What Is a Special Litigation Committee in Minnesota?

What is a special litigation committee?

A special litigation committee is a committee of independent directors or outside persons that a Minnesota company appoints to decide whether to pursue, settle, or end a derivative claim, meaning a claim an owner asserts on the company’s behalf. Unlike most board committees, it is not under the board’s control.

The corporate statute draws that line in Minn. Stat. § 302A.241, subd. 1: “Committees other than special litigation committees and committees formed pursuant to section 302A.673, subdivision 1, paragraph (d), are subject at all times to the direction and control of the board.” The Minnesota Supreme Court read that sentence this way in In re UnitedHealth Group Inc. S’holder Derivative Litig., 754 N.W.2d 544 (Minn. 2008): “By implication, then, an SLC is not subject to a board’s direction and control.”

Three statutes authorize the committee, one for each common entity type:

1. Corporations: Minn. Stat. § 302A.241, subd. 1.
2. Nonprofit corporations: Minn. Stat. § 317A.241, subd. 1, which uses the same words.
3. LLCs: Minn. Stat. § 322C.0905, subd. 1, which lets the company “appoint a special litigation committee to investigate the claims asserted in the proceeding and determine whether pursuing the action is in the best interests of the company.”

The LLC statute also spells out the court’s test and the burden of proof. For corporations and nonprofits, those rules come from Minnesota Supreme Court decisions.

When does a Minnesota company need a special litigation committee?

A Minnesota company needs a special litigation committee when an owner demands that the company sue its own insiders, or sues on the company’s behalf, and the people who would normally decide are the ones accused. The committee lets the company make that decision despite the conflict.

A derivative claim belongs to the company, not the owner who brings it. The Minnesota Supreme Court explained in UnitedHealth that a committee lets a corporation dismiss or settle a derivative suit “despite a conflict of interest on the part of some or all directors.” The UnitedHealth court read its 2003 Janssen decision to imply “that no deference is to be given to the decision of a conflicted board of directors that never attempted to create an independent SLC in the first place.”

The process usually starts with a demand. Under Minn. Stat. § 322C.0902, an LLC member may sue derivatively in two situations. The first is when the member asks the people who run the company to have it sue, and they do not “bring the action within a reasonable time.” Depending on how the LLC is run, that demand goes to the other members, the managers, or the board of governors. The second is when “a demand under clause (1) would be futile.” For corporations, Minn. R. Civ. P. 23.09 requires the complaint to “allege with particularity the efforts, if any, made by the plaintiff to obtain the desired action from the directors or comparable authority.” When a derivative demand letter arrives, the board’s first decision is whether it can answer the demand itself or needs a committee. The broader procedure is covered in how derivative lawsuits work in Minnesota.

How does a Minnesota corporation set up a special litigation committee?

A Minnesota corporation’s board establishes a special litigation committee by a resolution approved by “a majority of the directors currently holding office,” under Minn. Stat. § 302A.241, subd. 1. Unless the articles or bylaws provide otherwise, the committee’s members are then appointed by “a majority of the directors present,” under subdivision 2. A committee has the board’s authority “only to the extent provided in the resolution,” so the resolution should give the committee full authority to decide the claim.

The statute and the cases set the requirements:

1. Who may serve. Under subdivision 2, “Committee members shall be natural persons. Unless the articles or bylaws provide for a different membership or manner of appointment, a committee shall consist of one or more persons, who need not be directors, appointed by affirmative vote of a majority of the directors present.” A retired judge, an outside attorney, or a director who joined the board after the events is eligible, subject to the independence test below.
2. How the committee meets. Under subdivision 4, “Sections 302A.231 to 302A.239 apply to committees and members of committees to the same extent as those sections apply to the board and directors.” The same notice and waiver rules for board meetings govern the committee’s meetings.
3. Real authority, not an advisory role. In Janssen v. Best & Flanagan, 662 N.W.2d 876 (Minn. 2003), the court said: “A mere advisory role of the special litigation committee fails to bestow a sufficient legitimacy to warrant deference to the committee’s decision by the court.” The resolution in UnitedHealth gave the committee “complete power and authority to investigate [the derivative claims] and analyze the legal rights or remedies of the Company and determine whether those rights or remedies should be pursued.”
4. No board power to add members at will. The UnitedHealth board kept the power to add members whenever it wished. The court held “that the existence of an expansion provision is one factor in a court’s totality-of-the-circumstances evaluation of an SLC’s independence.” A resolution should limit any power to add members to replacing a member who cannot serve.

A Minnesota nonprofit corporation follows the parallel rule. Minn. Stat. § 317A.241, subd. 1, provides: “Committees may include a special litigation committee consisting of one or more independent directors or other independent persons to consider legal rights or remedies of the corporation and whether those rights and remedies should be pursued. Committees other than special litigation committees are subject at all times to the direction and control of the board.” Under subdivision 2, “Committee members must be natural persons.”

How does a Minnesota LLC appoint a special litigation committee?

A Minnesota LLC appoints a special litigation committee of one or more disinterested and independent individuals once it “is named as or made a party in a derivative proceeding,” under Minn. Stat. § 322C.0905, subd. 1. Under subdivision 3, the appointment belongs to the members, managers, or governors “not named as defendants or plaintiffs in the proceeding,” and passes to those named as defendants only if all of them are named as defendants or plaintiffs. Choose carefully, because the court later asks whether those members were disinterested and independent and acted in good faith, independently, and with reasonable care.

Subdivision 3 matches the appointing group to the way the LLC is run by its members, managers, and governors:

• Member-managed: “by the consent of a majority of the members not named as defendants or plaintiffs in the proceeding.” If all members are named as defendants or plaintiffs, the appointment is made “by a majority of the members named as defendants.”
• Manager-managed: “by a majority of the managers not named as defendants or plaintiffs in the proceeding,” with the same fallback to the managers named as defendants if every manager is a party.
• Board-managed: “by a majority of governors not named as defendants or plaintiffs in the proceeding,” again with the fallback to the governors named as defendants.

Under subdivision 2, “A special litigation committee may be composed of one or more disinterested and independent individuals, who may be members.” Read the company’s operating agreement before the vote, because it may address committees, indemnification, or how the company acts.

What makes a committee member independent and disinterested?

A committee member is independent and disinterested when nothing in the member’s financial, business, family, or social ties to the accused people would keep the member from deciding the claim on its merits. Minnesota courts look at the whole picture: “A court must consider the totality of the circumstances when evaluating an SLC’s independence,” under UnitedHealth.

UnitedHealth listed factors other courts have considered, including whether the members are defendants, whether they face direct and substantial liability, whether they were on the board when the alleged wrongdoing occurred, whether they participated in or approved it, whether they had business dealings with the company, whether they “had business or social relationships with one or more of the defendants,” and whether they received advice from independent counsel. The committee in that case was two former Minnesota Supreme Court justices who, the court noted, “had no discernible connection to the UnitedHealth board.”

The plaintiff’s attorney will test those ties. In one case, I deposed a committee member to show the member was too close to a defendant. I asked when the two had met and learned it was at a young age. I asked about social gatherings and learned the member had just attended the defendant’s birthday party. That kind of fact gives a court a concrete reason to doubt that the member can judge the defendant objectively. A board should run the same inquiry before appointment: family ties, business relationships, reporting lines, and close friendships with anyone accused.

What does a good-faith investigation require?

A good-faith investigation is one the committee designs itself, that hears from the owner who brought the claim, that covers every claim asserted, and that weighs the company’s business interests rather than only the odds of winning in court. Minnesota courts review how the committee investigated, not whether they agree with its answer.

Janssen shows what fails. The board told its one-person committee to accept the findings of earlier reports. The court agreed “that Murnane lacked independence because the MPRA’s initial resolution restricted his factual investigation.” It added: “Murnane never interviewed Janssen or their attorneys, a fundamental task in reaching an informed decision about the merits of their complaints.” The court expected the committee to consider “how joining or quashing the lawsuit could affect MPRA’s economic health, relations between the board of directors and members, MPRA’s public relations, and other factors common to reasoned business decisions.”

Two Court of Appeals decisions show what passes. In Blohm v. Kelly, 765 N.W.2d 147 (Minn. App. 2009), a single attorney interviewed both shareholders with their lawyers present, reviewed the litigation record, and wrote a 19-page report, and the court deferred on the claims the report addressed. In Blum v. Thompson, 901 N.W.2d 203 (Minn. App. 2017), the court found no authority that an investigation lacks good faith merely because the committee did not hire an expert, and it accepted joint interviews of the defendants. That committee “repeatedly asked all parties and their counsel to identify additional witnesses to interview, and documents and other information to review.”

Scope matters as much as method. In Blohm, the committee declined to analyze one group of claims, and the court held “no deference is due to the extent that the SLC does not investigate and analyze a claim.”

How does the stay of a derivative lawsuit work during the investigation?

During the investigation, a court can stay part or all of the lawsuit. In a Minnesota LLC, the statute makes a stay of discovery the default on the committee’s motion. In a corporation, the court decides in its discretion whether to stay further proceedings, as the district court did in Blohm.

For LLCs, Minn. Stat. § 322C.0905, subd. 1, provides: “If the company appoints a special litigation committee, on motion by the committee made in the name of the company, except for good cause shown, the court shall stay discovery for the time reasonably necessary to permit the committee to make its investigation.” The stay has two limits. The same subdivision says it “does not prevent the court from enforcing a person’s right to information under section 322C.0410 or, for good cause shown, granting extraordinary relief in the form of a temporary restraining order or preliminary injunction.” In a manager-managed or board-managed LLC, a member can still obtain company records under Minn. Stat. § 322C.0410, subd. 2, if three conditions are met. The first is that “the member seeks the information for a purpose material to the member’s interest as a member.” The second is that the member makes “a demand in a record received by the company, describing with reasonable particularity the information sought and the purpose for seeking the information.” The third is that “the information sought is directly connected to the member’s purpose.” Within ten days after receiving the demand, the company must tell the member in a record what it will provide, when and where, and its reasons for declining anything. A member of a member-managed LLC has the records rights in subdivision 1 instead.

The corporate statute has no stay provision. In Blohm, the district court stayed the case one week before trial at the defendants’ request, “at a time when the SLC had not yet conducted an investigation.” The Court of Appeals found no abuse of discretion. It called the question whether the company “should have delegated authority to the SLC at an earlier stage” debatable, but “a matter for the district court’s discretion.”

How does a Minnesota court review the committee’s decision?

A Minnesota court defers to a special litigation committee’s decision if the company or the committee proves the members were independent and the investigation was sound. In UnitedHealth, the Minnesota Supreme Court held “that, under the Minnesota business judgment rule, a court should defer to an SLC’s decision to settle a shareholder derivative action if (1) the members of the SLC possessed a disinterested independence and (2) the SLC’s investigative procedures and methodologies were adequate, appropriate, and pursued in good faith.”

UnitedHealth answered that question for a decision to settle, and the Court of Appeals has applied the same test to recommendations not to pursue claims in Blohm and Blum. Three features of the review shape how a committee should work:

• The company and other proponents carry the burden. The court concluded “that the corporation, as well as any other proponent of the SLC recommendation, should bear the burden to show that the elements of our standard have been met.”
• The court does not reweigh the decision. In Blohm, the Court of Appeals held that a court asks whether the committee considered the relevant business factors, not how it weighed them. This is the Minnesota business judgment rule applied to litigation decisions.
• The court approves any dismissal or settlement. Under Minn. R. Civ. P. 23.09, “The action shall not be dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs.”

For LLCs, the statute writes the test into law. Under Minn. Stat. § 322C.0905, subd. 4, “After appropriate investigation, a special litigation committee may determine that it is in the best interests of the limited liability company that the proceeding” continue under the plaintiff, continue under the committee, “be settled on terms approved by the committee,” or be dismissed. Under subdivision 5, the committee “shall file with the court a statement of its determination and its report supporting its determination, giving notice to the plaintiff.” Then “The court shall determine whether the members of the committee were disinterested and independent and whether the committee conducted its investigation and made its recommendation in good faith, independently, and with reasonable care, with the committee having the burden of proof.”

What happens when a committee fails the court’s test?

When a committee fails the court’s test, the company loses control of the claim and the lawsuit goes forward on its merits, with no second chance to form a better committee or redo the investigation.

UnitedHealth reaffirmed Janssen on this point: “if the initial SLC investigation and recommendation fail to satisfy this standard, ’the derivative suit proceeds on its merits’ with no opportunity to rectify any deficiencies.” In Janssen, the board tried to fix its first resolution with a broader second one, and the court refused to consider the improved investigation, reasoning that if boards could keep improving an investigation after the fact, “the rights of shareholders and members will be effectively nullified.” Blohm applied the same rule to scope: “The caselaw does not permit a remand to allow the SLC to expand the scope of its investigation and analysis.”

The LLC statute states the consequence directly. When the court does not find that the members were disinterested and independent and that the committee acted in good faith, independently, and with reasonable care, Minn. Stat. § 322C.0905, subd. 5, provides that “the court shall dissolve the stay of discovery entered under subdivision 1 and allow the action to proceed under the direction of the plaintiff.”

What does a special litigation committee not resolve?

A special litigation committee decides only the company’s claims. It does not end an owner’s direct claims, and it does not by itself satisfy the directors’ own duties.

Direct claims continue. In Blum, the Court of Appeals deferred to the committee on the derivative counts but reversed summary judgment on the minority shareholders’ direct claims: “The district court erred by granting summary judgment to respondents on counts 1, 2, and 3. The district court did not err by granting summary judgment to respondents on counts 4 through 7.” A shareholder of a corporation that is not publicly held may still sue under Minn. Stat. § 302A.751, subd. 1. The statute covers directors or others in control who “have acted in a manner unfairly prejudicial toward one or more shareholders in their capacities as shareholders or directors,” or as officers or employees of a closely held corporation. Shareholder oppression claims have their own page. In a closely held corporation, the court in that action considers “the reasonable expectations of all shareholders as they exist at the inception and develop during the course of the shareholders’ relationship with the corporation and with each other,” under subdivision 3a. The Blum shareholders’ claim relied on that standard, among others. An LLC member keeps a direct action under Minn. Stat. § 322C.0901, subd. 1, but under subdivision 2 must “plead and prove an actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the limited liability company.”

Directors keep their own duty. Under Minn. Stat. § 302A.241, subd. 6, “The establishment of, delegation of authority to, and action by a committee does not alone constitute compliance by a director with the standard of conduct set forth in section 302A.251.” A director may rely on “a committee of the board upon which the director does not serve, duly established in accordance with section 302A.241, as to matters within its designated authority, if the director reasonably believes the committee to merit confidence,” under Minn. Stat. § 302A.251, subd. 2, but not when the director has knowledge that “makes the reliance otherwise permitted by paragraph (a) unwarranted.”

In a corporation, committee members get directors’ protections. Under § 302A.241, subd. 7, “Committee members are deemed to be directors for purposes of sections 302A.251, 302A.255, and 302A.521.” That brings the standard of conduct in § 302A.251, subd. 1, and the indemnification rules in Minn. Stat. § 302A.521, which treats a “member of a committee of the board” as holding an official capacity.

What are the key steps for a board facing a derivative claim?

A special litigation committee protects a Minnesota company only when the board builds it right the first time. I suggest the board appoint people with no ties to the accused and give them complete authority in writing, because courts test both. I also suggest the board stay out of the investigation and make sure the committee hears from the owner who brought the claim and addresses every claim asserted, because courts review the investigation too. A committee built that way gives the company the strongest position to ask the court to defer to the committee’s decision about whether the lawsuit serves the business. These steps fit within the larger work of structuring and governing a Minnesota company. If your board has received a derivative demand or complaint, email me at aaron@aaronhall.com with a brief description of the claim and the names of the people involved, and I can tell you whether a special litigation committee fits your situation and who could serve on it.