In a seemingly routine discovery order issued in the Maxim stock-option backdating case, the Delaware Court of Chancery issued a decision that could have major ramifications for special committee practice. See Ryan v. Gifford, No. 2213-CC (Del. Ch. Nov. 30, 2007). Chancellor Chandler concluded that a special committee waives the attorney-client privilege protecting its communications with counsel when the committee reports its findings to the full board of directors, certain of whose members were alleged wrongdoers.
Shortly after the backdating controversy tore through the investment community, a shareholder in Maxim Integrated Products, Inc. brought a derivative action against several directors of Maxim (including members of the compensation committee) alleging that they had breached their fiduciary duties by approving backdated options. In response to this litigation, Maxim formed a special committee of its board to investigate any wrongdoing. The special committee retained counsel with whom it communicated over the course of the investigation, and that counsel ultimately presented a final report to Maxim’s full board of directors. After surviving a motion to dismiss, the plaintiff sought to compel production of all communications during the investigation and discovery regarding the counsel’s presentation. Maxim and its counsel asserted the attorney-client privilege.
In a letter opinion granting the motion to compel, Chancellor Chandler first recognized that absent good cause or waiver, the attorney-client privilege protects communications between a special committee and its counsel. He then analyzed the issue “assuming, but without deciding,” that Maxim could properly join in this privilege. The Chancellor concluded that the plaintiff had shown good cause under Garner v. Wolfinbarger, 430 F.2d 1093, 1103-04 (5th Cir. 1970), “vitiat[ing]” any privilege applicable to communications between counsel and Maxim. Rather than stopping here, however, he held in the alternative that any privilege had been waived. It is this second holding that is noteworthy.
According to Chancellor Chandler,
[t]he presentation of the report constitutes a waiver of privilege because the client, the Special Committee, disclosed its communications concerning the investigation and final report to third parties – the individual director defendants and [separate counsel] – whose interests are not common with the client . . . . The Special Committee was formed to investigate wrongdoing and in response to litigation in which certain directors were named as individual defendants. This describes a relationship . . . adversarial in nature.
He concluded that “because the individual director defendants specifically rely on the findings of the report for exculpation as individuals[,] . . . there can be no doubt that the common interest exception is inapplicable to extend the protection of the attorney-client privilege.” Moreover, the Chancellor held: “Though plaintiffs have demonstrated waiver of the privilege only as to the presentation of the report, this partial waiver operates as a complete waiver for all communications regarding th[e] subject matter.”
Following Chancellor Chandler’s logic, a committee formed of independent directors cannot report the reasoning behind its conclusions to the full board without exposing all of its communications with counsel to disclosure in judicial proceedings. Given the prominence of the Delaware courts, this holding may be influential in future cases involving special committees, whether involving Delaware corporations or those organized in other states. It would seem likely that this decision will have a chilling effect, certainly on communications between special committees and full boards, and potentially on the formation of special committees in the first place.
There are, however, flexibilities in the decision that might lessen its impact. First, the holding may apply only to certain special committees. Chancellor Chandler distinguished investigative special committees from special litigation committees which are created in response to formal demands by stockholders. But he made this distinction in a footnote discussing dicta unrelated to the waiver holding, and it is difficult to predict if a special litigation committee (which generally has the authority to dismiss an action) and a special committee (which generally does not have the authority to dismiss an action) differ enough to impact the Court’s decision regarding waiver.
Second, boards of directors may be able to take steps to avoid the Ryan decision. A special committee could theoretically ensure that its report is heard only by those directors who are not named as defendants in pending litigation or implicated as wrongdoers by the special committee’s investigation. This course of action is likely to be unhelpful, however, because special committees often are comprised of all the independent directors. A special committee also might limit the depth of its presentation, declare in writing its intent to preserve the privilege, and exclude all non-directors (such as the named defendants’ counsel or accounting personnel) in an attempt to avoid this new waiver doctrine; but whether any or all of these steps would prove fruitful remains unclear.