Recently, the Delaware Court of Chancery in Pfeiffer v. Leedle declined to dismiss a shareholder derivative action against a board for breach of fiduciary duty, where the directors allegedly approved stock options exceeding the maximum number of options permissible under the corporation’s stock incentive plan. C.A. No. 7831-VCP (Del. Ch. Nov. 8, 2013).
The Stock Incentive Plan provided that no participant could receive options relating to more than 150,000 shares of stock in any calendar year. Nevertheless, the board of directors allegedly awarded the CEO nearly 450,000 stock options in 2011, and 285,000 stock options in 2012.
Defendants moved to dismiss the complaint for failure to make a demand, and for failure to state a claim. The Court of Chancery rejected both arguments. Read More
Corporations contemplating going private should take note of recent rulings from the Delaware Court of Chancery, which provide clear guidance on how to structure their transactions to reduce the risk of being subjected to the “entire fairness” standard of review.
Several months ago, the Delaware Court of Chancery issued an important MFW decision, in which Chancellor Strine set forth the procedural mechanisms a company can employ so that a going-private transaction with its controlling stockholder can be reviewed under the deferential business judgment rule, as opposed to the more stringent entire fairness standard. In that decision, Chancellor Strine held that the business judgment rule would apply if: (1) the controlling stockholder at the outset conditions the transaction on the approval of both a special committee and a non-waivable vote of a majority of the minority investors; (2) the special committee was independent, (3) fully empowered to negotiate the transaction, or to say no definitively, and to select its own advisors, and (4) satisfied its requisite duty of care; and (5) the stockholders were fully informed and uncoerced.
More recently, in SEPTA v. Volgenau, C.A. No. 6354-VCN (Del. Ch. Aug. 5, 2013), Vice Chancellor Noble provided further clarity on when a sale of a company with a controlling stockholder will be entitled to business judgment rule review. In SEPTA, Vice Chancellor Noble applied the business judgment rule and granted summary judgment to the defendants in case that challenged the acquisition of SRA International by Providence Equity Partners. Like the change-in-control transaction in MFW, the change-in-control transaction in SEPTA was negotiated by a disinterested and independent special committee and approved by a majority of the minority stockholders. Unlike MFW, however, where the controlling stockholder was the buyer in the transaction, SEPTA involved a transaction in which a third party was the buyer, and in which the controlling stockholder agreed to roll over a portion of his shares into the merged entity. Read More
Several weeks ago we asked whether directors of public companies face potential liability for not preventing cyber attacks. But what about liability for other acts of oversight? Can directors be held personally liable for money damages when they have done nothing affirmatively wrong?
Generally, the answer is no. Many states, like Delaware, allow corporate charters to include provisions that protect directors (and sometimes officers) from money damages for certain breaches of fiduciary duty. Acts that are not protected include breaches of the duty of loyalty, intentional misconduct, knowing violations of the law or receiving an improper personal benefit. But where plaintiffs seek money damages for breaches of the duty of care, exculpatory provisions in corporate charters typically provide directors a defense to the claims.
Practically speaking, these provisions protect directors against claims of negligence, and some courts have held the provisions even go so far as to protect against “reckless indifference.” The protection stops, however, when a director consciously disregards his or her duties. For example, and with reference to the earlier discussion on cyber attacks, an exculpatory provision might not shield a director from money damages where (i) a damaging cyber attack occurred, and (ii) it could be proven that the director exhibited a “sustained or systematic failure to exercise reasonable oversight” over the company’s cybersecurity, such that it evidenced the director’s conscious disregard of cybersecurity. Read More
We previously discussed how important a special negotiating committee of independent directors can be when defending against stockholder challenges to change-of-control transactions – particularly for going private transactions with controlling stockholders, which usually require boards to be able to prove the “entire fairness” of the transaction. This week, in an important decision that may reach the Delaware Supreme Court, In re MFW Shareholders Litigation, the Delaware Court of Chancery again affirmed the importance of special committees in those circumstances, and offered a road map to companies and controlling stockholders on how to structure going private transactions.
Nearly two decades ago, in Kahn v. Lynch, the Delaware Supreme Court held that where (1) a special committee of independent directors or (2) a majority of the non-controlling stockholders approves a merger with a controlling stockholder, it shifts the burden of proving the entire fairness of the transaction from the defendants to the stockholder challenging the transaction. Last year, in Americas Mining Corp. v. Theriault, the Delaware Supreme Court reiterated that the use of a properly functioning special committee of independent directors is an integral part of the best practices that are used to establish the entire fairness of a merger with a controlling stockholder. Read More
Four derivative lawsuits against Facebook’s directors relating to alleged disclosure issues surrounding the company’s initial public offering have a new status: Dismissed. Last month, Judge Robert Sweet of the Southern District of New York dismissed the suits on standing and ripeness grounds, finding that IPO purchasers have no standing to pursue claims related to alleged misconduct that took place before the IPO. The dismissed derivative suits were “tag-along” actions that largely parroted allegations made by investors in a parallel securities class action also pending before Judge Sweet, and had sought to hold Facebook’s directors liable for damages the company might incur as a result of the securities class action.
In dismissing the suits, Judge Sweet held that plaintiffs who buy stock in an IPO lack standing to pursue derivative claims based on alleged misstatements in an IPO registration statement. As Judge Sweet explained, in order to have standing to sue derivatively on behalf of a company, a plaintiff must have owned stock in the company at the time of the alleged misconduct. The registration statement that the plaintiffs allege to have been misleading, however, was finalized and filed with the SEC two days before the IPO. Judge Sweet rejected plaintiffs’ attempts to create standing by arguing that the wrong continued through the date of the IPO because the directors did not correct the allegedly misleading statements by that date. Read More
When a shareholder makes a demand on a company to pursue litigation, the company’s board can look to generally well-developed law to determine how to evaluate the demand. Though there is no one particular procedure a board must employ, there are numerous cases that explain how the board must inform itself about the demand in order to reach a good faith, “rational business decision” about whether to accept or refuse.
The rules for considering a shareholder demand are pragmatic, and afford corporate boards a dependable road map for responding to shareholder requests.
One open question (at least in Delaware, where it matters most) has been whether a board’s informed, good faith decision to defer action on a demand constitutes a “rational business decision” that is protected by the business judgment rule. Delaware courts have long held that while an informed board can refuse a demand, the one thing a board cannot do is nothing. At the same time, however, corporations often face the circumstance where there are follow-on shareholder litigation demands entirely duplicative of existing litigations or investigations. In those circumstances, a board could have any number of business justifications for wanting to defer action on the demand until the ongoing proceedings are resolved, but that would seem to violate the rule against doing nothing.
Genius rock lyricist Geddy Lee of RUSH once wrote “If you choose not to decide, you have still made a choice.”
Accordingly, the Ninth Circuit and certain federal district courts have recognized that a board’s informed, good faith decision to defer action on a demand during pending litigation or investigations is itself a decision that can be shielded by the business judgment rule. For example, in 2009, the Ninth Circuit found there was a “compelling” business justification for deferring action on a demand where the company’s pursuit of the demand’s allegations could be cast as an admission of wrongdoing in ongoing litigation. Read More
On August 17, 2012, a shareholder filed a derivative suit in Delaware federal court against Viacom Inc.’s board of directors, alleging they wasted corporate assets by awarding lavish corporate bonuses. In a novel approach that hardly mentions the “say-on-pay” provisions of Dodd-Frank, the plaintiff argued that the company violated §162(m) of the Internal Revenue Code. Section 162(m) limits corporate tax deductions that can be taken by a company for any senior executive compensation over $1 million to that which is determined by objective, performance-based criteria such that a “third party having knowledge of the relevant facts could determine whether the goal is met.” 26 CFR § 1.162-27(e)(2)(ii).
The complaint alleges that Viacom’s tax deductions for the compensation in excess of $1 million paid to executive chairman Sumner Redstone and two other senior executives were based on subjective criteria like “leadership and vision” and therefore violated Section 162(m). The complaint seeks to force repayment to Viacom of $36 million in past compensation. The complaint also seeks broader voting rights on executive compensation issues. Specifically, the plaintiff wants Class B shareholders to have voting rights on executive compensation (currently, only Class A shareholders have them).
The complaint further alleges that Viacom’s Compensation Committee awarded these annual bonuses to its senior executives in a manner that violated its own shareholder-approved 2007 compensation plan, which required the Committee meet the requirements of §162(m). Read More