The special litigation committee: special handling required: the SLC is a powerful tool for boards in dealing with shareholder derivative litigation. But the committee's work is highly complex and carries significant risk if not conducted properly.

• Author: Newman, Craig A.
• Position: LIABILITY AND LITIGATION

FOR ALL THE ATTENTION corporate America is getting from regulators, law enforcement, and the plaintiffs' bar, board members have it tough right now. And, it's getting tougher. Between the fallout from the credit crisis and other financial or ethical misdeeds, corporations are seeing an upswing in shareholder derivative demands--the initial step in the legal process by which shareholders bring lawsuits on behalf of corporations against directors and senior executives.

Shareholder derivative suits are unique because board members and executives are usually responsible for bringing, and defending corporations against, litigations. But when potential wrongdoing involves board members and executives themselves, such as malfeasance or breach of fiduciary duty claims, the law recognizes that officers and directors aren't likely to recommend lawsuits against each other. Shareholder derivative suits therefore permit shareholders to bring these types of actions where management chooses not to do so.

Beyond the potential legal exposure, shareholder derivative actions can also cause great disruption to the culture and day-to-day operations of a company. Fortunately, the law provides a key measure of protection against these suits. Through the formation of a Special Litigation Committee (SLC), a company can maintain control over--and sometimes even bar--derivative lawsuits. The work of the SLC, however, is highly complex and requires significant expertise. If not handled properly, derivative plaintiffs could wind up in the driver's seat and generate tremendous havoc for a company, its officers and board members.

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In this article we discuss the role of the SLC and the initial steps that a board should consider if it decides to create an SLC after receiving a shareholder demand. We also focus on the actual work of the SLC (page 44) and round out with a look at the results of the SLC's work--an independent report (page 45)--and the different ways in which an SLC, and ultimately the company, may deal with a shareholder demand.

What is a Shareholder Demand?

A shareholder demand is a formal request, usually in the form of a letter written by counsel on behalf of a shareholder, alleging corporate misconduct and demanding that the company take action to remedy the resulting harm. The letter will typically claim that the board or senior executives have engaged in some sort of wrongdoing or mismanagement--often based on a recent news report, public filing, or settlement with regulators or law enforcement--and demand that the company investigate the allegations and file suit against the...