Corporate Governance

London v. Tyrrell: Questioning the Independence and Good Faith of a Special Litigation Committee

By Tracy Taylor

In London v. Tyrrell et al., No. 3321-CC, 2010 Del. Ch. LEXIS 54 (Del. Ch. March 11, 2010), the nominal defendant iGov formed a special litigation committee ('the SLC') that recommended dismissal of the plaintiffs' derivative suit.  The court denied the motion to dismiss because there were material questions of fact regarding: (1) the SLC's independence, (2) the good faith of its investigation, and (3) whether the grounds upon which it recommended dismissal of the lawsuit were reasonable.  

The case revolved around the 2007 Equity Plan adopted by the board.  The plan called for the issuance of 300,000 options to various directors and senior executives.  Plaintiffs challenged the plan, alleging that it "was designed to substantially reduce their ownership interests in iGov and increase defendants' interests to a level that would permit defendants to entrench themselves as iGov directors and managers."

Following a denial of a motion to dismiss for failing to make demand, the board formed a two person Special Committee to consider the litigation.  Discovery was stayed during the investigation.  The Committee ultimately recommended that the case be dismissed.  Plaintiffs asserted that the Committee recommendations had not met the standards set out in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981).  Zapata allows a court to review the independence of SLC members and consider whether the SLC conducted a good faith investigation of reasonable scope that yielded reasonable bases supporting its conclusion.  Even where the process is deemed appropriate, the court may exercise its own business judgment to determine whether the corporation's best interests would be served by dismissing the suit. 

After reviewing the evidence, the court concluded that there was a material question of fact as to the independence of both SLC members based on their relationship to Michael Tyrrell, iGov's President, Chief Operating Officer, and Treasurer.  Of concern was the fact that the first SLC member, John Vinter, was married to Tyrrell's cousin.  In addition, the court concluded that the SLC's second member, Vincent Salvatori, had earlier associations with Tyrell that may have given rise to a sense of obligation or loyalty to Tyrrell.  As the court observed:

• In sum, the independence inquiry under Zapata is critically important if the SLC process is to remain a legitimate mechanism in our corporate law. SLC members should be selected with the utmost care to ensure that they can, in both fact and appearance, carry out the extraordinary responsibility placed on them to determine the merits of the suit and the best interests of the corporation, acting as proxy for a disabled board. In this case, I am not satisfied that the independence prong of the Zapata standard has been met.

The court also had concern with the reasonableness of the investigation.  Conducting a reasonable investigation required an investigation of "theories of recovery asserted in the plaintiffs' complaint."  This required the Committee to "explore all relevant facts and sources of information that bear on the central allegations in the complaint." In addition, "the SLC must show that it correctly understood the law relevant to the case."

In this case, the court indicated a number of concerns with the investigation.  First, the Committee recommended that the duty of care claim be dismissed because of the presence of a waiver of liability provision.  The court found this unreasonable because this waiver of liability provision only eliminated money damages, not other kinds of relief.  The plaintiffs had sought additional relief, including recisssion of the 2007 Plan. 

As for the duty of loyalty claim, the court determined that the SLC had not conducted "a reasonably thorough investigation into defendants' process for adopting the 2007 Plan" and, as a result, did not have a "reasonable bases for concluding that the process was fair." Likewise, the court concluded that there was a material question of fact as to whether the SLC had a reasonable basis for determining that the option exercise price used in the 2007 Plan was fair. 

Based upon the first prong of the Zapata test, the Court denied the SLC's motion to dismiss the derivative claim. 

The primary materials for this case may be found on the DU Corporate Governance website.?

Full post as published by The Race to the Bottom on August 31, 2010 (boomark / email).