Nemec v. Shrader, No. 305, 2009, Witkemper v. Shrader, No. 309, 2009 (Del. April 6, 2010)
In this opinion written by Chief Justice Steele on behalf of a majority of the Delaware Supreme Court sitting en banc, the Court affirmed the Court of Chancery’s April 30, 2009 dismissal of an action against Booz Allen Hamilton Inc. (“Booz Allen” or the “Company”) and its directors for failure to state a claim that the directors breached either contractual or fiduciary duties in connection with the redemption of plaintiffs’ stock under the Booz Allen Officers Stock Rights Plan (“Stock Plan”). Specifically, the Supreme Court held that, because the Stock Plan expressly authorized the timing and price of the redemption, plaintiffs’ claim for breach of the implied contractual covenant of good faith and fair dealing failed as a matter of law. Similarly, because the Stock Plan created contractual duties that superseded any distinct fiduciary duties that might have applied to the directors’ conduct, plaintiffs’ claim against the directors for breach of the fiduciary duty of loyalty also failed as a matter of law.
Throughout their tenure at the Company, plaintiffs, two retired Booz Allen officers described by the Court of Chancery as “founding fathers” of the Company’s modern business, were partially compensated with annual stock rights that could, under the Stock Plan, be converted into Booz Allen common stock. Under the Stock Plan, each retired officer held a “put right” for a period of two years from the date of his or her retirement, to sell his or her shares back to the Company for book value. After expiration of the put right, the Company had the right but not the obligation to redeem all or part of the retired officer’s stock at book value.
Plaintiffs, who challenged the April 2008 redemption of their stock, alleged that the directors improperly timed the redemption to deprive plaintiffs of the benefit of increased consideration they otherwise would have received in connection with the Company’s subsequent $2.54 billion sale of its government consulting business to The Carlyle Group. Plaintiffs alleged that the directors knew the transaction was likely soon to occur at the time of the redemption and chose to redeem the stock in order to increase the share of sale proceeds they, who collectively held more than 10% of the Company’s common stock, would receive. Pursuant to the redemption, plaintiffs received $162.46 per share based on the Company’s pre-transaction book value. Other stockholders subsequently received more than $700 per share in the Carlyle transaction. The redemption of plaintiffs’ shares prior to the transaction resulted in an additional $60 million benefit distributed to the other shareholders, approximately $6 million of which went to the directors. Plaintiffs alleged that defendants (i) breached the implied covenant of good faith and fair dealing inherent in the Stock Plan in choosing to time the redemption so as to deprive plaintiffs of the value obtained in the Carlyle transaction, (ii) breached their fiduciary duty of loyalty by diverting millions of dollars to themselves at plaintiffs’ expense, and (iii) were unjustly enriched.
In affirming the Court of Chancery’s decision dismissing all claims, the Supreme Court noted the narrow nature of the implied covenant of good faith and fair dealing and stated that “[t]he covenant is a limited and extraordinary legal remedy” and will not be used to “infer language that contradicts a clear exercise of an express contractual right.” The Court of Chancery found no cognizable claim for breach of the implied covenant because the Stock Plan explicitly authorized the board’s decision to redeem the stock, at the time and price they chose to redeem. As the Court of Chancery stated, “contractually negotiated put and call rights are intended by both parties to be exercised at the time that is most advantageous to the party invoking the option.” Plaintiffs, the Supreme Court held, had received exactly what they had bargained for under the contract.
Thus affirming the Court of Chancery’s finding that the directors’ conduct was expressly addressed by contract, the Supreme Court held that any claims challenging the conduct must be addressed within the analytical framework of a breach of contract claim, and that any fiduciary duty claims arising out of the same conduct would be superfluous. The Court thus held that plaintiffs’ claim for breach of the fiduciary duty of loyalty was properly dismissed. The Court further noted that any benefit the directors received in connection with the redemption and subsequent Carlyle transaction was shared pro rata with all other stockholders and, therefore, the redemption was not an “interested transaction” under Delaware law. Finally, because the alleged wrong arose from conduct governed by contract, plaintiffs’ claim for unjust enrichment was properly dismissed.
Dissenting on behalf of himself and Justice Berger, Justice Jacobs disagreed with the majority’s narrow construction of the implied covenant of good faith and fair dealing. Asserting that it is not enough that a party rely on express contract provisions to eliminate advantages the counterparty would otherwise receive to avoid running afoul of the implied covenant, Justice Jacobs stated that the challenged conduct “must also further a legitimate interest of the party acting in reliance on the contract.” In the dissent’s view, plaintiffs sufficiently alleged that the directors did not seek to further a “legitimate” interest of the Company in choosing to redeem the retired officers’ stock and, therefore, their complaints should have survived a motion to dismiss.