Chancery Allows Claim for Breach of Fiduciary Duty for Approval of Stock Options in Violation of Stock Option Plan
Pfeiffer v. Leedle, C.A. No. 7831-VCP (Del. Ch. Nov. 8, 2013).
Issue Addressed: Whether the approval of stock option grants that exceeded the maximum number of stock options allowed under the stock incentive plan was the basis for a breach of fiduciary duty claim against both the board that approved it and the executive who received the stock option grants?
Short Answer: Yes.
The Court denied a motion to dismiss under both Court of Chancery Rule 12(b)(6) and Court of Chancery Rule 23.1. The Court found that there was a prima facie showing of a clear violation of the stock option plan and that the board either knowingly or deliberately exceeded its authority by granting options in excess of the number allowed under the plan. That knowing or deliberate violation of the stock option plan implicated a duty of loyalty, the breach of which cannot be exculpated by a charter provision adopted pursuant to Section 102(b)(7) of the Delaware General Corporation Law.
Moreover, the Court found that there was a reasonable inference that the executive who received the options in excess of those authorized by the plan knew or should have known that his receipt of those options was in violation of the plan, which also supported a claim for a breach of his fiduciary duty.
This 26-page opinion provides an excellent overview of the reason for the pre-suit demand requirement as well as the two major tests for determining pre-suit demand futility under Aronson and Rales.
The Court explained the high threshold that needs to be met under the second prong of the Aronson test which in essence requires that one rebut the business judgment rule presumption. That high threshold was met in this case. See footnotes 24 and 25.
The opinion includes a concise reiteration of the business judgment rule as well as a reminder that the business judgment rule does not only protect “correct” decisions. Rather, it also protects “reasonable decisions made by a board that is informed and acting in good faith,” even when those decisions are ultimately incorrect. See footnote 28.
The Court emphasized that the business judgment rule will not be rebutted and demand will not be excused when a plaintiff only alleges that a board merely failed to follow the terms of a stock incentive plan. Such an allegation fails to address the critical question of how the board reached the result that it did. However, when a board knowingly or deliberately failed to adhere to the terms of a stock incentive plan, a plaintiff can sufficiently circumvent the business judgment rule presumption by demonstrating that the action of the board was a clear and unambiguous violation of a stock incentive plan. The Court explained a prior decision which involved those facts. That decision was Sanders v. Wang, 1999 WL 1044880 (Del. Ch. Nov. 8, 1999) [coincidentally that decision was issued on the same day in November as the instant decision, albeit 14 years earlier].
The Sanders decision determined that it was not a valid exercise of business judgment for a board to exceed the number of authorized shares allowed by a plan. The Sanders case does not support pre-suit demand excusal whenever the terms of a stock plan are violated, but rather, Sanders teaches that when a plaintiff presents particularized allegations that indicate that the board clearly violated an unambiguous provision of the stock plan, it is proper to infer that such violation was committed knowingly or intentionally and, therefore, that demand should be excused. See footnote 38.
In the instant case, the Court concluded that there were sufficient allegations that the board clearly violated the unambiguous provisions of the stock plan, and therefore pre-suit demand was excused. Although the Sanders case granted judgment on the pleadings for the wrongful authorization of awards under the stock incentive plan, the pleadings in the instant case were not advanced enough for that type of motion.
The Court explained that because the allegations survived Rule 23.1, by necessity they would survive the less stringent standard under Rule 12(b)(6). The Rule 12(b)(6) standard is one of “reasonable conceivability” which asks whether there is a “possibility of recovery” under any reasonably conceivable set of circumstances.
The Court also allowed an unjust enrichment claim against the executive who received the options in excess of those authorized by the plan.