Opinion ID: 2210245
Heading Depth: 2
Heading Rank: 2

Heading: Did the PRC-Iowa board act independently?

Text: In ruling that PRC-Iowa properly refused Whalen's demand, the district court stated that, pursuant to Delaware law, Whalen conceded the independence and disinterest of the board by making demand on the PRC-Iowa board. Whalen asserts this was error. Under Delaware corporations law, a shareholder who elects to make a demand upon the board of directors concedes or waives the right to challenge the independence of a majority of the board to respond to the demand. See Seaford Funding, 672 A.2d at 71; Spiegel, 571 A.2d at 777. This rule is sometimes referred to as the corporate concession rule. See Seaford Funding, 672 A.2d at 71. In Seaford Funding the Delaware court of chancery refused to apply the corporate concession rule to a limited partner's derivative action against the general partner, a corporation. See id. at 71-72. The chancery court noted that the demand requirement promotes judicial efficiency by forcing a stockholder to exhaust its intra-corporate remedies, encourages intra-corporate solutions to internal problems and bars meritless claims of self-interested decision making. See id. The court reasoned, however, that the demand requirement, as applied to the facts in Seaford Funding, fails to promote judicial efficiency at least when there is a single general partner that is enveloped in a self-spun web of conflicting interests. Id. The court thus concluded that the limited partners' pre-suit demand did not constitute a concession that the general partner acted independently. Id. at 72. Whalen relies on Seaford Funding as support for his claim that he did not concede the independence or disinterest of the board by making pre-suit demand. There appear to be no later Delaware cases discussing Seaford Funding and its statement concerning application of the corporate concession rule to limited partnerships. One commentator, however, has stated that the court of chancery's holding in Seaford Funding may be limited to its specific facts and, at least where a limited partnership has multiple general partners or a single general partner that is a business entity such as a corporation, the corporate analogy of concession of independence when demand is made may be applied to limited partnerships in proper circumstances. Lubaroff and Altman, § 10.3, at 10-12. In Scattered Corp. v. Chicago Stock Exchange, a case decided after Seaford Funding, the Delaware supreme court commented on whether making a demand on a board of directors concedes independence of the board in derivative suits. See 701 A.2d at 74-75. [7] Scattered Corp. involved a stockholder derivative suit against the Chicago Stock Exchange of which plaintiffs, one a corporation and the other an individual, were members. Id. at 71. Plaintiffs made pre-suit demand upon the Board of Governors of the Exchange, alleging various misdeeds by board members. Id. In response to the demand, an executive committee of the board appointed a special committee consisting of past and current board members to investigate the allegations made in plaintiffs' demand. Id. The special committee retained independent counsel to assist it in the investigation. Id. Upon completion of its investigation, the special committee recommended that no further action be taken concerning plaintiffs' demand and the executive committee adopted the special committee's recommendation. Id. at 71-72. After plaintiffs filed a derivative action against the board, the court of chancery granted defendants' motions to dismiss, holding that plaintiffs' complaint failed to plead with particularity facts sufficient to create a reasonable doubt that the executive committee of the board had properly refused plaintiffs' pre-suit demand. Id. at 72. The court of chancery also stated that, by making a demand on the board, plaintiffs conceded the disinterestedness of both the full board and the executive committee. Id. at 74. On appeal, plaintiffs argued that the court of chancery erred in concluding that a demand on an independent board of directors concedes the independence of an executive committee of the board. Plaintiffs also argued that it was improper for the executive committee, instead of the full board, to act on the recommendation of the special committee to refuse the demand. At the beginning of the opinion, the Delaware supreme court stated: [W]e explicate the settled legal principles as they apply to these specific facts, holding that the making of a demand waives only any contention that the board was incapable of acting on the demand. A demand does not preclude a plaintiff from alleging with particularity facts creating a reason to doubt that a special committee in investigating the demand or the executive committee of the board in acting on the demand acted independently and in good faith or conducted a reasonable investigation. Id. at 71 (emphasis added). Later in the opinion, the court stated: In a derivative action involving refusal of a demand, any alleged bias or self-interest on the part of the board or a committee authorized to act on that demand should become part of the court's inquiry into whether the board or committee acted independently and in good faith, or whether it concluded a reasonable investigation. Id. at 75 (emphasis added). Applying these principles, the Delaware supreme court affirmed the court of chancery's decision that plaintiffs failed to allege with particularity facts creating a reasonable doubt concerning whether the executive committee acted independently or was disinterested, see id., or whether the investigation of the demand was reasonable and conducted in good faith. Id. at 77. The court noted that the board appointed the executive committee pursuant to Delaware Code Annotated title 8, section 141(c), which permits a board of directors to pass a resolution designating one or more committees that may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation. Id. at 75. In doing so, the court rejected plaintiffs' contention that the full board, by beginning an investigation and by appointing the special committee, reserved to itself the job of making an informed decision on the demand and thus only the board, not the executive committee, had the authority to reject plaintiffs' demand. Id. at 76. The court also rejected plaintiffs' contention that the dispute as to which body appointed the special committee, the full board or the executive committee, raised a strong inference that the executive committee was trying to protect committee members who were named as wrongdoers in the demand. Id. at 77.
We interpret the above-quoted statements from Scattered Corp. to mean that a pre-suit demand by a limited partner, to the general partner, in a derivative suit waives any contention that the general partner was incapable of acting on the demand. Conversely, making demand assumes that the general partner is capable of acting on the demand. We understand the phrase  capable of acting on the demand to mean that the general partner's board could properly appoint a special committee to investigate the demand and make recommendations to the board of the general partner. Additionally, the statements in Scattered Corp. that any alleged bias or self-interest on the part of the board or a committee authorized to act on that demand should become part of the court's inquiry into whether the board or committee acted independently and in good faith, or whether it conducted a reasonable investigation, see id. at 75, to mean that when a special committee is appointed, the inquiry under the business judgment rule focuses on the independence of the committee because that is the body that conducts the investigation. The board then decides whether to adopt the findings of the special committee. In effect, the board and committee are treated as one and the same. Applying these principles, we conclude that the PRC-Iowa board properly and lawfully appointed the special committee to investigate Whalen's demand. Authority supporting appointment of the special committee by the PRC-Iowa board is found in section 8.2 of the Amended and Restated Agreement of Limited Partnership of TCG which states in pertinent part: [T]he General Partners shall have the exclusive right to manage the business of the Partnership and are hereby authorized to take any action of any kind and to do anything and everything they deem necessary with respect thereto. We believe that the language of section 8.2 of the partnership agreement is sufficiently broad to include the authority of the board to appoint a special committee to investigate a demand made by a limited partner. Additional authority supporting appointment of the committee is found in Delaware Code Annotated title 6, section 17-403(c) which states in pertinent part: (c) Unless otherwise provided in the partnership agreement, a general partner of a limited partnership has the power and authority to delegate to 1 or more other persons the general partner's rights and powers to manage and control the business and affairs of the limited partnership, including to delegate to agents, officers and employees of the general partner or the limited partnership, and to delegate by a management agreement or another agreement with, or otherwise to, other persons. Unless otherwise provided in the partnership agreement, such delegation by a general partner of a limited partnership shall not cause the general partner to cease to be a general partner of the limited partnership. [8] See also Del.Code Ann. tit. 6, § 1518 (stating that a partner's rights and duties are subject to any agreement between them). Pursuant to section 8.2 of the partnership agreement and Delaware Code Annotated title 6, section 17-403(c), the board of PRC-Iowa appointed a special committee of nonboard members of the general partner. The special committee in turn appointed independent counsel which then conducted an extensive investigation of all evidence presented by plaintiff Whalen. Upon completion of its investigation, the special committee completed a report and recommended to PRC-Iowa's board that the allegations made in Whalen's demand had no merit. Based on this recommendation, the PRC-Iowa board was capable of, and did, deny Whalen's demand. The district court found that the special committee acted independently of the PRC-Iowa board, acted in good faith, and conducted a reasonable investigation. Based on the special committee's report, the court further concluded that PRC-Iowa acted with proper business judgment in following the special committee's recommendation and denied Whalen's demand. The court rejected Whalen's argument that defendants Connelly and Ellers stand on both sides of the transactions that caused injury to the partnership. The district court stated: [t]he transactions Plaintiff complains about, however, were mediated through corporations which were either affiliates of Defendant Connelly or of which Defendant Ellers was an officer and/or a director. The Court therefore finds that the appointment of Mr. Ganassi and Mr. Nelson, completely independent directors not beholden to John Connelly or Edward Ellers, and not affiliates of either of them, was entirely appropriate in this case, and serves to insulate the directors of PRC-Iowa, Inc., from any claim that they are not independent or free of self interest. The Court therefore finds that when Plaintiff made his demand upon PRC-Iowa, Inc., he conceded the independence of the directors of PRC-Iowa, Inc. By making these statements, the court, in effect, examined whether the special committee acted independently. We also believe it was appropriate for Connelly and Ellers, as directors of the PRC-Iowa board, to appoint a special committee given the fact that Whalen had sued Connelly and Ellers in Whalen I. We also agree with the district court's decision that special committee members Ganassi and Nelson were independent directors not beholden to Connelly or Ellers and thus were appropriate and disinterested persons to investigate the allegations made in Whalen's demand letter. Finally, we find no merit in Whalen's contention that the board of PRC-Iowa somehow abdicated its authority or responsibility as general partner by allowing PCI to appoint the special committee. Instead, the record shows that PRC-Iowa appointed the special committee. The record also shows that the PRC-Iowa board decided at a meeting held June 21, 1995, to adopt the findings and recommendations of the special committee. This shows that the PRC-Iowa board made the ultimate decision concerning whether to pursue the claims made in Whalen's demand letter. In summary, we conclude that the district court properly found that the special committee was properly and lawfully appointed. Additionally, even though the district court stated that Whalen conceded the independence of the PRC-Iowa board by making a demand, we believe the above discussion demonstrates that the district court also proceeded to adequately evaluate whether the board, acting through the special committee, was sufficiently independent. We thus need not decide as a matter of law whether, under Delaware law, the corporate concession rule applies to Whalen's derivative action.