I so often see the Board of Directors at a company acting badly that it’s almost is heartening to see things done the right way.
After a protracted period of familial disputes over the company, including a prior lawsuit, one side sent a Demand Letter, as is proper, alleging various Board members “breached their fiduciary duties and engaged in wrongful, self-serving and bad faith acts and omissions … which have resulted in catastrophic injury to [the Company] and corresponding and substantial loss of value to [the challenger’s] stock [in the Company].”
That prompted a Board Meeting where:
Attorney Sonnenfeld discussed the Demand Letter, corresponding ALI Principles, and the duty of care owed by the board to respond to the Demand Letter. He advised, ‘evaluation of the demand should be made by independent and disinterested directors.’ At that point, [the Members accused of wrongdoing] were excused from the meeting. ‘The meeting continued, attended by the independent and disinterested Directors … ‘ At that point, Attorney Sonnenfeld discussed the proper formation of a special litigation committee to address the issues in the Demand Letter. He advised that such committee retain independent counsel ‘to develop a response to the demand letter’ and he provided a preliminary list of candidates and their qualifications. He further ‘discussed the possible role and functions of the Committee in conjunction with the independent counsel.’ "
Lemenestrel v. Warden, 2008 PA Super 295 (Pa. Super. Ct. 2008)(emphasis added).
The company then hired independent counsel to perform an internal investigation of the claims, who concluded “there was no basis or evidence upon which to support a suit by the Company against the Wardens and that, therefore, pursuing those claims through litigation would not be in the best interests of the Company.”
Since the Board followed all the appropriate procedures, the Superior Court upheld the Court of Common Pleas’ holding that the Board’s decision not to pursue litigation was protected under the business judgment rule:
‘Decisions regarding litigation by or on behalf of a corporation, including shareholder derivative actions, are business decisions as much as any other financial decision. As such, they are within the province of the board of directors.’ The Cuker Court cautioned that, ‘if a court makes a preliminary determination that a business decision was made under proper circumstances, however that concept is currently defined, then the business judgment rule prohibits the court from going further and examining the merits of the underlying business decision.’ In other words: ‘Without considering the merits of the action, a court should determine the validity of the board’s decision to terminate the litigation; if that decision was made in accordance with the appropriate standards, then the court should dismiss the derivative action prior to litigation on the merits.’
Id., citing Cuker v. Mikalauskas, 547 Pa. 600, 692 A.2d 1042 (Pa. 1997), which adopted The American Law Institute’s Principles of Corporate Governance: Analysis and Recommendations ("ALI Principles"), particularly sections 7.07-7.10 and 7.13.
I’m sure the internal investigation was both a substantial burden on time and attention and a considerable expense, but look what it accomplished. An ounce of prevention is worth a pound of cure.