Member Article

As the general counsel of a company, you are busy working one day and the CEO walks into your office and says, "In the board meeting this morning, one of our directors asked me if a special committee was needed for a new issue that has come up. How do we know when a special committee is needed?" The following summary can be used as a starting point in determining your answer.

Special Committees

As contrasted to standing committees, such as the audit or compensation committees, corporate boards establish, on an ad hoc basis, special independent board committees, which fall into three separate categories:

(i) the special negotiation committee that is charged with the responsibility of considering and negotiating a proposed transaction involving a conflict of interest between the company and its directors, controlling shareholders, management or other fiduciaries,

(ii) the special litigation committee that is charged with the responsibility of deciding whether or not shareholder derivative litigation claims should be pursued, and

(iii) the special investigation committee that is charged with investigating and determining an appropriate response for alleged internal corporate wrongdoing.

Unlike a standing committee, the special committees do not usually operate under a formal written charter since their assigned tasks are usually concerned with a single issue that is not on-going in nature. The special committee’s responsibilities and authority are established pursuant to board resolutions that lay out who will be the members and what the committee’s resources, duties and powers will be.

A fundamental requirement is that the special committees be composed of directors who are independent and disinterested parties with respect to the matter at issue. Absent that, the work of the committee will be vulnerable to attack regarding its objectivity and impartiality in dealing with the conflicting parties. There have been numerous cases in which a special committee’s process was rejected by the courts because the committee members were, from the start, not truly independent and disinterested. Accordingly, a board must take great care in selecting the members of a special committee.

Special Negotiation Committee

The need for a special negotiation committee is triggered when, in connection with the approval of a transaction, (i) a majority of the board of directors has a conflict of interest with respect to such transaction, (ii) a minority of the board of directors (who has a conflict of interest with respect to such transaction) controls or dominates a majority of the board or (iii) such transaction involves a merger of the company with a controlling shareholder. These three categories are sometimes referred to as “interested transactions,” and the persons who have the related conflicts of interest with the company are referred to as “interested parties.”

The purpose behind using a special negotiation committee is twofold: (i) the use of a special negotiation committee can demonstrate fair dealing with the interested party at arm’s length and (ii) Delaware courts have determined that the use of a special negotiation committee will shift the burden of proving the entire fairness of the interested transaction from the company to the plaintiff. To obtain the benefit of these Delaware decisions, the special negotiation committee must run a “legitimate process.” It must be clear in the resolutions forming the committee that the special negotiation committee has the proper and unbridled authority to negotiate the transaction, that the special negotiation committee has full authority to select its own advisors, and what compensation will be paid to those directors serving on the committee. The special negotiation committee must be comprised entirely of “independent” directors.

Special Litigation Committee

When a shareholder makes a demand on a corporation with respect to a derivative claim against directors, often some or even all of the directors are made defendants and thus, they may be deemed to have a conflict of interest in considering whether the pursuit of the claims would be in the best interests of the company. In such event, it is common practice for a board to appoint a special litigation committee consisting of independent and disinterested directors who are charged with the authority to investigate the claims and to determine if their pursuit would be in the best interests of the corporation. Following an affirmative determination to pursue litigation, the special litigation committee would continue to be responsible for the claims made against the defendants.

Special Investigation Committee

Due to the increased number of whistle-blower complaints by employees, the growing activity of government regulators in investigating corporate wrongdoing, the expanded responsibilities of independent directors (especially the audit committee) in monitoring corporate conduct and the heightened sensitivity to accounting irregularities, boards of directors are more frequently encountering internal issues that raise the need for independent internal investigations.

Whenever corporate wrongdoing is suspected, the board must immediately decide: (1) whether an investigation should be conducted, and (2) whether it should be handled by management or by a special investigation committee. Some internal investigations may be readily handled by a company’s general counsel staff. But when there are credible allegations of serious corporate wrongdoing (for example, issuance of fraudulent financial statements or wrongdoing by corporate executives), it is usually prudent to appoint a special investigation committee to conduct an independent investigation with the assistance of independent legal counsel, forensic accountants and other independent third-party advisors. Most importantly, where wrongdoing is found, the committee has to decide what is the appropriate action for the company to take.

The credibility of the findings and conclusions of a special internal investigation will depend on how thorough, impartial and fair the investigation was conducted and how impartial and fair the special investigation committee and its advisors were. It is imperative to start with a clear board mandate as to the responsibilities, authority and resources of the special investigation committee as well as the scope of its investigation. Additionally, it is important to establish an appropriate record of the activities of the special investigation committee and its advisors and to preserve pertinent evidence developed in the investigation.

If you have any questions regarding special committees and their use, please contact the following attorneys.