(1) Whether board approval of a supplemental retirement bonus was a breach of fiduciary duty to the extent that it constituted waste and did not qualify for a tax deduction; and (2) Whether a stock option plan for the directors was self-interested and not entitled to the benefit of the business judgment rule.
(1) The Court found a failure to plead demand futility and dismissed the waste claim, and the Court found that Delaware law did not impose a fiduciary duty, per se, to minimize corporate taxes, thus rejecting a related tax argument about the deductibility of the compensation paid to a retiree; (2) The Court found also, however, that the stock option plan for directors did not have sufficient limitations despite shareholder authorization, and therefore, could be considered self-interested and not entitled to the benefit of the business judgment rule.
See Zucker v. Andreessen, 2012 WL 2366448 (Del. Ch. June 21, 2012) (decided one week prior to this case and dismissing a claim of corporate waste for a termination package of $40 million for the terminated CEO of Hewlett-Packard Company)
This 43-page decision contains a comprehensive and exemplary exegesis of the Delaware law on both waste claims as well as the related high threshold to establish demand futility for such a claim based on an alleged breach of fiduciary duty by directors. The waste claim related to an argument that a $1.8 million supplemental retirement “bonus” for a retiring CEO, in addition to an existing array of retirement benefits that he was previously granted, was wasteful.
In addition to the waste claim based on the supplemental “going away present” of $1.8 million (in addition to previously granted retirement benefits), plaintiff argued that the board breached its fiduciary duty by failing to minimize corporate taxes to the extent that the executive compensation did not meet the requirements for deductibility of Section 162 of the Internal Revenue Code. Section 162 provides for tax deductibility of executive compensation in excess of $1 million if certain requirements are met.
Moreover, the plaintiff challenged a stock option plan for directors which, although authorized by the shareholders, gave almost unfettered discretion to the directors in terms of deciding how many shares they were allowed to give themselves.
In addition to the exemplary recitation of the challenging requirements of Delaware law that must be met for a plaintiff to prevail on a claim that allegedly excessive compensation amounts to corporate waste, and the almost impossible threshold to establish a breach of fiduciary duty claim based on such an allegation (although it has been done, for example, in a case highlighted here), the Court in this opinion also provides a thorough discussion of the pre-suit demand requirements and the two-prong analysis under Aronson for establishing demand futility. This particular claim was dismissed for failure to establish demand futility.
No Per Se Duty to Minimize Corporate Taxes
In connection with the demand futility analysis and providing helpful examples of successfully establishing particularized facts that raise reasonable doubt that directors are disinterested and independent, such as when a director sits on both sides of a transaction or derives a benefit from a transaction that is not shared by the corporation or all stockholders generally, the Court observed that: “there is no general fiduciary duty to minimize taxes.” (citing Freedman v. Adams, 2012 WL 1099893, at *12 (Del. Ch. Mar. 30, 2012)). However, the Court noted that: “This is not to say that under certain circumstances overpayment of taxes or a poor tax strategy might not result from breaches of the fiduciary duties of care or loyalty or constitute waste.”
In its discussion of whether the retirement bonus constituted waste, the Court cited to prior Chancery decisions that recognize an exception to the common law rule that would otherwise prohibit retroactive executive compensation. See footnotes 46 and 47. Those cases recognize that retroactive bonuses are not per se impermissible or inappropriate where the amount awarded is not unreasonable in view of the services rendered.
Stock Options for Board of Directors
An additional claim of the plaintiff was that the stock option plan for the directors gave them the sole discretion in terms of the number of stock options they could give themselves for compensation. The Court used the hypothetical example that if they so chose, the directors were able to award each other stock options worth $21 million each for a total value of $260 million. The Court distinguished the decision of In Re 3COM Corp. Shareholders Litigation, 1999 WL 1009210 (Del. Ch. Oct. 25, 1999), which involved a stock option plan for directors which the Court in that case found to enjoy the protection of the business judgment rule because the terms of that stock option plan were sufficiently restricted in terms of the parameters and limitations imposed on the amount of stock options that could be given to the board within their discretion.
By contrast, the Court in this case found that the stock option plan of the directors did not enjoy the business judgment rule protection because there were insufficient limitations on the amount of stock options that the board could grant itself. Specifically, the Court in this case reasoned:
“The sufficiency of definition that anoints a stockholder-approved option or bonus plan with business judgment rule protection exists on a continuum. Though the stockholders approved this plan, there must be some meaningful limit imposed by the stockholders on the Board for the plan to be consecrated by 3COM and receive the blessing of the business judgment rule, else the ‘sufficiently defined terms’ language of 3COM is rendered toothless. A stockholder-approved carte blanche to the directors is insufficient. The more definite a plan, the more likely that a Board’s compensation decision will be labeled disinterested and qualify for protection under the business judgment rule. If a Board is free to use its absolute discretion under even a stockholder-approved plan, with little guidance as to the total pay that can be awarded, a Board will ultimately have to show that the transaction is entirely fair.” (emphasis in original).
The Board’s self-interested decision to award bonuses to themselves must be evaluated based on the entire fairness standard, but all other claims regarding executive compensation were dismissed.
SUPPLEMENT: The venerable Professor Bainbridge comments here on this case and the larger question of directors voting on their own compensation (and being subject to claims of excessive compensation.)