This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Delaware Court of Chancery recently allowed the same shareholder who successfully challenged a 2015 Investors Bancorp Inc. director and officer compensation plan to pursue a new suit over a similar 2019 replacement plan adopted one month after the court approved the settlement of the first action in Elburn v. Albanese, et al., No. 2019-0774-JRS, memorandum opinion (Del. Ch. April 21, 2020).

Vice Chancellor Joseph R. Slights’ April 21 memorandum opinion found plaintiff Robert Elburn passed the tough pre-suit demand test by showing the IBI directors might not act impartially in response to his breach-of-fiduciary-duty charges because they had made a “quid pro quo” arrangement with two top officers that enabled the first suit’s settlement.

Corporate litigators should note the court’s rejection of the defendants’ novel argument that to clear the threshold demand hurdle, a suit must plead “newspaper facts” – i.e. who, what, when, where and how details of the alleged wrong – to satisfy the particularized pleadings requirement of Court of Chancery Rules 12(b)(6) and 23.1.

Not always fatal

Although such specifics might sometimes be required under Rule 9(b) to prove a fraud claim, “the lack of this ‘specificity’ when pleading either fraud or demand futility is not, de jure, ‘fatal’ to the claim,” and derivative plaintiffs usually have less access to the background of deals they challenge, the court said.

The April 21 decision was the second time Elburn’s sued over a $50 million IBI stock award and cleared the pre-suit demand hurdle.

The Chancery Court dismissed his challenge to the directors’ 2015 equity incentive plan that awarded stock to the employee directors – principally CEO Kevin Cummings and COO Domenick Cama – but the Delaware Supreme Court reversed and remanded, finding possible self-dealing that would negate the protection of the business judgment rule.  In re Inv’rs Bancorp, Inc. S’holder Litig., 177 A.3d 1208 (Del. 2017).

A settlement of the first suit, approved June 21, 2019, called for the two executives of the Delaware-chartered bank holding company based in Short Hills, New Jersey, to give back all of their awards and for the non-executive directors to return an average of 40% of theirs for a 75% total reduction

New award, new suit

But when the board adopted a replacement plan one month later restoring all of the two top officers’ awards, Elburn filed a new derivative action claiming the executives conspired with the other board members to forfeit all of their awards — allowing the others to keep about 60% of theirs in the pact.

In return, the quid pro quo provided that as soon as the settlement won court approval, the non-employee directors would disloyally adopt a replacement plan that essentially duplicated the scope of the top officers’ award, again damaging the shareholders, Elburn’s new derivative action alleged.

Elburn said although directors have latitude to award lavish compensation to top executives, both board actions included a fatal element of self-interest—in the new case, a pact that let the non-employee directors keep most of their money from the first plan in return for replacing the executives’ award.

Moreover, the board only hinted that it might consider additional stock awards in a proxy issued in advance of a 2019 director election and never updated that disclosure after adopting the costly and unwarranted replacement stock plan, the suit said.

A chance to prove quid pro quo

Vice Chancellor Slights said the plaintiff’s allegations are sufficiently particularized to give him a chance to substantiate his conspiracy theory, noting that Elburn specifically charges that the executives and board agreed to the quid pro quo pact before the settlement of the first suit.

However, “targeted discovery is likely to reveal rather quickly if the quid pro quo agreement alleged in the complaint was actually reached,” he said. “If it was not, defendants are likely to earn summary judgment.”

The vice chancellor denied defendants’ motion for summary judgment on the fiduciary duty claims for failure make a pre-suit demand, but he refused plaintiff’s request for summary judgment on his charge that the directors violated their disclosure duty through misrepresentations and omissions in their 2019 director election proxy.

He quickly dispensed with the charge that the proxy misled investors to believe the board had only begun to consider a new stock plan when in fact that decision was imminent at the time of the proxy.  The charge is “not enough to state a viable disclosure claim, much less carry his burden to earn summary judgment on that claim,” the vice chancellor said.

A material failure to supplement?

However, the disclosure claim that the directors failed to supplement the proxy to indicate that the board had approved the compensation plan may have been an omission – but was it material to the shareholders’ decision to vote for the incumbent directors, the court asked?

The answer to that question, it said in denying the motion, can be found in further discovery as to how much the shareholders understood and approved of the likely size and cost of a new stock compensation plan for their directors and officers.

He noted that “the cases plaintiff cites where this court has ordered new director elections involved far more serious malfeasance than the disclosure violations plaintiff has alleged here.”