DELAWARE CORPORATE LAW DEVELOPMENTS RR DONNELLY: SEC HOT TOPICS INSTITUTE

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1 DELAWARE CORPORATE LAW DEVELOPMENTS RR DONNELLY: SEC HOT TOPICS INSTITUTE June 11, 2015 RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 1

2 Overview Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-Making and Reduce the Litigation Target Zone" by Chief Justice Leo E. Strine, Jr. Delaware Legislative Updates Washington Legislative Updates Private Company M&A Cigna v. Audax Healthcare: are target stockholders bound by release in LOT or post-closing indemnification? Great Hill: post-closing fraud liability of innocent stockholders Halpin: enforceability and interpretation of common stock drag along Cornerstone: 102(b)(7) defense for independent directors in actions subject to entire fairness review Healthways: aiding and abetting liability Executive and Director Compensation Friedman v. Khosrowshahi Seinfeld v. Slager Cambridge Retirement System v. Bosnjak Calma v. Templeton RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 2

3 DOCUMENTING THE DEAL: HOW QUALITY CONTROL AND CANDOR CAN IMPROVE BOARDROOM DECISION-MAKING AND REDUCE THE LITIGATION TARGET ZONE" by Chief Justice Leo E. Strine, Jr. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 3

4 The central premise of business judgment rule protection is that a decision is made by impartial decision makers whose interests are aligned with those of the stockholders. M&A transactions interject the possibility of self-interest, leading to intermediate standards of review such as Unocal and Revlon These standards are designed to shift power to independent board members, making them effective proxies for third-party bargaining. It is management that most often faces disparate incentives in an M&A transaction, i.e., are they better off with a strategic v. a private equity buyer? To counter that influence, the independent board members need unconflicted outside advisors with specialized expertise. The board should not let the CEO get out in front in discussions with a possible suitor, but should control the process. The board should select its own legal and financial advisors. It should look beyond management s recommendations in case management has co-opted the company s existing advisors. If the CEO is part of a bidding group, the legal and financial advisors to the independent directors should be of a caliber at least equal to the advisors on the other side. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 4

5 The board must pay particular attention to conflicts in selecting financial advisors. Financial advisors must be quizzed about material conflicts, such as: A strong relationship with a potential strategic buyer, An interest in the deal itself through a private equity arm, The desire to participate in the buy-side financing. The banker s individual team members should also disclose any potential interest in the deal. Hiring the independent legal advisor early can help the independent board members navigate investment banker selection and conflicts. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 5

6 The investment banker pitch process contains many potential pitfalls. What the bankers pitch is not their ability to give a caveat-laden fairness opinion but their M&A savvy the full range of their expertise and that is what the board should get. But to win the business, bankers may skew the financial analysis in their pitch book toward more optimistic valuations or views of the company s and its management s strength. Overly optimistic numbers will generally be negotiated down after bidders complete their diligence. This is also true of initial bids in an auction which may be revised downward after diligence. If the board accepts a lower bid, the earlier optimistic numbers provide fodder for the plaintiffs lawyers, unless the discrepancy is explained in the record RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 6

7 The board s best defense is a written record that explains the reasons for the board s decisions. The business advice given by the financial advisor must be in the record through minutes or board books or, ideally, both. Parties should resist the advice of counsel to the financial advisor seeking to sanitize the record to reflect only what is in the fairness opinion. At each important moment of judgment [e.g., conflicts handling, changes to base case projections], the record should reflect the reasons why the board acted and upon whose advice. Prior documentation should be reviewed to determine whether underlying assumptions have changes. The reasons for the changes should be reflected in the documentation to ensure that the changes were principled and based on objective factors untainted by self-interest. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 7

8 Minutes for such transactions should be more detailed, identifying the key factors considered by directors, the advisors input and why the board made its decision. Plaintiffs lawyers will focus on the amount of space given to topics on the agenda, so the written record should proportionately reflect the importance of the matter. Let the board know when the importance of the matter under consideration requires more detailed minutes, so that they will know what to expect. Red-lining is an important tool for alerting the board to changes in the materials, especially with respect to the bankers book. The board often sees multiple iterations of the same financial analyses, which are frequently just markups of the pitch book. Pointing out the changes and reviewing with directors the reasons for the material changes (e.g., key inputs to the valuation models) allows directors to understand and assess the impact of the changes Bankers need to stop frequently and ask if the directors understand the materials, giving them a chance to ask questions. Memorializing that discussion in the minutes helps directors in later depositions to defend the argument that changes were made to make the deal look better RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 8

9 Bankers and lawyers should give directors their best judgment not just an array of data. Bankers should not just present the football field the range of possible valuation methods and the value range but also their view of which methods are most applicable to the company and the proposed transaction That judgment should be reflected in the minutes Provide complex documents in advance of the meeting and allow directors to keep copies to study after the meeting. Allow them to take notes (with appropriate caveats). Don t merely post documents electronically for reading on an e-reader unless the directors are proficient at using such technology. Encourage perusal of paper. Strine s bottom line is: You and your clients get to write the play. Not only is there nothing wrong with that, but done properly and with integrity, there is everything right with that. The play should maximize the directors ability to bring their best collective judgment to bear on the difficult decisions they must make in the M & A context. And if avoiding legal embarrassment is a motivating factor for directors, use that factor for all it is worth to help them live up to what should be their overriding objective: doing the right thing for the company and the stockholders. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 9

10 DELAWARE LEGISLATIVE UPDATES RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 10

11 Legislative Update Forum Selection Fee Shifting Appraisal 204/205 Rapid Arbitration Act RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 11

12 Proposed Amendments to the DGCL On March 6, 2015, the Corporate Council of the Delaware State Bar announced proposed amendments to the Delaware General Corporation Law ( DGCL ) to address fee-shifting and appraisal arbitrage. The amendments are still making their way through the Delaware General Assembly (although they have been approved by the Corporation Law Section of the Delaware State Bar Association). RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 12

13 Forum Selection Amendments In Boilermakers Local 154 Retirement Fund v. Chevron Corp., an opinion issued in 2013 on a motion for judgment on the pleadings, then Chancellor, now-chief Justice Strine, held that forum selection bylaws are statutorily valid under the DGCL. Many corporations subsequently adopted forum selection provisions, either in their certificate of incorporation or in their bylaws. In reliance on Boilermakers, courts of other jurisdictions generally have enforced forum selection bylaws. In In City of Providence v. First Citizens BancShared, Inc., Chancellor Bouchard upheld a forum selection bylaw that chose a non-delaware forum as the exclusive jurisdiction for intracorporate claims. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 13

14 Forum Selection Amendments The forum selection amendments, if adopted into law, would effectively codify the Court of Chancery s decision in Boilermakers. The amendments would create a new Section 115 of the DGCL, which would expressly permit a certificate of incorporation or bylaw provision to select either the Delaware courts, or the Delaware courts and other forums, as the exclusive jurisdiction for intracorporate claims. Intracorporate claims, in turn, would be defined in new Section 115 as: claims, including claims in the right of the corporation (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery New Section 115 would prohibit a corporation from adopting a charter or bylaw provision selecting the courts in a different state, or arbitral forum as the exclusive jurisdiction for intracorporate claims. The effect of the forum selection amendments would be to allow a Delaware corporation to include in its charter or bylaws (1) a provision selecting the Delaware courts as the exclusive forum for intracorporate claims, or (2) a provision selecting the Delaware courts and one or more other forums as the exclusive forums for intracorporate claims. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 14

15 Fee-Shifting Amendments In ATP Tour, Inc. v. Deutscher v. Tennis Bund, the Delaware Supreme Court held that a fee-shifting bylaw i.e., a bylaw that would impose liability on a member of a corporation for a corporation s attorneys fees or other litigation expenses in connection with intracorporate claims if the member was not successful in such claims was facially valid with respect to a Delaware nonstock, membership corporation. ATP did not address expressly the validity of such fee-shifting provisions in the context of a stock corporation. Following ATP but prior to the release of the proposed fee-shifting amendments, at least thirty-three public stock corporations adopted feeshifting provisions and six stock corporations included such a provision in their initial public offering (IPO) certificate of incorporation or bylaws. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 15

16 Fee-Shifting Amendments A proposed DGCL provision would effectively prohibit stock corporations from adopting fee-shifting provisions with respect to intracorporate claims. The fee shifting proposal uses the definition of intracorporate claims from new section 115 (the forum selection proposal). The prohibition would not apply to non-stock membership corporations. The synopsis to the proposed legislation notes that the fee-shifting proposal is not intended to prevent the application of such provisions pursuant to a stockholders agreement or other writing signed by the stockholder against whom the provision is to be enforced. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 16

17 Appraisal Amendments A proposed amendment to the appraisal statute (Section 262) providing that, except for appraisal claims in connection with a short-form merger, appraisal for publicly listed stock cannot be pursued if (a) the shares seeking appraisal equal 1% or less of the stock outstanding and (b) the value of the shares for which appraisal is sought (as implied by the merger price) is $1 million or less. A proposed amendment to the appraisal statute permitting corporations to defray the statutory interest by pre-paying a cash amount to appraisal seekers, so that interest doesn t accrue on the pre-paid amount. The amount to be prepaid would be determined by the surviving corporation that is the respondent in the appraisal action. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 17

18 Forum Selection Amendments In Boilermakers Local 154 Retirement Fund v. Chevron Corp., an opinion issued in 2013 on a motion for judgment on the pleadings, then Chancellor, now-chief Justice Strine, held that forum selection bylaws are statutorily valid under the DGCL. Many corporations subsequently adopted forum selection provisions, either in their certificate of incorporation or in their bylaws. In reliance on Boilermakers, courts of other jurisdictions generally have enforced forum selection bylaws. In In City of Providence v. First Citizens BancShared, Inc., Chancellor Bouchard upheld a forum selection bylaw that chose a non-delaware forum as the exclusive jurisdiction for intracorporate claims. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 18

19 Forum Selection Amendments The forum selection amendments, if adopted into law, would effectively codify the Court of Chancery s decision in Boilermakers. The amendments would create a new Section 115 of the DGCL, which would expressly permit a certificate of incorporation or bylaw provision to select either the Delaware courts, or the Delaware courts and other forums, as the exclusive jurisdiction for intracorporate claims. Intracorporate claims, in turn, would be defined in new Section 115 as: claims, including claims in the right of the corporation (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery New Section 115 would prohibit a corporation from adopting a charter or bylaw provision selecting the courts in a different state, or arbitral forum as the exclusive jurisdiction for intracorporate claims. The effect of the forum selection amendments would be to allow a Delaware corporation to include in its charter or bylaws (1) a provision selecting the Delaware courts as the exclusive forum for intracorporate claims, or (2) a provision selecting the Delaware courts and one or more other forums as the exclusive forums for intracorporate claims. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 19

20 Sections 204 and 205: Ratification of Defective Corporate Acts Corporate acts in violation of the authority granted by the DGCL or the corporation s charter or bylaws may be void or voidable. Examples: Overissuance of stock. Creation and issuance of preferred stock not within the board s blank check powers. Out of order approval of charter amendment or merger agreement. Elections of directors with the wrong stockholder vote. Actions based on undated or predated stockholder consents. Under common law, void acts and stock cannot be ratified or otherwise validated on equitable grounds. Effective April 1, 2014: Section 204 enables the board and stockholders (if a stockholder vote was required for the act) of a corporation to ratify defective acts. Section 205 empowers the Court of Chancery to determine the validity of any defective corporate act (whether ratified under Section 204 or not), determine the validity of the ratification of any defective corporate act under Section 204, and modify or waive any of the procedures otherwise required by Section 204. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 20

21 Amendments to Sections 204 and 205 Multiple Defective Corporate Acts In A Single Set of Board Resolutions The proposed amendment to 204(b) confirms that the resolutions that the board of directors adopts to ratify a defective corporate act may include one or more other defective corporate acts. The proposed amendments make clear that the quorum and voting requirements applicable to each defective corporate act contained in a set of board resolutions ratifying one or more defective corporate acts are those applicable to each defective corporate act, viewed on an act-by-act basis. The proposed amendments to Section 204(c) are intended to conform that subsection to the amendment clarifying that the board may adopt a single set of resolutions ratifying multiple defective corporate acts. The proposed amendments provide that each defective corporate act rather than the board s resolutions ratifying one or more defective corporate act must be submitted to stockholders for their approval, except where the defective corporate act would not have required a vote of stockholders under the General Corporation Law, the certificate of incorporation or bylaws of the corporation, or any plan to which the corporation is a party, either at the time of the defective corporate act or the time the board adopts the resolutions ratifying the act (and provided that the defective corporate act did not result from a failure to comply with Section 203). 204(d) would also be amended to clarify that the quorum and voting requirements apply on an act-by-act basis. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 21

22 Amendments to Sections 204 and 205 Failure of the Incorporator to Elect the Initial Board The amendments add new section 204(b)(2), which addresses the situation in which the initial board of directors was not named in the original certificate of incorporation and has not been constituted by the incorporator. It permits those persons who have been acting as the corporation s directors under claim and color of an election or appointment to adopt resolutions ratifying the election of those persons who, despite having not been named in the certificate of incorporation or by the incorporator as the initial directors, first took action on behalf of the corporation as the board of directors. Certificate of Validation The proposed amendments dispense with the requirement that the board s resolutions ratifying the defective corporate act be attached to the certificate of validation. The proposed amendments require instead that the certificate of validation set forth specified information regarding the defective corporate act and the related failure of authorization. The changes to Section 204(e) clarify that a separate certificate of validation must be filed in respect of each defective corporate act that requires the filing of a certificate of validation, except in two limited cases. The first case occurs where the corporation had filed (or, to comply with the General Corporation Law, would have filed) a single certificate under another provision of the General Corporation Law to effect multiple defective corporate acts. The second case occurs where two or more overissues are being validated. In that case, a single certificate of validation may be used so long as the total increase in the authorized capital stock of each class or series of stock is effective as of the date of the earliest overissue referenced in the certificate of validation. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 22

23 Amendments to Sections 204 and 205 The amendments clarify the information that must be included in the form of certificate of validation in cases where: a certificate in respect of the defective corporate act had previously been filed and no changes are required to give effect to the ratification of the defective corporate act that is the subject of the certificate of validation the certificate as previously filed with the Secretary of State must be attached to the certificate of validation as an exhibit. a certificate in respect of the defective corporate act had previously been filed and changes are required to that certificate to give effect to the ratification of the defective corporate act that is the subject of the certificate of validation a certificate containing all of the information required under the other section of the General Corporation Law, including the changes necessary to give effect to the ratification of the defective corporate act, must be attached to the certificate of validation as an exhibit. the certificate of validation must also state the date and time as of which the certificate attached to it would have become effective the certificate attached to the certificate of validation under these circumstances need not be separately executed and acknowledged, and it need not include any statement required by any other section of the General Corporation Law that the instrument has been approved and adopted in accordance with such other section no certificate had previously been filed and the filing of a certificate was required to give effect to the ratification of a defective corporate act. a certificate containing all of the information required under the other section of the General Corporation Law must be attached to the certificate of validation as an exhibit the certificate of validation must also state the date and time as of which the certificate attached to it would have become effective the certificate attached to the certificate of validation under these circumstances need not be separately executed and acknowledged, and it need not include any statement required by any other section of the General Corporation Law that the instrument has been approved and adopted in accordance with such other section RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 23

24 Amendments to Sections 204 and 205 Stockholder Approval Section 204(d) would be amended to clarify that the only stockholders entitled to vote on the ratification of a defective corporate act, or to be counted for purposes of a quorum for such vote, are the holders of record of valid stock as of the record date for determining stockholders entitled to vote thereon. It does so by confirming that shares of putative stock will not be counted for purposes of determining the stockholders entitled to vote or to be counted for purposes of a quorum in any vote on the ratification of any defective corporate act. Action by Written Consent and the Required Notice Section 204(g) would be amended to provide that corporations that have a class of stock listed on a national securities exchange may give the notice required by Section 204(g) by means of a public filing pursuant to specified provisions of the Securities Exchange Act of The amendments would provide that, where the ratification of a defective corporate act is approved by consent of stockholders in lieu of a meeting, the notice required by Section 204(g) may be included in the notice required to be given pursuant to Section 228(e). The amendments would further clarify that, where a notice sent pursuant to Section 204(g) is included in a notice sent pursuant to Section 228(e), the notice must be sent to the parties entitled to receive the notice under both Section 204(g) and Section 228(e). The amendments to Section 204(g) would also clarify that no such notice need be provided to any holder of valid shares that acted by written consent in lieu of a meeting to approve the ratification of a defective corporate act or to putative stockholders who otherwise consented to the ratification. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 24

25 Amendments to Sections 204 and 205 Validation Effective Time Section 204(h)(6) currently defines validation effective time as the later of (x) the time at which the ratification of the defective corporate act is approved by stockholders (or, if no vote is required, the time at which the notice required by Section 204(g) is given) and (y) the time at which any certificate of validation has become effective. The amendments confirm that, in respect of the ratification of any defective corporate act that requires stockholder approval but does not require the filing of a certificate of validation, the validation effective time is the time at which the stockholders approve the ratification of the defective corporate act, whether the stockholders are acting at a meeting or by consent in lieu of a meeting pursuant to Section 228. Although the statute clarifies that, in such cases, the validation effective time commences upon the stockholders approval of the ratification of the defective corporate act, a corresponding amendment to Section 204(g) is being made to confirm that the 120-day period during which stockholders may challenge the ratification of a defective corporate act commences from the later of the validation effective time and the time at which the notice required by Section 204(g) is given. Finally, the amendments would amend the definition of validation effective time to permit the board of directors to fix a future validation effective time for any defective corporate act that is not required to be submitted to a vote of stockholders and that does not require the filing of a certificate of validation. Again, the 120-day period during which challenges to the ratification may be brought would commence from the later of the validation effective time and the time at which the notice required by Section 204(g) is given. The amendment is intended to obviate logistical issues that may arise in connection with the delivery of notices in situations where multiple defective corporate acts are being ratified at the same time. As amended, Section 204(h)(6) enables the board to set one date on which the ratification of all defective corporate acts approved by the board will be effective, regardless of when the notice under Section 204(g) is sent. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 25

26 Amendments to Sections 204 and Day Period Consistent with the proposed amendments that confirm that the 120-day period during which stockholders may challenge the ratification of a defective corporate act under Section 205 commences from the later of the validation effective time and the time at which the notice required by Section 204(g) is given, under amended 205(f), no such action may be brought after the expiration of 120 days from the later of the validation effective time and the time that notice of the ratification is given pursuant to Section 204(g), if notice is required under such section. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 26

27 Delaware Rapid Arbitration Act Overview: New legislation designed to give Delaware business entities greater capacity to resolve business disputes in a rapid and efficient manner through voluntary arbitration conducted by expert arbitrators under strict timelines. Opt-in Requirements: All parties must sign agreement to arbitrate with specific reference to the Delaware Rapid Arbitration Act. The agreement to arbitrate must be governed by Delaware law, but the deal documents need not be. One party must be a Delaware business entity; no party may be a consumer. Procedures: Final award must be issued within timeframe specified in the agreement or 120 days from arbitrator s appointment. Parties may agree by unanimous consent to extend the deadline for 60 days. Challenges to final awards due within 15 days; final award is deemed confirmed by the Court of Chancery 5 days after challenge period expires. Challenges taken directly to the Delaware Supreme Court by default. Parties can agree to private review by appellate arbitrators or to wave review. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 27

28 Delaware Rapid Arbitration Act Other Details: Arbitrator s fees reduced for missing deadlines; no fee if more than 60 days late. Arbitrators may be lawyers or experts; non-lawyer arbitrators empowered to hire counsel where appropriate. Delaware courts divested of jurisdiction to determine the scope of the arbitration. For example, the Court of Chancery may issue an injunction in aid of arbitration, but only until the arbitrator is appointed. Chancery also has jurisdiction to appoint an arbitrator if the chosen arbitrator refuses to serve, if the agreement does not provide how the arbitrator is to be chosen or if the contractual procedure fails, or with the consent of all parties. Arbitration may be held within or outside of Delaware, including outside the U.S. By default, arbitrators have authority to compel attendance of witnesses and the production of documents. Subpoena power (or power to award commission to permit depositions of a witness who cannot be subpoenaed) may be conferred by the agreement. Status: Passed by both chambers of the Delaware General Assembly, awaiting signature by the Governor. Takes effect 30 days after being signed into law. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 28

29 WASHINGTON LEGISLATIVE UPDATES RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 29

30 AMENDMENTS TO WBCA: - CORPORATE OPPORTUNITIES - UNIFORM BUSINESS ORGANIZATIONS CODE RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 30

31 Corporate Opportunities: 2015 Amendments to RCW 23B Provide specific approval mechanisms to set up safe harbor protections for a director or officer considering involvement in a business opportunity that might be a corporate opportunity Permit corporations to include in their articles of incorporation advance action provisions that limit or eliminate a director s or officer s duty to present a business opportunity to this corporation. Provide clear process if opportunity is presented and corporation disclaims the opportunity. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 31

32 2015 Corporate Opportunity Amendments Advance Action in Articles New section RCW 23B (5)(k) added to permissible article provisions By amendment to the articles of incorporation a corporation can have advance limitation/elimination of corporate opportunities. Precedent: DCGL 122(17): Siegman v. Tri-Star Pictures; MBCA Can cover directors and officers, but note further board approval for officers Importance for venture capital and private equity firms with investments and board presence Presentation/Disclaimer Process Effective disclaimer and use of opportunity not clear in case law New section RCW 23B similar process to that in RCW 23B for conflicting interest transactions RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 32

33 2015 Amended Sections RCW 23B (27) - Definition revision to Qualified Director RCW 23B (5)(k) - New section regarding inclusion of limitation in articles, distinction regarding officers RCW 23B (3) - Definition revision to Related Persons RCW 23B Safe harbor process (without advance provision in articles) for opportunity presentation and board or shareholder disclaimer (like conflicting interest procedures) RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 33

34 Uniform Business Organizations Code, The Uniform Law Commission Approach business corporation Common Provisions HUB limited partnership RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 34

35 Uniform Business Organizations Code General Provisions the HUB HUB and Spoke approach of Uniform Laws Commission ( NCCUSL ) for a uniform business organizations code Washington adopted the HUB, Article 1 General Provisions in S.B Centralizes common provisions such as registration, name use, filings, notices, Secretary of State functions, registered agents, foreign entities doing business in Washington, dissolution, reinstatement for profit and non-profit corporations, partnerships, limited liability partnerships, limited liability companies, cooperatives, etc. Article 1 will be effective January 1, 2016 Each type of business entity retains its entity-specific legal requirements Spoke provisions of the ULC act were not included what s next? RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 35

36 PRIVATE COMPANY M&A RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 36

37 Private Company M&A Important Delaware law developments concerning private company M&A: Cigna v. Audax Healthcare: are target stockholders bound by release in LOT or post-closing indemnification? Great Hill: post-closing fraud liability of innocent stockholders Halpin: enforceability and interpretation of common stock drag along RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 37

38 Private Company M&A - Cigna v. Audax Cigna v. Audax Health Solutions, 107 A. 3d 1082 (Del. Ch. 2014) (V.C. Parsons). Private company merger agreement Stockholders were asked to sign LOT containing release of claims All target stockholders were subject to an indemnification clawback of their merger consideration: No escrow Post-closing indemnification by all target stockholders for loss caused by breach of company reps; imposed directly by merger agreement whether or not holders signed support agreements Most reps and warranties survived months But certain fundamental reps survived indefinitely Some stockholders signed support agreements, agreeing contractually to the indemnification; Cigna did not, and sued RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 38

39 Private Company M&A - Cigna v. Audax Letter of transmittal: The Court invalidated the release in the LOT because there was no additional consideration for the release. Clawback: The clawback literally complied with facts ascertainable concept under Section 251. Under DGCL 251(b), any terms of a merger agreement may be made dependent on facts ascertainable outside of such agreement But the clawback violated implicit requirement of DGCL 251 that merger consideration be determinable with reasonable degree of precision. The Court held that to the extent the clawback was uncapped and applied for indefinite duration, it was not permissible. Court implicitly upheld: escrow (i.e., holdback instead of clawback) clawback for post-closing price adjustment if limited to 36 months or less (no ruling) RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 39

40 Private Company M&A - Cigna v. Audax Interesting issues raised If merger consideration must be determinable, is a large escrow really any different from a clawback? What about earn-outs? Private company securities? Most deals with escrows also include a clawback outside the escrow often indefinite and uncapped for certain breaches. Court s main concern seemed to be that the clawback period was indefinite o However, Delaware law will impose the applicable statute of limitations as an end date. o New Section 8106 expressly allows parties to choose up to 20 year survival periods. See Bear Stearns Mortgage Funding Trust 2006-SL1 v. EMC Mortgage LLC, 2015 WL (Del. Ch. Jan. 12, 2015) (V.C. Laster). RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 40

41 Private Company M&A - Cigna v. Audax Structuring the indemnity after Audax Contractual approach pre-closing joinder or support agreement (e.g., as condition to closing) true contract with pre-closing consideration should work for release as well Statutory approach holdback in escrow clawback for formulaic purchase price adjustment clawback limited to 36 months or less? if consideration is securities rather than cash: embed the adjustment terms in the security (e.g., deduct indemnification losses from liquidation preference) Pre-existing drag-along rights Use the proxy. See Halpin v. Riverstone National, Inc., 2015 WL (Del. Ch. Feb. 26, 2015) (V.C. Glasscock). Hybrid statutory/contractual approach in merger agreement, provide that % of merger consideration held back in escrow for years, but will be released early to any holder who contractually agrees to a clawback RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 41

42 Private Company M&A - Great Hill Great Hill Equity Partners v. SIG Growth Equity Fund, 2014 WL (Del. Ch. Nov. 26, 2014) (V.C. Glasscock). Discussed when affiliates of a selling corporation might be liable for fraud and whether innocent selling stockholders might be exposed to liability for fraud by those affiliates. Based on the pleaded allegations, Great Hill involved bad facts. The selling company s business depended heavily on certain third-party relationships. The buyer alleged that management actively concealed communications from the third parties to terminate these relationships. The buyer also alleged that management took action to permit questionable sales practices to continue so that the company s prospects looked better to the buyer. The buyer asked the CEO to roll over his equity. To induce the roll over, the principal stockholders acceded to an increased payout for the CEO under his employment agreement. The buyer allegedly did not know that the CEO s pay out was increased as a quid pro quo for rolling over. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 42

43 Private Company M&A - Great Hill Claims: Tort claims of fraud (fraudulent inducement, aiding and abetting fraud, civil conspiracy to commit fraud) Contract claims for breach of the specific reps and indemnification Unjust enrichment Fraud claims Court refused to grant motion to dismiss against the selling directors and stockholders. Facts sufficient to plead fraud claims Knowledge was attributed to a major stockholder because its principals were also selling company directors RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 43

44 Private Company M&A - Great Hill Contract claims The merger agreement had an indemnification provision that capped a stockholder s liability at different levels depending on the nature of the breach. But the exclusive remedy provision in the indemnification provisions carved out fraud or intentional misrepresentations: except (a) in the case of fraud or intentional misrepresentation (for which no limitations set forth herein shall be applicable)... the sole and exclusive remedies.... Sellers argued that the fraud carve out merely exempted claims against the fraudulent actors, but otherwise any claims against innocent stockholders were subject to the indemnification caps. Buyer argued that the fraud carve out meant that damages resulting from fraud would not be covered by the indemnity limitations and, therefore, innocent stockholders must provide indemnification for fraud. Court suggested that the better view may be that the limits on indemnification would apply to limit the exposure of innocent stockholders, but the court declined to resolve the issue on a motion to dismiss. Unjust enrichment The court also declined to dismiss claims for unjust enrichment against innocent stockholders. This matter has not been adequately addressed in the briefing, and I cannot say based on the record before me that the existence of a contract precludes recovery from innocent stockholders of benefits wrongfully obtained through fraud of those acting on their behalf. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 44

45 Private Company M&A - Halpin Halpin v. Riverstone National, Inc. (Del. Ch. Feb. 26, 2015) (V.C. Glasscock). Minority common holders sought to exercise appraisal rights, despite being party to a stockholders agreement that required them to vote for (or tender into) a deal approved by the majority. Under its terms, the obligation was not triggered unless the company gave the minority notice before the vote, which it did not; nor did the agreement give the majority a proxy to vote the minority s shares. Holding: minority not bound to vote yes, appraisal rights not lost. Open question: can common holders waive appraisal? Takeaways: not enough to just have a drag, must use it; get a proxy if possible; vote upfront (before controller delivers consent) RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 45

46 CORNERSTONE: SECTION 102(b)(7) DEFENSE FOR INDEPENDENT DIRECTORS IN ACTIONS SUBJECT TO ENTIRE FAIRNESS REVIEW RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 46

47 In re Cornerstone Therapeutics Inc., Stockholder Litig., 2014, 2015 WL (Del. May 14, 2015) The Delaware Supreme Court held that, regardless of the underlying standard of review for the board s conduct, including interested transactions subject to entire fairness, a claim seeking only monetary damages against a facially independent director of a Delaware corporation with an exculpatory charter provision must plead non-exculpated claims with respect to that director to survive a motion to dismiss. The case involved the consolidated appeal of two damages actions by stockholder plaintiffs arising out of go-private transactions involving a controlling stockholder. In both appeals: It was undisputed that the companies did not follow the process established by the Delaware Supreme Court in Kahn v. M & F Worldwide Corporation, and thus could not invoke the protection of the business judgment rule. So, entire fairness review presumptively applied to the transactions. The target corporations had exculpatory charter provisions, authorized under Section 102(b)(7) of the DGCL, insulating directors from liability for monetary damages arising from the breach of their duty of care. The independent directors moved to dismiss the claims against them, arguing that plaintiffs failed to plead any non-exculpated claims. The Court of Chancery denied the motions to dismiss, interpreting the Delaware Supreme Court s prior decisions in Emerald Partners v. Berlin to require denial of a motion to dismiss on the basis of entire fairness being the applicable standard of review. The Court of Chancery recommended certification of interlocutory appeal. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 47

48 The Delaware Supreme Court definitively stated, plaintiffs must plead a nonexculpated claim for breach of fiduciary duty against an independent director protected by an exculpatory charter provision, or that director will be entitled to be dismissed from the suit. The Court clarified that the Emerald Partners litigation did not answer the specific question at issue in these appeals. The Court emphasized that its statements in Emerald Partners that the Chancery Court read to require denial of dismissal of the claims against the facially independent directors in these appeals on the basis of the transactions at issue being subject to entire fairness review should be read in their case-specific context, which unlike these appeals, involved a viable, non-exculpated loyalty claim against each putatively independent director. The Court noted, [w]e decline to adopt an approach that would create incentives for independent directors to avoid serving as special committee members, or to reject transactions solely because their role in negotiating on behalf of the stockholders would cause them to remain as defendants until the end of any litigation challenging the transaction. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 48

49 HEALTHWAYS: AIDING AND ABETTING LIABILITY RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 49

50 Pontiac General Employees Retirement System v. Healthways, Inc., Del. Ch., Oct. 14, 2014: Transcript ruling on Motion to Dismiss. Dead Hand Poison Put: Provision at issue excludes from definition of continuing director : any individual whose initial nomination for, or assumption of office as, a member of that board occurs as a result of an actual or threatened solicitation of proxies or consents for the election or removal of one or more directors by any person or group Pled facts: Company debt documents historically contained only a poison put (and not a dead hand poison put); Dead hand poison put was included within days after stockholders overwhelming adopted a precatory proposal to stagger the board; and Documents produced in response to a 220 demand suggested no negotiation over this proposed change. Background law (Amylin) Poison Put (not dead hand) The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting such a provision, it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it. A provision so strongly in derogation of the stockholders franchise rights would likely put the trustee and noteholders on constructive notice of the possibility of its ultimate unenforceability. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 50

51 Aiding and abetting requires knowing participation in the breach by the non-fiduciary defendants. Satisfied if the defendant act[s] with the knowledge that the conduct advocated or assisted constitutes a breach of fiduciary duty. The adjective knowing modifies the concept of participation, not breach. It is not the fiduciary that must act with scienter, but rather the aider and abettor. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 51

52 With respect to the aiding and abetting claim, the Court held: While it is true that evidence of arm s-length negotiation negates claims of aiding and abetting, one is not allowed to propose terms, insist on terms, demand terms, contemplate terms, incorporate terms that take advantage of a conflict of interest that the fiduciary counterparts on the other side of the negotiating table face. (emphasis added). A third party puts itself at risk when it starts offering side benefits, entrenchment benefits, other types of concepts that create a conflict of interest for the fiduciaries with whom it s negotiating. There was ample precedent from this Court putting lenders on notice that [dead hand proxy put] provisions were highly suspect and could potentially lead to a breach of duty. Referencing SandRidge Energy and Amylin as the basis for its above holding. Based on the above, the plaintiffs aiding and abetting claims survived the defendant s motion to dismiss. See also The Fire and Police Pension Fund, San Antonio v. Robert J. Stanzione, et al. and Arris Group, Inc., C.A. No VCG, order (Del. Ch. Feb. 26, 2015); The Fire and Police Pension Fund, San Antonio v. Arris Group, Inc., No. 131, 2015, open. br. (Del. May 4, 2015); In re MGM Resorts International Litigation, C.A. No VCG (consol.) order (Del. Ch. May 28, 2015). RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 52

53 EXECUTIVE AND DIRECTOR COMPENSATION RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 53

54 Executive and Director Compensation: Increasing Litigation on Option Grants Historically, executive compensation has been difficult to challenge. See, e.g., Grimes v. Donald, 673 A.2d 1207, 1215 (Del.1996) ( If an independent and informed board, acting in good faith, determines that the services of a particular individual warrant large amounts of money... the board has made a business judgment. ); but see In re Citigroup Inc. Deriv. Litig., 964 A.2d 106, (Del. Ch. 2009) (refusing to dismiss complaint challenging compensation package and noting discretion under Delaware law to set compensation is broad but not unlimited ). New grounds for attacking compensation have developed. E.g., Section 162(m) lawsuits alleging that technical violations of plans that cause compensation to fall outside of 162(m) deductibility constitute waste and/or disclosure violation under Federal proxy rules. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 54

55 Failure to Comply with Plan Terms Over the past 2-3 years, litigation has shifted to attacking option grants to insiders as invalid because they have violated the terms of a stock plan. In a July 2014 opinion, Chancellor Bouchard noted that claims challenging the payment of compensation to an officer or director of a Delaware corporation based on an alleged violation of the terms of a compensation plan are a seemingly increasing area of litigation. Friedman v. Khosrowshahi, 2014 WL (Del. Ch. July 16, 2014) aff d, 2015 WL (Del. Mar. 6, 2015). Series of federal and state cases Abrams v. Wainscott, 2012 WL (D. Del. Aug. 21, 2012) Freedman v. Redstone, 2013 WL , at *9 (D. Del. July 16, 2013) aff d 753 F.3d 416 (3d. Cir. 2014) Halpert v. Zhang, 966 F.Supp.2d 406 (D. Del. Aug. 7, 2013) Pfeiffer v. Leedle, 2013 WL (Del. Ch. Nov. 8, 2013) Louisiana Mun. Police Employees Retirement System v. Bergstein, No VCL ( Simon Properties ) In Re Honeywell Int l Inc. Deriv. Litig., C.A. No CS (Del. Ch. Jan. 8, 2014) (TRANSCRIPT) Freedman v. Mulva, 2014 WL , at *4 (D. Del. Mar. 12, 2014) RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 55

56 Failure to Comply with Plan Terms These cases have two related elements: Have the clear terms of the plan been violated? Is a pre-suit demand excused? Generally, these cases are derivative cases, which require the plaintiff to either (i) demonstrate demand futility or (ii) make pre-suit demand (in which case, the board can decide to permit plaintiff to maintain the suit). An older Delaware Chancery decision, Sanders v. Wang, held that options purportedly granted under an option plan, but that did not comply with the plan, were void, and derivative litigation brought by a stockholder plaintiff could proceed against the directors without making pre-suit demand. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 56

57 Failure to Comply with Plan Terms Friedman v. Khosrowshahi, 2015 WL (Del. Mar. 6, 2015) The Delaware Supreme Court affirmed the Court of Chancery s dismissal of a breach of fiduciary duty claim related to an alleged violation of Expedia s stock incentive plan. The stock incentive plan granted the compensation committee the authority to make taxdeductible awards of restricted sock units to Expedia employees. The compensation committee was required to condition the award upon the achievement of one or more delineated performance goals. The plan expressly stated that the vesting of such awards could be subject to the satisfaction of any other conditions, such as continued employment, as the Committee may determine to be appropriate together with the achievement of one or more performance goals. Notably, the plan granted the compensation committee the authority to: amend awards previously granted (so long as the amendment did not affect the award s taxdeductible status) and to interpret the terms and provisions of the Plan and any Award issued under the Plan. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 57

58 Failure to Comply with Plan Terms The plaintiff in Friedman brought a derivative action challenging the grant of RSUs under the incentive plan to the CEO of Expedia. The terms and conditions of the awards initially conditioned its vesting upon the achievement of a performance goal and an additional operating income target. The compensation committee subsequently amended the terms and conditions of the award and removed the condition related to the operating income target. In a July 16, 2014 opinion, the Court of Chancery granted defendants motion to dismiss because the plaintiff failed to plead demand futility with particularity. Under the test from Aronson v. Lewis, demand is excused if particularized facts have been alleged to create a reasonable doubt either that (1) the directors are disinterested and independent or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Prior decisions from the Court of Chancery have held that the second prong of Aronson is satisfied, thereby excusing a pre-suit demand in a derivative action, where the plaintiff had sufficiently alleged a clear or intentional violation of a compensation plan approved by stockholders. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 58

59 Failure to Comply with Plan Terms The Court of Chancery in Friedman found that the plaintiff failed to assert allegations sufficient to infer that a majority of the board was interested or lacked independence or that the compensation committee committed a clear or intentional violation of the plan. The Court noted that under the terms of the plan, the compensation committee had the authority to waive the operating income target because such amendment did not affect the award s tax-deductible status. Further, the Court concluded that the plaintiff had, at most, identified a potential ambiguity in the RSU Award, which the compensation committee was expressly authorized to interpret under the terms of the plan. The Delaware Supreme Court upheld the Court of Chancery s finding that the complaint failed to allege any violation of the plan because (1) the board acted on a reasonable interpretation of the plan s terms and (2) to the extent the terms of the plan were ambiguous, the plan expressly gave the board authority to resolve any ambiguity. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 59

60 Failure to Comply with Plan Terms The Supreme Court s order in Friedman is noteworthy because it demonstrates that a provision in a compensation plan granting authority to the board or a committee thereof to interpret the terms of the plan or any award thereunder can be useful in overcoming a claim that the board or committee intentionally violated the plan. The Supreme Court s order also raised an interesting question. Traditionally, claims that directors breached their fiduciary duties by violating the terms of stockholder-approved compensation plans have been asserted derivatively as breach of fiduciary duty claims, which require a demand excusal analysis. The Supreme Court suggested that if such claims are brought as contract claims they may be subject to a different demand analysis. Specifically, the Supreme Court noted that Court of Chancery decisions arguably conflict on the issue of whether a stockholder-plaintiff must plead demand excusal if her claim is a breach of a stockholder-approved plan as a contract, and she seeks recovery under contract law. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 60

61 Failure to Comply with Plan Terms Risk of litigation remains in those cases where the violation of the plan is clear and unambiguous. o Further clarification is required in the wake of decisions like Leedle (2013) and Honeywell (2014). In those cases, plaintiffs appear to be asking for real concessions from the executives who received the grants (i.e., some give-back of compensation) in order to justify fee awards. o The request for real concessions appears to be driven in part by the Simon Properties litigation (spanning ), where the Court approved a mootness fee award. In 2011, defendants had amended the 1998 incentive plan to permit, in addition to performance based awards, the granting of options based solely upon the satisfaction of continuous service vesting requirements on such terms as may be established by the [Compensation] Committee. In response to the lawsuit, the defendants unilaterally decided that the compensation committee would not issue continuing service options unless the amendment authorizing such grants was approved by the stockholders at the 2014 annual meeting. In addition, the plan was amended to cap such grants to 600,000 in any year, unless a greater amount was otherwise approved by the stockholders. Ninety-seven percent of the stockholders approved amendments to plan in connection with the 2014 annual meeting. o As part of the action to moot the claims, the executive who had received 1 million options prior to the lawsuit only held 600,000 options by reason of the amendments to the plan. Plaintiffs were found to have caused the benefit and were awarded $1.76 million in fees. There is pending litigation where defendant corporations have brought actions under Section 205 of the DGCL to validate options. We will need to see how that litigation develops, and how it affects the dynamics of settling litigation. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 61

62 Self-dealing and Ineffective Stockholder Approval Option grants to directors subject to entire fairness as form of self-dealing Seinfeld v. Slager, 2012 WL (Del. Ch. Jun. 29, 2012) Vice Chancellor Glasscock held that a derivative claim alleging that directors breached their fiduciary duties by granting themselves excessive compensation survived a motion to dismiss. Similar claim dismissed in In re 3COM Corp. Sholder s Litig WL (Del.Ch. Oct. 25, 1999) (allegations failed to state claim in wake of options granted under a plan with sufficiently defined terms). Seinfeld rule: 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 stockholderapproved carte blanche to the directors is insufficient. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 62

63 Self-dealing and Ineffective Stockholder Approval Cambridge Retirement System v. Bosnjak, 2014 WL (Del. Ch. Jun. 26, 2014) A plaintiff stockholder of a public company, Unilife, filed breach of fiduciary duty claims against outside directors for awarding themselves equity grants and cash awards. The equity grants were submitted for stockholder approval at prior annual meetings, but the cash awards were not submitted for stockholder approval. The aggregate director compensation (for all directors total) was equal to 25% of the Company s revenues. The per director compensation, averaging $225,000, was over twice what directors of peer companies were paid. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 63

64 Self-dealing and Ineffective Stockholder Approval The Court in Cambridge held that demand was excused (i.e., the plaintiff could proceed with the litigation on behalf of the company) because the directors engaged in a selfdealing transaction. Because the directors were awarding themselves compensation, there was no inquiry into whether the awards were material to the directors. However, the Court dismissed the claims regarding the equity grants, because those grants were approved by a majority of the disinterested stockholders. In doing so, the Court held that the vote was fully informed even though the directors did not disclose that the compensation was higher than for peer companies: In my opinion, the absence of benchmarking information for outside directors was not a material omission... because the proxy statement disclosed all material terms of the precise equity awards that the stockholders were being asked to approve. The defendants did not move to dismiss the claims regarding the cash awards. The Chancellor observed that this was a sensible decision because the compensation constituted self-dealing and was not approved by stockholders. The defendants bear the burden of proving these grants are fair to the corporation. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 64

65 Self-dealing and Ineffective Stockholder Approval Calma v. Templeton, 2015 WL (Del. Ch. Apr. 30, 2015) A stockholder challenged, derivatively, the awards of restricted stock units (RSUs) granted to non-employee directors of the company under its stockholder-approved compensation plan, and the defendants moved to dismiss. Characteristics of the compensation plan: The company s directors, officers, employees, consultants, and advisors were all entitled to receive grants under the plan. The plan imposed a generic limit on compensation, whereby beneficiaries could not receive more than one million shares (or RSUs) per calendar year. Based on the company s stock price at the time the action was filed, one million RSUs were worth over $55 million. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 65

66 Self-dealing and Ineffective Stockholder Approval The total compensation (cash plus the fair value of the RSU awards) granted to nonemployee directors during the challenged time period ( ) was as follows: 2011: compensation ranged from $386,716 to $425,570 (with 4,000 RSUs granted at a grant date value of $339,320) 2012: compensation ranged from $333,160 to $388,160 (with 4,000 RSUs granted at a grant date value of $283,160) 2013: compensation ranged from $303,360 to $358,360 (with 4,000 RSUs granted at a grant date value of $253,360). The plaintiff argued that the RSU grants to the non-employee directors were excessive, when considered in conjunction with cash compensation the nonemployee directors received. The court focused on two of the plaintiff s theories of liability (i) breach of fiduciary duty and (ii) waste of corporate assets. The Court first concluded that the grants of RSUs to non-employee directors under the plan were self-dealing transactions and that the plaintiff established that demand was futile (a majority of the board in office when the complaint was filed had received RSU grants). RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 66

67 Self-dealing and Ineffective Stockholder Approval Breach of fiduciary duty claim The Court determined that the plaintiff stated a claim for breach of fiduciary duty. Defendants asserted a ratification affirmative defense arguing that stockholders approval of the plan was tantamount to ratification of the individual awards made under the plan. The Court noted the factual similarities to Seinfeld v. Slager and found that the company s stockholders did not approve, any action bearing specifically on the magnitude of compensation to be paid to its non-employee directors because the plan did not set forth the specific compensation to be granted to non-employee directors, nor did it set meaningful directorspecific caps on compensation. Finding no ratification defense and having already concluded that the RSU awards were selfdealing transactions, the Court proceeded under entire fairness. Defendants argued that the grants at issue were entirely fair because they were in line with the compensation of directors of peer companies. The plaintiff disputed whether some of the companies in the peer group brought forth by defendants were truly peers of the company based on market capitalization and other metrics. The court found that the plaintiff had raised meaningful questions as to whether certain companies should be included in the peer group, and thus found that the plaintiff stated a claim for breach of fiduciary duty. Waste claim The Court found that the plaintiff failed to state a claim for waste. The Court focused on the fact that the challenged equity grants were not one-time grants, but rather annual equity grants that served as the non-employee directors primary compensation. RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 67

68 Self-dealing and Ineffective Stockholder Approval Takeaways If directors are relying on a stockholder-approved compensation plan that allows for director grants, but does not specify the exact amount of grants, then the actual grants could be subject to challenge. However, dicta from Seinfeld v. Slager and Calma v. Templeton suggests that a meaningful ceiling on the amount of equity awards could constitute sufficient stockholder approval of grants to avoid entire fairness scrutiny. The Court in both Seinfeld and Calma took issue with the fact that based on the company s stock price and the limits imposed by the plans, a director could issue him or herself tens of millions of dollars worth of RSUs in a given year. Moreover, Calma suggests that where the compensation plan covers multiple and varied classes of beneficiaries, the ceilings should be beneficiary-specific, rather than one generic limit that applies to all beneficiaries (i.e. a limit for non-employee directors and a different limit for officers). RR DONNELLEY SEC HOT TOPICS INSTITUTE SEATTLE, WA 68