Fiduciary duty and other business governance disputes often are litigated and sometimes are arbitrated. Those disputes of course can involve businesses in the corporate form. Increasingly, they involve so-called “alternative entities”—businesses such as limited liability companies, some form of partnership (general, limited, limited liability, or master limited), or trusts.
The disputes can be between business owners and managers; between the owners; between the managers; between the managers and the business (such as a claim of entitlement to the advancement of defense expenses, or for indemnification), or in the bankruptcy context. Add to the mix potential insurance coverage disputes, including those involving major indemnification claims post-acquisition or post-divestiture. And, of course, business governance disputes also can involve nonprofit organizations.
Sometimes, at least seemingly, there is no alternative to litigate when principled negotiations have not been successful, or when injunctive relief is sought. In addition, litigation arguably has been beneficial to the extent that common law and statutory law have developed through the years as a result of lawsuits pursued throughout the country.
But it is easy to overlook the advantages of voluntary mediation of business governance disputes over litigation of those disputes. There are four such distinct advantages that should be considered on a clear day before a dispute arises and, in all events, at the outset of a dispute before litigation takes on a life of its own.
Minimizing cost and distraction: The first advantage is that resolution of a business governance dispute through mediation likely will minimize the cost and distraction otherwise associated with litigating the dispute. That minimization will go directly to the bottom line and will help preserve the sanity of the business principals, and permit them to focus on their day jobs—especially if the dispute can be successfully mediated pre-litigation, or at least at an early (ideally pre-discovery) stage.
Ability to shape/control the outcome: Second, resolution of a business governance dispute through mediation provides parties and their counsel with the opportunity to shape creative, mutually beneficial options and to control the ultimate outcome, mitigating the risk of an unanticipated and perhaps unfavorable one-sided result.
Confidential nature of the proceedings: Third, in litigation, the business governance dispute is on display for all the world. Even if certain filings are made under seal, redacted, publicly available versions of the documents will frame the dispute. Mediation, by its nature, is intended to ensure confidentiality of the proceedings and the outcome.
The opportunity for the parties to rebuild productive relationships: Finally, the parties to a successful mediation of a business governance dispute will have the opportunity to rebuild productive relationships going forward. This may seem unremarkable. But it can be especially important in the business governance dispute setting, because the peace achieved between the parties can have a materially positive effect on other constituencies.
For example, mutual benefit to the parties can result from shareholders, customers, vendors, regulators, prosecutors, rating agencies, analysts, potential investors, and others perceiving a righted-ship and clear sailing ahead.
But does any of this truly make a difference? Consider a hypothetical, drawn from numerous real-life scenarios—an illustration of where the rubber hits the road.
Company A was a U.S. publicly traded pharmaceutical corporation. Its specific focus was on developing and selling worldwide brain cancer treatment drugs. Company A’s founder held half of the issued and outstanding voting stock. Three retirement funds collectively held the other half, and they agreed to vote that stock as a bloc. Naturally, half of Company A’s board of directors were designated by the founder and the other half by the funds.
All seemed to go swimmingly for Company A since it went public. Board members were unified in naming a very talented CEO, and they shared a long-term strategic vision for Company A.
That is, until Company B came into the picture.
Company B was a privately held limited liability company, based off-shore, with no experience in pharma, but with lots of cash and with a desire to capitalize on what it projected would be positive results of Company A’s research and development, including promising clinical trials. Company B’s managing member reached out to Company A’s CEO to jointly explore strategic alternatives.
The CEO of Company A liked what she heard. In turn, she recommended to the board a hurried negotiation of a merger with Company B, with Company B to be the surviving entity. An agreement was reached, with hastily retained legal and financial advisers providing the best advice they could under the circumstances. A deal was announced.
The next day, investigative reporters published an article revealing a history of money-laundering and Foreign Corrupt Practices Act violations by Company B, neither of which was picked up by Company A’s due diligence.
A firestorm of shareholder lawsuits was leveled at Company A, its directors, officers, and advisers. Allegations ranged from fraud to breach of fiduciary duty. Company B was sued for aiding and abetting. With no limitations on venue, the suits were filed in several states and in numerous federal courts.
Company A’s stock price dropped precipitously. Most analysts that followed the stock changed their recommendations from “buy” to “sell.” Ratings agencies downgraded Company A’s debt. The U.S. Securities and Exchange Commission and the U.S. Department of Justice initiated separate but parallel investigations. The U.S. Food and Drug Administration initiated its own investigation.
Company A’s directors and officers demanded advancement of defense expenses. The directors designated by Company A’s founder favored providing the advancement (to himself and the other directors and officers), pursuant to the typical promise to repay amounts advanced if it later is determined that the recipients were not entitled to end-of-the-matter indemnification.
The directors designated by the three funds opposed advancement, believing that it was not in Company A’s best interests, and also citing its need for operating cash. The board was deadlocked.
The directors designated by Company A’s founder, and the officers, sought advancement from all three of Company A’s directors’ and officers’ insurance carriers since the company itself was not providing advancement.
The first carrier in the policy tower refused coverage, citing fraud exclusions. The second and third carriers likewise refused coverage, noting that the first coverage level hadn’t yet been exhausted.
The directors and officers filed suit against all three carriers. In addition, they filed an advancement enforcement action in the Delaware Court of Chancery, seeking expedited consideration of their claims and seeking prejudgment interest, post-judgment interest, and an award of “fees-for-fees”—the attorneys’ fees and other expenses incurred in prosecuting the action.
In the meantime, Company A provided notice to Company B that it was terminating the merger based upon Company B’s fraudulent inducement and breach of representations and warranties. Company B countersued, seeking specific performance of the merger agreement or, in the alternative, payment of the multi-million dollar termination fee.
The cases proceeded throughout the country. The SEC filed an enforcement action. The U.S. Justice Department sought and obtained indictments, including an indictment against Company A. The FDA initiated proceedings to bar Company A and its directors and officers from further involvement in the pharmaceutical industry.
Forum fights, depositions of directors and officers, discovery disputes, pretrial motion practice, hearings and trials ensured. Appeals followed.
Company A’s stock price was at a record low. Vendors were leery of doing business with the company. Potential customers—healthcare providers and individuals) fell away.
Company A ultimately filed for Chapter 11 bankruptcy protection, and the proceeding converted to a Chapter 7 liquidation. Virtually the only assets available were the D&O insurance policies and their proceeds.
Fights followed as to whose property those policies and proceeds were, and whether any sort of allocation was appropriate. Numerous directors and officers filed for bankruptcy protection. Company A was dissolved. Principals of Company B could not be located.
But what if some or all of the disputes described above had been successfully mediated?
Substantial costs associated with the litigation would have been avoided. The business principals would have been able to pursue the promising opportunities for innovation and societal benefit that Company A presented if, at the outset of the shareholder litigation, mediation had been considered.
Likewise, advancement disputes can be ripe for mediation, as can disputes between counterparties to a merger agreement and disputes between parties to a bankruptcy proceeding.
In Delaware, for example, members of the Court of Chancery often mediate one another’s pending cases at the request of the parties. The magistrate judges in the Delaware’s U.S. District Court also mediate matters pending in that court, and the U.S. Bankruptcy Court for the District of Delaware maintains a list of qualified mediators.
Perhaps most significantly, multi-jurisdictional disputes often can be effectively mediated by a single mediator.
With regard to the investigations launched by the SEC, the DOJ, and the FDA, notably each governmental agency openly encourages alternative dispute resolution generally and mediation in particular. The SEC’s website, for example, includes the following:
Mediation is a voluntary, non-binding process that allows parties to work with a mediator to try to quickly resolve differences. Mediation may result in a settlement that is mutually agreeable to all parties in the dispute, avoiding the need for arbitration or litigation.
The DOJ’s website says the following about the department’s Office of Dispute Resolution: “The mission of the Office of Dispute Resolution is to develop policy and to promote the effective use of alternative dispute resolution. …” See www.justice.gov/olp/alternative-dispute-resolution.
The Justice Department details its mediated case settlements on its website (see https://www.justice.gov/olp/settlements-achieved-through-adr), and it reports that, in 2015, it saved $14.2 million on litigation or discovery expenses, and spent more than $2.27 million for mediation services. See https://www.justice.gov/olp/alternative-dispute-resolution-department-justice.
The FDA, in connection with its Center for Drug Evaluation and Research states that, after a discussion with the CDER review team and the Division/Office Director,
If you are not satisfied with the outcome of that discussion, you may then take the matter to the CDER Ombudsman to discuss your options, one of which is for the Ombuds to informally investigate and facilitate resolution, either through shuttle diplomacy or mediation.
Is there a guarantee of resolving each and every one of the disputes? Of course not. But, had the parties and their counsel pursued mediation, they would have had the opportunity to work with one or more mediators to attempt in good faith to reach mutually beneficial outcomes, and to do so in a confidential setting.
Last, but certainly not least, had the parties and their counsel pursued mediation, they could have attempted to avoid Litigation Armageddon and to have pursued opportunities to rebuild productive relationships going forward.
There are special considerations to take into account in mediating business governance disputes. It is more important than ever to ensure that persons with settlement authority either participate in the mediation process or, far less preferably, be readily available by phone.
As a corollary, it is imperative that representatives of any potentially implicated insurers participate meaningfully in the mediation, even if subject to reservations of rights.
In addition, where settlement of a class action or derivative action results, other than on mootness grounds, presumably judicial action will be required under court rules to obtain approval of the settlement and payment of any appropriate fee award.
* * *
Counsel, whether in-house or outside, should have in their toolkits the option of mediating fiduciary duty and other business governance disputes. And business clients—whether the owners, the managers, the entities themselves, or others—will be well-served in giving early and serious consideration to that mediation option.
The task: The challenges of running a company facing multiple legal attacks.
The hypo: A pharmaceutical company’s merger explodes into litigation with the former suitor; its shareholders, insurers and board, and the government.
The (obvious) solution: Mediating corporate governance disputes to settle out some of these matters will help provide focus for the broader and potentially bigger fights.
The author is a partner with Young Conaway Stargatt & Taylor LLP in Wilmington, Del. He is chair of the Business Law Section of the American Bar Association. He is a member of the Panels of Distinguished Neutrals maintained by Alternatives’ publisher, the CPR Institute; he is on CPR’s Delaware At-Large Panel, and Banking, Accounting, and Financial Services Panel. He gratefully acknowledges helpful comments on this article received from Tom Sager, former Senior Vice President and General Counsel of E.I. du Pont de Nemours & Co.; former member of CPR’s board; a recipient of the 2009 CPR Institute Corporate Leadership Award, and currently a partner with Philadelphia-based Ballard Spahr LLP.
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