Indiana Supreme Court Rules That Corporate Directors May Sit on Special Litigation Committees

On June 28, 2010, the Indiana Supreme Court decided for the first time that a corporate director is qualified to sit on a special litigation committee to determine whether a corporation should pursue shareholder derivative litigation if that director does not face a substantial likelihood of personal liability in the litigation. In this case, In re ITT Derivative Litigation, No. 94S00-0911-CQ-508 (June 28, 2010), the Court answered a question of Indiana law certified to it by the United States District Court for the Southern District of New York.

Business Corporation Law

The Indiana Business Corporation Law (BCL) permits a board of directors to establish a Special Litigation Committee (SLC) of three of more "disinterested directors" (or other persons) to determine whether it is in the corporation's best interests to pursue shareholder derivative litigation. If the SLC determines that pursuing the derivative litigation is not in the corporation's best interests, that determination is "presumed to be conclusive against any shareholder making a demand or bringing a derivative proceeding with respect to such right or remedy," unless the plaintiff demonstrates the SLC was not disinterested or that the SLC did not make a good faith investigation. This standard is very protective of directors' authority to make decisions on behalf of corporations.

Special Litigation Committees

Last year, the Indiana Supreme Court accepted the certified question of Indiana law, which reads as follows:

What standard should be applied in determining whether a director is ‘disinterested' within the meaning of Indiana Code Section 23-1-32-4(d), and more specifically, is it the same standard as is used in determining whether a director is disinterested for purposes of excusing demand on the corporation's directors under Federal Rule of Civil Procedure 23.1 and Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993).

In the New York litigation that generated the question, plaintiffs brought a derivative action against ITT's board of directors for breach of fiduciary duty and gross mismanagement arising from ITT's criminal prosecution for the illegal export of military defense articles. Plaintiffs had demanded that ITT's board investigate and pursue action four months before bringing the lawsuit. In response to plaintiffs' demand, ITT appointed three of its outside directors to an SLC. All three of the SLC's directors were named as defendants in plaintiffs' complaint. Following its investigation and determination that furthering the action was not in ITT's best interests, the SLC moved to dismiss plaintiffs' claims.

Standard of Disinterestedness

Plaintiffs argued that the directors comprising the SLC were not "disinterested" because the directors were named defendants. They argued that the directors on the SLC could be "disinterested" only if plaintiffs made them parties to the action on the basis of a "frivolous or insubstantial claim."

The Indiana Supreme Court rejected the plaintiffs' position and ruled that the standard for whether directors are "disinterested" for purposes of serving on a SLC is whether the directors face a substantial likelihood of personal liability in the litigation.  This standard is identical to the standard for determining whether plaintiffs are required to make a demand at all; the BCL applies a consistent standard of disinterestedness in both contexts.

The Court's ruling is based not only on the language of the BCL, but also on Indiana's policy "expressing an even stronger preference for board management and direction than its predecessor statute." The Court ruled that Indiana's BCL emphasizes that boards should control corporate decisions in nearly every situation, so an interpretation that would easily disqualify directors from serving on SLCs is contrary to the BCL's policy. Indiana's "strongly pro-management version of the business judgment rule," allowing director liability only for recklessness or willful misconduct, is another example of this pro-director policy.

This decision by the Indiana Supreme Court will make it more difficult for shareholders to pursue derivative litigation and continues the line of cases supporting directors' authority to control the affairs of Indiana corporations.

Baker & Daniels' lawyers Jon Laramore and Matthew Albaugh represented amicus curiae Indiana Legal Foundation in this litigation.