In today's corporate environment, companies have increasingly undertaken internal investigations to assess concerns of corporate wrongdoing. While these investigations can be overseen by a company's board, the board may delegate this responsibility to an independent committee, particularly when the investigation concerns sensitive issues, senior management conduct, or concerns about the company's ability to conduct an independent investigation. This article explores the formation of demand review committees or special committees, the associated benefits and risks and the considerations regarding maintaining privilege.
Formation of a Demand Review Committee
If shareholders choose to make a demand on the board to pursue legal claims or take a particular action, the board has several strategic options in how to respond. As an initial matter, the board must determine whether it is adequately informed regarding the underlying issues set forth in the demand letter, including the factual, legal and financial issues that relate to the alleged wrongdoing. If the board is not adequately informed, it should consider whether it is necessary to conduct an investigation to gain a better understanding of the alleged wrongdoing. In such circumstances, boards often empanel a demand review committee to investigate and make recommendations to the full board regarding how to respond — or in some circumstances, demand review committees are empowered to act on the board's behalf. (See Del. Code. Ann. tit. 8 Section 141). The resolution forming the committee should detail the committee's objective as well as the scope of authority being delegated to the committee. The resolution should also provide for sufficient resources to ensure that the committee is capable of adequately investigating the litigation demand, including the right to hire independent counsel or other advisers, as well as the right to access company documents and employees. In choosing committee members, it is important to ensure that the committee members are independent and disinterested from the underlying alleged wrongdoing.
When considering the formation of a demand review or special committee, the board should conduct a cost-benefit analysis. A demand review committee can enhance the credibility of the board's decision-making process, demonstrating that the board is properly informed and giving the shareholder's demand appropriate consideration. Courts will examine whether the committee adequately investigated the claims, engaged an independent legal advisor, reviewed documents, interviewed witnesses or considered writing a report. However, considering the significant financial and internal costs associated with forming a demand review committee, there may be circumstances where formation of a committee may not be necessary nor beneficial. For example, if the cost of litigating or settling a pending derivative or class action is likely to be less than the cost of an independent investigation, or the facts of a potential investigation have already been established (either by outside sources such as the government or through an internal investigation or discovery), the board may decide that no investigation is necessary. Additionally, improper formation, lack of a clear mandate or behavior resulting in a privilege waiver may render the formation of the demand review committee ineffective, leaving the company with high costs but with very few benefits and protections. Such considerations should be made with the advice of counsel.
Preserving Committee Privilege
When conducting an internal investigation, the protection of privileged material is crucial. The use of a demand review committee can raise significant privilege issues for both the corporation and the committee itself. Courts acknowledge that the attorney-client privilege exists between a demand review committee or special committee and its independently retained counsel regarding confidential communications for the purpose of seeking legal advice. In addition, because independent counsel is assisting the demand review committee's investigation concerning alleged wrongdoing identified in a stockholder litigation demand, the investigation is in anticipation of litigation and the attorney work product doctrine should apply. Once again, care should be taken to ensure any relevant documents are drafted to maximize the application of all available privileges.
Key issues that demand review committees should consider include:
- Witness interviews. Witness interviews conducted by outside counsel are protected by attorney-client privilege because they are conducted in confidence to provide legal advice to the committee regarding the underlying wrongdoing set forth in the litigation demand letter. Committees should ensure that any memorialization of privileged interviews are kept confidential and include legal advice and impressions.
- Committee meetings. Meetings between the demand review committee and its independent counsel should be properly memorialized in minutes that clearly reflect legal advice being given or sought. Care should be given to make sure any third parties who attend such meetings do not constitute a waiver of any privilege. In addition, to the extent that members of the demand review committee meet without counsel present, such discussions may or may not be privileged. Members of the committee should consider whether the discussions reflect legal advice and draft the minutes accordingly.
- Reporting to the board. Questions often arise about the risk of privilege waiver, particularly if privileged material is cited in any report by the committee to the full board. Demand review committees should work closely with counsel and exercise caution, especially when the current board includes defendants named in a derivative lawsuit or directors or their counsel who lack a common interest with the committee.
- Motions to dismiss. When a demand review committee files a motion to dismiss a derivative action, derivative plaintiffs may contend that privileged material should be produced to them — including material created by or for the demand review committee — because derivative plaintiffs purport to stand in the shoes of the company and assert claims on its behalf (See Garner v. Wolfinbarger, 430 F.2d 1093, 1104, 5th Cir. 1970). However, many courts have rejected the Garner approach as inconsistent with the purpose of the privilege, which is to guarantee the confidentiality of an attorney-client communication. Members of demand review committees should ensure that they have a firm understanding of all potential privilege considerations in the relevant jurisdiction at the outset of their investigation and prepare any reports, memos, minutes or other documents with these considerations in mind.
Key Takeaways
In today's environment of rampant internal investigations, demand review committees can provide great benefit for a company's undertaking of internal investigations of alleged wrongdoing. When a board receives a litigation demand, some basic guidelines include:
- Ultimately, when making the decision to create a demand review committee, board members should balance the risks and benefits of forming a committee to ensure it is in the best interest of the company.
- Members of the demand review committee should refrain from discussing the deliberations of the committee with members of management or interested directors. The demand review committee should have a firm understanding of all relevant privilege considerations in the applicable jurisdiction and ensure that all relevant memorandums and reports are drafted with these considerations in mind.
The authors would like to thank Biaunca Morris, an associate at Dechert, for her assistance with this article.