Cambridge Ret. Sys. v. Bosnjak, C.A. No. 9178-CB (Del. Ch. June 26, 2014) (Bouchard, C.)
In this memorandum opinion, the Court of Chancery granted in part and denied in part the defendants’ motion to dismiss for failure to make a pre-suit demand on the board and for failure to state a claim, holding that demand was excused and that the plaintiff failed to allege adequately a breach of fiduciary duty or waste of corporate assets where the board of directors acted consistently with the terms of a stockholder-approved plan for director compensation.
In this derivative action, the plaintiff, Cambridge Retirement System, a stockholder of Unilife Corporation (“Unilife”), challenged transactions in which the defendants, Unilife’s board of directors, granted equity awards and paid cash compensation to themselves. At the time the challenged compensation was awarded, Unilife’s board of directors consisted of seven members, of which six were outside directors. Due to a resignation, the board consisted of six members, of which five were outside directors, at the time the complaint was filed.
Each equity award to the defendants was subject to, and received, stockholder approval. In addition to the equity awards, the defendants received cash compensation. Although the compensation structure was disclosed in a proxy statement, stockholder approval was not sought for the defendants’ cash compensation. Combining the equity awards and the cash compensation, the directors received $1,356,040 in 2012, approximately 25% of Unilife’s revenue for that year, and $668,240 in 2013, approximately 24% of Unilife’s revenue for that year. According to the plaintiff, the compensation constituted an extraordinary percentage of Unilife’s revenue and was excessive in comparison to other companies in Unilife’s market.
In denying the defendants’ motion to dismiss pursuant to Rule 23.1, the Court held that demand was excused because five of the six board members were personally interested in their own compensation. The Court found that the directors’ interest in their own compensation created reasonable doubt that they were disinterested and independent under Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984). The Court explained that appearing on both sides of a transaction means that a director is interested and payment of compensation to a board is a classic form of self-dealing.
The defendants contended that a director’s interest in compensation should not be “disabling” unless the compensation is material to the director. The Court declined to apply a materiality standard to a self-dealing transaction in the demand futility context because substantial precedent holds that, when self-dealing is present, alleging that the challenged transaction was material to the director is unnecessary. In addition, § 144 of the Delaware General Corporation Law applies to self-dealing contracts regardless of whether the transaction is material to the director. Because demand was excused and the defendants did not move to dismiss the portion of the fiduciary duty claim regarding cash compensation, the cash compensation claim survived.
The Court, however, granted the defendants’ motion to dismiss the plaintiff’s challenge to the equity compensation awards pursuant to Rule 12(b)(6). The Court held that the plaintiff failed to allege facts that cast doubt on the validity of the stockholder approval of the equity compensation plan, which is necessary to rebut the presumption afforded by the business judgment rule. According to the Court, self-interested transactions will be upheld if approved by a majority of stockholders, unless the plaintiff can show that the transaction was a gift of corporate assets, waste, ultra vires, illegal, or fraudulent. The Court explained that, in the absence of one of the aforementioned exceptions, a director does not breach the duty of loyalty when acting consistently with a stockholder-approved plan.
The plaintiff also alleged that the stockholder approval was not valid because material facts regarding compensation for directors at comparable firms were omitted from the proxy on which the votes were based. Under Delaware law, information is material if disclosure of the omitted fact has a substantial likelihood of altering the “total mix” of information as viewed by a reasonable investor. The Court found that the proxy statement disclosed the exact number of options, exercise price for the options, exercisability period of the options, and schedule over which the options would vest. Therefore, the plaintiff could not legitimately claim that the material terms of the transactions were not disclosed.
The Court then held that the plaintiff failed to state a claim for corporate waste. Although the amount of compensation granted to the directors may have raised questions of fairness, the Court determined that the amount of compensation did not rise to the level of corporate waste because the plaintiff’s allegations failed to plead adequately a “complete failure of consideration.”