• Thu. Sep 22nd, 2022

In-Depth Review Blog Don’t Let the Fox Enter the Hen Coop: Lessons from the El Pollo Loco Decision on the Independence of the Ad Hoc Litigation Committee

ByStephanie M. Akbar

Jul 13, 2022
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In a recent split decision in Diep v. Trimaran Pollo Partners LLC et al.the Delaware Supreme Court, sitting en banc, addressed the level of independence required of members of special litigation committees recommending the dismissal of shareholder derivative actions.

After a shareholder filed a lawsuit alleging directors and officers of fast-food restaurant chain El Pollo Loco, as well as the company’s majority shareholder, engaged in insider trading and misconduct to their fiduciary obligations, the defendants (including nominal defendant El Pollo Loco) have decided to dismiss the action for lack of prior demand and failure to declare. The Delaware Court of Chancery dismissed the petition, finding that the plaintiff successfully litigated insider trading allegations and also demonstrated that the petition would be futile because the majority of the board faced substantial risk. of responsibility. El Pollo Loco’s Board of Directors then appointed a Special Litigation Committee (“SLC”) with exclusive authority to investigate and act on shareholder derivative claims. Two of the three SLC members, William Floyd and Carol Lynton, were on the board of directors of El Pollo Loco at the time the defendants sought to have the derivative suit dismissed.

The SLC conducted what appeared to be a thorough investigation, resulting in a 377-page report, after which it decided to end the litigation. Applying the standard set out in Zapata Corp. vs. Maldonado, 430 A.2d 779 (Del. 1981), which places the burden on the SLC to show that there is no contested issue of material fact regarding the independence, good faith, or reasonableness of the investigation and of the SLC’s findings, the Delaware Court of Chancery granted the SLC’s motion and dismissed the case. On appeal, the plaintiff shareholder argued that SLC lacked independence because, although none of the members of SLC served on the board during the period of alleged misconduct, a majority had participated in the decision to to seek the dismissal of the action and had therefore “prejudged” the claims.

In a majority opinion written by Chief Justice Seitz, the Delaware Supreme Court found that the company had discharged its duty under Zapata to establish the independence of SLC members and confirmed dismissal. The majority was unconvinced by the argument that Floyd and Lynton’s membership on the board of directors of El Pollo Loco at the time of the defendants’ motion to dismiss undermined their independence. Although Floyd and Lynton attended a board meeting where there was an “ongoing litigation update”, that alone was not enough to show that either other of the individuals “substantially approved or participated” in the decision to file the petition on behalf of El Pollo Loco. The majority concluded that “mere knowledge of a matter does not compromise independence” in the absence of evidence that a member of the SLC had approved the filing of the motion to dismiss.

Judge Valihura is the author of the only dissent. She inferred that El Pollo Loco’s board of directors had at least tacitly approved and authorized the filing of the motion to dismiss when El Pollo Loco affirmatively sided with the motion to dismiss and then played a “role prominent” in presenting arguments on the request, rather than remaining neutral. Judge Valihura noted that this “was clearly authorized by someone” and that “someone” most likely was the board of directors of El Pollo Loco since “a company acts through its board of administration”. Further, because the motion went beyond technical or procedural arguments and “challenged the very substance of the allegations” that the SLC was then tasked to investigate, Judge Valihura found that Floyd and Lynton’s membership to the board of directors of El Pollo Loco when the decision was made to file this petition cast doubt on their independence.

This split decision highlights the factual nature of the Zapata independence investigation; it defies sweeping generalizations and instead requires examination of the particular circumstances in which the SLC was formed. However, it remains clear that the decision to appoint an SLC, the timing of its formation, and the composition of its members are each decisions that can significantly alter the course of derivative litigation. A carefully constituted SLC can take control of derivative claims and ensure that these lawsuits are handled in the best interests of the company – but only if the SLC can demonstrate that it is independent, objective and able to properly investigate. faith in claims.


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