"Pitfalls of Representing Special Litigation Committees: Tips to Prevent Waiver of the Attorney-Client Privilege"
Robert B. Bieck, Jr. and Sarah B. Belter
Jones Walker Insurance, Banking & Financial Services E*Lert
June 25, 2008

On November 30, 2007, the Delaware Court of Chancery ordered the Special Litigation Committee (“SLC”) of the Board of Directors (“Board”) of Maxim Integrated Products, Inc. (“Maxim”) to produce to shareholder derivative plaintiffs outside counsel’s report, and all related communications, to Maxim’s SLC concerning alleged backdated options that were the subject of the derivative suit.  Ryan v. Gifford, 2007 WL 4259557 (Del. Ch.—November 30, 2007) (“Gifford II”).  Though in our opinion this decision broke no new ground, it serves as a valuable reminder of the risks that SLCs and their counsel face in preserving the attorney-client privilege in Delaware and, most likely, elsewhere. 

Gifford II is the latest installment in the continuing saga of the shareholder derivative litigation arising from allegations that the executive officers and Compensation Committee of Maxim breached fiduciary duties when they granted improperly backdated options failed to recognize as an expense the amount by which those options were in the money and misrepresented to the public that Maxim granted the options at fair market value.  See Ryan v. Gifford, 918 A.2d 341, 357-58 (Del. Ch.—February 7, 2007) (“Gifford I”).  In response to that shareholder derivative action, the Maxim Board chartered a SLC to investigate the alleged stock option backdating, but, as observed by the Court of Chancery, the SLC appeared to lack the power to assert claims on behalf of Maxim and, thus, was not wholly independent from Maxim’s Board as required under Delaware law. See 8 Del. C. § 141(c); Zapata v. Maldonado, 430 A.2d 779 (Del. 1981); Gifford II, 2007 WL 4259557 at n. 2.  The SLC retained outside counsel (“Law Firm I”) to conduct an investigation into the alleged option backdating and to report back to it.

In the meantime, Maxim and the director defendants retained another law firm (“Law Firm II”) to represent Maxim in proceedings before the Securities and Exchange Commission and the Maxim directors named as individual defendants in the shareholder derivative litigation.  Gifford II, 2007 WL 4259557 at 4, n. 9.  On completion of Law Firm I’s investigation, the SLC presented an oral report, through its counsel -- Law Firm I, to the Maxim Board of Directors, including the director defendants in the shareholder derivative litigation, and Law Firm II.  Id

The plaintiffs then sought discovery of all communications between the SLC and its counsel, including Law Firm I’s presentation of its report to the SLC and Maxim’s Board. Id. at 2-3.  Both Law Firm I and Maxim objected, asserting the attorney-client privilege.  Id. at 3.  Plaintiffs also sought discovery of Law Firm I’s notes from its interviews conducted during its investigation and its forensic analysis of Maxim’s computer systems, including metadata.  Id.  Again, Law Firm I objected, this time under the limited work product privilege.  Id.  Maxim sought to apply the attorney-client privilege to not only the communications between the SLC and Law Firm I, but also to the communications between itself and Law Firm I.  Id. 

Assuming, without deciding, that a joint attorney-client privilege existed for purposes of its analysis and ruling, the Court of Chancery ruled in plaintiffs’ favor as to the communications and report supposedly covered by the joint attorney-client privilege.  The court rested its ruling on three independent grounds:  (1) existence of good cause under Delaware’s version of Garner v. Wolfinbarger, 430 F.2d 1093, 1103-04 (5th Cir. 1970), cert. denied, 401 U.S. 974 (1971) (“Garner”); (2) waiver by partial disclosure to persons outside the assumed joint privilege with the SLC, namely the individual director defendants and Law Firm II, and (3) waiver because the individual director defendants relied upon Law Firm I’s report to the SLC to exculpate themselves.  Id. at 3-4.  See also Ryan v. Gifford, 2008 WL 436999 (Del. Ch. Jan. 2, 2008 (clarifying that Gifford II was based on both a finding of good cause under Garner and waiver of the attorney-client privilege).   

The Existence of Good Cause Under Garner

Under Garner, shareholders who are beneficiaries of the fiduciary duties owed by directors and officers of a corporation and its counsel, may, on showing of good cause, become entitled to disclosure of communications ordinarily subject to the attorney-client privilege and work product doctrine. Garner, supra, 430 F.2d at 1103-04. See Deutsch v. Cogan, 580 A.2d 100, 104-05 (Del. Ch. 1990); Zirn v. VLI Corporation, 621 A.2d 773, 782-83 (Del. 1993) (Delaware courts follow Garner and extend its rule to work product). Delaware courts have arguable added a tenth factor to the Garner rule:  the existence of conflicts of interest and alleged breach of fiduciary duties.  See Deutsch, 580 A.2d at 107.  The Delaware courts have also refined the Garner list by focusing on three of the original nine Garner factors as particularly significant and sufficient to establish good cause:  (1) nature of the claim and whether it is colorable; (2) need or desirability for the information and its unavailability from other sources, and (3) the specificity of the identification of the information sought.  Gifford II at 3, citing Sealy Mattress Co. of New Jersey, Inc. v. Sealy, Inc., 1987 WL 12500 at *4, n. 4 (Del. Ch.—June 19, 1987).[1]

The Court of Chancery found that the first factor had been met because plaintiffs had stated a colorable claim by alleging that the Compensation Committee approved the grant of options at variance with the express terms of Maxim’s plan calling for the exercise price of the options to be set at fair market value as of the date the Compensation Committee approved the grant.  Gifford I, supra, 918 A.2d at 357-58.  The court found that the shareholder derivative plaintiffs met the second factor, unavailability of information from other sources, by demonstrating the lack of a written final report, and the inability to depose witnesses concerning the report or investigation because of assertions of privilege or invocation of the Fifth Amendment privilege not to testify.  Gifford II, supra, 2007 WL 4259557 at 3.  Though the court did not discuss any basis for finding the third Sealy factor, specificity of information requested, it described the requested information as presentation of the report on the internal investigation and other communications concerning the investigation and report.  Id.

The Court of Chancery did not address two Garner factors that seem likely to have had some application:  “whether the communication related to past or prospective actions” and “whether the communication is of advice concerning the litigation itself.”  Garner, supra, 430 F.2d at 1104.  By not discussing these two Garner factors, the court may have implicitly found them unhelpful to its decision.  Nevertheless, the failure to address these factors leaves some unanswered questions.  The first of the undiscussed factors, whether the communications involved past or prospective actions, could cut both for and against a showing of good cause.  Certainly, the internal investigation addressed whether backdating had occurred, how it occurred, and culpability for the backdating.  Accordingly, the report to the SLC and the communications concerning the internal investigation to that extent involved past actions and, consequently, went towards showing good cause for disclosure.  At the same time, even though the SLC did not have the power to assert claims on behalf of Maxim, Law Firm I’s report may well have contained advice about possible claims that Maxim could assert arising from the backdating and, to that extent, addressed prospective actions and cut against a finding of good cause.  If the report and related communications contained advice concerning possible Maxim claims, it triggered the other unmentioned Garner factor, advice concerning the litigation itself, again cutting against disclosure. 

Waiver of the Attorney-Client Privilege

The Court of Chancery found that Law Firm I’s presentation of its report to the SLC at a two-day Maxim Board meeting attended by Law Firm II and its defendant director clients waived the attorney-client privilege as to the internal investigation report and, because a partial waiver of this privilege operates as a complete waiver, waived the privilege over all communications by Law Firm I concerning the internal investigation and the report.  Gifford II, supra, 2007 WL 4259557 at 4.  According to the court, the oral report was more “than a mere acknowledgement of the existence of the report” and went into enough detail that, at the end of the two-day meeting, attendees were required to turn in any notes taken at the meeting.  Id.  The court found that the individual director defendants’ interests were not so aligned and non-adverse to the SLC’s interest as to support a finding of a joint privilege.  Id.  To the contrary, the SLC’s charter to investigate the allegations of wrongful backdating in litigation naming individual directors as defendants created a relationship “more akin to one adversarial in nature.”  Id.  Acknowledging the possible arguments that Law Firm II acted in a dual capacity as counsel for the individual director defendants and that they might be said to have attended the meetings in their fiduciary, not individual, capacities, the court found an additional grounds for waiver in the individual director defendants’ specific reliance on the findings of the report to exculpate themselves as individual defendants from liability.  Id

The dual capacity of Law Firm II as Maxim’s counsel and counsel to the individual director defendants clearly troubled the court, which observed that Law Firm II’s dual capacity “is a representational conflict about which the court anxiously awaits to be enlightened.”  Id. at 5, n. 9.  That observation, together with the court’s concern over the possible lack of independence of the SLC may go a long way towards explaining the holding in this case. and should put practitioners on guard.

Explaining Gifford II’s Outcome

Two key facts in Gifford II may explain the Court of Chancery’s ruling:  the questionable independence of the SLC and the disclosure of a detailed report to the very subjects of the report and their lawyer. 

Outside counsel’s engagement for an SLC often does not begin until after the formation or chartering of the SLC.  Even so, one of the first duties of outside counsel should be to examine the SLC’s charter to make sure that it is separate from and independent of the company and the directors and officers whose conflicts of interest prompted the formation of the SLC in the first place.  If the charter raises some question over the SLC’s independence, outside counsel should advise the SLC to return to the board and seek an amendment of the charter to cure the deficiencies.[2] 

The first waiver issue - disclosure of the report to the interested and, thus, conflicted individual director defendants and their counsel - presents more difficulties and seems inextricably tied to the SLC’s perceived lack of independence.  If the Maxim SLC had been truly independent, it could have taken all action on behalf of Maxim that it believed to be appropriate in the exercise of its business judgment.  In that vein, the SLC could have done no more than to disclose the bare conclusions of the report as the justification for the action taken on behalf of Maxim.  Absent a successful attack on the independence of the SLC, its judgment would have stood and the details of the report, as well as related communications, should have remained privileged.  It is also possible that the Maxim SLC could have disclosed more details to those directors, if any, not named as individual defendants in the shareholder derivative action and to any counsel representing only Maxim and not the individual director defendants.  After all, the report and the efforts of the SLC and its outside counsel were ultimately for the benefit of Maxim and, thus, its property.  Here, however, Maxim’s counsel’s dual representation of the corporation and the individual director defendants should have precluded disclosure of more than the bare conclusions reached by the SLC, absent an intentional waiver.  Shareholder derivative litigation is expensive and companies face great pressures to try to reduce those costs.  One obvious goal is to have counsel represent as many parties as possible, but this course of action risks conflicts of interest.  Outside counsel representing an SLC must look at the roles of both inside and other outside counsel for the company and determine whether, if fulfilling dual roles, those roles give rise to a conflict of interest that jeopardizes the attorney-client privilege in the event of disclosure.  If the SLC or the company wants to preserve the attorney-client privilege, then outside company counsel should represent only the company and not any of the conflicted or interested directors or officers. 

The record in Gifford II does not disclose whether the SLC, Maxim or any of the individual director defendants entered into any sort of written joint defense or interest agreement or other understanding.  Similarly, the record does not disclose whether the individual director defendants expressly stated in the minutes of the board meeting at which the Maxim SLC outside counsel presented the SLC’s oral report that they attended only in their fiduciary capacities or that Maxim’s lawyer went on record at that board meeting as attending only in its capacity as Maxim’s counsel.  Judging from the language used in the opinion, however, one suspects that neither a written agreement nor going on record at the board meeting as attending only in a fiduciary capacity or only in a capacity as Maxim’s counsel would have changed the result.  Instead, there remains the risk that a court will look through any professions of joint interest or express designations of a limited role to examine whether parties other than the SLC actually have interests adverse to them or cannot divorce their fiduciary roles from their individual capacities.

In Gifford II, the report of the internal investigation was oral.  The court addressed that fact in its application of the second Sealy factor – unavailability of the information from other sources, suggesting, but not ruling expressly, that a written report might have limited the disclosure to the writing as opposed to the oral communications.  This may be a distinction without difference because the same information will come out on a waiver of privilege, subject only in the case of an oral report to the vagaries of memory.

The good cause rule presents the last conundrum for outside counsel.  The activities of the SLC – at least in the context of the consideration and approval of a transaction involving interested directors or an SLC acting in the face of a shareholder derivative demand or lawsuit seem tailor made for a finding of good cause under Garner/Sealy, with the consequent result of disclosure.  Nevertheless, because a truly independent SLC is entitled to the presumption of the business judgment rule, disclosure of the SLC’s communications with outside counsel serves no purpose absent a successful attack on the SLC’s independence or rebuttal of the business judgment rule. 

Practical Considerations

Communications between outside counsel and a Board’s SLC or communications relating to internal investigation and the resulting reports, whether written or oral, do not have to lose their privilege.  The attorney-client privilege can and should apply to many of these sorts of engagements, and counsel should continue to take all reasonable steps to preserve the privilege, including:

  • Reciting the standard corporate “Miranda” warning at the beginning of interviews, explaining that outside counsel represents the corporation, or SLC, not the interviewee, and that the interview is privileged, but that this privilege belongs to the corporation or SLC, and it may waive that privilege if it so chooses even if that waiver results in the disclosure of facts that trigger actions adverse to the interviewee’s interests;
  • creating Chinese walls or ethical screens between constituents of the corporation, like its Audit Committee, or any special committee, and the rest of the corporation;
  • analyzing the roles and interests of the recipients of any of outside counsel’s communications for conflicts that can result in a loss of the privilege.

Regardless of these cautionary measures, because it can be in the ultimate interest of the corporation to waive the attorney-client privilege, and because of pitfalls like those illustrated in Gifford II, regular and special board of directors committees and their outside counsel should always conduct themselves on the assumption that their communications may lose their privileged status. 

[1] In Gifford II, the Court of Chancery relied primarily upon these three factors emphasized in Sealy.  Although the existence of a conflict of interest (another factor) was part and parcel of its finding of a waiver of the attorney-client privilege, it failed to mention that factor other than a passing reference to the derivative plaintiffs’ need for the information “to assess and ultimately prove, that certain fiduciaries of the Company breached their duties.”  Gifford II, 2007 WL 4259557 at 3.

[2] One might question the Court of Chancery’s suggestion that the Maxim SLC’s possible lack of independence called into question the existence of a joint privilege between the SLC and Maxim, but one cannot deny that concerns over the SLC’s independence called into question its judgment and colored the court’s perception of the legitimacy of the invocation of the privilege.