If your dispute with your partner has ended up in litigation, or maybe you have a friend or family member who has had a business dispute end up in litigation, you may have heard the term “SLC”. But what does that mean? SLC is an abbreviation for Special Litigation Committee. The SLC wields enormous power in the context of derivative claims. The SLC will either validate a derivative claim and recommend the derivative claim be pursued or settled, or will recommend that the derivative claim be dismissed. Since the business must adhere to the SLC’s determinations, and because of the deference provided to an SLC’s determinations, the SLC will either be your best friend or worst enemy depending on which side of the determination you end up. As a result, you must be properly prepared if an SLC is appointed in your matter.
To understand why it is necessary to properly prepare for the SLC, one must first understand the appointment of the SLC, the role of the SLC and the deference granted to the SLC. It is also important to understand the trends in the law as it relates to SLC determinations and recommendations. This article focuses on SLC’s in the context of a limited liability company dispute, however, most of this information is also relevant in the corporate context.
When a member has alleged a derivative claim, the other members or managers may form a SLC or an SLC may also be appointed under statute by the LLC. A properly appointed SLC should consist of “one or more independent governors or other independent persons to consider the legal rights or remedies of the corporation and whether those rights and remedies should be pursued.” Every member of a properly appointed SLC must be independent. Following appointment, the SLC is not subject to the control of the board. The independent SLC should be delegated the board’s power to control the derivative action and should not have a limited scope placed on its investigation.
Special litigation committees provide for an independent evaluation of a derivative action. They help balance the rights and duties of the managers and the dissenting member by providing the entity with ‘an important tool to rid itself of meritless or harmful litigation’ while preventing managers from using the committee to ‘wrest control of bona fide derivative claims away from well-meaning plaintiffs.’
While discharging their duties, SLC members are considered governors of the company which they are serving and are subject to the same standards applicable to all governors. One of those standards is the standard of care which requires the SLC to discharge their duties in “good faith”, in a manner they “reasonably believe to be in the best interests” of the company and with the “care an ordinarily prudent person in a like position would exercise under similar circumstances.”
A SLC and its investigation after appointment are protected by the business judgment rule. The business judgment rule acts as a presumption to protect a company’s board from derivative claims that the board made an unprofitable business decision. A director will not be liable for company losses if the director is disinterested, makes an informed business decision, and acts in good faith under the business judgment rule. The business judgment rule prevents judges from second guessing a board’s well-intentioned decision.
Whether the SLC has investigated in good faith will depend on the nature of the particular investigation and the SLC’s procedures and methods as a whole. The length and scope of the SLC’s investigation, the SLC’s use of independent counsel or experts, the entity’s or defendant’s involvement in the SLC’s investigation, and the adequacy and reliability of the information supplied to the SLC are all factors relevant to the adequacy of the SLC’s investigation.
After completing its investigation, the SLC must decide whether it is in the company’s best interests to pursue the derivative claims, settle the derivative claims, or seek dismissal of the derivative claims. Making this determination “involves the weighing and balancing of legal, ethical, commercial, promotional, public relations, fiscal and other factors familiar to the resolution of many if not most corporate problems.” The SLC should consider the long-term as well as short-term interests of the company and its members, and the employees, customers, suppliers and creditors of the company. In considering these factors as it relates to the costs of litigation, sometimes even non-frivolous derivative claims “may not be worth pursuing when the likelihood of victory is compared with the time, money, and hostility necessary to win.” Whether the company should ultimately pursue a cause of action is a matter of internal management and left to the discretion of the SLC.
Once the SLC determines whether to pursue, settle or dismiss the derivative claim, the company must follow this determination. If the derivative plaintiff disagrees with the SLC’s determination, the managers must establish that the SLC was independent and that the SLC’s investigation was adequate, appropriate and pursued in good faith. If the managers establish both criteria, the court must defer to the SLC’s decision and enter an order accordingly. If the managers fail to establish either of these criteria, the court need not defer to the SLC’s decision and the plaintiff’s derivative claim(s) may move forward on its merits with no opportunity to remedy the SLC’s deficiencies.
A review of recent cases which examined the determination of the SLC reveals a growing trend by SLCs to dismiss or not pursue derivative claims. In fact, nine of the ten SLCs recommended the derivative claims be dismissed or not pursued, and only one of the SLCs recommended the derivative claims be settled. Many factors were cited for dismissing/not pursuing the claims including: the derivative claims were frivolous; lack of benefit to the company; and costs of pursuing the claims to the company.
With an understanding of the purpose of the SLC, the power and deference granted to the SLC, and the recent trend of SLC determinations, it is easy to grasp the importance of dealing with the SLC. Whatever side of the derivative claim you may find yourself representing, derivative plaintiff, defendant or entity, it is vital to properly prepare for and to deal with the SLC. Next article posted will discuss how to prepare for the SLC.