Sutherland v. Sutherland, Del. Ch., C.A. No. 2399-VCL, Lamb, V.C. (May 5, 2008)

Plaintiff Martha S. Sutherland is a holder of 25% of the outstanding common stock of Dardanelle Timber Company (“Dardanelle”). Her brothers, Dwight Jr., Perry and Todd also each own 25% of Dardanelle’s common stock. Dwight D. Sutherland (“Dwight Sr. “), the siblings’ father, founded Dardanelle, and its wholly owned subsidiary Southwest, Inc. Prior to his death in 2003, Dwight Sr. and his wife Norma owned all of Dardanelle’s preferred stock, which carries voting rights. After Dwight Sr.’s death, the shares of preferred stock were transferred to a trust for Norma’s benefit. Perry is the trustee for Norma’s trust, and Perry has aligned himself with Todd. Thus, Perry and Todd have voting control over Dardanelle and Southwest. Perry and Todd, along with their cousin Mark Sutherland, constitute Southwest’s and Dardanelle’s boards of directors. Martha was a director of Southwest, but was removed when Dardanelle (Southwest’s sole stockholder) called an annual meeting and reduced the number of Southwest’s directors from four to three, and appointed Perry, Todd and Mark to those positions.

After obtaining certain Dardanelle books and records pursuant to Section 220 of the General Corporation Law of the State of Delaware, Martha brought a derivative and double derivative complaint in the Delaware Court of Chancery, alleging breach of fiduciary duty and waste. In response, the boards of directors of Dardanelle and Southwest amended the companies’ bylaws, increased the number of directors from three to four, and appointed Bryan Jeffrey to each board. The companies also formed a special litigation committee consisting solely of Jeffrey (the “SLC”). Jeffrey was given final and binding authority with respect to the claims asserted in Martha’s complaint and he hired independent counsel.

The SLC conducted an investigation and concluded that the companies should not pursue Martha’s claims. On that basis, the companies moved to dismiss. Martha opposed, claiming that the SLC had failed to satisfy the Zapata standard for independence, good faith and reasonable investigation.

In determining whether the SLC had met the Zapata standard, the Court first noted that as a one-member committee, the SLC was subject to closer scrutiny, because one-member SLCs are “less insulated from the influence of interested directors.” The Court concluded that Jeffrey was independent, despite plaintiff’s allegations of a “secret financial relationship” between him and
Southwest. Nevertheless, the Court concluded that the SLC’s report contained significant errors or shortcomings, including the failure to investigate payments made by Dardanelle to a contractor for improvements made to Perry’s house in 2000 and 2001. Defendants asserted that the SLC investigated those payments, but excluded them from the report on the grounds that they were part of Perry’s compensation and did not make his compensation for that year excessive. The Court found this explanation dubious, since the SLC had included exculpatory information of a similar character from the same time period relating to Perry’s purchase of discounted construction materials. The Court also found that the memoranda of the SLC’s interviews were insufficient, some failing to reflect the witnesses’ answers at all. Finally, the Court found that the SLC’s review of the companies’ general ledger was desultory and raised questions about the reasonableness and good faith of the investigation. Jeffrey, a CPA by training, testified that he spent approximately 6 hours reviewing the companies’ general ledgers, but did not have a plan or outline for his review prior to conducting it and took no notes.

For these reasons, the Court concluded that the SLC had not satisfied the Court it had acted in good faith and conducted a reasonable investigation, and the Court denied defendants’ motion to dismiss.

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