In Julian v. Eastern States Construction Service, Inc., 2008 WL 2673300 (Del. Ch., July 8, 2008), read opinion here, the Chancery Court required directors to disgorge a $1.3 million bonus they had given themselves in a self-interested manner, without any independent protections, and based on their failure to satisfy their burden to demonstrate the entire fairness of their decision.
The money quote follows (no pun intended) with the court’s reasoning that provides excellent guidance for anyone attempting to challenge the decision of board members to pay themselves large bonuses:
Self-interested directorial compensation decisions made without independent protections, like other interested transactions, are subject to entire fairness review.FN92 Directors of a Delaware corporation who stand on both sides of a transaction have “the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts.”FN93 They “are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.”FN94 The two components of entire fairness are fair dealing and fair price. Fair dealing “embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.”FN95 Fair price "assures the transaction was substantively fair by examining ‘the economic and financial considerations.’ “ FN96 (emphasis added.)
The two aspects of entire fairness are not independent. Rather, “the fair dealing prong informs the court as to the fairness of the price obtained through the process. The court does not focus on the components individually, but determines the entire fairness based on all aspects of the entire transaction.”FN97
*** [The Court further explained the reasoning for its conclusion as follows:]
To summarize, the Benchmark Bonuses were the product of an unfair process. The record indicates no coherent, credible reason for the bonuses other than in reaction to Gene’s retirement. Additionally, there was no notice, meaningful deliberation, or independent advice or research before the board’s action. In fact, as to the Management Group Bonus,
Bomberger had no clear idea what he was approving. In addition, the price was also unfair. There was no historical precedent for the size of the bonus. For example, Gene, who worked for the Eastern States Group through nearly all of 2005, received nothing.FN99 Finally, I do not find Stevens’ expert testimony persuasive. His “Independent Investor
Test” is so subjective and unsupported by work of other experts in the relevant field, that I find it unreliable and unhelpful in the circumstances of this case. I also note Bomberger could not cite any Delaware law that has adopted or supported Stevens’ theory. Therefore, I conclude Francis, Richard, and Bomberger failed to demonstrate the Benchmark
Bonuses were entirely fair and breached their fiduciary duty of loyalty to Benchmark when they approved them.FN100FN92. Valeant Pharms. Int’l v. Jerney, 921
A.2d 732, 745 (Del. Ch.2007).
FN93. Weinberger v. UOP, Inc., 457 A.2d
701, 710 (Del.1983).
FN94. Id.
FN95. Id. at 711.
FN96. Valeant Pharms., 921 A.2d at 746
(quoting Weinberger, 457 A.2d at 711).*** FN99. By 2005, the Julian Brothers had
created a common family paymaster,
Eastern States Management Group. At the
close of each year, the different Julian
Businesses would contribute money to
Eastern States Management Group which, in
turn, would make distributions to the
brothers. The Julian Brothers chose this
system, knowing specific businesses would
contribute more or less in a given year, but
overall it would balance out, stabilizing the
flow of distributions.
FN100. In making a business decision,
Delaware law presumes “ ‘the directors of a
corporation acted on an informed basis, in
good faith, and in the honest belief that the
action taken was in the best interests of the
company.’ “ See, e.g., In re Walt Disney Co.
Deriv. Litig., 906 A.2d 27, 52 (Del.2006)
(quoting Aronson v. Lewis, 473 A.2d 805,
812 (Del.1984)). Bomberger’s individual
defenses that his vote was not necessary to
approve the bonuses and that he did not
discuss the bonuses before the meeting, do
not excuse his approval of a plainly selfinterested
transaction. If anything, they work
against him as evidence that he did not make
a business decision in good faith on an
informed basis.