Corporate

Chancery Allows Claim for Excess Compensation in Sale Transaction

The Ravenswood Investment Company, L.P. v. Winmill, C.A. No. 3730-VCN (Del. Ch. May 31, 2011).

Brief Overview

This case involved a plaintiff who is a significant stockholder in a holding company managed by the individual defendants, a father and his two sons.  The complaint alleges breaches of fiduciary duty regarding the adoption of a stock buyback plan, the adoption of an options plan, the issuance of options to themselves, and the decision by the company to vote in favor of a transaction involving the sale of the interest of a subsidiary in a third entity.  This memorandum opinion grants in part and denies in part a motion to dismiss.  The Court only denied a motion to dismiss to the extent that the Court allowed a claim to proceed regarding the vote of the defendants in favor of the sale of an interest in an affiliated third entity that was alleged to be both self-interested and unfair to the company.

Brief Overview of Legal Analysis

First, the Court reviewed the familiar standard for a motion to dismiss under Court of Chancery Rule 23.1 based on the two-pronged test of Lewis v. Aronson to determine whether presuit demand was excused.  See 473 A.2d 805, 814 (Del. 1984).  The Court also discussed the separate analysis under Rule 12(b)(6) for a motion to dismiss for failure to state a claim. 

(1) Adoption of Stock Option Plan

The Court observed the well-known deference that applies to compensation decisions by a company for its executives but also recognized the exception where the individuals comprising the board and the management of the company are the same as those receiving the compensation. In those instances, the board bears the burden of proving that the salary and bonuses they pay themselves are entirely fair unless the board employs an independent compensation committee or submits the compensation plan to shareholders for approval.  See footnote 44.  Neither safeguard was employed here, and therefore, the defendants had the burden of demonstrating that the stock option plan was entirely fair to the company and its shareholders, although the plaintiff bears the burden of alleging facts that suggest the absence of fairness.  See footnote 45.

The plaintiff here alleged that defendants adopted the stock option plan with the intention to acquire a larger percentage of the shares of the company in order to dilute the public shareholders' equity.  Of course, the Court cited to other decisions holding that an options plan is not necessarily unfair simply because it has a dilutive effect on shareholders' equity.  Moreover, the motion to dismiss in this case did not seek dismissal of the claims regarding the issuance of the options, and therefore, the Court did not need to address the dilution claim.  However, a problem for the plaintiff in this case was that it did not allege facts suggesting unfairness in adopting the options plan because even if all the options were exercised the defendants would not obtain a majority, and therefore, the Court dismissed the claims challenging the adoption of the plan-as opposed to the issuance of the options.

(2) Claims Regarding the Adoption and Execution of a Stock Buyback Plan

The Court regarding these claims as derivative  in nature, and interpreted the claims as challenging the buyback plan in terms of either: (i) diminishing the value of the company, or (ii) reducing the proportional ownership of the public shareholders.  However, the Court found that the plaintiff did not allege with sufficient particularity facts indicating that the defendants were interested parties to the stock buyback plan or that the decision to engage in the buyback program was not the product of a valid business judgment.  In sum, the Court could not discern any "particularized allegation that would excuse Ravenswood from making demand with regard to this plan."

(3) Sale by Company of its Interest Affiliate

The plaintiff challenged the approval by the company, as a 22% shareholder in an affiliate, of the sale of the affiliate's 50% interest in a company called York and the acceptance by two directors of the company of separate compensation in connection with that sale.  The allegation is that the acceptance of that compensation tainted the decision of the company to vote its shares in favor of selling the interest that the company owned in the affiliate.  The Court discussed whether those claims were direct or derivative and whether the derivative claims survived the motion to dismiss under Rule 23.1. 

Because two of the three directors involved had a "material, disqualifying self interest" when they voted the shares of the company in favor of the sale of York, the claims did survive a motion to dismiss under Rule 23.1.  Likewise, the claims survived a motion to dismiss under Rule 12(b)6 because the allegations in the complaint were that the compensation was wrongfully paid to the directors in connection with the transaction which resulted in a benefit to the company from the transaction being smaller than it should have been.

Read more Delaware business litigation case summaries and commentary on Delaware Corporate and Commercial Litigation Blog, a blog hosted by Francis G.X. Pileggi, of Fox Rothschild LLP.

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