Corporate Governance

Delaware, Independence and Director Compensation: Sutherland v. Sutherland (Part 1)

By J. Robert Brown

On this Blog, we follow relatively closely the Delaware decisions that address director independence. Most often the issue comes up in the context of deriviative suits, usually on motions to dismiss for failure to make demand on the board.  In those circumstances, the board is presumed independent.  As we have noted often, the Delaware courts routinely ignore evidence suggesting that directors are not independent and dismiss cases without allowing for discovery on the matter.  The effect is to use pleading standards to at least sometimes dismiss cases that likely contain a board lacking in independence.

Less often the issue of independence arises in the context of a special litigation committee formed under the authority set out in Zapata.  Assuming demand excusal, the board can form a committee of independent directors to determine whether it is in the best interests of the company to have the lawsuit proceed.  In the case of a SLC, however, there is no presumption of independence.  Instead, the company has the burden of establishing independence.  Moreover, unlike the demand excusal cases, the plaintiff is allowed at least limited discovery on the independence issue.  With that in mind, we turn a recent Delaware case that examined independence in the context of a SLC.

In Sutherland v. Sutherland , 2008 Del. Ch. LEXIS 49 (Del. Ch. May 5, 2008), a 25% shareholder (and family member) filed a derivative suit. According to the opinion, the plaintiff alleged:

• that the individual defendants have used the companies' "corporate funds and assets for personal benefit." Specifically, the complaint asserts that Perry and Todd have caused the companies to pay for (1) personal flights they have taken on the corporate airplane; (2) personal tax and accounting services provided to them by Cimarron Lumber & Home Supply Company, Ltd., a Dardanelle affiliate; (3) use of a facility commonly known as the Maysville Training Center for personal vacations; and (4) "things [such] as rental cars, expensive hotels, limousines, club memberships, chartered private railroad cars for extended personal trips, private parties and personal living expenses, among many others." (footnote omitted).

The complaint likewise alleged the payment of excessive compensation and challenged the decisions to buy a corporate aircraft, to amend the bylaws to permit waiver of liability, and to expend $500,000 in defending against the efforts of plaintiff to exercise her inspection rights.

A one-person Zapata special litigation committee was formed to conduct an investigation. Predictably, the committee issued a written report concluding that it was not in the best interests of the companies to pursue the litigation. The defendants filed a motion to dismiss and plaintiff obtained limited discovery on the activities of the committee, including the independence of the single member.  In these circumstances, plaintiffs are largely left with a process challenge.  Were the court truly willing to impose the burden of proof on the party relying on the SLC, this might be an adequate approach.  But in fact the courts in Delaware do not.

We will explore more of this case tomorrow.  In the meantime, many of the filings, including a redacted version of the report by the SLC, can be found at the DU Corporate Governance web sit.

Full post as published by The Race to the Bottom on May 21, 2008 (boomark / email).