). The cases in which the types of gaffes in the committee process proven in Emerald proved fatal, indeed even may have been the basis for the imposition of liability, are well known. See, e.g., Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1148 (Del. Ch. 2006) (“At a minimum, the special committee should have control over its own sources of information and should have the loyalty of its advisors throughout the process.”); In re Loral Space & Commc’ns, Inc., 2008 WL 4293781, at *22 n.123 (Del. Ch. Sept. 19, 2008) (criticizing the special committee’s lack of independence and stating that “independence is the sin[e] qua non of the entire [special committee] negotiation process”) (internal citation omitted). As one might expect, these decisions appeared to have little use for de facto committees or well-intentioned directors who allowed the controlling stockholder access to their meetings or their analysis of their bid. Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997). Id. at 429. Id. at 430. Id. 29

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Chapter 3

Forming the Special Committee

The full board that determines to form a special committee will want to give careful consideration to the composition of that committee and its charter. Once formed, the committee will want to meet promptly, determine how it will organize itself, and, most importantly, set out on a process of selecting independent outside advisors. This chapter addresses each of these points.

A. THE SIZE OF THE SPECIAL COMMITTEE The committee may be comprised of any number of directors. By definition, therefore, a special committee may be comprised of only one director. One-person committees, though permissible, are strongly discouraged both as a practical matter and under applicable law. One-person committees arguably suffer from three practical problems. First, the director who is a committee of one has no one with whom to deliberate. Thus, the one-person committee suffers to the extent that the law or good business practice places a premium on an interchange of ideas and a deliberative process.1 From a practical perspective, the advisors to the one-person committee effectively fill the role of deliberative partners. This is not necessarily a bad thing, but it is certainly less than ideal in a structure in which the director is charged with making the decision, not the director and his counsel. Second, from a practical perspective, the one-person committee is more susceptible to coercion, both subtle or not so subtle. Members of one-person forensic committees, in particular, may find themselves subject to enormous pressures, especially if one or more key members of the board or management are the target of the committee’s inquiries. 1

In one reported opinion, the court cited to social science research supporting the court’s “common sense intuition that two heads are better than one in the context of special board committees.” Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1146 n.100 (Del. Ch. 2006) (citing Stephen M. Bainbridge, Why a Board? Group Decisionmaking in Corporate Governance, 55 VAND. L. REV. 1, 12 (2002)). 31

FORMING THE SPECIAL COMMITTEE

Third, since the independence of committee members is extremely important, as explained in detail below, courts have required one-person committees to be “like Caesar’s wife,” that is, “above reproach.”2 Put differently, the courts have made clear that they will review the independence of one-person committees more closely than that of other committees. Since the process itself relies on the rigor and independence of the committee, for the one-person committee, the entire process becomes dependent upon the integrity of a sole director. As one court wrote: “[t]he court necessarily places more trust in a multiple-member committee than in a committee where a single member works free of the oversight provided by at least one colleague.”3 In light of these issues, it is almost never a good idea to proceed with a one-person committee. To the extent that the board determines that only one member of the board is truly independent for purposes of the particular issue to be addressed by a special committee, it is desirable to consider expanding the board and adding one or more new directors to sit on the special committee (either with or without an understanding that they would resign after the committee concludes its work). Although this may seem a bit extreme, practical experience with one-person committees suggests strongly that (in many circumstances) proceeding in this way is almost always better than chartering the one-person committee, even if the sole member of the committee is an individual of high integrity and unquestioned independence.4 Though one-person committees are to be avoided, it is not the case that a committee should be made up of a large number of individuals. In our experience, committees of two, three, or four individuals tend to be optimal. In practice, most committees will work hard and meet frequently. In a transactional setting, for example, a committee will often be called upon to give direction to its counsel on an almost daily basis as negotiations proceed. A special committee of more than three or four members often becomes logistically unwieldy. Of course, in determining whether the special committee should be comprised of two, three, or four directors, consideration should be given to whether a two or four person committee is likely to be able to reach majority consensus on key decisions, given the personalities involved. If this is not likely, a committee of three would avoid deadlocks and be preferable.

B. THE COMPOSITION OF THE SPECIAL COMMITTEE A board will want to consider three overriding factors in deciding who should serve on a special committee. For each director being asked to serve on the committee, the 2 3 4

32

Lewis v. Fuqua, 502 A.2d 962, 967 (Del. Ch. 1985). Gesoff, 902 A.2d at 1146. Brinckerhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370 (Del. Ch. 2010) is instructive. There, the board delegated a conflicted transaction to the Audit and Conflicts Committee of the entity. That committee, however, was made up of only one independent member (of three). At counsel’s suggestion, the board was expanded by two, adding new independent directors and the three independents were then constituted as a special committee. The composition of and record of arm’s-length negotiations by this committee allowed the court to approve the settlement it reached, notwithstanding its doubts about the settlement itself.

THE COMPOSITION OF THE SPECIAL COMMITTEE

following should be evaluated: (1) independence, (2) disinterestedness, and (3) willingness to take up the task in a rigorous and independent manner.

i. Independence A special committee will not achieve its goals from a legal perspective unless its members are independent in the broadest definition of that term. The first inquiry that any reviewing court will bring to its scrutiny of the work of a special committee is whether the members of the committee were truly independent. If not, it is likely that the work of the special committee will be neither respected by a reviewing court nor lead to the burden-shifting effect that is the legally sought-after result of the process. It follows that the unquestioned independence of each member of the proposed committee is the first and most critical item for the board in determining who should sit on a special committee. Independence is broadly defined in this context. The Delaware Supreme Court has defined the inquiry as follows: The question of independence “turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind.” That is, the independence test ultimately “focus[es] on impartiality and objectivity.”5

It should be noted that various regulatory bodies, such as the stock exchanges, have promulgated rules defining independence for purposes of board service. Though these definitions inform the inquiry of whether a director is, or is not, independent for purposes of special committee service, merely meeting the stock exchange definition of independence does not end the inquiry. Although a director who is not independent under the New York Stock Exchange rules is unlikely to be found independent for purposes of serving on a special committee under Delaware law, the converse is not necessarily true. Instead, the analysis is importantly contextual and defies formulaic attempts at codification. At the outset, therefore, it may be useful to think about independence based in part upon the task of the committee. The first question, therefore, is logically, “independent from whom and independent for what purpose?”6 The broadest answer to this question is: independent from the subject (or object) the committee is formed to address. For example, to the extent that the special committee is formed to negotiate with a controlling stockholder, committee members must be wholly independent from that controller and its affiliates, and have no other ties, defined as broadly as possible, with the controller. Thus, directors who have served on committees designed to address transactions proposed by controlling stockholders have been found not to be independent from the controlling stockholder if they were employed by or had a financial interest in the controlling stockholder or its affiliates; or they received consulting or 5 6

In re Oracle Corp. Deriv. Litig., 824 A.2d 917, 920 (Del. Ch. 2003) (emphasis in original). Beam v. Stewart, 845 A.2d 1040, 1050 (Del. 2004). 33

FORMING THE SPECIAL COMMITTEE

other fees from the stockholder or its affiliates in the past, or had an expectation that they would receive such fees in the future.7 Similarly, if the special committee is formed to negotiate a transaction with a management-led buyout group, the question becomes whether the members of the committee have any entanglements with the managers. Cross directorships may be important here. If, for example, a potential special committee member is the CEO (chief executive officer) of a different corporation, do members of the corporation’s management sit on that board? If so, are they members of committees that may have a say on the CEO’s tenure or compensation? Likewise, in the context of an investigative committee, the question becomes whether a potential member of the committee has any relationship or entanglement with the persons likely to be targets of the investigation, such as management or even other board members. In the context of an SLC, for example, courts have been sensitive to even remote entanglements. In one case, a director who held a prominent professorship was deemed not to be independent from another director who was a substantial contributor to the same academic institution.8 More subtle social entanglements are also likely to become issues in the SLC context. One question that often arises in the course of special committee work is the extent to which non-business social factors could be held to disqualify a director from service on a special committee. In many contexts, a director may rest easy knowing that informal social ties with another director should not disqualify her from service on a special committee or otherwise render her interested or lacking in independence. Outside the special committee context, for example, the courts in Delaware have held that mere friendships are not alone enough to render a director incapable of considering a demand to bring litigation against a fellow director.9 There are exceptions to this general statement, however. For example, SLCs, formed to determine whether or not existing litigation should continue or be dismissed, are often held, in practice, to a more searching level of scrutiny for independence and disinterestedness than other types of special committees. Although no decision has expressly said so, it is often the case that if an SLC determines to seek dismissal of a derivative suit, the judge who reviews that motion is especially careful to examine and inquire into any and all social relationships of committee members, even seemingly

7

8 9

34

See, e.g., In Re Maxxam, Inc./Federated Dev. S’holders, 1997 WL 187317, at *21 (Del. Ch. Apr. 4, 1997) (finding that receipt of salary from affiliate of controlling stockholder and lucrative consulting contract, “while not conclusive . . . do raise concerns as to whether the Special Committee lacked independence”). Kahn v. Dairy Mart Convenience Stores, Inc., 1996 WL 159628, at *6 (Del. Ch. Mar. 29, 1996) (noting that special committee member was also a paid consultant for the corporation, raising concerns that he was beholden to the controlling shareholder); Rales v. Blasband, 634 A.2d 927, 937 (Del. 1993) (finding a reasonable doubt as to the ability of two members of the board to act independently concerning a controlling stockholder transaction in light of their employment with entities affiliated with the controlling stockholder). In re Oracle, 824 A.2d 917. Beam, 845 A.2d at 1050 (“Allegations of mere personal friendship . . . standing alone, are insufficient to raise a reasonable doubt about a director’s independence.”).

THE COMPOSITION OF THE SPECIAL COMMITTEE

casual ones. This is even more the case with the one-person SLC, which the courts have repeatedly held must be “above reproach.”10 In this arena, social friendships, at least those of long standing, might give a director reason to more carefully consider whether he should serve on an SLC.11 As noted elsewhere in this chapter, in one widely reported case, the Delaware Court of Chancery found that a distinguished Stanford professor and former SEC commissioner was not “independent” for purposes of serving on an SLC relating to an individual who was a substantial donor to the university and who had discussed making a large gift to establish a special institute there.12 Moreover, in a recent decision, the Delaware Court of Chancery questioned the independence of both members of an SLC—one on the ground that he was married to the cousin of a party whose conduct was at issue, and one on the ground that he had previously hired the party whose conduct was at issue as a consultant for his business and credited such party with helping him to sell his business at a profit.13 As with so much of the independence inquiry, the extent to which social ties should trigger alarm bells during the process of selecting a committee is highly contextual. The fact that two directors are both members of the leading golf club in town (along with 300 or so other individuals) should not, by itself, give rise to suspicion. On the other hand, if two directors frequently take family vacations together and have been close friends since meeting (or were even roommates) in college, the level of concern should be higher that a court would eventually conclude that the director was not sufficiently independent due to social relationships. Other factors, too, may play a role. Is the potential special committee director involved in the family life of the target director, as a godparent to his children, trustee of a family trust, or other position of respect and trust? Do the two directors work together on other boards, and if so, what is the nature of the relationship there? Do they work closely on the same charities, for the same church, or for the same private foundation? Although seemingly unimportant, such relationships may say a good deal about the nature of the personal relationship between the two individuals. The greater the number of these types of relationships, the higher the level of concern about the individual serving on the special committee. In addition to the conflict that can be identified in advance, another species of conflict may arise, typically in the transactional context, in which an uninvited or unanticipated bid is made by a party with whom an existing committee member has some relationship. We will borrow the lawyers’ description of this situation and identify it as a “thrust upon” conflict of interest. Such a conflict may also arise during the course of a forensic investigation if the committee uncovers suspected wrongdoing or involvement in questionable behavior by a party not previously implicated, who is

10 11

12 13

Lewis v. Fuqua, 502 A.2d 962, 967 (Del. Ch. 1985). In Beam v. Stewart, the Delaware Supreme Court recognized that if specific factual allegations were pled that demonstrated that a close personal friendship bordering on “familial loyalty and closeness” existed, these facts could render a director non-independent. Beam, 845 A.2d at 1050. In re Oracle, 824 A.2d 917. London v. Tyrrell, 2010 WL 877528, at *14–15 (Del. Ch. Mar. 11, 2010). 35

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connected in some way to a committee member. In Section c, “Case Study: The ‘Thrust-Upon’ Conflict,” which appears at the end of this section, we address the thrust-upon conflict arising in the transactional setting. Although there is no set formula for addressing such a conflict, there are a number of important steps that should be considered as part of the solution in every such case. First, the director who finds herself with the thrust-upon conflict should immediately disclose the conflict to her fellow committee members in detail. This should be done at a meeting at which minutes are taken so that there is a complete record of the disclosure having been made. Second, the newly conflicted director should absent herself after disclosing the conflict to the committee to allow the committee to determine how it wishes to proceed. Third, having received full disclosure of the nature and particulars of the conflict, where the other members of the committee determine to ask the conflicted director to continue to serve, such service should be with the understanding that any negotiation with or discussion of the conflict-producing party should be undertaken solely by the non-conflicted directors, with the conflicted director recusing herself from the discussions and any vote on the topic. To the extent that the conflict is more than remote, consideration should also be given to whether the newly conflicted committee member should be asked to resign from the special committee. Take, for example, the context in which the conflict-producing third party is the employer of the special committee member. In that context, the conflict is particularly acute, and it is fairly clear that the director would not have been appointed to the committee at the outset if the board had understood that the employer was involved (as an investigation target or third-party bidder). Although there is nothing in the law that would affirmatively require the director to resign from the special committee, it is difficult to imagine any scenario in which the director’s resignation would not be in the best interests of both the director and the committee.

ii. Disinterest In order to serve on a special committee, a director must not only be independent but also disinterested. At the simplest level, a disinterested director is one who has no personal interest, direct or indirect, financial or otherwise, in the subject of the committee’s work.14 Thus, in negotiating a merger with another corporation, the special committee member who owns a material equity interest in the counterparty to the transaction could be viewed as interested in the transaction and should not serve on the committee.15 Likewise, a director nominated for service on a committee investigating

14 15

36

See Beam, 845 A.2d at 1049 (“A director’s interest may be shown by demonstrating a potential personal benefit or detriment to the director as a result of the decision.”). However, courts have correctly held that a director having a material equity interest in the corporation is not a disqualifying financial “interest precluding such director from serving on a special committee,” since it is an interest that aligns the interests of the director with all other stockholders of the corporation. See, e.g., Orman v. Cullman, 794 A.2d 5, 26–27

CASE STUDY: THE THRUST-UPON CONFLICT

corporate conduct in connection with the payment of questionable fees would not want to serve if his own corporation were the recipient of some of the fees that were the subject of the investigation.

iii. Willingness to Serve in a Vigorous Manner As made clear above, it is not only the independence and disinterestedness of committee members that is key to the successful special committee, but also a willingness on the part of the director to serve in a vigorous manner that bespeaks independence. Put differently, it is not enough that the directors who make up the special committee are independent and disinterested on paper, they must also be willing to act in a manner that a reviewing court will later conclude demonstrates that they were independent in fact. Although the precise contours of independence vary from committee to committee, the call to go beyond mere independence on paper is likely to thrust the director into uncomfortable and adversarial situations. Worse still, these situations will often put them in opposition to their fellow directors, with whom they have built up a certain camaraderie and good feelings over time. But the director who is unwilling to risk the relationships that arise during the course of board service for the sake of discharging his duty in a most vigorous manner does no favor to the process or the committee itself. Of course, this is not to say that the law requires committee members to behave in any but the most courteous and professional manner. Courtesy and professionalism, however, are not to be misunderstood as a license to capitulate to a controlling stockholder. Most simply, the otherwise independent director who is asked to serve on the special committee should only accept that invitation if she is ready, willing, and able to take up the hard task at hand. This typically means a substantial increase in workload, at least during the time that the committee is doing its work, as well as the potential for conflict with fellow board members.

C. CASE STUDY: THE THRUST-UPON CONFLICT FACTS

A special committee of the board is formed to consider a potential sale of the corporation after the CEO, a board member, indicates an interest in pursuing a potential management-led buyout of this technology firm. The market is still recovering from widespread turmoil in the technology sector, and the corporation is currently trading for less than its cash. The committee, formed by the vote of all directors with the CEO abstaining, is comprised of three directors. Director A, a business school professor at (Del. Ch. 2002) (“A director who is also a shareholder of his corporation is more likely to have interests that are aligned with the other shareholders of that corporation as it is in his best interest, as a shareholder, to negotiate a transaction that will result in the largest return for all shareholders.” Id. at 27 n.56). 37

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a prominent local university, has been through the sale process in several other companies and has substantial experience as a director. Director B, a venture capitalist, has deep experience in the corporation’s industry and in the process of selling companies as well. Director C, an executive at a large firm, has years of experience related to the corporation’s industry. All three directors are independent by any standard. The committee hires outside counsel with experience working with transactional committees, and counsel confirms with each member of the committee their lack of conflicts, including any business or social relationships with the CEO or other key participants in the corporation’s industry who might be logical buyers. The committee then retains a prominent investment bank and sets to work. The committee determines to invite the CEO and his management group to submit a bid, but not to provide exclusivity to the CEO. Instead, the committee determines to authorize its investment bank quietly to solicit alternative transactions from logical strategic buyers. As a result of a rigorous process, management drops out of the bidding when it is unable to obtain financing for a bid substantially in excess of the corporation’s cash value, and two strategic bidders emerge. The committee, through a careful process, conducts an auction among the two strategic bidders and ultimately concludes that it will recommend a transaction with the buyer offering the highest price, who the committee also concludes is more likely to close a transaction, given potential anti-trust difficulties with the rival bidder. The currency for the transaction is the buyer’s shares, which are publicly traded and widely held. The committee recommends the transaction, the full board approves it, a merger agreement is signed, and a public announcement of the transaction is made. Approximately six weeks after the announcement of the transaction, Buyer, a software enterprise, pre-announces that it is likely to miss consensus earnings estimates for the quarter. Its stock, and the nominal value of the transaction, fall precipitously— by almost a third. Thereafter, the corporation begins to receive unsolicited, all-cash bids from private equity firms, who appear to be highly interested in concluding a transaction with the corporation. In a short period of time, the corporation receives no fewer than four unsolicited bids, and refers each to the committee. Although the committee originally preferred a transaction with a strategic buyer, in light of developments, it determines over the course of several meetings to exercise its right under the merger agreement to enter into negotiations with the unsolicited bidders, and directs the corporation to issue a press release disclosing the receipt of the unsolicited bids, as well as the committee’s determination that its fiduciary duties require it to enter negotiations with one or more of such bidders. During this entire process, the committee remains extremely active in overseeing developments, and meets frequently to receive reports from its advisors and to give direction to them. The committee’s chairman, Director A, is in almost daily contact with the committee’s advisors and becomes deeply enmeshed in the ongoing work of the committee.

38

CASE STUDY: THE THRUST-UPON CONFLICT

Thereafter, a fifth unsolicited financial bidder emerges. This bidder happens to be a private equity firm that has contributed heavily to the chairman’s educational institution and has endowed the university center currently run by the committee’s chairman. The chairman, understanding that there could be at least an appearance of a conflict, immediately approaches counsel, discloses the “thrust-upon” conflict and discusses its implications and his ability to continue to lead (indeed to participate at all in) the work of the committee. The chairman advises counsel that he has no direct interaction with the private equity firm or its principals, but was in fact interviewed by the bidder’s principal when he applied for his job as the first leader of the center at his university. Neither the bidder’s principal nor anyone else from the bidder firm is active in the work of the center. However, at least one partner of the bidder firm does sit on the university’s board of trustees and also serves as a mostly honorary advisor to the center. After discussion, the chairman determines that he should fully and promptly disclose the conflict to the other members of the committee and that they should deliberate on how best to proceed as a committee, with the chairman being available to answer questions, but otherwise recusing himself while the committee considers this new development. A meeting to discuss the new bid and the potential conflict is promptly scheduled. At the meeting, the chair fully discloses his conflict, and that disclosure is duly recorded in the minutes of the meeting. The chairman also indicates that he would be most comfortable recusing himself from participation in any discussion or vote concerning this bidder in light of the appearance of a conflict. The committee, after asking a number of questions relating to this potential conflict, then deliberates outside the presence of the chairman and determines that, in light of the nature of the conflict, the chair’s willingness to recuse himself with respect to discussions concerning this potential buyer, and, importantly, the chair’s deep involvement in the process and substantial value to the committee, that they should ask him to continue to serve as chair, recusing himself when and if the new bidder or its bid is discussed. ANALYSIS

The conflict that emerged here could not have been reasonably anticipated in light of the committee’s early focus on strategic buyers. It is, however, more than a trifling. Although never challenged in court,16 the prompt and full disclosure of the conflict, as soon as it arose, was critical to addressing the situation. Importantly, here the disclosure was made in the context of a formal meeting of the committee, and was on the record in that it was duly recorded in the minutes. Perhaps as much as any 16

Those familiar with the case law may believe that the case study was drawn from the Oracle litigation, in which, in the context of a committee formed to investigate whether to continue a derivative action, a well-known Stanford University professor and former SEC commissioner was found not to be independent of a prominent Silicon Valley industrialist who had donated millions to the university. In fact, however, the case study is not a reference to Professor Grundfest of Oracle fame. Instead, the facts recited arose in connection with the sale of a different Silicon Valley corporation.

39

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other practical advice that can be given, it is critical that counsel strongly discourage the reflexes of a closely knit committee to deal with such a matter informally, in oneon-one telephone calls. One-on-one calls are not the formal action of the committee, and do not get recorded in minutes. Disclosures of conflicts that are not recorded in contemporaneous minutes run the risk of meeting judicial disbelief in subsequent proceedings. In this case, the chairman’s willingness to recuse himself from consideration of the potentially conflicted party’s bid was also important. This decision helped preserve the integrity of the committee process and its outcome by insulating the chairman from the effects of a recognized and formally disclosed conflict. This course of action was significant, even though, as here, the conflicted director was a person of high integrity and in no sense subject to coercion or under the sway of the new bidder. In fact, the late-arising conflicted bidder eventually dropped from sight, as the bidding among the other financial firms increased beyond its price level. The chairman kept his word and did not participate in the discussion of the conflicted bid. At the end of the day, the corporation was sold to one of the unsolicited bidders for cash in an amount almost 50 percent more than the value of the initial stock for stock transaction, and no litigation was brought challenging the new transaction. We believe that, had a challenge been brought, a reviewing court would have determined that the thrust-upon conflict was adequately addressed and did not cast doubt on the committee’s work or the resulting transaction. In other words, neither the chairman nor the other committee members should have been disqualified on independence grounds in light of the way this thrust-upon conflict was handled. Alternatively, had the chairman not recognized the potential for an appearance of conflict and allowed the process to play out, and had the last bidder been successful, it is, in our view, likely that a court would have been critical of the committee, given the chairman’s undisclosed conflict. The lesson here is that neither the members of the transaction committee nor its counsel can ever stop being concerned about potential conflicts as a transaction develops. All of the constituents in the process need to be constantly vigilant as to conflicts, especially if a corporation is being sold and no one can predict who might eventually emerge as an interested bidder. If a conflict is thrust upon them, they must promptly disclose and address it. Of course, we have focused here on a conflict arising for a committee member, but unanticipated conflicts also arise for advisors, and they need to be equally aware of the continuing potential for a thrust-upon conflict as a transaction develops.

D. THE COMMITTEE CHARTER Having determined the composition of the committee, the next task for the board is to determine the charge and scope of delegation to make to the committee. The scope of the delegation to the committee is important. Not only must that delegation be consistent with applicable law and the corporation’s charter and bylaws, but it also must be broad enough to ensure that the committee has the requisite power and authority to 40

THE COMMITTEE CHARTER

fully address and take action on the matters within its purview. At the same time, that delegation should generally not be so broad as to authorize the committee to address matters well beyond the scope of its assignment. Particularly in the context of a conflict transaction, the importance of the committee’s charter cannot be overstated. In the event of a challenge to a conflict transaction in which a corporation is relying upon the existence of a special committee to evidence the procedural fairness of the transaction, a court will typically start by closely scrutinizing the power delegated to the committee, and the text of the authorizing resolutions are routinely quoted directly in such cases.17 If the court finds the delegation to the committee to be insufficient to handle the task at hand effectively, the likelihood is significantly reduced that the court will give the desired effect to the creation and operation of the committee.18

i. The Form of the Charter The full board of a corporation authorizes and approves the committee’s charter.19 The committee’s charter identifies the scope of the delegation of authority to the committee and represents the source of the committee’s power. The committee will not have authority to act with respect to any matters outside the scope of its charter. A committee’s charter may take the form of a stand-alone document, such as those typically used for standing committees of a board of a public corporation (such as a compensation committee or audit committee). Nevertheless, it is frequently the case that the delegation to a special committee is entirely contained in resolutions adopted by the board. Either approach is perfectly acceptable. In this regard, it is important to review carefully the corporation’s governing documents in connection with formation of a committee. Limitations on delegations to committees may be contained therein (discussed below). In addition, it is not unusual for a corporation’s bylaws to contain procedural provisions related to committees addressing matters such as quorum, notice of meetings, and requisite vote to approve matters that may either mandatorily apply to all committees or apply by default in the absence of an affirmative resolution by the board or committee to the contrary. Consideration should be given to whether such provisions in the charter and bylaws are appropriate for the special committee being formed. If not, and if the charter and bylaw provisions are not mandatory for all committees, such procedural points should be addressed directly in the board’s authorizing resolutions. 17

18

19

See, e.g., Kahn v. Sullivan, 594 A.2d 48, 53 (Del. 1991) (quoting the full board resolutions forming the special committee and outlining its authority); Freedman v. Restaurant Assocs. Indus., Inc., 1990 WL 135923, at *1 (Del. Ch. Sept. 19, 1990) (quoting board resolution delegating authority to the committee); Citron v. E.I. Du Pont de Nemours & Co., 584 A.2d 490, 494 (Del. Ch. 1990) (same). See, e.g., In re CNX Gas Corp. S’holders Litig., C.A. No. 5377, at 29 (Del. Ch. May 25, 2010) (holding that the use of a special committee in a going-private merger transaction was insufficient to shift the burden of proof where, among other issues, the special committee was not authorized to negotiate or consider alternatives to the transaction). 8 Del. C. § 141(c). 41

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ii. Restrictions on Delegations to Committees As an initial matter, the Delaware corporate statute—the General Corporation Law of the State of Delaware (the DGCL)—provides certain limitations with respect to matters that can properly be delegated to a committee of the board of the directors. Section 141(c) of the DGCL governs the creation and delegation to board committees. Section 141(c) distinguishes between corporations incorporated prior to July 1, 1996, and those incorporated after such time—with Section 141(c)(1) applying by default to corporations incorporated prior to July 1, 1996, and Section 141(c)(2) applying to corporations incorporated on or after July 1, 1996. Section 141(c)(1) provides for a more circumscribed permissible delegation to a committee of the board. A short summary of the distinction between the two statutory provisions follows. Section 141(c)(1)—Corporations Incorporated Prior to July 1, 1996: By resolution passed by a majority of the whole board, a board committee may be formed with full powers of the board, subject to certain specific exceptions: • The committee may not be empowered to amend the bylaws or to approve (and recommend to the stockholders) an amendment to the certificate of incorporation, a merger, a sale of all or substantially all of the corporation’s assets or a dissolution. Importantly, the restriction on the ability of the committee to approve a charter amendment includes a carve-out to allow a committee, to the extent authorized in the resolutions of the board, to fix the designations, preferences, or rights of stock issued pursuant to the corporation’s “blank check” power; provided, however, that one power relating to such stock that may not be so delegated is the determination of voting rights of such stock, which must be conferred by the board itself. • In addition, only if the resolution expressly so empowers the committee may it: ❍ Act for the board in declaring a dividend, ❍ Issue stock or fix preferences or rights of certain classes of stock, or ❍ Approve a certificate of ownership and merger in a Section 253 short form merger of a 90 percent owned subsidiary. Section 141(c)(2)—Corporations Incorporated On or After July 1, 1996: By resolution passed by the board (typically a majority of a quorum), a board committee may be formed with full powers of the board subject to the following two exceptions: • The committee cannot approve or adopt, or recommend to stockholders, any action or matter (other than the election or removal of directors) expressly required by the DGCL to be submitted to stockholders for a vote (which would include most mergers and amendments to the certificate of incorporation as well as a sale of all or substantially all of the corporation’s assets and a dissolution); and • A committee cannot adopt, amend or repeal any bylaw. For corporations formed prior to July 1, 1996 (and therefore subject to the more restrictive provisions of Section 141(c)(1) of the DGCL), such corporations may optin to the more expansive provisions of Section 141(c)(2) by adoption of a board 42

THE COMMITTEE CHARTER

resolution to this effect. Counsel advising corporations incorporated prior to July 1, 1996, should inquire as to whether the corporation has chosen to be governed by Section 141(c)(2) and, if not, strongly consider including a resolution in the delegation to the committee or other board resolutions which opts-in to Section 141(c)(2). Despite a large amount of overlap between the two statutory provisions, a corporation governed by Section 141(c)(1) may require greater precision in the committee charter to specifically include matters, such as declaring a dividend, issuing stock, or authorizing a short-form merger. Additionally, in certain matters, such as the authorization of a new series of preferred stock via a certificate of designation and without stockholder approval, Section 141(c)(1), unlike Section 141(c)(2), requires that the voting rights of the preferred stock be determined by the full board. The failure to account for this carve out from permissible delegation for creation and issuance of preferred stock may jeopardize the valid existence of such stock. As a result of the limitations on delegations to committees contained in both Section 141(c)(1) and Section 141(c)(2) of the DGCL, a board committee may not, for example, be delegated the authority to approve a merger agreement under Section 251 of the DGCL on behalf of the corporation where the corporation is being acquired in the merger, as this section generally requires the approval of the corporation’s stockholders to effect such a merger. Additionally, a committee may not be delegated authority to approve (on behalf of a corporation) a sale of all or substantially all of the assets of a corporation, an amendment to the corporation’s certificate of incorporation, or a dissolution of the corporation.20 In addition to the foregoing limitations on delegations to committees pursuant to the DGCL, it is important to also consider any requirements for and limitations upon delegations to committees contained in the corporation’s certificate of incorporation or bylaws. Although it is not unusual for such governing documents to contain a delegation of authority that tracks the language of the DGCL or permits a delegation to committees to the “fullest extent permitted by law,” there are instances in which a corporation’s governing documents do contain limitations or procedural hurdles. Frequent examples of such hurdles or limitations include requirements that (1) any committee of the board have at least a specified number of members; (2) a higher vote than the typical majority of the quorum is necessary for board action in order to form a committee; and (3) the a scope of delegation is more limited than is currently permitted by Section 141(c)(2) of the DGCL. In many cases, such restrictions may not inhibit the ability to form and delegate to a committee the requisite power and authority for the task. However, if a material limitation exists with respect to the permitted delegation to a committee and if such limitation appears in the corporation’s bylaws (as would typically be the case), the board may be able to amend the bylaws to remove any

20

Section (iii) below addresses how special committees may nonetheless be used to recommend approval of these categories of transactions while not being delegated the full power and authority of the board to approve such matters. This structure is customarily used in mergers and other transactions where the DGCL prohibits the committee from approving a matter on behalf of the corporation. 43

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such impediment, provided that the board is vested with the power to amend the bylaws by the corporation’s certificate of incorporation. Practitioners should be mindful of the limitations on delegations to board committees under Delaware law not only at the outset of a matter, but also to the extent that the matter being addressed by the committee evolves over time. For example, if a committee is formed at the outset to consider a financing transaction with a significant stockholder but is delegated the authority to consider alternatives to such transaction, it is possible that the type of transaction being considered could change and the committee could ultimately elect to pursue a merger transaction either with the significant stockholder or a third party. Although the committee could be permissibly delegated the full power and authority of the board with respect to the financing transaction, it would not be permitted, under the DGCL, to approve the merger on behalf of the corporation. Accordingly, if the committee’s mandate includes consideration of various types of transactions, the committee’s charter should be periodically reviewed to confirm that no issues are created, particularly if the transactions being considered may evolve over time.

iii. Recommend Versus Take Action In light of the restrictions imposed by the DGCL (and in some cases by the governing documents of a corporation), in certain instances the board may not permissibly delegate ultimate authority to a committee to act in lieu of the board. As noted above, the prototypical example of this arises in the context of a merger transaction that will require approval by a corporation’s stockholders. In such cases, and in recognition of these limitations, it is customary for a board nonetheless to form a special committee while providing in the delegation of authority that the committee shall have the authority to recommend to the full board what action, if any, to take with respect to the merger. Thus, the board does not delegate to the committee the authority to act on behalf of the corporation. If the committee provides a favorable recommendation as to the merger, the full board would then consider the approval of the merger agreement (as required by statute) based upon the committee’s approval and recommendation. Although these statutory limitations on delegation operate to weaken somewhat the power of the committee, as discussed below, there are certain provisions that should be added to the typical committee charter to ensure that the committee may nonetheless act as the ultimate gatekeeper in determining whether any conflict transaction will go forward. If no stockholder approval of the transaction under consideration is required (and assuming no limitation in the corporation’s governing documents), a board committee may be delegated the full power and authority of the board to take action on the matter at hand without any further involvement from the full board. A typical example of a transaction delegated to special committees in this context would be an equity or debt financing transaction with a controlling stockholder. In the context of a special committee formed in connection with derivative litigation, an SLC, it would be unusual for any of the statutory limitations on delegation to 44

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board committees to be relevant. However, committees formed to investigate and respond to a stockholder demand asserting potential derivative claims and committees formed to consider and respond to derivative litigation instituted by a stockholder of the corporation typically differ on the fundamental question of whether the committee will have the full power and authority to act on behalf of the corporation with respect to the matter at issue. In the case of a committee formed to respond to a stockholder demand, by making the demand upon the board, the stockholder has conceded that a majority of the board is not conflicted in assessing the claims made by the stockholder. In such circumstances, though fully permissible, there is usually only limited incentive to vest the committee with the full power and authority of the board with respect to the demand, and, more typically, the delegation to the committee would be limited to making a recommendation to the board. Moreover, there is Delaware case law suggesting that a committee formed to investigate a demand which receives a delegation of the full power of the board effectively surrenders the concession of independence inherent in the demand. Thus, the act of delegating all the board’s authority to the demand committee may act as a concession that a majority of the board is interested with respect to the subject of the demand.21 Thus, care needs to be taken here to avoid making a choice that has an unanticipated adverse impact on subsequent litigation. On the other hand, if the committee is an SLC, formed in response to derivative litigation, it may be very important to a reviewing court that the committee is vested with the full power and authority of the board to take action with respect to the litigation. For example, in Biondi v. Scrushy, the Delaware Court of Chancery parsed the delegation to the corporation’s SLC and highlighted language providing that the delegation to the committee was not intended to moot or waive the corporation’s planned motions to dismiss with respect to pending actions, provided that the committee would have the power to recommend that any motion or pleading be changed or withdrawn.22 Criticizing this limitation on delegation, the court stated: Read plainly, this resolution seemed to limit the SLC’s authority to prevent the company from seeking dismissal of the Tucker Action, with or without the SLC’s blessing. Although the SLC could “recommend” otherwise, nothing in the prior resolution authorizing the SLC to act for the board was “intended to moot or waive” the company’s planned motions for dismissal. This intent is further demonstrated by earlier language in the resolutions that indicated the board’s desire “to preserve to the company and the Board” the right to seek dismissal.23

21

22 23

See Sutherland v. Sutherland, 2010 WL 1838968, at *5–6 (Del. Ch. May 3, 2010) (“By appointing a special litigation committee, the Defendants conceded that self-dealing was adequately alleged in the original complaint . . . .”). 820 A. 2d 1148, 1155 (Del. Ch. 2003). Id. at 1155–6; see also In re Par Pharm., Inc. Deriv. Litig., 750 F. Supp. 641, 647 (S.D.N.Y. 1990) (vesting special litigation committee with a “mere advisory role” is not legally sufficient because such a role “fails to bestow sufficient legitimacy on the Board’s decision to warrant deference” by a reviewing court). 45

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The point was made even more forcefully in In Re Primedia Inc. Derivative Litig.24 There the court described the “key first step” to any analysis of an SLC’s motion to dismiss under Zapata to be an analysis of: [W]hether the special litigation committee was given full control over the claims. And that’s not just the right to evaluate whether or not to dismiss the claims. In my view, the special litigation committee . . . has to have the ability to do whatever the corporation could do with the claims. In other words, assert the claims in all or in part, allow plaintiffs’ counsel to proceed in whole or in part, settle the claims in whole or in part, or dismiss the claims in whole or in part.25

Accordingly, in the context of a committee formed to address pending derivative litigation, delegating to the committee the full power and authority of the board to take all necessary action pertaining to the litigation may be vital in assuring that the committee is given the desired effect by a reviewing court.

iv. The Power to Negotiate and Just Say No—Transactional Committees For most special committees formed to address conflict transactions, perhaps the most important elements of the committee charter are the power to reject a proposed transaction on behalf of the corporation (or just say no) and the power to engage in arm’s-length negotiations on behalf of the corporation. These are the fundamental elements that will address one of the threshold questions typically asked by a reviewing court—did the committee have a sufficiently broad delegation to enable it to fully replicate arm’s-length bargaining? Numerous decisions of Delaware courts have identified the power to just-say-no as vital to the efficacy of a special committee. For example, in In re First Boston, Inc. Shareholders Litigation,26 the Delaware Court of Chancery identified the “power to say ‘no’” or to refuse to approve a self-interested transaction as the “critical power” possessed by a special committee, which “gives utility to the device of special board committees . . .” The court explained: The power to say no is a significant power. It is the duty of directors serving on such a committee to approve only a transaction that is in the best interests of the public shareholders, to say no to any transaction that is not fair to those shareholders and is not the best transaction available.27

Thus, it is the special committee’s power to refuse to approve the transaction that gives the special committee leverage to bargain with the interested party.

24 25 26 27

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Consol. C.A. No. 1808-VCL (Del. Ch. June 14, 2010)(TRANSCRIPT). Id., trpt. at 69. 1990 WL 78836, at *7 (Del. Ch. June 7, 1990). Id.

THE COMMITTEE CHARTER

Delaware courts have also emphasized the need for the special committee to be able to negotiate at arm’s length. As the Delaware Court of Chancery explained in Rabkin v. Olin Corp.:28 The mere existence of an independent special committee, which appears to have existed here, does not itself shift the burden. At least two factors are required. First, the majority shareholder must not dictate the terms of the merger. Second, the special committee must have real bargaining power that it can exercise with the majority shareholder on an arms length basis.

Thus, in Rabkin, the court concluded that the burden of proving entire fairness of a $20 per share merger was not shifted, if the evidence demonstrated that the offer presented to the committee was “non-negotiable,” and if the special committee’s only charge was to pass on the “fairness, in terms of price, of the $20 offer.”29 Accordingly, the centerpieces of any special committee charter should be the power to say no to any or all transactions being considered by the committee and sufficient power to replicate arm’s- length bargaining in the context of a conflict transaction. A frequent source of tension in the context of a conflict transaction involving a controlling stockholder is whether the delegation to the special committee should go beyond the ability to reject the transaction. For example, should the committee be empowered to negotiate alternatives on behalf of the minority stockholders? Should the resolution include language broad enough to allow the special committee to engage in aggressive tactics directed at the “controlling” stockholder, including adopting a stockholder rights plan? In In re Pure Resources, Inc. Shareholders Litigation,30 a special committee formed to respond to an exchange offer by its majority stockholder sought unsuccessfully to obtain a delegation broad enough to permit such actions. While rejecting the argument that the subsidiary board of directors had breached its fiduciary duties in this regard, the Delaware Court of Chancery was somewhat critical of the committee for not making a more aggressive attempt to secure such power.31 Likewise, in Louisiana Municipal Police Employees Retirement System v. Fertitta,32 a special committee was formed to negotiate with the corporation’s controlling stockholder with respect to a going-private transaction. Following the signing of merger agreement, the controlling stockholder, among other things, purchased enough stock via market acquisitions to increase his ownership from approximately 39 percent to almost 57 percent of the corporation. There was no mention of the committee being vested with the power to adopt a rights plan. However, the court found that the failure of the board to take action to stop the “creeping takeover” by the controlling stockholder supported a reasonable inference that the board breached its fiduciary duty of loyalty. 28 29 30 31

32

1990 WL 47648, at *6 (Del. Ch. Apr. 17, 1990). Id. 808 A.2d 421 (Del. Ch. 2002). Id. at 443 (noting “the [s]pecial [c]ommittee’s failure to demand the power to use the normal range of techniques available to a non-controlled board responding to a third-party tender offer” and voicing its concern that generally subsidiary directors might be less than aggressive in protecting minority interests in a tender offer process). 2009 WL 2263406 (Del. Ch. July 28, 2009). 47

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In In re CNX Gas Corp. Shareholders Litigation,33 however, the court went a good bit further. In connection with its review of the work of a one-member special committee formed to represent the minority public stockholders in a freeze-out by a controlling stockholder, the court stated: A controller making a tender offer does not have an inalienable right to usurp or restrict the authority of the subsidiary board of directors. A subsidiary board, acting directly or though a special committee, can deploy a rights plan legitimately against a controller’s tender offer, just as against a third party tender offer, to provide the subsidiary with time to respond, negotiate and develop alternatives. The fact that the subsidiary’s alternatives may be limited as a practical matter does not require that the controller be given a veto over the board decision-making process.34

The court continued “[b]ecause a board in a third-party transaction would have the power to respond effectively to a tender offer, including by deploying a rights plan, a subsidiary board should have the same power if the freeze-out is to receive business judgment review.”35 In the context of this case, in which the court determined to apply the test first discussed in Cox Communications, the court stated that because the special committee was “deprived” of a power, the board would otherwise have had, “this fact provides a separate and independent basis to review a controlling stockholder freeze-out for entire fairness.”36 Notwithstanding the foregoing, no Delaware case has held that such a broad grant of authority must be delegated to a committee and, indeed, the Delaware Supreme Court has indicated that aggressive tactics of this type may only be used against a controlling stockholder in limited circumstances. However, the discussions in Pure Resources and Fertitta evidence the expectation of the Delaware courts that the committee will have fairly wide latitude in taking action in the best interests of the corporation and its minority stockholders.

v. Do’s and Don’ts As noted above, special committee charters vary in both form and substance. We set forth below some suggestions when drafting a committee charter, including certain items to include and avoid. Items to Include • Introductory Language: It is customary for authorizing resolutions to provide for several introductory clauses (typically set forth as “Whereas” clauses) to set the context for the creation of and delegation to a special committee. Such language is helpful for members of the board to understand both why the committee is being established and why certain directors are being excluded. Such language may 33 34 35 36

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C.A. No. 5377 (May 25, 2010). Id. at 31. Id. at 32. Id.

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likewise be helpful for a court when evaluating the decision of the board to create the committee and the selection of its members. Such introductory language would typically include the following: ❍ A summary of the event that has caused the creation of the committee (e.g., the board has received a proposal from the controlling stockholder to acquire the outstanding stock not currently owned by the controlling stockholder, filing of derivative litigation, receipt of a demand by a stockholder). ❍ The conflict of interest of certain members of the board (e.g., “Whereas, Mr. Smith and Ms. Jones are directors of the Corporation and are also officers or directors of the controlling stockholder and may, as a result, be deemed to have an interest in the transaction.”). ❍ The rationale for including the directors to be selected to serve on the committee (e.g., “Whereas, the Board wishes to establish a special committee consisting of directors who are not directly or indirectly affiliated with the controlling stockholder and who are not members of the corporations’ management to review and evaluate the proposed transaction.”). If less than all of the non-conflicted directors serving on the board are to constitute members of the committee, it is sometimes helpful to include in the initial clauses the rationale for excluding a non-conflicted director from the committee. This may not be appropriate in circumstances in which only a small subset of the non-conflicted directors are serving on the committee, but might be appropriate if a single non-conflicted director is excluded. Particularly in instances in which a court has questions as to the independence of members chosen to serve on a committee, Delaware courts have inquired as to why certain non-conflicted directors were not chosen in lieu of such persons.37 • Authority to Establish Committee: Once the introductory language is complete, the initial resolutions authorizing the creation of the special committee should reference the authority by which the committee is being formed—typically, this would be a reference to Section 141(c) of the DGCL, together with the applicable provision of the corporation’s charter or bylaws addressing the formation of board committees. • Names of Committee Members: The individuals to serve on the committee must be included in the delegation. It is permissible under the DGCL to provide for alternate 37

See In re Tele-Commc’ns, Inc. S’holder Litig., 2005 WL 3642727, at *9–10 (Del. Ch. Dec. 21, 2005) (“Defendants could not explain why [] a director who suffered a loss of over $13 million due to the premium [awarded to certain series stockholders in a merger] was not selected to be on the Special Committee” while one member of the committee gained $1.4 million by virtue of the different treatment); In re Loral Space & Commc’ns Inc., 2008 WL 4293781, at *22 (Del. Ch. Sept. 19, 2008) (finding that the composition of the special committee was flawed because the special committee chairman’s “relationships with [the controlling stockholder] were too substantial to make him a fit member of the [s]pecial [c]ommittee, much less [c]hairman,” while there also appeared to be other directors on the board who were not chosen for the special committee, but had fewer ties to the controlling parties). 49

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members of the committee to the extent a committee member is absent or unavailable to serve. However, this would be unusual in the context of a conflict committee or SLC and, as a general matter, would not be advisable for most committees considering significant transactions or derivative litigation, given the complex nature of many of these transactions and the cumbersome aspects of including a substitute member in many instances. • Authority with Respect to Conflict Transaction, Litigation, or Demand: As noted above, the scope of the delegation should be broad to enable the committee to do its job effectively without undue influence from interested parties. ❍ In the context of a special committee formed to consider a conflict of interest transaction, such delegation would typically include the power and authority (1) to review and evaluate the terms and conditions of the proposed transaction and to determine the advisability of the proposed transaction and any alternative thereto; (2) to negotiate with the counterparty (or any other party) related to a proposed transaction or any alternative thereto and, subject to applicable law, to approve the execution and delivery of any transaction documents that the committee deems appropriate; and (3) alternatively to determine whether the transaction is fair to the minority stockholders and recommend what action, if any, should be taken by the full board with respect to the proposed transaction or any alternative thereto. The language with respect to consideration of alternatives to a proposed transaction is important for two reasons. First, unless the definition of proposed transaction included in the authorizing resolutions is broad enough to contemplate changes to the structure of the initially contemplated proposed transaction, there may be a question as to whether the delegation to the committee adequately covers a revised transaction. Second, if the alternative language is not included, the delegation to the committee could be viewed as being unduly constrained, precluding the committee from seeking or considering transactions from other parties which may prove to be more beneficial to the corporation. ❍ In the context of a special committee formed in response to derivative litigation, the delegation would typically include the power and authority to (1) investigate all matters related to the pending litigation; (2) review and evaluate the findings of such investigation; and (3) take all actions that the committee deems to be appropriate and in the best interests of the corporation with respect to the litigation, including, without limitation, prosecution, control, and supervision of the litigation by the corporation. ❍ In the context of a special committee formed in response to receipt of a stockholder demand with respect to derivative claims, the delegation would typically include the power and authority to (1) investigate the matters contained in the stockholder demand; (2) consider, as applicable, whether pursuing litigation or otherwise pursuing a claim related to the demand would be in the best interests of the corporation and its stockholders; and (3) make a recommendation to the board with respect to such matters. ❍ Specific Statement Regarding Transaction Not Taking Place Without Committee Approval (Transactional Committees): We recommend that a conflict committee delegation include a specific statement that the board of the corporation will not 50

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•

•

•

•

38

approve the proposed transaction or any alternative thereto without the prior favorable recommendation of the proposed transaction or alternative thereto by the special committee. Such language represents a clear statement that the committee is empowered to say no to a deal and the corporation will not proceed with a transaction absent committee approval. Specific Statement Regarding “Final and Binding” Nature of Committee Determinations (SLCs): We recommend that an SLC delegation include a specific statement that the determinations made by the SLC shall be final and binding upon the corporation and shall not be subject to review by the board. Such language is a clear statement of the exclusive authority of the committee with respect to the pending litigation. Retention of Counsel, Investment Bankers, and Other Advisors: We recommend that a special committee be given explicit authority to retain its own counsel and other advisors and consultants as the committee may deem necessary or appropriate (including investment bankers) and to be empowered to enter into contracts with such advisors to be honored by the corporation. In most instances, it will be vital to the role of the committee to retain counsel to advise the committee (separate from corporation counsel) and, in the context of a committee formed to consider a transaction, to obtain independent financial advice. Not having such powers (or having the board insist upon use of the corporation’s counsel and investment advisors) would likely be viewed by a reviewing court as either limiting the effectiveness of the committee and its ability to do its job or as an effort by the conflicted parties to ensure that the committee members are receiving advice only from advisors who may have ties to the conflicted party or who may otherwise be viewed as not independent. Management Instruction Regarding Cooperation: It is also advisable to add to the authorizing resolutions a direction to management of the corporation to assist the committee in any manner requested by the committee, including, without limitation, by providing to the committee and its advisors any and all information and materials requested by the committee. Additionally, in the context of an SLC, it is prudent to include a non-destruction instruction to management (as well as directors, employees, and agents) instructing such parties to preserve all documents that may be relevant to pending litigation.38 Indemnification and Advancement: Although most directors enjoy rights to advancement of legal expenses and indemnification by virtue of the governing documents of the corporation (and/or through an indemnification agreement providing such rights), it is customary that authorizing resolutions for a special committee provide for a specific authorization of advancement of expenses and indemnification by the corporation to the fullest extent permitted by law. Because the risk of litigation is heightened in connection with any transaction involving conflicts of interest and, in the case of an SLC, litigation is already pending, the specific authorization of

In many cases, this will be accomplished outside the text of the resolution itself, such as in a hold letter from general or outside counsel. 51

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advancement and indemnification may provide some additional comfort to those directors being asked to serve on the committee. • Committee Fees: Practices vary significantly as to whether the fees that the committee will be paid should be set forth in the authorizing resolutions. As a general matter, we believe that it is preferable to provide both for committee fees in such authorizing resolutions and the basis on which the committee should be paid, i.e., per meeting or a flat fee. It is neither unusual nor inappropriate for the chair of the committee to receive some additional amount to reflect the additional time commitment that will likely be necessary to discharge that role. Provided that such fees are reasonable and unrelated to the ultimate conclusions of the committee (i.e., no fees should be contingent upon a transaction being approved), payment of such fees should not be problematic.39 Items to Exclude • Appointment of Specific Counsel or Investment Bankers for the Committee: Although the committee should be authorized to retain counsel, investment bankers, and other consultants, the authorizing resolutions of the full board should not purport to appoint any advisors to serve in this role. This decision should be made solely by the committee once it is formed and after proper deliberation as to what resources it will need to utilize. The appointment of any such advisors by the full board raises issues concerning the independence of the newly appointed committee.40 • Appointment of Committee Chair: Because the chair of the committee frequently takes the most active role in the work of the committee, including working with the advisors and charting the proper process, the identity and selection of the committee’s chair may be relevant to a reviewing court. For this reason, it is preferable that the committee chooses its chair instead of the full board. If the board designates the chair of the committee, a court may give additional scrutiny to the ties of the committee chair to management, the controlling stockholder, or any other interested party.41 Although the full board’s appointment of a committee chair is not uniformly a mistake, it should be avoided except in exceptional circumstances. 39

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For example, in In re Tele-Commc’ns, Inc. S’holder Litig., 2005 WL 3642727 (Del. Ch. Dec. 21, 2005), a special committee was formed to consider a potential merger transaction and it was contemplated that such committee would be “reasonably compensated” for its work. The committee process spanned only one week and involved four meetings and ultimately resulted in a favorable committee recommendation of the transaction which provided greater consideration to be paid to the class of stock held by the controlling stockholder than the class held widely by the minority stockholders. Following approval of the transaction, the corporation’s board authorized a payment of $1 million to each member of the committee. None of this information was disclosed to stockholders in connection with the merger transaction, and the court was highly critical of this set of circumstances. Committee fee structures are further discussed at Section (g) below. See Section (e)(i) below. For example, in In re Loral Space & Commc’ns Inc. Cons. Litig., 2008 WL 4293781 (Del. Ch. Sept. 19, 2008), the corporation’s board appointed a two-person special committee to

THE RETENTION OF ADVISORS

• Undue Limitations Upon the Committee’s Power: Although there may be circumstances in which the parties differ as to how expansive the delegation of power to the committee should be, it is of significant importance to avoid material limitations upon the committee’s ability to perform its role. In the case of an SLC created to address pending litigation, it is vital that the committee has the full power and authority to act on behalf of the board with respect to all matters relating to such litigation.

vi. Forms of Committee Charters In the appendices to this chapter, we set forth several forms of committee charters that may be appropriate, depending upon the matter being considered.

E. THE RETENTION OF ADVISORS The retention of competent and skilled advisors may be the decision by the committee that is most critical to the success of the committee’s work. As suggested above, the typical committee charter will empower the committee to select such advisors as it deems appropriate. The first order of business of any newly appointed committee should be to identify and select legal advisors, before doing virtually anything else. Remember, as a committee member, no matter how straightforward the task of the committee may seem, this assignment will soon descend into terra incognita and having a skilled guide along the way is likely to mean the difference between a special committee that helps the corporation (in terms of shifting burdens or otherwise) and one that does not.

i. Who retains the advisors? As businesspeople accustomed to working with in-house legal staff, the natural assumption of many newly appointed committee members is to look to the company’s general counsel to select a legal advisor for the special committee. After all, the general counsel does a good job managing litigation across the country (or world, depending on the size of the enterprise) and has a broad network of capable outside counsel

consider a financing transaction on behalf of the corporation, and despite the board having other directors with greater independence not serving on the committee, named as one of the members of the committee and its chair an individual with close ties to the corporation’s controlling stockholder (and the counterparty to the transaction ultimately approved). The Delaware Court of Chancery was critical of this appointment by the board, noting, “[O]ddly, the board chose to comprise the Special Committee of only two members and to make Harkey—an advisor of [the controlling stockholder]—its Chair.” Loral, 2008 WL 4293781, at *8. 53

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that the company uses for many different assignments. This just makes common sense, right? Wrong—the normal rules do not apply in the context of a special committee. The special committee is charged with retaining its own counsel, a job that cannot be delegated to in-house counsel.42 As a practical matter, this means that the committee must identify counsel skilled in the representation of special committees and settle on a practical means of sifting through such counsel until the special committee finds the lawyer it is certain will best assist it in discharging its function. This is not to suggest, however, that the general counsel or his staff cannot be a useful resource in helping to identify (and even screen for conflicts) lawyers or law firms who are known to be expert in representing committees. They can and often do, and, in this role, the general counsel is a resource to the committee that should not be overlooked.43 Of course, to the extent that the members of the committee have had positive experiences with particular lawyers in the past, or otherwise know lawyers by reputation, these, too, may be added to the list of possible advisors. In short, the very first task of the committee should be to assemble a list of qualified legal advisors who could act for the committee if selected.

ii. Who do the advisors represent? It is important in selecting advisors to understand what the special committee is asking them to do. The lawyers hired by the special committee will have one and only one client—the special committee. In a strict legal sense, they more broadly represent the company, since the committee is an “arm” of the company, but that does not mean that they answer to anyone at the company other than the special committee. Thus, a prominent aspect of the analysis of which advisors to choose is whether the special committee is comfortable that the lawyers it hires completely understand that they represent solely the committee. To the extent that other advisors may be hired, the same may be said. For instance, it would be wise to assure that an investment banker hired to help the committee sell the company has not worked so closely with senior management that it cannot be rigorously independent in its advice to the committee in the event that management became a bidder or the committee came to the conclusion that management preferred one outside bidder to another given subtle or overt signaling relating to future employment. In short, just like the committee itself, advisors must be independent, in the sense that they are able to represent the committee, and only the committee, vigorously. Advisors with real or perceived conflicts should be avoided.

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In one widely reported case, the Delaware Supreme Court found that a committee’s decision to hire counsel suggested by the corporation’s corporate parent was an indicator that the committee’s process was not to be trusted. Kahn v. Tremont, 694 A.2d 422, 429 (Del. 1997). We address the role of the corporate general counsel in this process at some greater length at Chapter Twelve, “The In-House Lawyer’s Role: What to Expect and How to Cope.”

THE RETENTION OF ADVISORS

iii. The Use of Experienced Company Advisors There is, of course, no rule that does not admit of caveats or qualifications. So, too, here. In many cases, the general advice to be cautious about hiring conflicted advisors gives way to a practical assessment of the unique qualifications an advisor might otherwise have. Take, for example, the case of an investment banker who has represented the company over several years, knows it well, and has done some financing work for it from time to time. Is there a reason to avoid hiring this banker if a committee is constituted to run a process leading to the sale of the company? It depends. To the extent that the banker’s knowledge about the company and its direct experience will allow the process to be jump-started, the committee may want to consider retaining that advisor, notwithstanding its past work with the company. On the other hand, if the lead banker is also sufficiently close to senior management that an issue may arise about the banker’s ability to give independent advice if the management team emerges as a bidder, then a different decision may be in order. The key here is for the committee to make an informed, on-the-record judgment. It is critical that there be a contemporaneous written record of the committee acknowledging any potential conflict, and making an informed decision about whether or not to proceed. In the absence of such a record in the minutes of the committee’s work, the odds are materially enhanced that a reviewing court will be critical of the conflict. The committee will want to weigh the pros and cons of retaining an arguably conflicted advisor on the record of the committee’s proceedings (at a meeting with minutes taken). The committee should then make a judgment after asking the advisor the hard questions, and even potentially discussing its plans with management. For example, were management to give the committee assurance that it would never be a bidder, the concern about a later-developing conflict is likely to evaporate. Likewise, notwithstanding the critical importance of counsel being independent and free from conflict, there are also situations in which some background with the company will make counsel more, rather than less, valuable to the committee. Take, for example, the lawyer who is being considered to represent a committee in connection with an investigation of a particular business practice. The fact that the lawyer may have had an unrelated representation of the company in the past and has a general understanding of the company and its key actors may be a positive rather than a negative. Again, this is a matter for judgment by the special committee, but judgment that is exercised in a meeting and on the record so as to minimize the potential for second-guessing later. Finally, if an independent outside firm is hired by the special committee, there are many circumstances in which that law firm will work with regular outside corporate counsel to accomplish a particular objective. A transactional committee formed to negotiate the sale of the company will often find that regular outside counsel’s assistance is critical to addressing technical representations and warranties, for example, as well as other provisions requiring knowledge of the company’s historic practices. In all events, however, it should be clear that regular counsel is acting at the behest and under the direction of the special committee.

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iv. Interviewing Potential Advisors Once the special committee identifies its short list of potential legal advisors, the next task at hand is to reach consensus on a sensible way to reduce the list to just one lawyer—the special committee’s counsel. Typically, this is done through a series of interviews of counsel, either by the entire special committee or a member of the special committee, often the chairman if one has been selected.44 It is typically a good idea not to include the company general or outside counsel in these interviews, even if one or both have suggested the firms that are interviewed.

1. Conﬂicts There are several important purposes to these interviews. At the outset, the committee will want to assure that counsel is not conflicted in any way. Given the critical role that advisors play in the process, assuring the unquestioned independence of advisors is almost as important as the committee itself being independent. In many cases, a conflict of interest would include current representation of the company or a prior representation that is related to the matter the special committee is formed to address. The more difficult question arises in connection with a prior and unrelated representation of the company. If the advisor previously worked for the company, with whom did she work? There are circumstances, for example, in which a long working relationship with senior management on other matters could well be disqualifying, for example, if the committee is formed to negotiate for the sale of the company to an LBO (leveraged buyout) group led by management. In that circumstance, a committee likely would not want to risk the possibility that a reviewing court would be critical of the committee for selecting a lawyer with close ties to management. Likewise, is it clear to the special committee that the advisor understands that the committee is her client and that she does not report to the general counsel? A lawyer with a close working relationship with the general counsel might mistakenly feel the need to keep inside counsel in the loop as the committee’s work unfolds. This could be a fatal mistake if the committee is charged with investigating board or management conduct. Is information relating to the prior representation and the nature of the relationships with the company’s staff forthcoming, or does the special committee find itself having to pry it loose from the lawyer? In our experience, the lawyer being interviewed should volunteer this information and advise the committee carefully to consider whether it is comfortable that the advisor’s loyalty would be solely to the committee. 2. What is the lawyer’s direct experience? In addition to assuring that counsel has no conflicts, the special committee should probe to determine how much direct

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It is not uncommon for the special committee to appoint a chairman even before setting to the task of selecting counsel. This is not invariably the case, however, and it is by no means required. In many instances, it is wise to first select counsel and then take advice from that counsel in connection with the selection of a chair. In addressing this topic, we have assumed that the committee will first select counsel and will then proceed to organize itself. See Chapter Five, “Committee’s First Steps.”

CASE STUDY: MEET YOUR NEW LAWYER!

experience counsel has in representing special committees in the past. As we argue throughout this volume, the discipline of representing a committee is a highly developed specialty, and hiring “first timers,” while generous, is probably not the best idea from the perspective of doing everything that can be done to assure the success of the committee and its work. Importantly, the committee should press the issue to assure that the lawyer who will actually lead the representation (as opposed to some other collection of lawyers within the firm) has actually represented special committees before. After all, the special committee will be taking advice from a person, not a firm. Beware of the slick pitch that seeks to impress with a long list of special committee representations conducted by everyone but the lawyer being interviewed. Likewise, the special committee should press hard to determine whether the lawyer who will lead the representation has had experience in the type of work that the committee will be facing. For example, a lawyer experienced in Securities and Exchange Commission (SEC) enforcement and who has led a dozen forensic investigations in the past might not be best suited to help a transactional committee consider the sale of the company. Likewise, the transactional lawyer who has sold a dozen large companies, often working with special committees, may lack the skills necessary to pursue a vigorous and thorough forensic investigation. Of course, this is not invariably the case, but in all events, the special committee should do its best to make sure that the lawyer who will head up this assignment has the specific skill set required.

3. Am I comfortable with this lawyer? Finally, and assuming that the special committee has found a lawyer who is skilled and has the particular experience that it is looking for, the special committee should size her up carefully. Although it may seem like a clear day, in many cases, the special committee will be about to sail directly into a squall, and the character of the person who will be manning the lines with the special committee matters. The special committee should ask itself a number of questions: When the going gets rough, do I want this person helping to guide me? Are we comfortable with this lawyer? How will she perform under pressure? Does she seem to understand the political issues we will have to navigate, and is her advice likely to be sound even in the midst of crisis? Is this a person from whom we are likely to take advice; or is she too young, too old, too fast and loose, or too conservative for us to be comfortable putting our reputation in her hands? How will I respond to this person after spending twenty hours with her? Forty? One hundred? The members of the special committee are about to form a close relationship—of the type forged in foxholes under fire—and should make sure that the lawyer is someone with whom they are comfortable. F. CASE STUDY: MEET YOUR NEW LAWYER! FACTS

A board meeting is called to consider a stockholder group’s rapid accumulation of the company’s stock. The company is not quite sure precisely what the stockholder wants, but in a call from the CEO in advance of the board meeting, you are told something 57

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about the company’s shareholder rights plan and about the need to investigate whether the stockholder has actually triggered the pill. You arrive at the meeting and as the board meeting unfolds, it becomes clear that you and two of your colleagues on the board are being suggested to staff the special committee to be formed to investigate the insurgent’s stock acquisition. The general counsel is present at the meeting and walks the board through the resolution appointing the special committee, including the portion that authorizes your new committee to hire such outside counsel and other advisors as it may deem appropriate. You accede to the call to service and the resolution is passed naming you and your colleagues as a special committee. Thereafter, the board meeting is adjourned and general counsel suggests that the newly formed committee meet in an adjoining conference room to begin its work. You are ushered into the room and introduced to a senior partner from a national and wellrespected firm with widely recognized expertise in corporate litigation. The lawyer has with him two associates and what appear to be voluminous files. The general counsel explains that this is your committee’s new lawyer, which he has helpfully chosen for you to allow your work to proceed without delay. Your new lawyer thanks the general counsel for the introduction and proceeds to hand out a series of three-inch ring binders containing extensive information about the insurgent stockholder group, public information about its past activities, and counsel’s initial conclusions that it may have “tripped the pill” through its association with another insurgent group that owns stock in the company. Slightly dazed, you listen attentively, wondering all the while where this lawyer came from, when he was hired, and how long he had to become knowledgeable about the rather intricate factual and legal issues he is declaiming upon. An hour later, having highlighted his materials, the senior lawyer asks you to get out your calendar and determine whether you are available for a meeting later in the week to “take action” based upon the lawyers’ careful investigation. You do so, and without even trying, your new special committee has begun work with “its” new counsel. ANALYSIS

This case study is drawn from facts developed in an actual litigation. Unfortunately, the fact pattern repeats itself, to one degree or another, with some degree of regularity. There are several problems presented by these facts. First, and most obviously, the fact that counsel was chosen for the committee, rather than by the committee, is a real problem which immediately raises the issue of whether the committee was actually independent. Because the issue that gave rise to the decision to appoint a committee relates to the potential use of a significant corporate anti-takeover device, management is arguably interested in what the committee is being asked to consider. After all, management’s jobs may be at stake if the accumulating stockholder is in fact pursuing or about to pursue a takeover. Second, the fact that counsel has been hard at work for at least a number of days before the board even met to consider appointing the committee, and has already virtually concluded the work of the committee before that body was even formed, 58

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suggests a committee process that is less than ideal. Put simply, the idea of establishing a committee is for that body to bring its independent judgment to bear, based on such investigation that it determines is appropriate in the circumstances. Though counsel is almost invariably heavily involved in the legwork of the committee, a committee is simply not doing its job if it sits passively by while counsel constructs its work plan without input, executes that work plan, and then presents its conclusions for the committee’s adoption. Of course, here, the facts were even more extreme—the work was done before the committee was even formed. We would suggest that, confronted with a fact pattern like that set forth above, the new committee should begin by thanking counsel for its work, and then insisting upon the right to identify and hire its own counsel. At the same time, the committee chair may want to have a serious conversation with the company’s general counsel, set the ground rules for the general counsel’s interactions with the work of the committee, and make it clear that the committee intends to do the job it was asked to do and not function as an extension of management or a passive “rubber stamp.” Of course, the national firm hired by the company could be considered part of the process of identifying potential counsel to the committee. On these facts, that firm may have already practically disqualified itself as counsel, by showing its poor judgment (and probable lack of experience) in attempting to railroad the process through the new committee. Put differently, what does it say about counsel’s experience working with committees and respect for these directors that it would presume to do the work of the not yet formed committee? Though there could be circumstances in which such counsel becomes the committee’s counsel, in this situation, it would seem preferable to identify different and independent counsel. Likewise, though the committee should consider the work product created for it as part of the overall universe of materials considered, it should also take counsel from its new lawyers as to what else, if anything, should be done as part of its work, and determine whether the previous law firm was less than complete or fair in its hurried assembly of its dossier on the insurgents. There can be circumstances in which the general counsel could bring a favored outside lawyer to meet with the committee for an interview at the committee’s first meeting, or the general counsel could ask the company’s outside counsel to assist by gathering together materials that the newly formed committee considers as a possible part of its work (even though the committee may reserve judgment on whether to give any weight to the materials or simply reject them). Surely, there could be exigencies in which time simply cannot be lost on the luxury of a more leisurely process. That said, however, in the eyes of most reviewing courts, there is and should be a fundamental difference between a process in to which the general counsel provides input and resources, and a process that the general counsel designs, executes, and controls throughout. In the case described above, the committee did none of the things suggested, and the matter was eventually decided by a non-Delaware court without reference to the facts set forth above. Although the decision was a victory for the insurgents, it did not turn on the fact that the committee process was a sham, orchestrated, designed and run entirely by the inside general counsel and his friend the “committee’s” counsel, 59

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but instead on nuances of the law beyond the scope of this work. We would suggest, however, that if similar facts were presented to a Delaware court, or the courts of many other jurisdictions, the result may well have been a decision that the committee’s work was not entitled to respect or deference, given the fact that it was really not the committee’s work at all, but instead the work of conflicted insiders and their hand-picked advisors.45

G. COMPENSATION OF COMMITTEE MEMBERS As noted in Section C, “Case Study: The Thrust-Upon Conflict,” of this chapter, the compensation of members of the special committee is sometimes included in the resolutions forming the special committee (which we recommend). If this is not done in the committee’s charter, such matter should be considered promptly, following the formation of the special committee and its retention of advisors. The timing of dealing with the compensation issue is important in order to avoid any appearance that the compensation of the special committee was influenced by the result of its work, or was in any way contingent46 on the results of the committee’s work. Though many committees set about their work without giving any serious consideration to how they will be compensated and how much that compensation will be, experience strongly suggests that this is a mistake. Service on a special committee takes time and effort that is typically not consistent with normal board service. It is not at all unusual for committees, both forensic and transactional, to expect to meet a dozen or more times, often over the course of several months. Moreover, because it is the duty of the committee either to simulate arm’s-length bargaining or to investigate and address the facts, wherever they may lead, it is not at all uncommon for members of the committee to find themselves in difficult and often unpleasant situations. Put simply, if the job is done properly, it is difficult work and there is a lot of it. Focusing on fair compensation for this difficult job at the outset not only avoids post hoc attack in litigation, but also removes even the possibility of real, as opposed to merely perceived, attempts to influence the outcome of the committee’s work through control of the purse. Two primary means have been utilized to compensate special committees: fixed fees and per meeting fees. The size of the fixed fee is often a function of the size of the company and the potential transaction involved, as well as the expected amount of work facing the committee. One could reasonably expect to be paid less while serving on the special committee of a $10 million company negotiating a $1 million asset disposition than while serving on a committee formed by a $10 billion company negotiating a $1 billion transaction. Attempting to generalize from the pure compensation data is thus a somewhat flawed exercise, in part because the data is typically sorted by amount

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In one well known case, the court found that the fact that the parent’s “General Counsel suggested the name of appropriate legal counsel to the Special Committee, and that individual was promptly retained,” was an indicator that the special committee’s process was not to be trusted. Tremont, 694 A.2d at 429; see also Gesoff, 902 A.2d at 1151. In re Tele-Commc’ns, 2005 WL 3642727, at *4–5.

COMPENSATION OF COMMITTEE MEMBERS

paid, rather than by the particulars of the transactions (or investigations) involved. Nonetheless, we attach, in appendices to this chapter, a list of special committee assignments and publicly disclosed compensation for recent large transactions. For larger transactions involving larger companies, it is not at all uncommon to see fixed fees in the $50,000 range. Indeed, fees that are multiples of this amount are not so rare as to be outside custom and practice (depending, of course, upon the particular circumstances). One approach to gauging an appropriate fixed fee for a committee is to consider the total amount of compensation paid to board members annually by the company, and attempt to estimate the percentage of a full year’s work that the committee service might take. Thus, a committee that expects to do substantial work over the course of four to six months might negotiate to be paid one-third to one-half of a full year’s director’s fee. For better or worse, case law provides little guidance on this subject and tends to set boundary conditions rather than provide useful criteria for developing a fee structure. In one case, where a transactional committee was paid $1 million per director for one week of work and the fee was decided upon after the committee approved a transaction that provided for greater consideration to be paid to the class of stock held by the controlling stockholder, the court suggested that the committee had arguably compromised its independence.47 The second prevailing compensation structure for the special committee is payment on a per meeting basis. This may be most appropriate if the committee is not formed to consider a transaction, but instead is charged with conducting an investigation likely to involve many meetings and/or interviews. It is not unusual in such cases to compensate committee members with the same per meeting fee that they would otherwise be paid attending to the work of the standing committees of the board, assuming that such fees are paid. For many companies, per meeting fees of between $1,000 and $2,500 are not unusual. Of course, the investigative committee can also choose to negotiate to be compensated on a fixed-fee basis, and the ultimate decision on which structure to adopt is often as much a matter of the company’s custom and practice as anything else. In all events, however, settling upon an appropriate compensation structure and amount is best done at the outset of the special committee’s work, if not addressed in the resolutions forming the special committee.

47

In re Tele-Commc’ns, 2005 WL 3642727, at *4–5. 61

FORMING THE SPECIAL COMMITTEE

H. APPENDIX A: SAMPLE SPECIAL LITIGATION COMMITTEE CHARTER COMMITTEE CHARTER REGARDING SPECIAL LITIGATION COMMITTEE PROPOSED RESOLUTION OF THE BOARD OF DIRECTORS OF ____________________________________ ESTABLISHING A SPECIAL LITIGATION COMMITTEE WHEREAS, a lawsuit asserting certain derivative claims purportedly on behalf of _______________ (the “Corporation”) styled [INSERT SUIT CAPTION] has been filed in [INSERT COURT], and is pending as [INSERT CIVIL ACTION NUMBER] (the “Litigation”); and WHEREAS, the Board of Directors of the Corporation (the “Board”) has determined that it is desirable and in the best interests of the Corporation and its stockholders to form a special committee of the Board to investigate, review, and analyze the facts and circumstances surrounding the Litigation and determine what, if any, claims the Corporation may have in connection therewith and what action, if any, the Corporation should take with respect to any such claims. NOW, THEREFORE, BE IT RESOLVED, that pursuant to Section 141(c) of the General Corporation Law of the State of Delaware and Article __, Section __ of the [Bylaws] [Certificate of Incorporation] of the Corporation, as amended to date, the Board hereby establishes a special committee of the Board (the “Special Litigation Committee”); FURTHER RESOLVED, that _______________, _______________, and ____________ are hereby designated as members of the Special Litigation Committee, with the duties and powers granted to such Special Litigation Committee as hereinafter described; FURTHER RESOLVED, that the Board hereby determines that each of Messrs. __________, ___________, and ___________ is independent, is not a member of the Corporation’s management, and does not have an interest in the Litigation which would impair the ability of such individual to perform his/her duties on the Special Litigation Committee; FURTHER RESOLVED, that the Special Litigation Committee be, and hereby is, authorized and empowered to investigate all matters related to the Litigation, review and evaluate the findings of such investigation, and take all actions as the Special Litigation Committee deems appropriate and in the best interests of the Corporation with respect thereto, including, without limitation, prosecution, control, and supervision of the Litigation by the Corporation including, if determined to be appropriate, its settlement; FURTHER RESOLVED, that (i) the Special Litigation Committee be, and hereby is, authorized and empowered to exercise all of the powers of the Board with respect to the authority granted herein, including, without limitation, the powers (a) to retain, at the Corporation’s expense, any independent advisors that are acceptable to the Special Litigation Committee in its sole discretion, including legal counsel, as it deems necessary or desirable to assist and advise it in connection with the investigation or the Litigation; and (b) to enter into such arrangements providing for the retention, compensation, reimbursement of expenses, and indemnification of such persons as the 62

APPENDIX A: SAMPLE SPECIAL COMMITTEE CHARTER

Special Litigation Committee determines to be necessary, appropriate, or advisable, thereby obligating the Corporation to pay all fees, expenses, and disbursements and to honor all other obligations of the Corporation under such contracts; (ii) the Corporation be, and hereby is, authorized and directed to pay all fees, expenses, and disbursements of such counsel, consultants, agents, and advisors on presentation of statements approved by the Special Litigation Committee, subject to any applicable insurance policies; and (iii) the Special Litigation Committee be, and hereby is, authorized and empowered to take any and all actions necessary or convenient to effect the foregoing; FURTHER RESOLVED, that the determinations made by the Special Litigation Committee shall be final and binding upon the Corporation and shall not be subject to review or approval by the Board; FURTHER RESOLVED, that the directors, officers, agents, and employees of the Corporation be, and hereby are, directed to assist the Special Litigation Committee and to provide it with all information and documents it requests; FURTHER RESOLVED, that the directors, officers, agents, and employees of the Corporation be, and hereby are, directed to (a) maintain and safeguard all documents that are potentially relevant to the Litigation; and (b) not dispose of or destroy any such documents, whether pursuant to ordinary procedures for document retention/ destruction or otherwise. In this regard, the term “document” should be interpreted broadly to include, without limitation, all original documents, non-identical copies (i.e., copies bearing notes), handwritten notes, drafts, emails, and all other documents stored electronically; FURTHER RESOLVED, that, in accordance with the Certificate of Incorporation and Bylaws of the Corporation, in each case as amended to date, the Corporation, to the fullest extent permitted by law, shall indemnify, hold harmless, and advance expenses to each member of the Special Litigation Committee; [FURTHER RESOLVED, that the members of the Special Litigation Committee, in view of the duties and burdens imposed herein and the amount of time the proper discharge these duties will require, shall be compensated for their services as members of the Special Litigation Committee at a rate of (1) $[INSERT] per in-person meeting of the Special Litigation Committee and/or each day during which a member spends a material portion of the day on the business of the Special Litigation Committee; (2) $[INSERT] per telephonic, video-conference, or other electronically held meeting of the Special Litigation Committee; and (3) in all cases, each member’s out-of-pocket expenses]; and FURTHER RESOLVED, that the Special Litigation Committee, be and hereby is, authorized, empowered, and directed to do and perform, or cause to be done and performed, all such acts and things and to sign and deliver or cause to be signed and delivered, all such documents, certificates, and other instruments, and to take all such other actions as are necessary, advisable, or appropriate in order to effectuate the purpose and intent of the foregoing resolutions.

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I. APPENDIX B: SAMPLE INVESTIGATORY SPECIAL COMMITTEE CHARTER COMMITTEE CHARTER REGARDING STOCKHOLDER DEMAND PROPOSED RESOLUTIONS OF THE BOARD OF DIRECTORS OF ____________________________ ESTABLISHING A SPECIAL COMMITTEE WHEREAS, the Board of Directors (the “Board”) of ___________, a Delaware corporation (the “Corporation”) has received [a letter dated ________________, from _______________, a purported stockholder of the Corporation, which letter makes certain demands upon the Board (the “Demand”)]; WHEREAS, the Demand requests that the Board [initiate litigation against certain persons identified therein in connection with _______________________]; WHEREAS, the Board has considered the Demand and determined that it is in the best interests of the corporation to appoint a special committee to investigate, review, and analyze the facts, circumstances, and issues discussed in the Demand and to recommend to the Board whether or not [litigation against such persons identified in the Demand] is in the best interests of the corporation; and WHEREAS, the Board has determined that ______, ________, and __________ are eligible to serve as members of such special committee because [INSERT REASONS], and that their appointment to serve as members of such special committee is in the best interests of the Corporation. NOW, THEREFORE, BE IT RESOLVED, pursuant to Section 141(c) of the General Corporation Law of the State of Delaware and Article ___, Section ___ of the [Bylaws] [Certificate of Incorporation] of the Corporation, that the Board does hereby create, constitute, and appoint a special committee of the Board (the “Committee”) to investigate, review, and analyze the facts, circumstances, and issues discussed in the Demand, and does appoint ________, ________, and _________ as members of the Committee, with the duties and powers hereinafter described; FURTHER RESOLVED, that the Board delegates to the Committee the power and authority to consider whether or not litigation against one or more persons identified in the Demand with respect to the matters discussed in the Demand is in the best interests of the Corporation, and to recommend to the Board what action the Corporation should take with respect thereto; FURTHER RESOLVED, that the Committee is hereby authorized and empowered to retain and compensate at the Corporation’s sole expense such experts and advisers, including without limitation independent legal counsel, as the Committee shall deem necessary or desirable in order to assist it in the discharge of its responsibilities; FURTHER RESOLVED, that upon completion of its investigation, the Committee shall make a report to the Board stating the Committee’s recommendation whether [litigation against one or more persons identified in the Demand] would be in the best interests of the Corporation, together with the facts, circumstances, and other bases supporting the Committee’s recommendation of any action (including without limitation the commencement of litigation) that the Committee may believe to be in the best interests of the Corporation; 64

APPENDIX B: SAMPLE INVESTIGATORY SPECIAL COMMITTEE CHARTER

FURTHER RESOLVED, that the Committee is hereby authorized and directed to continue in existence until such time as the Committee shall recommend its dissolution to the Board; [FURTHER RESOLVED, that in the event the Committee determines in its sole discretion that the power and authority delegated to the Committee by these resolutions is insufficient in any respect to permit the Committee to investigate, review, and analyze the issues described in the Demand, the Committee shall submit to the Board a request for an expansion of its power and authority;] FURTHER RESOLVED, that the directors, officers, agents, and employees of the Corporation, and each of them are hereby authorized and directed to assist the Committee in the discharge of its responsibilities and are further authorized and directed to provide the Committee with all information and materials, including without limitation any books, records, projections, and financial statements of the corporation and any documents, reports, or studies pertaining to the issues described in the Demand, that the Committee or any member thereof may request in furtherance of its responsibilities; FURTHER RESOLVED, that the Committee, and each member thereof, is hereby authorized and empowered to do all acts as may be necessary or appropriate in its, his, or her judgment to carry out the duties of the Committee contemplated by these resolutions; FURTHER RESOLVED, that the officers of the Corporation are hereby authorized, and directed to take all such further action and to prepare, execute, acknowledge, file, deliver, and record all such further documents and instruments by and on behalf of the Corporation, and in its name, or otherwise, as in the judgment of the Committee shall be necessary, appropriate, or advisable in order fully to carry out the intent and to accomplish the execution of the purposes of the foregoing resolutions; FURTHER RESOLVED, that, in accordance with the Certificate of Incorporation and Bylaws of the Corporation, in each case as amended to date, the Corporation, to the fullest extent permitted by law, shall indemnify, hold harmless, and advance expenses to each member of the Committee; [FURTHER RESOLVED, that each member of the Committee shall be paid $[] [per month] [per meeting] for the services contemplated hereby]; and FURTHER RESOLVED, that any and all actions heretofore taken by the officers of the Corporation, or any of them, with respect to and in contemplation of, the transactions authorized by any of the foregoing resolutions, are hereby authorized, approved, ratified, and confirmed.

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J. APPENDIX C: SAMPLE NEGOTIATING SPECIAL COMMITTEE CHARTER PROPOSED RESOLUTIONS TO ESTABLISH NEGOTIATING COMMITTEE PROPOSED RESOLUTIONS OF THE BOARD OF DIRECTORS OF ____________________________ ESTABLISHING A SPECIAL COMMITTEE WHEREAS, the Board of Directors of __________________, a Delaware corporation (the “Corporation”), is considering a strategic transaction with [Controlling Stockholder] (“_______________”) [on the terms and conditions set forth in an offer submitted by [Controlling Stockholder] (as such terms and conditions may be modified prior to the final determination with respect thereto by the Special Committee of the Board of Directors established hereby, the “Proposed Transaction”)]; WHEREAS, [Controlling Stockholder] owns approximately ___percent of the Corporation’s [outstanding capital stock]; WHEREAS, ________and _______________ are directors and officers of the Corporation and also are [officers] of [Controlling Stockholder] and/or its affiliates and may, as a result thereof, be deemed to have an interest in the Proposed Transaction; WHEREAS, ____________________ is a director and an officer of the Corporation; and WHEREAS, the Board of Directors (the “Board”) wishes to establish a special committee of the Board consisting of directors who are not directly or indirectly affiliated with [Controlling Stockholder] and who are not members of the Corporation’s management to review and evaluate the Proposed Transaction and to take such other action with respect to the Proposed Transaction as shall be authorized in the following resolutions. NOW, THEREFORE, BE IT RESOLVED, that pursuant to Section 141(c) of the General Corporation Law of the State of Delaware and Article ___, Section _____ of the [Bylaws] [Certificate of Incorporation] of the Corporation, the Board hereby establishes a special committee of the Board (the “Special Committee”); FURTHER RESOLVED, that ___________, ________________, _____________, and ___________ are hereby designated as the members of the Special Committee, with the duties and powers granted to such Special Committee as hereinafter described; FURTHER RESOLVED, that the Board hereby delegates to the Special Committee the exclusive power and authority (1) to review and to evaluate the terms and conditions, and determine the advisability of the Proposed Transaction and any alternative thereto; (2) to negotiate with [Controlling Stockholder] or any other party the Special Committee deems appropriate with respect to the terms and conditions of the Proposed Transaction or any alternative thereto and, if the Special Committee deems appropriate, but subject to the limitations of applicable law, approve the execution and delivery of documents setting forth the Proposed Transaction or any alternative transaction on behalf of the Corporation; (3) to determine whether the Proposed Transaction or any alternative thereto negotiated by the Special Committee is fair to, and in the best 66

APPENDIX C: SAMPLE NEGOTIATING SPECIAL COMMITTEE CHARTER

interests of, the Corporation and all of its stockholders (other than [Controlling Stockholder]); and (4) to recommend to the full Board what action, if any, should be taken by the Board with respect to the Proposed Transaction or any alternative thereto; FURTHER RESOLVED, that the Board shall not recommend the Proposed Transaction or alternative thereto for approval by the Corporation’s stockholders or otherwise approve the Proposed Transaction or any alternative thereto without a prior favorable recommendation of the Proposed Transaction by the Special Committee; FURTHER RESOLVED, that the Special Committee is hereby authorized and empowered to retain independent legal counsel to advise it and assist it in connection with fulfilling its duties as delegated by the Board; FURTHER RESOLVED, that the Special Committee is hereby authorized and empowered to retain such other consultants and agents, including, without limitation, independent investment bankers, as the Special Committee may deem necessary or appropriate to perform such services and render such opinions as may be necessary or appropriate in order for the Special Committee to discharge its duties; FURTHER RESOLVED, that the Special Committee is hereby authorized and empowered to enter into such contracts providing for the retention, compensation, reimbursement of expenses, and indemnification of such legal counsel, investment bankers, consultants, and agents as the Special Committee may deem necessary or appropriate, and that the Corporation is hereby authorized and directed to pay all fees, expenses, and disbursements of such legal counsel, investment bankers, consultants, and agents on presentation of statements approved by the Special Committee, and that the Corporation shall pay all fees, expenses, and disbursements of such legal counsel, investment bankers, consultants, and agents and shall honor all other obligations of the Corporation under such contracts; FURTHER RESOLVED, that the officers of the Corporation are hereby directed to provide to the Special Committee, each member thereof, and any of their advisers, agents, counsel, and designees, such information and materials, including, without limitation, the books, records, projections, and financial statements of the Corporation and any documents, reports or studies pertaining to the Proposed Transaction or any alternative thereto as may be useful or helpful in the discharge of the Special Committee’s duties or as may be determined by the Special Committee, or any member thereof, to be appropriate or advisable in connection with the discharge of the duties of the Special Committee and each of its members; FURTHER RESOLVED, that the Special Committee is authorized to solicit the views of the Corporation’s executive officers regarding the terms and conditions of the Proposed Transaction or any alternative thereto to assist the Committee in its review and evaluation of such terms and conditions, including the views of the executive officers on any reports, studies, or similar information pertaining to the Proposed Transaction or any alternative thereto prepared or submitted to the Special Committee by [Controlling Stockholder]or any other person, or its investment bankers, consultants, and other agents and, as appropriate, any reports, studies, or similar information prepared by the Special Committee’s investment bankers, consultants, and other agents; 67

FORMING THE SPECIAL COMMITTEE

FURTHER RESOLVED, that the Special Committee, and each member thereof, is hereby authorized and empowered to do all acts as may be necessary or appropriate in its, his, or her judgment to carry out the duties of the Special Committee contemplated by these resolutions; FURTHER RESOLVED, that the officers of the Corporation are hereby authorized and directed to take all such further action and to prepare, execute, acknowledge, file, deliver and record all such further documents and instruments by and on behalf of the Corporation, and in its name, or otherwise, as in the judgment of the Special Committee shall be necessary, appropriate or advisable in order fully to carry out the intent and to accomplish the execution of the purposes of the foregoing resolutions; FURTHER RESOLVED, that, in accordance with the [Certificate of Incorporation and Bylaws] of the Corporation, each member of the Special Committee is hereby indemnified and held harmless by the Corporation and its successors and assigns to the fullest extent permitted by any applicable law; FURTHER RESOLVED, that each member of the Special Committee shall be paid [$______] per member for the services contemplated hereby; provided, however, if the Special Committee is still in existence and participating in the activities contemplated hereby [________] from the date hereof, then each member of the Special Committee shall receive [$_____] per month beginning with the first month following the [____] anniversary of the date hereof; and FURTHER RESOLVED, that any and all actions heretofore taken by the officers of the Corporation, or any of them, with respect to and in contemplation of, the transactions authorized by any of the foregoing resolutions, are hereby authorized, approved, ratified, and confirmed.

68

APPENDIX D: SAMPLE CONFLICT TRANSACTION SPECIAL COMMITTEE CHARTER

K. APPENDIX D: SAMPLE CONFLICT TRANSACTION SPECIAL COMMITTEE CHARTER COMMITTEE CHARTER REGARDING SALE TRANSACTION PROPOSED RESOLUTIONS OF THE BOARD OF DIRECTORS OF ___________________________ ESTABLISHING THE SPECIAL COMMITTEE WHEREAS, the Board of Directors (the “Board”) of ______________, a Delaware corporation (the “Corporation”), is considering a potential transaction (a “Potential Transaction”) between the Corporation and a third-party (a “Potential Acquirer”) and the Corporation’s alternatives thereto; WHEREAS, certain directors and officers of the Corporation and/or its affiliates may be deemed to have interests in a Potential Transaction that are different from, or in addition to, the interests of the Corporation’s stockholders generally; and WHEREAS, the Board wishes to establish a special committee of the Board consisting of directors who are independent, who are not members of the Corporation’s management, and who do not have an interest in any Potential Transaction that is different from, or in addition to, the interests of the Corporation’s stockholders generally, to review and evaluate any Potential Transaction and the Corporation’s other strategic alternatives, and to take such other action with respect thereto as shall be authorized in the following resolutions. NOW, THEREFORE, BE IT RESOLVED, that pursuant to Section 141(c) of the General Corporation Law of the State of Delaware and Article ___, Section __ of the [Bylaws] [Certificate of Incorporation] of the Corporation, as amended to date, the Board hereby establishes a special committee of the Board (the “Special Committee”); FURTHER RESOLVED, that ______________, ______________, and ___________ are hereby designated as the members of the Special Committee, with the duties and powers granted to such Special Committee as hereinafter described; FURTHER RESOLVED, that the Board hereby determines that each of Messrs. ________, ________, and ________ is independent, is not a member of the Corporation’s management, and does not have an interest in any Potential Transaction that is different from, or in addition to, the interests of the Corporation’s stockholders generally; FURTHER RESOLVED, that the Board hereby delegates to the Special Committee the exclusive power and authority (1) to review and to evaluate the terms and conditions, and to determine the advisability of, any Potential Transaction and any alternative thereto; (2) to negotiate with any Potential Acquirer (or any other party the Special Committee deems appropriate) with respect to the terms and conditions of any Potential Transaction or any alternative thereto and, if the Special Committee deems appropriate, but subject to the limitations of applicable law, approve the execution and delivery of documents in connection with any Potential Transaction or any alternative transaction on behalf of the Corporation; (3) to determine whether a Potential Transaction or any alternative thereto negotiated by the Special Committee is fair to, and in the best interests of, the Corporation and its stockholders; and (4) to recommend to the full 69

FORMING THE SPECIAL COMMITTEE

Board what action, if any, should be taken by the Board with respect to a Potential Transaction or any alternative thereto; FURTHER RESOLVED, that the Board shall not approve a Potential Transaction or any alternative thereto, or recommend a Potential Transaction or any alternative thereto for approval by the Corporation’s stockholders, without a prior favorable recommendation of the Potential Transaction or any such alternative by the Special Committee; FURTHER RESOLVED, that the Special Committee is hereby authorized and empowered to retain independent legal counsel to advise it and assist it in connection with fulfilling its duties as delegated by the Board; FURTHER RESOLVED, that the Special Committee is hereby authorized and empowered to retain such other consultants and agents, including, without limitation, independent investment bankers, as the Special Committee may deem necessary or appropriate to advise it and assist it in connection with fulfilling its duties as delegated by the Board and to perform such services and render such opinions as may be necessary or appropriate in order for the Special Committee to discharge such duties; FURTHER RESOLVED, that the Special Committee is hereby authorized and empowered to enter into such contracts providing for the retention, compensation, reimbursement of expenses, and indemnification of such legal counsel, investment bankers, consultants, and agents as the Special Committee may in its sole discretion deem necessary or appropriate, and that the Corporation is hereby authorized and directed to pay all fees, expenses, and disbursements of such legal counsel, investment bankers, consultants, and agents on presentation of statements approved by the Special Committee, and that the Corporation shall pay all fees, expenses, and disbursements of such legal counsel, investment bankers, consultants, and agents and shall honor all other obligations of the Corporation under such contracts; and any such contract entered into by the Special Committee is hereby approved, adopted, confirmed, and ratified, and, to the extent necessary or advisable, the officers of the Corporation are hereby authorized and directed to execute any such contract, for and on behalf of the Corporation, and the execution thereby by any such officer shall constitute approval thereof by the Board and shall represent the Corporation’s acknowledgment and acceptance of the terms and conditions thereof; FURTHER RESOLVED, that the officers of the Corporation are hereby directed to provide to the Special Committee, each member thereof, and any of their advisers, agents, counsel, and designees, such information and materials, including, without limitation, the books, records, projections, and financial statements of the Corporation and any documents, reports or studies pertaining to a Potential Transaction or any alternative thereto as may be useful or helpful in the discharge of the Special Committee’s duties or as may be determined by the Special Committee, or any member thereof, to be appropriate or advisable in connection with the discharge of the duties of the Special Committee and each of its members; FURTHER RESOLVED, that the Special Committee is authorized to solicit the views of the Corporation’s executive, financial, and other officers regarding the terms and conditions of any Potential Transaction or any alternative thereto to assist the Special Committee in its review and evaluation of such terms and conditions, including 70

APPENDIX D: SAMPLE CONFLICT TRANSACTION SPECIAL COMMITTEE CHARTER

the views of such officers on any reports, studies, or similar information pertaining to any Potential Transaction or any alternative thereto prepared or submitted to the Special Committee by its investment bankers, consultants, and other agents; FURTHER RESOLVED, that the Special Committee, and each member thereof, is hereby authorized and empowered to do all acts as may be necessary or appropriate in its, his, or her judgment to carry out the duties of the Special Committee contemplated by these resolutions; FURTHER RESOLVED, that the officers of the Corporation are hereby authorized and directed to take all such further action and to prepare, execute, acknowledge, file, deliver, and record all such further documents and instruments by and on behalf of the Corporation, and in its name, or otherwise, as in the judgment of the Special Committee shall be necessary, appropriate, or advisable in order fully to carry out the intent and to accomplish the execution of the purposes of the foregoing resolutions; FURTHER RESOLVED, that, in accordance with the Certificate of Incorporation and Bylaws of the Corporation, in each case as amended to date, the Corporation, to the fullest extent permitted by law, shall indemnify, hold harmless, and advance expenses to each member of the Special Committee; [FURTHER RESOLVED, that each member of the Special Committee shall be paid $[] [per month] [per meeting] for the services contemplated hereby]; and FURTHER RESOLVED, that any and all actions heretofore taken by the officers of the Corporation, or any of them, with respect to and in contemplation of, the transactions authorized by any of the foregoing resolutions, are hereby authorized, approved, ratified, and confirmed.

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L. APPENDIX E: SAMPLE SPECIAL COMMITTEE GUIDELINES AND PROCEDURES PROCEDURES TO SUPPLEMENT BOARD DELEGATION *** GUIDELINES AND PROCEDURES OF THE SPECIAL COMMITTEE OF THE BOARD OF DIRECTORS OF ________________________________ Section 1.1. Meetings. Meetings of the Special Committee for any purpose or purposes may be called at any time by the Chairman of the Special Committee (the “Chairman”) or by a majority of the members of the Special Committee. Section 1.2. Notice of Meetings; Waiver of Notice. Notice of any meeting of the Special Committee may be provided in person, by telephone, by facsimile, or by other means of electronic transmission, and shall be delivered to each member of the Special Committee not less than 24 hours before the start of the meeting. Any member of the Special Committee may waive notice of the meeting, either before or after the time stated therein, and such waiver shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at nor the purpose of any regular or special meeting of the Special Committee need be specified in a waiver of notice. Section 1.3. Quorum; Adjournment. Except as otherwise provided, at each meeting of the Special Committee the presence in person of a majority of the members of the Special Committee shall be necessary and sufficient to constitute a quorum. Any meeting may be adjourned from time to time by the vote of a majority of those present. Section 1.4. Organization. Meetings of the Special Committee shall be presided over by the Chairman, or in his or her absence, by a member of the Special Committee elected by the members of Special Committee present at the meeting, at which a quorum is present. The person presiding over the meeting may appoint any person to act as secretary of the meeting. Section 1.5. Voting. At all meetings of the Special Committee at which a quorum is present, the vote of a majority of the members of the Special Committee present at the meeting shall constitute the act of the Special Committee. Section 1.6. Action By Unanimous Consent of the Members of the Special Committee. Any action required or permitted to be taken at any meeting of the Special Committee may be taken without a meeting, without prior notice, and without a vote, if a consent or consents in writing or electronic transmission, setting forth the action so taken, shall be signed or executed by all the members of the Special Committee. Section 1.7. Telephonic Meetings Permitted. Members of the Special Committee may participate in a meeting thereof by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can 72

APPENDIX E: SAMPLE SPECIAL COMMITTEE GUIDELINES AND PROCEDURES

hear each other, and participation in a meeting pursuant to these Guidelines and Procedures shall be deemed to constitute presence in person at such meeting. Section 1.8. Form of Records. Any records maintained by the Special Committee in the regular course of its business may be kept on, or by means of, or be in the form of, any information storage device or method, provided that the records so kept can be converted into clearly legible paper form within a reasonable time. The Chairman shall arrange for the minutes of each meeting of the Special Committee to be duly recorded in the minute book of the Special Committee. Section 1.9. Amendment of Guidelines and Procedures. These Guidelines and Procedures may be altered, amended, or repealed, and new Guidelines and Procedures made, by the members of the Special Committee. To the extent any provision of these Guidelines and Procedures is inconsistent with any guideline, procedure, rule, or regulation imposed upon the operations of the Special Committee by the Board of Directors, such guideline, procedure, rule, or regulation mandated by the Board of Directors shall control and shall have the same effect as an amendment to any such provision of these Guidelines and Procedures.

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M. APPENDIX F: RECENT SPECIAL COMMITTEE FEES48

Target Name

Acquirer Name

Pacific Energy Partners, L.P.

Merger Agreement Date

Fee Description

6/11/2006

Encore Medical Corporation

Plains All $887.02 American Pipeline, L.P. The Blackstone $465.08 Group

PETCO Animal Supplies, Inc.

Investment Group

$1,657.63

7/13/2006

$816.13

7/21/2006

$325.04

7/23/2006

Chairman received $50,000 and each other committee member received $40,000. Each committee member received a retainer of $5,000 per month. The Chairman received a retainer of $6,000. Each committee member received $2,500 for each in person meeting and $1,500 for each telephonic meeting. Each committee member received $25,000. Chairman received $100,000 and each other committee member received $50,000.

$20,811.15

7/24/2006

NCO Group, Inc. Managementled Buyout Newkirk Realty Lexington Trust, Inc. Corporate Properties Trust HCA Inc. Investment Group Featherlite, Inc.

Venture Catalyst Incorporated

Kinder Morgan, Inc.

48

74

Transaction Value (in millions)

6/30/2006

Universal $71.89 Trailer Holdings Corp. International $18.63 Game Technology

7/26/2006

Managementled Buyout

8/28/2006

$14,365.16

8/25/2006

Chairman received $100,000 and each other committee member received $60,000. Chairman received $40,000 and each other committee member received $25,000. Each committee member received $5,000 for 40 hours of service and $100 per hour of service beyond the initial 40 hours. Chairman received a cash retainer of $250,000 and each other committee member received a cash retainer of $125,000. Each committee member received $2,000 for each in person meeting and $1,000 for each telephonic meeting.

Information contained within this appendix was drawn from www.sharkrepellent.net.

APPENDIX F: RECENT SPECIAL COMMITTEE FEES

Metrologic Instruments, Inc.

Managementled Buyout

$215.67

9/12/2006

Cornell Companies, Inc.

Veritas Capital

$256.02

10/6/2006

Clark, Inc.

AEGON N.V.

$303.98

11/1/2006

Netsmart Technologies, Inc. Gold Kist Inc.

Investment Group

$108.04

11/18/2006

Pilgrim’s Pride $1,071.77 Corporation

12/3/2006

Rotonics Manufacturing Inc. Realogy Corporation

Managementled Buyout

$26.55

12/12/2006

Apollo Management, L.P. Investment Group

$6,431.27

12/15/2006

$16,723.66

12/19/2006

Welsh, Carson, Anderson & Stowe

$1,387.97

1/7/2007

Each committee member received $75,000.

Managementled Buyout

$1,721.80

1/19/2007

Managementled Buyout

$343.8

1/28/2007

Investment Group

$17.79

2/6/2007

Chairman received $100,000 and each other committee member received $40,000. Each committee member received a retainer of $20,000 and $2,600 for each committee meeting attended. Chairman received $10,000 and each other committee member received $5,000. In addition, each committee member received $1,000 for each meeting attended in person and $500 for each meeting attended telephonically.

Harrah’s Entertainment, Inc. United Surgical Partners International, Inc. Swift Transportation Co., Inc. Educate, Inc.

Wellco Enterprises, Inc.

Chairman received a retainer of $40,000 and each other committee member received a retainer of $35,000. Each committee member received $2,000 for each meeting of the special committee attended. Chairman received a $15,000 retainer, and each other committee member received a $10,000 retainer. Each committee member received $2,000 for each meeting of the committee attended (in person or telephonically). Chairman received $60,000. Each committee member received $1,500 per meeting. Chairman received $60,000. Each other committee member received $50,000. Each committee member received approximately $7,506. Chairman received $100,000 and each other committee member received $75,000. Each committee member received $6,000 per meeting.

(continued)

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FORMING THE SPECIAL COMMITTEE

Target Name

Acquirer Name

Transaction Value (in millions)

Merger Agreement Date

Free Description

Lear Corporation American Real $2,393.58 Estate Partners, L.P. Station Casinos, Management- $4,121.81 Inc. led Buyout

2/9/2007

Kronos Incorporated

Each committee member received $2,500 per meeting attended. Chairman received $90,000 and each other committee member received $60,000. Chairman received $50,000 and each other committee member received $25,000. Each committee member received $1,000 per meeting attended.

2/23/2007

Hellman & Friedman, L.L.C. Inland American Real Estate Trust, Inc. Agilent Technologies, Inc.

$1,741.56

3/22/2007

$441.22

4/2/2007

$245.65

4/5/2007

Catalina Marketing Corporation

Hellman & Friedman, L.L.C.

$1,511.47

4/17/2007

Symbion, Inc.

Crestview Partners, L.P.

$487.88

4/24/2007

Covansys Corporation

Computer Sciences Corporation Managementled Buyout

$1,237.10

4/25/2007

$8,234.66

5/2/2007

Each committee member received $30,000 per month.

Pearson PLC

$503.76

5/14/2007

Acxiom Corporation

Investment Group

$1,825.97

5/16/2007

EGL, Inc.

Apollo Management, L.P.

$2,207.71

5/24/2007

CKX, Inc.

Managementled Buyout

$746.11

6/1/2007

Each committee member “received customary compensation.” The Chairman received $30,000 and each other committee member received $15,000, for the first 30day period of service on the committee. Chairman received $75,000 and each other committee member received $25,000. Each committee member received $1,500 per meeting attended. Members of the committee received in the aggregate a minimum of $50,000.

Winston Hotels, Inc.

Stratagene Corporation

Cablevision Systems Corporation eCollege.com

76

Chairman received $33,000 and each other committee member received $23,000. In addition, each committee member received $500 for each meeting attended. Committee members received, in the aggregate, $108,250, and the Chairman received an additional $10,000. Chairman received $54,936. Each other committee member received $29,936. Each committee member received $50,000.

APPENDIX F: RECENT SPECIAL COMMITTEE FEES

Laureate Education Inc.

Managementled Buyout

$3,215.04

6/3/2007

Biomet, Inc.

Investment Group

$11,308.47

6/7/2007

Back Yard Burgers, Inc.

Cherokee $33.32 Advisors, L.L.C. James River The D. E. Shaw $522.2 Group, Inc. Group Nuveen Investment $5,163.86 Investments, Inc. Group

6/10/2007

Reddy Ice Holdings, Inc. New Brunswick Scientific Co., Inc.

GSO Capital Partners, L.P. Eppendorf AG

$681.54

7/2/2007

$106.31

7/10/2007

Keystone Automotive Industries, Inc. Cumulus Media Inc.

LKQ Corporation

$795.15

7/16/2007

Managementled Buyout

$467.48

7/23/2007

6/11/2007 6/19/2007

Chairman received a monthly rate of $40,000 for months where special committee duties exceed 100 hours, $30,000 for months where special committee duties are between 50 and 100 hours and $20,000 for months in which special committee duties are less than 50 hours. Each other committee member received $30,000 for months where special committee duties exceed 100 hours, $22,500 for months where special committee duties are between 50 and 100 hours and $15,000 for months where special committee duties are less than 50 hours. Committee members received $5,000 per quarter, as well as $1,800 per in-person meeting and $1,200 per telephonic meeting. Committee members also received a one-time payment of $5,000. Chairman received $25,000 and each other committee member received $18,000. Committee members received $500 per meeting. Each committee member received $2,500 for each day that such member attended a full day meeting or otherwise devoted substantial time to special committee matters. Committee members did not receive any additional fees. Chairman received $3,500 in 2006 and $7,000 in 2007. In addition, each committee member received $800 per meeting attended. Chairman received $50,000 and each other committee member received $25,000. Each committee member received $1,500 per meeting attended (in person or telephonically). (continued) 77

FORMING THE SPECIAL COMMITTEE

Target Name

Acquirer Name

Transaction Value (in millions)

Merger Agreement Date

Free Description

MarkWest Hydrocarbon, Inc.

MarkWest Energy Partners, L.P.

$733.51

9/5/2007

Claymont Steel Holdings, Inc. Bright Horizons Family Solutions, Inc. Quadra Realty Trust, Inc.

Evraz Group S.A. Bain Capital

$412.82

12/9/2007

$1,268.10

1/14/2008

Hypo Real Estate Holding AG WebMD Health Corp.

$178.9

1/28/2008

$2,305.90

2/20/2008

Wendy’s International, Inc. World Waste Technologies, Inc.

Triarc $2,340.71 Companies, Inc. Vertex Energy, $1.93 Inc.

4/23/2008

Tercica, Inc.

Ipsen, S.A.

$266.33

6/4/2008

Applera Corporation - Applied Biosystems Group Landry’s Restaurants, Inc.

Invitrogen Corporation

$6,417.85

6/11/2008

Chairman received a monthly fee of $31,250 (with an aggregate maximum of $125,000) and each other committee member received a monthly fee of $25,000 (each with an aggregate maximum of $100,000). In addition, committee members received $1,000 per meeting attended. Each committee member received $25,000. Chairman received $125,000 and each other committee member received $100,000. Chairman received $90,000 and each other committee member received $50,000. Chairman received $75,000 and each other committee member received $50,000. Chairman received $75,000 and each other committee member received $50,000. Each committee member received $5,000 per month (for up to 6 months) and an option to acquire up to 300,000 shares of common stock of the Company. The Chairman received $32,500 and the other committee member received $19,500. Each committee member received $1,500 per meeting attended.

Management Led Buyout

$132.95

6/16/2008

APP Pharmaceuticals, Inc. Meadow Valley Corporation

Fresenius SE

$4,652.19

7/6/2008

Insight Equity

$58.26

7/28/2008

HLTH Corporation

78

5/19/2008

Chairman received $60,000, and each other committee member received $50,000. Each committee member received $50,000. Chairman received $65,000 per year and each other committee member received $40,000 per year.

APPENDIX F: RECENT SPECIAL COMMITTEE FEES

Prescient Applied Park City Intelligence, Inc. Group, Inc.

$1.83

8/28/2008

UST Inc.

$10,256.34

9/7/2008

$52.46

9/18/2008

Omrix Biopharmaceuticals, Inc. Smith Investment A.O. Smith Company Corporation

$428.26

11/23/2008

$323.05

12/9/2008

Tarrant Apparel Group

Managementled Buyout

$15.18

2/26/2009

En Pointe Technologies, Inc. NationsHealth, Inc.

ManagementLed Buyout

$12.96

3/11/2009

The ComVest Group

$3.37

4/30/2009

Pomeroy IT Solutions, Inc. Hiland Partners, LP

Management Led Buyout HH GP Holding, L.L.C. WebMD Health Corp.

$46.35

5/19/2009

$39.66

6/1/2009

$1,288.56

6/17/2009

Hirsch International Corp.

Managementled Buyout

$2.72

7/2/2009

Life Sciences Research, Inc.

Managementled Buyout

$93.61

7/8/2009

Centerplate, Inc.

HLTH Corporation

Altria Group, Inc. Kohlberg & Company, L.L.C. Johnson & Johnson

Special committee and board fees and expenses were $25,000. Each committee member received $125,000. The sole committee member received $100,000. Chairman received $50,000 and each other committee member received $25,000. Chairman received $30,000 plus $750 per meeting attended. The other committee member received $1,500 per day worked plus $500 per meeting attended. Each Co-Chairman received $100,000 and each other committee member received $80,000. Each Co-Chairman received $2,000 per meeting attended and each other committee member received $1,500 per meeting attended. Each committee member received $60,000. Each committee member received $25,000 for each of 2008 and 2009. Each committee member received $8,000 per month. Each committee member received $30,000. Chairman received $70,000. The other committee member received $50,000. Chairman received $26,500. The other committee members received $23,000 and $22,000, respectively. Each committee member received $50,000, as well as an additional $2,000 per meeting attended in person and $1,000 per meeting attended telephonically. (continued)

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FORMING THE SPECIAL COMMITTEE

Target Name

Acquirer Name

Transaction Value (in millions)

Merger Agreement Date

Free Description

PepsiAmericas, Inc.

PepsiCo, Inc.

$1,999.67

8/3/2009

The Pepsi Bottling Group, Inc.

PepsiCo, Inc.

$5,283.31

8/3/2009

Hi-Shear Technology Corporation

Chemring Group PLC

$131.05

9/16/2009

$279.68

9/23/2009

Chairman received a retainer of $15,000. Each other committee member received a retainer of $5,000. All committee members received $1,000 per meeting. Chairman received a retainer of $35,000. Each other committee member received a retainer of $20,000. Each committee member received $1,500 per meeting attended. Chairman received $2,500 and each committee member received $2,000 for each meeting attended in person. Chairman received $2,000 and each committee member received $1,500 for each meeting attended telephonically. Chairman received a special payment of $50,000 and each other committee member received a special payment of $25,000. Chairman received an upfront retainer of $50,000 and each other committee member received an upfront retainer of $25,000. Chairman received a quarterly retainer of $25,000 and each other committee member received a quarterly retainer of $15,000. Chairman received a $65,000 retainer, Vice Chairman received a $45,000 retainer and each other committee member received a $25,000 retainer. Chairman received $25,000 per month and each other committee member received $20,000 per month. Each committee member received $10,000.

SkyTerra Harbinger Communications, Capital Inc. Partners

American Community Properties Trust

Federal Capital $40.53 Partners

9/25/2009

Affiliated Computer Services, Inc.

Xerox Corporation

$6,462.29

9/27/2009

Franklin Electronic Publishers, Incorporated

Managementled Buyout

$12.5

9/30/2009

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APPENDIX F: RECENT SPECIAL COMMITTEE FEES

Allion Healthcare, Inc.

H.I.G. Capital Management Inc. The Steak n Shake Company

$189.41

10/18/2009

$22.95

10/22/2009

Investment Group

$4,013.71

11/5/2009

Silicon Storage ManagementTechnology, Inc. led Buyout

$201.29

11/13/2009

QuadraMed Corporation

Francisco Partners

$159.11

12/7/2009

Highbury Financial Inc.

Affiliated Managers Group, Inc.

$113.56

12/12/2009

Airvana, Inc.

Investment Group

$481.03

12/17/2009

Global Med Technologies, Inc. Silicon Storage Technology, Inc.

Haemonetics Corporation

$44.69

1/31/2010

Microchip Technology Incorporated

$292.36

2/2/2010

Spectrum Brands, Inc.

Harbinger Capital Partners

$588.1

2/9/2010

Western Sizzlin Corporation

IMS Health Incorporated

Aggregate special committee and board fees and expenses totaled $20,000. Chairman received $250 per quarter. Each committee member received $500 per telephonic meeting and $1,500 for each meeting attended inperson. Chairman received $25,000 and each other committee member received $10,000. Each committee member received $1,500 for each committee meeting attended. Each committee member received $1000 per meeting attended in person and $800 per telephonic meeting. Chairman received $15,000 per month. Each other committee member received $3,000 per month. Chairman received an annual fee of $40,000. Each other committee member received an annual fee of $20,000. Each committee member received $1,000 per meeting attended (in person or telephonically). Chairman received $15,000 per month between July and December 2009 and $7,500 per month thereafter. Each other committee member received $10,000 per month between July and December 2009 and $5,000 per month thereafter. Chairman received $5,000. Each committee member received $1,500 per meeting. Each committee member received $1,000 per meeting attended in person or $800 per telephonic meeting. Each committee member received $80,000. (continued)

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FORMING THE SPECIAL COMMITTEE

Target Name

Acquirer Name

Transaction Value (in millions)

Merger Agreement Date

Free Description

Pinnacle Gas Resources, Inc.

Managementled Buyout

$10.31

2/23/2010

Crystal River Capital, Inc.

Brookfield Asset Management Inc.

$13.75

2/23/2010

CKE Restaurants, Inc. SouthWest Water Company

Thomas H. Lee $610.96 Partners, L.P. Investment $273.63 Group

Chairman received $50,000. Each other committee member received their ordinary compensation for attendance at committee meetings. Each committee member received $15,000 per month through February 2010 and $7,500 per month thereafter. Each committee member also received $1,500 per meeting attended. Each committee member received $25,000. Chairman received a $5,000 retainer. Each other committee member received a $2,500 retainer. Each committee member received $1,000 per meeting. Chairman received $15,000 per month. Each other committee member received $10,000 per month. Chairman received $80,000 (including compensation for service as chairman of another committee). Each other committee member received $15,000. Chairman received $30,000. Each other committee member received $20,000.

2/26/2010 3/2/2010

RCN Corporation ABRY Partners, L.L.C.

$535.98

3/5/2010

The Orchard Enterprises, Inc.

$7.52

3/15/2010

$447.23

3/28/2010

$987.82

4/11/2010

Each committee member received $2,000.

$693.27

4/15/2010

$693.92

4/18/2010

Each committee member received $20,000. Each committee member received $25,000.

BWAY Holding Company

JDS Capital Management, L.L.C.

Madison Dearborn Partners, L.L.C. DynCorp Cerberus International Inc. Capital Management, L.P. Phase Forward Oracle Incorporated Corporation CKE Apollo Restaurants, Inc. Management, L.P.

82

Chapter 4

Getting Ready: Director Indoctrination

The decision has been made to use a special committee, and the committee has now been properly formed and chartered. Independent outside counsel has been selected and is ready to go. The very first task for counsel, before helping the committee design its investigation or negotiation, is to indoctrinate the members of the committee in a firm understanding of their new role and duty. We refer to this as director indoctrination because it is different in nature and scope than the typical director briefing in a corporate matter. In this case, the law demands that the directors who make up the committee take on a new role. In the case of a committee formed in response to a demand, or a forensic committee formed to investigate without a demand, that role is one of inquisitor. In the transactional setting, the role is arm’s-length negotiation adversary. Make no mistake; these roles are fundamentally different than the typical oversight role of a corporate director. The challenge for counsel is to help the directors who are now his clients fully understand how their roles have changed and what is expected of them in these new roles. Professor (and former Chancellor) William T. Allen described that challenge: When special committees have appeared to push and resist their colleagues, it has been. . . because the men and women who comprised the committee have understood that as a result of accepting this special assignment, they have a new duty and stand in a new and different relationship to the firm’s management or its controlling shareholder. When. . . a special committee has appeared to perform this special assignment badly, it is probably because its members have been ill-served by their advisors and, as a result, have failed to understand or to accept the radical change in that relationship that had occurred.

*** [I]f the special committee process is to have integrity, it falls in the first instance to the lawyers to unwrap the bindings that have joined the directors into a single board; to instill in the committee a clear understanding of the radically altered

83

GETTING READY: DIRECTOR INDOCTRINATION

state in which it finds itself and to lead the committee to a full understanding of its new duty.1

What follows is a brief discussion of the roles members of a special committee are called upon to fill, and what they mean to the director who steps up to fill them.

A. WHAT ARE WE TRYING TO DO AND FOR WHOM ARE WE TRYING TO DO IT? Every committee process should begin with the directors who make up the special committee receiving a briefing designed to clearly answer these questions. The role is meaningfully different from the typical oversight role of the board. This may explain why the reported cases contain a surprising number of instances in which the court has found that special committee members simply failed to understand their task— a failure that can be fatal to the special committee process.2 The clearest answer to the questions is: It depends on why the committee was formed. To begin to answer the questions, directors need to understand that almost every special committee is formed because there is at least a bona fide question about whether the law will recognize action by the full board as independent and disinterested. Thus, behind almost every special committee is an interested board, a controlling stockholder, or other facts that give rise to reasonable doubts about the ability of the board, sitting as a committee of the whole, to act in a manner that will be respected by a reviewing court. After all, boards do not typically set in motion the extraordinary process, expense, and potential disruption that accompany a special committee without good reason. In the transactional context, committees are formed as a result of the existence of a controlling stockholder. Another reason to form a committee could be because the transaction involves a management buyout and management is represented on the board, or because the potential transaction involves a sale to a corporation whose representatives sit on the board, among other reasons. In this setting, the primary task of the special committee is to evaluate and, if appropriate, negotiate a transaction with the conflicted party in a manner that, to the greatest extent possible, simulates aggressive arm’s-length bargaining. Often, depending upon the nature of the transaction, the transactional committee will be given the power to negotiate and recommend a transaction to the full board for approval, since the final approval of certain types of corporate transactions cannot be delegated to committees by law.3 Other times, the transactional committee will have the full power of the board to negotiate and conclude a transaction, for instance, in connection with the sale of a division or other asset of the company that does 1 2 3

84

William T. Allen, Independent Directors In MBO Transactions: Are They Fact or Fantasy? 45 BUS. LAW. 2055, 2061-6 (Aug. 1990). In re Trans World Airlines, Inc. S’holder Litig., 1988 WL 111271, at *4–5 (Del. Ch. Oct. 21, 1988). See the discussion of scope of permissible delegation in Chapter Three, “Forming the Special Committee.”

WHAT DOES IT MEAN TO SIMULATE ARM’S-LENGTH BARGAINING?

not constitute the sale of all or substantially all of the assets of the company as a legal matter.4 Thus, the transactional committee will carry out its duties with several constituencies in mind: typically, the full board to whom it will, in most cases, report, and, more importantly, the public stockholders of the company who will have a keen interest in seeing that the committee did everything in its power to conduct a fully independent, arm’s-length process. If a special committee is formed to investigate a stockholder demand or potential wrongdoing suspected by the board or otherwise identified by a whistleblower, the duty of the committee will be to design and execute as thorough and impartial an investigation as possible, within such timing and resource constraints as may be appropriate in the circumstances. In this circumstance, the duty of the committee will be to follow the evidence wherever it leads, regardless of who is potentially liable and who may or may not be implicated by the facts. If a special litigation committee (SLC) is formed after a suit is brought against the company, the role of the director is not only to investigate the facts implicated in the litigation but also to make judgments about whether it is in the company’s best interests to allow the case to continue to be prosecuted by the plaintiff stockholder, take over the prosecution, attempt to settle the case, or, alternatively, seek its dismissal. The constituencies of these forensic committees may be substantially broader than the typical transactional committee. The committee’s constituencies, in these contexts, are the stockholders in general and, in appropriate cases, the demanding stockholder in particular. More broadly, it could be said that such a committee acts indirectly as a cog in the wheel of our system of justice and in some cases may find itself interacting with regulators or even prosecutors. The simple answers, therefore, are that the role of a transactional committee is to simulate aggressive arm’s-length bargaining for the benefit of stockholders, and the role of the forensic committee is to learn the facts and make judgments about what is in the company’s best interests as a result of the facts it finds.

B. WHAT DOES IT MEAN TO SIMULATE ARM’S-LENGTH BARGAINING? What does it mean to simulate arm’s-length bargaining? In the context of a transaction involving a potential management LBO (leveraged buyout), the first step is to understand that the committee’s friend and colleague, the CEO (chief executive officer), has just become a negotiation adversary. The CEO and other members of senior management are no longer on the team for purposes of this negotiation, but now sit on the other side of the negotiation table. What flows from this? Well, the obvious answer is that it’s now time to hire an independent financial advisor who will be tasked with representing the committee and, 4

In the sale of “all or substantially all” of the corporation’s assets, governing statutes often prohibit delegation to a committee of the final power to conclude such a transaction, which is typically reserved to the full board. See, e.g., 8 Del. C. § Sections 141(c), 271. 85

GETTING READY: DIRECTOR INDOCTRINATION

indirectly, the stockholders who the committee is representing. Earlier, we wrote at some length about the importance of selecting truly independent advisors. The reasons should begin to become clear now. The company’s long-time banker, with his close relationship with senior management, might not be the best possible choice as the special committee’s banker if the committee really wants to negotiate with the management team. The potential for conflicted loyalty or even worse, a “slip” at a critical time in the negotiation may be significant.5 As set forth in somewhat greater detail in Chapter Five, “Committee’s First Steps,” the role of an arm’s-length bargaining agent also suggests thinking about a strategy designed to get the best possible deal from the other party to the negotiation. The objective is not about just trying to get a good deal or a fair deal, or about trying to structure a result in which both parties win. This is not the compensation committee, whose job is to try to devise a fair deal for the CEO and senior management. The goal of a member of the special committee is to get the best deal for the stockholders being represented.6 If any member of the committee is not ready, willing, and able to jump into the fray and negotiate to that end, with every available tool, that member should resign from the committee. Put simply, the committee members should assume that the committee is negotiating with the members’ own money. How would the members approach this assignment if this company were its largest single asset, and selling it at the right price meant that the members could retire now, while selling it poorly meant going back to work? Although we address formulating strategy in Chapter Five, below, a few touchstones may be helpful. Start by acknowledging the surprising (and counterintuitive) amount of power that the committee really has. This is often overlooked in practice. A committee charged with negotiating a transaction has power that flows from the mere fact that it exists. After all, if the committee was formed, it was formed to achieve a legal benefit in the face of a conflict. This is power because all parties will begin the process with some basic understanding that your committee is in place to fulfill a function (which at least at some level involves protecting them or the transaction being negotiated). It is also power in the sense that if the committee says no to a particular transaction, the practical chances of that transaction (or one like it) ever getting done are close to zero. Full boards rarely, if ever, override the recommendation of negotiation committees. The potential cost to the other directors in litigation is just too high. Similarly, the committee formed to negotiate with the majority or controlling stockholder has just such situational power. If the committee uses its ability to say no, the controller must either abandon the transaction or, alternatively, use its majority power to force it through. Doing so, however, is almost sure to result in judicial sanction in the form of an eventual 5

6

86

As we have tried to make clear earlier, there is almost no rule relating to special committee practice that does not admit of exceptions. This one is no different. There could be many situations in which an investment banker with deep knowledge of the corporation could be quite useful to the committee and worth the conflict risk. It will be for the committee, working with counsel, to make a contextually specific judgment in each case. Of course, the best deal for the stockholders that is achieved could be a fair deal and/or one in which both sides win. That is not problematic as long as the committee’s efforts and approach has been to get the best deal possible for the stockholders.

WHAT DOES IT MEAN TO SIMULATE ARM’S-LENGTH BARGAINING?

appraisal or unfair dealing judgment, which adds substantially to both the “friction costs” and real economic costs of the transaction. Thus, the well-counseled majority or controlling stockholder will understand that it cannot practically use its power against the committee and that the committee’s power to say no is one that, if invoked, will result in real problems for the controller. Thus, the rational (and well-counseled) controlling stockholder will logically approach a negotiation expecting to be in the unfamiliar position of having to defer occasionally to the committee in negotiation and not win every point. Anticipate that the controller has been counseled that less is more in this situation and exploit that fact. Do not approach this activity on the assumption that the committee is necessarily subservient to anyone. It is not. Understanding the power that flows from this unique situation, coupled with an understanding of the goal of simulating arm’s-length negotiation, leads to powerful results and, hopefully, an entirely new way of thinking about things. If a committee conceives itself as wielding situational power, the next question is, what is the best way to use that power? One of the first and most useful exercises of its power is for the committee to set the rules of the negotiation from the very outset. A committee should consider establishing rules or procedures such as the following. • Require all communications to go through the investment banker. Although this could be viewed as standard in many sales processes, it should not be a surprise if negotiating adversaries attempt to exploit the familiarity associated with working together on the board to try to bypass a truly independent banker—after all, it is easier dealing with the committee than with someone who is so “formal.” • Establish a schedule that benefits the committee’s position and stick to it. Assuming an outside investment banker has been hired, management may soon decide that it has a relative and potentially short-lived timing advantage over the negotiating team, since it will take at least some time for the committee’s banker to “come up to speed” and really understand the company or the asset it is selling. The committee should not let the negotiating team be rushed to the table before its own financial advisor understands the company, its upside, and its problems. If this means that the first negotiating session should be scheduled several weeks after the retention of the banker, so be it. Just as no rational committee member would sell their own company through an agent who didn’t really understand it, it should not be willing to sell someone else’s company in exactly that situation. In no circumstance should the committee allow a negotiating adversary to dictate the timing of its work or that of its financial advisor. Allowing the negotiating adversary to give the committee the bum’s rush will prevent the committee from doing its job. It should not be allowed to happen. • Consider inviting others to the party. There are undoubtedly times when exclusivity is appropriate. Those times are nowhere near as frequent as the times that a negotiating adversary asks for exclusivity. Committees should consider structuring a process that involves all potentially responsible bidders, and not just a favored management group. After all, the presence of multiple buyers is likely to lead to a value maximizing bidding situation. There are surely circumstances in which, working with the committee’s financial advisor, the committee will conclude that 87

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this is not the best way to proceed. Nevertheless, there are many times when refusing to grant a bidder exclusivity is the best route, and the management team’s request for exclusivity based upon an appeal to personal friendship or collegiality deserves a polite but firm no in response. Although the decision regarding whether to grant a request for a period of exclusive dealing is highly contextual and is not easily susceptible to categorical analysis, it is one likely to receive careful post hoc scrutiny in court. To the extent that the committee determines to grant anyone exclusivity, be certain that you are clear about the reasons for doing so and that the committee has the advice of its banker that this is a wise thing to do in the circumstances.7 • Establish the committee’s role vis-à-vis management. Committees are often formed in response to a controller’s decision to make a bid and in that sense may start out in a reactive mode. In other cases, however, if the committee is formed to oversee the sale of the company either because of potential management involvement or another board member’s conflict, the committee is not at all reactive but instead initiates the process and “sets the stage” for all the subsequent activities. No matter what the context, however, management is always the one constituency over which the committee has power. The sooner that management understands that it works for the committee, or at least that it must take direction from the committee, the better. Though friction between management and the committee can arise from conflicting economic interests (for example, where management is interested in buying the company and the committee is interested in maximizing price by any means available), such friction is to be expected and typically is easily understood and addressed. The more typical case, however, involves friction that arises from a failure of the committee to communicate its expectations for management and management’s role in the process from the outset clearly and unambiguously. Simply because management is not a buyer does not necessarily mean that management can be counted upon to support the committee’s function without reservation. After all, management will be concerned, at some level, about their careers and future employment, and it is not at all unusual to see management favorites emerge as the process unfolds. This is natural and to be expected, but it is the committee’s job to assure that management’s views about who might be a favorable employer do not in any way taint or infect the process. As bidders perform due diligence, they invariably interface closely with management. The committee must assure that all are treated equally—unless the committee decides otherwise. Case law suggests that the committee needs to be actively involved in the due diligence process from the outset.8 Special committee members will want to seek advice from counsel as to how best to structure the process to keep management under the supervision of the committee as the broader process evolves.

7

8

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Under most state corporate statutes, a director’s reliance on the advice of experts chosen with reasonable care is a potent defense to a claim that the director breached his fiduciary duty. See, e.g., §141(e) (Directors shall be “fully protected” in relying in good faith upon outside advisors selected with reasonable care.) See, e.g., In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171 (Del. Ch. 2007).

INQUISITOR? THOUGHTS ON THE ROLE OF THE FORENSIC COMMITTEE

• Establish the committee’s control over the process. The process can unfold on the schedule and pursuant to the rules established by the committee or, instead, the committee can find itself in a purely reactive mode, responding to a pack of out-of-control bidders. The committee can establish its control over the process by preparing and circulating a statement of bidding guidelines or procedures, as well as a timeline for participants. These can be waived or modified at the insistence of the committee.9 By establishing bidding procedures and clearly articulating the committee’s expected timing, the committee can hope to exert at least some degree of control over the process.10 In short, simulating aggressive arm’s-length bargaining means plotting a course with outside legal and financial advisors with a single goal in mind: to achieve the best possible transaction. Friendships and board collegiality need not invariably be sacrificed, but they do need to be checked at the door to the conference room where the process is planned out and executed.

C. INQUISITOR? THOUGHTS ON THE ROLE OF THE FORENSIC COMMITTEE As described above, there are two types of forensic committees: the SLC chartered to determine whether existing litigation should continue to be prosecuted, and a pre-suit investigation committee triggered either by receipt of a demand from a stockholder or other internal request to investigate, such as a complaint from a whistleblower. Regardless of its genesis, the role of the forensic committee is to investigate the matters at issue in the lawsuit, identified in the demand, or otherwise identified by the whistleblower or other party in interest. Broadly, this means that the committee should do whatever is necessary to understand the facts at issue and the law that may apply to those facts. We have referred to this role as that of inquisitor, intending to mean “a person who investigates in an official capacity” (rather than a member of the Inquisition). Although some definitions of inquisitor associate the word with an “excessively rigorous” or “harsh” questioner, we do not so intend. Thus, as used here, inquisitor refers to the committee as the official body that investigates—thoroughly to be sure, but never harshly. We have broadly lumped both SLCs and pre-suit investigation committees into one forensic category, but there is a significant difference between the two. Pre-suit committees are formed either because a stockholder or a whistleblower believes that they have identified a potential wrong. Many times, the conduct identified is determined to not have happened, be misapprehended by the complaining party, or simply not be 9

10

The law recognizes that disparate treatment among bidders is acceptable if the committee is able to show that it perceived that the disparate treatment was in aid of maximization of the result. See, e.g., In re J.P. Stevens & Co., Inc. S’holders Litig., 542 A.2d 770, 781-82 (Del. Ch. 1988); Mills Acq. Co. v. MacMillian, Inc., 559 A.2d 1281, 1286 (Del. 1989). A set of sample bidding procedures are included as Appendix A, “Sample Bidding Procedures,” to this chapter. Also included as Appendix B, “Sample Bidding Procedures—Superior Proposals,” is a set of procedures for use if the corporation is already in contract and receives multiple unsolicited overbids. 89

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wrong in light of the facts and law as determined by the committee. These investigations may turn out to be less difficult to conduct than others, and they will not inevitably lead to litigation by the complaining party after the committee has concluded its work. The work of the SLC, however, by its very nature, arises in a different context. An SLC is typically established only after litigation has been brought and usually after a court has been asked to dismiss the case and has refused to do so (or after counsel has determined that such a motion would not be worthwhile). Thus, in the case of most SLCs, someone, either counsel or the court, has effectively made a judgment that there is enough pled in the complaint to state a claim against the defendants, which, as a legal matter, separates the SLC context from the pre-suit demand context. Moreover, since the SLC is formed to consider whether to continue to prosecute existing litigation, it is certain that following the work of an SLC, there will be further proceedings in court and thus a spotlight on the work of the SLC. That is not to suggest, of course, that the work of the pre-suit committee should be undertaken with any less vigor or seriousness of purpose than the work of an SLC. Recent experience has shown that some of the more egregious examples of misbehavior during the stock option backdating scandal were uncovered as a result of pre-suit stockholder demands or board inquiries, rather than after-the-fact SLCs. Instead, it is meant to stress to the directors serving on an SLC that they find themselves serving in a contextually distinct role. Typically, forensic committees proceed by collecting documents and interviewing persons who may have knowledge of the facts that the committee is charged to investigate. Although counsel will ordinarily formulate the document requests, receive the production, and review it on behalf of the committee, it is appropriate, in our view, for counsel to prepare and share key documents with the committee so that the committee members themselves can have access to the more important documents gathered by counsel. Although it is customary for counsel to take the lead in the committee’s interviews, and though committees often find that attending each and every interview is simply not feasible, the best forensic committees will pick their spots and personally sit in on the interviews of the potentially important witnesses. Committee attendance demonstrates to a reviewing court that the committee members were involved and engaged in the process, but it is also important for a more subtle reason. Unlike more formal legal proceedings, committee interviews are rarely if ever recorded or transcribed, so, by default, the record of what happens at a committee interview is the notes of the committee members and counsel who attend the interview. These notes are often gathered up and transcribed into a memorandum. Such a memorandum in turn becomes the committee’s official record of the facts it learned from the witness. Sometimes, facts disclosed during an interview subsequently take on increased significance; it is not entirely unheard of for a key witness to attempt, at a later date, to recant what he told the committee as a more complete record emerges. If no committee member attended the recanting witness’s interview, it becomes convenient for a witness simply to deny that what he said is reflected in the interview memorandum and claim that counsel misunderstood or misapprehended what they were told. In our experience, the attendance of at least one committee member at important interviews tends to minimize this urge to rewrite the record after the fact. 90

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In the same vein, it is important for counsel to prepare and circulate interview memoranda promptly after each interview for committee review. Thus, to the extent that a committee member’s recollection of what happened at the interview differs from the counsel’s memorandum, the difference can be addressed and corrected while memories are fresh, rather than later, when they have invariably dulled. Since committees sometimes find themselves conducting dozens of interviews to complete their work, what any one person may have said months earlier is often difficult to recall with specificity. Thus, the interview memos take on more importance as the process goes forward, and the importance of capturing the key facts in those memoranda becomes clear. Just as transactional committees are formed because of an underlying conflict, the same is often true of forensic committees. Especially if one or more current board members are potential targets of the investigation, the committee typically will want to keep its proceedings confidential until the committee’s report is complete. At the same time, it is customary to provide periodic updates to the full board regarding the committee’s work, which typically take the form of a briefing as to the work the committee has done to date, the volume of work it anticipates to complete its task, and a projected completion date. Providing more substantive information by way of a briefing, at least if an active investigation is under way and one or more sitting board members are potential targets of that investigation, could be viewed as inconsistent with the committee’s independence and generally should be avoided. Once a pre-suit committee has conducted its interviews, reviewed its documents, and been fully briefed on the law, it becomes the duty of the committee to decide what, if anything, should be done as a result of the facts it has found, in light of the applicable law. In many cases, the decision is simply to make a report to the full board recommending that no further action be taken. There are, however, situations in which the pre-suit committee determines that some action is appropriate and in the best interests of the company. In these cases, the committee has a variety of options at its disposal. It can recommend11 that either a suit be commenced on the company’s behalf or some other action be taken by the company to improve the company’s governance, or seek a pre-suit settlement from one or more individuals. Any of these courses of action may lead to a good deal of disharmony, even acrimony, on the board. After all, in many cases, the committee has determined that a fellow director has acted in a manner worthy of censure, or worse. This is the time, more than any other, when the special committee director must grasp the true meaning of independence. The questions for the director are: Are you willing to stand up to the pressure that comes your way from other directors? Are you prepared to stand your ground based on your unbiased reading of the facts and application of the relevant law? If the answers are yes, a court is more likely to respect the committee’s work in the event that suit is subsequently brought by a disgruntled stockholder.

11

If properly formed and chartered (see Chapter Three), a committee charged with investigating a stockholder’s demand will be empowered to recommend a course of action to the board, but not to take action itself. By contrast, a special litigation committee (SLC) will almost invariably be delegated the full power of the board to act and thus will not recommend anything. 91

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D. UNDERSTANDING THE ROLE OF IN-HOUSE AND OTHER COUNSEL As the special committee conducts its negotiations or investigation, it is important to understand the proper role of counsel in the process. Even though the company’s general counsel may have been the directors’ primary legal advisor on matters pertaining the business of the company, that is not the likely to be the case once a special committee is formed.12 Indeed, on the contrary, the conduct of the general counsel may be part of the forensic committee’s investigation, or the general counsel may have made a bid as part of a senior management LBO team and is therefore a negotiating adversary. In these instances, it is often the case that the general counsel is plainly disqualified from providing advice to special committee members, at least on topics to be addressed by the committee. Even if the general counsel is not a direct target of the committee, he still will find himself in an ethically challenging spot, since the general counsel is likely to have given legal advice to one or more other directors, who are at least theoretically in conflict with the committee. In the event that the general counsel learns the specifics of the special committee’s work, it is conceivable that the general counsel could find himself in a difficult and uncomfortable spot when and if a conflicted director asks him for information or advice about the special committee or its work. Thus, it is typically best for the committee members to consult the committee’s counsel for legal advice, and to communicate with the general counsel through the committee’s lawyer, and not directly. Of course, as noted above, there are many circumstances in which the general counsel can and should play a role in the work of the committee. These include assistance in working through representations and warranties in a transaction context (at the request and direction of the special committee’s counsel) or providing assistance to the forensic committee in getting started by, for example, suggesting potential advisors for the committee to interview or providing advice regarding which advisors are likely to have conflicts disabling them from representing the committee. The committee should approach the question of how and when to utilize the general counsel as part of its work carefully, however, and only after taking advice on the topic from its own counsel. Many times a general counsel will attempt to insert herself into the work of the committee. There are several reported cases, for example, in which a general counsel either sought to or did attend committee meetings, ostensibly as a resource to the committee.13 This is almost invariably a bad idea and should be avoided. The exception, of course, is if the general counsel is invited to attend a meeting or portion of a meeting by the committee itself, for good reason.

12

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In Chapter Twelve, “The In-House Lawyer’s Role: What to Expect and How to Cope,” we address this topic in a manner more directly relevant to and from the perspective of general counsel. See, e.g., In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171 (Del. Ch. 2007); Sonet v. Plum Creek Timber Co., 1999 WL 160174, at *4 n.24 (Del. Ch. Mar. 18, 1999).

CASE STUDIES

E. DEALING WITH ACTORS WHO DO NOT UNDERSTAND (OR RESPECT) THE ROLE OF THE COMMITTEE Experience suggests that, at times, one or more corporate actors will attempt to intervene or interfere in the work of the committee for personal reasons that are inconsistent with the best interests of the company. It is important that committee members be aware of such attempts to interfere in the committee’s work and take appropriate action to terminate such attempts when and if they occur. What is appropriate action will, of course, depend upon the circumstance. On the one end of the spectrum, a well-meaning but nonetheless overly aggressive general counsel may easily be addressed by a committee member’s private admonition, or, if necessary, a discreet call to the CEO. At the other end of the spectrum is the board member or members who are targets of the committee’s investigation and who are actively attempting to subvert the committee’s report and its conclusions, or otherwise pressure the individual members of the committee to come to a conclusion that departs from the facts found by the committee. At the outset, it may be appropriate to have the committee’s counsel address this behavior with the counsel for the other directors, or the general counsel in the event that they have no counsel acting for them. If this discussion does not produce the desired result, it may be appropriate for the chairman of the committee to speak directly with the dissenting director to suggest that continued attempts to interfere with the committee’s work will become part of the committee’s record and are likely to negatively influence the outcome of the committee’s work. In one particularly egregious situation, the authors represented a committee that added a section to its final report detailing direct attempts to interfere with the work of the committee, thus putting the conduct of the bad actors on the record. Finally, the ultimate weapon at the disposal of the committee when faced with persistent and destructive attacks by targets of the committee’s investigation is a noisy withdrawal, i.e., the public resignation of all members of the committee from the board, often accompanied by a statement of the reasons for the resignation. This course of action is appropriate under relatively rare circumstances; it should be pursued only if the bad actors’ conduct has jeopardized the committee members’ personal reputations and no other alternative is available.

F. CASE STUDIES i. It’s fair, so we approved it FACTS

A 77 percent owned public company receives an offer from its controlling stockholder. The board decides to appoint a special committee to negotiate the controller’s offer. The two independent members of the board are appointed as a special committee and hire independent counsel and a top-tier independent investment banker. The committee instructs the investment banker to determine whether the controller’s offer is fair, and

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the banker determines that it cannot opine that the controller’s initial offer is fair from a financial point of view. Upon receiving this advice, the committee directs the banker to negotiate with the controlling stockholder to attempt to achieve a fair price. Although market disruptions intervene, the controller later puts forward a revised bid that the banker determines is “within a range of fairness.” The banker asks for additional consideration, and the controller asks whether the banker is prepared to opine that his bid is not fair from a financial point of view. The banker demurs and simply states that the controller’s offer should be higher. The controller declines to raise his bid and the banker advises the committee that the bid is “within the range of fairness.” The special committee thereafter unanimously approves the transaction and recommends its approval to the full board. The board approves the transaction and recommends it to stockholders, who vote overwhelmingly in favor of the transaction. In ensuing litigation, each member of the special committee has his deposition taken by the plaintiff’s attorneys. Each testifies that the special committee did not attempt to obtain the “highest price possible” but instead to determine whether the controlling stockholder’s offer was “fair from a financial standpoint.” In reviewing these facts, the court determines not to enjoin the transaction. The court also determines, however, that in light of the fact that the committee appeared to have an “imperfect appreciation of the proper scope and purpose of such a special committee” and “did not supply an acceptable surrogate for the energetic, informed and aggressive negotiation that one would reasonably expect from an arm’s length adversary,” that the work of the committee would lead to no legal benefit, and the controlling stockholder would continue to have the burden of showing the “entire fairness” of the transaction in post-closing litigation.14 ANALYSIS

The special committee made two key decisions of which the court was particularly critical. First, neither the committee nor its banker appears to have fully understood that its goal was to achieve the best available transaction, even if it was unfair to the controlling stockholder. By focusing instead on achieving some balanced and abstract notion of fairness in the transaction, the committee incurred the court’s displeasure. Second, the committee completely delegated the task of negotiating the transaction to its investment banker, without meaningful input into the design of the process or its execution. Moreover, the controller appears to have focused on whether or not the committee’s investment banker could opine that his offer was unfair as his negotiating strategy, and the committee, through its banker, appears largely to have accepted that paradigm. Rather than attempt to change the playing field that was effectively dictated to it by the controller, the committee agreed to play on that field and not to challenge the box into which it was placed by the controller. Indeed, the committee’s financial advisor, taking a cue from its client, also appeared to succumb to the controller’s statement of the negotiating issues and focused on whether the bid was fair rather than whether the bid was the best that could be achieved in the circumstances. 14

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This case study is drawn directly from Trans World Airlines, 1988 WL 111271.

CASE STUDIES

It appears that, in this situation, the committee could have taken a number of steps to improve the chances of the committee process itself leading to a better result. First, assuming that it had received the indoctrination we discussed in detail above, it could have ensured that its financial advisors, and in particular the individual investment bankers who were most directly involved in the day-to-day negotiation of the transaction, understood what the role of the committee was, and, to the extent that they were given the charge to lead the negotiations, what their clients (the committee) expected from them—not merely a fair transaction, but the best available transaction. In addition, the committee could have reinforced that message by meeting frequently with their financial advisors to oversee how the bankers were going to approach the negotiations, and then gathered feedback from the negotiation and provided instructions as to how to proceed as the negotiation developed. Of course, even more simply, one or both committee members could have attended the negotiation sessions themselves, although that is not invariably required. In short, by having been directly involved in the design and execution of the process, even in a primarily oversight role, the committee could probably have avoided the judicial criticism it endured. Of course, before it designed the process, it would have had to understand what it was doing and why; that is, it would have had to be indoctrinated by experienced counsel.

ii. The One-Person Negotiating Committee15 FACTS

An English entity (Parent) owns approximately 80 percent of a United States (U.S.) public company (Subsidiary) and decides that it is no longer valuable to maintain Subsidiary’s public status. After some consideration, Parent determines to investigate purchasing the minority shares it does not already own in Subsidiary. Over a period of months, Parent considers how best to proceed. A report is prepared based upon information supplied by an American lawyer who represents both Parent and Subsidiary. In that report, Parent is told to expect that the minority stockholders will demand at least the book value of the company in a transaction, $16.20 per share, and that any price below book “will be difficult to sell to the minority.” Thereafter, a follow-up report is prepared that explains the process by which a public company can be taken private, and the report indicates that the same lawyer has provided an introduction to a “small investment bank” that was willing to assist in executing the transaction. Additional time passes, and eventually a comprehensive, step-by-step report is prepared for Parent. In that report, Parent is advised that the small investment bank has undertaken certain work to analyze the transaction and has estimated the advisory fees to be incurred. Parent is also advised that Subsidiary has recently paid approximately

15

Lest we be accused of embellishing, the facts of this case study were drawn directly from Gesoff v. IIC Indus. Inc., 902 A.2d 1130 (Del. Ch. 2006). 95

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$13 per share to purchase its shares in the market and that it should expect to pay no less. Thereafter Parent’s board authorizes a bid for Subsidiary’s shares at $13 per share in the form of a tender offer, to be followed by a short-form merger. The price, which is not based on any financial analysis, is set to mirror the market, as established by Subsidiary’s recent transactions. The Parent board also authorizes the Subsidiary to spend up to $100 thousand on a fairness opinion from a banker, and directs that the process through which the Subsidiary would request the opinion should await further thought, given that the members of the board requesting the opinion “should be independent.” Based on the advice of outside counsel to both Parent and Subsidiary, the Subsidiary determines to appoint a special committee of one, although it does not then take formal action to do so. Thereafter, a key officer of Parent flies to New York, meets with the investment bank (which the not-yet-formed special committee has not even interviewed), and then meets with the director nominated to form the special committee to discuss how best to proceed. The Parent company officer, the not-yet-established special committee, and conflicted outside counsel then meet, and counsel pitches his services to the special committee. During this time period, the prospective special committee member inquires of counsel whether a conflict exists between such counsel’s representation of the Parent, Subsidiary, and the special committee and is assured that no conflict exists. Thereafter, before the special committee is formed, counsel promises the previously contacted investment bank that “we are very close to having you signed up for the project.” Several days later, the Subsidiary board formally acts by consent to appoint the oneperson special committee and gives the committee authority to hire advisors, but limits the amount of fees for advisors to $100 thousand, which is, coincidentally, the amount of the quote received earlier from the small investment bank. Having been appointed, the one-person special committee proceeds to hire the handpicked investment bank and conflicted counsel without interviewing other candidates or learning of their extensive interaction prior to the appointment of the committee. At this point, an officer of Parent prepares an email in which it is explained that the Parent should begin the process by making a low bid, and that, thereafter, the special committee would be likely to make a counteroffer that was a “bit higher.” The Parent would then meet the new price, the special committee would approve it, and the special committee’s bank would issue a fairness opinion. Following receipt of this advice, the Parent board determines not to bid at book, $16.20, or at the lower market price discussed and previously authorized, $13, but instead to make its low bid at $10 per share. Representatives of the Parent explain that $10 is the price at which the Parent sought to begin the process, leaving room to negotiate later. Thereafter, the special committee’s banker begins work on the offer and prepares various valuations and analyses of the Subsidiary. The special committee member offers suggestions regarding certain valuation approaches, but the investment bank rejects these valuations. Unknown to the special committee, the banker also shares its valuation analyses with the Parent company, leading to a later finding by the court that the Parent had access to the special committee’s valuation analysis throughout the process. 96

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Following the special committee’s analysis of the $10 offer, the one-man special committee negotiates with Parent and advises that he will reject the $10 offer. He further advises that any offer, in order to be considered, must exceed the mid-point of the committee’s valuation range, or $10.30 per share, and should really be $10.50 if Parent wants his endorsement of the deal. Thereafter, the Parent company officer issues a new memorandum to the Parent board, explaining that, were the Parent to raise its offer to $10.50 per share, the special committee would approve and endorse it. Parent does so, the special committee recommends the transaction and a tender offer is made. The tender offer, however, is wildly unsuccessful, and, Parent then decides to proceed by way of long-form merger, having failed to attract sufficient shares to purchase the company in a short-form transaction. Several months pass, and the merger is eventually submitted to the one-person special committee. Rather than taking the opportunity to negotiate for a better transaction, the special committee expresses the view that the merger is substantively the same transaction previously approved, and thus determines to recommend the merger without asking for or receiving a new fairness opinion and without conducting any further work. Parent then proceeds with the merger, the success of which is a foregone conclusion. Stockholders bring suit challenging the transaction, and the court issues a lengthy opinion finding that Parent failed to meet the entire fairness test and awarding damages. ANALYSIS

This case study presents an excellent how-not-to guide. The court’s decision after trial provides deep insight into how a special committee’s process is likely to be evaluated by a reviewing court and should be considered a must-read for any serious student of the subject. The court’s first concern was that the special committee was made up of only one member. Citing social science research suggesting that groups tend to outscore individuals in making complex decisions,16 the court went on to suggest that, in this case, “a second director might have ameliorated the process by counseling [the sole director] to think again, or by making it more difficult for [Parent] to exert the control it exerted over the special committee.”17 The court also found that the lack of independence of the advisors to the special committee was of great significance. The court singled out for special criticism counsel’s advice to the committee that his simultaneous representation of the buyer and seller in the transaction was not a conflict. The court wrote: [The special committee’s] decision to retain [the conflicted lawyer] as the special committee’s legal counsel was, if anything, even more damaging to the special committee’s duty to be well and independently informed. [The conflicted lawyer]. . . had indeed been advising [Parent] on its approach to the tender offer from the 16 17

Gesoff, 902 A.2d at 1146, n.100 citing Stephen M. Bainbridge, Why a Board? Group Decisionmaking in Corporate Governance, 55 VAND. L. REV. 1, 12 (2002). Id. at 1149. 97

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beginning. No reasonable observer could have believed that [lawyer] was an appropriate independent counsel for the. . . special committee. It is most unfortunate, therefore, that [the special committee] accepted [lawyer’s] frankly incredible statement that his dual representation. . . presented no conflict of interest. Both [lawyer’s] work as counsel for the. . . special committee, and [the committee’s] blithe acceptance of his representation are evidence of unfair dealing. . .. Here [Parent] ensured control over the special committee process by the simple expedient of inserting its own counsel directly into the opposition camp.18

In addition to conflicted counsel, however, the special committee here also chose a banker who the court found had done at least substantial preliminary work with Parent’s representatives prior to being hired by the special committee. The fact that the banker was “effectively selected” by Parent, and had been promised work by Parent rather than the special committee, was found to rob the banker’s “opinion of its value as an indicator of fairness” and also was an “indicator that the parties did not structure the process in a way that was entirely fair.”19 The court also had criticism for the limited scope and vagueness of the committee’s mandate, finding that it failed to set out a clear range of authority for the special committee and instead provided merely for a “vague recommendation as to the transaction.”20 With respect to the substance of the special committee’s work, the court found it unsettling that when Parent changed the transaction from a tender offer to a merger, the special committee did not seize the opportunity to take further action to evaluate or negotiate the new transaction. Instead, the record showed that the special committee determined that its earlier approval of the tender offer could be relied upon when confronted with a later merger. Not only was the court critical of this approach, the court also expressed doubt as to whether the special committee’s mandate was broad enough to address the merger, or was drafted only to authorize the committee to address the tender offer. Finally, the court was especially critical of how the transaction was negotiated. Describing it as a “stylized mockery of arm’s-length negotiations,”21 the court stated that the committee must act with informed diligence and seek the best result available for its constituents in light of the facts at hand. Recalling the fact that the committee’s banker’s work was extensively shared with Parent, the court noted that, “[a]t a minimum, the special committee should have control over its own sources of information and should have the loyalty of its advisors throughout the process.”22 In short, at virtually every turn, the process described in this case study was poorly executed. Although any one of the flaws described in this case study could have doomed the special committee’s work, the confluence of all of the factors led to a substantial damages award against Parent, given its inability to carry its burden of showing the entire fairness of the transaction.

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Id. Id. at 1150–51. Id. at 1149. Id. at 1148. Id.

APPENDIX A: SAMPLE BIDDING PROCEDURES

G. APPENDIX A: SAMPLE BIDDING PROCEDURES SAMPLE BIDDING PROCEDURES [Date] Dear Sir or Madam: On behalf of __________________________ (“______________” or the “corporation”), we are writing to inform you of the procedures for submitting a final, binding proposal (the “Proposal”) for your potential acquisition of the corporation, as more fully described in the Agreement and Plan of Merger (the “Agreement”) and Disclosure Schedules. Your Proposal should be submitted to the following address no later than ___: 00 _.m. on _________, _____________, ____, 20___, with the Agreement and Disclosure Schedules, marked to show changes from the form provided, due ____________, ____________, ___, 20__ (as discussed below): [Contact] Your Proposal should be in writing, executed by an officer or other representative authorized to bind the prospective purchaser to its terms, and include each of the following: 1) The total consideration (in U.S. dollars) that you will pay for 100 percent of the common stock of the corporation, expressed on a per share basis. Please include the form of consideration (cash, stock, or combination thereof) you would use in the transaction. 2) The Agreement and Disclosure Schedules, marked to show changes, if any, from the form provided. The form of Agreement is enclosed, and you will be receiving the Disclosure Schedules shortly. Any revisions to the Agreement or Disclosure Schedules you may elect to make should be marked to show the exact changes you propose. Your proposed Agreement should be one that you are willing to sign. So that we may provide you with feedback prior to the submission of your Proposal, we request that you submit any revisions you propose to make to the Agreement and Disclosure Schedules to the corporation’s legal advisor, ________________, to the attention of _________________ (Tel: ____________/Email: __________) by __:00 __M ____ on _________, _____________ __, 20__. The extent and nature of modification to the Agreement and Disclosure Schedules will be important factors in evaluating your Proposal. Significant revisions to the form of Agreement or Disclosure Schedules provided are likely to place you at a competitive disadvantage to others who are prepared to execute the Agreement substantially as provided by the corporation. 3) A statement of how you plan to finance your Proposal, including a detailed table of sources and uses in the Agreement, the prospective purchaser’s obligation to consummate the transaction is not contingent upon the arrangement of financing. If your Proposal requires financing from external sources, please (i) disclose existing arrangements you have made or commitments you have received for financing

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covering the total consideration and/or (ii) include firm commitment letters for any third party financing. It is expected that all conditions in any financing documents will mirror those in the Agreement. All relevant letters should specify the names and telephone numbers of the appropriate individuals at the lending institutions involved, so that ____________ may contact them directly for clarification and verification. 4) Confirmation that your due diligence is complete, that all required approvals within your organization have been obtained, and that there are no conditions to your Proposal other than those set out in the Agreement. 5) The name and contact numbers of those persons who will be prepared to answer questions regarding your Proposal. Your Proposal should represent the best and final terms under which you are willing to enter into the Agreement. You should not assume that you will be given an opportunity to re-bid or increase the amount of your Proposal. As soon as practicable following the submission of Proposals, the corporation will evaluate all Proposals and determine which Proposal, if any, will be accepted. A Proposal will only be deemed to be accepted upon the execution and delivery to the corporation of a definitive agreement. Until such time, the corporation will not have any obligation to any potential purchaser, and following the execution of definitive documentation, the corporation’s obligations will be only to the other party to such definitive documentation, and only as set forth therein. The corporation expressly reserves the right, in its sole discretion and at any time, to amend or modify any or all of the procedures set forth herein, the manner in which the sale process is conducted, and the terms and conditions set forth in the Agreement. The corporation also reserves the right to reject any and all Proposals without providing any reasons therefore, to alter, accelerate, or terminate this process at any time, to negotiate at any time with any prospective purchaser individually or simultaneously with other prospective purchasers, and to discuss with any prospective purchaser, at any time, the terms of any Proposal submitted by such party, and to execute a definitive agreement at any time with any prospective purchaser. The existence and content of this letter (which is also being sent to other interested parties) and of your Proposal are subject to the confidentiality agreement that you previously entered into with the corporation. All communications, meetings and confidential information to be provided will be coordinated through _____________. Under no circumstances should you contact anyone at the corporation without the consent of _____________, _____________ will be available, on behalf of the corporation, to consult with prospective purchasers in order to provide guidance as to the form and content of contemplated Proposals and to respond to inquiries concerning the guidelines set forth above. You will be solely responsible for all costs of your investigation and evaluation of a potential transaction involving the corporation, including without limitation the fees and expenses of your advisors, whether or not the corporation proceeds with your Proposal, and under no circumstances shall the corporation, _____________ or any of

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their respective representatives or advisors be obligated to reimburse you for any such costs. If you have any questions concerning the procedures described above, please call ___________ at _______________ or _______ at ______________. Sincerely,

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H. APPENDIX B: SAMPLE BIDDING PROCEDURES—COMPETING SUPERIOR PROPOSALS SAMPLE BIDDING PROCEDURES FOR COMPETING “SUPERIOR PROPOSALS” CONFIDENTIAL [Date] [Address] Dear _________: On behalf of ___________ Corporation (the “corporation”) we want to acknowledge receipt of and thank you for your unsolicited, non-binding proposal to acquire the corporation. As you know, following receipt of your unsolicited proposal, the Board of Directors of the corporation met and determined that your proposal constituted a “Takeover Proposal” as defined in the Merger Agreement between and among the corporation, [Merger Sub and Parent] (the “Merger Agreement”), and the Board authorized us to give you access to due diligence, and to engage in discussions with you regarding your Takeover Proposal. As you may also be aware from our recent press release, in addition to your Takeover Proposal, the corporation also received unsolicited, non-binding proposals from [____] other potential acquirers, each of which the corporation’s Board determined to be “Takeover Proposals.” In each case, the Board also authorized us to provide due diligence and to engage in discussions with the parties making such unsolicited Takeover Proposals. As you know, the corporation is also a party to the Merger Agreement with [Parent], to which the corporation remains committed, and which it intends to submit to its stockholders for a vote unless and until the Board receives and accepts a “Superior Proposal” as defined in the Merger Agreement. In light of the foregoing, as well as our pre-existing contractual commitments, we are writing to let you know how we propose to conduct discussions and negotiations with you. While your recent proposal meets the definition of a “Takeover Proposal” under our Merger Agreement with [Parent], it is nevertheless not a definitive, firm or unconditional offer and it would be irresponsible of the corporation’s Board to accept your proposal as made. The Board can only accept a definitive, firm and unconditional offer that is signed by you. You should know that the Board is meeting on [Date] and at that time intends to consider any firm, unconditional, definitive offers that are evidenced by a signed definitive agreement, and, if more than one, to compare them, and determine if any are superior to the transaction we have already signed with [Parent]. Furthermore, in order to allow the Board to consider maturely any final, firm, unconditional, and definitive offer that you may wish to make, we would suggest that it be provided to the corporation sufficiently far in advance of the [Date] Board meeting to allow such consideration by the Board. You should also know that we intend to advise [Parent] of our [Date] Board meeting, and the steps we intend to take at such meeting. This letter sets forth the guidelines and procedures pursuant to which the Board will receive and consider any final, firm, unconditional, and definitive offer you, or any other party which has made a Takeover Proposal, may wish to make. 102

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In evaluating any definitive offer it receives, the corporation will consider such matters as it deems appropriate including, without limitation, (i) the highest possible value offered; (ii) the certainty and speed of closing; (iii) the terms contained in your proposed definitive acquisition agreement, which shall be in a form that you are prepared to execute, and which shall be marked to indicate changes from the existing merger agreement between the corporation and [Parent]; (iv) the extent that your proposal presents any material level of anti-trust or other regulatory risk; and (v) the existing obligations of the corporation pursuant to the Merger Agreement. Please review the following guidelines carefully. Any definitive final offer submitted which is not in compliance with these procedures and guidelines will place you at a distinct disadvantage. Please note that the corporation’s legal and financial advisors will be available to consult with you and your representatives to clarify or provide guidance with respect to any of the matters raised herein prior to the submission date. 1. Your offer should be addressed and delivered to: [CORPORATION] Attention: [____________________] with copies to: [ATTORNEYS] and [BANKERS] 2. In order to be considered by our Board, any definitive final offer you chose to make must be received no later than 5:00 P.M., on [Date] and state that it remains open for at least 72 hours after receipt. 3. Your offer should clearly state the consideration, in U.S. dollars, that you are willing to pay. The offer should reflect the final financial terms under which you are willing to enter into a definitive agreement. Purchase price will be heavily weighted in evaluation of your offer. 4. Your offer must clearly state the legal identity of the acquiring entity. 5. To be considered by our Board at its [Date] meeting, your offer must be submitted with a copy of a definitive acquisition agreement, clearly marked to show changes, if any, desired by you from the existing merger agreement between the corporation and [Parent]. Your willingness to accept a definitive acquisition agreement without significant adverse modifications from the [Parent] merger agreement will be another important factor in the evaluation of your offer. The corporation will take the extent and nature of any changes made in the definitive acquisition agreement into consideration in its evaluation your offer. Please do not provide conceptual comments, and please also understand that the corporation will not accept any offer which requires it to enter into an agreement which lacks a customary “fiduciary out.” 103

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6. Your offer should state that all required approvals, including the authorization of your corporation’s Board of Directors or the equivalent, have been obtained prior to submitting your offer. If any required approvals have not been received prior to your submission of your offer, then the offer must list each such approval that must be obtained, as well as any other facts or circumstances that you can reasonably foresee that might affect the timing or certainty of closing. Please understand that the certainty of closing will be heavily weighted in evaluation of your offer, and the corporation reserves the right to reject any offer, even an offer at a superior price, which contains what its Board of Directors determines, in its sole discretion, to be any appreciable degree of regulatory risk. 7. Any offer which is subject to a financing contingency will be considered as having a higher level of risk of consummation and will therefore place the prospective party at a significant disadvantage. Whether or not the offer includes financing from external sources, you should include in your offer a statement detailing your financial ability to consummate the transaction expeditiously. If financing is to be provided by external sources, your offer should include all relevant commitment letters (which should not be subject to further due diligence) and a list of contacts and telephone numbers of each of your financing sources with whom financing arrangements can be verified. 8. Your offer should indicate an estimate of the date at which you would expect to be able to close the transaction. The expected timing of the closing will be a factor considered by the corporation in evaluating your offer. 9. We expect that you should have completed your due diligence investigation by the time that any final offer you may determine to make is to be submitted. Accordingly, there should be no due diligence contingencies associated with your offer. [In the event that you have not yet completed your due diligence, we will make every effort to schedule follow-up interviews, if requested, with key executives prior to [Date]]. Any offer conditioned upon further due diligence will place a party at a distinct disadvantage. 10. Your offer should designate a contact person to whom questions regarding your offer may be directed. Kindly provide the telephone, fax, and mobile numbers and e-mail address for the designated individual. *** The corporation, with the advice and assistance of its advisors, will evaluate any final, firm offer received from you as expeditiously as is reasonably practicable. In evaluating offers, the corporation will consider such matters as it deems appropriate, including, without limitation, the value proposed, the certainty and speed of closure, and the terms and conditions contained in your definitive acquisition agreement. The corporation will only consider offers which its Board of Directors determines to be Superior Proposals pursuant to the terms of the Merger Agreement. The corporation anticipates that, after evaluation of any offers received, it may invite one party to meet with it and its advisors for the purpose of clarifying any outstanding questions or issues associated with the party’s offer and reaching agreement on any necessary ancillary matters. Provided that the corporation determines that your 104

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offer is a Superior Proposal under the Merger Agreement, and that it is determined to be the best of all of the Superior Proposals received, if any, the corporation expects to submit the definitive acquisition agreement to its Board as promptly as practicable after the agreement is finalized. The corporation reserves the right in its sole discretion to reject your offer without assigning any reasons therefore, and none of the corporation or its representatives will have any liability as a result of the rejection of your offer. The corporation reserves the right to modify these procedures at any time, consider definitive offers submitted by any other party making a Takeover Proposal consistent with the Merger Agreement, to decline to consider any definitive final offer you may chose to make for any reason or no reason, and to take actions inconsistent with this letter at any time, with or without notice of any kind to anyone. This letter is being provided subject to the confidentiality agreement which you have previously signed. Any public disclosure of the terms of these procedures, or any reference to the existence of these procedures or this letter will constitute a breach of such confidentiality agreement. Please direct any questions you may have about this process or your offer to _________ at _________. Thank you for your interest in the corporation. Sincerely,

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Chapter 5

The Committee’s First Steps

Once the special committee has been established, retained its advisors, and received its indoctrination, the special committee should begin its deliberations by devising a work plan for its activities. Spending the time at the outset of the committee process to formulate an initial work plan facilitates conducting a thorough yet efficient special committee process. In practice, we have also found that the discipline inherent in thinking through the likely phases of the work plan is an excellent opportunity for counsel to reinforce the committee indoctrination process discussed in Chapter Four, “Getting Ready: Director Indoctrination.” In this chapter, we briefly discuss some of the planning and other initial steps that an investigative committee and a transactional committee typically should consider at this early stage.

A. INVESTIGATIVE COMMITTEES i. Identifying the Subject and Goal of the Investigation It should be possible to determine the subject of the investigation (or at least a starting point) according to the event, action, or other catalyst that gives rise to the need for the investigation. The call for an investigation can originate from various sources and in myriad contexts. For example, the need for a corporate investigation can come from an internal source such as (1) a whistleblower alleging corporate misconduct, (2) the board or management seeking to address major or minor compliance problems, or (3) a corporation deciding to conduct a routine internal investigation for possible problems. The need for an investigation also can result from an external catalyst such as (1) a stockholder demand that the corporation pursue litigation for alleged harm done to the corporation, (2) a government investigation or enforcement action, or (3) a thirdparty fiduciary (such as a law firm or outside auditor) noting some potential problem or wrongdoing. Just how broad the scope of the investigation needs to be and how much ground the investigation will need to cover likely will not be clear at the beginning stages of 107

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a forensic committee’s work. Nevertheless, the special committee should attempt to make an initial assessment of what will likely need to be done in the context of the investigation it was formed to conduct. At the initial stages, two factors typically play an important role in determining the anticipated scope of the investigatory work: the severity of the allegations and the particular alleged source of the conduct or action. Although it is important for the committee to conduct an initial assessment of the anticipated scope of work likely to be necessary to conduct its investigation, any such initial plan needs to be flexible, and revisited and altered periodically as the investigation progresses. Ultimately, the special committee’s work should go where the investigation leads it.

ii. Confirming the Independence and Disinterestedness of the Committee Members and the Authority of the Committee Obviously, the directors chosen to serve on an investigative committee should be disinterested and independent. Although by this stage the directors of the investigative committee have already been chosen, the disinterestedness and independence of the committee members should be confirmed by counsel to the special committee before the substantive work of the committee begins. In addition, as the investigative work progresses, both the special committee members and its counsel should remain watchful for any unexpected developments or thrust-upon conflicts arising during the investigation that could call into question the independence or disinterestedness of the committee members. Truly independent and disinterested members of the committee will not have been involved in any capacity related to alleged wrongdoing and have no personal interest in the results of the investigation.1 At the same time that the committee confirms its independence, it should, together with its counsel, confirm that it has appropriate authority pursuant to the board resolutions through which it was established. If the board resolutions are not broad enough to encompass what the investigative committee plans to do, then the committee should promptly seek an expansion of its authority under the resolutions or, alternatively, narrow the scope of its work to conform to the authorizing resolutions. Also, as with everything else, the issue of whether the committee has sufficiently broad authority to do its job needs to be reassessed as the investigative work progresses. To the extent that the committee believes its authority is not sufficiently broad, it is often better for the committee to raise and attempt to address this issue at the initial stages. Delineating clear and explicit guidelines for the committee at the outset is vital because of the tendency for tension to arise as the substantive investigative process gets under way.

1

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For an in depth discussion of the standards of independence and disinterestedness required of committee members, see Chapter Three, “Forming the Special Committee.”

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iii. Establishing the Role of Counsel The investigative committee also needs to consider the role that counsel will play in the investigation. As a general matter, experienced counsel will be invaluable to an investigative committee in helping the committee plan and conduct the investigation and reach conclusions once the investigation has been completed. Counsel should also be able to conduct much of the necessary (and often tedious) collection and review of documents and provide substantial assistance in the interviewing of witnesses. In addition to counsel, the committee can also utilize outside experts for necessary guidance on technical issues such as financial, accounting, engineering, and any other disciplines that are needed by the committee to fulfill its function. Nevertheless, ultimately it is the responsibility of the members of the committee to reach conclusions and make decisions on an informed basis. As a practical matter, this means that counsel can be relied on to do much of the time-consuming legwork, but the committee members themselves need to be actively involved in the oversight and execution of the process. For example, counsel will often take the lead in reviewing documents received from the company and third parties, particularly if such documents are voluminous. Once counsel does its initial review, counsel should report back to the committee as to the results of the document review. Thus, the committee and counsel should discuss, among other things, what information was found, what information was not found, whether any new document requests should be made, and whether there are any new potential areas of inquiry that should be pursued. In addition, committee members should be provided and should review key documents relevant to the investigation. With respect to the interview phase of the investigation, the committee must be involved. Typically, counsel will take the lead with most of the interviews conducted. There is nothing problematic with this as interviewing a witness for an investigation is somewhat akin to taking a deposition, which is certainly familiar to experienced counsel. It would be prudent in most situations, however, that one or more committee members participate in the interviews. It is worth the effort for all committee members to participate in interviews, either in person or remotely, to the extent that the interviewees are key persons who are expected to provide very significant information regarding the subject matter of the investigation. Another role that the counsel to an investigative committee typically assumes is the role of corporate secretary for the committee. Outside the committee process, in more ordinary times, the general counsel or other executive of the company often functions as the corporate secretary and is in charge of preparing and maintaining the minutes of board meetings and committee meetings. Given that the special committee is formed to be independent of the regular corporate management structure, however, management should typically not function in the capacity of the corporate secretary for the investigative committee once it begins its work. Rather, counsel to the committee should fulfill this role by taking minutes, having them approved by the committee, and maintaining a minute book.

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iv. Initial Document Requests One of the most important first steps in the investigation process is for the committee, and preferably counsel to the committee, to meet with one or more knowledgeable members of the company’s management to discuss the company’s record-keeping system, document retention and destruction policies, and the most efficient process for locating and retrieving documents once the process is under way. In order to aid the investigative process as well as to have a good record of the committee’s work, it is important that an accurate record be kept of which documents have been collected and reviewed, and the source of such documents. As in litigation, counsel should be attentive to assuring that appropriate sources of electronic documents are preserved and searched. The initial request for relevant documents by the committee should likely be tailored according to the catalyst giving rise to the need for the investigation and the likely sources that will shed light on the status of the situation (i.e., if the catalyst is a demand from a stockholder plaintiff, the requests should be tailored according to the substance of the plaintiff’s claims). The committee should consider any discovery requests (including potential requests) as part of its initial investigation. The committee should also seek information beyond documents in the possession of the company to include relevant documents held by third parties, including law firms and other advisors to the company. Depending on the subject and intensity of the investigation, many of the more standard corporate documents would be a good starting point, including the minutes of board meetings or committee meetings bearing on the subject matter, documents distributed at such meetings, and relevant Securities and Exchange Commission (SEC) filings. Other documents that may prove helpful, particularly in identifying potential witnesses, include press releases, closing binders, due-diligence schedules, and analyst reports. To the extent any of these are in the possession of third parties, counsel could assist the committee in developing clear written requests to the third parties. The general counsel’s staff is often helpful in paving the way for the interaction between outside parties and the committee’s counsel. An appropriately placed request by the general counsel to outside vendors or advisors to the company is often hugely helpful to the committee in assuring the assistance of such parties.

v. Organizing Interviews Following the collection and review of all relevant documents, the next step is to develop a list of persons the committee will seek to interview. The committee or its counsel (often with the assistance of the general counsel’s office) will need to schedule interviews of all pertinent parties, including directors, senior managers, other employees with knowledge of the matters, outside third-party advisors, and other persons with knowledge of the matters. The interviewing process (discussed in Chapter Six, “Getting Down to Work (Investigative Committees)”) can present

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several significant challenges, not the least of which is the voluntary nature of the process.2

vi. Demonstrating Commitment to the Investigation Ultimately, the duty of an investigative committee is “to carefully and open-mindedly investigate the alleged wrongdoing.”3 Therefore, an investigative committee must not start the investigation with any anticipated conclusion or result in mind. Rather, the goal must be to investigate the facts and then let the investigative process run its course based on the facts gathered and objective legal analysis. If an investigative committee takes actions or makes statements calling into question its commitment to investigate carefully and objectively the alleged wrongdoing, the entire work of the committee may be for naught. A good example of such a situation is found in Biondi v. Scrushy,4 which involved a stockholder-initiated derivative action alleging that certain directors of HealthSouth Corporation, including its chairman and then CEO (chief executive officer) Richard Scrushy, sold stock while in the possession of material non-public information. HealthSouth formed a special litigation committee (SLC) to investigate the allegations. The HealthSouth SLC moved to stay the derivative litigation so that the SLC could complete its investigation and decide what course of action HealthSouth should pursue. Although such requests for a stay of litigation are routinely granted under established law, the Delaware Court of Chancery rejected the SLC’s motion to stay. The court was very troubled by a number of potential deficiencies in the SLC process, including, most egregiously, a public statement by the chairman of the SLC vindicating Scrushy before the work of the SLC’s investigation had progressed beyond its initial stages. The court stated: [T]here is one fact alone that would warrant denying a stay and that, in combination with these other factors, makes the denial of a stay an easy call: the public announcement by the SLC’s Chairman . . . of his opinion that the . . . report [prepared by counsel to HealthSouth] vindicated Scrushy. This extraordinary announcement came at a time when the SLC’s own investigation was just getting underway . . . . *** How can the court and the company’s stockholders reasonably repose confidence in an SLC whose Chairman has publicly and prematurely issued statements exculpating

2

3 4

Unlike the government or litigants in a civil action, the committee lacks the legal power to compel recalcitrant third parties to comply with its requests. Absent subpoena power and the enforcement mechanism of contempt, the committee is often dependent upon the corporate relationships with the third parties to secure its documents. Biondi v. Scrushy, 820 A.2d 1148, 1156 (Del. Ch. 2003). Id.

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one of the key company insiders whose conduct is supposed to be impartially investigated by the SLC? The answer is that they cannot.5

The court, therefore, denied the SLC’s motion to stay the derivative litigation. It is critical that an investigative committee be committed to conducting a thorough and objective investigation from the outset if the committee’s work is to be given legal respect. If the committee instead views its function as to attack the allegations in a plaintiff’s complaint of wrongdoing by corporate insiders, then it will not have done its job and its conclusions will not be afforded legal respect.6 Furthermore, if the committee’s work is to be given legal respect, it is important that the investigative committee avoid making any statements or taking any actions during the investigative process that suggest the committee is not committed to conducting a thorough and objective investigation. Subject to disclosure or other obligations that must be addressed by counsel, the typical response of the committee to questions regarding its work or the subjects of the committee’s investigation should almost universally be, “No comment.”

B. TRANSACTIONAL COMMITTEES i. Starting with the End in Mind At the outset of the work of any transactional committee process, it is important for the committee to consider not only what it seeks to achieve through the committee process but also various potential outcomes to the process. We call this “starting with the end in mind” but it could just as easily be called “having a clear understanding of what you’ve set out to do.” Perhaps most important of all is the critical need for committee members to approach the process with an open mind. It is not uncommon for special committee members to have preconceived ideas about where the process will lead, but a typical special committee process often involves many twists and turns, and it will likely be difficult to predict with any certainty where the process will conclude. Avoiding an unduly limited view of the potential outcomes and giving consideration to various alternatives at the outset will help to avoid a deal-focused mentality and will better prepare a committee to address contingencies if they arise. In this regard, the committee should spend time at the outset structuring a process that is most likely to both achieve the committee’s goals as well as mitigate the risks associated with various outcomes. In conceiving of a range of potential outcomes, committee members should understand that the possibility that no transaction will be approved is a potential outcome. In other chapters, we discuss the importance of a committee having the power to say

5 6

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Id. at 1166. See London v. Tyrrell, 2010 WL 877528, at *27 (Del. Ch. Mar. 11, 2010) (denying an SLC’s motion to dismiss a stockholder derivative litigation because of “material questions of fact as to the SLC’s independence, the reasonableness of its investigation, and whether it had reasonable bases for its conclusions”).

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no to any proposed transaction.7 In considering what the committee seeks to accomplish through its work, the power to say no should be taken to heart and the committee should be mindful that, in many cases, the goal of the committee process should not necessarily be to approve any transaction, but only the best transaction; and no transaction in circumstances in which no best transaction is available. If the committee concludes that the corporation’s stockholders would be better served by no transaction taking place relative to any transaction being proposed, the committee should act accordingly to reject a proposed transaction. Put differently, in fulfilling its duties, a special committee must understand that its task is not merely to get the deal done, but instead is to allow a transaction to proceed only if it is, in the honest and objective view of the committee, a favorable transaction for the company and its stockholders.8 There are, of course, circumstances in which the completion of a transaction is vital to the ongoing business of the company—such as a financing transaction for a company in desperate need of cash. In such circumstances, the committee should be appropriately focused on finding the best available deal for the company, which may or may not be the best available deal offered by management or the controlling stockholder.9 To the extent that a committee process results in a transaction for the company, the two questions that the committee will want to feel comfortable answering yes to are the following: (1) Was this transaction in the best interests of the company’s minority stockholders? (2) Did the process employed result in the committee obtaining the best transaction reasonably available to the company and its stockholders? Of course, both questions need to be viewed through the lens of the current circumstances facing a company, and recognition should be given to certain limitations that may exist in the process by virtue of external factors. For example, a company that is in significant financial distress may not have the luxury of unlimited time to consider a transaction and other alternatives. Moreover, certain counterparties may not be able to move with the necessary speed to accomplish a transaction. Additionally, if a party with an effective veto right—e.g., a controlling stockholder—has indicated that it will not vote its shares to support a certain transaction, a committee need not exert energy in furtherance of a futile process.10 However, the committee should ensure that any such limitations are both well founded and well documented in the process. Delaware courts have faulted special committees that have readily acceded to the view that there is only one possible party with which to engage in a transaction (i.e., the management or a large stockholder). The courts have also been less than kind to committees that were unable to conceive of the process ending without a transaction. For example, in In re Loral Space & Communications Inc. Consolidated Litigation,11 a special committee of the board of Loral Space and Communications, Inc. was formed 7 8 9 10

11

See, e.g., Chapter Seven, “Getting Down to Work (Transactional Committees),” Section a, “The Power to Say No and Its Importance.” See Kahn v. Lynch, 638 A.2d at 1120. See In re Loral, 2008 WL 4293781. See McMullin v. Beran, 765 A.2d 910, 920 (Del. 2000) (stating board has no duty to engage in a “futile exercise” in the context of a merger transaction in which a majority stockholder objects to certain alternative transactions). 2008 WL 4293781 (Del. Ch. Sept. 19, 2008). 113

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with the narrow mandate to raise $300 million in equity capital through a transaction with MHR, the company’s controlling stockholder. The Delaware Court of Chancery found that the special committee acceded to these limitations on its scope of authority, despite the fact that there was “no magic to the $300 million figure and that the company’s own financial advisor suggested viable options for raising capital that involved both debt and equity.”12 The special committee then made no effort to see if capital was available on terms better than MHR was offering and rejected expressions of interest by other potential investors who did not indicate an intention to provide the full $300 million. Ultimately, the committee approved an issuance of preferred stock to MHR on less favorable terms to the company than might have been obtained in the open market. In this regard, the Delaware Court of Chancery stated: [T]he Special Committee immediately allowed itself to go down the most dangerous path for anyone dealing with a controlling stockholder—that of believing that its only option was to do a deal with the controller. From the get-go, the Special Committee was pushed by [its CEO] and the [controlling stockholder] to move very rapidly to acquire $300 million in equity capital, leading the Special Committee to believe that time was of the essence. Although the Special Committee’s literal mandate varied over time, substantively the Special Committee was only empowered to consider an equity investment from its [controlling stockholder].13

The court ultimately gave no credence to the special committee process and summarized: Using its effective control, [the controlling stockholder] set in motion a process in which the only option that the Special Committee considered was a deal with the [controlling stockholder] itself. Rather than acting as an effective agent for the public stockholders by aggressively demanding a market check or seeking out better-than-market terms from [the controlling stockholder] in exchange for no market check, the Special Committee gave [the controlling stockholder] terms that were highly favorable to [the controlling stockholder], in comparison to the convertible preferred transactions its own advisor deemed comparable.14

The Loral case highlights the importance of a special committee considering, at the outset, whether the delegation to the committee has effectively narrowed the possible outcomes to the committee process in a manner that will adversely affect the ability of the committee to pursue the best possible transaction on behalf of the company. The committee should be hesitant to accept any charge that unduly limits the process to transactions with the management or a large stockholder. The special committee should also actively test any explicit or implicit limitations (timing, structure, counterparties, etc.) sought to be placed upon it and not simply rely upon the instructions of parties with a differing interest. At the end of a special committee process, a controlling stockholder or members of management ultimately may offer a very attractive transaction for the company, one 12 13 14

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Id., at *1. Id., at *9. Id., at *2.

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that is superior to any available transaction with an unaffiliated third party. In certain circumstances, it is also important for the committee to recognize this possible (if not probable) outcome. Notwithstanding the existence of a special committee, the likelihood of litigation will increase upon entry into any such transaction. In addition, given the conflicts of interest or the involvement of a controlling stockholder, a court will typically apply a less deferential standard of review with respect to the decision to approve the transaction. A committee should not shy away from its task as a result of the often-inevitable prospect of litigation in a conflict transaction. Nevertheless, a committee should be attuned to the likelihood of litigation; it should assume that the court will subject its work to a detailed review and that the plaintiff will be motivated to pick apart and cast doubt on the bona fides of the transaction resulting from the process. Understanding the scrutiny with which conflict transactions are viewed by courts at the outset is helpful in focusing the committee on the need for the process clearly to evidence the bona fides of any conflict transaction through a fair process involving arm’s-length negotiations. Such a process is not only in the best interest of the committee but also will benefit the counterparty in the long run by providing the incentive to put together a transaction that will withstand any legal challenge.

1. Formulating Basic Strategy for Negotiations. Once the special committee has retained advisors, organized itself, and considered potential outcomes, consideration must be given to how the committee intends to handle negotiations. In considering this question, the most important overarching point is that any such negotiations must be designed to replicate arm’s-length bargaining.15 The negotiations need not be a death struggle, but “they should be vigorous and spirited, and provide evidence that the special committee and the parent are not colluding to injure the minority stockholders.”16 In this regard, Delaware courts have viewed adversarial negotiations as evidence that the special committee was able to bargain effectively with the interested party. For example, in Rosenblatt v. Getty Oil Co.,17 the aggressive and highly adversarial position taken by the special committee with respect to the valuation of certain assets was held to “completely support[] a conclusion that [the negotiations] were conducted at arm’s length.”18 Likewise, in In re Triton Group Ltd. Shareholder Litigation,19 the court found that “[t]he special committee’s independence and its aggressiveness in negotiating . . . all belie plaintiff’s claim that the committee members breached their duty of care or loyalty to the minority shareholders.” In In re TransWorld Airlines, Inc. Shareholder Litigation,20 by contrast, the court held that “the special committee did not supply an acceptable surrogate for the energetic, 15

16 17 18 19 20

See, e.g., Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1145 (Del. Ch. 2006) (“To summarize Delaware cases, the goal of the process established by the board of the subsidiary must be to come as close as possible to simulating arm’s-length bargaining with the parent.”). Id. at 1148. 493 A.2d 929, 937 (Del. 1985). Id. at 937. 1991 WL 36471, at *9 (Del. Ch. Feb. 22, 1991), aff’d sub nom. Glinert v. Lord, 604 A.2d 417 (Del. 1991). 1988 WL 111271, at *7 (Del. Ch. Oct. 21, 1988). 115

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informed and aggressive negotiation that one would reasonably expect from an arm’s length adversary” because the special committee was entirely passive, and played no role in the negotiation of the price and terms. Accordingly, at the outset, the special committee’s negotiation strategy should take into account the need for true arm’slength negotiations and the duty of the special committee to represent and protect the company’s minority stockholders. Part of the initial strategy for negotiations should encompass the actions, if any, taken before the committee process begins. Hopefully, it will be the case that no pre-negotiations or other decisions as to the substance of the process will have taken place before the committee was formed. The committee can be at a disadvantage if it is presented, at the outset, with a transaction that has already been negotiated to any material extent among interested parties, or between interested parties and a third party; or appears to chart a specific course for a committee (to the benefit of an interested party). Courts have been wary of validating the committee process in such circumstances. For example, in In re Netsmart Technologies, Inc. Shareholders Litigation,21 the court considered a going-private merger entered into with a private-equity buyer that was negotiated through a special committee process. In finding a reasonable probability of a breach of the board’s Revlon duties in connection with the sale, the court focused upon management’s decision before the formation of the committee to pursue a private-equity merger over a strategic merger, noting that “[b]y the time the Special Committee began its work, the inertial energy of the sale process was already clearly directed at a private equity deal.”22 In In re SS&C Technologies, Inc. Shareholders Litigation,23 the Delaware Court of Chancery declined to approve a settlement of litigation relating to a management-led buyout of the company’s minority stockholders by merger. Before the formation of a special committee, the company’s CEO had engaged in negotiations with the ultimate buyer, and the transaction contemplated the CEO gaining a significant equity interest in the surviving company and a new employment agreement. The committee was given the power to explore alternative transactions and successfully negotiated improvements to the terms initially negotiated by the CEO. Nevertheless, the court remained uncomfortable with the sales process, asking: [D]id [the CEO’s] general agreement to do a deal with [the private equity buyer] make it more difficult for the special committee to attract competing bids, especially from buyers not interested in having [the CEO] own a significant equity interest in the surviving enterprise? And, did [the CEO’s] negotiation of a price range with [the private equity buyer] unfairly impede the special committee in securing the best terms reasonably available?24

21 22 23 24

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924 A.2d 171 (Del. Ch. 2007). Id. at 199. 911 A.2d 816 (Del. Ch. 2006). Id. at 820.

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If actions have been taken before the outset of the committee process that may cause judicial concern, the committee’s basic strategy for negotiations may involve a need to rehabilitate the process by actively reconsidering the initial starting point for the process and not hesitating to change course. Additionally, in such instances, the committee should consider whether it needs to go the extra mile in demonstrating its detailed search for alternative transactions relative to an initial offer proposed in conjunction with interested insiders. Broadly speaking, the basic strategy for negotiations should address two points: (1) how the negotiation process should be structured—e.g., Will the committee be reaching out and having discussions with a wide range of potential counterparties, or will the process be narrowly targeted to a limited number of third parties?; and (2) Who will be handling the negotiations on behalf of the committee? As to the breadth and structure of the process, there is no requirement that the committee engage in a process with limitless bounds. However, the committee should be prepared to defend a decision to engage in a more circumscribed process and, if possible in such circumstances, obtain advice from its independent professional advisors as to concerns related to a wide-ranging canvas of alternative transactions. If there are conflicts of interest among key insiders and it could be argued that the ultimate transaction benefits such parties, a court will often need to be convinced that the purpose of a narrowly-designed process was not to benefit those insiders.25 With respect to the primary party to handle the negotiations, there is some measure of flexibility. The members of the committee need not be directly involved in all negotiations, and it is not unusual for the committee to rely upon its independent advisors to act as the direct participants in most negotiations, under the guidance and direction of the committee. However, the committee should hesitate to permit a party with additional or different interests in the matter to take a lead position in important negotiations without, at a minimum, the direct involvement and oversight by the committee or its advisors. In In re Lear Corp. Shareholder Litigation,26 the court criticized a special committee for delegating to the company CEO the power to negotiate the pricing of a proposed going-private transaction with a third-party purchaser without the participation of the committee representatives or its advisors. The proposed transaction would have provided for continued employment of the CEO and, importantly, secured his retirement benefits and provided him with a cash payment for his equity in the company—at a point closely following the CEO’s negotiations with the company’s board about his retirement benefits and potential liquidity for his stock ownership. The court described the CEO’s status as lead negotiator as “far from ideal and unnecessarily raises concerns about the integrity and skill of those trying to represent Lear’s public investors.”27 Although the court ultimately concluded that the involvement of the CEO in this

25

26 27

See, e.g., Netsmart, 924 A.2d at 177 (finding that plaintiffs had established that the Netsmart board “likely did not have a reasonable basis for failing to undertake any exploration of interest by strategic buyers”). 926 A.2d 94 (Del. Ch. 2007). Id. at 116–17. 117

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manner did not affect “the overall reasonableness” of the sales effort to obtain the highest price for the company, the court enjoined the vote on the transaction until disclosures could be included in the proxy statement as to the CEO’s prior communications with the board about his retirement benefits and his net worth being heavily tied to the value of the company’s equity.28 As the Lear decision demonstrates, a reviewing court will closely scrutinize the parties taking a lead position in negotiations if such parties have additional or differing interests. A decision by a committee to allow an interested party to act as the lead negotiator may be criticized and cause a court to question the decision making or independence of a special committee. As a result, if possible, it is prudent for the committee and its independent advisors to handle negotiations with respect to the important business points. In circumstances in which the committee believes that the CEO or other senior members of management will greatly assist with the negotiations, the committee should be mindful of any conflicts that such parties may have and, at a minimum, ensure that such parties are accompanied by a member of the committee or the committee’s independent advisors in any such negotiations.

2. Keeping in Mind the Ultimate Disclosure When considering the committee process to be employed as to a proposed transaction, including the retention of advisors, the strategy for negotiations, and the differing interests of certain parties in the process, it is often helpful to focus the committee on the potential disclosures that may be required at the conclusion of a committee process. We explore this topic in greater depth in Chapter Seven, “Getting Down to Work (Transactional Committees),” Section e, “Understanding the Required Disclosures of the Committee’s Work.” Two primary categories of disclosures should be kept in mind: disclosures (1) to be made in connection with seeking stockholder approval of a transaction or other stockholder action (e.g., the tendering of stock), and (2) that may need to be made in a litigation setting. The most obvious potential disclosures are those to the stockholders of the company if seeking stockholder approval of a transaction or aspect thereof. No stockholder approval will be necessary if the special committee does not approve a transaction, and certain matters that are delegated to a special committee will not require an ultimate transaction be submitted to the company’s stockholders. Nevertheless, many transactions considered by special committees—particularly transactions involving a potential sale of the company—will need to be submitted to the company’s stockholders if first approved by the special committee (and then the full board). It is prudent for a committee to assume that the conclusion of the committee process may require the company to seek stockholder approval for two reasons. First, the form of a transaction, if any, may be unclear at the beginning of the process. Second, the outcome of a special committee process will always be uncertain at the outset. Under well-settled Delaware law, a company has an obligation to disclose to its stockholders all material information concerning the stockholder decision in question,

28

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Id. at 98.

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whether it be a matter of corporate governance or a corporate transaction.29 As stated by the Delaware Supreme Court, “[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”30 Thus, a fact is material if there is a substantial likelihood that its disclosure would have been viewed by a reasonable stockholder as significantly altering the total mix of available information.31 The threshold employed for materiality is not high because it relates to anything that may implicate real or perceived conflicts of interest. Therefore, the committee should understand that a detailed description of the special committee process may ultimately be set forth in a proxy statement or other disclosure document, potentially subjecting the committee to criticism for perceived defects of the process. Any problematic disclosures related to the conflicts of interest or the process more broadly may also hinder the company’s chances of obtaining any necessary approval for the transaction. In certain circumstances, it may be helpful for counsel to share with the committee sample disclosures from prior transactions to illustrate for committee members the level of detail required in typical deal disclosure documents. In addition to disclosure that may need to be made when soliciting stockholder approval of a transaction, the committee should also be mindful of the potential disclosures to be made in a litigation setting. A conflict of interest transaction is at or near the top of the list of transactions most likely to result in litigation. Among other reasons, such transactions are attractive targets for a plaintiff because complaints filed in conflict transactions are not easily disposed of with the filing of a motion to dismiss given that a court must take as true, for purposes of such motion, all facts pled in the complaint by plaintiffs. If a plaintiff makes allegations as to self-interest or an improper process by interested fiduciaries or a controlling stockholder, a court will be reluctant to dismiss such actions without a closer analysis of the facts revealed through discovery in litigation. As a result, members of a committee should assume that litigation will be filed if a transaction results from the special committee process. If litigation is filed, the committee should assume that discovery taken in such litigation will be wide ranging and will include the discovery of any relevant documents pertaining to the transaction (including email transmissions). Committee members should also understand, at the outset, that they will be called upon to give depositions relating to the committee process and approval. Although there may be a basis, in certain instances, to exclude the production of materials based upon the attorney–client privilege or other applicable privileges or immunities, as discussed in more detail in Chapter Seven, the committee should assume that all communications relating to the transaction may one day be subject to discovery and disclosure in a litigation setting. It is vital for the committee to understand the potential scope of disclosure at the outset. In today’s fast-paced, electronically oriented society, email communications, in particular, have become a treasure trove for a plaintiff’s counsel in any litigation matter. Such communications are often hastily written without thought or concern to 29 30 31

Stroud v. Milliken Enters., Inc., 552 A.2d 476, 480 (Del. 1989) Rosenblatt, 493 A.2d at 944 (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 450 (1976)). Id. 119

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how a party seeking to challenge a transaction might construe or attempt to spin such communications. Parties sending emails may also mistakenly assume, in some cases, that the attorney–client privilege will necessarily apply because an attorney is copied on the transmission. Courts often give such communications great weight, and they can either bolster or, more often, significantly undermine the credibility of a special committee process.32 A well-advised committee understands these issues at the outset. Such potential disclosures highlight the need for arm’s-length bargaining and a committee process that is able to withstand the close scrutiny of a judicial process.

ii. Due Diligence Upon the formation of a special committee, for most companies the decision-making process will depart significantly from the norm. Outside the context of a conflict of interest transaction, a company’s management typically plays the primary role in running a process aimed at considering a transaction, subject to the oversight and guidance of the company’s board. In most instances, management will be working in tandem with the company’s regular outside counsel to negotiate and document any such transactions, as well as to perform any background diligence on such transactions. A special committee process typically will turn the traditional process on its head. At a minimum, the role of corporate management and regular corporate counsel will change from driving the process to supporting the process being driven by the special committee in light of conflicts of interest. Such conflicts may be present for members of management, who will frequently have additional or different interests in a conflict transaction (and may be the parties on the other side of the transaction with interests directly contrary to those of the company’s stockholders). To a lesser extent, similar conflict concerns may exist with respect to the regular outside counsel who, despite not having a direct financial interest in the matter being considered, may have a longterm relationship with members of management or other interested parties and therefore may not be in the best position to provide dispassionate advice. Below, we discuss certain considerations as to corporate management and regular outside counsel for the company as the committee process gets under way.

1. The Role of Management. Corporate management frequently has additional or different interests in a conflict transaction by virtue of, among other things, the terms of existing employment agreements, prospects for future employment following certain transactions, and the potential for equity involvement on the buy-side of a sale transaction. For these reasons, the committee must proceed cautiously as to the extent and manner of management involvement in the process. The level and extent of 32

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See, e.g., Gesoff, 902 A.2d at 1139 (“At the heart of this [negotiation] process was an email exchange between [representative of controlling stockholder] and [corporation and committee counsel] . . . which clearly outlines the manipulative way in which [controlling stockholder] envisioned the negotiation process with the special committee.”).

TRANSACTIONAL COMMITTEES

concern about management’s involvement in various matters will, of course, be dependent upon the particular facts and circumstances and the level of materiality of management’s differing interests. Regardless of the level of conflict of interests among members of management, such parties, by necessity, will play a role in assisting with due diligence in the special committee process. Typically, management will play a significant role in facilitating and assisting with the internal due diligence of the committee and its advisors. The members of the committee and its advisors will be at an informational disadvantage at the outset of the committee process as to internal documents that have been generated by the company in connection with considering a potential transaction or otherwise bear upon the company’s financial condition or other factors implicated in the committee process. Consequently it will be incumbent upon the committee to request, and management to provide, the committee and its advisors with the most up-to-date financial information related to the company, including any current projections by management as to the company’s future performance. Current and historical financial information and best estimates of future financial performance by management are typically vital to the consideration by the committee’s financial advisor of its advice related to a potential transaction and are necessary inputs to accurate financial modeling and considerations as to an advisor’s ability to provide a fairness opinion as to any ultimate transaction. Management should also furnish to the committee and its advisors any other material information known to management that may have a bearing on the financial condition of the company or other matters related to a proposed transaction, including an accurate summary of any information relating to the additional or different interests of management in the transaction, which may not be fully known or appreciated by the committee. At all times, management should act as a resource for the committee in providing information and answering questions of the committee and its advisors in a fully transparent manner. In doing so, management must be willing to set aside its traditional role of leading a process for a transaction on behalf of the company and allowing the committee and its advisors to take over such role. Management may also have an important role to play with respect to facilitating due diligence matters vis-à-vis potential counterparties to a transaction. However, management’s role in external due diligence is one that must be carefully monitored and controlled by the committee. Depending upon the nature of the contemplated transaction, it will typically be very natural for a counterparty to a transaction with the company to seek discussions with and presentations from management as to the company’s business. Management will also frequently play a central role in gathering financial information and other documents that the counterparty will seek to review in connection with its diligence with respect to the company. There is nothing inappropriate about management furnishing necessary information to such parties in connection with a diligence process, as long as the committee and its advisors are actively overseeing such process. The necessity for management to be involved in the diligence process undertaken by a third party must be tempered by concerns regarding conflicts of interest.

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In In re Netsmart Technologies, Inc. Shareholders Litigation,33 the Delaware Court of Chancery criticized the special committee and its advisors for permitting management to take the primary role in facilitating and responding to due diligence requests by potential third party buyers, stating: The Special Committee’s and its advisors’ [let] the due diligence process . . . be driven by management. In easily imagined circumstances, this approach to due diligence could be highly problematic. If management had an incentive to favor a particular bidder (or type of bidder), it could use the due diligence process to its advantage, by using different body language and verbal emphasis with different bidders. “She’s fine” can mean different things depending on how it is said. One obvious reason for concern is the possibility that some bidders might desire to retain existing management or to provide them with future incentives while others might not. In this respect, the Netsmart Special Committee was less than ideally engaged. [The CEO] was left unattended to bandy such issues around with the invited bidders.34

Accordingly, if management has personal incentives to favor a particular counterparty or group of counterparties, the committee should set up a structure to ensure that the committee’s advisors are included on any correspondence with respect to materials provided to third parties and, more importantly, make certain that the committee’s advisors (or even the committee itself) have a representative present during material due diligence discussions. Management should also be instructed, at the outset, that it is not appropriate to discuss potential future employment arrangements or similar issues with any third parties during the due diligence process and that any such discussions will need to wait until key financial terms are agreed with a counterparty. If a third party presses the issue of management retention at the outset or preconditions its willingness to submit a proposal on reaching agreements with management, the special committee should resist this, if possible, and, if it is ultimately determined to be prudent to allow such discussions, the committee should assure that any such discussions take place with a committee advisor present and should progress to the minimum extent necessary to satisfy the demands of such third party. In summary, there is an important role for corporate management to play in assisting with due diligence in a special committee process. In general, that role is as a resource for the committee and to assist in addressing diligence requests from potential counterparties; however, the committee needs to assure that the interaction between management and potential counterparties is directly overseen by members of the committee or its advisors. In this regard, it should be a standard operating procedure for the committee’s financial advisors to be copied on any information transmitted by management to bidders with respect to diligence matters and to be present for diligence discussions involving management and third parties as appropriate.

2. The Role of Traditional Outside Counsel. At the commencement of a special committee process, the traditional outside counsel to the company should play the role of 33 34

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924 A.2d 171 (Del. Ch. 2007). Id. at 194.

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facilitator of and advocate for the special committee process and act as a resource with respect to due diligence matters. Regular outside counsel plays a central role both with respect to due-diligence matters at the inception of the committee process as well as on a going-forward basis. Given outside counsel’s knowledge of the company’s business and operations, often including knowledge of significant contracts to which the company is a party, regular outside counsel will be able to assist management in identifying any necessary background documents to be furnished to the committee and its advisors. In addition, regular outside counsel typically will be very knowledgeable as to regulatory issues, federal securities law issues, and other company-specific legal issues, and can greatly assist the committee and its advisors in identifying any gating issues in connection with particular transactions being contemplated, as well as complications that could arise for the company under existing contracts, securities laws, or from a regulatory standpoint. Moreover, because regular outside counsel rarely has the same direct level of conflict of interest attributable to certain members of management, there is typically less concern that the involvement of such counsel would taint the process. As matters progress through the special committee process, and as discussed in more detail in Chapter Nine, “Negotiating the Transaction Documents,” regular outside counsel typically will continue to play an active role in facilitating due diligence matters related to the company, providing advice related to matters within their expertise, and helping to act as a buffer between the committee and interested parties. Regular outside counsel should also strive to be supportive of a committee process, recognizing that a typical committee process is often more time consuming, costly, and disruptive than the management of the company may anticipate.

iii. Case Study: Stacking the Deck FACTS

The chairman, CEO, and 52 percent stockholder (through an affiliated entity) of a publicly traded company determine to negotiate a two-step going-private transaction with the company. In connection with such negotiations, the target company appoints a special committee of three independent directors to consider the transaction, and the special committee retains independent legal and financial advisors. Notably, however, the legal and financial advisors recently utilized by a prior special committee and the company in connection with a different transaction are co-opted by the CEO to act on his behalf in connection with the proposed going- private transaction and are thus not available to the committee. Armed with new advisors largely unfamiliar with the company, the special committee sets out on its task. In connection with the financial analysis undertaken by the special committee, the financial advisor seeks and is provided with projections created in March that had been prepared by the company’s then CFO (chief financial officer). At the same time, however, projections from June forecasting substantially higher growth than the March projections also exist. Although the June projections are made available to the CEO’s legal advisor, financial advisor, and lender, the then CFO, based upon instructions from the CEO, does not furnish the June projections to the 123

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special committee’s advisors. The June projections are also not disclosed in the disclosure documents soliciting stockholders to tender their shares. A transaction is ultimately negotiated between the special committee and the CEO. Shortly after public announcement of the transaction, a fiduciary duty lawsuit as well as an appraisal action are filed against the transaction. The Delaware Court of Chancery finds that the failure to disclose the June projections in the company’s disclosure documents was a breach of the duty of disclosure. In addition, the court finds that the failure of the CEO to disclose the June projections to the special committee (along with, among other things, the company’s prior advisors now aligning themselves with the controlling stockholder and working contrary to the interests of the minority stockholders) evidenced an unfair process that would not withstand entire fairness scrutiny.35 Substantial damages are awarded. ANALYSIS

The foregoing facts and judicial result evidence some fairly obvious principles (i.e., that it is wrong to withhold material information from the special committee and stockholders), but also highlight a broader judicial concern as to the need for the special committee not to be at any informational disadvantage when considering a transaction. This need for equality of information imposes an affirmative burden on management as well as a controlling stockholder to disclose corporate information in its possession that may be material to the special committee process. In addition, the special committee’s advisors should be diligent in obtaining assurances from management and other interested parties that all relevant information has been provided. Though it should go without saying, the active concealment of material information from the special committee will likely result, in and of itself, in a Delaware court finding breaches of fiduciary duties among the complicit parties and otherwise serve to significantly decrease the likelihood of a Delaware court upholding the transaction in question. Simply stated, a court of equity will be loathe to endorse a transaction if an interested fiduciary actively concealed material information to its benefit. The foregoing facts demonstrate that a court will also look beyond the obvious and most troublesome facts creating an informational disadvantage (i.e., concealment) to more subtle disadvantages involving the use of professional advisors. There was no question that the advisors retained by the special committee in this case were competent and well qualified to do their job. Clearly, however, it troubled the court that the advisors with the greatest historical knowledge of and involvement with the company switched sides to use that knowledge to benefit the controlling stockholder in negotiating against the company and its minority stockholders. In such circumstances, the historical advisors to the company should either remain as advisors to the company or not be involved at all—and a special committee should properly object to historical corporate advisors acting in a manner adverse to the company in these types of matters.

35

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This case study is drawn directly from In re Emerging Commc’ns, Inc. S’holders Litig., 2004 WL 1305745 (Del. Ch. May 3, 2004).

Chapter 6

Getting Down to Work (Investigative Committees)

Once the investigative committee has completed the initial organizational tasks— including confirming the scope of the committee’s authority, engaging counsel, coming up with a game plan, and sending out initial document requests—the committee is then ready to begin its substantive work. The substantive work of an investigative committee involves, among other things, conducting the investigation and setting forth the committee’s findings and conclusions in a final written report. We discuss the preparation of the written report in Chapter Eight, “Drafting the Forensic Committee’s Report.” In this chapter, we discuss the fact-gathering phase of the committee’s work. Facts are typically gathered through the review of documents and interviews of persons with relevant knowledge. Document review is a critically important, but relatively straightforward, part of the investigative committee’s work. The interview phase of the committee’s work, however, is fraught with numerous issues and considerations, including considerations relating to being able to assert and maintain legal privileges with respect to the committee’s work. Privilege issues should be a major consideration for the committee that determines how to structure and conduct its investigation. Therefore, in this chapter we first briefly discuss general privilege issues.

A. ISSUES AND CONSIDERATIONS REGARDING LEGAL PRIVILEGES It is important for the investigative committee carefully to consider privilege issues (such as attorney–client privilege and attorney work product immunity) at the outset and to take steps to maximize the chances that the committee will be able to assert the privilege if it so chooses once the investigation has been concluded. It is certainly possible that, at the conclusion of the investigation, the committee or the company could decide to disclose the committee’s report, thus arguably waiving privilege. Nevertheless, such a disclosure should only result from an exercise of discretion by the committee; it should not result from an action that the committee is forced to take as 125

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a result of the failure to preserve the privilege during the investigative process. In order to take the steps needed to protect the committee’s ability to claim privilege, a basic understanding of potentially applicable privileges is needed. We next briefly summarize what are commonly referred to as the attorney–client privilege, the work product doctrine, and the joint defense privilege. We then discuss steps that the committee and counsel should take from the beginning of the process to preserve these privileges during the course of their work.

i. The Attorney–Client Privilege The attorney–client privilege is intended to encourage full and frank communication between clients and their attorneys. As a general matter, the party seeking to invoke the privilege bears the burden of establishing its existence. A commonly used standard for attorney–client privilege is as follows: A client has a privilege to refuse to disclose and to prevent any other person from disclosing confidential communications made for the purpose of facilitating the rendition of professional legal services to the client between the client or the client’s representative and the client’s lawyer or the lawyer’s representative.

The privilege may be claimed by the client or a representative of a company, association, or other organization. Communication has been defined to include any means by which information or thought is conveyed from one person to another. A communication is confidential if it is not intended to be disclosed to third persons other than those to whom disclosure is made in: (1) furtherance of the rendition of professional legal services to the client, or (2) the transmission of the communication, as is reasonably necessary. The client must also specifically designate the communication as confidential or transmit it under circumstances that could reasonably be assumed to include confidentiality. Documents are another form of communication covered by the attorney–client privilege. In order for documents to be privileged, they must be delivered to an attorney with the purpose of getting legal advice or constitute that advice. Not all statements made by or to a lawyer are protected. Rather, in order to be privileged, communications must be made for the purpose of facilitating the rendition of professional legal services to the client. Furthermore, although the privilege protects communications, it does not protect facts from discovery, even if the exclusive source of a witness’s knowledge of those facts is the client’s attorney. Likewise, the attorney– client privilege protects legal advice, as opposed to business or personal advice. Merely having an attorney present while business strategies are being discussed will not be enough to sustain the privilege. Instead, a court will seek to determine whether the statements sought to be protected were made for the primary purpose of facilitating legal services.1 1

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In a stockholder action, attorney–client privilege is not absolute and, if the legal advice relates to a matter that becomes the subject of a suit by a stockholder against the corporation, the

ISSUES AND CONSIDERATIONS REGARDING LEGAL PRIVILEGES

ii. The Work Product Doctrine Many investigations conducted by investigative committees relate to matters that are or could be the subject of civil or criminal litigation. Therefore, some of the committee’s work could be protected under the work product privilege.2 As a general matter, to qualify as work product, material must be (1) documents and tangible things; (2) prepared in anticipation of litigation or for trial; and (3) prepared by or for another party or by or for that other party’s representative. Substantively, the work product doctrine protects fact-gathering in anticipation of litigation and strategy or tactical advice concerning pending or anticipated litigation. Courts typically do not require the existence of an actual pending lawsuit, but only that materials be written specifically in preparation for threatened or anticipated litigation. The work product doctrine is embodied in the rules of civil procedure. Under the Federal Rules of Civil Procedure (FRCP), Rule 26(b)(3) provides, in pertinent part, as follows: Trial Preparation: Materials. (A) Documents and Tangible Things. Ordinarily, a party may not discover documents and tangible things that are prepared in anticipation of litigation or for trial by or for another party or its representative (including the other party’s attorney, consultant, surety, indemnitor, insurer, or agent). But, subject to Rule 26(b)(4), those materials may be discovered if:

(i) they are otherwise discoverable under Rule 26(b)(1); and

(ii) the party shows that it has substantial need for the materials to prepare its case and cannot, without undue hardship, obtain their substantial equivalent by other means. (B) Protection Against Disclosure. If the court orders discovery of those materials, it must protect against disclosure of the mental impressions, conclusions, opinions, or legal theories of a party’s attorney or other representative concerning the litigation.3

At the outset, therefore, in order to qualify under the work product privilege, materials must be written in preparation for threatened or anticipated litigation. The question of whether a document was prepared in anticipation of litigation is a highly factual question. As Chancellor William T. Allen of the Delaware Court of Chancery observed on this subject: In order to determine whether documents produced prior to the commencement of litigation were produced “in anticipation of litigation” under [Rule 26(b)(3)], one

2

3

invocation of the privilege may be restricted or denied entirely. See infra Chapter Eleven, “Controlling Fallout from the Committee Process.” What is commonly referred to here and elsewhere as the work product privilege is not really a privilege, but technically an immunity. We nevertheless use the commonly used term work product privilege. Fed. R. Civ. P. 26(b)(3). 127

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may ask first, do the documents reflect the collection of information with respect to historical fact relating to a potential claim that is actually considered in connection with that research activity. Documents satisfying this test (e.g., witness statement) would represent a paradigm instance of documents created in anticipation of litigation. If documents do not meet this gathering-of-historical-fact test standard, they still may qualify as being created in anticipation of litigation, but they are likely to do so only if they directly reflect consideration of legal strategies, tactics or theories of foreseen future litigation.4

Traditionally, work product has been split into two categories: factual and opinion work product. Factual work product includes those materials prepared for litigation that reflect solely the gathering of facts surrounding the events giving rise to the action. Opinion work product includes mental impressions, opinions, legal theories, or those materials that reveal an attorney’s thought processes or trial strategy. Under this line of analysis, factual work product is subject to discovery if the moving party could demonstrate a substantial need for the materials or the inability without undue hardship to obtain the substantial equivalent of the protected work. On the other hand, opinion work product, since it represents traditionally sacrosanct attorney mental impressions, is absolutely protected and, as some courts have held, could never be subject to discovery.5 Other courts, such as the Delaware Supreme Court, however, have rejected the idea of absolute protection for opinion work product.6

iii. The Joint Defense Privilege The work of an investigative committee will involve gathering facts from employees of the company and perhaps even third parties. If one or more employees or other third parties have their own separate counsel, it is worthwhile to consider whether steps should be taken to facilitate and preserve the ability to later assert the joint defense privilege. The joint defense privilege is not a separate privilege from the attorney– client privilege, but merely an extension.7 The joint defense privilege acts to protect parties who share a common interest as they share information. Though not absolute, the rule provides protection for privileged material that needs to be shared, as long as the material has not been compromised by partial disclosure or deemed by the court to be necessary in the interests of justice. Both state and federal courts generally recognize and apply the common interest or joint defense doctrine. The person asserting the privilege must show that (1) the 4 5

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Carlton Invs. v. TLC Beatrice Int’l Hldg’s., Inc., 1996 WL 535407, at *3 (Del. Ch. Sept. 17, 1996). See 8 Wright & Miller, Federal Practice and Procedure § 2026, at 398–401 (2d ed. 2009); see Fed. R. Civ. P. 26(b)(3) (court “must protect against disclosure of the mental impressions, conclusions, opinions, or legal theories of a party’s attorney or other representative concerning the litigation”). See Tackett v. State Farm Fire & Cas. Ins. Co., 653 A.2d 254, 262 (Del. 1995). E.g., Katz v. AT&T Corp., 191 F.R.D. 433, 436 (E.D. Pa. 2000) (“The common interest doctrine does not create an independent privilege, but depends upon a proper showing of the other elements of the attorney–client privilege.”)

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communications were made in the course of a joint defense effort; (2) the statements were designed to further the effort; and (3) the privilege has not been waived. In order for the common interest doctrine to apply, the parties must have an identity or community of interest. A community of interest exists if different persons or entities have a substantially similar legal interest with respect to the subject matter of a communication between an attorney and client concerning legal advice.8 If the parties (1) believe that they share certain common interests concerning the subject matter of the investigation and it is in the joint interests of the parties to share certain documents, factual material, mental impressions, memoranda, interview reports, litigation strategies, and other information, and (2) wish to enhance their ability to assert that their sharing of such information does not somehow waive the attorney– client privilege, they should consider entering into a formal joint defense agreement that lays out the rights, obligations, and expectations of the parties with respect to their mutual cooperation and sharing of information. Nevertheless, the special committee and its counsel should understand that the applicability of the joint defense privilege is not nearly as reliable as the attorney–client privilege and should proceed accordingly.

B. STEPS TO PRESERVE PRIVILEGE At the outset, counsel should advise the committee members generally with respect to parameters of potential applicable privileges and steps that can be taken to maintain the privilege. Counsel should also consider any particular privilege issues likely to arise given the nature and expected scope of the investigation and tailor the investigation process taking into consideration such issues. In addition, counsel should confirm in writing to the committee (and perhaps also to the company) that counsel is being engaged to assist the committee in its investigation and give legal advice to the committee regarding the investigation process, the subject matter of the investigation, and legal rights and obligations relating thereto, and that all communications with counsel are intended to be confidential and subject to the protections of the attorney–client privilege. This will help confirm that the purpose of counsel’s involvement is to provide legal advice and not just merely to gather facts and provide business advice. Although it may seem overly simplistic, counsel also needs to impress upon committee members the importance of confidentiality during the investigation. Basic points like not sharing the committee’s work product or advice should be stressed. Committee members should understand that the embargo on sharing information and advice extends to the management of the company and non-committee directors who may be deemed not to share a sufficient common interest with the committee, depending upon the circumstances. Even inadvertent disclosure by a member of the committee or its counsel could result in the waiver of privilege. 8

E.g., Union Carbide v. Dow Chem. Co., 619 F. Supp. 1036, 1047 (D. Del. 1985) (“Third party communications do, however, retain a protective shield if the parties have a common legal interest, such as where they are co-defendants or are involved in or anticipate joint litigation.”). 129

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Also, in an effort to maintain the confidentiality of the process, the committee should instruct and encourage any persons interviewed during the investigation not to discuss the interview with others.9 Moreover, all documents, memoranda, and other confidential materials generated by the committee and/or its counsel containing legal advice should be labeled as confidential and privileged, and disseminated only internally with the committee and its counsel. To the extent that outside consultants are needed to assist in the investigation, it is often best to have those consultants retained through counsel to the committee for the purpose of assisting counsel in rendering legal advice to the committee. Although these and other steps geared to preserve the ability to assert privilege should be taken, the bottom line is that the committee and its counsel should operate throughout the process with an expectation that their work and their communications will become discoverable. Given the nature of an investigative committee’s work and the potential for subsequent litigation or proceedings, in many situations one of the following will occur: (1) the committee or the company will voluntarily waive the privilege; (2) there will be deemed to have been a waiver of the privilege that was not intended by the committee or the company; or (3) discovery will be permitted despite the fact that the privilege may be applicable. In light of this reality, the committee and its counsel should proceed with the expectation that their work, including even internal communications among just the committee members and/or counsel, will be subject to discovery. Therefore, as a general guideline, committee members should try to avoid taking notes at committee meetings or during interviews. Rather, a designated person, preferably counsel to the committee, should be tasked with taking notes and preparing minutes of meetings and summaries of interviews. In addition, although the work of the investigative committee is still ongoing, substantive matters are best addressed through either telephonic conference calls or in-person meetings. It is always a good idea to avoid discussing substantive matters on a back and forth basis through emails or other written communications that later become subject to discovery.

C. REVIEWING THE RELEVANT DOCUMENTS Once the committee has acquired the documents initially requested, the documents need to be carefully reviewed. In an investigation, documents are a necessary part of understanding what might have happened, although documents alone rarely tell the full story. Investigations will typically involve many thousands, if not millions, of

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Some courts have held that communications with non-senior members of management are not privileged. Consequently, there is a risk that interviews with mid-level or lower-level employees of the corporation will not be privileged. Given this, the committee needs to decide whether to seek information in interviews from lower-level employees (those who are not in a position to control or be substantially involved in a decision about any action that the corporation may take upon the advice of the attorney) and risk waiving privilege, or to proceed without the full factual background if privilege is to be maintained.

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pages of documents. Nevertheless, the review of the documents is an important part of the process and a thorough review is necessary. The major objectives of the review process should be: (1) to ensure a comprehensive review; (2) identify what other documents may need to be reviewed before proceeding to the interview phase of the investigation; (3) preserve the integrity of the original documents; (4) if need be, protect all applicable privileges; and (5) conduct the review with as minimal disruption to the company’s business as practicable.10 The document review process is vital to ensuring that the next stages of the investigation, including primarily interviews of persons who may have relevant knowledge, can be done effectively. Upon substantial completion of the document review, a relatively small and manageable set of key documents (or hot documents) should be put together and provided to the committee members. In conjunction with putting together the hot document binders, it often makes sense to prepare a chronology of events. A chronology is a good way to familiarize oneself with the sequence of events and should be updated to incorporate facts learned during the interviews as well. The gathering and review of relevant documents is a critical part of the investigation, as the committee cannot rely on interviews alone to conduct its investigation. After all, investigations are typically done if there is alleged noncompliance or wrongdoing by someone within the company, and many employees of the company will be reluctant to supply information voluntarily that may implicate one of their fellow employees. In addition, some interviewees may be too intimidated to share the whole truth. In light of these realities, knowledge of the appropriate documents is key for the interviewers in eliciting and reviewing the interviewees’ responses. The use of selected documents in the interview process often will facilitate the ability of a committee to conduct an effective interview. This means that the committee and its counsel will need a good working knowledge of the key documents prior to conducting interviews.

D. FACT GATHERING FROM PERSONS WITH RELEVANT INFORMATION In addition to reviewing relevant existing documents, an investigative committee will also want to gather data from persons with knowledge with respect to the subject matter of the investigation. This stage of the process is extremely important, as there is almost always important information that cannot be gleaned from a mere review of documents. Once the document production and review is complete (or at least substantially complete), the committee will be in a position to identify an initial list of persons who should be approached as part of the committee’s fact-gathering process. Depending on the scope and nature of the investigation, this could range anywhere from gathering information from one or two persons to a comprehensive and involved process that involves the interviews of many persons. In determining how to go about this 10

See generally Larry A. Gaydos, Gathering and Organizing Relevant Documents: An Essential Task in Any Investigation, in INTERNAL CORPORATE INVESTIGATIONS (Brian & McNeil eds., ABA 1992). 131

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stage of the fact-gathering process, the primary consideration is the thoroughness and effectiveness of the process. A legitimate secondary consideration can include the administrative burden, cost, and overall efficiency of the process. The committee will need to reach some balance with respect to these (sometimes competing) considerations. Facts from knowledgeable persons can be gathered in different ways, such as through a written questionnaire or through an interview. An interview could be conducted telephonically or in person. In most situations, an in-person interview is more effective for fact-gathering purposes than a written questionnaire. An interviewee is likely to be more forthcoming in being interviewed than in filling out a written questionnaire. Also, when conducting an in-person interview, the interviewer will get constant feedback from the interviewee (visual cues, voice inflection, etc.) that may assist the interviewer. The interview permits the opportunity to ask follow-up questions based on the responses and other feedback provided by the interviewee. In addition, as is discussed later in this chapter, notes taken by counsel to the committee in an interview likely will be subject to greater protection in litigation discovery than responses to written questionnaires. Therefore, in most situations, an in-person interview conducted with the assistance of experienced counsel will be the best way to gather facts for an investigation. On the other hand, depending on the nature and scope of the investigation, it simply may not be feasible or rational (in terms of time, cost, or administrative burden) to conduct an in-person interview of each potentially person from whom the committee wants to gather data. In such situations, it may make sense to implement a hybrid approach. For example, arrangements could be made to set up in-person interviews with persons who the committee knows will have or are expected to have important information. Other persons who are not expected to have important information but may have relevant information could be provided written questionnaires. Alternatively, such persons could be contacted telephonically for initial interviews to determine the extent of their knowledge of or involvement in the relevant matters. If it appears, based on the written questionnaire or the initial telephone discussion, that any additional persons have key information, then in-person interviews could be arranged for these persons as well. There are obviously many different ways to set up the fact-gathering process, and each investigation will have its own unique set of considerations to take into account. Nevertheless, the guiding principle needs to be that the fact-gathering process is geared to pursuing all leads and to the committee doing its job in a thorough and effective fashion.11 As long as the thoroughness and effectiveness of the committee’s process is not compromised, the committee is free to take into account other considerations such as cost, time, and administrative burden. In most situations, a hybrid approach is adopted.

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See London, 2010 WL 877528, at *17 (“[B]efore an SLC decides not to explore specific acts of alleged misconduct because the costs of a full investigation outweigh any harm that may been caused by those specific acts, the SLC should carefully analyze whether a summary investigation of those specific acts could shed light on the more serious allegations in the plaintiffs’ complaint. A total failure to explore the less serious allegations in plaintiffs’ complaint may cast doubt on the reasonableness and good faith of an SLC’s investigation when exploring those less serious allegations, at least in summary fashion, would have helped the SLC gain a full understanding of the more serious allegations in plaintiffs’ complaint.”).

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Key persons are interviewed in person while information is gathered through telephone discussions or written questionnaires from a larger group of non-key witnesses.

i. Identifying Interviewees and Conducting the Interviews It is almost certain that the alleged wrongdoers will be among those the committee will want to interview. The number and identity of the other interviewees will necessarily depend upon the nature of the problems investigated and the need for additional information or explanation. The committee should exercise discretion in deciding who to interview, including possible consideration of balancing between the need for additional explanation versus causing additional distraction. Witness interviews are a very important part of an investigative committee’s process. The interview process will enable the committee not only to gather facts relevant to its investigation, but also to assess the credibility of the witnesses.12 This may be particularly important if the witness is the alleged wrongdoer who may be subject to subsequent litigation or government investigation. In-person meetings provide the best opportunity to assess demeanor and credibility. Given the importance of the witness interview process, the committee and its counsel should not approach this stage of the process casually. Rather, the committee and its counsel need to be well prepared to conduct the interviews. With respect to the level of preparation that is needed, a witness interview should be approached in the same fashion as a deposition. This means that interviews should not be scheduled too early in the process. Rather, they should be conducted after a review of the relevant documents has been completed and the key legal and factual issues have been considered. Also, the committee should have the assistance of trained and experienced counsel to assist it in conducting interviews of the key witnesses.

ii. Warnings to Non-Client Interviewees At the beginning of each interview, it is vital that the committee interviewer start by explaining the purpose of the interview and whether the interviewee understands how the information they will be providing will be utilized during the committee’s investigation. If counsel to the committee is involved and handling the interview process for the committee, counsel should also begin the interview by explaining that counsel represents the committee during the investigation and not the interviewee, and that the interviewee has the opportunity to have his own counsel present during the interview if he so chooses. The need for these warnings becomes particularly acute if the person being interviewed is an employee of the company. In such situations, an employee may believe that the employee and the company are “on the same side” and that the employee is merely talking with someone that represents the employee as well as the company.

12

In the context of discussing persons being interviewed by the committee, the terms witness and interviewee are used interchangeably to refer to such persons. 133

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To avoid any such potential confusion, it is the responsibility of the committee and its counsel to inform the interviewee up front that, among other things: (1) the counsel represents the committee and not the employee; (2) any information provided by the interviewee to the counsel may be privileged, but it is the committee’s privilege and not the employee’s privilege; and (3) the committee (and not the employee) will decide whether to waive the privilege and whether to share any of the information provided by the employee to third parties.13 The reason for such warnings is to ensure that the company (and not the employee) maintains control of its attorney–client privilege and to uphold the ethical obligation of an attorney to disclose conflicts of interest.14 Although pre-interview warnings should generally include the standard elements described above, the warnings will need to be tailored to the circumstances. For example, if it is quite likely that the company will indeed waive legal privileges with respect to the subject matter of the investigation. If so, a standard warning that “the committee (and not the employee) will decide whether to waive the privilege and whether to share any of the information provided by the employee to third parties,” may arguably be insufficient and expose the company to claims that the witness was not adequately warned as to the likelihood of waiver. Delivering appropriate pre-interview warnings in a clear and unequivocal manner before the interview begins likely will affect the interviewee in a way that will deter 13

See generally Dennis J. Block and Nancy E. Barton, Internal Corporate Investigations: Implications of the Attorney–client Privilege and Work Product Doctrine, in INTERNAL CORPORATE INVESTIGATIONS (Brian & McNeil eds., ABA 1992). Former federal judge Frederick B. Lacey coined the term Adnarim warnings (Miranda spelled backwards) and set them forth, in pertinent part, as follows: I am not your lawyer, I represent the [committee]. It is the [committee]’s interests I have been retained to serve. You are entitled to have your own lawyer. . . You may wish not to talk to me at all. What you tell me, if it relates to the performance of your duties, and is confidential, will be privileged. The privilege, however,. . . is not your privilege to claim. It is the [committee]’s privilege. Thus, not only can I tell, I must tell, others in the corporation what you have told me, if it is necessary to enable me to provide the legal services to the [committee] it has retained me to provide. Moreover, the [committee] can waive its privilege and thus, the president, or I, or someone else, can disclose to the authorities what you tell me if the [committee] decides to waive its privilege. Also, if I find wrongdoing, I am under certain obligations to report it to the Board of Directors and perhaps to the stockholders. . .. Do you understand?

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Brian and McNeil, supra, at 30–31 (remarks by Frederick B. Lacey). Nevertheless, there is no requirement that private companies (in the absence of state action) inform interviewees that they have the right to remain silent given that the Fifth Amendment right against self-incrimination, on which Miranda warnings are based, only apply to government action. See Nuzzo v. Nw. Airlines, Inc., 887 F. Supp. 28 (D. Mass. 1995). See Upjohn Co. v. United States, 449 U.S. 383, 389 (1981). ABA Model Rule 1.13(f) provides that: In dealing with an organization’s directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when the lawyer knows or reasonably should know that the organization’s interests are adverse to those of the constituents with whom the lawyer is dealing. Model Rules of Prof’l Conduct R. 1.13(f).

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the goal of the committee to get as much information as possible in the interview. Such warnings could frighten the interviewee and undermine the willingness to cooperate in the investigation. Nevertheless, such warnings must be given. If the warnings are not given, then there is a real risk that the evidence or information obtained will not be permitted to be used in any legal proceedings.15 In addition, the law firm or counsel involved will likely find itself subject to ethical misconduct charges and subject to disqualification from any further proceedings in the matter.16

iii. Protecting Employees’ Rights The investigative committee’s work will almost always include interviews of employees of the company. In this situation, the committee and its counsel are in a somewhat complicated situation. On the one hand, the committee needs to do its job on behalf of the company to gather facts in determining whether there has been any non-compliance or wrongdoing with respect to the subject matter being investigated by the committee. On the other hand, the rights of employees of the company must be understood and respected. The rights and obligations of employees in the context of internal corporate investigations are not completely clear and can vary greatly depending on the situation and the jurisdiction. Some general observations that are applicable to many situations can be made.17 First, most jurisdictions recognize some level of a duty to cooperate that places a general obligation on an employee to comply with all reasonable instructions from the employer in an internal investigation. A number of states have codified a duty to cooperate that essentially provides that an employee shall substantially comply with all the directions of his employer concerning the service on which he is engaged, except if such obedience is impossible or unlawful, or would impose new and unreasonable burdens upon the employee. Even in states that do not have such a statute, courts often recognize an employee’s duty to cooperate that is inherent in the employer–employee relationship. The employee’s duty to cooperate exists with respect to lawful and reasonable directions from the employer. Therefore, although this rarely is an issue, the committee should be careful not to request employees to take any actions that would be unreasonable. Generally speaking, requesting that an employee appear for an in-person interview conducted by the committee and its counsel will be deemed to be a reasonable request to the extent the subject matter of the interview relates to the matters within the scope of the employment duties of the employee. Second, the employee often will have certain rights that could affect the extent of his obligation. For example, an employee may have contractual, statutory, or other rights that limit the company’s ability to demand full cooperation (i.e., if a union is involved).

15 16 17

See, e.g., United States v. Nicholas & Ruehle, SACR 08-00139-CJC (C.D. Cal. April 1, 2009). See id.; see also E.F. Hutton & Co. v. Brown, 305 F. Supp. 371 (S.D. Tex. 1969). See generally Joseph F. Coyne, Jr. et al., Employees’ Rights and Duties During an Internal Investigation, in INTERNAL CORPORATE INVESTIGATIONS (Brian & McNeil eds., ABA 1992). 135

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Also, it is important that the committee consider whether employees providing information come under the protections of federal or state whistleblower laws. Third, an employee of a private company participating in an internal company investigation does not, as a general matter, have a constitutional right against selfincrimination pursuant to the Fifth Amendment to the United States Constitution.18 As a practical matter, this means that a company may have the legal right to terminate an employee who refuses to cooperate in an internal investigation. Fortunately, although employees are often hesitant to be interviewed by a committee, only infrequently do employees flatly refuse to appear for an interview or to provide any information to the committee. If such a situation were to arise and the committee were to conclude that there is no reasonable basis for the employee to refuse to provide information, then the committee could make a recommendation to the board of directors that the company discharge the employee. Fourth, absent state action or a special statutory right, an employee of a private company participating in an internal investigation does not, as a general matter, have a constitutional right to legal counsel pursuant to the Sixth Amendment to the United States Constitution. Nevertheless, the employee, as an individual, always has the right to consult a personal lawyer. To the extent an employee requests that he have counsel present during the interview, the committee and its counsel should consider such request carefully in light of the circumstances. If there is reason to believe that the employee may be subject to jeopardy (whether in the form of civil litigation, criminal allegations, adverse corporate action, or government investigation), then it may be prudent to advise the employee to retain separate counsel19 and have the employee’s counsel present during the interview. Even if the employee is not believed to be in jeopardy, once an employee makes a request to have his own counsel attend the interview, the committee should grant such request unless there are substantive reasons not to. A related issue that is usually of significant interest to the employee is whether the company will reimburse the employee for the costs of the employee’s counsel. The employee may have a right to reimbursement (or indemnification or advancement) under applicable laws or the company’s governing documents. Alternatively, the company may have the discretion to determine whether to reimburse the employee’s legal costs.20 18

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Government employees, on the other hand, do have a right against being faced with selfincrimination and termination. See Garrity v. New Jersey, 385 U.S. 493 (1967). If the private corporation is a government-regulated entity or there is some other aspect of government or state action with respect to the investigation, then whether an employee has a constitutional right against self-incrimination will have to be carefully considered. The comments to the Model Rules of Professional Conduct provide: There are times when the organization’s interest may be or become adverse to those of one or more of its constituents. In such circumstances the lawyer should advise any constituent. . . that the lawyer cannot represent such constituent, and that such person may wish to obtain independent representation. . . . Whether such a warning should be given by the lawyer for the organization to any constituent individual may turn on the facts of each case. Model Rules of Prof’l Conduct R. 1.13 (Comments 10 and 11). In January 2003, the Department of Justice released its Principles of Federal Prosecution of Business Organizations, which is better known as the Thompson Memorandum. The Thompson Memorandum set forth guidelines for federal prosecutors in determining whether to indict and

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Given the rights of employees, counsel to the committee should consider these and other related issues carefully prior to conducting interviews of employees so as not to expose the company to litigation or other allegations of wrongdoing. Although the rights of employees need to be kept in mind, such rights should not distract the committee from its task to conduct a thorough and effective investigation.

iv. Methods of Recording Interviews The method by which the interviews will be recorded should be determined according to the demands and expectations of each particular investigation. One important consideration for the committee is to conduct the interviews in a manner that facilitates a full and free flow of information. Thus, it is rarely a good idea to record interviews on tape, videotape them, or conduct them before a court reporter. Doing so tends to

prosecute a corporation. The Thompson Memorandum provided, among other things, that decisions by a corporation to advance legal fees to employees may be taken into account in determining whether the corporation should receive credit for cooperating with a government investigation. The Thompson Memorandum significantly complicated the decision of a corporation as to whether to advance legal fees to employees (or reimburse such legal fees) and raised the specter of “state” action with respect to the decisions of private employers. In United States v. Stein, 435 F. Supp. 2d 330 (S.D.N.Y. 2006), thirteen former KPMG partners and employees moved to dismiss criminal indictments against them on the grounds that, among other things, the government’s actions violated their rights to due process under the Fifth Amendment and their right to counsel under the Sixth Amendment. This dispute arose out of a government investigation into allegedly abusive tax shelters and an audit of KPMG. The individuals alleged that pursuant to the Thompson Memorandum, government prosecutors made clear to KPMG that its decision to advance legal fees to the individuals would not be looked upon favorably. Allegedly in response to this pressure, KPMG placed restrictions on the advancement of legal fees to the individuals (including putting a cap on the amounts advanced and disallowing certain requests for advancement) in an effort to satisfy the federal guidelines for cooperation and, thereby, potentially avoid a criminal indictment of KPMG. Despite the fact that KPMG was a private employer, the court held that the government’s actions infringed on the individuals’ Sixth Amendment right to counsel. The court stated: The government here acted with the purpose of minimizing these defendants’ access to resources necessary to mount their defenses or, at least, in reckless disregard that this would be the likely result of its actions. In these circumstances, it is not unfair to hold it accountable.

Id. at 366–67. On appeal, the U.S. Court of Appeals for the Second Circuit affirmed the trial court’s decision and again rejected the government’s argument that KPMG’s advancement decisions involved private action outside the scope of the Sixth Amendment. United States v. Stein, 541 F.3d 130 (2d Cir. 2008). The Second Circuit held that KPMG’s policy on advancement followed as a direct consequence of the government’s overwhelming influence and therefore amounted to state action. The guidelines set forth in the Thompson Memorandum were subsequently revised to virtually prohibit federal prosecutors, in determining whether a corporation should receive credit for cooperating with a government investigation, from considering whether the corporation pays or advances its employees’ legal fees. 137

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hinder a free flow of information. Likewise, such contemporaneous recordings may become discoverable later. By contrast, it is often helpful to the process for interviewers simply to rely on taking notes during the interviews, as this may ease any apprehension or disinclination to speak freely an interviewee may have during the interview. For this same reason, it may prove beneficial to locate the interviews where the interviewees would feel comfortable and not distracted by work. Privilege issues are another very important set of considerations in determining how to record interviews. Depending on the circumstances, the work of the committee and its counsel in the fact-gathering process (including with respect to interviews) might be subject to protection under the work product doctrine. Videos or transcripts of a witness interview, and responses to written questionnaires or written witness statements, are likely to be classified as factual work product. On the other hand, notes taken by counsel to memorialize an interview and a memorandum summarizing the interview prepared by counsel based on such notes are likely to constitute opinion work product. Although both factual work product and opinion work product are often protected from discovery, there are significant differences in the discoverability of factual work product as opposed to opinion work product. Although there is disagreement among the courts as to whether opinion work product is absolutely privileged, even those courts that do not recognize an absolute privilege recognize that a higher burden must be met to discover opinion work product as opposed to factual work product. As the United States Supreme Court noted in Upjohn Co. v. United States, “[f]orcing an attorney to disclose notes and memoranda of witnesses’ oral statements is particularly disfavored because it tends to reveal a lawyer’s mental processes.”21 The lawyer taking notes should take care to intersperse within such notes the impressions, analysis, and opinions of counsel with respect to the interview. This will make such notes clearly opinion work product and help avoid a conclusion that the lawyer was merely acting as a scrivener and, therefore, the lawyer’s notes should not constitute opinion work product.22 Following the interview, counsel should prepare a memorandum summarizing the interview. To maximize the chances that such a memorandum will be deemed to be privileged, the memorandum should include the lawyer’s mental impressions, analysis, and opinions.23

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449 U.S. 383, 401 (1981); see Ryan v. Gifford, 2007 WL 4259557, at *16 (Del. Ch. Nov. 30, 2007) (noting that court will not order production of attorney notes of interviews and “risk erosion of the work product doctrine, particularly if the notes are indeed opinion work product”). See Ryan, 2007 WL 4259559, at *16 (ordering that attorney notes of interviews be made available for in camera inspection to determine if they are indeed opinion work product subject to protection). In addition, the memorandum should also reflect that the interviewee: (1) was asked to keep the subject matter of the discussion confidential; (2) was told that the committee has sought legal advice from counsel and the interview is being conducted to enable counsel to learn the facts so that it can render legal advice to the committee; and (3) was given warnings at the start of the interview that the counsel is representing the committee and not the interviewee.

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Hence, having counsel take notes of interviews and avoiding recording of such interviews may greatly enhance the possibility of claiming privilege with respect to such materials. In all events, the investigative committee and its counsel should keep the distinction between opinion work product and factual work product in mind as it determines how to record or memorialize witness interviews.

E. DOCUMENTING THE COMMITTEE PROCESS In documenting the committee process, it is important to consider that the investigative committee will be doing significant work and there is a good chance that its work and/ or conclusions may be challenged in some form or other. Therefore, it is critical that the committee be thorough and fulfill its charge. The committee members should actively participate in the investigative process. In addition, the committee should take care to document the process by which it conducts the investigation and reaches its conclusion. The committee should meet as often as necessary to get the job done. The committee may hold its meetings by telephone and the meetings should be held in the same manner as other board meetings, including the recording of the minutes of each meeting. Counsel to the committee should also be responsible for taking minutes of committee meetings. Ideally, a single person will be designated to take notes during the meeting, who would then use those notes to prepare draft minutes. It is best to avoid having multiple people taking notes at committee meetings, as discovery of such notes in subsequent litigation inevitably leads to attempts by plaintiff-litigants to seek to allege internal inconsistencies with respect to the committee’s work and conclusions. There are many schools of thought with respect to the level of detail in minutes. As a general rule, we find ourselves in the long-form minutes school. The reasons for this are several. First, a reviewing court will want to know about the process followed and specifically what inputs the committee had in making decisions, what issues the committee considered, and the reasoning behind the committee’s decisions. Long-form minutes tend to allow the draftsman to cover all these issues in detail, and thus give a reviewing court a higher comfort level that, whatever the result reached by the committee, it was only after careful and detailed consideration of all the issues. Another benefit of long-form minutes is that they serve as an aide memoir for committee members in the event that they are called upon to testify in depositions or court. Minutes that merely recite that “several issues were considered and discussed by the committee” tend not to serve this purpose. Of course, no rule that calls for the exercise of judgment will fail to admit of some exceptions. Undoubtedly, a number of investigations cover topics that are so sensitive that recording them in detail might reasonably be perceived as contrary to the company’s best interests. In general, however, given the role of the reviewing court, we tend to prefer long-form minutes whenever possible. Regardless of whether they are long form or otherwise, minutes should, at a minimum, evidence the process being conducted by the investigative committee, which 139

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likely would include a list of attendees, the length of the meeting, the status of the investigation, the topics discussed or considered, any decisions made, issues that remain to be explored, and the timing for next steps. It often is best to avoid stating any conclusions or theories in minutes if significant work remains to be done by the committee. Also, minutes should be carefully reviewed with an eye toward future litigation before they are approved, because it would be best not to include statements or observations that could be taken out of context. In addition, the committee should maintain documentation with respect to the work done that is not reflected in minutes of the committee meetings. For example, the investigative committee should maintain a record of items, such as a list of documents requested, a list of parties from whom documents were sought, a record of documents reviewed, a list of witnesses interviewed, notes of witness interviews, interview memoranda, and presentation materials at committee meetings. Failure to have such a compilation could call into question the reasonableness of the process undertaken by the committee. If the committee actually does its job appropriately, having these materials available will greatly assist the committee in demonstrating the thoroughness and reasonableness of its work to a court or whoever else may be reviewing such work. Once the committee members are confident that the investigation and evaluation stages are sufficiently complete, the committee may commence with preparing its conclusions. The committee would be well advised by counsel to highlight the fact that all of its preliminary conclusions are just that, preliminary, and subject to change or revision based on further investigation. The process of preparing and finalizing the written report is addressed in detail in Chapter Eight. Once the committee’s work is fully completed and presented to the full board, minutes and related materials can be turned over to the company. In the rare circumstances in which the committee materials contain confidential or sensitive information that may compromise the work of the committee or the future of certain witnesses interviewed, the committee could decide to have its counsel maintain these materials until, through the passage of time or occurrence of events, the information in the materials is sufficiently stale that it can be turned over. We stress that it is a truly rare situation in which it would be appropriate to hold back materials from the company once the work of the committee is complete.24

24

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Rarely, a committee’s counsel may be instructed by the corporation, following completion of the committee’s work, to turn over all records pertaining to the committee’s work, including any and all copies of such work to the corporation. Setting aside the practical impossibility of ever rooting out all emails from a particular assignment, counsel is well advised to proceed cautiously in response to this request. The Rules of Professional Conduct may impose upon the lawyer the obligation to maintain certain documents in her files, and, even absent such affirmative obligation, counsel’s legal malpractice insurer may require certain record keeping procedures to be followed.

Chapter 7

Getting Down to Work (Transactional Committees)

Following its formation and retention of advisors, a special negotiating committee will begin its work in earnest. This chapter addresses procedural matters relating to meetings of the committee, confidentiality of communications and use of experts, discusses the general approach the committee should take as to its assignment and includes practical suggestions in the form of practice pointers.

A. THE POWER TO SAY NO AND ITS IMPORTANCE As discussed, the power to say no to a proposed transaction on behalf of the company should be a central feature in any delegation to a special committee. Indeed, the power to say no may be so important to the vitality of a special committee that it is not an overstatement to say that a committee should only be created to consider a transaction if it will have this important power. This is because the central underpinning of a court’s validation of transactions negotiated by a special committee is the conclusion that the negotiation through the special committee replicated arm’s-length bargaining. Vesting the committee with full responsibility for the negotiations inherently involves the right to walk away from a transaction. As the Delaware Court of Chancery has stated, “[i]t is that power [to say no] and the recognition of the responsibility it implies by committees of disinterested directors, that gives utility to the device of special board committees in change of control transactions.”1 Likewise, the Delaware Court of Chancery has stated that “[t]he controller’s commitment to leave the essential fate of the transaction in the hands of the special committee is a significant one, because it ensures that the merger offer is not negotiated in the shadow of punitive action by the controller if the minority resists the merger.”2 If the interested parties are not willing to

1 2

In re First Boston, Inc. S’holders Litig., 1990 WL 78836, *7 (Del. Ch. June 7, 1990). Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1146 (Del. Ch. 2006). 141

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vest the power to reject the transaction in the independent body (and to abide by such rejection), the inference that follows is that the conflicted parties wish to influence the process or preserve the flexibility to make a final determination on the matter. The inability of a committee to say no to a proposed transaction is likely to directly impact the standard of review applied to the committee’s work under Delaware law. One of the primary benefits sought to be achieved through the use of a special negotiating committee is the receipt of a more deferential standard of review—specifically to shift the burden of proof as to the entire fairness of a transaction with a controlling stockholder from the company to a party challenging the transaction or, outside the context of a controlling stockholder transaction, to seek to obtain application of the deferential business judgment standard of review in a transaction in which a majority of the board has an interest. If a committee has not been delegated the power to say no to a transaction and therefore cannot effectively bargain on an arm’s-length basis, a court is unlikely to analyze the transaction under a more deferential standard of review to the company.3 One of the clearest statements of this principle is the Delaware Supreme Court’s opinion in the seminal case of Kahn v. Lynch Communications Systems, Inc.,4 in which a special committee was formed to negotiate with the company’s controlling stockholder as to that stockholder’s proposed acquisition of the shares of the company that it did not already own. The special committee actively negotiated with Alcatel, the controlling stockholder, and obtained improvements to Alcatel’s offer on three separate occasions. However, the committee ultimately approved Alcatel’s final offer only after and in response to Alcatel threatening to initiate an offer directly to the company’s stockholders at a lower price if the special committee did not agree to its proposal. In analyzing the question whether the existence of the special committee would serve to shift the burden of proof to the plaintiff with respect to entire fairness, the court determined that the special committee did not have the power to engage in arm’slength negotiations because it did not have the power to say no to Alcatel and, accordingly, the burden of proof with respect to entire fairness would not shift to the plaintiff. In this regard, the court stated: The record reflects that the ability of the Committee effectively to negotiate at arm’s length was compromised by Alcatel’s threats to proceed with a hostile tender offer if the $15.50 price was not approved by the Committee and the Lynch board. The fact that the Independent Committee rejected three initial offers . . . cannot alter the conclusion that any semblance of arm’s length bargaining ended when the Independent Committee surrendered to the ultimatum that accompanied Alcatel’s final offer.5

3

4 5

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Indeed, it appears that if the Cox Communications standard in the freeze-out context is utilized and survives appellate scrutiny, then only a committee with a full delegation of power will be effective in shifting the burden. See generally, In re CNX Gas Corp. S’holders Litig., C.A. No. 5377 (Del. Ch. May 25, 2010). 638 A.2d 1110 (Del. 1994). Id. at 1121.

THE POWER TO SAY NO AND ITS IMPORTANCE

The holding in Kahn v. Lynch is consistent with several decisions of Delaware courts declining to shift the burden of proof in an entire fairness setting or otherwise apply a more deferential standard of review where the special committee was explicitly or implicitly not given the ability to say no to a transaction and engage in true arm’s-length bargaining.6 As might be expected, in instances in which a reviewing court declines to apply a more favorable standard of review to a committee transaction in light of the committee not being given the power to say no and engage in arm’s-length negotiations, the court will typically be reluctant to uphold the transaction under the more searching standard. For example, in In re Digex Inc. Shareholders Litigation,7 a special committee of the board of Digex Inc. was created to consider proposals submitted by Digex’s majority stockholder, Intermedia Communications, Inc. The special committee retained qualified and independent legal and financial advisors. However, the special committee was not given the power to say no to a transaction, but rather was empowered to “participate in the transaction process and make recommendations to the full board on matters where there could be a perceived conflict of interest between Intermedia and Digex.”8 Intermedia largely excluded the committee from its negotiations, which ultimately centered on a sale of Intermedia, including Intermedia agreeing that Digex would grant a waiver of the restrictions on business combinations under Section 203 of the DGCL in connection with a sale of Intermedia. When the Digex board considered the question of waiving the application of Section 203 of the DGCL, it did not refer the question to the special committee (despite the readily apparent conflicts of a majority of the members of the board) and, notwithstanding the vote against the waiver by the members of the special committee, the Intermedia designees on the Digex board outvoted the members of the special committee and approved the waiver. In litigation that ensued in the Delaware Court of Chancery, the court unsurprisingly gave no credence to the special committee’s involvement in the transaction and, on a motion for preliminary injunction, found that the plaintiffs established a likelihood of success on the merits that the defendants had breached their fiduciary duties in waiving the protections of Section 203 of the DGCL.9 The foregoing cases can be contrasted with several examples of Delaware decisions validating the committee process and referencing the importance of the committee’s power to say no to the proposed transaction as evidence of its ability to engage in

6

7 8 9

See Am. Gen. Corp. v. Tex. Air Corp., 1987 WL 6337, at *4 (Del. Ch. Feb. 5, 1987) (where controlling stockholder issued an ultimatum, the committee lost its ability “to negotiate in arm’s-length manner” and, consequently, the burden of establishing entire fairness would remain with defendants); Freedman v. Restaurant Assocs. Indus., Inc., 1990 WL 135923, at *7–8 (Del. Ch. Sept. 19, 1990) (where conflicted management had the power and exercised such power to veto actions of the special committee, the court will not shift the burden of proof regarding entire fairness); Kahn v. Dairy Mart Convenience Stores, Inc., 1996 WL 159628, at *3 (Del. Ch. Mar. 29, 1996) (conflicted CEO/controlling stockholder effectively prohibited committee from entertaining higher offers even though such offers were submitted.). 789 A.2d 1176 (Del Ch. 2000). Id. at 1183. Id. at 1214. 143

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arm’s-length bargaining. For example, in Kohls v. Duthie,10 a special committee was formed to consider a going-private transaction with a third-party purchaser in which the company’s CEO and approximately 33 percent stockholder would roll over his equity into the surviving entity. The committee was delegated the full power and authority of the board to consider the transaction, including the power to say no, and used this power to vigorously negotiate the terms of a transaction. Litigation was filed following the agreement for the going-private transaction. Notably, plaintiffs in the litigation were also plaintiffs in a pending derivative lawsuit on behalf of the company challenging the CEO’s earlier acquisition of his equity position in the company for one thousand dollars on corporate opportunity grounds. The effect of the going-private transaction would be to extinguish the derivative claims. Based upon the special committee’s vigorous process and its power to say no, the Delaware Court of Chancery validated the going-private transaction and concluded that the deferential business judgment rule would likely apply to the transaction. Likewise, in In re First Boston, Inc. Shareholders Litigation,11 special committee approval of a cash-out transaction was held to be protected by the business judgment rule. In validating the committee’s work, the court identified the “power to say ‘no’” or to refuse to approve a self-interested transaction as the “critical power” possessed by a special committee, which “gives utility to the device of special board committees.”12 The court explained: It is not sufficient for such directors to achieve the best price that a fiduciary will pay if that price is not a fair price. Nor is [it] sufficient to get a price that falls within a range of ‘fair values’ somehow defined, if the fiduciary (or another) would pay more. The fiduciary’s best price may not be fair and the fiduciaries’ position may preclude the emerge[nce] of alternative transactions at a higher price. The only leverage that a special committee may have where a fiduciary’s position precludes alternatives (such as here or where a controlling shareholder owns a majority of voting power) is the power to say no and, thus, to force the fiduciary to choose among the options of implementing a frank self-dealing transaction at a price that knowledgeable directors have disapproved, to improve the terms of the transaction or abandon the transaction.13

Thus, it is the special committee’s power to refuse the transaction that gives the special committee leverage to bargain with the interested party.

B. THE USE OF EXPERTS (BANKERS AND OTHERS) The retention of appropriate independent experts and the reliance by a special committee upon their advice is, for most committees, a necessary and valuable tool. In addition to legal advisors, the most typical category of advisors for a committee to retain is financial 10 11 12 13

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765 A.2d 1274 (Del. Ch. 2000). Kahn, 1990 WL 78836 (Del. Ch. June 7, 1990). Id., at *7. Id. This language was cited by the Delaware Supreme Court in Kahn v. Lynch.

THE USE OF EXPERTS (BANKERS AND OTHERS)

advisors and investment bankers. In the context of a proposed sale transaction, including a merger or sale of substantially all of the company’s assets, and for most other financial transactions, obtaining the advice of a knowledgeable financial advisor will greatly assist a committee in understanding the transaction, negotiating the transaction, and assessing whether the terms of any transaction are fair to the company. In appropriate cases, other categories of advisors may be necessary to assist a committee. For example, the retention of an executive compensation expert might be appropriate if the committee is tasked with considering compensation-related matters, or retention of an advisor with restructuring expertise might be appropriate in certain distressed-sale transactions. The committee’s mandate should include the ability to retain appropriate advisors, and the committee should, in the normal course, act to retain legal and financial advisors and, where appropriate, consider the retention of other specialty advisors. The special committee’s advisors play a very important role in analyzing a proposed transaction, including the structure of the proposed transaction, and guiding the negotiations and deliberations by the committee as to the proposed transaction. Although the committee, of course, has the final say in how a process will be run, it is typically the advisors who are the architects of the transaction and who act as the quarterback in proposing the strategy by which the committee will approach the negotiations. Given the fact that management often has conflicts of interest in connection with a transaction being considered by a special committee, the advisors to a committee typically have to play a more significant role in the transaction, including assuming roles that management would typically perform in a non-conflict transaction, such as leading the negotiations and performing due diligence with respect to the transaction. As the Delaware Court of Chancery has stated: Critical to the effectiveness of the special committee process has been the selection of experienced financial and legal advisors, who can help the special committee overcome the lack of managerial expertise at their disposal. When it works well, the combination of a special committee, with general business acumen and a fair amount of company specific knowledge, with wily advisors who know how to pull the levers in merger transactions in order to extract economic advantage, is a potent one of large benefit to minority stockholders.14

At the outset, it is important that the committee and its advisors have an understanding of the advisors’ roles, particularly that of the financial advisor for the committee. The role should be encapsulated in the engagement letter executed by such advisor. The matters to be addressed should be identified, such as the role of the advisor in negotiations, whether the advisor will be conducting a canvass of the market for alternative transactions, whether it is contemplated that the advisor will be requested to render a fairness opinion,15 and the scope of any such opinion in the context of the contemplated transaction. 14 15

In re Cox Commc’ns, Inc. S’hlder Litig., 879 A.2d 604, 618 (Del. Ch. 2005). We note, as a practical matter, the importance of discussing whether an advisor will give a fairness opinion at the outset of an engagement and then confirming that in writing. In our experience, some bankers refuse (on policy grounds) to give fairness opinions in certain types of transactions. It is important to know and understand this before hiring the banker. 145

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Because of the importance of the role of the committee’s advisors, it is vital that a committee retain advisors with experience and expertise in conflict transactions and the process by which such transactions should be considered and negotiated. The importance of advisors to a committee is well known to the Delaware courts and in connection with any challenge to a transaction, a court will focus not only upon the independence of the experts selected by the committee, but also the expertise of the advisors and the process for the negotiations organized and led by such advisors. As the Delaware Court of Chancery recently stated in criticizing a committee that determined to retain an advisor the court found to be grossly inexperienced and outgunned: As this court has observed on numerous occasions, the “effectiveness of a Special Committee often lies in the quality of the advice its members receive from their legal and financial advisors.” Here, the Special Committee chose a financial advisor that was not qualified to swim in the deep end.16

In addition to being invaluable for the committee’s task and important to a court’s assessment of the committee process, another benefit of the retention of appropriate advisors is the protection afforded to members of the committee who rely upon advisors in good faith. Section 141(e) of the General Corporation Law protects members of a board who rely in good faith upon, among other things, reports of outside experts selected with reasonable care. It provides as follows: A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member’s duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation’s officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person’s professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.17

Accordingly, to the extent that the members of a special committee obtain information, opinions, reports, or statements from qualified advisors in making a determination regarding a business combination or other transaction and rely on such matters in good faith, they should be fully protected with respect to such reliance. We have touted the importance of expert advisors to a committee process, but the importance of such advisors is not without limitations. It is ultimately the committee’s (and not the advisors’) decision whether to proceed with a transaction. A committee should not blindly rely upon the advice of its advisors or maintain a detached role from the proposed transactions being considered by virtue of the involvement of advisors. Rather, the committee should actively engage with its advisors, ask questions, and challenge the conclusions and advice of its advisors if appropriate.

16 17

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In re Loral Space & Commc’ns Inc. Litig., 2008 WL 4293781, at *3 (Del. Ch. Sept. 19, 2008). 8 Del. C. § 141(e) (emphasis added).

THE USE OF EXPERTS (BANKERS AND OTHERS)

i. Fairness Opinions The importance and role of fairness opinions from committee investment bankers is often misunderstood by committee members. Though fairness opinions are routinely sought and received by transactional committees, the goal of the committee process is not simply to negotiate a transaction that will allow the bankers to give a fairness opinion. In many cases, the goal is to secure the best available transaction, which may be a good deal more favorable than a merely fair transaction. This dichotomy lay at the heart of the court’s decision in In re Trans World Airlines, Inc. Shareholders Litigation.18 There, a stockholder sought to enjoin the effectuation of a going-private merger between an entity controlled by Trans World Airlines’ (TWA’s) largest stockholder and TWA. In response to the initial offer by the controlling stockholder, TWA formed a special committee of two independent directors, and the committee retained separate counsel and a financial advisor. The committee then charged its financial advisor with negotiating with the controlling stockholder. The financial advisor negotiated with the controlling stockholder until the point at which it could render a fairness opinion. Following the financial advisor’s determination that it could give such opinion on the then-proposed terms, the advisor informed the committee, and the committee approved the transaction. In describing the role of the committee, one of its members summarized: Our function wasn’t to deal with [the controlling stockholder] at all, the independent committee. That was [the financial advisor’s] charge to do that. Their charge was to negotiate until they felt they could render their fairness opinion, and whatever that range was, I don’t know.19

In addition to the significant problem that neither the committee nor its advisor understood that the committee needed to seek the best possible transaction, not solely one as to which the financial advisor could opine, the court noted that “the committee appears to have relied almost completely upon the efforts of [the financial advisor], both with respect to the evaluation of the fairness of the price offered and with respect to such negotiations as occurred.”20 Although the court acknowledged that it is not unusual for a committee to place heavy reliance upon its advisors, the court concluded that “the special committee did not supply an acceptable surrogate for the energetic, informed and aggressive negotiation that one would reasonably expect from an arm’slength adversary.”21 The TWA decision graphically illustrates the limitations upon the value of a fairness opinion given by a financial advisor in connection with conflict transactions. Although it is customary and advisable for a fairness opinion to be provided by the committee’s financial advisor in connection with a business combination transaction, and such an opinion will, in certain respects, represent a stamp of approval by the financial advisor

18 19 20 21

1988 WL 111271 (Del. Ch. Oct. 21, 1988). WL 111271, at *4. Id. Id., at *7. 147

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as to the fairness of the transaction from a financial point of view, the receipt of a fairness opinion will not fully insulate a transaction negotiated by a special committee from challenge. Indeed, some committee members and advisors may labor under the misperception that if a fairness opinion has been furnished to a special committee, any challenge to the committee process will be futile. That is plainly not the case. The existence of a fairness opinion says nothing about the process that resulted in the approval of the transaction. The mere fact that a transaction might pass the test of financial fairness does not mean that it is the best transaction that could have been negotiated under the circumstances or that the committee effectively acted as a surrogate for arm’s-length negotiations. If the existence of a fairness opinion were so determinative, then there would be no need for the committee process so long as the controlling stockholder or other party made a proposal that met the minimum requirements of fairness. In practice, it is also the case that some courts maintain a healthy skepticism of fairness opinions. It has been observed, for example, that it is always possible for a company to find a financial advisor willing to say that a transaction is fair in order to earn a tidy fee. Likewise, courts who find themselves addressing fairness opinions regularly, as the Delaware courts do, are aware that financial advisors may, by modifying certain assumptions in their analysis, dramatically impact the conclusions in a fairness analysis. This is not to suggest that financial advisors adjust their inputs to achieve particular results, but rather that sophisticated courts understand the level of flexibility in a banker’s analysis and appreciate that a transaction that happens to fall within the low end of a range of fairness may not necessarily be the best available, or even desirable. Delaware court decisions are replete with examples of transactions for which a fairness opinion was rendered, but the court nonetheless invalidated or otherwise rejected the transaction.22 Thus, the committee should view the receipt of a fairness opinion as a necessary step in its analysis in most transactions and one that a court and the company’s stockholders will expect in a business combination transaction. Nevertheless, it is not the only step the court will expect the committee to have taken. The fairness opinion should provide some comfort to the committee with respect to the pricing it has negotiated and, therefore, provides additional support for its ultimate decision as to the merits of a transaction. It should not mistakenly be viewed as being determinative of a particular judicial result in the event of litigation, nor should the receipt of a fairness opinion lead the committee to believe that the process by which the committee arrived at the transaction will be any less important or subject to less scrutiny by a court. 22

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See, e.g., In re Loral, 2008 WL 4293781, at *30 and n.151 (holding that the financing of a loan by the controlling stockholder to the corporation was unfair to the corporation and noting the willingness of the special committee’s financial advisor to find a way to justify the issuance of a fairness opinion rather than a willingness to perform real valuation work); Gesoff, 902 A.2d at 1141 (fairness opinion rendered by the special committee’s financial advisor at $10.50 per share tender offer price where court determined the appraised value at $14.30 per share); In re Emerging Commc’ns, Inc., S’holder Litig., 2004 WL 1305745 (Del. Ch. May 3, 2004) (fairness opinion rendered at $10.25 per share transaction price where court determined the appraised value of the shares is $38 per share).

COMMUNICATING WITH THE COMMITTEE AND CONFIDENTIALITY

C. COMMUNICATING WITH THE COMMITTEE AND CONFIDENTIALITY A touchstone for an effective committee process is the ability of the committee to maintain the confidentiality of its deliberations from conflicted parties who may be able to benefit from this information or influence the committee process through knowledge of this information. Care must therefore be taken to ensure that no sensitive communications are sent to the counterparty to a proposed transaction or its representatives and that no back-channel conversations occur in which members of the committee or its advisors disclose any such information to a conflicted party. Additionally, for purposes of committee meetings and communications among the committee and its advisors, consideration should be given to whether each person attending the meeting or receiving the communication might have an interest in the matter that might suggest that they not participate in the meeting (or a portion thereof)—a matter that frequently arises as it relates to members of management. If information is inappropriately disclosed to interested parties, a reviewing court often will review the harm caused by the disclosure as well as analyze the facts to determine whether the disclosure resulted from a one-time, inadvertent error or whether such disclosure is indicative of flaws that call into question the entire committee process. In the Delaware Court of Chancery decision in In re Emerging Communications Shareholders Litigation,23 plaintiffs were able successfully to attack the negotiation process conducted by a special committee with its CEO and controlling stockholder in connection with a proposed going-private transaction by pointing to evidence that it was the regular practice of the committee’s chair to send faxes to committee members and committee counsel through the CEO and controlling stockholders’ secretary with instructions where to send the faxes. Although there was no evidence that the CEO or his advisors saw the faxes or were told of the contents thereof, the court stated: [T]his practice cannot help but undermine confidence in the integrity of the bargaining process. It is manifest that [the chair of the committee’s] decision to route those materials through the secretary who shares the same office as [the CEO]—[the committee chair’s] bargaining adversary—rather than route them through the office of the Committee’s counsel . . . created a serious risk of compromising the Committee’s process and its effectiveness in negotiating the highest available value.24

For this and other reasons, the court found the committee to be an ineffective representative for the minority stockholders, stating: [The committee chair] was careless, if not reckless, by routing all of his communications with the other Special Committee members through [the CEO’s secretary]. The result was to give [the CEO] access to the Committee’s confidential deliberations and strategy. That inexplicable method of channeling communications to

23 24

2004 WL 1305745. Id., at *8. 149

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[the committee chair’s] fellow Committee members further confirms the severe information imbalance that existed between the two “bargaining” sides.25

The importance of confidentiality does not extend solely to keeping deliberations of the committee secret from the party on the other side of the proposed transaction. The committee must also use care with respect to disclosures to members of management if management has additional or different interests in a transaction. Where management will obtain financial benefits from a transaction that are additional or different from the stockholders generally or in circumstances where members of management rely upon staying in the good graces of a controlling stockholder in order to maintain their positions, there is often temptation for management to divulge information as to the committee process or otherwise attempt to use such information to its benefit. Accordingly, although it may sometimes be desirable for management to be present at committee meetings to provide information to or answer questions from the committee, a reviewing court will often be suspicious if conflicted management obtains sensitive information as to a committee’s negotiations or strategy—whether or not management uses or misuses that information. Given the need to present a process that simulated arm’slength bargaining, the committee should make certain that management is not privy to its deliberations or other sensitive information. Case law demonstrates the kinds of information leaks to which the courts have been sensitive. In In re Netsmart Technologies, Inc. Shareholders Litigation,26 for example, a committee was formed to negotiate a sale of the company. The search for purchasers focused upon financial buyers who would be more likely to retain members of management, and a deal was ultimately struck with two private equity buyers. In finding that plaintiffs had demonstrated a likelihood of success on the merits in an injunction proceeding as to the transaction, the court noted the participation by members of management and others in committee meetings: Even when it was formed, the Special Committee largely deliberated with [interested CEO] right at the table, along with the company’s general counsel, and other of [interested CEO’s] subordinates. Although the Special Committee had executive sessions, it included in those sessions the same bank that had been working with management all along. As a result, one rationally doubts how confidential these sessions really were.27

Likewise, in Gesoff v. IIC Industries Inc.,28 the Delaware Court of Chancery was highly critical of the fact that the committee’s financial advisor (who had been selected at the behest of the controlling stockholder or its representatives), unbeknownst to the committee, was forwarding its financial analysis and related materials to a representative of the controlling stockholder in connection with a proposed going-private transaction, noting: [Representative of controlling stockholder] testified under cross-examination that he received draft valuations from [the committee’s financial advisor] of IIC’s 25 26 27 28

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Id., at *36. 924 A.2d 171. Id. at 193. 902 A.2d 1130.

MEETINGS OF THE COMMITTEE AND DOCUMENTING PROCEEDINGS

subsidiaries or investments. [Representative of controlling stockholder] also testified that he received [the financial advisor’s] valuation ranges for IIC. These were shared in a memorandum sent to certain members of [the controlling stockholder’s] board . . . Throughout the entire process, therefore, [the controlling stockholder] had almost full access to the special committee’s valuation numbers and analysis.29

Although it is an elementary principle that you do not wish your adversary in negotiations to have access to your negotiation strategy and financial analysis, several special committees have been faulted for doing just that. At the outset of a committee process, it is therefore prudent for counsel to spend some time discussing with the committee the confidentiality of its deliberations and to make certain that a protocol is in place for communications among committee members and its advisors. Committee members should never send committee materials to anyone without discussing it first with committee counsel. Consideration in this regard should also be given to the attendees at committee meetings and the portions of meetings attended by and materials received by non-committee members or advisors.

D. MEETINGS OF THE COMMITTEE AND DOCUMENTING PROCEEDINGS i. Committee Meetings During a special committee process, the committee will likely have multiple meetings. The requirements for quorum and the necessary vote required for a committee to approve a matter will be a function of the committee’s charter or authorizing resolutions and the company’s governing documents. It is customary that a majority of the committee constitutes a quorum and that a majority of those present at a meeting at which a quorum is present may take action. However, given that a committee is typically addressing significant corporate matters and often has a small number of members, most committees make important decisions only if all members are present and all committee members approve the decision. The aggregate number of committee meetings and frequency of such meetings will vary depending upon the nature of the committee’s assignment and particular facts. For most committees, it will be important that the committee meet regularly to be updated on the status of matters, even if no formal committee action is required to be taken. For example, if a committee and its advisors are in the midst of important negotiations with respect to a significant transaction, the committee may need to meet very

29

Id. at 1140; see also In re Freeport-McMoran Sulphur, Inc. S’holder Litig., 2005 WL 1653923, at *14 (Del. Ch. June 30, 2005) (finding sufficient evidence of a lack of independence of special committee where interested member of management participated in committee meetings and secretly communicated with the general counsel about valuation process); In re Loral, 2008 WL 4293781, at *22 (chair of special committee forwarded summary of open issues and “fall back” positions received from committee counsel to controlling stockholder representatives). 151

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frequently to be updated on the status of negotiations and to make decisions as to how to respond to proposals received from third parties. Such negotiations can be very fluid, and it will be important not only that the committee be up to speed with respect to the current status of negotiations, but also that it provide input and guidance to its advisors on a real-time basis. Likewise, in the context of a drawn-out sales process, a committee will want to have periodic meetings to receive an update on status and the work being performed by the advisors and to direct the advisors as to next steps in such process. As a general matter, when it comes to committee meetings, more is more. Having multiple committee meetings keeps committee members abreast of all recent developments and actively involved in the process with an opportunity to provide frequent input as to the direction of the process—all of which is important to the vitality of the committee. Additionally, because such meetings, unlike informal discussions among members and/or members and advisors, will be documented in committee minutes, having formal committee meetings, even if they are short and merely update the committee, demonstrates an active committee process that will ultimately provide comfort to a reviewing court. Indeed, it is not uncommon for a reviewing court to specifically note the number of committee meetings in supporting its view of the process.30 It is not uncommon for the bulk of committee meetings to take place telephonically. Given that committee members and advisors are frequently spread throughout the country (and sometimes the world), telephonic meetings are often the only practical means by which committee meetings may take place on short notice and the only efficient and sensible way to update the committee. Although telephonic meetings are perfectly appropriate and recognized by Delaware law, it is not advisable that all committee meetings take place telephonically. If possible, in-person meetings should be held for significant meetings involving detailed legal and financial presentations and if important decisions need to be made. The level of attention and time commitment those meetings necessitate and the opportunity for participants to discuss matters “face to face” often results in higher productivity and better deliberations by the committee. In-person meetings also assist in demonstrating a record of careful attention to matters by the committee; reviewing courts appreciate the difference between in-person and telephonic meetings. For example, in In re Emerging Communications, Inc. Shareholders Litigation31 a case in which the court determined not to defer to the work of a committee, the court noted: There were several obstacles to the ability of these three directors to operate as a fully functioning Special Committee. Located on different continents and separated

30

31

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See, e.g., In re Cysive, Inc. S’holders Litig., 836 A.2d 531, 546 (Del. Ch. 2003) (noting that the special committee met twenty-one times during the months before and after approval of a merger transaction in validating the committee process) and Kohls, 765 A.2d at 1285 (“The committee met more than twenty times and approved the final merger proposal at the conclusion of a two-day meeting at which it received reports from both its legal and financial advisors”). 2004 WL 1305745.

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by a time difference of 14 hours, the three Committee members were never able to meet in person. Instead, they had to conduct their business by telephone and fax.32

Likewise, in In re Cysive,33 though the court endorsed the committee process, including multiple meetings, it referenced the lack of in-person meetings: “Although these [committee] meetings were telephonic, the record is clear that [the committee members] expended a great deal of personal time and energy performing their duties.” Finally, in criticizing the detached role of a committee member, the court in In re Loral34 described such committee member as someone “who was content to simply show up by telephone at meetings when the Special Committee’s advisors called for one.” Although the committee has the discretion to determine the appropriate parties to invite to committee meetings, attendance at committee meetings (whether in-person or by telephone) should typically be limited to the members of the committee and the committee’s advisors. There may be instances in which the committee determines that it is desirable to invite members of management or other parties to a committee meeting or meetings in order for such persons to report to the committee or provide input as to particular matters. If such parties may be deemed to be interested in the matters being considered by the committee, regular attendance at committee meetings by such parties will be a basis to challenge the committee process, in some cases, successfully. As noted in Section d above, the routine presence of the corporate CEO and/or general counsel is often criticized by reviewing courts, especially if such individuals have interests that diverge from those protected by the committee.35 Accordingly, to the extent that it is deemed to be advisable for interested parties (such as management) to attend one or more committee meetings, there should be a clear rationale for the attendance articulated in the minutes of the committee, and the participation of such parties should be narrowly circumscribed to this purpose (e.g., updating the committee on a particular matter). In no case should the interested party remain present for the committee’s deliberations, and the limited nature and scope of the attendance by the interested party should be clearly set forth in the minutes of the committee meeting. In connection with any committee meeting, the committee’s advisors should strive to deliver to the members of the committee any presentation materials, key agreements, or other items as far in advance of the meeting as practicable to allow committee members sufficient time to review and digest such materials in advance of the meeting. This will not always be possible if matters are changing quickly in the negotiations and documentation. If it is not possible to provide materials well in advance of meetings or the materials provided are voluminous and complex, the committee’s advisors should provide executive summaries or more detailed presentations to make certain that directors fully understand the matters being presented. Since presentation materials or other materials provided to a committee become part of the record of the meeting and, 32 33 34 35

Id., at *22–23. 836 A.2d at 546. 2008 WL 4293781, at *16. See, e.g., In re Netsmart, 924 A.2d 171; In re Freeport-McMoran Sulphur, 2005 WL 1653923. 153

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in many cases, may be subject to disclosure in litigation or sought by the Securities and Commission (SEC) for purposes of filing in connection with proxy materials prepared by the company, advisors should draft any such presentation materials with care.

ii. Minutes and Documenting Proceedings Because a special committee is usually formed to address both a significant potential corporate matter (e.g., a sale transaction) and one in which conflicts of interest are present, there is often a high likelihood of litigation arising from a transaction approved by a special committee. If litigation is commenced, the minutes of special committee meetings will almost always be discoverable and plaintiff’s counsel as well as a reviewing court will closely scrutinize the minutes of the committee meetings to understand the process by which the committee approved the transaction. In depositions of special committee members, such members will be questioned as to the committee process, and minutes will serve to refresh the committee’s recollection of the process (which, in some cases, may have taken place at a time some distance in the past). Such minutes may also guide the questions asked by plaintiff’s counsel and his line of attack. From the perspective of defending a transaction, therefore, committee minutes represent perhaps the most important evidence of the committee process and are often the first line of defense against a challenge to that transaction. As a result, the importance of minutes of the committee’s deliberations cannot be overstated. Preparation of special committee minutes is a task for the committee’s counsel, which should have significant experience in such matters. There are different theories with respect to minute taking by counsel. Some counsel express a preference for very succinct minutes that merely recite the minimum necessary to reflect what has transpired at the meeting—e.g., the committee received a presentation from its financial advisors, the committee approved the transaction documents. The theory of proponents of this approach is that this is advisable because the minutes will not say anything that is later viewed as problematic. As set forth above in connection with our discussion of the minutes of investigative committees, we believe that the better practice is for counsel to draft a more detailed set of minutes that set out with greater specificity the discussions and decisions that took place at the meeting. For example, minutes should recite the key advice received from the committee’s legal and financial advisors, topics discussed with respect to matters being negotiated, and the committee’s conclusions concerning such matters. Minutes should also recite factors that the committee weighed in reaching particular decisions, the rationale for the ultimate decision, and important facts that transpired between the committee meetings relevant to the process. Of course, the minutes should always clearly recite who attended the meeting, and if certain parties participated in the meeting (if less than the full meeting). As noted above, if a potentially conflicted party is called to attend a portion of a committee meeting, the minutes should clearly reflect the point at which the individual joined and left the meeting. Detailed minutes should benefit the committee by highlighting the careful process it employed, its consideration and discussion of important issues, and its strategic decisions. 154

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If a court can review a record that evidences a thoughtful and active process, it will be more likely to defer to the work of the committee. Such minutes will also be much more helpful to committee members being asked to recall events that took place months (or sometimes years) earlier and serve as an aide memoire to such individuals regarding the various matters considered by the committee. At the same time, minutes need not and should not be a transcript of every utterance at a meeting. Because conversations are often wide-ranging and disjointed, minutes that delve into side comments and unnecessary minutia are not helpful in creating a clear record of what took place at the meeting. Additionally, to encourage full and free discussions of the matters being considered and avoid comments being taken out of context, it is normally not advisable to document verbatim exchanges or conversations among members of the committee or back-and-forth dialogue concerning the matters being considered. Due to the importance of the minutes being an accurate record of the committee’s deliberations, the more detail contained in the minutes, the greater the burden for accuracy. Accordingly, a balance must be struck in the level of detail. As noted above, however, we believe that it is important that the minutes contain sufficient detail to document the important discussions, presentations, considerations, and decisions of the committee, and bare-bones minutes are not desirable. As a general matter, minutes should be prepared on a timely basis following each committee meeting and promptly circulated for approval. In certain cases, it may be desirable to allow a short time to elapse in order for factual circumstances to unfold in greater detail, or for a subsequent meeting or two to be held that will sharpen the focus of the minutes on the most important factual items and provide proper emphasis to matters. However, in every case, counsel should strive to have all or almost all minutes completed and approved prior to the approval and announcement of a transaction. Given the risk of litigation associated with many special committee matters and the likelihood that litigation may commence shortly following the approval and announcement of a transaction, the committee will want to avoid the judicial skepticism that may accrue to minutes prepared following the initiation of litigation—particularly if the meetings took place several months earlier. In In re Netsmart Shareholders Litigation,36 the committee met approximately one month following the announcement of a going-private merger transaction and initiation of litigation regarding the transaction to approve minutes for ten committee meetings, the earliest of which was more than five months prior. Of this belated, post-litigation approval of minutes, the court stated that the “tardy, omnibus consideration of meeting minutes is, to state the obvious, not confidence inspiring.”37 As noted above, courts will draw conclusions from the manner in which minutes are drafted that can impact litigation in important ways. For example, in In re The Walt

36 37

924 A.2d 171 (Del. Ch. 2007). Counsel who have actually worked on transactions with a committee understand just how timeconsuming and fast moving the process tends to be. If, as is often the case, the choice is between drafting minutes or moving the deal forward, the cases point towards the practical answer–do both. 155

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Disney Co. Derivative Litigation,38 the court denied defendant’s motion to dismiss a complaint alleging a lack of good faith by a disinterested board with respect to certain employment and compensation arrangements reached with Michael Ovitz, its former president, by reference, in part, to the sparse minutes reflecting deliberations of the company’s compensation committee and board as to the employment agreement. In this regard, the court stated: Less than one and one-half pages of the fifteen pages of [board] minutes were devoted to discussions of Ovitz’s hiring as Disney’s new president. Actually, most of that time appears to have been spent discussing compensation for [one of the board members]. No presentations were made to the [board] regarding the terms of the draft [employment] agreement. No questions were raised, at least so far as the minutes reflect.39

Accordingly, the lack of detail in the minutes contributed to the court’s unwillingness, at the motion to dismiss stage, to grant a dismissal of allegations of bad faith conduct by a company’s board—a very difficult standard for a plaintiff to meet. Moreover, the court assumed that silence in the minutes as to questions and discussion meant that no such discussions occurred. Finally, the court appeared to equate the length of discussion of a topic in the minutes with the amount of time spent by the board and the committee in actually discussing the matter. Committee counsel should keep this last point in mind when drafting committee minutes. Particularly in circumstances in which both important and ancillary topics are addressed at a meeting, the text of the minutes should not short-change the discussion relating to the important topic if such matter was the focal point of the meeting. As demonstrated by the Disney decision, the quality of the descriptions contained in minutes can play a large role in the success of motion practice in court, thereby serving to either curtail litigation or extend litigation in instances in which it might otherwise have been disposed of at an earlier stage. In In re Prime Hospitality, Inc.,40 the Delaware Court of Chancery considered a settlement to litigation involving a challenge to a going-private transaction pursuant to which Prime Hospitality was acquired by Blackstone. An objector challenged the settlement on various grounds, including a lack of vigorous prosecution by plaintiff’s counsel. The court declined to approve the settlement on the ground that the post-confirmatory discovery record left many unresolved conflicts, including the fact that the minutes of the Prime Hospitality board meetings prior to the approval of the transaction largely reflected “business as usual” with only very abbreviated references to a sales process, in a manner seemingly at odds with the detailed proxy disclosures about the sales process undertaken by the company.41

38 39 40 41

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825 A.2d 275 (Del. Ch. 2003). Id. at 287. 2005 WL 1138738 (Del. Ch. May 4, 2005). Id., at *13.

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iii. Practice Pointers Committee minutes should reflect a single, accurate summary of the record of deliberations with respect to a proposed transaction. A short summary of recommendations when drafting committee minutes follows: • Reflect the deliberative process with details. ❍ Capture the scope of discussion (include, pros, cons, alternatives) and process for approval. ❍ Draft such that topics that received in-depth consideration at the meeting are reflected as such—longer discussions get more “ink” than shorter ones. ❍ When applicable, reflect the information and material presented to the committee (e.g., investment bank presentation PowerPoint slides) at the meeting, and if documents were provided to members for advance consideration, make sure to reflect that directors had adequate opportunity to review key documents prior to acting on them. ❍ When possible, specifically refer (by title and date) to any documents considered by the committee and the timing of the delivery of specific documents. ❍ Reflect participation by advisors (financial, legal, accounting, compensation consultants) and experts; where a basis to do so exists, indicate whether the committee relied upon the advisor’s or expert’s report, advice or opinion. • Do not record or transcribe meetings verbatim: ❍ This practice can have a chilling effect on healthy exchange of information. ❍ There is some expectation of privacy of board deliberations. • Draft and circulate minutes for approval promptly. ❍ Because of the importance of minutes, review of minutes by the committee must not be a last-minute, perfunctory process. • Counsel taking minutes should be prepared and seek clarification when needed. ❍ Proposed resolutions for anticipated actions should be drafted and circulated to the committee prior to meeting, where possible. ❍ At a meeting at which a proposed transaction is to be approved, counsel should endeavor to submit in advance a summary of factors to be considered with respect to the transaction. • Use concise, unambiguous language to avoid having a court look to other sources for clarification or definition. Ensure that minutes are accurate and complete to avoid calling the entire record into question. • The following basic elements to be identified for each meeting: ❍ Date and location ❍ Whether the meeting is held telephonically or in person ❍ Beginning and ending time ❍ Name of those attending and those absent ❍ Acting chairperson and secretary ❍ Names of presenters and other participants ❍ General topics of discussion (may indicate by heading) ❍ Indication of action taken 157

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❍ ❍ ❍

Comings and goings of members and participants Resolutions adopted References (by specific title and date) to briefing materials distributed in advance of meeting and materials discussed or presented at the meeting.

iv. Notes and Document Retention Counsel is frequently asked whether members of the committee should take notes during committee meetings and, if they choose to do so, whether they should dispose of the notes at a later time. It is appropriate for special committee counsel to address the subject of note-taking by members at an introductory meeting. Counsel should not attempt to impose a ban or actively discourage note-taking, because some committee members may believe that taking notes will assist them in analyzing the issues being considered by the committee and that it would be unnatural for them not to do so. However, counsel should remind the committee that he will prepare detailed minutes of each committee meeting, so there is no need for members of the committee to document the committee meetings themselves. Rather, notes should be taken, if at all, for the purpose of highlighting discussion points or questions the committee members would like answered. Counsel should also advise the committee as to issues that arise from taking and retaining notes of meetings. First, counsel should remind the committee that notes by members of the committee are discoverable in litigation. Because notes frequently represent disjointed thoughts, questions, or issues, a plaintiff’s counsel will attempt to use inconsistencies between notes and committee minutes or seize upon phrases or sentences in notes to paint a different picture of the meeting than is reflected in the minutes and to further their case. Notes also typically result in committee members sitting for longer depositions and being asked to explain statements contained therein. If a director chooses to take notes, the question becomes what advice counsel should provide to members of the committee with respect to the retention of notes. Because notes should reflect the questions of directors, discussion points, or clarifications, once a director has such matters addressed at the meeting, there may be little utility for the director to keep such notes and a director should feel comfortable in disposing of them. Committee counsel may advise the committee that disposal is appropriate if the committee member no longer has a need to keep such notes. Of course, in the event that litigation is filed, or if litigation is or should be anticipated, committee members should not dispose of any materials related to the matter without first consulting with counsel. Similar issues may arise with respect to presentation materials or other materials furnished to members of the committee in connection with a meeting. If such materials are sent electronically in advance, a copy will necessarily be saved, which should reduce the need for members of the committee to keep a hard copy following the meeting. If materials are handed out at committee meetings, it is preferable to have such materials collected at the conclusion of the meeting if the committee members have finished with them. If committee members prefer to keep the materials, they should be 158

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mindful about the pitfalls of making notes; materials with notes on them must be separately produced in litigation. It may be prudent for committee counsel to follow up to seek the return of such materials.

E. UNDERSTANDING THE REQUIRED DISCLOSURES OF THE COMMITTEE’S WORK There are several categories of potential disclosures that accompany a typical special committee process, and it is important that members of the committee understand these disclosures as they navigate the committee process. The most obvious category of potential disclosure is in connection with the solicitation of stockholder approval in connection with a transaction. Although not all matters delegated to a committee will ultimately need to be approved by the company’s stockholders, a large portion of committee assignments, including matters related to a sale of the company or recapitalization transaction, will almost always require stockholder approval. If this is the case, the company will typically need to prepare a proxy statement pursuant to which it will solicit stockholder approval. In such circumstances, directors owe a duty of disclosure with complete candor. This duty requires the directors to disclose fully all material facts within their control that would have a significant impact on a stockholder vote or other similar decision. Directors are required to disclose all material information concerning the matter in question, whether it be a matter of corporate governance or a corporate transaction.42 “An omitted fact is material if there is a substantial likelihood that a reasonable stockholder would consider it important in deciding how to vote.”43 The Delaware Supreme Court has confirmed that “[c]ompleteness, not adequacy, is both the norm and the mandate” because the duty of disclosure is a fiduciary duty.44 Due to these disclosure obligations, proxy statements and similar disclosure documents are detailed in nature and contain fairly voluminous disclosures regarding the committee process. One of the most important disclosure sections of a typical proxy statement is the background of the transaction section, which summarizes the sequence of events leading up to approval of the transaction by the company. This section will highlight the formation of the committee, the negotiation process utilized by the committee on behalf of the company, important meeting dates and events, and a host of other details regarding the process that led to the transaction. The background of the transaction constitutes the narrative of events that many stockholders will review to gauge whether the transaction was fairly negotiated or infected by conflicts of interest. Additionally, the proxy statement will include sections summarizing the factors considered by the committee in choosing to approve the transaction as well as standard disclosures regarding any additional or different interests of members of the board in the transaction, 42 43 44

Stroud v. Milliken Enters., Inc., 552 A.2d 476, 480 (Del. 1989). Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). See Lynch v. Vickers Energy Corp., 383 A.2d 278, 281 (Del. 1977). 159

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or relationships between the advisors for the committee and the company or interested parties. The upshot of the need for a proxy statement to contain such detailed disclosures is that the committee should be mindful that material decisions made by the committee throughout the process and important meetings will be referenced in a public disclosure document. Additionally, in considering the retention of counsel, financial advisors, or other consultants, if such advisors have relationships with the company or other parties that may be argued to compromise the independence of such advisors, then such facts will need to be disclosed.45 Furthermore, fee arrangements with financial advisors are often subject to disclosure, so the committee will need to take care, at the front end, to ensure that the terms of the engagement letter for such advisors are not problematic.46 With respect to proxy materials, the SEC has also requested, in many cases, that investment banker materials either be filed with the SEC or summarized in disclosure documents. In addition to disclosures needed when soliciting stockholder approval for a matter, there is an entirely different category of disclosure that accompanies the institution of litigation with respect to a committee matter. The risk of litigation is high for most committee matters. Moreover, any transaction between the company and its controlling stockholder and almost all transactions in which material conflicts of interest exist will not be easily dismissed by a company at an early stage in litigation. Thus, such matters often involve significant discovery being taken with respect to the transaction. Discovery will often involve both the production of documents as well as the taking of depositions. With respect to producing documents, the committee will not only have to produce the easy items, such as committee minutes and presentation materials received by the committee and drafts of transaction documents being negotiated by

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46

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See, e.g., In re John Q. Hammons Hotels Inc. S’holder Litig., 2009 WL 3165613, at *16 (Del. Ch. Oct. 2, 2009) (stressing the importance of disclosure of potential conflicts of interest of financial advisors); David P. Simonetti Rollover IRA v. Margolis, 2008 WL 5048692, at *8 (Del. Ch. June 27, 2008) (“[I]t is imperative for the stockholders to be able to understand what factors might influence the financial advisor’s analytical efforts . . . . A financial advisor’s own proprietary financial interest in a proposed transaction must be carefully considered in assessing how much credence to give its analysis.”); In re Nat’l City Corp. S’holders Litig., 2009 WL 2425389 (Del. Ch. July 31, 2009), aff’d, 2010 WL 1728931 (Del. Apr. 30, 2010) (ORDER) (approving a class action disclosure-only settlement where the additional disclosures—which included the disclosure of a potential conflict of the financial advisor—provided a reasonable, though meager, benefit to the shareholder class). See, e.g., County of York Employees Ret. Plan v. Merrill Lynch & Co., 2008 WL 4824053, at *11 (Del. Ch. Oct. 28, 2008) (finding that plaintiff had not alleged a disclosure violation because the financial advisor’s compensation was contingent on the consummation of the transaction, a fact that had been disclosed in the proxy statement); La. Municipal Police Employees’ Ret. Sys. v. Crawford, 918 A.2d 1172 (Del. Ch. 2007) (holding that the board of directors breached its duty of disclosure to stockholders by not disclosing that the company’s investment bankers were entitled to receive the majority of their bankers fees upon the board’s approval of the proposed merger and were thus incentivized to issue favorable opinions regarding the merger).

UNDERSTANDING THE REQUIRED DISCLOSURES OF THE COMMITTEE’S WORK

the committee, but production will also be called for regarding all communications relating to the transaction, including all email communications. In this regard, committee members should be advised and endeavor at the outset of a matter to organize and segregate emails related to the special committee assignment into folders for ease of retrieval. Directors should also consider the email address to which communications will be sent and the deletion protocol on their computer. Upon litigation being filed, the electronic files of directors will need to be searched for relevant content and directors will want to make certain that emails are stored securely.47 Although certain emails and other communications may be subject, in appropriate cases, to withholding from disclosure to plaintiff’s counsel on the grounds of attorney– client, work product, or other applicable privilege, directors should be advised and assume that any and all emails they send may be discoverable, for two reasons. First, the only emails that may be withheld on the basis of attorney–client privilege are those involving the giving or receiving of legal advice. The mere fact that an attorney is copied on an email will not result in the privilege being applied and, even if the privilege were to apply, it may be waived depending upon the other recipients of the email transmission. Second, it will sometimes be the case that the committee will voluntarily choose to waive the attorney–client privilege in order to defend its decisions, in part, on the basis that it received advice of its legal counsel. If the committee chooses to waive the privilege for this purpose, it may not selectively waive privilege; as a result, all communications with counsel regarding the subject matter waived will be subject to disclosure.48 Long experience teaches that individuals will draft and send emails discussing matters and including language that never would be included in a letter sent to the same recipient. The committee should be counseled at the outset to avoid substantive communications or discussions via email and that members should consider whether they would be comfortable with a plaintiff’s counsel or a court reviewing any email

47

48

Kahn v. Dairy Mart Convenience Stores, Inc., 1996 WL 159628, at *6 (Del. Ch. Mar. 29, 1996) (noting that special committee member was also a paid consultant for the corporation, raising concerns that he was beholden to the controlling shareholder); Rales v. Blasband, 634 A.2d 927, 937 (Del. 1993) (finding a reasonable doubt as to the ability of two members of the board to act independently concerning a controlling stockholder transaction in light of their employment with entities affiliated with the controlling stockholder). Ashmore v. Metrica Corp., 2007 WL 1464541, at *1 (Del. Ch. May 11, 2007) (“[D]efendants, having asserted privilege with respect to [legal] advice during discovery, will not be allowed to rely at trial upon the fact that advice was given. Principles of waiver and fairness, metaphorically expressed as preventing a party from using the privilege as both a sword and a shield, require the Court to disregard attempts by plaintiff to invoke privilege, only to change their mind on the eve of trial.”); see also In re Toys R’ Us, Inc. S’holder Litig., 877 A.2d 975, 996 n.23 (Del. Ch. 2005) (“In past cases, this court has refused to allow boards to tout their reliance on advice of counsel as evidence of their good faith and prudence while shielding the back-and-forth they had with counsel.”); Hercules, Inc. v. Exxon Corp., 434 F. Supp. 136, 156 (D. Del. 1977) (“In general, the voluntary waiver by a client, without limitation, of one or more privileged documents passing between a certain attorney and the client discussing a certain subject waives the privilege as to all communications between the same attorney and the same client on the same subject.”). 161

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transmission they send before doing so. This requires a change in the standard operating procedure for most individuals. However, it is important that directors understand the potential for disclosure with respect to email transmissions, not only to other members of the committee or advisors but also with members of management or other interested parties, that have the potential to be particularly damaging to a committee process. Finally, committee members should understand the possibility that each of them will be deposed and potentially called to testify in open court with respect to the transaction. Sending and receiving email transmissions and other communications with interested parties or that otherwise have the potential to be cast in a bad light can make this experience particularly unpleasant. Having a healthy appreciation of the categories of and potential for disclosure at the outset and during the course of a committee process can greatly assist members of the committee in eliminating careless mistakes with communications that might otherwise serve as fodder for a plaintiff’s counsel. Committee counsel should discuss these matters with the committee at the outset and as many times thereafter as may be appropriate.

F. CASE STUDY: THE EMAILING DIRECTOR FACTS

A Delaware company forms a special committee to consider a recapitalization transaction in which the company’s controlling stockholder will obtain benefits that are additional or different from those of the minority stockholders. The committee retains legal and financial advisors to assist in its consideration of the transaction. One committee member who is somewhat skeptical about the merits of the recapitalization repeatedly sends emails to the members of the committee and its counsel with respect to various aspects of the proposed recapitalization and the process being employed by the special committee. The emails sent to the committee and its counsel include emails: (1) criticizing the selection process to retain the financial advisor to the committee; (2) criticizing the merits of the proposed recapitalization, including references to the director only being able to approve the transaction if it were conditioned upon a majority of the minority vote; and (3) suggesting certain interests of management in the proposed recapitalization and concerns as to whether management was being fully candid in its discussions with the committee. In addition, at most meetings of the committee, this director expresses a negative view of the transaction and whether such transaction represents an attractive transaction for the company’s minority stockholders. The director also inquires as to the effect of less than unanimous approval of the committee if she is unable to become comfortable with the merits of the transaction. At the conclusion of its deliberations and following certain negotiations with the controlling stockholder, the committee unanimously approves the transaction and elects not to condition the transaction upon a majority of the minority vote. Following the approval by the full board of the recapitalization and its public announcement, litigation is filed.

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CASE STUDY: THE EMAILING DIRECTOR

ANALYSIS

Although the circumstances presented in the facts are more extreme than the typical set of circumstances surrounding a committee process, they underscore concerns about email communications, as well as the right way to express concerns about the process and substance regarding the committee’s assignment. The director sending the emails in the above example possessed characteristics of a very good committee member—she was engaged in the process and cared deeply about approving only a transaction that she believed was in the best interests of the minority stockholders. Moreover, a good committee member should actively question and challenge a proposed transaction with a controlling stockholder and only approve a transaction with which she is comfortable. Additionally, part of her rationale for certain of her statements was to motivate fellow committee members to show more backbone in addressing the issues facing the committee. Unfortunately, the approach taken by the director ultimately resulted in a more troubling record to defend in litigation. As a starting point, despite admonitions from counsel, the director failed to appreciate that her various emails would likely (at least in part) become part of the record in any litigation setting. This director labored under the mistaken belief that by copying committee counsel on her correspondence to other committee members, all of such communications would be privileged. Though it is possible that certain emails may benefit from the attorney–client privilege depending upon the specific facts, as a general matter the mere copying of counsel on an email will not be sufficient to shield the communication from discovery. Moreover, even if certain of the communications were protected by privilege, it is not unusual in special committee matters for the committee to wish to rely upon the advice of counsel in defending its decisions in a litigation setting. In order to do so, the committee must waive the attorney–client privilege with respect to advice rendered by committee counsel, at least as to specific subject matters covered by the waiver. If this decision is made, the committee may not waive privilege only as to the selective (and favorable) items that it wishes to be disclosed to the court; rather, all matters covered by the waived subject matter must be turned over. Accordingly, even assuming that privilege might attach to emails of the nature sent by this director, such emails may handcuff the committee if it otherwise believes that it would be advantageous to waive privilege in defending litigation. A spotless, worry-free record with respect to email communications is rare, but the foregoing example highlights the importance of committee counsel expressing as clearly as possible that committee members should assume that any email they send may one day be produced in litigation relating to the matter and the committee member will potentially be examined in deposition with respect to the substance of their emails. Additionally, if committee counsel begins to receive emails that appear to address substantive matters in detail, including the perceptions of committee members, counsel should address the topic of email communications promptly with the committee to address, to the extent possible, the creation of a problematic record. The above example also raises the question about what, if anything, to do in response to the receipt of problematic emails or other communications from committee members or other interested parties. Should counsel or other members of the committee

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respond to the problematic email to try to mitigate its negative effects? Whether a response is warranted is something that will necessarily depend upon the specific facts and circumstances. On the one hand, there is some benefit to quickly and directly addressing any clear mistakes in such an email or to otherwise indicate disagreement with the substance of the email on a real-time basis. This also provides an answer to the question that directors might otherwise receive in discovery as to why they did not respond if they strongly disagreed with the statements in the email. On the other hand, in the case of a strong-willed director who is “married” to his email device, a response (or series of responses) will invariably lead to further comment and may serve to magnify the issue. A lengthy email exchange is typically not helpful. Circumstances in which one director is significantly more negative on the transaction than his fellow directors also may present difficult issues. There is typically no requirement that a committee act unanimously to approve a matter delegated to it. However, it is very rare to have a split vote at a committee, and most committees would strongly prefer to present a united front, one way or another, on a transaction. A split committee may also make the prospect of litigation more likely, on the theory that there is more likely to be troubling facts underlying the disagreement at the committee level. The potential for a negative vote by one committee member can also create challenges in drafting minutes for committee meetings. In this regard, we recommend that meeting minutes contain fairly detailed descriptions of the matters considered at the meeting. There is a judicial recognition that there will be give and take in meetings and lively discussions between directors on matters on which reasonable minds can differ. This specific back and forth need not (and should not) be documented in minutes. However, at some point, if the objections of a director go beyond that give and take in reaching a consensus about the best course for the company, it may be necessary to note the rationale for the disagreement in order for the minutes to be accurate and to explain, if necessary, the ultimate negative vote on the matter.

G. AVOIDING FALLING INTO THE DEAL MENTALITY Finally, a few words about negotiating dynamics. There is one trap in all transactions that experienced deal makers and deal counsel encounter over and over again, but on which only few seem to focus in the heat of the moment. That is the trap of becoming so enamored of the process of negotiating a transaction that the deal takes on a life of its own. If this happens, the focus shifts, ever so subtly, from getting the best deal available to getting this deal done. The consequences are often far less than optimal for all involved. In order to avoid the circumstance in which counsel and the special committee find themselves pursuing the deal for the deal’s sake, both the committee members themselves and committee counsel and financial advisors should address each new decision that the committee is called upon to make with the simple question: When I have decided what to do on this issue, will this still be the best transaction available, or has the initial deal morphed beyond recognition? If, as often happens in negotiation, the deal on the table has changed so dramatically that it would not have been pursued at 164

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the outset if the special committee had known how it would look at this later juncture, then it is time for the committee to take a time-out and reevaluate whether it continues to make sense to pursue the transaction, no matter how far along the negotiation or the process. Of course, it is logically possible that the deal has changed in many favorable ways from when it was initially evaluated, but we are still waiting to see the first such example in practice. Real-world experience suggests that the changes that occur as a deal is negotiated tend to detract the attractiveness of the original transaction, not to enhance it. This is not to suggest that, during the course of a truly arm’s-length negotiation, both sides should not expect to give up on points and reach compromise on others. Of course they should, and to expect otherwise is both unrealistic and likely to assure that no deal ever gets done. We are suggesting, however, that as fiduciaries, members of the committee need to somehow immunize themselves from the single-minded focus on completing a transaction regardless of how it has changed. Deals change and sometimes those changes, collectively, make the deal sufficiently risky or otherwise unattractive, so much so that what initially looked like a very good deal is no longer a worthwhile transaction. Ultimately, the work of the special committee and its fiduciaries is not measured by the twists and turns in the negotiation, but by the final product of that negotiation. If what you end up with is not something that you would have signed at the outset, then it is worth objective reconsideration as to whether the transaction should be recommended to the full board (which is highly likely to accept the special committee’s recommendation without significant debate) or to the stockholders (who will typically be required to approve the transaction).

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Chapter 8

Drafting the Forensic Committee’s Report

By now, the forensic committee has completed its review of documents and interviewed its key witnesses. Perhaps it has finished its interviews altogether, or perhaps it has heard enough to know how the committee will be likely to decide the issues under investigation. In any event, the committee has now turned to the question of what its report will say. The task of drafting the report of the committee typically falls to counsel, in the first instance. Since this is the committee’s report, however, it is, in all instances, appropriate for counsel to sit down with the full committee to walk through the key issues, review the facts, and take guidance from the committee on how issues should be resolved. Of course, at the point that the committee charges counsel to begin drafting, the committee should also have arrived at tentative conclusions concerning the matters it has under investigation and share those conclusions with counsel. Below, we examine some of the issues that typically arise during this initial decision-making stage of the committee’s work.

A. THE IMPORTANCE OF A WRITTEN REPORT OF THE COMMITTEE At the outset, the first question to arise is whether the committee should document its work and its conclusions. In many cases, it will be a foregone conclusion that the committee can and should prepare a written report of its work, carefully documenting its investigation and conclusions. At times, however, this conclusion is less certain, and the question of whether to commit the work of the committee to writing arises. In response to the stock option backdating scandal1 that swept through the Silicon Valley

1

Stock option backdating refers to the practice of awarding options effective on a date that preceded the date of the award, often at market lows. In many cases, backdated awards resulted in an immediate windfall to the option recipient. After being uncovered, the practice was widely condemned by the courts, the Securities and Exchange Commission (SEC), and the financial 167

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in the late part of the first decade of the twenty-first century, for example, committees charged to investigate demands or special litigation committees (SLCs) formed in response to stockholder litigation frequently found that the allegations of the demand or the complaint were well founded and that backdating had taken place. At the same time, criminal authorities began to take an interest in such matters, and in certain cases, executives were criminally indicted for their role in the practice. Against this backdrop, counsel for many forensic committees began to question whether it was actually in the best interests of the corporation to commit to writing a virtual road map that could be utilized by a criminal prosecutor or voracious plaintiff’s attorney to prosecute key corporate executives criminally or, alternatively, to sue the corporation for substantial damages. Faced with this decision, several committees determined to do nothing other than prepare a press release describing the fact that they had been unable to find evidence substantiating the date of issuance of some option grants and to announce what steps, if any, were being taken as a result of the committee’s work. The committees that determined to proceed in this way faced substantial criticism by reviewing courts. In almost all cases, it became public that the companies involved had spent several (if not many) millions of dollars on their committees’ work, which seemed to fuel the courts’ incredulity at the practice of not preparing a thorough written report. The courts reacted harshly to the work of these committees. In one case, faced with no written report of a committee’s work, the court ordered that the committee’s key documents be turned over to the derivative plaintiff.2 In another, the plaintiff proceeded with its litigation after a committee was formed to investigate a demand, and the court that supervised the case brought by other stockholders repeatedly criticized the committee’s failure to prepare a report of its investigation.3 Nor did it matter, as some practitioners have suggested that it should, whether the committee in question had been formed to investigate a pending lawsuit or instead in response to a demand. The courts appeared to be equally unimpressed with committees

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press. Several criminal prosecutions were also brought as a result of facts uncovered during options backdating investigations. Ryan v. Gifford, 2007 WL 4259557, at *3 (Del. Ch. Nov. 3, 2007) (ordering production of communications between committee and its counsel and documents related to the committee’s work held by the corporation and its counsel, and noting as of “particular importance” in its analysis the “unavailability of this information from other sources,” given the failure of the committee to produce a report); see also Ryan v. Gifford, 2008 WL 43699, at *2 (Del. Ch. Jan. 8, 2008) (denying the committee’s request to certify an interlocutory appeal from court’s earlier discovery order and expressly noting the lack of a written report, “[n]otwithstanding the significant cost of the investigation, the importance of its results, and the need for transparency”). In re Elecs. Imaging S’holders Litig., C.A. No. 2797 (Del. Ch. Aug. 7, 2007) (Transcript). The court’s remarks were clear and to the point: “[I]t’s puzzling and it’s surprising, and it is difficult, frankly, to read. . . this summary of recommendations, without some understanding in writing about what. . . the facts were, what. . . the investigation uncovered, what the investigating body concluded happened, who was responsible for the things that they obviously concluded happened, and what exactly it was they think happened. None of that’s in writing. It’s amazing.” (Trpt. 54-55). The judge went on to note that, in the event he had been asked to take action with respect to the committee’s work, he would not do so without a written report. (Trpt. 68).

THE IMPORTANCE OF A WRITTEN REPORT OF THE COMMITTEE

that did not prepare a written report, regardless of whether the committee was established to investigate a demand rather than to investigate whether to take over pending litigation. If, as often happened, the committees involved caused the departure of key executives from the corporation and a revamping of corporate compensation practices, the courts seemed to have no better reaction to the lack of documentation of the committees’ work. In other words, in the courts’ view, the lack of documentation was not justified, even by the fact that the committees involved eventually “did the right thing” by visiting consequences on those they found to have engaged in wrongdoing and otherwise caused corporate practices to change. The reasons for this reaction to the lack of a written committee report appear obvious in hindsight. The committee that decides to abjure the documentation of its work in the circumstance in which a court proceeding is either under way or likely to develop effectively deprives the courts of an opportunity to play their assigned role in the review of the committee’s work. Although such a committee is able to point to the results of its work, the court still has no way to measure whether the results were appropriate in the circumstances, given the failure to record in detail what the committee did and the basis for its conclusions. Courts attuned to focusing on the process followed by a board and staying out of a substantive review of the result of the board’s work (a shorthand way of describing the business judgment rule) were unable to address a situation in which they were invited to rely on the results of the committee’s work as evidence that its cloaked process should be respected. Another concern arises in the criminal context in which corporate self-reporting may lead to a reduced sentence and the corporation itself is a potential criminal defendant. In that context, a reviewing court could find that a committee acted disloyally and preferred the interests of the executive to those of the corporation, because it avoided preparing a written report for fear of jeopardizing the liberty interests of one or more key executives.4 Thus, in our view, every forensic committee should approach its work assuming that it will eventually produce a written report outlining that work, its conclusions, and the basis for those conclusions. The one possible exception is the case in which the committee determines that its work is not likely to become a part of any judicial process; for example, if an investigation is undertaken in response to a request by the board or one of its committees, and the investigation results in conclusions that are not likely to give rise to litigation.5 However, if a committee acts in response to a stockholder’s demand or the institution of a lawsuit, the committee should plan to produce a thorough written work product.

4

5

Of course, the properly advised committee will understand that the interests of the corporation can be and sometimes are distinct from the interests of its senior executives, board members, or other powerful constituencies. Even in these circumstances, it may be wise to consider preparing a written report for the corporation’s records in order to be able to demonstrate that the matter was thoroughly examined. 169

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B. THE SCOPE OF THE WRITTEN REPORT The fact that the committee should expect to produce a report in writing is not to suggest that each and every committee must rewrite War and Peace. To the contrary, there is no magic length for a forensic committee’s report; instead, the length and complexity of the report should generally mirror the scope of the work actually performed by the committee. If there were relatively few documents and the matter was disposed of with a handful of interviews by the committee, a shorter report would typically be in order. This might be the case, for example, if a demand to investigate was determined to be based upon centrally important facts that were simply incorrect. If the committee’s work took many months, however, and involved the collection and review of hundreds of thousands of documents and interviews of dozens of witnesses, a somewhat more prolix document is likely to be the result. In every case, however, the drafter of the report should have in mind the ultimate audience, which, in many cases, will be a court. Given that a court’s review tends to focus upon the process that directors use to make decisions (rather than the substance of the decisions themselves),6 it follows that the scope of the report should describe what the committee did, include a presentation of the facts determined by the committee, provide an overview of the legal principles that the committee has applied, and, finally, set forth the committee’s conclusions and the basis for each. To the extent that the committee’s charter calls upon it to make recommendations, it should support each recommendation it determines to make with a description of its reasoning. In the words of one court, the report should tell the reader “what. . . the facts were, what. . . the investigation uncovered, what the investigating body concluded happened [and]. . . who was responsible.”7 As a general guideline, the written reports of SLCs tend to be somewhat more detailed than the reports of other forensic committees; however, that is not invariably the case.8 Committees formed to investigate stockholder demands will typically support their conclusions (for or against the demand to sue) in sufficient detail to make clear that the committee did its work in a reasonably thorough manner.

C. DECIDING WHAT TO INCLUDE IN WRITING Every forensic committee that does its work carefully and thoroughly will undoubtedly be faced with the judgment of deciding which details to include in its report and 6

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As noted earlier, this approach to review is a hallmark of the business judgment rule. Assuming that the court determines that the committee’s members were independent and disinterested, the rule will typically apply. An exception to the more narrow focus on process and independence is the case of the SLC, at least if chartered by a Delaware corporation, addressed elsewhere. See, e.g., Zapata Corp. v. Maldonado, 430 A. 2d 779 (Del. 1981) (describing two-step process for review of the SLC dismissal motion). In re Elecs. Imaging, C.A. No. 2797 (Del. Ch. Aug. 7, 2007) (Transcript). See, e.g., Zapata, 430 A.2d at 788 (“The Motion [to dismiss by the SLC] should include a thorough written record of the investigation and its findings and recommendations.”).

DECIDING WHAT TO INCLUDE IN WRITING

which to lay aside. During the process of reviewing documents and interviewing witnesses, it is natural to expect that many facts will emerge that are not central to the issues the committee has been charged to investigate. At the same time, however, it is not at all uncommon to stumble upon facts that, while not directly related to the charge of the committee, the members believe should be addressed in due course in order to strengthen the governance or internal controls of the corporation. Invariably, judgment is required to determine how deeply to address any topic and which facts to include in any report. The exercise of that judgment is informed by many considerations. Foremost among them is making sure that the ultimate reader of the report, usually a court, is comfortable that the committee has, in fact, considered and made decisions with respect to central issues and in light of key facts it uncovered or should have uncovered. The law provides an important backdrop here. Courts expect directors to make decisions, but the deference shown to directors who do so in an impartial and thoughtful way melts away if the record suggests that a director or a board simply ignored a key fact or otherwise chose to turn away from an unpleasant issue.9 What follows are what we have called a series of rules intended to help guide the committee’s judgment regarding what its report should contain.10

i. Rule One: Avert not thine eyes The first rule of deciding what to include in a report is shaped from the perspective of the report’s ultimate reader: Avert not thine eyes. Put differently, and in a more secular tone, ignoring difficult issues or embarrassing facts that bear centrally upon what the committee is supposed to be doing is likely to lead a reviewing court to conclude that the committee was more interested in avoiding unpleasantness than doing its duty. A reviewing court might also conclude that the committee’s decision to avoid addressing a difficult issue is evidence that the committee is actually subject to the domination and control of a majority holder or otherwise not sufficiently independent from the targets of the investigation, which, as noted in Chapter Three, “Forming the Special Committee,” above, are conclusions that should be avoided at all costs. Since the process of reviewing a committee’s work is invariably one that is carried out with the benefit of hindsight and sometimes (but not always) after further discovery is granted to a plaintiff’s lawyer, it is almost never a good idea to fail to address the difficult issues or embarrassing facts that emerge during the committee process.

9

10

In the rubric of the case law, a decision is protected by the presumptions of the business judgment rule, but a failure to make a decision is subject to the much more difficult negligence standard of review. Aronson v. Lewis, 473 A.2d 805, 813 (Del. 1984) (the rule “operates only in the context of director action [and] it has no role where directors. . . absent a conscious decision, failed to act”). To call these rules is undoubtedly an overstatement. Since this is an area in which sound judgment is the most important ingredient brought to bear, these are offered as no more than guideposts in the exercise of that judgment. 171

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Likewise, the mention and appropriate disposition of the difficult issue or embarrassing fact shows that the committee did, in fact, make a decision on the topic, which is likely to earn deference from a reviewing court rather than approbation. Indeed, in many cases, it may not matter what the committee actually decides to do with the troubling issue, since a court is likely to focus more on the process than the result. Of course, if the committee’s determination is facially irrational, then the protections otherwise afforded its decision are likely to evaporate, but in the majority of cases, the court that reviews the committee’s work is likely to be more interested in determining whether the committee did a thorough job than whether or not it would have agreed with each and every decision made by the committee. In Carlton Investments v. TLC Beatrice International Holdings, Inc., a decision from the Delaware Court of Chancery, an SLC formed during the pendency of hotly contested litigation investigated and determined to settle the case over the vigorous objection of the plaintiff. The court, after expressly noting that it was of the view that the committee’s judgment with respect to particular issues was “more likely to be wrong than right,”11 nonetheless approved the settlement and concluded: This settlement process and result, although not perfect, is in my opinion an example of a fair and reasonable settlement achieved by an independent SLC with the assistance of experienced counsel. While reasonable minds might differ over any number of decisions (and I would) I conclude that the result as a whole is reasonable and the product of independent, informed action of directors acting in good faith.12

Thus, the court was applying its own business judgment to approve a motion by an SLC as required by Delaware law in the SLC context, and disagreed with the committee’s decision on a particular point. The court nonetheless determined to approve the work of the SLC on grounds that it was, on the whole, a fair and reasonable settlement conducted in good faith by independent board members. One of the most often-heard responses to the foregoing rule of what to include in a committee report is that including the troubling facts and dealing with the difficult issues that arise does harm to the corporation by providing the plaintiff’s lawyer, who in at least some cases can be expected to have access to the report, a road map outlining how to proceed. In other words, the argument goes, if the committee does not include a particular fact or issue in its report, the plaintiff’s lawyer may never stumble upon it, so why include the point? As rational as this may seem at the time, the answer is almost always rooted in who the ultimate reader of the report is likely to be and what end the corporation was seeking to reach by chartering the committee to begin with. If a difficult issue is one that a court, with the benefit of hindsight, is likely to conclude should have been addressed by the committee and the issue is “ducked,” the judicial deference that might otherwise be given to the committee and its work may evaporate. Likewise, if the purpose for which the committee was formed was to gain some potential burden shift or other

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Carlton Inv. v. TLC Beatrice Int’l Hldgs., Inc., 1997 WL305829, at *17 (Del. Ch. May 30, 1997). Id., at *20.

DECIDING WHAT TO INCLUDE IN WRITING

litigation advantage, then proceeding in an expedient fashion risks the court eventually concluding that the corporation or individual defendants are not entitled to the benefits sought in a later court case. Some would argue that a committee should do its best to balance these risks and benefits, since the future is always unpredictable and since the role of the forensic committee is to investigate. Nevertheless, we believe that it rarely makes sense to counsel a committee to avoid the difficult or embarrassing issue, provided that it is within the purview of what the committee has been asked to address.13

ii. Rule Two: Speak truth to power A closely related second rule of the written report of a forensic committee relates to preserving and demonstrating the independence in fact of the committee. In cases in which a committee is charged with investigating a controlling stockholder or other powerful constituency, the committee is well served by the maxim: Speak truth to power. The committee is charged to investigate. It should do so and state the essential facts as it finds them. If that process leads to hurt feelings or an unhappy majority stockholder, so be it. If the committee was formed, it was formed to achieve a corporate benefit, which may or may not have incidental beneficial effects on the individual targets of the committee’s investigation. A committee is missing that point if it worries about whether a plain and frank discussion of the key facts it found to exist might give offense. The exercise is not designed to comfort the controlling stockholder or powerful director. It is to investigate impartially, address the facts found, and determine what, if anything, should come of the facts found to exist. The most common criticism of this approach to articulating the committee’s findings is that it has within it the potential to tear at the cohesiveness and collegiality of the board. That is often a fair point. The suggestion here, however, is not to seek to create dissension if none need exist, but also not to shirk from stating the facts on the grounds that doing so will hurt someone’s feelings. Although the cohesiveness and collegiality of the board are worthy goals, at the point that a forensic committee is chartered, it is entirely possible that one or more directors have engaged in at least questionable (if not necessarily sanctionable) conduct. As a committee member, the question to ask is not whether stating the facts as the committee found them in a report is likely to destroy the cohesiveness of the board, but instead whether the conduct under investigation has itself already done so. Just as addressing a difficult issue is likely to help persuade a reviewing court that the committee understood its duty, laying out the facts and letting them speak for themselves without undue concern about hurt feelings also tends to persuade a reviewing court that the members of the committee had the integrity or independence necessary

13

We hasten to add, however, that facts uncovered of an embarrassing personal nature that do not bear upon the work of the committee should be dealt with as in any other situation, with discretion and good taste. 173

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to do their jobs. Following this rule can provide powerful evidence that the committee was not only independent on paper, but also in fact.

iii. Rule Three: Separate the wheat from the chaff Having determined to address each issue critical to resolution of the committee’s charge and to lay out the key facts as found, the third rule is: Separate the wheat from the chaff. A committee will invariably create a massive record, over the course of a several-month forensic investigation involving the collection of hundreds of thousands of pages of documents and the interview of dozens of witnesses. The risk is that the reviewing court will drown in a sea of irrelevant detail that includes each fact learned and every issue considered, no matter how extraneous to the core of the committee’s investigation. Not only does this lead to a report of truly ponderous length, it also risks the criticism that the committee has missed the forest for the trees. The answer, of course, is to focus on the key facts developed and the key issues resolved. In many cases, this will involve a tight focus on a preliminary outline of the report, prepared through a careful collaboration between counsel and the committee. On reading the report, the committee member may want to ask, “How does what I am reading fit with what we are charged to investigate?” If the answer is difficult to discern, or is that it does not, then the report is likely to have too much chaff and not enough wheat. There will, of course, be times when counsel explains that a particular section is necessary in order to address a legal requirement. In the main, however, the careful non-lawyer’s view of whether or not a particular discussion is appropriate is often just as valuable (or more valuable) than that of the drafting attorney.

iv. Rule Four: Avoid the gratuitous By the time counsel sits down to draft the report of a forensic committee charged with conducting an in-depth and difficult investigation, he is likely to have formed personal views about the individuals involved in the investigation. Feelings are likely to have been ruffled, and the committee will have been forced to overcome or work around any number of difficulties or frustrations during the course of its investigation. The text of the report is not the place to express those frustrations (assuming, of course, that they did not translate into material limitations on the ability of the committee to discharge its responsibilities). In drafting the report: Avoid the gratuitous. There is undoubtedly a very human temptation to characterize events or motives, or to settle scores with the gratuitous comment. As richly as it may be deserved, it is never a good idea. In many cases, the report itself will be in the nature of a recommendation to the full board, and the committee will not have the power to act independently. In such cases, a report filled with gratuitous and unnecessary characterizations or judgmental comments is not likely to be viewed as appropriate by other disinterested members of the board. To the extent that the targets of the investigation have mounted a fight to 174

A SAMPLE REPORT OUTLINE

convince the other members of the board to reject the recommendations of the committee, a report replete with the drafter’s attempt to settle scores rather than dispassionate fact-finding is likely to play into the hands of those who would have the work of the committee rejected.

v. Rule Five: Draft to build consensus Assuming that the committee is made up of more than one director, there will be times when the members of a committee need to reach a compromise with respect to a particular fact or issue. When drafting the report, counsel should be sensitive to issues around which the committee has not perfectly coalesced and draft in a way that is most likely to allow the dissenting member(s) of the committee to become comfortable with the report. Depending upon the committee’s findings, any forensic committee’s report may well run directly into powerful headwinds. It follows that a less than unanimous committee is highly undesirable. To the extent that the chairman of the committee has failed to guide his fellow directors to consensus before the report is committed to writing, the draftsman should be sensitive to the open issues and attempt to draft in a way that leads to consensus rather than division.

D. A SAMPLE REPORT OUTLINE There is no magic formula for what a report must contain and no requirement that a report must be laid out in a particular manner, but many reports eventually come to include the following major topics.

i. A Description of the Committee and Its Work Here, the report typically describes the committee, names its individual members, sets forth when and why it was formed, and describes the delegation of authority given to the committee by the board. This section will also typically contain a high-level overview of the steps the committee took to discharge its obligations, describing generally from whom documents were collected and the approximate number of such documents, by whom the documents were reviewed and the role of the committee in that process, the identity of persons interviewed and the role the committee played in those interviews, the number of meetings held by the committee, and the process by which the final report of the committee was prepared.

ii. An Executive Summary of Findings and Recommendations After introducing the committee and its work, the report will typically contain an executive summary that describes in as few pages as possible what the committee’s key findings and recommendations (if any) are. 175

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iii. Facts Found by the Committee Following the executive summary, many reports have a section that describes the key facts found by the committee. This section can be organized by topic, if the committee has been charged to investigate more than one issue, or in any way that the committee determines adds to the readability and usefulness of the report.

iv. An Overview of the Law as Understood by the Committee Many reports, either before or after the section of the report setting forth the facts found by the committee, include a high-level description of the legal principles that guided the committee. This need not be a full brief of each and every case on point or a detailed explanation of the subtleties of each legal principle tangentially touching on the work of the committee. Instead, it is intended to be a high-level, businessperson’s recital of the general legal concepts understood and applied by the committee. The purpose of including a section describing the relevant legal principles as understood by the committee is to allow a reviewing court to confirm that the committee correctly understood the law and considered the appropriate principles in formulating its conclusions and recommendations. It is not meant to be a lawyer’s brief.

v. Specific Factors Considered by the Committee in Making Its Decision Many reports include analyses of a series of practical factors often considered by courts in evaluating committees’ reports. These factors, which can be derived from case law but are intensely practical, often include the analysis of issues such as: the merits of the claim, including whether the plaintiff or demanding stockholder’s allegations state a claim and, if so, whether they are supported by the evidence found by the committee;14 the injury to the corporation, including an analysis of whether the underlying acts or transactions were fair to the corporation;15 the costs of prosecution of the claim, including an inquiry into the likely indemnification expenses that will be required to be borne by the corporation;16 effects on operations, and specifically whether the prosecution of an action would be likely to have a significant adverse effect on the management’s ability to run the corporation, and the impact of litigation on the morale of the corporation’s employees and executives;17 a cost-benefit analysis, inquiring whether the 14 15 16 17

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See generally Strougo v. Padegs, 27 F. Supp. 2d 442 (S.D.N.Y. 1998); Mills v. Esmark, Inc., 544 F. Supp. 1275 (N.D. Ill. 1982). See, e.g., Kaplan v. Wyatt, 499 A.2d 1184 (Del. 1985); Mills v. Esmark, Inc., 573 F. Supp. 169 (N.D. Ill 1983). Lewis v. Fuqua, 502 A.2d 962 (Del. Ch. 1985); Abella v. Universal Leaf Tobacco Co., 546 F. Supp. 795 (E.D. Va. 1982). Lewis, 502 A.2d at 971; Abella, 546 F. Supp at 801; Stein v. Bailey, 531 F. Supp. 684 (S.D.N.Y. 1982).

WORKING WITH THE COMMITTEE TO FINALIZE THE REPORT

likelihood of success on the merits of a prosecution justifies the costs of prosecuting the claims;18 consideration of whether the defendants or targets of the investigation knowingly authorized the alleged misconduct, and what they knew about the alleged wrong; and, finally, the effect of remedial action taken, if any.19

vi. The Committee’s Conclusions When preparing a brief, lawyers conceptualize their task as setting forth facts, describing the law, and then applying the law to the facts. The job of preparing the conclusions section of the committee’s report is similar but not identical to the task of applying the law to the facts. Typically, the committee’s report does not describe in detail how its conclusions and recommendations flow from the application of the law to the facts, relying instead on its lawyers to make those arguments at a later date. Instead, the committee’s report typically will contain a series of conclusions, supported by the committee’s thoughts about why the conclusions are justified, which would include legal reasoning only if the committee believes it may be useful.

vii. Recommendations Finally, the committee may choose to include recommendations as part of its report, either separately or as part of its conclusions. In the context of a committee charged with reporting back to the full board, these recommendations are typically that the full board either take action or not. In the case of an SLC, the report is likely to contain a description of the action that the SLC has determined to take, rather than a recommendation for further action, by way of information to the full board. In addition, depending upon the nature of the investigation and the committee’s findings, it is possible that, during the course of its work, the committee found internal control deficiencies or other governance shortcomings that it determines to address by way of recommendations to the full board.

E. WORKING WITH THE COMMITTEE TO FINALIZE THE REPORT Once the text of the report is prepared, the process of consensus building begins in earnest. Depending upon the length of the document, it may be appropriate to plan an in-person session to turn pages and even to review the report on a line-by-line basis.20

18 19 20

In re E.F. Hutton Banking Practices Litig., 634 F. Supp. 265 (S.D.N.Y. 1986); Mills, 544 F. Supp. at 1282. Stein, 531 F. Supp. at 690. When distributing the draft, counsel should take pains to assure that the members of the committee understand the nature of the attorney–client privilege and the fact that the privilege may be lost in the event that the work is distributed beyond the committee itself. No matter how 177

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At this point, the work of the committee turns from investigation to crafting what will hopefully be a unanimous report and, if appropriate, recommendations. The importance of give and take to build consensus among committee members at this stage of the process cannot be overemphasized. A committee should strive to achieve real buy-in as to key findings, conclusions, and recommendations among all committee members, rather than merely tepid support. In many cases, the report of a forensic committee is held up to searching criticism at the level of the full board or later in court, and in those cases, having members of the committee who are not fully committed to the committee’s findings and conclusions poses a serious risk to the process itself. That risk is that the skilled plaintiff’s lawyer or the unhappy targets of the investigation will succeed in picking the committee apart, finding by finding, and eventually member by member. To characterize Benjamin Franklin’s famous dictum, a committee must be ready to hang together in defense of its report, for fear of hanging separately if those who would object to the report are allowed to deconstruct the report and attack the cohesiveness of the committee itself. Once the page-turning process is completed, counsel should typically prepare a second draft of the report for the committee’s review. Multiple in-person sessions are rarely needed to finalize a report, but the committee should commit whatever time is necessary to drive the process of preparing the report to its conclusion. Although not required, the authors believe that it is useful to suggest that each member of the committee sign the final report in the form that it is to be presented. This tends to assure that each committee member is truly committed to the report and often has the beneficial effect of flushing out any last-minute concerns of committee members.

F. FINAL STEPS OF THE FORENSIC COMMITTEE Once the report is finalized and signed, what happens next depends upon the nature of the committee. In the case of a committee chartered to investigate a stockholder demand and to report back to the full board, the report is typically forwarded to the corporate secretary with a request that it be distributed to all directors either at or in advance of the next meeting of the board and filed with the records of the corporation. The committee, either with or without counsel, will typically make a presentation to the full board, outlining the scope of the committee’s work, as well as its key findings, conclusions, and recommendations. If the committee merely has the power to recommend and not to take action independently, it falls upon the full board to accept or reject the committee’s report. Assuming that the committee determines not to bring suit in response to the stockholder’s demand, and the full board concurs, counsel for the corporation then typically writes to the demanding stockholder advising that the

sophisticated the businesspeople who sit on the committee, it is never a bad idea to remind the committee of the ground rules of the privilege with each successive draft. Committee members who are unsure of those rules should ask counsel for a briefing if it is not offered. 178

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committee has made its report, the board has accepted the committee’s recommendations, and the decision not to file suit has been taken.21 If the committee determines instead to recommend that a lawsuit be commenced or alternatively that remedial action be taken, and the full board approves such recommendation, the corporation will then instruct counsel to commence such litigation, or the recommended remedial action will be instituted. In either event, courtesy suggests notice of the disposition of the matter to the demanding stockholder. In cases in which the forensic committee is an SLC, vested with the full power and authority of the board to act itself without further action by the board, the SLC will either file a motion to dismiss the litigation (if it has determined to do so as a result of its investigation) or seek to intervene as a party plaintiff (in the event that the SLC has determined to prosecute). Of course, an SLC may also determine to settle the litigation with the defendants, and such settlement would typically be presented to the court with jurisdiction over the case for review and approval. In any event, custom suggests that the SLC would also report to the full board what action it determined to take for informational purposes only.

21

In Levine v. Smith, 591 A.2d 194 (Del. 1991), the Delaware Supreme Court gave an indication of just how important such a letter could be. There, the court quoted counsel’s letter rejecting the demand as evidence on which the trial court could rely. The letter advised the complaining stockholder that, “following review of the matters set forth in your. . . [demand] letter” the board had determined that litigation would not be in the corporation’s best interest. The Delaware Supreme Court found that the “only reasonable inference” that could be drawn from the letter, which was attached to the plaintiff’s complaint, was that the directors “did act in an informed manner” in addressing the demand and that this inference overcame the pleading that the board “did nothing.” Levine, 591 A.2d at 214 (emphasis added); see also Scattered Corp. v. Chic. Stock Exch. Inc., 701 A.2d 70, 76 (Del. 1997). The court’s willingness to rely on the letter, at least if it was attached to the plaintiff’s complaint, strongly suggests that such a letter should be sent promptly upon the board’s approval of the committee’s recommendation and that it should include key details regarding the scope of the committee’s work. 179

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Chapter 9

Negotiating the Transaction Documents

Once a transactional committee has been properly constituted, retained the necessary advisors, and formulated a strategy for negotiations, the difficult work begins: negotiating the transaction documents. The negotiation of the transaction documents is a big task and typically involves a significant time commitment by members of the special committee. This chapter discusses the necessity of having an informed and active committee, explores the respective roles of the committee’s counsel and regular outside counsel to the corporation in assisting the committee in its function, and discusses the means by which the committee can have an efficient and effective relationship with the full board, depending upon the context of the transaction.

A. THE NEED FOR AN INFORMED AND ACTIVE COMMITTEE Once vested with appropriate authority, the touchstone for an effective independent committee is the exercise of its authority in an informed and active manner. Being informed will require that the committee members are knowledgeable about the contemplated transaction, the business of the corporation, and the status of negotiations and documentation relating to the transaction being contemplated. Being active requires a significant level of involvement in the negotiations—whether through personal involvement in such negotiations or through frequent communications with the parties directly handling the negotiations at the behest of the special committee. There is simply no shortcut for the members of the committee rolling up their collective sleeves and devoting the necessary time and energy to the matter. The Delaware Supreme Court’s opinion in Kahn v. Tremont indicates that the active nature of a special committee—that is, its “care, attention and sense of individual responsibility”—is crucial in assessing the effectiveness of the committee process and, consequently, the standard of review applied to a transaction.1 In Tremont, the special committee was formed to consider whether the corporation should purchase a block of 1

694 A.2d 422, 430 (Del. 1997). 181

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stock from an affiliated corporation. The court’s discussion is instructive on how a special committee ought not to perform its duties: The record is replete with examples of how the lack of the Special Committee’s independence fostered an atmosphere in which the directors were permitted to default on their obligation to remain fully informed. Most notable, was the failure of all three [Special Committee members] to attend the informational meetings with the Special Committee’s advisors. These meetings were scheduled so that the Special Committee could explore, through the exchange of ideas with its advisors, the validity of the . . . proposal and what terms the board should demand in order to make the purchase more beneficial to [the corporation]. Although [the Special Committee] had requested an independent analysis . . . the report was not read prior to the Special Committee’s . . . vote on the purchase of the NL stock. The failure of the individual directors to fully participate in an active process severely limited the exchange of ideas and prevented the Special Committee as a whole from acquiring critical knowledge of essential aspects of the purchase. In sum, . . . the Special Committee did not operate in a manner which entitled the defendants to shift from themselves the burden [of showing the entire fairness of the transaction].2

The Tremont court also reserved harsh criticism for a member of the committee who, due to his travel and work schedule, attended none of the meetings of the special committee. The court held that such committee member had “abdicated” his responsibility as a committee member and that his absence from all meetings “rendered him ill-suited as a defender of the interests of minority stockholders in the dynamics of fast moving negotiations.”3 Likewise, in In re Loral, Space and Communications Inc., the court was highly critical of both the energy certain special committee members brought to the task of considering a financing transaction with the corporation’s controlling stockholder as well as its lack of activity at crucial points in the process. With respect to the involvement of one of the two committee members (Mr. Simon, the more independent of the two committee members), the court summarized: To the extent that the Special Committee was active in the negotiations, Harkey was the member involved. This is not to suggest that Simon did not participate in the Special Committee process by attending Special Committee calls, but he otherwise deferred entirely to Harkey and the Committee’s advisors. That is evident in Simon’s emails early in the process negotiation asking “What is happening???” and “I am wondering where we are headed.” Later in the process, Simon went camping on a remote lake with no electricity for a one-month period beginning in late August. Simon took a six-mile boat trip for “a couple telephone meetings” during that time, but his involvement was clearly limited. Simon’s emails and his role while he was camping at the lake are consistent with the impression that Simon gave at trial— someone who realized that he had responsibilities as a special committee member but who was content to simply show up by telephone at meetings when the special

2 3 182

Id. Id. at 429.

THE NEED FOR AN INFORMED AND ACTIVE COMMITTEE

committee’s advisors called for one. As a result, Simon was often unaware of or perplexed by the state of negotiations.4

With regard to the committee’s effectiveness in serving as a surrogate for arm’slength bargaining with a third party, the court focused upon the “less-than-intrepid manner in which [the committee] approached its assignment.”5 The court noted: Whenever the Special Committee or its advisors had an opportunity to] use leverage it had or create additional leverage, they found a way to avoid doing so. . . . [T]he Special Committee simply continued to reject any exploration of alternative options at all, not even bothering to see where they might lead. . .. 6

The court summarized: [I]t is the sheer accumulation of examples of timorousness and inactivity that contributes to my conclusion that this Special Committee did not fulfill its intended function. When, over the course of nearly a year, there appears to be no instance in which the Special Committee took any of the numerous opportunities available to it to explore the marketplace and determine whether it could obtain better terms than were available from the controlling stockholder, MHR, it is impossible for me to conclude that the Special Committee acted as an effective guarantor of fairness.7

In contrast, the Delaware Court of Chancery’s approval of the special committee process employed in In re Cysive, Inc. Shareholders Litigation8 is instructive on how a special committee ought to perform its duties. In the context of a proposed goingprivate transaction by Cysive’s controlling stockholder, the court noted that the special committee met twenty-one times and expended a great deal of personal time and energy in embarking on a process that was thorough and reasonably designed to obtain the best price for Cysive’s public stockholders. In particular, the court found: [T]he record indicates that the special committee took its responsibilities seriously. The committee bargained hard with Snowbird, holding out to get a higher price and ensuring that the committee retained the flexibility to accept a higher bid. Indeed, throughout the negotiations—and, indeed, to this day—the committee has entertained inquiries and has worked diligently to develop a higher-value alternative for Cysive’s public stockholders. *** To that end, the committee negotiated with [the controlling stockholder] aggressively and obtained a price above liquidation value and the pre-announcement price of Cysive’s stock, thereby guaranteeing an immediate and certain return to the public stockholders. At the same time, the committee retained the flexibility to accept a higher bid, thus subjecting the Snowbird Agreement to a post-signing market check. . . . Negotiations with seven such parties have occurred since signing. Thus, the committee retained the flexibility to abandon the [agreement with the controlling stockholder] in 4 5 6 7 8

2008 WL 4293781, at *16, (Del. Ch. Sept. 19, 2008). Id., at *25. Id. Id., at *26. 836 A.2d 531 (Del. Ch. 2003). 183

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favor of a better deal and did not subject the company to any unreasonable penalty for doing so.9

Based on this record, the court found that “the special committee process was effective enough to warrant that the ultimate burden of proving unfairness must rest on the plaintiffs.”10 Likewise, where a committee was formed by adding two independent outsiders to the board, with a broad delegation of power and the ability to say no and clearly negotiated at arm’s length, the court approved the settlement of litigation by that committee as part of a merger, even though the court expressed concerns about the substance of the settlement itself.11 There is no single template for a committee to handle the negotiation of the transaction documents and to meet its requirement of being informed and active. Although the committee may directly participate in all negotiations with respect to transaction documents, it is more customary (and perfectly appropriate) for the committee’s advisors to handle the bulk of the direct negotiations with input and oversight from the committee. In this regard, an important job of the advisors to a special committee is to keep the members of the committee fully informed with respect to the status of and developments in the negotiations. Many transactions involve voluminous and dense transaction documents, complex legal and financial issues, and tight deadlines. Without the benefit of experienced and competent advisors, it is more difficult for a special committee to achieve the appropriate level of understanding and to appreciate all aspects and ramifications of a transaction being considered. Professional advisors can quickly and efficiently summarize and condense the voluminous information and focus the members of the committee on the important transaction terms as well as the key legal and financial issues associated with different transactions and proposals. It is customary for such advisors to prepare detailed summaries and presentations for the committee highlighting transaction terms, legal issues, financial analyses, and other matters, and such information should be provided to committee members as far in advance of committee meetings as possible to allow the members adequate time to digest the information being provided. Engaging in frequent meetings with committee advisors will allow committee members to be fully informed with respect to the transaction and status of negotiations. Additionally, members of a special committee of a Delaware corporation are fully protected in relying in good faith upon the information, reports, and statements provided by its advisors that have been selected with reasonable care.12 In the context of transactions with a controlling stockholder, it is sometimes the case that a plaintiff may challenge whether the committee was fully informed by virtue of important information not disclosed to the committee by the controlling stockholder (who may have unique knowledge of the transactions in certain instances). In the

9 10 11 12

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Id. at 554–56. Id. at 556. Brinckerhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370, 393–95 (Del. Ch. 2010). 8 Del. C. §141(e).

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Delaware Court of Chancery’s opinion in Kahn v. Tremont Corp.,13 the plaintiffs argued that the committee process should not be given legal effect by the court because the committee was not provided information regarding the assessment of the controlling stockholder’s financial advisor as to the magnitude of a potential discount on the price of stock contemplated to be purchased by the corporation. The court rejected such claim on the ground that required disclosure of such information would not be consistent with arm’s-length negotiations and was information that could otherwise be obtained through a qualified broker. The court identified the categories of information required to be disclosed by the controlling stockholder to ensure a fully informed committee as follows: (1) the fiduciary must fully and fairly disclose all of the material terms of the proposed transaction; (2) the fiduciary must disclose all material facts relating to the use or value of the assets in question to the beneficiary itself. Such facts would include alternative uses for assets or “hidden value” (e.g., there is oil under the land subject to sales negotiation); (3) the fiduciary must disclose all material facts which it knows relating to the market value of the subject matter of the proposed transaction. Such facts would include for example. . . forthcoming changes in legal regulation or technological changes that would affect the value of the asset in question either to the subsidiary or to others. This listing is intended to include all material information known to the fiduciary except that information that relates only to its consideration of the price at which it will buy or sell and how it would finance a purchase or invest the proceeds of a sale.14

Accordingly, in appropriate transactions with a controlling stockholder, a committee will want to seek out and consider any specialized knowledge or information the controlling stockholder may have with respect to the business or operations of the corporation, or the assets being purchased from or transferred to the controlling stockholder, to make certain that the committee is fully informed prior to making its decision.

B. THE ROLE OF THE COMMITTEE COUNSEL The primary role of the counsel for the special committee with respect to negotiations is to help the committee structure and execute a negotiating process that will be free from material conflicts of interest (and be given appropriate recognition in the event of judicial review), while at the same time maximizing efficiency. In most cases, this will involve counsel for the committee taking the primary leadership role in directing the negotiation process, and, as discussed in more detail below, regular outside counsel to the corporation will have a more limited role of supporting the committee’s counsel however it can—upon the request of the special committee. One challenge for special committee counsel in most transactions in reaching its objective of having a spotless negotiation process arises from the fact that it is 13 14

1996 WL 145452, at *20 (Del Ch. Mar. 21, 1996), rev’d on other grounds, 694 A.2d 422 (1997). Id., at *16. 185

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typically one of the few “new guests to the party.” Because counsel for the special committee usually has had little or no involvement with the corporation prior to its engagement, it is often dropped into factual circumstances in which management, the board, regular outside counsel to the corporation, and the controlling stockholder (if any) have a long history and relationship with one another and the dynamics of such relationships may influence how those parties interact with one another. It will be important for special committee counsel to attempt to get the lay of the land quickly because this may influence counsel’s approach to the various issues that may arise during the course of the representation. Although the primary role of committee counsel is to provide legal advice and assure a good process, committee counsel cannot ignore the realities of interpersonal relationships and the parties’ history together, and these will influence the best way to set the tone in order to achieve the committee’s goals. By the time the negotiation of the transaction documents begins in earnest, the committee counsel will hopefully have been successful in indoctrinating the special committee and, along with regular outside counsel, the general counsel, and/or others, setting appropriate expectations for the process. However, as negotiations get underway and continue (often for much longer than the parties may like), the interested parties may tend to display frustration or other behavior that is not conducive to an ideal process. The committee’s counsel must seek to minimize or eliminate behavior that could cause judicial concern in the event of a challenge to a transaction, including striving to ensure that the process is not compromised by the interested parties to the transaction seeking to influence the process. This will often require both the ability to have blunt and candid conversations with interested parties regarding how the process will be run while at the same time negotiating around ever-present political issues and egos. A special committee must never yield in its resolve to negotiate only the best transaction (if any) for the minority stockholders. Nevertheless, the ability of special committee counsel to set the right tone and to disagree without being disagreeable may be of vital importance in determining whether the process achieves a successful conclusion, including maintaining a comfort level (to the extent possible) with the committee in approaching the transaction. Negotiation must be undertaken with a firm hand by the committee, but it is typically in everyone’s interest to avoid excessive hostility. Being attuned to the personalities of the parties involved, including the personal relationships of the members of the committee with different constituencies, is often helpful to keeping matters on course. As an obvious example, certain messages are better given and received in a one-on-one conversation between the chair of the special committee and the CEO (chief executive officer) or other interested party than by committee counsel writing an adversarial letter to the CEO or other interested party. Negotiating the transaction may also require a careful balancing act between the desires to maximize efficiency and create a clean factual record for a reviewing court. Considerations in this regard may often arise when analyzing the role of regular corporate counsel in connection with the transaction. As a starting point, it must be recognized that the importance of having a special committee represented by separate counsel is to ensure that the committee is receiving disinterested and independent legal advice relating to a potential transaction, and alleviate concerns that regular corporate counsel may have close ties to current management or a controlling stockholder if such 186

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parties may have differing interests or, indeed, be on the other side of the transaction being considered. At the same time, however, the existence of a special committee and its retention of separate outside counsel typically does not mean that regular outside counsel plays no role in the matter. Often, it is prudent for the regular outside counsel to play a role at the request and under the supervision of the special committee counsel, given considerations of efficiency and the extensive knowledge of the corporation possessed by regular outside counsel. Where and how regular corporate counsel can or should assist the committee will depend upon the particular factual circumstances of the matter being considered because there is no one-size-fits-all in negotiating a conflict transaction. We explore the roles of special committee counsel and regular outside counsel in more detail below and in Section C, “The Role of Regular Outside Counsel to the Corporation,” of this chapter. A few matters typically precede the negotiation of transaction documents and fall squarely within the purview of the committee’s counsel. First, the committee’s counsel should typically assist in the retention of the committee’s financial advisor. This would include assisting the committee in interviewing a financial advisor with the requisite expertise to assist the committee with its consideration of the matters at hand. A critical part of such role will be to assist in negotiating the engagement letter with the financial advisor to the committee, as such document will outline the contemplated scope of the role for such financial advisor. Among the important items to be addressed in such document are whether the financial advisor will assist the committee in negotiating the proposed transactions, whether the financial advisor’s role will include the consideration of strategic alternatives to the contemplated transaction, and whether the financial advisor will be providing ongoing advice as to the terms of the contemplated transaction. Additionally, committee counsel should consider whether the financial advisor will be asked to provide a fairness opinion, the contours of any such opinion, and what limitations or caveats the financial advisor may seek with respect to any such opinion. Retention of a financial advisor will also involve careful consideration of the fees payable to the financial advisor and the structure for the payment of such fees, restrictions on the financial advisor’s actions while retained by the committee (for example, restricting any other representation related to the matters being considered, such as participating in the financing of the transaction), and ensuring that the financial advisors are free from disabling conflicts of interest by virtue of prior or existing representations of parties involved. The retention of a financial advisor by the committee and the contours of that engagement impact the scope of the committee counsel’s job with respect to the negotiation of the transaction documents. For example, if the financial advisor’s retention is to include negotiating the proposed transactions, then the financial advisor (as opposed to the committee’s counsel) may take a lead role in the negotiation of pricing and fundamental business terms in connection with a proposed transaction—with the committee’s counsel supporting the role of the financial advisor in this aspect of the negotiation and taking a leadership role in the negotiation of the legal aspects of the transaction. A second important role for the committee’s counsel that is outside the negotiation of the transaction documents is to fully document the deliberations of the committee 187

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in connection with such negotiations. Minutes of committee meetings are the single most important evidence of the special committee’s process and deliberations. Because it is often the case that the work of a special committee relates to a significant transaction for a corporation, including a sale transaction, which may require the preparation of proxy materials to solicit stockholder approval as well as raise a likelihood of litigation, the deliberations of a special committee (and the minutes documenting such deliberations) may be subject to significant scrutiny. It is therefore vital that the special committee’s deliberations be fully and accurately documented in the minutes of the committee’s meetings. This job is most appropriately handled by counsel for the special committee, who will be in attendance at all committee meetings and who should be experienced in drafting these minutes with an eye towards the potential ultimate disclosure relating to the minutes. In the context of the negotiation of the transaction documents, it will be appropriate for the minutes to document the positions taken by the committee in negotiations, the issues considered by the committee and the resulting strategy employed in such negotiations, the legal and financial advice received by the committee from its advisors on important matters, and the ultimate decisions made by the committee, including the reasons for the decisions and the facts and factors weighed in reaching such decisions.15 As noted above, the division of labor with respect to the negotiation of the transaction documents between the committee counsel and regular outside counsel to the corporation may vary depending upon the nature of the matters being negotiated and the history regarding outside counsel’s role with respect to the counterparty to the transaction. For example, there are many instances in which regular outside counsel may have very close ties to the controlling stockholder (e.g., dating back to the formation of the corporation prior to an initial public offering). Such counsel would be ill suited to have any material involvement on behalf of the special committee in a transaction if the controlling stockholder is on the other side of the transaction. On the other hand, there are instances in which a large (even controlling) stockholder (using separate counsel) has had a long and stormy relationship with the corporation and regular outside counsel, and the traditional role of regular outside counsel to the corporation has been adversarial with the large stockholder. In such cases, there would be less concern about regular corporation counsel playing a role in the negotiation of the transaction documents in a transaction if the large or controlling stockholder is on the other side of the transaction—subject to the direction and control of the committee, of course. It is, of course, not at all unusual for the committee’s counsel effectively to handle all aspects of the legal negotiation with respect to transaction documents on behalf of the corporation and effectively to supplant the corporation’s regular outside counsel on the transaction.16 In many cases, however, the members of the committee may

15

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A more detailed discussion of committee minutes is set forth in Chapter Seven, “Getting Down to Work (Transactional Committees),” Section E, “Understanding the Required Disclosures of the Committee’s Work.” For obvious reasons, regular outside counsel should be wary of switching sides to represent management or a controlling stockholder in a transaction, and a special committee should give

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appropriately have a high degree of comfort with regular outside counsel effectively acting on their behalf, notwithstanding the existence of a potential conflict of interest involving members of management or a large stockholder, and believe that it will be more difficult for the committee to do its job effectively without the input and guidance from regular outside counsel. In cases in which the other party to the proposed transaction, whether a controlling stockholder or otherwise, is represented by separate counsel and the special committee has its own independent counsel, involvement by regular corporate counsel, subject to the oversight and control of the committee and its counsel, while not ideal, may present only a small risk of judicial concern in the negotiation process, particularly if regular corporate counsel does not act in a manner that causes concern and special committee counsel meets regularly and independently with the committee. There are often very pragmatic reasons why the involvement of regular outside counsel will benefit the special committee and why the committee would want to rely on the assistance of such counsel. Regular outside counsel will undoubtedly have extensive knowledge of the corporation’s business and operations. In connection with a sale transaction, it may be more efficient for the corporation’s regular outside counsel to be directly involved in negotiations related to the more fact-intensive representations and warranties proposed to be made by the corporation, as well as those that may require factual knowledge concerning the corporation’s historic business practices. Moreover, in most cases it will make more sense for the corporation’s regular outside counsel to have an important role with respect to regulatory issues and filings related to the transactions, and take a role in drafting disclosure documents necessary for the transaction under the direction of committee counsel. As a result, it is not uncommon that committee counsel and regular outside counsel work as a team in many aspects of negotiating the transaction documents. This necessary teaming works best if traditional outside counsel understands that its role is to support the committee and its counsel and not to lead the transaction. If the regular outside counsel is working in tandem with the committee’s counsel in connection with the negotiation of transaction documents in a conflict transaction, the committee’s counsel should be vigilant in ascertaining whether the conduct of regular outside counsel raises questions about its loyalty. If any concerns develop relating to regular outside counsel working to favor the interests of a party with a conflict of interest or inappropriately disclosing to interested parties matters discussed or considered by the committee, the committee’s counsel must alert the committee’s chair and assure strong consideration to objecting to any such representation by regular outside counsel if such role for regular outside counsel would disadvantage the committee in its work. In In re Emerging Commc’ns, Inc. S’holders Litig., 2004 WL 1305745, at *32 (Del. Ch. May 3, 2004), the court was critical of the corporation’s legal and financial advisors being co-opted by its controlling stockholder in connection with a privatization transaction, stating that the “switch was unfair to [the corporation], because during [the corporation’s] entire existence, Prudential and Cahill had been its advisers and they possessed material nonpublic information about [the corporation’s] values, business and prospects.” Accordingly, the court stated that such advisors were in the best position to represent the minority stockholders, but were acting in a manner adverse to the minority’s interest by acting for the controlling stockholder. 189

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that swift action is taken. In such circumstances, it would be appropriate to minimize or terminate the role of regular outside counsel in the committee process—particularly with respect to access to sensitive information. The committee’s counsel should attempt to structure a negotiation process that results in the best transaction for the corporation’s stockholders (or no transaction if not in the best interest of the corporation’s stockholders), provides maximum insulation from the influence of parties with conflicts of interest, maximizes efficiency under the circumstances, and is carefully documented to present a clear record of the negotiations and deliberations for review by a court. Certain general guidelines related to the negotiation of transaction documents are as follows: • Timing. The committee should set the timing for its consideration of a proposed transaction and the negotiation of the transaction documents. Although there may be genuine business reasons why certain transactions may need to be on an expedited schedule (to which the committee should be sensitive), the committee’s counsel should not allow potentially conflicted parties (e.g., the controlling stockholder or management) to dictate timing to the special committee with respect to the negotiation process and vetting of different proposals by the committee. Indeed, the committee should be very hesitant to move quickly at the behest of an interested party in the absence of a compelling reason to do, as such negotiating tactic is often used to curtail a full process by the special committee.17 Likewise, a reviewing court is likely to be critical of an immediate response from a committee after a controlling party takes an extended period of time to respond to a committee’s counteroffer.18 • Process. The committee should set the process by which a potential transaction will be considered. For example, in the context of a sale, the committee should determine the method most likely to maximize value—whether a full auction or otherwise. Although the committee may, of course, take into account demands from the potential counterparty to a transaction, the committee should not feel bound to follow any such demands, even if the failure to do so prevents the process from going forward. • Meetings. The committee should determine when committee meetings will be held and who will attend committee meetings (and for what purpose). It may be appropriate to invite members of management to attend portions of certain committee meetings, but if management has conflicting interests, care should be taken to avoid the perception that management is driving (or meddling in) the process. 17

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See, e.g., In re Loral, 2008 WL 4293781, at *2 (criticizing formation of the committee with a mandate to raise a specific amount of equity “fast” via a transaction with its controlling stockholder, resulting in the committee eschewing other alternative sources of financing and where there was no compelling need for the financing (and the transaction ultimately took a much longer period of time to consummate)). Brinckerhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370, 393 (Del. Ch. 2010) (where controlling stockholder took a month to respond to committee’s offer and committee then offered to split the difference in less than twenty-four hours, “a skeptical mind might wonder about the illusion of resistance followed by the reality of submission”).

THE ROLE OF THE COMMITTEE COUNSEL

Since participation in committee meetings by interested parties is a frequent target for plaintiff’s counsel in challenging the committee process, such participation should be limited and permitted only if necessary.19 Management should be used as an informational resource, and it is not typically advisable for management regularly to attend committee meetings. In some instances, it may be appropriate for regular corporate counsel to attend committee meetings as an informational resource. Again, however, committee counsel should be sensitive to avoiding the appearance of regular corporate counsel controlling the process or serving as a conduit of information to others with direct conflicts. As a general matter, most, if not all, committee meetings should involve at least an interval during which the committee’s counsel is the only party present with the members of the committee in “executive session.” Additionally, the optics of the process are improved if meetings are held involving only the committee and its counsel (and financial advisor). Finally, it is prudent to hold at least a portion of the committee meetings in person. Although in-person meetings will not be practical for all meetings, it is preferable that meetings at which significant decisions are to be made are done face to face. • Negotiation Response. The committee should determine (in conjunction with its advisors) the appropriate response to offers from potential counterparties and who should communicate the response to the counterparty (e.g., financial advisor, committee counsel, chair of the committee). More broadly, the committee should determine who will speak for or on behalf of the committee with respect to different portions of the negotiations. • Documentation. As noted above, the committee’s counsel is responsible for documenting the deliberations of the committee to create a clear record of the process employed in connection with the potential transaction. In the midst of negotiations, it may be prudent for the committee to have multiple meetings (even if mostly telephonic meetings) in order that the committee can be appropriately updated on the most recent information and give direction to its negotiators. Telephonic meetings (even if short) are often the most efficient way for the committee and its advisors to get together to receive updates. Meetings are favored over informal, piecemeal discussions among members, both to ensure that all relevant parties are hearing the same information and have an opportunity to interact, and to allow committee counsel to document such deliberations formally in committee minutes, which will be helpful in demonstrating a deliberative, well-informed, and conflict-free process. Committee members should keep in mind that one-on-one calls among some but not all committee members typically do not become part of the record and should avoid making important decisions or tackling difficult issues in such calls. • Confidentiality. The confidentiality of the special committee’s negotiations is of paramount importance. Obviously, the negotiations become compromised if

19

See, e.g., Blackmore P’rs, L.P. v. Link Energy LLC, 2005 WL2709639, at *5 (Del. Ch. Oct. 14, 2005) (challenging the presence of the CEO (chief executive officer) and one other interested director at most committee meetings); In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171, 193 (Del. Ch. 2007) (criticizing the special committee for giving the CEO “virtually unlimited access to their deliberations”). 191

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sensitive information relating to the committee’s negotiation strategy and views on pricing fall into the hands of the counterparty to the transaction. In the context of a conflict transaction in which members of management or a controlling stockholder may be on the other side of the transaction or have conflicting interests, concern regarding leaks is real and significant. Delaware case law is replete with examples of confidential information being shared with counterparties to a proposed transaction, and the inevitable effect is to raise a significant question for the reviewing court as to the process.20 Committee counsel must advise the committee as to the importance of confidentiality in order to protect the process from conflicted parties. • Instruction to Interested Parties on Conflict Points. Often, a buyer in a sales transaction will desire that members of management remain employed with the corporation following the closing of the transaction. If this is the case, a typical issue relates to the timing and negotiation of the post-closing employment arrangements between the buyer and members of management. In this regard, it is prudent for the committee to provide explicit instructions to management not to engage in any such discussions without the prior consent of the committee. As a general matter, the committee should insist that any discussions about compensation be deferred at least until the time that the committee has agreed with the buyer with respect to pricing of the transaction; following such time, the committee may consider whether to have a representative of the committee or one of its advisors be present for any conversations on these topics between management and the buyer—or, at a minimum, be regularly apprised as to the status of any such discussions.21

C. THE ROLE OF REGULAR OUTSIDE COUNSEL TO THE CORPORATION As touched on in the preceding section, the role of outside counsel will vary from transaction to transaction if a special committee is in place. However, in virtually all

20 21

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See Chapter Seven, Section d, “Meetings of the Committee and Documenting Proceedings,” for a detailed discussion of these cases. See, e.g., In re Lear Corp. S’holder Litig., 926 A.2d 94 (Del. Ch. 2007) (“[A] reasonable stockholder would want to know an important economic motivation of the negotiator singularly employed by a board to obtain the best price for the stockholders, when that motivation could rationally lead that negotiator to favor a deal at a less than optimal price, because the procession of a deal was more important to him, given his overall economic interest, than only doing a deal at the right price.”); Wayne County Employees Ret. Sys. v. Corti, 2009 WL 2219260 (Del. Ch. 2009) (finding that managers of a company were not seeking to entrench themselves in respect of their involvement in a change of control transaction where the third-party acquirer, not the managers, had assumed the managers’ roles in the combined company); In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171 (Del. Ch. 2007) (acknowledging that management’s incentives in a deal process in which management was significantly involved may have narrowed the options and alternatives being considered).

THE ROLE OF REGULAR OUTSIDE COUNSEL TO THE CORPORATION

cases, there is some role (and in many cases a significant role) for the regular outside counsel of the corporation in connection with a conflict transaction. As discussed in Chapter Four, “Getting Ready: Director Indoctrination,” one of the most important roles that regular outside counsel to a corporation can play at the outset in connection with a conflict transaction is (in conjunction with the corporation’s general counsel) to assist in educating members of management (sometimes including the general counsel), interested parties (such as a controlling stockholder), and other members of the board about the special committee process in order to set appropriate expectations, validate the importance of the special committee process, and emphasize the importance of running a good and careful process. Regular outside counsel will typically both know well and be trusted by management and members of the board; as a result, such counsel is in a unique position (with great credibility) to educate these parties as to what to expect during the course of a special committee process. Because members of management often have never been involved in a special committee process and are accustomed to setting the timing and being actively involved in every significant matter relating to the corporation, a comprehensive briefing at the front end of the process from regular outside counsel can greatly assist the process. If a board is contemplating forming a special committee and special committee counsel has not yet been appointed, it is prudent for regular outside counsel to have the board and management fully understand the nature of the committee process before embarking upon such a process. A common misconception of parties unfamiliar with the process is that the committee process will be quick and painless. Another is that it will largely be pro forma, simply putting a stamp of approval on what other parties have already agreed to in order to make a transaction presentable to a court; i.e., the process is merely window dressing. The regular outside counsel who failed to correct such misapprehensions about a committee does a great disservice to his clients that will have a number of results. The inevitable outcome of this failure will be a more difficult process and greater unhappiness on the part of its participants. In addition, frequently a misguided process is apt to incur the criticism of a court, which will not overlook the ineffectiveness of the committee or excessive involvement by interested parties. In connection with the negotiation of the transaction documents, regular outside counsel should keep a watchful eye on brewing frustration or unhappiness among members of management, a controlling stockholder, or other interested parties. Such frustrations are often inevitable, as the special committee process often takes more time, is more costly, and, given the need for arm’s-length negotiations, is more contentious than parties were hoping would be the case. Frequently, parties may contact regular outside counsel to vent such frustrations, and often such parties may take cues from the reaction of regular outside counsel to their frustration as to what steps they should take next. Because the course and conduct of the negotiations are vital to the overall process, regular outside counsel can often play a pivotal role in preventing interested parties from taking steps that may be viewed as seeking to influence or interfere with the process during negotiations or otherwise taking detrimental actions that will be fodder for a plaintiff’s counsel down the road. This will sometimes include 193

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encouraging members of the committee who may feel pressured to stay the course and not be deterred from completing their task. An adept regular outside counsel, with a pre-existing and trusted relationship with certain of the interested parties or members of the board, can make the negotiation process proceed more smoothly. He can help insulate both the committee members and committee’s advisors from overreaching by interested parties by continuously validating the process and clearly advising against conduct that could be perceived poorly by the committee or a reviewing court. With respect to the specifics of negotiation of the transaction documents, there is no one-size-fits-all for conflict transactions. As discussed previously, the appropriate level of involvement in the negotiations by regular outside counsel to the corporation will vary depending upon the nature of the transaction, the identity of the parties, and the relationships between regular outside counsel and interested parties. The hallmark of a successful interaction between committee counsel and outside counsel is the latter’s willingness to defer to the committee and its counsel to lead the transaction and a clear understanding that its role is to support the committee when asked. In order to smooth the way to a positive working relationship, committee counsel and regular outside counsel should discuss the relevant tasks to be performed in the context of the negotiations and attempt to agree upon a division of labor for certain tasks. These discussions should consider matters of efficiency while being mindful of any potential for allegations of conflicts of interest. Sophisticated counsel will recognize and understand the issues with respect to which particular care must be taken to avoid any appearance of conflict that could create a less than ideal factual record— such as price negotiation, structure of the negotiation process, auction versus limited consideration of counterparties, or treatment of different potential counterparties. The members of the committee should also discuss this matter with committee counsel and be comfortable with the tasks assigned to regular outside counsel and committee counsel.

D. INTERACTION WITH THE FULL BOARD The appropriate level of interaction between the special committee and the full board will vary from transaction to transaction, depending upon the nature of the transaction and the particular factual circumstances. For example, if it is permissible for a board to delegate its full power and authority to a committee with respect to a particular matter—such as most financing transactions—and the board delegates such full power and authority to a committee, there will not be a legal requirement that the full board meet to further consider the matter. In such circumstances, the level of interaction between the committee and the full board may be minimal. On the other hand, if the law prohibits the full delegation of the matter to a committee—such as in the case of a sale of the corporation (at least in Delaware)—or if the board otherwise elects not to delegate the final approval of the matter to the committee, there will, at a minimum, need to be some interaction with the board and at least one meeting of the full board to consider the committee’s recommendations.

194

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Another matter that influences the level of interaction between the committee and the full board is the composition of the board relative to the composition of the committee. In some instances, the committee is composed of all members of the board who do not have a conflict of interest with respect to the transaction, and all of the non-committee members on the board (either by virtue of being on the other side of the transaction or otherwise) will be fully up to speed with respect to the transaction being considered. In such circumstances, the committee may itself constitute a quorum of the full board, and it may be the case that the remaining members of the board choose to abstain from voting or recuse themselves from consideration of the subject transactions. If this is the case, the interaction between the full board and the committee will not present a material issue, and the committee (as members of the full board) will be able to take the necessary steps at the board level to approve the transaction without significant concern about the members of the board who do not serve on the committee. On the other hand, if the matter is not fully delegated to the committee and there are members of the board not serving on the committee who have no material conflict of interest or would participate in the ultimate consideration by the board of the matter, a greater amount of process at the board level will be necessary to make sure that the non-committee members are comfortable that they have satisfied their fiduciary duties in considering the matters before the board. It may be prudent in such cases for the full board to meet periodically during the committee process and for any remaining directors who are free from conflicts to be briefed on the status of matters being considered by the committee (with any conflicted directors recusing themselves from such discussions). In connection with the board meeting or meetings at which the committee will present its recommendation to the board and seek ultimate board action, it will be important that the special committee provide the board will a full reporting as to the process employed by it, any material analyses undertaken by the committee’s advisors, and summaries of the terms and conditions of the matters for consideration by the full board. Attempting to shortcut the process by which the full board considers the matter or to unduly compress the consideration by the full board may cause a court to have concern with respect to the consideration of the matter by the full board or to criticize the process.22 Committee counsel and regular outside counsel should confer about these matters to make sure that the members of the board not serving on the committee have an adequate opportunity to consider the recommendation of the committee and materials underlying such recommendation. Notwithstanding the foregoing, if the board has delegated a matter to a committee in a conflict transaction, the full board should allow the committee to do its work and not meddle in the process. Overt meddling, even in the form of demands for frequent

22

For example, in In re Emerging Commc’ns, Inc. S’holders Litig., 2004 WL 1305745, at *9 (Del. Ch. June 4, 2004), in the context of a proposed privatization transaction requiring full board approval, the court noted that the non-committee members of the board were given less than a day to review the financial materials prepared by the special committee’s financial advisor in advance of the meeting of the full board to consider approval of the transaction.

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informational updates or attempts to take control of the timing of a negotiation, will often be viewed as an attempt by the conflicted parties to influence the process to their benefit. Included in this admonition should be the recognition that, if matters arise that are not clearly contemplated by the mandate to the committee but that involve conflicts of interest, such matters should be presented to the committee. Additionally, any efforts by an interested majority of the board to override contrary votes or recommendations of the members of the committee or otherwise exclude the committee from the process will be subject to significant judicial scrutiny. A good example of this appears in the Delaware Court of Chancery’s decision in In re Digex, Inc. Shareholders Litigation, 789 A.2d 1176 (Del. Ch. 2000). In Digex, the Delaware Court of Chancery considered an application for preliminary injunction with respect to a proposed acquisition of Intermedia Communications, Inc., by WorldCom, Inc. Intermedia’s most valuable asset was its controlling interest in Digex, Inc., and, by virtue of its ownership, Intermedia appointed five of the eight members of the Digex board. Due to significant financial difficulties at Intermedia, Intermedia was considering strategic alternatives including both a sale of Intermedia and a sale of Intermedia’s stock position in Digex (which at the time exceeded the value of Intermedia as a whole). Among other conflicts, the Intermedia designees on the Digex board stood to receive significant payments/consideration from a sale of Intermedia, but not from a sale of Digex. As a result of the conflicts of interest among the majority of its members, the Digex board appointed a special committee of two outside directors unaffiliated with Intermedia “to participate in the transaction process and make recommendations to the full board on matters in which there could be a perceived conflict of interest between Intermedia and Digex.”23 Following its formation, the special committee retained experienced legal and financial advisors. After several parties indicated interest in Intermedia and/or Digex, WorldCom and Global Crossing were the two finalists in the process. Approximately forty-eight hours before a Global Crossing offer was to expire, WorldCom advised Intermedia that it was prepared to buy Digex for $120 per share or more. The next day, WorldCom switched its interest to an acquisition of Intermedia, and Intermedia and WorldCom began negotiating a merger agreement by which WorldCom would acquire Intermedia. During these merger negotiations, WorldCom insisted upon a waiver from the Digex board to exempt the post-merger business relationships between WorldCom and Digex from the restrictions arising from 8 Del. C. § 203, the Delaware anti-takeover statute, and Intermedia agreed to such exemption without any involvement by the Digex special committee in the negotiations. At a Digex board meeting the next day, four Intermedia designees on the Digex board approved the Section 203 waiver over the dissent of the two members of the special committee and the president of Digex. Litigation was filed challenging, among other things, the waiver of the statute by Intermedia’s representatives on the Digex board. In assessing the merits of this claim, the Delaware Court of Chancery focused on the fact that the Digex special committee was excluded from the negotiations as to the waiver and that the waiver was approved

23

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Digex, 789 A.2d at 1183.

A WORD ABOUT SUBSTANCE

over the objections of the special committee and with little or no deliberation at the Digex board. The court stated: [The] lack of any involvement by the Special Committee is particularly remarkable because Intermedia continues to assert that the Special Committee was created by Digex, specifically by the interested directors, “to evaluate the fairness to the Digex public shareholders of any transaction which involved the sale of [Intermedia’s] Digex stock and to participate in any such transaction.”. . . [T]he Special Committee had no legal authority to directly block Intermedia’s decision to sell its shares in Digex. The § 203 waiver negotiation, however, is exactly where the Special Committee should have been most relevant in this whole process. But this is precisely the point at which the Special Committee is missing in action—not through any failure of its own, but as a result of the control by the conflicted directors over the process.24

As to the lack of deliberations at the Digex board meeting, the court stated: “Based on the record of what was discussed at the [Board] meeting, or rather the complete lack thereof, if any of the directors based their vote on anything that occurred at the board meeting, I doubt that the waiver vote could even pass the most deferential business judgment review.”25 The court concluded that the defendants were unlikely to be able to satisfy the fair dealing prong of the entire fairness standard with respect to grant of the waiver.26 The type of transaction, the scope of the delegation by the full board to the committee, and the composition of the committee relative to the composition of the full board will therefore importantly influence the amount and type of interaction between the two. The goal is to design a process that enables the special committee to operate in a manner independent of the full board while at the same time ensuring that statutory requirements are met and directors not serving on the committee are adequately informed if such directors need to reach a determination following a recommendation of the special committee.

E. A WORD ABOUT SUBSTANCE Heretofore, we have stressed repeatedly that a reviewing court is often likely to focus on the process followed by a transactional committee and not the economic substance of its conclusions. As with almost all other rules, this one has an exception. If the result of the special committee’s work has the effect of settling or compromising representative litigation, the court is called upon to assess that work carefully and to apply its own business judgment in evaluating the result.27 Thus, in Brinckerhoff v. Texas Eastern Products Pipeline Co., LLC, the court evaluated the premium delivered by the special committee as a result of negotiation with the 24 25 26 27

Digex, 789 A.2d at 1209. Id. at 1210–11. Id. at 1211. Polk v. Good, 507 A.2d 531, 535 (Del. 1986). 197

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controller by comparing it to premiums observed in similar circumstances as reported in academic literature.28 The court also conducted a careful review and analysis of the special committee’s investment banker report.29 Though the court ultimately approved the settlement, its review of both academic studies and the substance of the committee’s banker’s work suggests that, at least if a settlement of representative litigation is involved, the committee should be prepared to defend both the substance of the result it delivered as well as the process followed to achieve that result.

28

29

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Brinckherhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370, 393–94 (Del. Ch. 2010) (discussing Guhan Subramanina, Post-Siliconix Freeze-outs: Theory and Evidence, 36 J. LEGAL STUD. 1 (2007)). The court noted the 18.2 percent “cumulative abnormal returns” in Siliconixtype deals and the 38.6 percent return in Kahn v. Lynch-type mergers reported in the literature. Id. at 393–94.

Chapter 10

What to Do? (The Forensic Committee)

As the forensic committee completes its investigation, a necessary part of the process is deciding what to do. Logically, there are three broad conclusions that will be available as a result of almost any forensic investigation in response to a demand or complaint. The first conclusion is either there is no basis for further proceedings or any potential claim is not worth prosecuting from the point of view of the corporation. The second possible conclusion is that there is a basis for proceeding to litigate but no settlement can be reached. The third is that there is a basis for proceeding, and a settlement can and should be reached. How the committee determines to proceed will, in the first instance, be a function of its charter: Does it have the full power and authority of the board to take action, or, alternatively, does it have only the power to make a recommendation to the full board regarding how to proceed? As noted elsewhere in this work, the former will typically be a special litigation committee (SLC), and the latter is more likely to be a committee formed to investigate a stockholder demand. The precise steps that the committee takes as a result of its conclusions will vary depending upon its scope of authority. Each scenario is discussed below, from the perspective of a demand committee and that of an SLC.

A. THE DECISION THAT FURTHER PROCEEDINGS SHOULD NOT BE PURSUED i. The Demand Committee The first potential conclusion to a committee process is a determination by the committee that no further proceedings should be pursued. In the context of a committee formed to investigate a stockholder demand, the decision would be to recommend rejecting the demand and declining to bring a lawsuit against the targets of the committee’s investigation. In the context in which the committee recommends to the full board that a demand to sue should be rejected, it would typically be appropriate for the targets of the committee’s investigation to consider abstaining from participation in the 199

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vote of the board. Likewise, as noted elsewhere, it would also be appropriate for counsel to correspond with the demanding stockholder to advise such stockholder that, based on the committee’s investigation, the full board has determined not to bring suit. In the event that suit is then brought by the demanding stockholder, the law set down by the courts of Delaware is that, in order to proceed, the stockholder bears the burden of pleading that the board’s rejection of his demand was wrongful.1 Moreover, in the context of a so-called demand refused case, in which the stockholder has the burden of pleading the wrongfulness of the rejection with more than mere conclusory pleadings,2 the pleading must allege specific facts that are sufficient to overcome the business judgment rule.3 As the Delaware Supreme Court has explained, in any business judgment rule case, the issues for the court are the independence of a majority of the board, the reasonableness of the investigation, and good faith.4 If a demand is made, however, the independence of a majority of the board is conceded, so the court’s inquiry is typically limited to the good faith and reasonableness of the committee’s investigation.5 Reasonableness in this context has been defined as implicating “the business judgment rule’s requirement of procedural due care, that is, whether the . . . Board acted on an informed basis in rejecting [the] demand.”6 In most cases, the stockholder must prepare this specific, nonconclusory pleading without the benefit of discovery in his demand refused case.7 This is a difficult burden on the objecting stockholder. Of course, it is precisely the ability to lay this difficult burden on the objecting stockholder that often motivates the decision to form a committee in response to a demand.

1 2 3 4 5

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FLI Deep Marine LLC v. McKim, 2009 WL 1204363, at *3 (Del. Ch. Apr. 21, 2009). Levine v. Smith, 591 A.2d 194, 211 (Del. 1991), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990). Id. Id. Note, however, that the concession of independence is not conclusive or irreversible. To the contrary, the Delaware Supreme Court has held that even in spite of the concession implicit in making a demand, a shareholder may still be able to overcome refusal of the demand by showing that the committee lacked independence in fact. As the court explained, “failure of an otherwise independent-appearing board or committee to act independently is a failure to carry out its fiduciary duties in good faith or to conduct a reasonable investigation. Such failure could constitute wrongful refusal.” Scattered Corp. v. Chic. Stock Exch., Inc., 701 A.2d 70, 75 (Del. 1997), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Levine v. Smith, 591 A.2d at 213. The Delaware courts have made clear that discovery is not appropriate to allow the stockholder to meet his burden of showing wrongful refusal in the case brought alleging such refusal. Grimes v. Donald, 673 A.2d 1207, 1218 (Del. 1996); Scattered Corp., 701 A.2d at 78. However, the very same authorities have made clear that a plaintiff is entitled to access “targeted” corporate records relating to “the process and findings of the Board” and committee in response to the demand by use of a separate demand for books and records under 8 Del. C. § 220. Scattered Corp., 701 A.2d at 78. Thus, though it may be necessary for a plaintiff to commence a separate action under 8 Del. C. § 220 to get access to the committee’s report and related documents, provided that the plaintiff takes the steps necessary, he often will ultimately be able to access the data prior to bringing the “demand refused” case.

THE DECISION THAT FURTHER PROCEEDINGS SHOULD NOT BE PURSUED

That the decision not to proceed is difficult to overcome does not mean that it is impossible to overcome. Courts that have found a board’s refusal to be wrongful have often done so in circumstances in which, notwithstanding the concession of independence inherent in the decision to make a demand, the court concluded either that the committee’s actions themselves showed a lack of independence8 or a controlling or majority stockholder dominated the process and improperly derived personal benefit at the expense of the corporation.9 Thus, the committee charged to investigate a demand, even though often the beneficiary of a very helpful legal framework, is not immune from review and challenge in court and, as noted elsewhere in this work, must approach its work fully cognizant of the fact that a court is likely to review its investigation at some level.

ii. The Special Litigation Committee The SLC context differs from the typical demand committee in one critically important aspect: By the time an SLC has been formed, it is usually apparent that a majority of the board is not able to function independently to consider whether to continue to prosecute derivative litigation.10 For example, SLCs are often formed after a derivative case has been filed and the defendants have lost a motion asserting that a majority of the board was independent for purposes of considering a demand. Given this important contextual difference, the rules pertaining to a decision by an SLC to seek to dismiss already-pending litigation following an investigation differ, at least under Delaware law, from those pertaining to a demand committee, which starts its work with the presumption that it is independent. In order for the decision of an SLC to dismiss a pending case to be entitled to judicial approval, the SLC bears the burden of demonstrating that there are no material facts at issue relating to the independence of the SLC, its good faith, and the reasonableness of its investigation.11 In this regard, the stockholder plaintiff is permitted discovery into the independence, good faith, and reasonableness of the SLC’s investigation,

8

9

10

11

Stepak v. Addison, 20 F.3d 398 (11th Cir. 1994) (rejection “wrongful” because the investigation was dominated by a law firm that also represented alleged wrongdoers in criminal proceedings involving subject matter of demand). See, e.g., Burns v. Friedli, 241 F. Supp. 2d 519 (D. Md. 2003) (board was beholden to two director defendants who allegedly engaged in wrongful transactions for personal gain); Behradrezaee v. Dashtara, 910 A.2d 349 (D.C. 2006) (board was controlled by the majority holder and the controller’s wife was alleged to have received financial benefits to corporation’s detriment). Indeed, some cases have found that the decision to appoint an SLC, with full power of the board to determine how best to proceed with respect to a pending derivative suit, operates as a concession that a majority of the board is not sufficiently independent to consider the matter. Abbey v. Computer & Commc’ns. Tech. Corp., 457 A.2d 368 (Del. Ch. 1983); see also Spiegel, 571 A.2d at 776. Thus, caution should be the rule of the day in deciding which type of a committee to form, and the advice of experienced counsel should be considered in that regard. Zapata Corp. v. Maldonado, 430 A.2d 779, 788 (Del. 1981). 201

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and the motion to dismiss should be supported by “a thorough written record of the investigation and its findings and recommendations.”12 But in the context of an SLC seeking the dismissal of a stockholder derivative case after an investigation, not only does the SLC carry the burden of demonstrating an absence of material facts regarding its independence, its good faith, and the reasonableness of its investigation; its motion is also subject to a discretionary second level of analysis by the court. The court has the discretion to apply its own business judgment and determine whether the motion should be granted. The court is directed to, “when appropriate, give special consideration to matters of law and public policy in addition to the corporation’s best interests.”13 In short, the trial court is given the authority to take a second look at the substance of what the committee did to determine, in its own judgment, whether the substance of the committee’s work appears to justify dismissal, considering all of the circumstances. The court that devised this unusual test was candid as to its purpose. The test is “intended to thwart instances in which corporate actions meet the criteria of step one, but the result does not appear to satisfy its spirit, or in which corporate actions would simply prematurely terminate a stockholder grievance deserving of further consideration in the corporation’s interest.”14 The court further described this test as the “essential key in striking the balance between legitimate corporate claims . . . and a corporation’s best interests.”15 The test appears to be linked to the court’s caution that, in this context, the trial court must be “mindful that directors are passing judgment on fellow directors in the same corporation” and ask the question whether a “there but for the grace of God go I empathy might not play a role” in the committee’s decision.16 Surprisingly, relatively few courts who have ruled on SLC motions to terminate litigation have engaged in the discretionary second-step analysis. Instead, the cases in which motions to dismiss litigation have been denied are typically cases in which the court has expressed real concerns about the independence of the committee or the reasonableness of its conclusions. Likewise, cases that have approved committees’ motions to dismiss often appear to be decided based on the reviewing court’s comfort concerning the good faith, independence, and reasonableness of the committee and its work. Having concluded that there is no material issue pertaining to these core issues, reviewing courts typically have not proceeded to the second-step analysis. One of the unusual cases to apply the second step and approve the SLC’s proposed disposition of pending litigation, in the context of a settlement of the claims brought on the corporation’s behalf over the stiff opposition of the complaining stockholder, suggested that the second-step analysis itself will still involve some degree of deference to the reasonable judgment of the SLC, even if the reviewing court might come to a different conclusion. In Carlton Investments v. TLC Beatrice International

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Id. at 788. Zapata Corp., 430 A.2d at 789. Id. Id. Id. at 787.

THE DECISION THAT FURTHER PROCEEDINGS SHOULD NOT BE PURSUED

Holdings, Inc.,17 the court was required to review and pass on a proposed settlement of litigation involving the payment of large amounts of money by the defendants to settle claims brought by stockholder plaintiffs and fully investigated by an SLC. In its analysis of one of many components to the settlement, the court came to the conclusion that, though the SLC’s judgment was in “good faith, independent, and well-advised,” its judgment concerning the claim was “more likely to be wrong than right.”18 The court found, however, that even if the SLC was wrong about this particular claim, it appeared that the amount recovered, in total, fell “within a range which reasonable minds might accept” even though the “SLC’s investigation and conclusions are not free from criticism.”19 The court concluded by noting that “while reasonable minds might differ over any number of decisions (and I would) I conclude that the result as a whole is reasonable and the product of independent, informed action of directors acting in good faith.”20 In short, while noting differences with several of the SLC’s conclusions, in applying the second-step analysis, the court nonetheless deferred to the SLC process as a whole, given previous findings that the process was conducted in good faith and by independent directors and that the SLC’s analysis of the issues presented was reasonable. In Re Primedia Inc. Derivative Litigation is another rather unusual case in which the court proceeded to the second step of the Zapata analysis but still ruled in favor of the SLC’s motion to dismiss pending litigation.21 The court determined that the second step was justified because there was a “patina . . . of something else” present. In fact, the court began its analysis from the proposition that a motion to dismiss the claims asserted in the underlying litigation would likely have been denied if presented. At the same time, however, the court also expressed the view that a statute of limitations defense might prevail in that same context.22 Weighing the possibility of a successful statute of limitations defense, the potential for a relatively small damages award, the likelihood that the company would be forced to pay for the cost of defending most of the likely witnesses at deposition and trial, and the expected reduction of the ultimate award by an attorneys’ fee, the court concluded that the SLC’s motion to dismiss should be granted. The ruling is particularly useful, however, for its insight into how the court approached application of the Zapata test. First, the court made clear that it recognized that any SLC investigation was a “human endeavor” as to which “[p]erfection is not attainable.”23 The court then turned to an analysis of whether the committee was “given full control over the claims,” including the ability to assert claims, allow plaintiffs’ counsel to proceed, settle claims, or seek dismissal of them. The court stated that it viewed this as the “key first step . . . for any Zapata analysis.”24 17 18 19 20 21 22 23 24

1997 WL 305829 (Del. Ch. May 30, 1997). Carlton Invs., 1997 WL 305829, at *17. Id., at *19. Id., at *20. Consol. C.A. No. 1808-VCL (Del. Ch. June 14, 2010)(TRANSCRIPT). Id. trpt at 76–7. Id. trpt at 45. Id. trpt at 69 203

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Applying the established independence inquiry of the analysis, the court made clear that the questions it would confront were “whether the special litigation committee members were independent” and “whether they conducted a good faith investigation.”25 The court indicated that these issues were subject to analysis under “effectively a summary judgment standard” and made clear that independence for this analysis was “not only facially but also in what they did.”26 Finding that the committee utilized two respected experts and made “very good use” of them,27 and that the committee considered the strengths and weaknesses of the claims asserted and the costs associated with pursuing each, the court determined that the committee’s investigation appeared reasonable and in good faith. However, given the existence of a document produced by the defendants that appeared to strongly support the claims asserted in the underlying litigation, the court determined to proceed to the second step of Zapata. Describing the process that he would follow in applying the second step, the judge said, “. . . [w]hat I’m supposed to do under the second step of Zapata is really think, well, is this a settlement that I would recommend to a client they accept, putting myself in the corporation’s shoes from that standpoint.”28 The court indicated that if this test could not be met, that it would be likely to conclude that the second step of Zapata had not been met either.29 It may seem a bit strange to conceive of Zapata’s second step in terms of whether the court could recommend a “settlement” of the claims if the motion before the court contemplated that the claims would be dismissed. Nevertheless, on closer analysis of the court’s application of this test, it appears to be nothing more than the court asking the common-sense question whether the claims asserted were ultimately likely to be worth the effort to pursue. Concluding that the claims were likely meritorious but nonetheless that any potential recovery was low, the court granted the motion to dismiss describing his review of the SLC’s work as follows: [N]othing here is so out of line that, under the second step of Zapata, it would cause me to second guess the special litigation committee’s judgment. In other words, checking this against my own independent view of what one might reasonably do with this type of claim, it is logical to me that the special litigation committee could conclude that it was not something that was in the company’s best interest to pursue. That is, I think ultimately what the check in the second step of Zapata requires.30

Thus, even though the court was willing to conclude that the claims asserted were likely meritorious, it still granted the motion to dismiss because it was convinced that the SLC fairly assessed the potential value of those claims and concluded that they were not in the company’s interest to pursue. Importantly, the court’s analysis appears to rely heavily upon the expert reports commissioned and relied upon by the committee, 25 26 27 28 29 30

204

Id. trpt at 70. Id. Id. Id. trpt at 34. Id. trpt at 75. Id. trpt at 79.

THE DECISION THAT FURTHER PROCEEDINGS SHOULD NOT BE PURSUED

which, as noted previously, the court specifically commended. In other words, where, as in this instance, the committee had carefully built a record supporting its conclusions, the court appeared willing to defer to the committee’s judgment, given its conclusion that the committee was both independent and acted independently and in good faith. Thus, the decisions to date elucidating the legal principles that govern the review of an SLC’s attempt to dismiss a case demonstrate the critical importance of the independence of the committee, both on paper and in fact, the importance of a thorough process, and the existence of supportable business reasons for the decision to dismiss.

iii. The Transactional Committee Although it may seem strange to address the settlement of litigation by a transactional committee, the subject does arise from time to time. In Brinckerhoff v. Texas Eastern Products Piperline Co., LLC,31 the committee was originally formed to consider a controlling stockholder’s merger proposal. Unlike the typical case, however, the merger appears to have been proposed principally to extinguish certain pending derivative claims against the controller.32 The court found it “troubling” that the special committee determined that the claims had “significant value” but ultimately approved a transaction according, arguably, “no value” to these claims.33 Importantly, however, the committee was able to demonstrate that its counsel, working with an outside advisor to the committee, actually placed a value on the derivative litigation being extinguished. Moreover, the court found that the committee’s counsel did not simply accept the advisor’s view at face value, but instead “critiqued them” and directed that modifications be made to the analysis.34 Finally, the special committee negotiated the transaction using a range at the upper end of the range of values ascribed to the litigation.35 The court approved the settlement reached by the committee even though it viewed the question as a “close” one, and notwithstanding the court’s inability to determine the degree to which the final settlement included consideration for settlement of the derivative claim.36 Even where the court reviewed academic literature suggesting that the premium ultimately achieved in negotiations was less than expected, based on empirical studies, the court nonetheless approved the settlement. Relying on the committee’s banker’s sensitivity analysis showing that even a very significant value for the derivative claims would not move the transaction out of the range of fairness,37 the court ultimately drew comfort from the unquestioned independence of the committee 31 32 33 34 35 36 37

986 A.2d 370 (Del. Ch. 2010). Id. at 373 (“The record convinces me that the goal of extinguishing the plaintiffs’ standing to maintain the derivative action was a primary reason for pursuing the merger.”). Id. at 392–93. Id. at 394–95. Id. Id. In this case, the final settlement was in the form of a negotiated exchange ratio, and thus there was no separate consideration paid specifically to extinguish the derivative claims. Id. at 395. 205

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and its advisors, the record of arm’s-length negotiations, and the vigorous prosecution of the derivative claims before the settlement. Echoing Chancellor Allen’s holding approving the TLC Beatrice settlement (in the SLC context), the court wrote: Perfection is an unattainable standard that Delaware law does not require, even in a transaction with a controller. The record as a whole supports the view that the Teppco Special Committee used the derivative action as an effective negotiation tool to increase the merger consideration and obtain a fair result. Although the question is close, and although I continue to have concerns, I approve the settlement as fair and reasonable.38

Clearly, process mattered in this case, and a fair reading of the case suggests that the result could easily have gone the other way, absent skillful work by the committee and its advisors. Thus, although transactional committees are not often called upon to consider the settlement of litigation, if the issue arises, they will be expected to consider carefully what is being given up in the settlement and demonstrate independence and arm’slength bargaining.

B. THE DECISION TO PURSUE CLAIMS i. The Demand Committee The committee formed to review a stockholder’s demand may conclude that it is appropriate and in the best interests of the corporation to pursue some or all of the claims set forth in the demand. In that case, the committee, assuming that its power is limited to making a recommendation, will bring its conclusions to the full board for action. At this point, it is incumbent upon the disinterested members of the board to make a decision regarding whether or not to accept the committee’s recommendations. In the event that the board acts to accept the committee’s recommendations, the corporation, in its own name and through the counsel of its choice, then typically brings the claims. It bears noting that in this context, real challenges are likely to emerge. The political complications associated with asking a board to commence proceedings against one or more of its members are likely to be significant. Overlooking the human dynamic at this point in the committee’s process can have significant consequences, even though duty, not politics, drives the decision to proceed or not. Precisely what steps should be taken if a committee determines to present a recommendation to sue will depend, in each case, upon the then-current composition of the board and the number of current directors against whom the committee recommends bringing suit. Issues involving the participation of interested directors at the full board level almost invariably arise. At the outset, it may be advisable to insist that the director or directors who the committee has determined should be sued recuse themselves from participation in the meeting at which the committee makes its recommendations. 38

206

Id.

THE DECISION TO PURSUE CLAIMS

The participation of such directors in the meeting at which the committee presents its report and recommends action may subsequently be found to jeopardize the attorney– client privilege.39 Another alternative would be to expand the board’s delegation of authority to the committee to allow it to act independently of further board review in commencing litigation. Though such action would likely convert the committee to an SLC, it would be acting in the absence of any finding that would cast doubt upon the independence of the members of the committee itself, and, given that it would have already determined to proceed with litigation, the type of judicial review of SLC decisions not to bring suit (described above) would not be implicated. What happens if the committee, after careful and thorough investigation, determines to recommend that the corporation proceed with a lawsuit and the board declines to accept the committee’s recommendation? Most lawyers who practice in this area advise committee members to consider resignation from the board at this point. Failure of the full board to accept the committee’s recommendations is almost certain to lead to a lawsuit by the demanding stockholder, and the likelihood that the board will be able to work together effectively in the future is minimal. Moreover, a committee director who did not resign from the board at this point would be opening himself to potential criticism in subsequent litigation, and a resignation would be likely to go far to insulate the director from potential personal liability. Though there is no rule of law mandating resignation, it is often the only practical avenue open to committee directors in this context.40

ii. The Special Litigation Committee The decision to pursue claims is less complicated for an SLC than for a demand committee, since the SLC has typically already been delegated the full power and authority of the board to take whatever action it deems to be in the best interests of the corporation. If the SLC determines to pursue claims, the SLC typically will engage counsel on the corporation’s behalf and file a motion to intervene in the pending derivative suit to assert control over it on behalf of the corporation. Such motions are fairly rare in practice, but they do occur, and courts will typically allow the committee’s counsel to displace the derivative plaintiff and his counsel, since the derivative plaintiff’s status exists solely to bring action on behalf of the corporation if the corporation refuses to do so. In practice, however, an SLC rarely finds that it is in the best interests of the corporation to prosecute all claims asserted by the derivative stockholder against all defendants sued. It is more common, therefore, to see a mixed motion to intervene on behalf of the corporation and a partial motion to dismiss seeking to dismiss parties or claims. 39 40

See Ryan v. Gifford, 2007 WL 4259557, at *3 (Del. Ch. Nov. 30, 2007). See Hollinger Int’l, Inc. v. Black, 844 A.2d 1022, 1043-44 (Del. Ch. 2004) (noting the resignation of four independent directors after five conflicted directors had declined to accept committee’s recommendations). 207

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C. THE DECISION TO ATTEMPT TO REACH A SETTLEMENT Not every investigation by a demand committee or on SLC necessarily must result in a decision not to proceed or to sue. Instead, there are circumstances in which a committee determines that there are potentially viable claims, but the company’s best interests lie in settling those claims without further proceedings. The issues that arise in this context are discussed below.

i. The Demand Committee The demand committee that determines that there are claims that should be settled faces a number of interesting challenges. The first question that often arises is: Settled with whom? Given that a stockholder has made a demand, should the settlement include the demanding stockholder’s counsel or only the potential defendants? If the settlement is to be struck solely with the potential defendants, the committee will want to consider whether it has the power to enter into a settlement and, if not, seek a further resolution of the board granting it the power to negotiate one. Practically speaking, a demand committee that attempts to settle one or more of the claims it has investigated will want to consider whether any settlement outside litigation will have the beneficial effect of cutting off future claims by other stockholders. Under the law, the settlement of a lawsuit, supervised by a court, typically will bar any future litigation of the same claims by other stockholders. A settlement with a committee outside the context of a lawsuit does not carry with it the same legal bar, however. This will often drive the decision to commence two sets of negotiations: one with the demanding stockholder and another with the potential defendants in a lawsuit. The ideal result in this situation may be the filing of a complaint by the demanding stockholder followed by the settlement of the litigation in accordance with a previously negotiated resolution. There are circumstances, of course, in which a committee would prefer to settle outside of the public filing of a complaint, but doing so carries with it the potential cost that one or more other stockholders will bring suit on the same facts or transactions settled by the committee. In other words, a settlement outside of litigation may not finally buy peace for the defendants who participated in the settlement. For this reason, insurers will often insist upon a settlement of litigation if they agree to participate in the settlement at any level. Another type of settlement may involve governance changes on a going-forward basis in exchange for the release of claims. In this scenario, the committee may determine that no individuals have acted in a manner that is culpable, but the company itself can be strengthened by the adoption of new or different procedures designed to avoid repetition of the challenged conduct or transaction. In these circumstances, the committee is faced with the same issues described above—if it settles claims with the demanding stockholder for such governance changes absent the filing of a lawsuit, the company is technically exposed to the same claims being filed by other stockholders. 208

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Settlement in any of these contexts also almost invariably involves the demand for payment of a fee by the complaining stockholder’s counsel. Most jurisdictions would require that the parties postpone discussion of the matter of a fee until after they reach agreement on a settlement in the context of litigation, and also require court approval of any fee agreed upon. Nevertheless, the matter is less clear in the context in which a stockholder’s lawyer merely makes a demand and does not file litigation. Payment of a fee in that context may not be subject to court supervision,41 but, as noted above, settlement in that context may not provide the settling parties with the protection otherwise available if the litigation is settled.

ii. The Special Litigation Committee Settlement in the SLC context often avoids many of the thornier issues that may be presented in the context of the settlement of claims prior to litigation. The reason, of course, is that, in the SLC context, litigation is often already extant, so the settlement is almost invariably subject to court approval and will carry with it the bar against re-litigation that inheres in any settlement of litigation. An SLC that wishes to settle claims, however, still has to answer the question: Settle with whom? In one of the few reported cases to consider an SLC’s settlement of claims, the SLC determined to negotiate directly with the defendants in the lawsuit and not with the stockholder plaintiff’s lawyer.42 The practical implications of this decision were twofold. On the one hand, the SLC was able to reach a settlement in a case in which the stockholder plaintiffs appeared unwilling to agree to any reasonable settlement; on the other, settling around the plaintiffs cast them in the role of objectors to the settlement and guaranteed a fight in court over the approval of the settlement. In either the demand or SLC context, the decision to attempt to settle deserves serious exploration. Given the strong potential for judicial review of a settlement, however, a committee should strive to ensure that any settlement it recommends is well matched to the corporate harm being addressed and, in all cases, is more than mere window dressing. Put differently, it is not the committee’s function to attempt to avoid litigation by settling otherwise viable claims for a token. In order to survive judicial review, any settlement must be substantial in the context of the claims being settled. Importantly, however, the law on point suggests that the committee need not hold out only for a settlement that achieves maximum current returns from the lawsuit, but instead can settle based upon what it perceives to be the company’s long-term best interests. As one court explained: The whole point of recognizing the board’s authority and responsibility in this context is to allow the board’s judgment concerning what is in the long-run best 41

42

It appears that, as of the time of publication of this book, the matter has yet to be decided in any published decision. There are, however, policy reasons why a court could conclude that it had a role in approving fees in this context, even in the absence of litigation, since the demanding stockholder is arguably making demand in a quasi-fiduciary capacity. Carlton Invs., 1997 WL 305829. 209

WHAT TO DO? (THE FORENSIC COMMITTEE)

interest of the corporation to be acted upon. That may not be the same as maximizing the return from the lawsuit. The SLC can legitimately sacrifice present compensation in the settlement if its good faith, informed judgment indicates to it that that course is best for the corporation.43

Nor is it the case that every settlement must involve the recovery of funds. In the past, committees have found it appropriate to work with the board to revise governance practices, adopt new practices, or give teeth to otherwise merely aspirational governance goals. The type of settlement that a committee recommends is likely to be as diverse as the types of claims investigated and the views of the individuals making up the committee as to the best interests of the company. The questions that individual committee members might want to ask about a proposed settlement include: Is this settlement logical? How does it relate to the wrong being addressed by the committee? Is it proportional to the harm inflicted on the company? Can we explain this as a rational response to what we determined to have happened during our investigation? Other questions to consider might be: Is the settlement likely to prevent the future occurrence of the behavior we have investigated and found to be the basis for a claim? Would I accept this as a fair compromise if I held the claim personally and the wrong had been done to me and not the company? If the committee member can comfortably answer these questions, the settlement is probably a good one and one that is likely to be approved by a reviewing court. There is a caution in order here. Often, just like on the deal side of committee work, practitioners may find that a committee that starts off attempting to reach an otherwise desirable settlement finds itself negotiated to the point that the settlement has morphed so completely that the committee would not have recommended it if it had been presented in this form at the outset. In such circumstances, both counsel and committee members need to do their utmost to avoid allowing a deal mentality to control the outcome. Step back. Take a deep breath. If the substance of the settlement has been negotiated to the point that one would not have recommended it at the outset, the mere fact that time and effort have gone into negotiations is not a good reason to recommend the changed deal. A reviewing court will not give the committee a pass if it acts out of deal fatigue or has become enslaved by a deal mentality. Instead, a court will examine the settlement for its substance, and it is no excuse that the dynamics of the negotiation got the best of the committee.

D. CONCLUSION OF AN INTERNAL INVESTIGATION Deciding whether or not to settle, and whether the settlement should involve the plaintiff or be directly between the committee and the (potential) defendants, is useful

43

210

Carlton Invs., 1997 WL 305829, at *11. A similar result occurred in the context of settlement of derivative and merger litigation in Brinckerhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370 (Del. Ch. 2010). There, the court approved a settlement of derivative and merger litigation and was satisfied that the committee did its job, even though the court expressed “concerns” about the “close” question presented. Id. at 394–95. The court made clear that “perfection is an unattainable standard that Delaware law does not require, even in a transaction with a controller.” Id. at 395.

CASE STUDIES

in many cases, but does not exhaust the entire spectrum of forensic committee outcomes. Many times, committees are formed not in response to litigation or stockholder demands but instead in response to a whistleblower communication, an audit comment, or an internal concern at the board or other level. In those circumstances, the committee is typically not settling with anyone; instead, the committee decides whether the issue raised is of concern and, if so, how best to address it. In these nonadversarial (or only quasi-adversarial) settings, there are other concerns that the committee faces in deciding what to do. Depending upon the nature of the investigation and its findings, public disclosure may be appropriate or even necessary. Likewise, even if the work of the committee is not disclosed to the investing public, the substance of the committee’s investigation and findings may need to be disclosed to the company’s outside auditors in connection with their audit of the company’s financial statements. Therefore, the decision to take action by a committee may find its way into financial statement footnotes, regardless of whether disclosure is required under federal securities law. Likewise, the decision of a committee to take some corrective action in connection with its investigatory findings, while typically not subject to judicial review, may well lead to the filing of a lawsuit, especially if the action taken is disclosed. Thus, notwithstanding the temptation to proceed with some degree of alacrity, committees formed to conduct internal investigations outside the litigation or demand context will want to proceed deliberately and with adequate documentation of their work to address the eventuality that the work of the committee becomes public or subject to litigation. Likewise, as addressed in some detail in Chapter Eleven, “Controlling Fallout from the Committee Process,” to the extent that this (or any other type) of forensic committee determines that criminal conduct may have taken place, it will need to address the issues that arise from the federal sentencing guidelines; specifically, the question of whether the committee should (or must) self-report to the criminal authorities. These are not easy decisions and should be taken in close consultation with competent and experienced committee counsel.

E. CASE STUDIES i. Let’s get rid of this case FACTS

A public company pre-announces a likely earnings miss due to inventory control issues, and its stock drops sharply. A raft of securities law class actions are filed in various federal courts around the country. Soon thereafter, a derivative case is filed in state court by a different plaintiff attacking the board’s failure of oversight arising from its failure to institute inventory control and accounting systems sufficient to prevent the earnings miss. The board hires counsel for the new derivative case, and counsel files a motion to dismiss for failure to make demand on the board. After briefing and argument, the court concludes that there are specific allegations in the complaint sufficient to raise a 211

WHAT TO DO? (THE FORENSIC COMMITTEE)

reasonable doubt about the independence of a majority of the board. The board then determines that two directors who were not attacked as interested in the complaint should be appointed as an SLC with the full power of the board to investigate the claims asserted in the litigation and take such action as may be appropriate. The special committee meets, organizes itself, hires counsel, and then sets out on a full and complete investigation of the claims asserted in the derivative case. One of the committee members is a lawyer who practices corporate law at a major national firm that does not typically perform services for the company. The committee hires a partner of the lawyer committee member, given that individual’s national reputation in litigation and the committee’s comfort with that lawyer and his firm. At the outset, the court presiding over the derivative case agrees that the case should be stayed to allow the SLC an opportunity to do its job, and stays the derivative case for three months while the committee conducts its investigation. Over the course of the next three months, the committee interviews dozens of witnesses and its counsel collects and analyzes hundreds of thousands of pages of paper from all the logical sources. The committee also consults accounting and other experts as part of its investigation. Although dormant initially, the class action cases come to life during the course of the committee’s work. The committee attempts to stay the class action cases, but the judges supervising these cases, all in jurisdictions different from that in which the derivative case is pending, decline to stay their actions. Thus, as the committee is building its record, the class plaintiffs begin to take documents and depositions from many of the same sources. After ninety days of hard work, the committee meets with counsel and spends several hours discussing how best to proceed. After considering all the options, the committee decides that the derivative plaintiff’s oversight claim is weak at best and that it would not be in the best interests of the company to pursue the claim. Accordingly, the committee determines to seek dismissal of the derivative claims. The committee then instructs counsel to prepare a comprehensive draft report for review. Counsel does so, and in a series of additional sessions, the committee carefully reviews and comments on the draft report, after which the draft is finally approved. As a result of its work, the committee directs counsel to move to dismiss the derivative claim on the basis that it is not in the company’s best interests to proceed. In light of the increasingly aggressive class plaintiffs, however, the committee determines that it would be preferable if its lawyers did not actually file the report of the committee with the court in connection with its motion to dismiss, hoping that by not filing the report the company will be able to argue later that the report is privileged and not discoverable by the class plaintiffs. The derivative plaintiff seeks and is granted leave to take discovery of the committee’s work and secures an order requiring that the committee’s report, interview memoranda, and collected documents be turned over. The committee attempts unsuccessfully to appeal this interim ruling and, after further deliberation, complies with the order. The derivative plaintiff takes long depositions of both committee members and presents expert testimony at the hearing to the effect that the oversight failure at issue was both egregious and easily recognizable to any reasonably attentive layperson. 212

CASE STUDIES

The derivative plaintiff also attacks the committee for choosing as its counsel a firm associated with one of the two members of the committee, arguing the committee member’s law firm compensation will be impacted positively by the choice of his own firm and thus the choice of counsel has rendered the committee member interested financially in the work of the committee. Finally, the committee is attacked for failing to interview two former employees who the stockholder plaintiff contends had relevant information. The court concludes that the two members of the committee were independent and acted independently and that the choice of the committee member’s law firm to represent the committee does not alter that view. The court likewise finds that the plaintiff has a point that the committee failed to interview at least two witnesses who could have reasonably had information pertinent to the committee’s inquiries. Nevertheless, the court finds that the committee acted reasonably and in good faith throughout its investigation, given that it interviewed twenty-nine other witnesses, and determined that the two witnesses who were not interviewed were likely to have merely cumulative information. The court also conducts the discretionary second-step analysis under Zapata, applies its own business judgment, and determines that, on the whole, the work of the committee was reasonable, even though it would not have reached precisely the same conclusions. The court then approves the dismissal. ANALYSIS

This case study illustrates a number of points that arise frequently during the course of special committee work. The backdrop of class litigation is often an unfortunate fact of life in these situations, and the lack of any working system to allow state and federal courts to coordinate proceedings in matters such as this often leads to competing discovery demands that make the work of the committee quite uncomfortable. There is no particularly good answer to addressing this issue. Although motions to stay the securities cases are often denied in this context, that is not invariably true. Also, in the event that counsel conducting the defense of the securities cases determines a bona fide motion to dismiss can be filed, the automatic stay provisions of the federal securities law often have the effect of shutting down discovery in the class-action cases, at least for a time. If the motion to dismiss has been adjudicated against the defendants or the motion to stay is denied, however, the committee may well find itself running an investigation parallel to the ongoing discovery in the class action, which invariably leads to thorny practical and legal issues. For example, the counsel to the defendants will urge their clients to approach the committee cautiously, on the grounds that anything that the client says to the committee may be fair game in a later deposition in the class case. Even those witnesses who have already been deposed are likely to be guarded in speaking with the committee, perhaps because of either lessons learned in preparing for the adversarial deposition or a not irrational fear of being forced into a similar experience.44 In all events, the pendency of active class cases is likely to make the committee process more difficult and the witnesses appearing before the committee somewhat more wary than usual. 44

It is typically the case that witnesses are deposed once in a case. That is not invariably true in all circumstances, however. 213

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Other issues arise. Counsel sometimes worry about the priority of discovery, i.e., should the committee attempt to interview the witness before his deposition is taken, or should it be content to conduct the interview following the deposition? The sequence and priority of discovery is often driven by an underlying question about whether the committee’s interviews will be found to be privileged as against the class, such that the class lawyer would not be permitted to inquire into the substance of the committee’s interview.45 The argument about privilege involves whether discovery of the committee’s interviews (assuming that they are conducted by counsel to the committee) erodes the protected work product of counsel, given the pendency of the derivative suit that is the subject of investigation by the committee. A critical self-analysis privilege, which exists in some jurisdictions, may also play a role.46 How these issues are addressed varies from lawyer to lawyer and from jurisdiction to jurisdiction. The common law offers little guidance on whether a committee may assert privilege against a class counsel’s attempts to uncover what the committee is doing (in real time, as it were). Moreover, in this case study, the judges supervising the class action cases appeared to be relatively unpersuaded by a privilege argument, since they refused to stay their actions. The second issue worthy of note in the analysis of this case study is the committee’s initial attempt to move for dismissal while withholding its written report. As noted above in Chapter Eight, “Drafting the Forensic Committee’s Report,” there has been outright judicial hostility to attempts to do this in the past. In the authors’ view, this attempt would fare no better. Nevertheless, here, the stockholder has secured a court order accessing the discovery materials sought, and the committee has grudgingly turned them over.47 Note, as well, that the court has reviewed the committee’s work under the Zapata two-step rubric. Concluding that the committee did its work thoroughly and independently, the court also applied the discretionary second step of the analysis before granting the committee’s motion. The point is that, although courts often do not proceed to the discretionary second step of the analysis if they are content with the first, that is not universally the case, and any court could use the second step in any particular case. Perhaps the most important point to be observed here, however, is that the court’s approval turns upon the committee’s independence and thoroughness. Given the extensive work done by the committee, the court concludes that the committee was 45

46

47

214

In Ryan, 2007 WL 4259557, at *3 n.2, the court recognized that a Zapata committee would hold a privilege that could be protected. In that case, however, given, among other things, the lack of a thorough written report and a waiver of any potential privilege by virtue of the committee’s presentation of its work to the targets of its investigation and their counsel, the court conducted an analysis under Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970), and concluded that good cause existed for ordering production. Some jurisdictions recognize a judge-made privilege protecting self-critical analysis, which could be utilized to shield a committee investigation. Granger v. Nat’l R.R. Passenger Corp., 116 F.R.D. 507, 510 (E.D. Pa. 1987). Delaware has declined to recognize such a privilege. Grimes v. DSC Commc’ns Corp., 724 A.2d 561, 570–71 (Del. Ch. 1998). Note that our hypothetical committee has also sought, unsuccessfully, to appeal the trial court’s discovery ruling in this regard. Appellate courts are extremely unlikely to accept interlocutory appeals relating to discovery matters. The point, of course, is that the fight about discovery at the trial court is likely to be the committee’s one and only chance to argue about what it will be required to turn over to the stockholder plaintiffs.

CASE STUDIES

both independent and acted independently—two critical hallmarks of a successful committee. With respect to the court’s finding regarding the independence of the committee, the choice of counsel bears note. Lawyers who are board members may seek out their firm or their current or former partners to represent them. This issue was raised in the Carlton Investments v. TLC Beatrice matter, in which the court concluded that the choice of a lawyer from one of the committee member’s firms was likely to enhance rather than detract from the process, given the fact that at least one member of the committee was already comfortable with the lawyer and knew the lawyer to be a skilled practitioner from direct, firsthand experience. The court wrote: “The fact that Mr. Webster chose to use members of his highly reputable firm to assist him in the process seems efficient, rather than culpable.”48 The record in the case, however, also included testimony to the effect that the committee member received no compensation directly tied to the choice of his firm as counsel. In addition, in this case study, the fact that the committee did not interview two potential witnesses who may have had largely cumulative information did not render its work less than thorough, where it did in fact interview twenty-nine witnesses and it concluded that it had sufficient information to conclude its investigation. In general, it is likely that a court would defer to a committee’s informed decision as to when to stop its investigation and how many interviews are enough. That deference, however, is most likely to be granted if the committee in fact interviewed all of the logical witnesses and had a goodfaith basis to believe that it had sufficient information on which to make a decision.

ii. Pay up! FACTS

The chairman, CEO, and majority stockholder of a public company also owns several smaller, private companies. Over time, the private companies enter into agreements with the public company to provide management and various other services. The chairman approves each transaction and does not bother to trouble the board of the public company with the details, although the board is informed of the fact of the transactions. The chairman discloses his ownership of the private companies each year on the routine conflict of interest disclosure form filled out by all directors, but the forms are simply filed with the company and no action is taken. The company eventually has a falling out with its auditors and new auditors are hired. During the first audit by the new auditors, they flag the transactions with the chairman’s other companies and communicate their concerns about the transactions to the chairman of the audit committee. That audit committee chair, an outside director with social but no business ties to the controlling stockholder, brings the matter to the attention of the full audit committee. All three members of the audit committee are unfamiliar with the terms of the transactions and, after speaking at some length with

48

Carlton Invs., 1997 WL 305829, at *11. 215

WHAT TO DO? (THE FORENSIC COMMITTEE)

the company’s new audit partner, determine to investigate the transactions. The audit committee proceeds to hire outside counsel and, after conducting several interviews, attempts to interview the company’s chairman. The chairman arrives at his interview with the company’s general counsel and the lead partner of the company’s outside law firm, and counsel for the chairman begins the session by insisting that everything said is privileged. Counsel for the audit committee suggests that this may not be the case, and, while the lawyers are debating the issue, the target of the investigation stands up and begins to declaim upon the fairness of the transactions and how he is sure that everyone on the board knew of them. The attempted interview deteriorates, with general counsel for the company objecting to the audit committee’s counsel’s attempts to ask questions relating to the specifics of the transactions, and outside counsel eventually advising the controlling stockholder not to answer any more questions before the controller and his team storm out of the meeting. Undaunted, the audit committee presses on with its investigation and soon comes to the conclusion that the various transactions were not fully and fairly disclosed to the board, are not at or near market rates, and involve terms that are overly generous to the controlling stockholder and demonstrably unfair to the company. The audit committee thereafter determines to seek a resolution of the matter in which the contracts will either be set aside or revised to market terms, and the controlling stockholder will repay the company the difference between the contract rates received and the fair value of the services rendered. When advised of the audit committee’s determination, the controlling stockholder reacts poorly and determines to remove the members of the audit committee from the board and replace them with new independent directors. The audit committee members in turn make public disclosure of the fact that they were replaced by the controlling stockholder after conducting an internal investigation of his dealings with the company, and the SEC promptly begins an informal inquiry. Before the new independent directors are appointed, the remaining non-audit committee directors determine to approach the controller and seek to work out a solution that involves some degree of restitution by the controlling stockholder (and hopefully does not involve their removal from the board). Notwithstanding the growing storm, the chairman/controlling stockholder is not willing to see reason and removes the remaining outside directors. The SEC inquiry, in turn, moves quickly from informal inquiry to formal investigation. At the same time, a private stockholder brings suit for corporate books and records, demanding a copy of the audit committee’s report of its internal investigation. The company defends vigorously, claiming privilege, but loses the case and is forced to turn over the report. Armed with the report, the stockholders’ counsel brings a case against the controlling stockholder seeking several million dollars in damages and the rescission of the contracts. The new board, in a show of backbone, determines not to attempt to assert control over the stockholder action. The new board also determines to dismiss the general counsel and the company’s regular outside law firm, and confronts the controlling stockholder. Finally coming to his senses, the controller hires new counsel and

216

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authorizes her to begin negotiations to settle both the SEC inquiry and the stockholder lawsuit. After protracted negotiations, the stockholder lawsuit is eventually settled, but for a substantial sum. The settlement also involves the reformation of various of the challenged contracts. The controller, through counsel, then seeks indemnification from the board pursuant to the company’s bylaws, which the newly emboldened board denies. After further tussling, the company settles with the SEC and moves forward. ANALYSIS

This case study focuses on the perils of an investigation in the context of a controlled company. In those circumstances, and especially if the controlling stockholder is the target of the investigation, the members of the committee formed to investigate alleged wrongdoing face special challenges. From the very beginning, such a committee is faced with difficult problems. If the committee concludes that there was no wrongdoing, the naturally skeptical outside observer is likely to begin an analysis of the committee’s work with the prejudgment that the committee has proven itself not independent of the controller by virtue of its conclusion. In such a case, the committee will want to be especially carefully to assure that it has followed a vigorous and thorough procedure to allow it to best respond to such criticism. Alternatively, if, as occasionally happens and as is illustrated in this case study, the committee determines that the controlling stockholder has engaged in conduct that constitutes a harm for which the company should be made whole, they are likely to face the wrath of the controlling stockholder. In such a circumstance, they should expect to be faced with removal, and the only consolation to committee members in such a situation is that they have done what their duty requires. Of course, when accepting a board seat in a controlled company, especially a seat that is designed to allow the company to hold itself out as having an independent audit committee, the individual director must understand from the outset that precisely this difficult situation could arise, and if the director wishes to be held out to the public as independent he must be prepared to act independently when called upon to do so. The same may be said of the non-audit committee members of the board, who, in this case study, attempted to confront the controller after the audit committee members were removed. In the face of the naked exercise of the controller’s power in an obvious attempt to cut off potential legal troubles, the clear duty of the other members of the board was to carry forward the work of the then-dismissed audit committee, even if threatened with their own dismissal. Put differently, when faced with a similar set of facts, the director who chose to do nothing would open himself up to vigorous criticism, both from the SEC and the plaintiff’s bar, and would likely not be able to claim to be independent of the controller going forward. Note that the noisy withdrawal of the audit committee members when terminated as directors drew the attention of both the SEC and the plaintiff’s bar, which is not an uncommon occurrence and is precisely the leverage that a truly independent committee may ultimately wield in difficult discussions with a controlling stockholder. Note as well that while the controller at first ignored these outside actors, by the

217

WHAT TO DO? (THE FORENSIC COMMITTEE)

time he exercised his raw power of control for a second time to dismiss the non-audit committee board members, the SEC response was prompt and decidedly unfavorable. Although there is never a way to predict how an independent regulatory agency will (or will not) react to a specific set of facts, the predicted response set forth in the case study is not far off the mark, given actual experience and a newly energized agency. The role of both inside and outside counsel is also worth note here. In each case, the lawyers made a poor choice, preferring the controller, who at the time was obviously acting in a manner adverse to the interests of the company, to any sense of loyalty or duty to the company itself, which was the lawyers’ actual client. It goes without saying that counsel, and especially inside general counsel of a controlled company, may often face situations in which the controlling party assumes incorrectly that the general counsel “works for” the controlling stockholder. In this (incorrect) view, the controller becomes convinced that he is the company and therefore whatever course of conduct he chooses to pursue must be consistent with the best interests of the company, since they are effectively one and the same. This may be a fine view for a controlling stockholder to take in the context of a 100 percent owned private company with no other constituencies, but it is never the correct view in the context of a public company, which will typically have many other constituencies. It invariably falls to general counsel to act as the voice of reason, reminding and cajoling the controller to understand what he already knows: The company is an entity apart from the controller, no matter how often it seems otherwise. This is no easy task, and in many situations it is a long-term struggle. Just as in the case of the outside director who joins the board of a controlled company, however, the general counsel who accepts the role of a fiduciary for a controlled company must understand, at the outset, that she is signing up for a particularly challenging role, and that her job security may hinge importantly on her diplomatic skills as much as her legal acuity. Of course, it is not only the general counsel who has failed here, but also the company’s regular outside counsel, who determined to join the controller’s team in light of the lawyer’s apparent failure to understand who his client was, or, alternatively, in disregard of his duty in pursuit of a more mercenary view of the lawyer’s ethical obligations. As difficult as it may be to explain to one’s partners why you lost a large public company client, it is often more difficult to explain why the firm needs to retain counsel in the context of an SEC inquiry. Counsel’s suggestion that the interview itself was subject to privilege raises another interesting issue that often arises in committee investigations. If the committee is investigating transactions instigated by a director with an interest arguably adverse to the company, it is highly doubtful that an attorney–client privilege covers the interviewee in the context of that interview. Thus, careful counsel to the committee should give plain warnings to each interviewee that they should not assume that the discussion is privileged and that such counsel does not represent the interviewee. When faced with an interviewee who attempts to assert that the interview is privileged, counsel for the committee should assure that such witness understands that is not the case and that there is no assurance that anything said at the interview can or will be protected. Failure to do so can lead to significant issues. 218

CASE STUDIES

As for the controller’s demand for indemnification in connection with the settlement, the law generally provides that the settlement of actions on behalf of the company (so-called derivative suits) may not be indemnified.49 The reason is obvious. If the company were required to reimburse a director for settling a suit brought on behalf of the company, there would be no situation in which the entity would ever be made whole. Instead, money would flow in as part of a settlement, and an equal and offsetting amount of money would flow out to satisfy indemnity obligations. Even if the case that had been brought and settled was a class claim and not a case that was seeking to remedy a corporate wrong (which would be highly unlikely on the facts of this hypothetical), most state indemnity statutes require that, before a settling director is indemnified, the board must conclude that the director has acted in or not opposed to the best interests of the company,50 which would appear to be a challenge in light of the facts of this case study. Finally, note that had the controlling stockholder fully disclosed the details of the underlying contracts and suggested that an independent committee be formed to negotiate those details on behalf of the company, this case study and its outcome would likely read very differently.

49 50

See 8 Del. C. § 145(a). See, e.g., 8 Del. C. § 145(b). 219

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Chapter 11

Controlling Fallout from the Committee Process

The work of a special committee can be time-consuming and arduous, but rewarding in that it often creates a meaningful benefit to the company. Once the substantive work of the committee is complete, the hard part is certainly over. Nevertheless, issues often arise even after the committee has completed its substantive work. With respect to a transactional committee, the committee may continue to have a role regarding unsolicited third-party proposals prior to the closing and oversight of the arrangements negotiated with management. In addition, the special committee and its counsel will have to defend any litigation challenges that ensue. Likewise, litigation and other issues often arise as a result of the investigative committee’s conclusions and final report. One important issue arising in most special committee assignments after the substantive work has been completed is preservation of any legal privileges that may apply with respect to the work of the committee. For investigative committees, there may be related issues—such as whether to disclose or publicly file the committee’s written report, and the potential impact of the committee’s report on any litigation alleging criminal conduct. This chapter discusses the applicable legal privileges and certain related issues that may arise following the completion of a special committee’s substantive work.

A. THE TRANSACTIONAL COMMITTEE—EXPECT TO WAIVE THE PRIVILEGE If litigation challenges a transaction approved by a special committee, the committee should seriously consider voluntarily waiving the attorney–client privilege. Keep in mind that special committees are typically used in the transactional context if the transaction under consideration is an interested transaction. In such situations, the role of the special committee is to protect and enhance the interests of the company and its unaffiliated stockholders. Given the nature of this role, courts have criticized decisions by transactional special committees to invoke the attorney–client privilege. For example, in In re Pure Resources, Inc. Shareholders Litigation, the Delaware Court of Chancery criticized the special committee for refusing to waive the privilege 221

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regarding discussions that had taken place leading to the special committee’s authority being “whittled down.”1 The special committee, in this case, was established to respond to a bid by a 65 percent stockholder to acquire the remaining shares of the company in exchange for shares of the controlling stockholder’s own stock. When stockholders raised the issue of the adequacy of the special committee’s authority, the special committee sought clarification from the company as to its authority. The special committee drafted a resolution setting forth the broad authority it was seeking. After discussions between the special committee and counsel for the controlling stockholder, however, the resolution was drastically whittled down, leaving the special committee with little of the authority it had been seeking. The court commented that although the record did not say why the special committee allowed this to happen, it supported possible justifications for this action. The court noted that its “ability to have confidence in these justifications has been compromised by the Special Committee’s odd decision to invoke the attorney–client privilege as to its discussion of these issues.”2 In its criticism of these actions of the special committee, the court stated: [I]n general it seems unwise for a special committee to hide behind the privilege, except when the disclosure of attorney–client discussions would reveal litigationspecific advice or compromise the special committee’s bargaining power. In other than those circumstances, the very nature of the special committee process as an integrity-ensuring device requires judicial access to communications with advisors, especially when such committees rely so heavily on these advisors to negotiate and provide expertise in the absence of the non-conflicted assistance of management. In other cases, of course, this court has explicitly drawn negative inferences when a board has shielded its actions from view.3

Thus, the court was extremely critical of the special committee’s decision to invoke the attorney–client privilege so as to shield its discussions from judicial access and review. Though waiver is not required in every case, it should seriously be considered if the transaction is challenged in court.

B. INVESTIGATIVE COMMITTEES—PRESERVE LEGAL PRIVILEGES IF POSSIBLE As a general consideration, “the work of [a forensic or investigative] committee (including its notes, letters, and memoranda) normally is not discoverable in litigation.”4 Nonetheless, it is prudent that a “committee. . . assume that all documents it inspects

1 2 3 4

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808 A.2d 421, 431 (Del. Ch. 2002). Id. (commenting that special committee seems to have acquiesced in its acceptance of defeat at the hands of controlling stockholder’s attorneys). Id. See 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations & Business Organizations § 13.15, at 13–74 (3d ed. 1998).

INVESTIGATIVE COMMITTEES—PRESERVE LEGAL PRIVILEGES IF POSSIBLE

and/or generates could be discoverable.”5 There are a number of established exceptions to the general rule that an investigative committee’s materials are not discoverable;for example, if a party challenges the committee’s independence, neutrality, or good faith.6

i. The Attorney–Client Privilege It is generally recognized that the attorney–client privilege protects the communications between a client and an attorney acting in his professional capacity if the communications are intended to be confidential and the confidentiality is not waived. Even assuming that the committee carries its burden of establishing that the attorney–client privilege applies to a particular communication, this privilege is not absolute. This is particularly true in the context of litigation between a company and its stockholders. In stockholder litigation, there is an “oft-invoked exception” to the attorney–client privilege.7 Pursuant to this exception, where the company is in suit against its stockholders on charges of acting inimically to stockholder interests, protection of those interests as well as those of the company and of the public require that the availability of the privilege be subject to the right of the stockholders to show “good cause” why the privilege should not apply.8

In determining whether a stockholder has shown sufficient good cause, courts generally follow the approach outlined by the Fifth Circuit in Garner v. Wolfinbarger.9 The Garner approach requires the court to look to several factors, including: (1) the number of shares owned by the stockholder and the percentage of the stock this represents, (2) whether the stockholder has asserted a colorable claim, (3) the necessity of the requested information and its unavailability from other sources, (4) whether the stockholder has sufficiently identified the information sought and is not merely fishing for information, and (5) whether the information is advice concerning the litigation itself.10 The Garner exception therefore provides stockholder plaintiffs with a means to discover advice (even if such advice falls within the attorney–client privilege) received by corporate fiduciaries that are charged with acting in the stockholder’s best interests.

ii. The Work Product Doctrine In addition to the attorney–client privilege, an investigative committee’s work may also be protected by the work product doctrine. “The work product doctrine is intended

5 6

7 8 9 10

Id. Many of the concepts and principles discussed in this subsection are applicable to board committees, boards, and companies in general. Given that these issues are often presented in the context of investigative or forensic special committees, the discussion is mostly geared to that context. Grimes v. DSC Commc’ns Corp., 724 A.2d 561, 568 (Del. Ch. 1998). Id. (quoting Garner v. Wolfinbarger, 430 F.2d 1093, 1103–04 (5th Cir. 1970)). 430 F.2d 1093, 1103–04 (5th Cir. 1970). Delaware courts have adopted the Garner approach. E.g., Grimes, 724 A.2d at 568. Garner, 430 F.2d at 1103–04; see also Grimes, 724 A.2d at 568. 223

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to protect ‘materials an attorney assembled and brought into being in anticipation of litigation.’”11 There is a recognized exception to the work product privilege that permits a party to obtain information that would otherwise be considered protected work product upon a showing of substantial need for the materials and an inability, without undue hardship, to obtain equivalent materials through other means.12 Courts have found substantial need existed, for example, if a plaintiff brought an action to inspect the books and records of a company relating to a special committee’s recommendation to reject the plaintiff’s pre-suit stockholder demand to initiate derivative litigation and the company’s acceptance of the recommendation.13 In that context, the court found that the plaintiff needed access to documents that revealed the deliberative process in which the committee and the board engaged. Specifically, the court ordered that the plaintiff have access to the special committee’s report and minutes of board meetings at which the special committee’s report was discussed and the special committee’s recommendation was adopted. Numerous courts have held that notes and memoranda of witness interviews and client conferences fall within the parameters of the work product privilege.14 Nonetheless, in other situations, courts have ordered the production of all transcripts, notes, and summaries of witness interviews conducted by a special committee to enable the derivative plaintiff to “explore the quality of the committee’s determinations” and the committee’s good faith and independence.15

iii. The Waiver of Privilege Even if certain communications or materials are subject to the attorney–client or work product privileges, the special committee can nonetheless waive the privilege. “A waiver may result from the voluntary disclosure of privileged information to third parties.”16 It is difficult to predict with any real confidence the scope and extent of the waiver if some privileged communications or information is disclosed. If otherwise privileged information or communications is voluntarily and intentionally disclosed, then the privilege as to the subject matter covered by that information or communication is clearly waived. The question then arises whether the privilege is also waived as to undisclosed information or communications that are related to the information or communications that were disclosed. 11 12 13 14 15

16

224

E.g., Grimes, 724 A.2d at 569–70 (citing Lee v. Engle, 1995 WL 761222, at *4 (Del. Ch. Dec. 15, 1995)). Fed. R. Civ. P. 26(b)(3). Grimes, 724 A.2d at 570. See, e.g., Lowe v. White & Spicer, 1990 WL 251387, at *1 (Del. Super. Nov. 2, 1990). E.g., Kindt v. Lund, 2001 WL 1671438, at *8 (Del. Ch. Dec. 14, 2001); see also Grimes, 724 A.2d at 567 (denying plaintiff’s request for access to interview summaries prepared by the special committee’s counsel and explaining that a further showing of need would be required). E.g., Am. Legacy Found. v. Lorillard Tobacco Co., 2004 WL 2521289, at *5 (Del. Ch. Nov. 3, 2004) (quoting Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery § 7-2[c][1] (2004 ed.) (citing Zirn v. VLI Corp., 621 A.2d 773, 781–82 (Del. 1993)).

DISCOVERY REQUESTS BY DERIVATIVE PLAINTIFFS IN RESPONSE TO DECISIONS

The rules of evidence of most jurisdictions codify the doctrine of waiver. The Federal Rules of Evidence (FRE) provide that a waiver extends to undisclosed communications if (1) the waiver is intentional, (2) the disclosed and undisclosed communications or information concern the same subject matter, and (3) they ought in fairness to be considered together.17 The Uniform Rules of Evidence adopted by many states generally provide that a holder of the privilege waives the privilege if it voluntarily discloses or consents to disclosure of any significant part of the privileged matter, unless the disclosure itself is privileged.18 Despite this codification, there are issues that still need to be determined by a court—whether the disclosed and undisclosed information “ought in fairness . . . be considered together19” under the approach of the federal rules and whether the disclosed information constitutes a “significant part of the privileged matter”20 under the approach of the Uniform Rules of Evidence—that make it difficult to predict the scope of the waiver if some, but not all, of the privileged information or communication is disclosed. In short, there is a real risk that partial disclosures of privileged communications or information surrender the privilege as to all related communications or information.21 Given that the premise for the work product doctrine is different than that of the attorney–client privilege, the waiver issues with respect to the work product doctrine are somewhat different. Many courts have held that, as a general matter, voluntary disclosures do not automatically constitute a waiver of the work product doctrine.The factors that courts will typically look to in making this determination include: (1) whether the disclosure was voluntary, (2) whether the party making the disclosure reasonably believed that the disclosed materials would remain confidential by the third party to which it was given (e.g., government agency), (3) whether the party asserting the privilege is doing so in a manner consistent with the purpose of the privilege, and (4) public policy factors relating to a potential waiver of the privilege. There are no bright-line rules or tests for determining what is waived if there are only partial disclosures of otherwise privileged information. Courts often seem to take a case-by-case approach in considering the extent of the waiver. Therefore, careful consideration needs to be given to these issues before making partial disclosures of otherwise privileged information. The committee should also understand that there is no guarantee that the committee’s report and other materials will remain privileged.

C. DISCOVERY REQUESTS BY DERIVATIVE PLAINTIFFS IN RESPONSE TO DECISIONS MADE BY A SPECIAL LITIGATION COMMITTEE When discussing the circumstances under which special litigation committee (SLC) materials can be discoverable, it is necessary to address the line of cases dealing with 17 18 19 20 21

See Fed. R. Evid. 502. See, e.g., D.R.E. 510. See Fed. R. Evid. 502. See D.R.E. 510. See, e.g., Citadel Hldg. Corp. v. Roven, 603 A.2d 818, 825 (Del. 1992). 225

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derivative plaintiffs seeking discovery in response to decisions made by an SLC. In Zapata Corp. v. Maldonado,22 the Delaware Supreme Court articulated the considerations a court should undertake if an SLC requests the dismissal of a derivative suit. A court must determine whether the SLC acted independently of the company and conducted a reasonable investigation in good faith. Limited discovery designed to facilitate inquiries by the court into the independence and good faith of the committee and the reasonableness of its investigation and conclusions is permitted at the court’s discretion. In Kaplan v. Wyatt,23 the court held that the derivative plaintiff was not entitled to the production of the thousands of documents reviewed by the SLC because such all-encompassing discovery is not within the spirit of Zapata’s limited discovery guidelines. Another situation in which documents created or considered by an SLC may be discoverable is if a derivative plaintiff opposes a proposed settlement entered into by the SLC and the defendants. In this circumstance, the issue for the court is again the independence and the good faith of the committee and the bases supporting its decision to settle. In Carlton Investments v. TLC Beatrice International Holdings, Inc.,24 the court stated that the “inquiry requires an evaluation of whether the SLC knew enough about the strengths and weaknesses of the claims to negotiate a fair and reasonable settlement, and whether the settlement reached is in fact fair and reasonable.” Using this guideline, the court found that the SLC report and accompanying documents were properly discoverable given that they should provide a sufficient basis for determining “whether the investigation was done in good faith and in an informed manner and whether the conclusions reached can be thought fair.”25

D. CONSEQUENCES OF DISCLOSING THE INVESTIGATIVE COMMITTEE’S REPORT Once an investigative committee has completed its work and finalized its report, a decision must be made as to what to do with the report. Depending on the committee’s charge, the committee would almost certainly provide its report to the board of the company. The committee or the board would then have to consider whether the report should be made available to select third parties or made publicly available. The decision of whether to disclose the committee report should be carefully considered by not just the committee, but also the board and management of the company to the extent that members of the board or management are not implicated by the findings in the committee’s report. Disclosure of the committee report could have significant and far-reaching consequences to the company. Therefore, it often is prudent that a collective decision on behalf of the company be made on this issue.

22 23 24 25

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430 A.2d 779 (Del. 1981). 484 A.2d 501, 511 (Del. Ch. 1984). 1997 WL 38130, at *1 (Del. Ch. Jan. 29, 1997). Id., at *6.

CONSEQUENCES OF DISCLOSING THE INVESTIGATIVE COMMITTEE’S REPORT

There are several general considerations in making the decision regarding whether to disclose the committee report.26 First, is there a statute, law, or other requirement that potentially mandates that the committee report be provided to a third party (such as the government)? Second, assuming there is no requirement for disclosing the committee report, is it nevertheless prudent (balancing all the benefits, costs, and risks) to disclose the committee report to third parties? Third, if the committee report is to be disclosed to third parties, to whom should it be provided? Each situation will involve its own unique considerations in determining whether to disclose the committee report. Another important consideration in determining whether to disclose the report is how broad the waiver of the privilege resulting from such disclosure might be. The disclosure of a committee report generally will mean that the attorney–client privilege with respect to the report itself will be waived. The disclosure of the report, however, may also result in the waiver of additional materials beyond the report itself.27 For example, assume a special committee’s report directly cites to certain witness interviews conducted by the committee. If the committee report is disclosed, then there is a real risk that the privilege with respect to the notes and other materials related to those interviews is also waived. Alternatively, assume that the special committee’s report does not directly cite or quote to witness interviews, but that it is clear from the background section of the report that approximately twenty witnesses were interviewed and that these interviews to some extent were relied upon by the special committee in compiling its report. Given this reliance on witness interviews, an argument could be made that the special committee’s disclosure of the report functions as a waiver of privilege as to all materials relied upon in the formation of the report, including interview summaries. Once again, given the lack of certainty surrounding any disclosure of the committee’s report, caution is in order before disclosure is made.

i. Criminal Conduct: Dealing with Organizational Fallout from Findings Implicating Criminal Conduct One threshold issue in which the committee report implicates potential criminal conduct by the company or persons within the company is whether the company or its officers or directors will be committing a crime by not disclosing the committee report to the

26

27

See generally Thomas E. Holliday and Charles J. Stevens, Disclosure of Results of Internal Investigations to the Government or Other Third Parties, in Internal Corporate Investigations (Brian & McNeil eds., ABA 1992). A few courts have recognized that, as a matter of public policy, a corporation that voluntarily discloses the results of an investigation in a limited manner to a government authority may be able to do so without waiving the attorney–client privilege. See, e.g., Diversified Indus., Inc. v. Meredith, 572 F.2d 596 (8th Cir. 1977). Most courts, however, have rejected such a limited waiver or selective waiver theory and have adopted a blanket waiver approach. See, e.g., In re Qwest Commc’ns Int’l Inc., 450 F.3d 1179 (10th Cir. 2006); In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289 (6th Cir. 2002); In re Steinhardt P’rs, L.P., 9 F.3d 230 (2d Cir. 1993); Westinghouse Elec. Corp. v. Republic of the Philippines, 951 F.2d 1414 (3d Cir. 1991). 227

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appropriate government authorities. There may be statutory or regulatory provisions requiring that the company disclose any noncompliance or violation of rules or laws of which the company becomes aware.28 Assuming there are no applicable statutory or regulatory requirements in this regard, then the common law would apply. Generally, the common law does not require a company to report knowledge of criminal conduct to government authorities or to disclose evidence of that conduct. Although “misprision of felony” is still an offense under federal law, the federal statute provides: Whoever, having knowledge of the actual commission of a felony cognizable by a court of the United States, conceals and does not as soon as possible make known the same to some judge or other person in civil or military authority under the United States, shall be fined under this title or imprisoned not more than three years, or both.29

This offense—consistent with the general common law—requires an affirmative step to conceal a known felony rather than merely failing to report it.30 Courts have held that “mere silence” with nothing else is insufficient to constitute an affirmative step to conceal a crime.31 It does not take much, however, for a court to find that an affirmative step to conceal has taken place. For example, if a government authority is conducting an investigation, providing an untruthful statement likely will be sufficient to constitute an affirmative act to conceal the crime.32 Also, the partial disclosure of some information that misleads a government authority could also potentially be deemed to be an affirmative act to conceal a crime. Even if the conclusion is that there is no requirement that a committee report be disclosed to third persons, there may nevertheless be good reasons for disclosing the report. For example, one of the potential benefits of disclosing a committee report to the appropriate government authorities is the positive view of government authorities toward such voluntary disclosure in determining whether to prosecute the company and/or the severity of any sentence the company may receive if a prosecution were successful. There also could be a formal voluntary disclosure program or amnesty program insulating the company from criminal prosecution. Voluntary disclosure could also give the company an opportunity to tell its story, walk prosecutors through the facts, and explain the legal defenses the company has available to it.

28 29 30 31 32

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For example, there are various statutes that apply to companies in certain highly regulated industries that are subject to mandatory disclosure requirements of criminal conduct. 18 U.S.C. § 4 (emphasis added). See United States v. Johnson, 546 F.2d 1225, 1227 (5th Cir. 1977) (“The mere failure to report a felony is not sufficient to constitute a violation of 18 U.S.C.A. § 4.”). E.g., United States v. Ciambrone, 750 F.2d 1416, 1418 (9th Cir. 1984). If there is an affirmative act of concealment, then various other statutes or laws in addition to the misprision of a felony statute, such as the laws against making a false statement or obstructing justice, likely would be violated as well.

CONSEQUENCES OF DISCLOSING THE INVESTIGATIVE COMMITTEE’S REPORT

ii. Federal Sentencing Guidelines There are also some benefits from voluntary disclosure built into the federal sentencing guidelines for organizations that went into effect on November 1, 1991. The guidelines establish a formula for calculating the applicable punishment for a given crime. The federal sentencing guidelines establish certain base penalties depending on the nature of the crime and its economic effect. Since an organization cannot be imprisoned, the base penalties for an organization are generally in the form of fines. The base fine will be the highest of (1) the base fine amount specified for the offense level in the guideline table for the criminal conduct at issue, (2) the organization’s economic gain as a result of the criminal conduct, and (3) the economic loss caused to others by the organization’s criminal conduct to the extent that such loss was caused intentionally, knowingly, or recklessly.33 The next step is to calculate the company’s culpability score. The multipliers associated with each score are used to multiply the base fine to create a range of minimum fine to maximum fine. For example, a culpability score of five has a multiple range between one and two, whereas a culpability score of ten has a multiple range between two and four. A company starts with a culpability score of five that is then adjusted taking into account the relevant facts and circumstances. Aggravating factors will increase the culpability score, and mitigating factors will decrease it. One of the mitigating factors under the federal sentencing guidelines that will reduce the culpability score is cooperation with prosecutors. Active cooperation by the company with the prosecutor’s investigation yields a two-point reduction in the culpability score. The company can get a five-point reduction in the culpability score if it: (1) voluntarily discloses the criminal conduct to the government before a threat of government investigation or prosecution, (2) actively and fully cooperates in the government investigation, and (3) accepts responsibility for the conduct before trial (which basically means pleading guilty to the charges). The base fine is then multiplied by the multipliers associated with the culpability factor to get a range of minimum fine to maximum fine. It is up to the judge to set the fine, typically within that range. The guidelines are just that—guidelines—as the judge always has the final say. Nevertheless, the guidelines are typically followed and thus are quite important. The benefits of voluntary disclosure thus not only include being able to make the argument to government authorities that the company should not be indicted in the first instance given the company’s internal investigation and voluntary disclosure to the government, but also potentially having a smaller fine imposed at sentencing should an indictment be returned. On the other hand, there are real and potentially significant costs and risks associated with such voluntary disclosure. With its knowledge of the criminal conduct, the government authority may nevertheless decide to pursue a criminal prosecution and seek a harsh sentence. Moreover, the efforts of the company and the investigative committee in conducting a thorough and comprehensive investigation can provide 33

United States Sentencing Commission, Guidelines Manual § 8C2.4. 229

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a detailed road map for government authorities to craft a strong indictment and bolster their prosecution of the company. In addition, despite all the caveats and reservation of rights, a voluntary disclosure could be an implicit admission of guilt. Furthermore, despite voluntary disclosure being a laudable act when considered in isolation, a court could easily conclude that, given the nature and scope of the underlying criminal conduct, the mitigating effect of the voluntary disclosure should be minimal if not nonexistent. Under the federal sentencing guidelines, however, the risk that voluntary disclosure will not be considered and given weight in determining the ultimate penalty has been greatly reduced. The decision whether to disclose to government authorities is a very important and often complex one, with many considerations that should only be made by the company after careful consideration and analysis of the potential benefits, costs, and risks.

iii. Department of Justice’s Principles of Federal Prosecution of Business Organizations Instances of corporate misconduct that are also potentially criminal and may bring into play the Department of Justice’s Principles of Federal Prosecution of Business Organizations, which in recent years has been more commonly referred to variously as the Thompson Memorandum, the McNulty Memorandum, and/or the Filip Memorandum. The Thompson Memorandum was issued in January 2003, and it set forth guidelines for federal prosecutors in determining whether to indict and prosecute a company or other business entity. The Thompson Memorandum provided, among other things, that federal prosecutors may consider the corporation’s willingness to identify the culprits within the corporation, including senior executives; make witnesses available; disclose the complete results of its investigation; and waive attorney–client and work-product privileges. One factor the prosecutor may weigh in assessing the adequacy of a corporation’s cooperation is the completeness of its disclosure, including, if necessary, a waiver of the attorney–client and work product protections. Thus, the Thompson Memorandum not only incentivized but also strongly pressured companies facing potential criminal charges to waive legal privileges. The Thompson Memorandum unleashed a firestorm of criticism and threats of legislation to reinstate the protections of attorney–client privilege and the work product doctrine. In December 2006, the Department of Justice issued the McNulty Memorandum, which revised some of the guidelines in the Thompson Memorandum. The revised guidelines under the McNulty Memorandum set forth certain limits to demands or requests by prosecutors that a company waive legal privilege. Pursuant to the McNulty Memorandum, federal prosecutors could request privileged information only where there was a legitimate need for such information. In determining whether there was a legitimate need, the following factors could be considered: (1) the likelihood and degree to which the privileged information will benefit the government’s investigation; 230

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(2) whether the information sought can be obtained in a timely and complete fashion by using alternative means that do not require waiver; (3) the completeness of the voluntary disclosure already provided; and (4) the collateral consequences to a company of a waiver. The McNulty Memorandum went on to provide that prosecutors should first request purely factual information (Category I information),34 which may or may not be privileged, relating to the underlying misconduct. Only if the factual information provides an incomplete basis to conduct a thorough investigation should prosecutors then request that the company provide attorney–client communications or nonfactual attorney work product (Category II).35 The McNulty Memorandum cautions that Category II information should only be sought in rare circumstances. The McNulty Memorandum was viewed by many as a half-measure that did not solve the fundamental problems with the Thompson Memorandum. For example, the McNulty Memorandum provided that “[w]aiver of the attorney–client and work product protections is not a prerequisite to a finding that a corporation has cooperated in the government’s investigation.” Nevertheless, the McNulty Memorandum also stated that a “corporation’s response to the government’s request for waiver of privilege for Category I information may be considered in determining whether a corporation has cooperated in the government’s investigation.” As a result, the pressure on a corporation to waive the privilege continued to be immense, and the intense criticism regarding these guidelines continued. In August 2008, the guidelines were revised further in the Filip Memorandum. The Filip Memorandum expressly provided that “[e]ligibility for cooperation credit is not predicated upon the waiver of attorney–client privilege or work product protection. Instead, the sort of cooperation that is most valuable to resolving allegations of misconduct by a corporation and its officers, directors, employees, or agents is disclosure of the relevant facts concerning such misconduct.”36 The Filip Memorandum also discussed cooperation with respect to potential facts gathered by an internal corporate investigation. Often, the corporation gathers facts through an internal investigation. Exactly how and by whom the facts are gathered is for the corporation to decide. Many corporations choose to collect information about potential misconduct through lawyers, a 34

35

36

This so-called Category I information could include “copies of key documents, witness statements, or purely factual interview memoranda regarding the underlying misconduct, organization charts created by company counsel, factual chronologies, factual summaries, or reports (or portions thereof) containing investigative facts documented by counsel.” “[Category II] information includes legal advice given to the corporation before, during, and after the underlying misconduct occurred. This category of privileged information might include the production of attorney notes, memoranda or reports (or portions thereof) containing counsel’s mental impressions and conclusions, legal determinations reached as a result of an internal investigation, or legal advice given to the corporation.” The Filip Memorandum describes relevant facts as including, for example, “How and when did the alleged misconduct occur? Who promoted or approved it? Who was responsible for committing it?” 231

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process that may confer attorney–client privilege or attorney work product protection on at least some of the information collected. Other corporations may choose a method of fact-gathering that does not have that effect—for example, having employee or other witness statements collected after interviews by non-attorney personnel. Whichever process the corporation selects, the government’s key measure of cooperation must remain the same . . . : has the party timely disclosed the relevant facts about the putative misconduct? That is the operative question in assigning cooperation credit for the disclosure of information—not whether the corporation discloses attorney–client or work product materials.37

There are at least two lessons to learn from the various sets of guidelines. First, whatever the guidelines are today, they are subject to revision and are likely to be revised in the future. Second, and more important, if potential criminal charges are implicated, there will be significant incentives for a corporation to disclose an investigative committee’s report (and the committee’s work product and communications).

iv. Potential Libel Claims Another set of issues to consider is whether the disclosure of the committee report could give rise to claims such as libel, slander, or defamation by employees of the corporation or third parties.38 If, at the end of its work, the investigative committee concludes that there was serious wrongdoing, breaches, or noncompliance, it is typical for the committee report to lay out the facts, the evidence for such wrongdoing, and the conclusions with respect to the wrongdoing (likely including the persons who were responsible for and/or were aware of the wrongdoing). After all, the committee report is not a place to mince words if the committee has concluded that there was serious wrongdoing. The persons who are identified as potential wrongdoers, in one capacity or another, have a lot at stake. They may be subject to termination by the corporation, their personal and professional reputations may be severely damaged, and they may have to face further civil or government proceedings. In such situations, the possibility of potential libel or similar claims should be considered. Potential libel or similar claims are assessed based on the factual circumstances and the application of a panoply of constitutional and common law doctrines that are designed to balance, on the one hand, a person’s legitimate interests in not having his

37

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The Filip Memorandum notes that if witness interviews are conducted by counsel, then notes and memoranda generated from the interviews that are subject to the protections of attorney– client privilege and/or attorney work product need not be produced to prosecutors in order to receive cooperation credit. The Filip Memorandum continues that to “earn such credit, however, the corporation does need to produce, and prosecutors may request, relevant factual information—including relevant factual information acquired through those interviews, unless the identical information has otherwise been provided—as well as relevant non-privileged evidence such as accounting and business records and emails between non-attorney employees or agents.” See generally John G. Koeltl and Edwin G. Schallert, Report of the Investigation, in INTERNAL CORPORATE INVESTIGATIONS (Brian & McNeil eds., ABA 1992).

CASE STUDY: ANNOUNCING INVESTIGATION RESULTS TO THE FULL BOARD

reputation tarnished and, on the other hand, a corporation’s interest in being able to police itself and ensure that its employees and agents are complying with applicable laws, regulations, and corporate policies. There are some steps, however, that can hopefully minimize the potential for a successful libel claim to be made against the committee or the corporation based on the contents of the committee report. These steps include: (1) providing in the committee report explicit factual detail and support with respect to any conclusions relating to a person’s culpability; (2) verifying and confirming the accuracy of the factual details and premises that form the basis for the conclusions relating to a person’s culpability; (3) avoiding the use of overly broad, loose, or colorful language in the report; and (4) avoiding unnecessary disclosure of the committee report.

E. CASE STUDY: ANNOUNCING INVESTIGATION RESULTS TO THE FULL BOARD39 FACTS

Shortly after a published report suggesting that a corporation likely had improperly backdated stock option grants, stockholder-initiated derivative litigation is filed. The corporation’s board appoints a special committee of one director to investigate the corporation’s past stock option granting practices. The committee is not, however, an SLC formed under the rubric of Zapata. Instead, the committee is directed to investigate, but is not authorized to bring suit on the corporation’s behalf without further action by the full board. The committee and its counsel investigate the alleged option backdating over a period of six months, but do not prepare a written report summarizing their findings. Instead, the committee and its counsel make an oral presentation to the full board at a meeting at which all the directors (including those who had allegedly engaged in backdating and were targets in the investigation), the corporation’s outside counsel, and the directors’ personal counsel are present. After the meeting, the corporation issues a press release acknowledging deficiencies in its past option-granting practices but exonerating its directors from wrongdoing. The director defendants rely on the findings of the committee to argue that they should be exculpated from personal liability in the derivative litigation. The derivative plaintiffs seek production of materials relating to the committee’s investigation and eventually move for an order compelling production. The plaintiffs seek to discover, among other things: (1) communications between the committee and its counsel on the one hand and the full board on the other, and (2) communications between the committee and its counsel that occurred during the committee’s investigation. The defendants claim that communications between the committee and its counsel were protected by attorney–client privilege, and the corporation claims that communications

39

This case study is based on two related decisions from the Delaware Court of Chancery in the same litigation challenging certain stock option backdating in Maxim Integrated Products, Inc. Ryan v. Gifford, 2007 WL 4259557 (Del. Ch. Nov. 30, 2007), and Ryan v. Gifford, 2008 WL 43699 (Del. Ch. Jan. 2, 2008). 233

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between the committee’s counsel and the corporation (including the presentation of the committee’s final report to the board) are protected by a joint privilege. ANALYSIS

Does the oral presentation by the special committee of its findings to the full board constitute a waiver of the privilege with respect to the communications made to the board? As a general matter, otherwise privileged communications are not waived just because they are discussed between a committee of a board and a full board. There are several reasons for this general rule, including that there typically remains an expectation of confidentiality and there typically is more than sufficient commonality of interest to maintain the privilege. In the scenario here, however, there are at least several factors making it difficult to argue that the privilege has not been waived. First, the directors probably will be deemed to have attended the meeting in their personal capacity as opposed to solely in their corporate capacity. After all, the directors had their outside, personal counsel present at the meeting. In addition, the directors subsequently used the special committee’s findings to argue that they should be exculpated from personal liability. If the directors were there in their personal capacity, then they would be deemed outsiders with respect to the privileged information. Disclosure of otherwise privileged information to outsiders results in the waiver of the privilege. Another potential basis for arguing that the privilege was not waived is that the directors, the special committee, and the corporation could communicate among each other freely, pursuant to the joint defense privilege. The problem with this argument, under the assumed facts here, is that certain of the directors on the full board who attended the meeting were the targets of the investigation themselves. Hence, arguably, there is an actual adversity of interest much less a sufficient commonality of interest to maintain a joint defense privilege with respect to the communications at the meeting.40 Assuming the oral presentation by the special committee of its findings to the full board does constitute a waiver of the privilege with respect to the communications made to the board, does this waiver extend to communications between the special committee and its own counsel? The next issue is whether the waiver resulting from the oral presentation extends to anything beyond the oral presentation itself. In this situation, there is a real risk that the presentation to the committee (a partial waiver) will be deemed to apply to all communications regarding this subject matter. Given that the oral presentation provided the directors with the findings and results of the committee’s investigation in lieu of a written report, the waiver of the privilege likely would constitute a subject-matter

40

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As noted by the court in Ryan v. Gifford, the directors did not have interests “so parallel and non-adverse that, at least with respect to the transaction involved, they may be regarded as acting as joint venturers.” and “[T]he special committee was formed to investigate wrongdoing and in response to litigation in which certain directors were named as individual defendants. This describes a relationship more akin to one adversarial in nature.” Ryan, 2007 WL 4259557, at *3 and n.8.

CASE STUDY: ANNOUNCING INVESTIGATION RESULTS TO THE FULL BOARD

waiver, so that all communications between the committee and its counsel relating to the committee’s investigation, findings, and conclusions would be subject to discovery. What could the committee and board have done differently to maximize their ability to claim privilege? To a certain extent, it is always a guessing game as to what could have been done differently. Under the circumstances, it obviously would have been better if the committee were established as a true Zapata SLC authorized to take action on behalf of the corporation, rather than a committee that had to report back to the board. If the committee had been a fully authorized SLC, then there would have been no need to make a presentation to the board at all. If a presentation to the board was necessary, it would have been best to try to establish a record that the board members were there solely in their corporate capacities and not in their individual capacities. This would have meant that outside counsel to the directors should not have been present, and the individual directors should not have relied on the special committee’s findings to seek exculpation from personal liability. Rather, the directors should have relied on the corporation or the committee to make these arguments. Although these and other steps could have been taken, it is not at all clear that any such steps would have yielded a significantly different result, especially in the context of derivative litigation. In derivative litigation, if the stockholder plaintiffs establish good cause under the doctrine set forth in Garner v. Wolfinbarger,41 they will be entitled to discovery even with respect to privileged communications. Here, the report of the committee was unavailable from other sources (e.g., the committee had not prepared a written report), and this information clearly would be of great importance to the claims in the litigation. Hence, it would have been difficult to maintain the privilege with respect to the committee’s report, irrespective of the steps taken.

41

430 F.2d 1093 (5th Cir. 1970). 235

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Chapter 12

The In-House Lawyer’s Role: What to Expect and How to Cope

Of all the actors in the special committee drama, it is ironically almost invariably the case that in-house counsel is least prepared to deal with the committee process and often comes through the process with the most bumps and bruises. New counsel for the independent committee will typically not view it as their job to brief in-house counsel. At the same time, regular corporate counsel will typically not be asked to brief the general counsel on the process. Thus, the committee process often begins with the corporation’s chief legal officer not really knowing what to expect. Into this vacuum, the general counsel will often attempt to insert her special skills at managing legal projects, and that is typically where the problem begins. If the in-house counsel follows her instincts and attempts to manage the process, she is often perceived by the committee as an officious intermeddler (at best) or, more darkly, a rogue actor attempting to sabotage the process. In many cases, in-house counsel can avoid the mistakes that seem to be repeated in many committee assignments simply by better understanding the committee process and her role in it. The following pages describe the changes in in-house counsel’s role that accompany the appointment of a special committee and make suggestions for how best to deal with what is often terra incognita.

A. UNDERSTANDING THE POTENTIAL APPEARANCE OF CONFLICT OF THE IN-HOUSE LAWYER In the special committee process, the mere perception of a conflict is of great significance. Thus, whether or not in-house counsel has an actual conflict is of less relevance than whether there appears to be a conflict. For all of the reasons explained in the preceding chapters, committee counsel will almost invariably be sensitive, even hypersensitive, to any aspect of the committee process that may be perceived (rightly or wrongly) as having the potential to be influenced by a conflicted fiduciary. In the context of a committee investigation, the general counsel will almost invariably be perceived as closely tied to one or more targets of the investigation, particularly if 237

THE IN-HOUSE LAWYER’S ROLE: WHAT TO EXPECT AND HOW TO COPE

the investigation focuses on members of senior management or non-management board members. After all, in most cases, the general counsel reports to the CEO (chief executive officer) and often views the CEO as a client. Likewise, the CEO is almost always in a position to exert direct and substantial influence over the general counsel by controlling the general counsel’s compensation and, in some cases, job tenure. Thus, it is likely, though perhaps not entirely accurate, that the general counsel who attempts to insert himself into the forensic committee’s work will be viewed as serving two masters: the corporation, in the person of its committee, and the management team that he counsels on a daily basis. This potential for divided loyalty is likely to be a deep-seated concern for committee counsel and give rise to a view of the general counsel as potentially conflicted, whether or not an actual conflict exists. Thus it should become clear that, from the perspective of committee counsel, the corporation’s general counsel is likely to be regarded with some degree of concern from the outset. It may not matter how incorrect this prejudgment, or how independent of senior management or the board the general counsel actually is. As has been made clear in the preceding chapters, the general counsel’s participation in committee practice magnifies and exalts the mere perception of conflict almost beyond recognition. Of course, as noted above, it falls to committee counsel to recognize this danger from the outset and do his best to shield the committee and the committee process itself from any perception of taint, whether or not that view is deserved by or fair to the general counsel. The same predisposition to be wary of the general counsel is often evident in the work of a transactional committee as well. If a transactional committee is formed to address a potential conflict transaction, the reason is evident. If a transactional committee is formed to oversee the sale of the corporation itself, the issue also arises, especially if the management team has the potential to become a bidder for the corporation, or, alternatively, the jobs of senior management are at stake in the transaction. Thus, counsel for the committee is probably predisposed to view the general counsel with some degree of skepticism from the outset of most committee assignments. Understanding that the general counsel is likely to be perceived in this way is the most important key to understanding the role of the general counsel in any committee process and how the general counsel can best assist, rather than interfere, with the process.

B. UNDERSTANDING HOW THE APPEARANCE OF CONFLICT SHAPES THE ROLE OF IN-HOUSE COUNSEL IN THE COMMITTEE PROCESS Consistent with our admonitions regarding conflicts in prior chapters, the appearance of conflict in the committee context directly influences the role that any well-advised committee will allow the general counsel to play in its process. This appearance not only shapes but in some ways dictates a new role for the general counsel, one that will at the same time be unfamiliar and uncomfortable. The role will be unfamiliar because the general counsel will be expected to become an adjunct to the committee process, 238

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a process that is being led by the committee’s counsel. The role will be uncomfortable because the general counsel will be expected to avoid trying to manage the process. Face it, rising to the level of chief legal officer in a public corporation takes a certain skill set: the ability to manage diverse matters, the ability to herd often numerous outside counsel toward a common goal shaped by the in-house legal department, the management of lawyer billings to a legal department budget, and the ability to stay well informed about key legal issues in each significant matter overseen by the in-house legal department so as to be on top of the corporation’s docket of cases and other matters. The individual with these skills is often someone who is more likely than not a hands-on manager, often a Type A personality; someone who might even be uncharitably perceived as hooked on controlling those around him. Similarly, most general counsel are likely not accustomed to being told by outside lawyers or law firms, who they have selected, that they cannot have certain information and are unwelcome at certain meetings. Welcome to the world of special committee work. A general counsel’s ability to live through this process depends upon his ability and willingness to grasp his role in this new universe. So what, precisely, is the role of the general counsel in the special committee process? Put most simply, it is to be a resource and, if appropriate, a facilitator. It is to support the work of the committee when asked to do so, but not attempt to direct or control that work. Unlike everything else the general counsel does, this role is not the role of manager. Likewise, the instinctual search for information does not serve the general counsel well in dealing with the special committee. To the contrary, the special committee and its counsel are likely to perceive the general counsel’s request for reports, updates, or briefings as inappropriate, rather than as simply what the general counsel expects from all of the corporation’s lawyers. In-house counsel, just like everyone else in the process, has to learn to await the outcome of the committee’s work and its decisions without attempting to get a read on what the committee is doing and why. If the general counsel learns to see the committee and its lawyers as outside of the universe of lawyers and projects that his office is expected to manage and oversee, then the chance of inadvertently stepping into trouble is significantly decreased.

C. HELPING THE SPECIAL COMMITTEE GET STARTED Armed with a new understanding of the general counsel’s role in the committee process, it makes sense now to turn to an outline of how the general counsel can best discharge that role. At the outset, there is the ability to assist the special committee in getting its process underway. This typically involves assisting in the committee’s work of selecting counsel; providing internal and logistical support to the committee; and, at times, coordinating committee document collection, interviews, and other logistical support. Likewise, in a more substantive vein, the general counsel often plays an important role in helping to facilitate due diligence in the transactional setting and assisting often unfamiliar counsel with the scope of representations and warranties and the matters that need to be included in transaction disclosure schedules. Each is addressed below. 239

THE IN-HOUSE LAWYER’S ROLE: WHAT TO EXPECT AND HOW TO COPE

i. Selection of Counsel It should be clear at the outset that the decision of whom to select as counsel is a matter for the special committee and not the general counsel. It is often the case, however, that the directors who make up the committee will ask for recommendations or other information from the general counsel. When asked, the general counsel should be prepared to assist the committee by strongly suggesting that the committee retain independent counsel rather than relying on regular outside counsel to the corporation. When asked, the general counsel should also be prepared to provide a list of recommended firms for the committee to interview. In that circumstance, the general counsel will typically make initial inquiries of independent firms to determine whether they are free of conflicts, and may also make initial inquiries about the expertise of the firm or its individual lawyers in advising special committees. The art here is to recognize that it is ultimately the committee’s job to interview counsel and select the lawyers who best meet the needs of the committee. The general counsel will want to avoid anything other than high-level information gathering from potential counsel, with a view towards being able to suggest a list of firms and/or individual lawyers for the committee to interview. Attempting to steer the committee towards old colleagues, classmates, or social friends is less than a good idea. A note of caution is also in order. The general counsel should avoid the temptation to try to condition potential committee counsel to be responsive to him or her during the initial contact process. In one widely reported decision, the Delaware Supreme Court found that the fact that a parent corporation’s general counsel suggested the name of legal counsel to the special committee and that the special committee then “promptly retained” such counsel was a notable indicator that the special committee’s process was not to be trusted.1 How many lawyers should the general counsel be prepared to suggest that the committee interview? There is only one correct answer to this question, and that is more than one. The general counsel who carefully screens a number of firms and then helpfully provides the single best candidate (and only that candidate), no matter how well intentioned, is inadvertently helping to establish precisely the wrong record. A reviewing plaintiff’s attorney or a court is likely to argue or conclude that the general counsel effectively handpicked the committee’s counsel (if the committee accepts the implicit invitation to interview only the lawyer that the general counsel has suggested). Experience suggests that the correct number of candidates is usually between two and four. This number of potential candidates is manageable and creates the record that the special committee cast its net widely, not relying on only one recommendation. Providing fewer than two or three risks the criticism that counsel for the committee was hand picked (or almost handpicked); providing more than four names may be less than helpful, since even the most dedicated committee is likely to find that interviewing more than four firms becomes a bit confusing. After assisting the committee by providing the names and contact information of qualified counsel, the role of the general counsel in helping to select counsel for the

1

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Kahn v. Tremont Corp., 694 A.2d 422, 429 (Del. 1997).

HELPING THE SPECIAL COMMITTEE GET STARTED

special committee is at an end. The general counsel should avoid participation in the committee’s interview of such counsel once contact information has been provided.

ii. Dealing with Billing and Other Mechanics of the Committee’s Representation by Outside Counsel Once the special committee has selected its counsel, the typical mechanics of interfacing with such counsel should be given careful consideration, and if appropriate, special arrangements should be made in this regard. At the outset, though committee counsel is paid by the corporation, the general counsel needs to understand that such counsel are not managed by the corporation’s in-house legal staff, but instead by the committee itself. This means that it is not appropriate for the general counsel to proceed as usual, by introducing himself and explaining the corporation’s billing guidelines, acceptable billing rates or practices, or communicating other management techniques for corporate outside counsel. Though it is not inappropriate for the general counsel to volunteer to provide the committee with the corporation’s routine billing guidelines or other management techniques for potential use and implementation by the committee, it is, in all cases, up to the committee to determine whether or not to utilize such guidelines or other management techniques in dealing with its counsel.2 Volunteering to provide such materials to the committee is quite a different matter than creating a record of in-house legal counsel attempting to exert authority over or attempting to manage the special committee’s counsel. Issues also often arise regarding how the committee’s lawyer’s bills should be handled. Bills should typically be sent to and approved by the special committee’s chair, who should direct that payment be made by the corporation. The corporation should then pay, on the committee’s direction, without further oversight or interference. Indeed, in some circumstances, particularly in the case of investigative committees, it may be appropriate for special committee counsel to create two separate billing statements: a detailed statement for review and approval by the committee chair, and a summary statement to be forwarded by the committee chair for payment by the corporation. This will not be necessary in all cases, but it is appropriate for the committee to consider whether to utilize this technique, especially in cases in which the committee is formed to investigate. The reason, of course, is that the finely detailed billing statements tend to serve as an outline of what the special committee’s counsel is doing. To the extent that in-house counsel is in possession of this information, an argument can be made, after the fact, that the same information was available to the targets of the committee’s investigation, whether or not the general counsel actually reviewed the data or briefed management on it. By understanding that these unusual billing arrangements serve a valuable purpose, and taking the steps necessary to assure that they are put in place and operate smoothly, the general counsel can assist 2

Practical problems arise if the corporation’s billing guidelines require committee counsel to get prior approval from or otherwise answer to in-house lawyers in the course of representing the committee. As noted in the text, creating a record of this sort should be avoided at all costs. 241

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the committee by avoiding the creation of a record that is both unnecessary and unhelpful. Likewise, if the committee or its new counsel is not sufficiently experienced to put such a process in place, the general counsel can add value to the committee’s work by suggesting proactively that the committee consider precisely such a process. Finally, routine management techniques like asking outside counsel for a budget or regular updates should also be avoided. The key for the general counsel here is that the special committee, even though it represents the corporation, does not answer to the corporation’s in-house legal function. This is often a difficult concept for the general counsel to grasp, especially since, as the chief legal officer, his job is to manage the company’s legal matters and legal counsel. Though the special committee’s counsel may seem like one of the many sets of lawyers to be managed by the general counsel, it is not. Indeed, just the opposite is true. This is a set of lawyers that is substantively different and that does not fall under the purview of the office of the general counsel. Understanding that at the outset makes the process smoother and will avoid many of the pitfalls typically encountered in special committee practice.

iii. Providing Internal Support to the Committee The special committee and its counsel will invariably need some level of internal support as they go about their work. The job of supporting the committee typically falls to the office of the general counsel. The type and extent of support needed will vary from committee to committee, but there are several examples that repeat themselves time and again in special committee practice. For example, if the investigative committee seeks documents from the company’s files, in most cases it will rely upon the office of the general counsel to assist it in gathering such documents. In this case, the general counsel will want to approach the committee’s request for assistance in much the same way that it works with outside litigation counsel to request documents from the company. Internal memos requesting documents should be prepared and directed to the persons most likely to have responsive documents. Appropriate litigation holds should be prepared and disseminated internally. Based upon the committee counsel’s needs, determined in consultation with such counsel, in-house paralegals may also be utilized to process the documents gathered and, in appropriate circumstances, to provide bates or control numbers to the production. Depending upon the volume of such documents and the special committee’s counsel’s desires, it may be appropriate for in-house counsel to facilitate the scanning and production of the documents to special committee counsel through in-house or outside litigation support vendors. Note, however, that the role described above is a facilitation role. It is most definitely not the role of in-house counsel to review documents requested by special committee counsel to determine what should be withheld as privileged3 or otherwise 3

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Documents are typically not privileged as against the special committee, since the committee is acting for the corporation.

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make relevance calls. Though it may be necessary to review documents for responsiveness to the committee’s request, that role is different than making judgments about what the committee really needs, which in all cases is a judgment for the committee’s counsel, not the in-house legal staff. In today’s milieu, in which vastly more documents are stored in electronic rather than hard copy form, it is also appropriate for in-house counsel to facilitate the special committee’s search for documents by collaborating with the committee on a work plan to secure such data. In-house counsel is also likely to be of assistance to the special committee by gathering documents from directors or other corporate constituencies, directing third-party advisors to deal with committee counsel just as they would corporate counsel, and assisting in the scheduling of interviews of corporate personnel. Of course, in each case, the assistance described would not be provided unless requested by the committee. Sometimes the scope of the special committee’s work is sufficiently broad that it becomes necessary to provide internal secretarial and logistics support. Though this is not typically the case, the need does arise from time to time. In one forensic investigation, the special committee, with the assistance of the general counsel, hired a full-time secretary and paralegal, who were given separate, locked office space at the company’s headquarters and whose work was purposefully kept off the company’s network of computer servers for security purposes. These special situations may also require the assistance of the general counsel.

iv. Supporting the Transactional Committee Transactional committees also find themselves in need of support from the general counsel’s office. In the case of a sale of the company, committee counsel is not likely to be sufficiently conversant in detailed information about the company and its business operations to be able to work entirely independently of the general counsel and the company’s regular outside counsel. A number of matters, such as negotiating the scope of representations and warranties or completing the typical disclosure schedule in a merger, often require in-depth, company-specific information, which only the general counsel’s office and long-standing, regular outside counsel are likely to have. In this context, then, the general counsel serves a valuable role by directly providing advice and information as called upon by the committee, and by assuring that regular outside counsel works seamlessly with committee counsel. Due diligence is another area in which the office of the general counsel is often invaluable to a transactional committee. The committee’s counsel is likely to need assistance in coordinating management presentations and assembling the data room, both functions that the committee counsel typically will not be able to do efficiently on its own. It is important to recognize, however, that as in all other areas discussed here, the role of the general counsel is to support and facilitate, not manage. Committee counsel that delegates sole responsibility for these functions to the general counsel is creating a bad record, which may become important if the transaction is eventually challenged in court. In the Delaware Court of Chancery’s widely reported decision in 243

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In re Netsmart Technologies, Inc. Shareholders Litigation,4 the court was critical of a transactional committee that allowed the management team to make due diligence presentations without the presence or oversight of the committee or its counsel. In a particularly memorable piece of judicial craftsmanship, the judge emphasized the point that management has a potential interest in the outcome of the transaction and, if given the opportunity to shade due diligence without the oversight of the committee, could shade it in a manner not conducive to maximization of the result. The court wrote: The Special Committee’s and its advisors’ involvement in the due diligence process was less vigorous. They let this process be driven by management. In easily imagined circumstances, this approach to due diligence could be highly problematic. If management had an incentive to favor a particular bidder (or type of bidder), it could use the due diligence process to its advantage, by using different body language and verbal emphasis with different bidders. “She’s fine” can mean different things depending on how it is said.5

Once again, the point is not that management and the office of the general counsel invariably have a conflict in situations in which a committee is formed to oversee a transaction. It is the case, however, that there is very often the perception of a conflict in such situations, and this dictates that the committee should be involved in diligence. Thus, the general counsel should understand that this is not the typical sale process. In short, there is an important role for the office of the general counsel to play in the work of many committees. That role is quite a bit different from the general counsel’s typical role, however, and understanding the boundaries of that role and being sensitive to the reasons for those boundaries is likely to be a key to making the general counsel a net plus, rather than a potentially serious negative, in the special committee process.

D. AVOIDING COMMON PITFALLS As any special committee process unfolds, there are, surprisingly, common missteps that experienced committee practitioners see repeated time and again. What follows, while not an exhaustive list, attempts to address the most common potential pitfalls in the committee process in which the general counsel is often directly involved.

i. Controlling the Process: Give It Up! As we noted above, the typical role of the general counsel is to oversee and give direction to the legal affairs of the company. The appointment of a special committee removes the general counsel from that role as it pertains to the committee and the subject matter of its investigation or negotiation. That is so even though the committee’s work is, broadly speaking, part of the legal affairs of the company. Friction between the general

4 5

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In re Netsmart Techs., Inc. S’holders Litig., 924 A. 2d 171 (Del. Ch. 2007). Netsmart, 924 A.2d at 194.

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counsel and the special committee almost invariably arises if the general counsel attempts to exert control over the committee and its process, and the committee or its counsel reject that attempt. The simplest way to avoid this first misstep is for the general counsel to abandon the expectation that committee counsel will report to her, brief her on the work of the committee, or generally be answerable to the general counsel or her staff during the committee process. That means that the general counsel anticipates being asked to assist the committee and report to committee counsel when the task is finished, but without expecting to be able to ask for, or receive, the courtesy in return. The general counsel should suppress the temptation to ask the committee about its timing, its work plan, or the status of its investigation, all of which will likely cause experienced counsel to the committee to begin to question precisely what she is doing and for whom. As noted above, asking for or demanding a budget from the special committee is also a mistake, and doing so is likely to cause no small degree of friction with the committee and its counsel. A general counsel who controls her curiosity and curbs her instinct to manage will avoid the most common and often serious missteps in the process.

ii. Staying Away from Meetings In many companies, it is the practice of the general counsel to attend meetings of standing board committees and to take minutes of the proceedings of those committees. A general counsel should not expect to do so in the special committee context. Indeed, if asked to do so by a special committee member, the general counsel should take the opportunity to advise the committee member that this is almost invariably the work of special committee counsel and that her presence at meetings will only help those attacking the committee’s work later on. The theory of such an attack will be that the committee was not independent because it allowed the general counsel to attend its proceedings and have a behind-the-scenes look at what it was doing in real time. If invited to attend any particular meeting of the special committee by its counsel, the general counsel should assure that committee counsel has thought about the record being created by her attendance and will attend only in the case in which committee counsel provides assurances that her presence is needed, and then only those portions of the meeting in which she is actively needed as a participant. Minutes of the work of the special committee should, as suggested above, be kept by the committee’s counsel. Whether or not the general counsel serves as corporate secretary, minutes should not be funneled to the general counsel for filing with the records of the company until after the committee completes its work, at which point it is usually appropriate to have the proceedings of the committee filed with the company’s permanent records.

iii. Acting as the Board Interface In the context of a forensic committee in which the conduct of one or more board members is at issue, it often happens that the non-committee board members, after 245

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some interval of time passes, become worried about what the committee is doing, why it is doing what it is doing, what its preliminary conclusions may be, and what timing it contemplates to complete its process. Often, this happens relatively early in the committee’s life cycle, and often the result of the board’s unease is a direction to the general counsel to interface with the committee on behalf of the board. Armed with the authority of the board, the general counsel then begins to probe and ask questions of committee counsel. At times, the general counsel might try to establish a deadline for the committee’s work. At other times, the general counsel might demand that the committee provide him or her with a report on its activities or, failing that, appear before the full board and provide it with a report concerning any number of details regarding its work. This is a blunder of somewhat greater proportions than the other matters addressed above (although each of them have proven harmful to the special committee process from time to time as well) because this series of events often takes place on the record and in a manner that is easy to re-create in ensuing litigation. The new power relationships at work here often involves a board attempting to reassert control over a special committee process that may seem to have gotten out of control. The general counsel is newly empowered by the board, often in the aftermath of a series of disappointing interactions with the committee. The stage is set for a poor outcome, absent experienced practitioners stepping forward to attempt to avoid what could turn out to be a very nasty series of events. At the outset, at least in the case of a special litigation committee (SLC), in order for the process to have a chance at surviving court scrutiny, the board has typically ceded all of its power to the committee. Thus, attempts to withdraw that delegation of power are of questionable legal validity. If the board has, in fact, delegated away all of its power with respect to a certain subject matter, what authority does it have to withdraw or cancel that delegation? Even in cases in which the special committee is only empowered to recommend a result to the board, attempts to withdraw the authority of the committee, or exert control over it, present a situation in which the committee will be advised that it must react strongly, on pain of losing any benefit to the company from its existence or the process it has followed to date. Thus, if the committee buckles under the pressure, it is likely that a court will eventually determine that the committee was not independent in fact, or at the least did not act independently when it mattered. So the special committee typically will be advised to reject the board’s attempt to reassert its control over the process. Moreover, typically, serious disclosure issues arise at this point in the process. If the formation of the committee has been disclosed initially, outside counsel may well determine that attempts to disband the committee should also be disclosed. As noted previously, this subjects the conduct to heightened public scrutiny and risks the potential that stockholder lawyers or regulators become unwelcome and active participants in the process. So the stage is set for bad things to happen: The special committee and the board will in most cases come to loggerheads, and, depending upon the facts of the situation,

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counsel may determine that some of the events that have transpired need to be disclosed. An experienced general counsel will recognize in this dog’s breakfast a genuine opportunity to be of service in the highest tradition—the opportunity to shut down the board’s attempts to reassert control when it first arises at a meeting of the board or in informal conversations among non-committee board members. The general counsel who steps into this breach is the unsung hero of the special committee process. Explaining to the non-committee board members how the committee and its counsel are likely to react to attempts to control them, and the potential disclosure implications for the situation, will typically go a long way toward calming the waters. Of course, convincing the non-committee board members to back off is not always possible, but it is a task worth trying. This is not to suggest that it is inappropriate for the board to ask the committee to brief the full board on its progress from time to time. This often occurs, even in special committee investigations. In these circumstances, however, updates are typically kept to broad outlines of the committee’s work to date, the work it intends to perform before concluding its process, and broad (and universally imprecise) estimates concerning timing of the process.

iv. Controlling Curiosity and the Urge to Meddle In addition to non-committee board members seeking to meddle in the process, frequently there is also the question of in-house counsel’s natural curiosity and urge to meddle. Simply put, the work of summoning the discipline necessary to overcome the desire to investigate and become involved is worth the effort, even if it is a great effort. Just as the special committee counsel is not likely to be kindly disposed to attempts by the general counsel or her staff to manage the committee’s process or its lawyers, so, too, attempts to become informed or to become involved are not likely to be well received, except at the most broad level. This means that even though both the board and the general counsel are probably entitled to ask the forensic committee’s counsel (and, in some cases, even to receive an answer) about how far the committee’s work has progressed and its expected timing to completion, those questions should only be asked occasionally and should not be expected to come with a full status report on witnesses interviewed and to be interviewed, etc. Likewise, as noted above, asking the committee for a budget or a work plan is not likely to be useful in supporting the committee’s efforts to create a record of a separately functioning independent committee and, therefore, is not helpful. It follows that asking the committee to justify what it is doing falls within the same proscription. Of course, the timing of a transactional committee’s work may be more relevant to the work of the general counsel and the various constituencies to which the in-house counsel may be responsible, given the many things that need to be done in connection with an acquisition, sale, or divestiture. It is therefore incumbent upon the committee’s counsel to make sure that the result of a transactional committee’s work is coordinated

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with the company to assure that press releases are prepared and issued and disclosures are drafted, reviewed, and filed, etc. Suffice it to say that, in the typical transactional committee process, questions relating to the timing of the process are likely to be understood as necessary to fulfill legitimate business needs, rather than merely satisfy idle curiosity. Finally, this is not an attempt to catalog the ways in which a poorly briefed general counsel may attempt to meddle in the process; such ways are limited only by the creativity of counsel. Nevertheless, it is almost uniformly the case that counsel who give in to, rather than resist, the urge to meddle unintentionally help to create a bad record for the special committee and are likely to find themselves in hot water either with the committee members or others. Given that the committee members are likely to continue as independent members of the board, often with a say concerning the general counsel’s compensation or even retention, acting in a way that exhibits a lack of knowledge or sensitivity to the committee’s legitimate needs is often a very poor career choice.

v. Preparing and Debriefing Witnesses Finally, in the forensic context, we have from time to time encountered in-house counsel who has attempted to prepare witnesses for their committee interviews as if the exercise were a deposition by a hostile examiner. In some cases, this activity has been coupled with in-depth debriefing of witnesses already interviewed by the special committee in an attempt to make preparation sessions more effective or otherwise to learn the direction that the committee is taking in these interviews. From the perspective of counsel to the special committee, such activity is rarely perceived as helpful to the process. At the outset, preparing directors or senior officers by coaching them with canned answers to anticipated questions is always a mistake. Experienced special committee counsel will quickly learn that interviewees have been fed a “party line,” and will become more suspicious and less willing to credit the testimony of prepared witnesses. Of course, if the general counsel participates in these sessions, interesting issues relating to privilege often arise; the committee is generally recognized to share in the company’s privilege. Consequently, the preparation of a corporate witness by a corporate officer may waive the right to claim privilege relating to the preparation that the individual may otherwise have in his own right. Likewise, the perception by special committee counsel that witnesses have been carefully prepared in advance of committee interviews will naturally lead to greater emphasis on the testimony of the witnesses who appeared earliest in the process (who generally would not have had access to the feedback from debriefing of later witnesses). When faced with a process that was obviously interfered with, special committee counsel also will often tend to place more weight on contemporaneous documentary evidence than on canned interview answers, and thus may tend to give the documents greater weight than would typically be the case. The result is often to

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skew the committee’s conclusions in a way that may tend to be less favorable to the witnesses who were prepared and who might otherwise have been credited by the committee as being candid and helpful. Indeed, if this type of activity rises to the level of outright obstruction, the special committee may find itself in the position of having to note the apparent activity in its report. This is not to say that the general preparation of a prospective interviewee is always inappropriate. To the contrary, a preparation session that explains the nature of the interview that will be conducted (e.g., who the committee is and how the process works) and encourages the prospective witness to tell the story the way that he remembers it candidly and without undue spin or gloss may be a good thing from the special committee’s perspective. But, especially for lawyers who have a litigation background, the urge to help prepare a witness by selectively refreshing recollection, massaging answers, and spinning those that are not perceived as helpful is often too great to overcome. The result is often an inadvertently created adversarial process, which is most definitely not what the committee process should be. In the same vein, if the general counsel attempts to debrief individuals who have met with the special committee to learn more about the committee’s lines of inquiry and investigation, she is likely to be viewed as improperly interfering with the committee process. It is likely that such information will be used to prepare other prospective interviewees in a manner that tends to obstruct or retard the special committee’s attempts to develop facts. In addition, since some witnesses may be re-interviewed by the committee in light of new facts that are uncovered or other unexpected developments, the committee will be rightfully concerned that the debriefing itself may have affected the witnesses’ candor or willingness to give helpful answers in the follow-up session. Finally, funneling prospective interviewees to outside corporate counsel does little to avoid or ameliorate the concerns addressed above. It is undoubtedly the case that every interviewee has the right to consult counsel of his choice in advance of an interview and prepare for that interview however he deems best. It is very different for regular outside counsel, working with in-house general counsel, to intervene in a way that turns the process into an adversarial one. Put simply, the general counsel who sets out to obscure the special committee’s search for the unvarnished facts by creating a more adversarial process is likely to get her wish. Although committees in general lack the subpoena power of courts, they wield the power of the pen, and committee reports commenting unfavorably upon the candor of witnesses or the interference of corporate personnel are not entirely without precedent. Ultimately, however, any general counsel who forgets that the committee is made up of independent directors, who ultimately have an important say on her compensation and tenure, has given the board cause to question her judgment. In one particularly difficult special committee assignment in which the authors were involved, the board eventually determined to terminate the general counsel’s employment because the lawyer involved both prepared and debriefed witnesses, and led an all-out effort to “protect” key witnesses from what the general counsel (quite incorrectly) perceived was an overly aggressive committee. Unfortunately for this general counsel, the board did not ultimately view these activities as helpful.

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E. CASE STUDY: DON QUIXOTE AND THE MEDDLING GENERAL COUNSEL FACTS

A large public company is sued by a stockholder challenging a grant of options. All directors but one have received the challenged grants (the sole director who did not receive the grants joined the board after they were made). The board establishes the sole disinterested director as an SLC of one to investigate the alleged wrongdoing and take such action as may be appropriate as a result of his investigation. The resolution establishing the SLC authorizes the director to hire counsel and any other necessary or appropriate experts, and delegates the full power of the board to the committee to take any action it determines appropriate as a result of its investigation. The general counsel of the company, himself a recipient of several of the challenged option grants, suggests that one of the firm’s regular outside counsel be hired as counsel to the SLC, in order to assist the sole member of the committee. That firm both does substantial business with the company and is also the counsel of record in the pending litigation relating to the option grant. The one-director SLC, while never having run an in-depth forensic investigation, immediately understands that the general counsel’s helpfulness may not be in the interest of the committee. As his first act, he politely declines to hire conflicted counsel. Instead, the SLC proceeds to identify and interview a number of firms with experience in special committee work and hires independent counsel of his own choosing. Within a month of counsel being hired, the lead lawyer for the SLC’s legal team receives a call from the general counsel, who invites him to lunch. Counsel accepts the invitation. After pleasantries are over, the general counsel spends some time making clear that the allegations that are under investigation by the SLC are entirely without merit, and then begins to ask very specific questions about the committee’s work plan for its investigation and how the committee intends to demonstrate that the claims in litigation are baseless. Counsel for the SLC becomes uncomfortable and politely declines to answer the questions. Counsel for the SLC also suggests that the general counsel would do well to allow the committee process to unfold without interference, especially since the general counsel himself is a potential target of the investigation. The general counsel insists that he must have the information he is seeking so that he can keep the board briefed as to the progress of the investigation. SLC counsel again politely disagrees, and the lunch ends. Thereafter, the SLC goes about its work. As interviews of the board members are conducted, it appears that the directors interviewed tell a highly consistent story. Thereafter, the general counsel is interviewed. At the outset of the interview, the general counsel, who arrives at the interview unrepresented, demands the right to make a statement. As the SLC and its counsel listen, the general counsel denounces the committee for the questions it is asking because the tone of its investigation appears to be lending more credence to the plaintiff’s allegations than they deserve. The SLC counsel then asks the general counsel how he knows what questions the committee is asking, and discovers that the general counsel has debriefed each director

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who has been interviewed by the committee. On further questioning, it appears that the general counsel has also met with directors prior to their interviews to prepare them, sharing with each the questions the SLC is likely to ask based upon the debriefing of each prior interviewee and working with the directors on their answers. Counsel for the SLC requests that the general counsel cease what is perceived as interference with the special committee process, and the general counsel asserts the self-evident proposition that the persons being interviewed by the committee are entitled to counsel of their choosing, including the right to seek advice from the general counsel. The interview ends on an unsettled note, and it is clear that the general counsel intends to continue the practice of preparing and debriefing witnesses. From here, things go downhill. One by one, directors begin to call upon the special committee director and urge him to conclude his investigation speedily and in a manner that exonerates all involved. In response to each more direct approach, the SLC director responds that he has a duty to follow the facts where they lead and intends to do no more and no less. Finally, at a rump meeting of directors called without notice to the special committee director, things come to a boiling point as several of the targets of the investigation demand that the board act to dismiss the troublesome and clearly misguided SLC. Later reports from the meeting suggest that the articulated grounds for this extraordinary proposal were that the SLC had been led astray by his overly aggressive (out-of-control) counsel and thus was no longer fit to serve as an objective arbiter of the facts, especially since the targets of the investigation knew that they had done nothing wrong. The general counsel is present at the meeting and gives advice to the effect that the full board has the power and authority to disband the special committee, especially given the fact that the committee now appears to be on a misguided witch hunt. Fortunately, the directors’ newly hired special counsel is also at the meeting and is successful in dissuading them from voting on the plan to dismiss the SLC. Thereafter, the director who makes up the SLC learns of the meeting of directors and considers resigning from the board, but instead determines to complete his work and simply document in the SLC’s report what he perceives to be attempts to undermine the committee’s work. Thereafter, with the assistance of the directors’ able special counsel, the board and the primary targets of the investigation gradually come to a negotiated settlement with first the special committee and then the stockholder plaintiff. The SLC determines to endorse the settlement and join in the plaintiff’s motion seeking dismissal of the litigation. The litigation settlement is approved by the court, and the SLC’s report does not become a matter of public record. As part of the resolution of the matter, the general counsel is allowed to resign to pursue other opportunities. ANALYSIS

This case study illustrates a number of points made throughout this book. First, the job of a one-person special committee (particularly the one-person SLC) can be lonely and challenging. Especially if the task at hand is to conduct an investigation of the board and management, the one-person special committee may quickly become a target in

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the boardroom. There is a great deal of wisdom in a reviewing court taking an especially hard look at the work of a one-person SLC, especially if the committee comes to the conclusion that there is no basis on which to bring or continue suit against his colleagues on the board. More importantly, however, the case study demonstrates that the general counsel’s urges to control, choreograph, and generally meddle in the process are urges that must be carefully controlled. Especially if the general counsel may be a target of the investigation or a long-time advisor to one or more of the targets of the investigation, the greater the degree of meddling, the greater the chance that the SLC views that conduct as not only misguided but potentially intentionally harmful. Of course, the greater the degree of meddling, the greater the chance that the process is eventually discarded by a reviewing court. Attempts by the general counsel to control the course of the investigation, shape testimony, or otherwise bully the committee into or away from a position are all uniformly bad ideas. As noted above in the text, the wise general counsel is one who understands that the formation of the SLC (or any other special committee, for that matter) begins what may be a prolonged period where things run quite differently than normal. As a simple rule of thumb, the best thing a general counsel can do is to stay out of the way of the special committee process unless asked (by the committee) to do otherwise. Finally, once a board properly delegates its power and authority to an SLC and charges that committee with coming to its own independent conclusion and acting on behalf of the company as the committee sees fit, there is simply no turning back. Even if the full board has the power to withdraw the delegation of its power to the SLC (a philosophical question about which experts could disagree), dismantling a committee once it begins to reach conclusions that the targets of the investigation do not like can only lead to disaster. In the past, so-called “noisy resignations” from the board by the SLC members have resulted in some cases; in others, the work of the aborted special committee has been successfully subpoenaed by litigation adversaries. The lesson, of course, is clear. A board that votes to form an SLC needs to understand that the committee is expected to be independent and to act independently. If the board is not ready to have one or more of its members follow the evidence wherever it may lead, then a special committee should never be appointed ab initio.

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Chapter 13

The Role of the Controlling Stockholder and Management: What to Expect and How to Cope

The most direct beneficiaries of a well-run special committee process are the parties that have a conflict of interest, which in most settings are management and/or controlling stockholders (referred to interchangeably herein as the control parties). Although these actors in the drama often have the most at stake, they also have little, if any, control over the special committee process once it is initiated. One of two responses uniformly occur in response to the control parties’ realization that they have lost control of the process: The control parties can respond to the inherent loss of control that accompanies the appointment of a committee in a way that helps the process and thus helps the controller’s ultimate goal. Alternatively, some or all of the control parties react negatively, sowing the seeds for a later determination that the committee process is not worthy of deference or did not otherwise insulate the control parties from the conflict. Thus, how control parties respond to the appointment and functioning of a committee can make all the difference to the result. This chapter addresses a control party’s possible range of responses in various circumstances and analyzes each. Whether faced with a forensic committee or a negotiating committee, the general guidelines for control parties or other interested persons are similar. As the astute observer might expect, these guidelines tend to mirror the guidelines for the special committee itself. First, and of paramount importance, management and/or controlling stockholders must make sure they are committed to the special committee process before they begin that process. Second, control parties should use their influence on the board to ensure that only truly independent members are appointed to the special committee and that the special committee is provided ample authority to do its job effectively. Third, the control parties should provide the necessary information and support to the special committee so that it can do its job on a fully informed basis. Fourth, control parties need to resist the urge to interfere with or meddle in the committee’s work. Finally, with respect to negotiating committees, the control parties must be willing to conduct their side of the negotiation process in a manner that is consistent with and respects the special committee’s ability to run a process that replicates 253

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arm’s-length bargaining. Although each of these guidelines is easy to articulate, beware. Just as the independent board member who joins the special committee finds herself in uncharted and unfamiliar territory, precisely the same discontinuity is likely to befall the typical control party.

A. COMMITMENT TO PROCESS Given that having a special committee process that does not truly replicate arm’slength bargaining yields no or only minimal benefits, the control parties must be fully committed to the special committee process before initiating that process. As discussed, there are many ways to deal with a conflict of interest situation. There is often no legal requirement, particularly in a transaction setting, that a special committee be formed. Hence, control parties have a choice as to whether to set up a special committee. There is no point in management proposing and starting down the special committee road unless it is committed to staying the course until conclusion despite the difficulties encountered on the way. If management and the controlling stockholder are not committed to letting the special committee process run its course, then alternatives to the special committee should be pursued. In many conflict of interest situations, the best and most prudent choice is to set up and delegate full authority to the special committee to address the conflicted matter. Another potential alternative is to have the board itself deal with the matter, despite potential conflicts of interest, but taking every possible step to ensure that the matter is handled in a way that is demonstrably fair to the company and its stockholders. The worst possible alternative is to set up a special committee and then allow a patently flawed special committee process to unfold. In this situation, the company will have incurred all the costs, administrative burden, delay, and inefficiencies of the special committee process, but will not have received any benefits of having had a special committee. In addition, a flawed special committee often reflects badly on all involved, including the special committee members, management, and controlling stockholders. Therefore, a special committee process should only be initiated if all involved, including the control parties, fully understand and are committed to the special committee process running its course. All right, the control party is probably saying to herself, “I understand that there are alternatives to forming a special committee, but my counsel assures me that my risk is minimized by using a committee and I can put up with anything to get this deal done.” But that is precisely what we are addressing here when we say that the control party must commit to the process, not merely be willing to accept it begrudgingly. As a control party, are you really ready to cede your ability to exercise control, over almost all aspects of the process, to a committee of independent directors charged with acting objectively in the best interest of the company, if the company will be your counterparty in negotiations? The landscape of the law in this area is littered with control parties who half-heartedly accepted the process, did not like how events unfolded, decided to take control of the runaway process, and then found that the deal that they were pursuing was enjoined or, worse still, closed subject to a substantial award of damages 254

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at a later date. Our first point then is our most fundamental—do not form a committee unless you are prepared to cede control to it.

B. THE SELECTION OF COMMITTEE MEMBERS AND ADVISORS As explained in greater detail in Chapter Three, “Forming the Special Committee,” the independence of the members of the special committee is critical to the special committee process achieving its goal. If the committee members are not independent, then the special committee’s work will not yield legal benefits. There is, therefore, absolutely nothing to be gained and much to lose from control parties attempting to stack the special committee with those who are not truly and demonstrably independent. Indeed, given that they are the ultimate beneficiaries of an effective special committee process, management and/or controlling stockholders would be well served by being particularly vigilant to ensure that the members of the special committee are indeed independent. The examples of having obviously interested or non-independent persons on a special committee are unusual. Rather, the situation that does arise from time to time are members who qualify as independent under the stock exchange rules or similar regulatory regimes but have less obvious affiliations with or allegiance to the interested person. As discussed earlier, the concept of independence that is used for the purposes of determining whether a special committee process should be accorded legal respect is different than and not limited to the regulatory definitions for the independence of directors. It will be in the control parties’ interest carefully to assess whether there is any material risk that the persons being considered for the special committee might not be found to be independent under the common law standard. If there is such a risk, then management and/or the controlling person should exert their influence to select other persons for whom there is no risk to populate the special committee. Similarly, it is in the interest of the control parties that the special committee hire independent legal or financial advisors. As a general matter, the special committee should not engage advisors who have significant relationships with the company and/ or the controlling stockholder. To the extent these relationships are not already known to the committee, the control parties should inform the committee of such relationships so that the special committee does not end up engaging an advisor who will not be deemed independent. The control parties should also be very careful to permit the special committee to make its own choice with respect to its advisors. As explained in detail above, a properly functioning special committee should select its own advisors and interview those advisors before hiring them. It is far from optimal and often materially harmful to have interested management or the interested controlling stockholder handpick the special committee members or choose the counsel for the committee.1 1

See, e.g., In re Fort Howard Corp. S’holders Litig., 1988 WL 83147, at *12 (Del. Ch. Aug. 8, 1988); see also 1 David A. Drexler et al., Delaware Corporation Law and Practice § 15.05[5] 255

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Importantly, this is one area in which the control parties can beneficially impact the process not merely by staying out of the way, but also by affirmatively encouraging the committee to hire competent and vigorously independent advisors. Doing so is likely to help sow the seeds for a positive outcome of the process. Of course, only the control party who truly understands the process and its goals is likely to affirmatively encourage the committee to act independently from the outset—but that is precisely what we mean when we challenge the control party to be committed to the process.

C. THE SCOPE OF AUTHORITY GIVEN TO THE COMMITTEE As described in detail in Chapter Three, once a decision is made to use a special committee, the committee must be given sufficiently broad authority to do its job. With respect to an investigative committee, this means giving the special committee the power to take the investigation to where it leads rather than unduly restraining the scope of the investigation at its outset. With respect to a transactional committee, this means empowering the committee not only to consider the merits of the transaction being proposed but also to understand the opportunity costs of pursuing the transaction and the alternatives to the proposed transaction. One relatively straightforward example of the scope that is needed for a transactional special committee arises if the company needs additional capital and the controlling stockholder offers to make an additional investment in the company. In the event that a special committee is used in this scenario, the special committee must at minimum understand and consider the fairness of the exchange of value between the controlling stockholder and the company (i.e., the money the company is getting as compared to the equity or debt securities the controlling stockholder is getting in return). In addition, to replicate arm’s-length bargaining, the special committee should also consider whether there are available alternatives to raising the needed capital that are more attractive to the company. After all, it would be difficult meaningfully to assess the fairness of the terms of the controlling stockholder proposed financing without understanding what potential capital-raising alternatives exist for the company. Therefore, the control parties should take steps to ensure that the special committee’s authority includes the ability to consider the availability of alternatives. A slightly more complicated example in which there is sometimes a disagreement between the controlling stockholder and the special committee as to the scope of the special committee’s authority occurs if the controlling stockholder seeks to sell some of its equity interests in the company back to the company in return for cash. Once again, the special committee needs to understand and consider the fairness of the

(2009) (citing to Kahn v. Tremont Corp., 694 A.2d 422, 429 (Del. 1997) (“[T]he same standards for determining independence and disinterest applied to committee members are applied to their advisors. Thus, judicial criticism has been leveled against employment of experts recommended by management and, even where selected by the committee members, the independence of an attorney or investment banker who previously performed services for the corporation may be viewed with suspicion.”)). 256

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exchange of value between the controlling stockholder and the company (i.e., the repurchase price for the stock). There is rarely disagreement that the scope of the special committee’s authority must include the ability to analyze and negotiate the fairness of this exchange of value. Disputes do sometimes arise, however, with respect to whether the special committee should consider whether there is a better use for the company’s cash. Management and controlling stockholders sometimes take the view that how the company uses its cash—whether to make acquisitions, expand operations, enter a new line of business, pay dividends—is a board issue because there is no conflict of interest; hence, it should be beyond the scope of the special committee to consider such alternatives. The contrary view is that although how a company uses its cash is a board issue as a general matter, the special committee cannot consider the repurchase price in isolation but rather needs to consider (at least generally) the opportunity costs to the company of using its cash to monetize a portion of the controlling stockholder’s investment. Indeed, the conflict of interest in the proposed transaction is not only in connection with the repurchase price but also in connection with whether the company should be using its cash to repurchase its own stock (irrespective of the price). Although the question of how a company uses its cash is undisputedly a board issue, the special committee nevertheless needs to understand the company’s other options since these would be the opportunity costs for pursuing the proposed transaction of repurchasing stock from the controlling stockholder. For example, if the company has an attractive acquisition opportunity, then using the company’s cash to provide liquidity to the controlling stockholder rather than using it to pursue the acquisition opportunity may raise fiduciary duty issues. Although there no doubt needs to be a balanced approach, and every situation is unique, the authors believe that the special committee must at least be empowered to consider and take into account the opportunity cost with respect to the transaction that is proposed. An even more controversial view, expressed in several recent opinions, is that in negotiating a minority freeze-out transaction with a control party, the special committee should have, and if appropriate consider using, the power to deploy a stockholder rights plan or poison pill to provide the subsidiary with “time to respond, negotiate, and develop alternatives.” Although no controller is likely to appreciate a special committee using a poison pill to circumscribe its ability to maneuver, the case law suggests that such action, once viewed as extraordinary, is not only becoming accepted but also even expected in certain contexts.2 One of the keys to avoiding disputes or disagreements in the special committee process is for the interested party and the special committee to coordinate up front as to what the appropriate process and relative roles of the parties involved should be, and then continue to maintain open lines of communication to allow the process to evolve as needed based on developments. Having such discussions up front as to the process, the role, and authority of the committee has significant benefits. First, if the controlling stockholder unilaterally dictates what the scope and authority of the special committee should be, the special committee may not understand the 2

In re CNX Gas Corp. S’holders Litig., C.A. No. 5377, at 31 (Del. Ch. May 25, 2010). 257

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reasons for the controlling stockholder’s decisions. In addition, the special committee will perceive that whatever limitations and/or restrictions on the scope of its authority have been imposed on it by the controlling stockholder. By involving the committee and its advisors up front and discussing the issues regarding the scope and authority of the committee, there is a good chance that the committee will understand and agree with the nature of the scope and authority provided to the committee. Second, by involving the committee up front in the formulation of the process, the special committee members will be invested in the process and have some trust and faith as to the integrity of the process rather than feel that a process has been imposed on them. Given that the nature of a transactional special committee often will lead to intense negotiations and back and forth on substantive deal terms, having everyone on the same page as to the process up front significantly reduces the risk that the substantive negotiations will degenerate into an unmanageable situation.

D. THE APPROPRIATE ROLE FOR MANAGEMENT Management is typically used to running the show on a daily basis, but must learn and would be well advised to let the special committee process run its course independent of management influence. That is not to say that management has no role in the process. Management usually possesses knowledge and insight into the business and operations of the company that the special committee does not have and cannot easily obtain except through management. Management needs to provide the necessary support to the special committee. This will typically involve providing information and reports to the committee, or otherwise explaining the business and operations of the company to the special committee and/or its legal and financial advisors. In the transactional setting, this will also often involve deep involvement in the due diligence process, optimally under the direction and oversight of the special committee. Special committees will typically want to get management’s views with respect to the merits of a potential transaction. Although the special committee certainly should not be seen as deferring to management’s views, it is often critical that the special committee obtain management’s insights as part of the committee’s process to do a complete and thorough analysis in order to proceed on an informed basis. If the special committee has not consulted management, or at least not since some new development has occurred, management can certainly request to speak to the committee. There is nothing at all problematic with the special committee getting information and insights from management or with management sharing its views with the special committee. This is all part of the special committee’s information gathering and evaluation process. However, the special committee needs to do its own independent evaluation and assessment and cannot substitute the judgment of others (whether it be management, controlling stockholders, or someone else) for its own judgment. Therefore, the interaction between management and/or the controlling stockholder, on the one hand, and the special committee, on the other hand, needs to be consistent with the special committee’s obligation to give independent consideration to the issues

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presented and then make an independent decision on behalf of the company and its stockholders.3

E. RESISTING THE URGE TO MEDDLE For management or any other control party, the lack of control that arises from their perspective as a result of a special committee process can be particularly unnerving. Well-advised control parties usually understand and have little difficulty resisting the urge to interfere with or meddle in the special committee’s work at the beginning stages of the special committee process. Nevertheless, as the process (from the controller’s point of view) drags on and does not seem to be proceeding efficiently or quickly enough, the urge to give the special committee a kick in the pants increases tremendously. As difficult as it may be, however, management and controlling stockholders must resist the urge to interfere or meddle with, or attempt to reassert some semblance of control over, the runaway special committee process. Interfering with or meddling in the special committee process creates a whole host of problems. First, in most situations, it is unlikely to have the desired effect. Special committees do not often react positively to management’s interference. As noted in Chapter Twelve, “The In-house Lawyer’s Role: What to Expect and How to Cope,” for example, independent counsel to a special committee typically will advise the committee that it needs to run its process as it deems fit regardless of outside pressures, and the committee cannot be seen as succumbing to such pressure. In short, the first reaction of a truly independent special committee in the face of a control party’s attempts to reassert control is to dig in and behave in a more, rather than less, deliberate manner. Second, such interference or meddling increases the difficulties of defending against a legal challenge to the validity of the special committee process. Remember, the process itself very often will face post hoc scrutiny in litigation. Almost every aspect of the process, therefore, is on the record, whether or not the control party thinks so. Moreover, the most substantial and direct beneficiaries of a well-run special committee process are often management and the controlling stockholder. Interfering with the special committee process makes it that much more difficult in litigation to demonstrate that the special committee process truly replicated arm’s-length bargaining and, therefore, that such process should be accorded legal respect.

F. NEGOTIATING WITH THE RECORD IN MIND Unlike most other negotiations, the control party’s negotiations with the special committee are almost always on the record. Thus, rather than simply asserting its position 3

See In re IBP, Inc. S’holders Litig., 789 A.2d 14, 33 (Del. Ch. 2001) (“The bidding process was being run by IBP’s special committee. As members of the Rawhide group, Peterson, Bond and their subordinates were considered interested participants. Thus, while IBP management played a key informational role, the special committee had the final say.”). 259

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and refusing to budge, in formulating its negotiating strategy, the control party needs to proceed with the needs of the special committee in mind. Practically, therefore, the controller needs to understand from the outset that the task of the special committee in the transactional context is to simulate arm’s-length bargaining. Moreover, a properly chartered special committee will have an important power with which to attempt to tame the control party’s natural desire to use its position of control to get what it wants in negotiation—the power to say no.4 In the face of the special committee’s exercise of that power, the transaction sought by the controller is effectively dead, absent the control party’s desire to fight protracted and expensive litigation over the entire fairness of the transaction, which it will be overwhelmingly likely to lose in the context in which the transaction is crammed down after being rejected by the committee. Thus, in formulating its negotiating strategy, the control party needs to approach how it will proceed with an awareness of the special committee’s goals and the record that is being created as the negotiations unfold.

i. Playing Hardball In simplest terms, negotiating with the record in mind means that management and/or controlling stockholders should negotiate with the special committee the way they would with a third party. There is nothing wrong with negotiating hard or firmly. If the negotiations resemble bullying or pushing around the committee more than arm’slength negotiations with a third party, however, the special committee process likely will not be given legal deference. A court has observed: I find that it is reasonably probable that the Special Committee members were truly independent and that they performed their tasks in a proper manner. I also find, however, that at the end of their negotiations with Texas Air the Committee members were issued an ultimatum and told that they must accept the $16.50 per share price or Texas Air would proceed with the transaction without their input. This ultimatum, in effect, took from the Special Committee its ability to negotiate in an arms-length manner[.]5

As a general rule, ultimatums or take-it-or-leave-it propositions (especially early in the process, when they are tantamount to threats) are not looked upon favorably and should be avoided. For example, in Kahn v. Lynch Communication Systems, Inc.,6 the court found that “in this case the coercion was extant and directed to a specific price offer which was, in effect, presented in the form of a take it or leave it ultimatum by a controlling stockholder with the capability of following through on its threat of a hostile takeover.” That being said, there will always come a time in a negotiation in which one is willing to move no more, and the controlling stockholder is entitled to stick firmly to its position.

4 5 6

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See infra Chapter Three, “Forming the Special Committe.” Am. Gen. Corp. v. Tex. Air Corp., 1987 WL 6337, at *4 (Del. Ch. Feb. 5, 1987). 638 A.2d 1110, 1120 (Del. 1994).

NEGOTIATING WITH THE RECORD IN MIND

ii. Controlling the Stockholder’s Duty of Candor The controlling stockholder also has a duty of candor if it is engaging in a transaction with a company and/or the company’s minority stockholders. This duty of candor often comes up in the context of going-private transactions. In a going-private transaction, if the controlling stockholder seeks to purchase all of the stock of the company that it does not already own, the controlling stockholder will have a duty of candor that will require it to disclose certain information. The standard for this disclosure obligation was discussed in Lynch v. Vickers Energy Corp.,7 in which the Delaware Supreme Court held that a majority stockholder owed a fiduciary duty to the minority stockholders of “‘complete candor’ in disclosing fully ‘all of the facts and circumstances surrounding the’ tender offer.”8 The majority stockholder in that case erred by failing to disclose an estimate of the target’s value that was higher than the estimate it did disclose to the minority stockholders. Although this case involved a duty of disclosure to minority stockholders and not a special committee, the majority stockholder’s duty of candor stems from the Lynch line of cases.9 The controlling stockholder’s duty of candor in going-private transactions also encompasses a general duty of full disclosure to the special committee. As a court has observed, a controlling stockholder has a “duty of fair disclosure and [a] duty to avoid misleading the independent directors and the minority.”10 The Delaware Court of Chancery in Kahn v. Tremont Corp. detailed the duty of a controlling stockholder to disclose material information to a special committee. In this case, one stockholder owned 44 percent of the buyer’s shares and 62 percent of the seller’s shares, and all were controlled by the same person.11 The court held that there was a category of information, such as “the top price it would or could pay,” that a controlling stockholder would not have to disclose to a special committee, even though it was material.12

7 8 9 10 11 12

383 A.2d 278 (Del. 1978). Id. at 279. See, e.g., Solash v. Telex Corp., 1988 WL 3587, at *11 (Del. Ch. Jan. 19, 1988) (citing Lynch v. Vickers Energy Corp., 429 A.2d 497 (Del. 1981)). In re Pure Res., Inc., S’holders Litig., 808 A.2d 421, 445 n.47 (Del. Ch. 2002). 1996 WL 145452, at *1. Id. at *15. It is clear that a controlling stockholder need not disclose to the target the maximum amount that it is willing to pay for the target’s shares. As the Delaware Court of Chancery has held in connection with a tender offer, a controlling stockholder is “not obligated . . . to disclose how much it might be willing to pay [or] whether [a] number . . . reflect[s] a value that [it] considered paying, or perhaps even had determined to offer.” In re Life Techs., Inc. S’holders Litig., 1998 WL 1812280, at *5 (Del. Ch. Nov. 24, 1998); see also Kahn v. Tremont Corp., 1996 WL 145452, at *15 (Del. Ch. Mar. 21, 1996), rev’d in part, 694 A.2d 422 (Del. 1997) (citing, as an example of material information that would not have to be disclosed to a special committee, “the top price that a proposed buyer would be willing or able to pay”); Rosenblatt v. Getty Oil Co., 493 A.2d 929, 939 (Del. 1985) (clarifying that the Delaware Supreme Court’s earlier decision in Weinberger did not require that a “majority shareholder must under all circumstances disclose its top bid to the minority”). 261

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Using the standard of materiality,13 the court detailed general rules of disclosure, according to which the fiduciary must: (1) Fully and fairly disclose all of the material terms of the proposed transaction. (2) Disclose all material facts relating to the use or value of the assets in question to the beneficiary itself, which would include alternative uses for assets or hidden value (e.g., oil under the land subject to a sales negotiation). (3) Disclose all material facts which it knows relating to the market value of the subject matter of the proposed transaction. Such facts would include for example to forthcoming changes in legal regulation or technological changes that would affect the value of the asset in question. . . . For example, if the fiduciary were negotiating to buy a business and the fiduciary possessed nonpublic information that existing restrictive and costly regulations pertaining to that business were going to be eliminated, that information would have to be disclosed. This list is intended to include all material information known to the fiduciary except that information that relates only to its consideration of the price at which it will buy or sell and how it would finance a purchase or invest the proceeds of a sale.14 The Delaware Supreme Court, in an appeal of this decision, affirmed that a controlling stockholder was not required to disclose to the special committee that third parties had decided not to purchase the target’s stock.15 The Delaware Supreme Court also held that the controlling stockholder did not have a duty to disclose the information given to it by its financial advisors regarding a control discount for the target’s stock. The controlling stockholder “had no duty to disclose information which might be adverse to its interests because the normal standards of arms-length bargaining do not mandate a disclosure of weaknesses.”16 Also, because a “well-advised committee could have learned from its financial and legal advisers” of the same information, there was no need to disclose the information.17 In In re Emerging Communications, Inc. Shareholders Litigation,18 the Delaware Court of Chancery analyzed the duty of a majority stockholder to disclose a target’s financial projections (if the projections were possessed only by the majority stockholder) to the target’s special committee during a tender offer situation. Because this “highly material fact” was not disclosed to the special committee, the court held that the committee was not fully informed and thus could not have fulfilled its fiduciary duties. Also, the majority stockholder’s representation about its available financing, which the court found to be false (which made it seem that it could pay less than it really could), also kept the special committee from being fully informed. The court

13 14 15 16 17 18

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TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976) (a fact that a reasonable investor would consider “important in deciding how to vote”). Kahn, 1996 WL 145452, at *16 and n.23 (internal citations and emphasis omitted). Kahn v. Tremont Corp., 694 A.2d at 432. Id. Kahn v. Tremont Corp., 1997 WL 689488, at *4 (Del. Ch. Oct. 28, 1997). 2004 WL 1305745 (Del. Ch. June 4, 2004).

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held that the majority shareholder had “violated the fiduciary duty of disclosure . . . owed to their fellow directors.”19 In short, the fact that a special committee has been appointed to protect the interests of the minority stockholders of a company does not lessen the fiduciary duties of a controlling stockholder to the company and the minority stockholders. Therefore, the controlling stockholder must deal with the special committee on an above-board basis and make sure that material information in its possession (subject to the limited exceptions discussed above) regarding a potential transaction is provided to the special committee.

iii. The Rights of Controlling Stockholders Qua Stockholders Although controlling stockholders do owe fiduciary duties to the company and its stockholders, it is well established that a controlling stockholder does not owe fiduciary duties in its capacity as a stockholder. For example, “a stockholder is under no duty to sell its holdings in a company, even if it is a majority stockholder, merely because the sale would profit the minority.”20 Also, there is no affirmative duty on the controlling stockholder to auction the company if seeking to cash out the minority. In other words, it is permissible for a controlling stockholder to seek to buy all the stock of the company it does not already own while at the same time maintaining that it is not interested in selling the company or its stake in the company. “No part of [a controlling stockholder’s] fiduciary duty . . . requires [it] to sell [its] interest.”21 Although a controlling stockholder has a right to sell its own interest, as a fiduciary to the minority stockholders, it does not have a right to time the transaction to financially injure the minority stockholders and benefit itself.22 In addition, all stockholders, even controlling stockholders, have a right to vote their own interests free of any fiduciary duty.23 Therefore, even if the company is presented with an offer to buy the company that is very attractive and in the best interests of the minority stockholders, the controlling stockholder is under no obligation to vote its stock in favor of such sale. Put differently, the controlling stockholder is in a position, free of any fiduciary duty, to veto strategic alternatives that it does not support. Hence, if a company is faced with a proposal from a controlling stockholder to buy out the minority stockholders, the company has a duty to respect the rights of the

19 20 21 22 23

Id. at *36. Bershad v. Curtiss-Wright Corp., 535 A.2d 840, 845 (Del. 1987). Mendel v. Carroll, 651 A.2d 297, 306 (Del. Ch. 1994). See, e.g., Van de Walle v. Unimation, Inc., 1991 WL 29303, at *12 (Del. Ch. Mar. 7, 1991). See Mary Siegel, “The Erosion of the Law of Controlling Shareholders,” 24 DEL. J. CORP. L. 27, 32 (1999) (citing to Thorpe v. CERBCO, Inc., 676 A.2d 436, 442 (Del. 1996) and Williams v. Geier, 671 A.2d 1368, 1380–81 (Del. 1996), among others); see also Emerson Radio Corp. v. Int’l Jensen Inc., 1996 WL 483086, at *17 (Del. Ch. Aug. 20, 1996) (“[E]ven a majority stockholder is entitled to vote its shares as it chooses, including to further its own financial interest.”); Lofland v. DeSabatino, 1991 WL 138505, at *4 (Del. Ch. July 25, 1991) (“A shareholder is not prohibited from voting his shares in his own best interest, even if he is a director, as long as he does not violate fiduciary duties owed to other shareholders.”). 263

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controlling stockholder “while assuring that if any transaction of the type proposed was to be accomplished, it would be accomplished only on terms that were fair to the public shareholders and represented the best available terms from their point of view.”24

G. THE INTERESTED PARTY TYPICALLY SUFFERS THE CONSEQUENCES OF A FLAWED SPECIAL COMMITTEE PROCESS Even if a company goes through the hassle, cost, inefficiencies, and delays of a special committee process, in reality, if it is ultimately determined by a court that the special committee process did not truly replicate arm’s-length bargaining, then there is no real legal benefit to having had a special committee in the first place. Rather, in terms of the legal standard, it is as if the special committee did not exist, and the defendants will bear the burden to demonstrate the entire fairness of the transaction. And if the defendants fail to meet this burden, the remedy awarded by the court is usually borne by the interested party. There are many examples of this result, including the Delaware Court of Chancery’s decision in In re Loral Space & Communications Inc.25 Loral Space and Communications Inc. (Loral) emerged from bankruptcy in 2005 with a large institutional stockholder base comprised of former creditors, the largest of which was MHR Fund Management LLC (MHR). Of the eight Loral directors, three were MHR executives. In addition, Loral’s vice chairman and CEO (chief executive officer) and another director, who was appointed as one of the two members on a special committee, were affiliated with MHR. In 2006, it was recognized that Loral was in need of additional capital. It was proposed that MHR make an additional $300 million equity investment in Loral—an amount equal to over half of Loral’s existing stock market capitalization. Without considering the possibility of other forms or sources of financing, the Loral board appointed a two-member special committee, consisting of a director affiliated with MHR as its chairman and a director unaffiliated with MHR, to evaluate and negotiate the proposed transaction. The negotiations between the committee and MHR resulted in a securities purchase agreement (the MHR Financing). Loral stockholders sued, alleging that the MHR Financing was a conflicted transaction that was unfair to Loral. In holding that the defendants did not meet their burden under the entire fairness standard, the court emphasized the lack of efficacy of the special committee, particularly given its failure to consider all potential sources of financing and its suspect composition. As described at length in the court’s opinion, the committee was flawed in its composition, its mandate to negotiate the proposed financing with MHR as opposed to finding the best deal reasonably available, and its futile negotiation approach. The court found that MHR dictated the timing, price, and terms of the transaction and that the committee failed to use any leverage that it had or to create additional leverage 24 25

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Mendel, 651 A.2d at 306. 2008 WL 4293781 (Del. Ch. Sept. 19, 2008).

CASE STUDIES

in negotiating the financing. The court held that it was impossible to conclude that the committee had acted as an effective negotiator. As a remedy, the court reformed the terms of the MHR Financing so that the terms were fair to Loral. In other words, the court altered the terms of the deal after the fact to the benefit of Loral and to the detriment of MHR. This is but another example of how the interested party, here MHR, has the most to gain from a well-run special committee process and the most to lose from a flawed special committee process. Control parties negotiating a transaction with a special committee have much to gain if the special committee process is well understood and respected. Just as clearly, such parties have much to lose if the process is not well understood or otherwise disrespected. It will serve the control party well to understand that, in the special committee negotiation, less is often more, and restraint is always preferable to blunt force.

H. CASE STUDIES i. Fostering Communication FACTS

The company is a publicly traded company with a controlling stockholder. The controlling stockholder owns approximately 25 percent of the company’s equity on an economic basis, but given that much of its equity ownership is in the form of super voting stock (which only the controlling stockholder owns), the controlling stockholder’s ownership accounts for approximately 60 percent of the voting power of the outstanding stock. The board of the company consists of eight persons; three are affiliated with the controlling stockholder, two are members of senior management, and three are independent. The company receives an expression of interest in a buyout from a third party. At the ensuing board meeting, it is clear that a majority of the board members view the expression of interest as potentially attractive and worth considering. The controlling stockholder also lets it be known that if the company wishes to pursue the acquisition, it intends to cut its own deal with the third party, and that unless it is satisfied with the terms it receives for its stock, the controlling stockholder will not support a sale of the company to the third party. Also, the third party, which is not an industry player, has made clear its interest in retaining senior management of the company if it succeeds in its acquisition. The board next considers how the process going forward should be structured and seeks advice regarding how to set up a process that will respect the reasonable expectations of all parties. ANALYSIS

As an initial matter, the situation outlined above is almost definitely an interested transaction, as five of the eight members of the board have potentially material conflicts of interest. In this scenario, there can be no deal without the controlling

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stockholder’s support, given that the controlling stockholder has majority voting power and stockholder approval will be required to consummate a sale of the company. Furthermore, the controlling stockholder has no fiduciary duties whatsoever in terms of exercising its rights in its capacity as a stockholder either to vote for or against a proposed sale of the company. Nor is it necessarily problematic that the controlling stockholder may only support a deal if it gets some different or higher consideration for its super voting stock than the public stockholders get for their shares. Nevertheless, there are significant conflicts of interest here, and the interests of the public stockholders will need to be protected and advanced during any process to sell the company. In this type of situation, given the inherent financial conflicts of interest in this scenario among the controlling stockholder, management, and the public stockholders, the board would be well advised to form a special committee authorized to control the process by which a potential sale transaction is explored. The special committee should have a broad mandate to consider various strategic alternatives. Given that management, the controlling stockholder, and the special committee all have significant stakes in the outcome of this process and any negotiations, it would be very productive for the parties to agree on a set of general guidelines for a process moving forward. A sample process guideline follows. • The company’s board will form a special committee and authorize it to consider the expression of interest as well as other potential strategic alternatives. • The special committee will engage financial advisors, including a financial advisor to provide advice as to potential strategic alternatives and valuation analyses and, ultimately (if required), to deliver a fairness opinion. • Management will provide the special committee with a detailed description of all the financial interest and incentives held by members of senior management that would or might come to fruition in any of the strategic alternatives that are under consideration—such as stock options, change of control payments, existing and prospective employment, or consulting arrangements—so the special committee can evaluate whether management has any conflict in considering the various strategic alternatives that might impact management’s objectivity. Management will also update the committee with respect to any new potential financial interests and incentives as negotiations progress and the process moves forward. • The special committee, after consulting with management and the controlling stockholder, will identify the strategic alternative it believes is in the best interests of the stockholders of the company. • The controlling stockholder will inform the special committee whether it supports pursuing the strategic alternative identified by the special committee. • If the controlling stockholder supports the strategic alternative selected by the committee, and assuming that the selected strategic alternative is a potential sale to a third party, the special committee will determine whether a market check is necessary prior to commencing negotiations with the third party. • The special committee will conduct negotiations with respect to the selected strategic alternative to see whether a deal can be reached. If the selected strategic alternative is a potential sale to a third party, the controlling stockholder will be 266

CASE STUDIES

•

•

•

•

permitted to conduct negotiations with the third party to see whether the sale will yield a price for the controlling stockholder’s stock that the controlling stockholder will support.26 The controlling stockholder and management (to the extent management is involved in certain aspects of the negotiations) will report to the special committee as to their negotiations with the third party. The special committee will conduct its own negotiations with the third party and also provide frequent input and guidance to management as to any aspects of the negotiations that management is handling (such as with respect to commercial or operational issues). If the special committee believes that negotiations have produced the best and final offer for the public stockholders with respect to the strategic alternative selected, the special committee will consider whether it believes that the offer is fair to and in the best interests of the public stockholders of the company, taking into account whatever consideration or financial incentives are being received by the controlling stockholder and management. If the special committee concludes that the offer is acceptable from the perspective of the public stockholders of the company, then the parties shall begin the negotiation and preparation of definitive agreements, with ongoing participation by the committee, management, and the controlling stockholder. If the full board approves the transaction, definitive agreements will be promptly executed.

Please note two very important observations regarding the above sample process guideline. First, this is but one example of a process guideline. Depending on the circumstances, a process guideline that has significantly different substantive elements and/or sequencing may be just as appropriate as, or more appropriate than, the above example. Second, regardless of the elements contained in the process guideline utilized, it is ultimately just a set of guidelines that will likely need to be massaged and revisited as the actual transaction unfolds. The most important benefit of such a process guideline is the very exercise of preparing it. Preparing a process guideline at the initial stages of the process helps facilitate communications and align expectations among the various constituencies, fosters understanding of the legitimate concerns of each of the parties, and reduces the risk of misunderstanding and unnecessary friction during what will be an intense and difficult process.27 It also gets the process started on a basis of open communication and 26

27

During the time this chapter was being drafted, the John Q. Hammons decision was issued by the Delaware Court of Chancery and then appealed (but not yet decided) by the Delaware Supreme Court. Hammons holds that a special committee itself is insufficient to result in the deferential business judgment standard of review where the controlling party negotiates separately. In such cases, the business judgment standard is only available if the transaction is also put to a majority of the unaffiliated stockholder vote. Given the pending of the appeal at press time, counsel would do well to consult the outcome of this case before importing these guidelines wholesale. Having a process guideline can be helpful in the context of an investigatory special committee as well. As in the context above, establishing guidelines in a forensic committee context helps facilitate communication and align expectations. 267

THE ROLE OF THE CONTROLLING STOCKHOLDER AND MANAGEMENT

dialogue, which is essential to ensuring that the process does not unnecessarily devolve into lack of communication and misunderstandings, with each of the parties slipping into a bunker mentality, an outcome that is ultimately to the detriment of all parties.

ii. The Disappearing Bid28 FACTS

The company’s founder, largest stockholder, and chairman of the board, who owns 7 percent of the outstanding equity but voting control of 42 percent (the equity owned by the chairman is a special super-voting class of stock), decides to join forces with a well-known buyout firm to launch a bid for the company. The buyout firm and its partner launch an all cash bid at $59.25, or approximately $8.2 billion, a 15 percent premium to market. A special committee of target directors independent of the chairman is formed promptly to consider the bid. Almost immediately, the special committee perceives serious issues. The committee learns that, in connection with his bid for the company, the chairman has entered into an exclusivity agreement with the buyout firm that provides that he will work exclusively with that firm until a merger agreement is signed. The bid as initially made contemplates a post-signing “go shop” period during which the company, through its special committee, will have the right to market itself. Nevertheless, the committee, supported by its outside financial advisor and outside law firm, is immediately concerned that the chairman’s exclusive dealing arrangement with the first bidder will effectively mean that no other serious bidder is likely to step forward, because without the support of the 42 percent stockholder, there is no likelihood that a higher bid will succeed. Thus, the committee promptly demands that the buyout firm and the chairman agree to set aside the exclusivity agreement and compete with all other potentially interested parties. The bidders refuse and a protracted standoff results. Approximately a month later, with the parties seemingly set upon irreconcilable positions, the bidding group raises its price to $62 per share and agrees that the chairman’s super-voting stock will be voted specially on a one-vote-for-one-share basis (rather than the 10:1 basis it was provided under the company’s governing documents), thus reducing the chairman’s clout in the deal from a 42 percent voting block to a 7 percent voting block. Rather than breaking the logjam, the committee continues to press for setting aside the exclusivity agreement between the chairman and the buyout group.

28

268

This case study is drawn from Steven Flax’s article Mutiny, which appeared in the July/August 2008 issue of Corporate Board Member magazine, as well as a blog posting ascribed to the independent members of the corporation’s board entitled, somewhat infelicitously, Is Darwin Deason a Crook? found at http://www.topix.com/forum/com/acs. Both sources are worth reading for their excellent description of just how many things can go wrong if a controller plays hardball and the special committee becomes entrenched in its position. Of course, without firsthand knowledge of the matter, we do not suggest that the case study is factually based, merely that it is drawn from the identified sources.

CASE STUDIES

Soon thereafter, the independent directors raise eyebrows by voting to pay the committee members additional special consideration for their work: $125 thousand for the chairman and $100 thousand each for the members, on top of the amounts to which they were otherwise entitled for serving on the committee. After several months of standoff, the committee and the chairman’s group agree to a fifty-five-day waiver of the exclusivity agreement. Notwithstanding the waiver, few competing bids emerge in the process. Those that do are largely strategic bidders. The first, an archcompetitor, steps forward with a largely unfinanced bid and demands due diligence. Over the strenuous objections of management, the committee determines to share sensitive competitive information with this bidder, including information relating to situations in which the two firms had directly competed. Although the competitor’s bid never gets off the ground, shortly thereafter the competitor wins a head-to-head competition for new business, which the company’s management is certain it lost due to having to reveal the competitive data to the third party—thus creating a significant rift between the special committee and management. Additional problems arise in addressing strategic bidders. Having perceived themselves as having been burned by the first strategic bidder, management, apparently at the direction of the chairman, refuses to meet with representatives of a second strategic bidder, after they fly several hours to the meeting as part of their due diligence. During the time all of this is playing out, the world credit markets begin to teeter on the edge of what would become one of the great meltdowns in corporate history. At the same time, the company’s key customers begin to decline to renew contracts on the basis of management uncertainty at the company. As if that were not enough, the company’s large institutional stockholders begin to communicate publicly their displeasure at not being able to consider the roughly $2 billion premium implied in the buyout group’s offer. Thereafter, with the credit markets collapsing, the buyout firm withdraws its bid. The chairman then meets with the independent directors and allegedly demands their immediate resignations. They decline. The independents respond with a blog posted on the “Affiliated Computer Services Forum” entitled Is Darwin Deason [the Chairman] a Crook? and accuse the chairman of various ill deeds, characterizing his demand for their resignations as “a remarkable piece of bullying and thuggery.” The directors also bring suit for a declaration that their handling of the matter was consistent with their fiduciary duties. Finally, the saga ends with the resignation of the independent directors (both those on the committee and those who were not) and the appointment of new independent directors after review by the departing directors, who concluded that there was “no reason to believe” that the new directors were “not independent.”29

29

The events described in the case study ended in late 2007. In early 2010, however, Xerox closed its purchase of the corporation, in a $6.4 billion transaction in which the chairman demanded (and got) a $300 million premium for his shares of super-voting stock. See Dallas Morning News, Affiliated Computer Services Founder Darwin Deason Set to Become a Billionaire in Xerox Deal, Nov. 15, 2009. 269

THE ROLE OF THE CONTROLLING STOCKHOLDER AND MANAGEMENT

ANALYSIS

The Disappearing Bid is an excellent catalogue of just about everything that can go wrong if a fiercely independent committee meets a fiercely stubborn controller. Several lessons emerge. First, from the controller’s perspective, although hardball is not outlawed, it is sometimes met by stubborn opposition, which can mean that no deal gets done. Is it really worth establishing the upper hand in these circumstances? What would have happened if the controller simply agreed at the outset, as he did months later, that the buyout group would agree to have the chairman’s shares voted on a 1:1 basis rather than 10:1 basis? Second, the subject of what to do with strategic bidders comes up in every sale of the company context. There are ways that have been worked out in the past to allow the qualified strategic bidder to access, on a limited basis, the core strategic information. But that typically is done with layers of protection and only after the bidder is judged to be sufficiently committed to the process so as to not be merely fishing for information. This is often an area in which, in order to best protect the company and the process, the committee needs to work closely, not at odds, with the senior management team. Likewise, from the perspective of the management team, refusing to meet with potential bidders simply because they are competitors is not conducive to a healthy process or long-term job security. Third, public recriminations and lawsuits between board members, though sometimes unavoidable, are always evidence of a failed process. The parties will never agree about why this process failed, but from the outside observer’s point of view, one key element that appeared to be missing was a bona fide attempt to communicate and resolve issues, rather than a contest of wills to determine who was more stubborn. In the end, the facts here suggest that a chance to sell the company at a reasonable premium was lost, and, as a postscript, the company was later sold in a deal that closed in early 2010 for roughly $1.8 billion less than the buyout group offered in the pre-meltdown 2007 time period.

270

Conclusion

And so ends our treatise with a cautionary tale of how badly a special committee process can go awry. We end then, where we began. Special Committee practice is a highly demanding specialty. The work of special committee members is challenging and sometimes thankless, often involving committee members in litigation, or, at least, unpleasantness. Special committee service has never been for the faint-hearted. We hope that this work serves to educate the various constituencies in the special committee process and allows each of them to play their role from a more informed, and hopefully, constructive basis. Wilmington, DE June, 2010

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Table of Authorities

Cases Abbey v. Computer & Commc’ns Tech. Corp., 457 A.2d 368 (Del. Ch. 1983) . . . . . . . . . . . 14, 201 Abella v. Universal Leaf Tobacco Co., 546 F. Supp. 795 (E.D. Va. 1982) . . . . . . . . . . . . . . . . . 176 Allison v. Gen. Motors Corp., 604 F. Supp. 1106 (D. Del. 1985) . . . . . . . . . . . . . . . . . . . . . . . . . 15 Am. Gen. Corp. v. Tex. Air Corp., 1987 WL 6337 (Del. Ch. Feb. 5, 1987) . . . . . . . . . . . . . 143, 260 Am. Legacy Found. v. Lorillard Tobacco Co., 2004 WL 2521289 (Del. Ch. Nov. 3, 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 Aronson v. Lewis, 473 A.2d 805 (Del. 1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 171 Ashmore v. Metrica Corp., 2007 WL 1464541 (Del. Ch. May 11, 2007) . . . . . . . . . . . . . . . . . . 161 Auerback v. Bennett, 393 N.E.2d 994 (N.Y. 1979) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Beam v. Stewart, 845 A.2d 1040 (Del. 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33, 35 Behradrezaee v. Dashtara, 910 A.2d 349 (D.C. 2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 Bershad v. Curtiss-Wright Corp., 535 A.2d 840 (Del. 1987) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 Biondi v. Scrushy, 820 A.2d 1148 (Del. Ch. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 Blackmore P’rs, L.P. v. Link Energy LLC, 2005 WL 2709639 (Del. Ch. Oct. 14, 2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191 In re Boston Celtics Ltd. P’ship S’holders Litig., 1999 WL 641902 (Del. Ch. Aug. 6, 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Boxer v. Husky Oil Co., 429 A.2d 995 (Del. Ch. 1981) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Braddock v. Zimmerman, 906 A.2d 776 (Del. 2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Brehm v. Eisner, 746 A.2d 244 (Del. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 14, 15, 21, 22, 200 Brickell P’rs v. Wise, 794 A.2d 1 (Del. Ch. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Brinckerhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370 (Del. Ch. 2010) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20, 28, 32, 184, 190, 197–98, 205, 210 BTZ, Inc. v. Nat’l Intergroup, Inc., 1993 WL 133211 (Del. Ch. Apr. 7, 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Burns v. Friedli, 241 F. Supp. 2d 519 (D. Md. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996) . . . . . . . . . . . . . . . . . . . . . 20 Carlton Inv. v. TLC Beatrice Int’l Hldg’s., Inc., 1997 WL 305829 (Del. Ch. May 30, 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172, 203, 209, 210, 215 Carlton Inv. v. TLC Beatrice Int’l Hldg’s., Inc., 1997 WL 38130 (Del. Ch. Jan. 29, 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226 Carlton Invs. v. TLC Beatrice Int’l Hldg’s., Inc., 1996 WL 535407 (Del. Ch. Sept. 17, 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 Cede & Co. v. Technicolor, Inc., 634 A.2d 345 (Del. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Charal Inv. Co. v. Rockefeller, 1995 WL 684869 (Del. Ch. Nov. 7, 1995) . . . . . . . . . . . . . . . . . . 14 Ciambrone, United States v., 750 F.2d 1416 (9th Cir. 1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228 273

TABLE OF AUTHORITIES

Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156 (Del. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Citadel Hldg. Corp. v. Roven, 603 A.2d 818 (Del. 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 Citron v. E.I. Du Pont de Nemours & Co., 584 A.2d 490 (Del. Ch. 1990) . . . . . . . . . . . . . . . . . . 41 In re CNX Gas Corp. S’holders Litig., 4 A.3d 397 (Del. Ch. 2010) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18, 25, 41, 48, 142, 257 In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289 (6th Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227 Conrad v. Blank, 940 A.2d 28 (Del. Ch. 2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 County of York Employees Ret. Plan v. Merrill Lynch & Co., 2008 WL 4824053 (Del. Ch. Oct. 28, 2008) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 In re Cox Commc’ns, Inc. S’holders Litig., 879 A.2d 604 (Del. Ch. 2005) . . . . . . . . . . . . . . 23, 145 In re Cysive, Inc. S’holders Litig., 836 A.2d 531 (Del. Ch. 2003) . . . . . . . . . . . . . . . . 152, 153, 183 David P. Simonetti Rollover IRA v. Margolis, 2008 WL 5048692 (Del. Ch. June 27, 2008) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 In re Digex Inc. S’holders Litig., 789 A.2d 1176 (Del. Ch. 2000) . . . . . . . . . . . . . . . . . . . . 143, 196 Diversified Indus., Inc. v. Meredith, 572 F.2d 596 (8th Cir. 1977) . . . . . . . . . . . . . . . . . . . . . . . 227 E.F. Hutton & Co. v. Brown, 305 F. Supp. 371 (S.D. Tex. 1969) . . . . . . . . . . . . . . . . . . . . . . . . 135 In re E.F. Hutton Banking Practices Litig., 634 F. Supp. 265 (S.D.N.Y. 1986) . . . . . . . . . . . . . 177 In re Elecs. Imaging S’holders Litig., C.A. No. 2797 (Del. Ch. Aug. 7, 2007) . . . . . . . . . . 168, 170 Emerald P’rs v. Berlin, 2001 WL 115340 (Del. Ch. Feb. 7, 2001) . . . . . . . . . . . . . . . . . . . . . . . . 28 Emerald P’rs v. Berlin, 2003 WL 21003437 (Del. Ch. Apr. 28, 2003) . . . . . . . . . . . . . . . . . . . . . 29 In re Emerging Commc’ns, Inc. S’holder Litig., 2004 WL 1305745 (Del. Ch. May 3, 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23, 124, 148, 149, 152, 189, 195, 262 Emerson Radio Corp. v. Int’l Jensen Inc., 1996 WL 483086 (Del. Ch. Aug. 20, 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 In re First Boston, Inc. S’holders Litig., 1990 WL 78836 (Del. Ch. June 7, 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46, 141, 144 FLI Deep Marine LLC v. McKim, 2009 WL 1204363 (Del. Ch. Apr. 21, 2009) . . . . . . . . . . . . . 200 In re Fort Howard Corp. S’holders Litig., 1988 WL 83147 (Del. Ch. Aug. 8, 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255 Freedman v. Restaurant Assocs. Indus., Inc., 1990 WL 135923 (Del. Ch. Sept. 19, 1990), revised Sept. 21, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24, 41, 143 In re Freeport-McMoran Sulphur, Inc. S’holder Litig., 2005 WL 1653923 (Del. Ch. June 30, 2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .151, 153 Gantler v. Stephens, 965 A.2d 695 (Del. 2009) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970) . . . . . . . . . . . . . . . . . . . . . . . 214, 223, 235 Garrity v. New Jersey, 385 U.S. 493 (1967) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136 Gelfman v. Weeden Investors, L.P., 792 A.2d 977 (Del. Ch. 2001) . . . . . . . . . . . . . . . . . . . . . . . . 26 Gesoff v. IIC Indus., Inc., 902 A.2d 1130 (Del. Ch. 2006) . . . . . . . . . . . . . 29, 31, 95, 115, 141, 150 Getty Oil Co. v. Skelly Oil Co., 267 A.2d 883 (Del. 1970) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Glinert v. Lord, 604 A.2d 417 (Del. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 Gotham P’rs, L.P. v. Hallwood Realty P’rs, L.P., 2000 WL 1476663 (Del. Ch. Sept. 27, 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125 (Del. 1963) . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Granger v. Nat’l R.R. Passenger Corp., 116 F.R.D. 507 (E.D. Pa. 1987) . . . . . . . . . . . . . . . . . . 214 Grimes v. Donald, 673 A.2d 1207 (Del. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15, 200 Grimes v. DSC Commc’ns Corp., 724 A.2d 561 (Del. Ch. 1998) . . . . . . . . . . . . . . . . . . . . . . . . 223 Hercules, Inc. v. Exxon Corp., 434 F. Supp. 136 (D. Del. 1977) . . . . . . . . . . . . . . . . . . . . . . . . . 161 Hollinger Int’l, Inc. v. Black, 844 A.2d 1022 (Del. Ch. 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . 207 In re IBP, Inc. S’holders Litig., 789 A.2d 14 (Del. Ch. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . 259 In re J.P. Stevens & Co. S’holders Litig., 542 A.2d 770 (Del. Ch. 1988) . . . . . . . . . . . . . . . . . . . 89 In re John Q. Hammons Hotels Inc. S’holder Litig., 2009 WL 3165613 (Del. Ch. Oct. 2, 2009) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

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TABLE OF AUTHORITIES

Johnson, United States v., 546 F.2d 1225 (5th Cir. 1977) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228 Kahn v. Dairy Mart Convenience Stores, Inc., 1996 WL 159628 (Del. Ch. Mar. 29, 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34, 143, 161 Kahn v. Lynch Commc’n Sys., Inc., 669 A.2d 79 (Del. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110 (Del. 1994) . . . . . . . . . . . 22, 23, 113, 142, 260 Kahn v. Sullivan, 594 A.2d 48 (Del. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997) . . . . . . . . . . . . . . .15, 29, 54, 181, 240, 256, 262 Kahn v. Tremont Corp., 1996 WL 145452 (Del. Ch. Mar. 21, 1996) . . . . . . . . . . . . . . . . . 185, 261 Kahn v. Tremont Corp., 1997 WL 689488 (Del. Ch. Oct. 28, 1997) . . . . . . . . . . . . . . . . . . . . . . 262 Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726 (Del. 1988) . . . . . . . . . . . . . . . . . . . . . . 14 Kaplan v. Wyatt, 484 A.2d 501 (Del. Ch. 1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226 Kaplan v. Wyatt, 499 A.2d 1184 (Del. 1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 Kaplan v. Wyatt, 1984 WL 8274 (Del. Ch. Jan. 18, 1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Katz v. AT&T Corp., 191 F.R.D. 433 (E.D. Pa. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 Kindt v. Lund, 2001 WL 1671438 (Del. Ch. Dec. 14, 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 Kohls v. Duthie, 765 A.2d 1274 (Del. Ch. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22, 144 La. Municipal Police Employees’ Ret. Sys. v. Crawford, 918 A.2d 1172 (Del. Ch. 2007) . . . . . 160 La. Municipal Police Employees Ret. Sys. v. Fertitta, 2009 WL 2263406 (Del. Ch. July 28, 2009) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 In re Lear Corp. S’holder Litig., 926 A.2d 94 (Del. Ch. 2007) . . . . . . . . . . . . . . . . . . . . . . 117, 192 Lee v. Engle, 1995 WL 761222 (Del. Ch. Dec. 15, 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 Levine v. Smith, 591 A.2d 194 (Del. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 179, 200 Lewis v. Fuqua, 502 A.2d 962 (Del. Ch. 1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32, 35, 176 In re Life Techs., Inc. S’holders Litig., 1998 WL 1812280 (Del. Ch. Nov. 24, 1998) . . . . . . . . . 261 In re LNR Props. Corp. S’holders Litig., 896 A.2d 169 (Del. Ch. 2005) . . . . . . . . . . . . . . . 5, 22–23 Lofland v. DiSabatino, 1991 WL 138505 (Del. Ch. July 25, 1991) . . . . . . . . . . . . . . . . . . . . . . . 263 London v. Tyrrell, 2010 WL 877528 (Del. Ch. Mar. 11, 2010) . . . . . . . . . . . . . . . . . . . . . . . 35, 112 In re Loral Space & Commc’ns Inc., 2008 WL 4293781 (Del. Ch. Sept. 19, 2008) . . . . . . . . . . . . . . . . . 29, 49, 52, 113, 146, 148, 151, 153, 182, 190, 264 Lowe v. White & Spicer, 1990 WL 251387 (Del. Super. Nov. 2, 1990) . . . . . . . . . . . . . . . . . . . . 224 Lynch v. Vickers Energy Corp., 383 A.2d 278 (Del. 1977) . . . . . . . . . . . . . . . . . . . . . . . . . 159, 261 Lynch v. Vickers Energy Corp., 429 A.2d 497 (Del. 1981) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261 In re Maxxam, Inc./Federated Dev. S’holders Litig., 1997 WL 187317 (Del. Ch. Apr. 4, 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 McMullin v. Beran, 765 A.2d 910 (Del. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21, 113 Mendel v. Carroll, 651 A.2d 297 (Del. Ch. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263, 264 Mills Acq. Co. v. MacMillan, Inc., 559 A.2d 1261 (Del. 1989) . . . . . . . . . . . . . . . . . . . . . . . . 22, 89 Mills v. Esmark, Inc., 544 F. Supp. 1275 (N.D. Ill. 1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 Mills v. Esmark, Inc., 573 F. Supp. 169 (N.D. Ill. 1983) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 Mount Moriah Cemetery v. Moritz, 1991 WL 50149 (Del. Ch. Apr. 4, 1991) . . . . . . . . . . . . . . . . 15 In re Nat’l City Corp. S’holders Litig., 2009 WL 2425389 (Del. Ch. July 31, 2009) . . . . . . . . . 160 In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171 (Del. Ch. 2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . 88, 92, 116, 122, 150, 153, 155, 191, 192, 244 Nicholas & Ruehle, United States v., SACR 08-00139-CJC (C.D. Cal. Apr. 1, 2009) . . . . . . . . 135 Nuzzo v. Nw. Airlines, Inc., 887 F. Supp. 28 (D. Mass. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 In re Oracle Corp. Deriv. Litig., 824 A.2d 917 (Del. Ch. 2003) . . . . . . . . . . . . . . . . . . . . 33, 34, 35 Orman v. Cullman, 794 A.2d 5 (Del. Ch. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18, 21, 36–37 In re Par Pharm., Inc. Deriv. Litig., 750 F. Supp. 641 (S.D.N.Y. 1990) . . . . . . . . . . . . . . . . . . . . 45 Phillips v. Insituform of N. Am., Inc., 1987 WL 16285 (Del. Ch. Aug. 27, 1987) . . . . . . . . . . . . . 18 Pogostin v. Rice, 480 A.2d 619 (Del. 1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Polk v. Good, 507 A.2d 531 (Del. 1986) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 In re Primedia Inc. Derivative Litig., Consol. C.A. No. 1808-VCL (Del. Ch. June 14, 2010) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

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In re Prime Hospitality, Inc., 2005 WL 1138738 (Del. Ch. May 4, 2005) . . . . . . . . . . . . . . 156, 203 In re Pure Res., Inc. S’holders Litig., 808 A.2d 421 (Del. Ch. 2002) . . . . . . . . . . . . . . 47, 221, 261 In re Qwest Commc’ns Int’l Inc., 450 F.3d 1179 (10th Cir. 2006) . . . . . . . . . . . . . . . . . . . . . . . . 227 Rabkin v. Olin Corp., 1990 WL 47648 (Del. Ch. Apr. 17, 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Rales v. Blasband, 634 A.2d 927 (Del. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 21, 34, 161 Rosenblatt v. Getty Oil Co., 493 A.2d 929 (Del. 1985) . . . . . . . . . . . . . . 19, 22, 115, 119, 159, 261 Rubin v. Posner, 701 F. Supp. 1041 (D. Del. 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Ryan v. Gifford, 2007 WL 4259557 (Del. Ch. Nov. 30, 2007) . . . . . . . 138, 168, 207, 214, 233, 234 Ryan v. Gifford, 2008 WL 43699 (Del. Ch. Jan. 2, 2008) . . . . . . . . . . . . . . . . . . . . . . . . . . 168, 233 Scattered Corp. v. Chi. Stock Exch., Inc., 701 A.2d 70 (Del. 1997) . . . . . . . . . . . . . 14, 15, 179, 200 Seagraves v. Urstact Prop. Co., 1996 WL 159626 (Del. Ch. Apr. 1, 1996) . . . . . . . . . . . . . . . . . 23 Smith v. Good Music Station, Inc., 129 A.2d 242 (Del. Ch. 1957) . . . . . . . . . . . . . . . . . . . . . . . . . 21 Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19–20 Solash v. Telex Corp., 1988 WL 3587 (Del. Ch. Jan. 19, 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . 261 Sonet v. Plum Creek Timber Co., 1999 WL 160174 (Del. Ch. Mar. 18, 1999) . . . . . . . . . . . . . . . 92 Sonet v. Timber Co., L.P., 722 A.2d 319 (Del. Ch. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Spiegel v. Buntrock, 571 A.2d 767 (Del. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 14, 200, 201 In re SS&C Techs, Inc. S’holders Litig., 911 A.2d 816 (Del. Ch. 2006) . . . . . . . . . . . . . . . . . . . 116 In re Steinhardt P’rs, L.P., 9 F.3d 230 (2d Cir. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227 Stein, United States v., 435 F. Supp. 2d 330 (S.D.N.Y. 2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 Stein, United States v., 541 F.3d 130 (2d Cir. 2008) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 Stein v. Bailey, 531 F. Supp. 684 (S.D.N.Y. 1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176, 177 Stepak v. Addison, 20 F.3d 398 (11th Cir. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 Stone v. Ritter, 911 A.2d 362 (Del. 2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Stroud v. Milliken Enters., Inc., 552 A.2d 476 (Del. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . 119, 159 Strougo v. Padegs, 27 F. Supp. 2d 442 (S.D.N.Y. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 Summa Corp. v. Trans World Airlines, Inc., 540 A.2d 403 (Del. 1988) . . . . . . . . . . . . . . . . . . . . 19 Sutherland v. Sutherland, 2010 WL 1838968 (Del. Ch. May 3, 2010) . . . . . . . . . . . . . . . . . . . . . 45 Tackett v. State Farm Fire & Cas. Ins. Co., 653 A.2d 254 (Del. 1995) . . . . . . . . . . . . . . . . . . . . 128 In re Tele-Commc’ns, Inc. S’holder Litig., 2005 WL 3642727 (Del. Ch. Dec. 21, 2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18, 49, 52, 60, 61 Thorpe v. CERBCO, Inc., 676 A.2d 436 (Del. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 In re Toys ‘R’ Us, Inc. S’holder Litig., 877 A.2d 975 (Del. Ch. 2005) . . . . . . . . . . . . . . . . . . . . 161 In re Trans World Airlines, Inc. S’holder Litig., 1988 WL 111271 (Del. Ch. Oct. 21, 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84, 115, 147 TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (1976) . . . . . . . . . . . . . . . . . . . . . . . 119, 159, 262 Union Carbide Corp. v. Dow Chem. Co., 619 F. Supp. 1036 (D. Del. 1985) . . . . . . . . . . . . . . . 129 Upjohn Co. v. United States, 449 U.S. 383 (1981) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134, 138 In re USACafes, L.P. Litig., 600 A.2d 43 (Del. Ch. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 U.S. W., Inc. v. Time Warner Inc., 1996 WL 307445 (Del. Ch. June 6, 1996) . . . . . . . . . . . . . . . 26 Van de Walle v. Unimation, Inc., 1991 WL 29303 (Del. Ch. Mar. 7, 1991) . . . . . . . . . . . . . 19, 263 VantagePoint Venture P’rs 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005) . . . . . . . . . . . . . . . 13 In re Walt Disney Co. Deriv. Litig., 825 A.2d 275 (Del. Ch. 2003) . . . . . . . . . . . . . . . . . 22, 155–56 In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del. 2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Wayne County Employees’ Ret. Sys. v. Corti, 2009 WL 2219260 (Del. Ch. July 24, 2009) . . . . 192 Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4, 18, 19 Westinghouse Elec. Corp. v. Republic of Philippines, 951 F.2d 1414 (3d Cir. 1991) . . . . . . . . . 227 In re W. Nat’l Corp. S’holders Litig., 2000 WL 710192 (Del. Ch. May 22, 2000) . . . . . . . . . . . . 24 In re Wheelabrator Techs., Inc. S’holders Litig., 663 A.2d 1194 (Del. Ch. 1995) . . . . . . . . . . . . 22 Williams v. Geier, 671 A.2d 1368 (Del. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981) . . . 16, 46, 170, 201, 202–4, 213, 214, 226 Zirn v. VLI Corp., 621 A.2d 773 (Del. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

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Statutes & Rules 8 Del. C. § 141(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28, 85 8 Del. C. § 141(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41, 42–43, 49 8 Del. C. § 141(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88, 146 8 Del. C. § 145(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 8 Del. C. § 145(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 8 Del. C. § 203 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196 8 Del. C. § 220 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 8 Del. C. § 271 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 18 U.S.C. § 4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228 Ct. Ch. R. 23.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 D.R.E. 510 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 Fed. R. Civ. P. 23.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Fed. R. Civ. P. 26(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .127 Fed. R. Civ. P. 26(b)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127, 128 Fed. R. Civ. P. 26(b)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 Fed. R. Evid. 502 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 Model Rules of Prof’l Conduct R. 1.13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134, 136

Other Authorities 1 David A. Drexler et al., Delaware Corporation Law and Practice (2009) . . . . . . . . . . 23, 255–256 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations & Business Organizations (3d ed. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18, 222 13 William Meade Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations (perm. ed., rev. vol. 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 8 Wright & Miller, Federal Practice and Procedure (2d ed. 2009) . . . . . . . . . . . . . . . . . . . . . . . . 128 Dallas Morning News, Affiliated Computer Services Founder Darwin Deason Set to Become a Billionaire in Xerox Deal, Nov. 15, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .269 Dennis J. Block and Nancy E. Barton, Internal Corporate Investigations: Implications of the Attorney-Client Privilege and Work Product Doctrine, in Internal Corporate Investigations (Brian & McNeil eds., ABA 1992) . . . . . . . . . . . . . . . . . .134 Guhan Subramanina, Post-Siliconix Freeze-outs: Theory and Evidence, 36 J. LEGAL STUD. 1 (2007) 275 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198 http://www.topix.com/forum/com/acs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 268 John G. Koeltl and Edwin G. Schallert, Report of the Investigation, in INTERNAL CORPORATE INVESTIGATIONS (Brian & McNeil eds., ABA 1992) . . . . . . . . . . . . . . . .232 Joseph F. Coyne, Jr. et al., Employees’ Rights and Duties During an Internal Investigation, in INTERNAL CORPORATE INVESTIGATIONS (Brian & McNeil eds., ABA 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135 Larry A. Gaydos, Gathering and Organizing Relevant Documents: An Essential Task in Any Investigation, in INTERNAL CORPORATE INVESTIGATIONS (Brian & McNeil eds., ABA 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 Mary Siegel, “The Erosion of the Law of Controlling Shareholders,” 24 DEL. J. CORP. L. 27 (1999). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .263 Stephen M. Bainbridge, Why a Board? Group Decisionmaking in Corporate Governance, 55 VAND. L. REV. 1 (2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31, 97 Thomas E. Holliday and Charles J. Stevens, Disclosure of Results of Internal Investigations to the Government or Other Third Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227 U.S. Const. amend. V. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136 U.S. Const. amend. VI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .152

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Varallo, Dreisbach & Rohrbacher, Fundamentals of Corporate Governance: A Guide for Directors and Corporate Counsel (2d ed. 2009) . . . . . . . . . . . . . . . . . . . . . . . . . . . xv William T. Allen, Independent Directors In MBO Transactions: Are They Fact or Fantasy?, 45 BUS. LAW. 2055 (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24, 83 www.sharkrepellent.net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

278

Index

A Active committee negotiating transaction documents and, 181–85 Arm’s length bargaining, 84, 85–89 agent, role of, 86 benefits of committee’s position, scheduling, 87 committee’s control over the process, 88–89 committee’s role vis-à-vis management, 88 communications through investment banker, 87 Attorney–client privilege. See also Privilege investigative committee, 126, 177, 223

B Board of directors, 1 Business judgment rule, 15, 16, 18, 23, 171, 267

C Commitment (to special committee process) controlling stakeholders, 4–5, 254–55 directors, 5–6 Commitment to the investigation, demonstrating, 111 Committee advisors conflicts, 56 experienced company advisors, use of, 55 identifying, 53–54 interviewing, 56–57 representation of, 54 retention of, 53–57 role of counsel, establishing, 109 selection of, 255–56 Committee charter, 40–53 do’s and don’ts, 48–53 form of, 41, 53 power to negotiate and just say no, 46–48 recommend versus take action, 44–46 sample guidelines and procedures, 72–73

restrictions on delegations to committees, 42–44 Committee counsel, role during negotiating transaction documents, 185–92 Committee members compensation of, 60–61 selection of, 255–56 Communication fostering, 265–68 through the investment banker, 87 Composition of special committee, 32–37 disinterestedness, 36–37 independence, 33–36 willingness to serve in a vigorous manner, 37 Conflicted board transactions, 5–6. See also Corporate transactions; Transactions Conflict of interest transactions, 1 affecting minority of the board, 6–7 benefits of using special committees in, 22–25 use of committee in limited partnership and LLC context, 25–28 Controlled transactions, 18 Controlling stockholders, 253–70 appropriate role for management, 258–59 commitment to process, 4–5, 254–55 committee members and advisors, selection of, 255–56 disclosure obligations to the special committee, 113–15, 118–20 duty of candor, 261–63 fostering communication, 265–68 guidelines for, 253–54 qua stockholders, rights of, 263–64 record of negotiations, 93–95 resisting the urge to meddle, 259 role in assuring committee independence, 33 role in assuring proper scope of committee charter, 43 scope of authority, 256–58 279

INDEX

Controlling stockholder transactions, 4–5. See also Corporate transactions; Transactions Control parties. See Controlling stockholders Corporate transactions. See also Transactions conflicted board transactions, 5–6 controlling stockholder transactions, 4–5 Criminal conduct, 227–28

Draft to build consensus, 175 Due diligence process, 120–23 management, role of, 120–22 outside counsel, role of, 122–23 Duty of care, 19–21. See also Fiduciary duty(ies) Duty of loyalty, 21. See also Fiduciary duty(ies)

D

E

Deal mentality, avoiding, 164–65 De facto special committee, 28–29 Demand committee, 13, 14–16 deciding to pursue claims, 14–15, 206–7 deciding to settle, 208–9 determining not to pursue claims, 15–16, 199–201 Demand requirement in derivative cases, 12–13 Department of Justice federal prosecution of business organizations, principles of, 230–32 Derivative claims/actions, 12 Director independence acting independently/“independence in fact,” 33–36 Director indoctrination, 83–105 arm’s length bargaining, stimulating, 84, 85–89 dealing with actor’s who do not understand (or respect) the committee’s work, 93 failure to understand the task, 84–85 forensic committee, role of, 85, 89–91 in-house counsel, 92 Director interest, disclosure, 159, 162 Disclosure of conflicts, 40 Disclosure obligations to the special committee, controlling stockholders, 113–15, 118–20 Discovery of committee’s work in litigation, 225–26 Disinterestedness of committee members, 15, 36–37, 108 Documenting committee meetings (minutes), 154–56. See also Meetings fact and opinion work product, 127–28, 223–24 government position regarding impact of privilege claims on prosecution, 231 preserving privilege, 129–30, 222–25 privilege issues, 125–29 prompt approval of, 155 short v. long, 155 waiver of privilege, 224–25 waiver of work product, 225

Engagement letters, 145 Entire fairness standard, 4, 18–19, 22, 23, 26 Experienced company advisors, use of, 55. See also Advisors Experts, use of in transactional committees, 144–48

280

F Factual work product, 128. See also Work product doctrine Fair dealing, 4, 19 Fairness opinions, 147–48 Fair price, 4, 19 Federal prosecution of business organizations, principles of, 230–32 Federal sentencing guidelines, 229–30 Fiduciary duty(ies), 25 duty of care, 19–21 duty of loyalty, 21 in limited partnership and LLC content, 26 Filip Memorandum, 231–32 Forensic committee, 2, 85, 89–91, 199–19 case study, 211–19 collection and review of documents, 90–91 dealing with rogue actors, 237 deciding to pursue claims, 206–7 determining not to pursue claims, 199–206 determining to settle, 208–10 employee “duty” to cooperate, interviews, 135 internal investigation, conclusion of, 210–11 interview memoranda, 91 interviews, conducting, 90–91 protecting employees’ rights, 135–37 recording interviews, 90 reporting conclusions to the board, 91 reports, drafting, 167–79 warnings to interviewees, 133–35 written report. See Written report, Forensic committee Fostering communication, controlling stockholders, 265–68. See also Communication Futility of demand, 13

INDEX

G Going private transactions, 5–6, 20, 29, 41, 47, 116, 117, 123, 144, 147, 149, 150–51, 155, 156, 261

I Independence of committee members, 15, 33–36, 108 Informed committee, negotiating transaction documents and, 181–85 In-house counsel appearance of conflict shaping committee process, 238–39 facilitating “mechanics” of special committee representation, 239–44 pitfalls, avoiding, 244–49 role in committee work, 92 In-house lawyer, 237–52 acting as the board interface, 245–47 conflict appearance of, 237–38 controlling curiosity and the urge to meddle, 247–48 controlling the process, 244–45 dealing with billing procedures and policies, 241–42 identification of potential counsel for committee, 240–41 internal support to committee, 242–43 preparing and debriefing witnesses, 248–49 special committee get started, helping, 239–44 staying away from meetings, 245 supporting to transactional committee, 243–44 Initial document requests, 110 Inquisitor, 89–91 Internal affairs doctrine, 12, 13 Interested transaction, 4–5, 26. See also Transactions Interview(ing/s) committee advisors, 56–57 employee “duty” to cooperate, 135 memoranda, 91 conducting, 90–91 recording, 90, 137–39 organizing, 110–11 Intrinsic fairness standard, 19 Investigation results to the full board, announcing, 233–35 Investigative committee, 2, 107–12, 125–40 attorney–client privilege, 126, 223 authority of, 108

commitment to the investigation, demonstrating, 111 disclosing the report, consequences of. See Investigative committee’s report, disclosing disinterestedness of committee members, 108 employees’ rights, protecting, 135–37 gathering fact from persons with relevant information, 131–39 goal of investigation, 107–8 independence of committee members, 108 initial document requests, 110 interviewees, identifying, 133 interviews, conducting, 133 joint defense privilege, 128–29 non-demand, 17 organizing interviews, 110–11 preserving privileges, 129–30, 222–25 privilege issues, 125–29 process, documenting, 139–40 recording interviews, methods of, 137–39 relevant documents, reviewing, 130–31 role of counsel, establishing, 109 subject identification, 107–8 waiver of privilege, 224–25 warnings to non-client interviewees, 133–35 work product doctrine, 127–28, 223–24 Investigative committee’s report, disclosing, 226–33 criminal conduct, 227–28 Department of Justice’s principles of federal prosecution of business organizations, 230–32 federal sentencing guidelines, 229–30 potential libel claims, 232–33

J Joint defense privilege, 128–29. See also Privilege

L Libel claims, avoiding, 232–33 Limited liability companies benefits of using a committee in conflict transactions in, 25–28 Limited partnerships benefits of using a committee in conflict transactions in, 25–28

M Majority of minority vote, 162 Management conflicts, 120–22 McNulty Memorandum, 230–31

281

INDEX

Meetings, 151–56, 190–91 documenting committee, 154–56 frequency of, 151 prompt approval of, 155 short v. long form minutes, 155 telephonic v. in person meetings, 152–53

N Non-demand investigative committee substantive review of committee work, 17 Note taking by committee members, 158–59

O One member committee, 29, 32, 48, 215 One-person negotiating committee, 95–98 Opinion work product, 128. See also Work product doctrine Organizing interviews, 110–11 Outside counsel briefing board as to committee process, 193 relationships, 194 role in due diligence process, 122–23 role in negotiations, 188–90, 192–94

P Pending litigation, addressing, 3–4 Potential advisors, interviewing, 56–57. See also Advisors Potential corporate wrongdoing, investigating, 2–3 Power to negotiate and just say no, 46–48, 141–44 Pre-suit committee interviews, conducting, 90, 91 Privilege attorney–client, 126, 223 expect to waive, 221–22 joint defense, 128–29 preserving, 129–30 waiver of, 224–25

R Reasons not to establish committee, 8 Recommend versus take action, 44–46 Record of negotiations, controlling stockholders, 259–64 Restrictions on delegations to committees, 42–44 Role of counsel, establishing, 109

S Sample bidding procedures, 99–101 for competing superior proposals, 102–5 Sample conflict transaction special committee charter, 69–71

282

Sample guidelines and procedures, committee charter, 72–73 Sample investigatory special committee charter, 64–65 Sample negotiating special committee charter, 66–68 Sample report outline, forensic committee committee, description of, 175 committee’s work, description of, 175 conclusion, 177 factors, considering, 176–77 facts, 176 findings and recommendations, executive summary of, 175 overview of the law, 176 recommendations, 177 Sample special committee charter, 62–63 Special committee, 1–9 composition of, 32–37 corporate transactions, 4–6 disinterestedness, 36–37 fees, 52, 74–82 forensic or investigative, 2 forming, 31 independence, 33–36 legal benefits and implications of, 29 may not be advisable, 7–9 members of, 1–2 minority of the board, conflict of interest affecting, 6–7 negotiating or transactional, 2 pending litigation, addressing, 3–4 potential corporate wrongdoing, investigating, 2–3 role of, 11–29 size of, 31–32 stockholder (member) demands, investigating, 3 types of, 2 willingness to serve in a vigorous manner, 37 Special litigation committee (SLC), 85, 168 commitment to the investigation, demonstrating, 111–12 concluding process, 211–15 deciding to pursue claims, 207 discoverability of materials, 212–14, 225–26 independence, 34–35 interviews, conducting, 89 pending litigation, addressing, 4 reports, 212 seeking dismissal of claims, 16, 201–5 settling claims, 209–10

INDEX

Stockholder demands, 2, 14, 17, 45, 64–65, 85, 90, 107, 170, 178, 199, 224 Stock option backdating, 167–68 Substantive review of committee work, 159–62

T Thompson Memorandum, 230 Timing of demand investigation, 190 Thrust upon conflicts, 37–40, 60 Transactional committee, 114–24, 141–65 arm’s length bargaining, 84, 85–89 awareness of potential disclosures, 118–20 communicating with, 149–51 “deal mentality,” avoiding, 164–65 determining not to pursue claims, 205–6 documenting committee meetings (minutes), 154–56 due diligence process, oversight of, 120–23 duty of care, 19–21 duty of loyalty, 21 engagement letters, 145 entire fairness standard, 18–19 fairness opinions, 147–48 frequency of meetings, 151 interaction with the full board, 194–97 involvement in negotiations/oversight, 123–24 legal standards, 17–21 maintaining confidentiality, 149–51 meetings, 151–54 negotiation strategy, formulating, 115–18 notes and document retention, 158–59 power to say “no,” 141–44 practice pointers, 157–58 prompt approval of minutes, 155 sample bidding procedures, 99–105 settlement of litigation, 20 short v. long form minutes, 155 substantive review of committee work, 159–62, 197–98 telephonic v. in person meetings, 152–53 use of experts, 144–48 waiver of privilege, 221–22 work plan, 112–20

Transaction documents, negotiating, 181–98 committee counsel, role of, 185–92 confidentiality, 191–92 documentation, 191 informed and active committee, need for, 181–85 instruction to interested parties on conflict points, 192 interaction with the full board, 194–97 meetings, 190–91 negotiating response, 191 process, 190 regular outside counsel, role of, 188–90, 192–94 substantive review of committee work, 197–98 timing, 190 Transactions controlling stockholder, 4–5 interested, 4–5 conflicted board, 5–6

U Use of committees for alternative entity conflicts, 35

W Waiver of privilege. See also Privilege investigative committee, 224–25 transactional committee, 221–22 Whistleblower complaints, 89 Work product doctrine factual, 128 investigative committee, 127–28, 223–24 opinion, 128 Written report, forensic committee, 167–79 draft to build consensus, 175 finalizing, 177–78 importance of, 167–69 libel claims, avoiding, 232–33 sample outline, 175–77 scope of, 169 Wrongful refusal of demand, 14–15

283