Caesar’s Wife: How a Single-Member Special Litigation Committee Can Avoid Reproach
The Delaware Court of Chancery recently granted a motion by a single-member special litigation committee to terminate a stockholder derivative suit. In a 77-page opinion, Vice Chancellor Lori W. Will found that the one-member special litigation committee conducted a good faith investigation and reached reasonable conclusions regarding the transactions at issue. The opinion demonstrates that the court’s oversight of a single-member special litigation committee will be rigorous, and it offers valuable practice points for future single-member committees.
In 2017, Baker Hughes, an oilfield services company, merged with General Electric’s oil and gas division. GE acquired a majority of Baker Hughes’s stock, along with the power to control a majority of the board of directors. The merger involved a two-year lockup agreement, whereby GE could not sell its Baker Hughes stock without Conflicts Committee approval. Shortly thereafter, GE experienced liquidity challenges and wanted to raise cash through asset sales. Because of the lockup agreement, after lengthy negotiations, the entities agreed to a multibillion-dollar separation agreement that allowed GE to sell its majority stake in Baker Hughes.
In early 2019, stockholders filed a consolidated derivative action seeking more than $1 billion, arguing that GE, driven by a need for liquidity, exercised control over Baker Hughes in order to force the company to agree to transactions that unfairly favored GE. After a motion to dismiss was granted only in part, the Baker Hughes board formed a special litigation committee (“SLC”). The SLC consisted of a single independent and disinterested director, who in turn retained independent legal and financial advisors. The SLC’s investigation lasted nine months and involved over a dozen minuted meetings. The investigation culminated in a written report detailing the SLC’s factual assessments, the applicable legal standards, the merits of plaintiffs’ claims, and other factors considered by the SLC. The SLC determined that it was in the best interests of the company and its stockholders to terminate the derivative action and filed a motion to that effect. Plaintiffs then pursued discovery to test the independence, good faith, and reasonableness of the SLC’s investigation and its conclusions. The court granted the SLC’s motion to terminate, but only after motion practice, oral argument, and live testimony from the sole SLC member.
Under Delaware law, an SLC’s decision to terminate litigation is subject to review under a two-step analysis. The first step is a review of the independence and good faith of the SLC member(s) and an inquiry into whether the SLC conducted a reasonable investigation capable of supporting its own conclusions. This inquiry is “broad and nuanced” when applied to single-member SLCs: that person should, like “Caesar’s wife, be above reproach.” Lewis v. Fuqua, 502 A.2d 962, 967 (Del. Ch. 1985). The second step of the analysis is discretionary and allows the court to apply its own business judgment to the SLC’s conclusions.
Vice Chancellor Will’s first-step independence analysis centered largely on communications between the sole committee member and the chairman of the Baker Hughes board. Plaintiffs pointed to three sets of communications as evidence of the committee member’s partiality, and the court examined each email and text message in great detail, noting that “certain of these communications should not have occurred” but nevertheless granted the motion.
The first set of communications involved emails and a text message between the SLC member and the board’s chairman regarding a potential expansion of the board. Such an expansion would possibly have allowed the SLC to add additional members. The court evaluated these emails in light of contemporaneous communications between the SLC and its counsel and the committee member’s live testimony that the purpose of these messages was purely logistical. The committee member “credibly testified” that the purpose was to understand the timing of any potential board expansion, as a new committee member would need to be brought up to speed, and the litigation stay already needed to be extended in order for the SLC to complete its process. There was perhaps some irony in Plaintiff’s challenge to these communications: adding new, outside directors with no role in the challenged events would seem to improve, rather than hinder, the process.
Plaintiffs also challenged two sentences of an email thread between the committee member and chairman discussing pandemic planning. The committee member noted that a remote SLC interview had a “good outcome”. The court ultimately found this phrase to refer to overcoming internet connection complications, rather than to the substance of the SLC’s investigation, but noted that the SLC member “undoubtedly” did not have a reason to discuss the interview in the first instance.
Finally, Plaintiffs flagged a text message from the SLC member to the chairman which mentioned an SLC meeting and ended with, “Thanks for the wine!” The court noted that all Baker Hughes board members received wine as part of virtual social events during the pandemic, and therefore such a remark did not go to the committee’s independence.
Together, the court’s careful parsing of these communications illuminates a set of ground rules for committee member communications. SLC members should be mindful of their communications with others on the board and should generally not discuss the committee’s work with non-members. Any concerns in this space are best discussed with counsel. Indeed, where a reference to the SLC’s work is absolutely essential for logistical planning purposes, the communication should clearly identify the logistical need and clearly limit the communication to that need. As this case illustrates, innocuous social events such as virtual happy hours that involve de minimis gifts to the entire board likely do not jeopardize the board member’s independence, but they increase litigation risk and highlight the reasons to avoid such discussion if possible.
The Baker Hughes opinion also provides guidance on the thoroughness of a committee’s final report. Plaintiffs pointed to the SLC report’s failure to discuss potential conflicts that certain board advisors allegedly had during the disputed transactions. The court concluded that the report’s “silence” on this issue was “unfortunate” but “not fatal”, as the SLC was ultimately able to demonstrate that it reviewed relevant documents and inquired into the potential conflicts. The length of the court’s discussion demonstrates the importance of including all lines of inquiry and investigation in the report itself. Inclusion of this portion of the committee member’s investigation would likely have obviated the need for additional discovery and live testimony on the topic in subsequent litigation.
This case demonstrates that a court will carefully examine the work of a special litigation committee, particularly one with a single member. If plaintiffs challenge communications between the committee member and defendants, the court may compare each communication, no matter how brief, to witness testimony and documentary evidence, including communications with counsel and interview notes. Likewise, if plaintiffs challenge the thoroughness of an investigation, the court will likely examine the number of hours spent, documents reviewed, and interviews conducted, as well as the substance of the report. In this case, the court even reviewed the number of interviews (2 out of 22) that the sole committee member was unable to attend due to scheduling conflicts. Few, if any, of the Plaintiffs’ critiques were given short shrift, with the court addressing even those contentions it considered “scattershot”. But the opinion also reiterates the important role that special litigation committees play in corporate governance, and the prospect that a well-functioning committee’s work can change the outcome of a derivative suit.
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