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Espinoza v. Zuckerberg, No. 9745-CB (Del. Ch. Oct. 28, 2015) (Bouchard, C.)

October 28, 2015

In a decision reinforcing the importance of observing corporate formalities, Chancellor Bouchard found that a controlling stockholder cannot ratify a board’s self-dealing with something as informal as an affidavit, a conversation with directors, or “liking a Facebook post of a proposed corporate action.”

The plaintiff, suing derivatively, challenged the Facebook board’s decision to increase compensation to its outside, non-management directors, a group that included six of the eight board members. The board conceded that a majority of its members were interested in the transaction, presumptively triggering the entire fairness standard of judicial review. However, the board argued that since a fully informed disinterested majority of stockholders had ratified the increased compensation, the board’s decision warranted the more deferential business judgment rule review.

The ratification had come in the form of an affidavit and subsequent deposition testimony from Mark Zuckerberg, who controls more than 61% of Facebook’s voting power. As a Facebook director, Zuckerberg had attended the board meeting at which the new compensation plan was discussed and approved. As an inside director, he is not a participant in the new plan and was therefore disinterested in its approval. 

The Court held that “stockholder ratification of a self-dealing transaction must be accomplished formally by a vote at a meeting of stockholders or by written consent in order to shift the standard of review” from entire fairness to the business judgment rule. Then, applying the entire fairness standard, the Court denied the defendants’ motion for summary judgment on the plaintiff’s breach of fiduciary duty claim.

In discussing the two modes by which stockholders assent to corporate action, the Court noted that both voting at a stockholder meeting and acting by written consent “ensure precision...and transparency to all stockholders.” When seeking assent by a vote at a meeting of stockholders, boards must give proper notice, prepare and make available a list of stockholders, disclose all material information about the question presented, and keep a record of the proceedings. Assent by written consent requires “prompt” notice to the non-consenting stockholders of the corporate action and “strict compliance with the ministerial requirements...such as the dating of the consent by each consenting stockholder.” The Court observed that Delaware courts’ insistence on observing formalities when seeking stockholder assent avoids “ambiguity and misinterpretation” while fostering “certainty and efficiency.”

The Court concluded that Zuckerberg’s purported ratification lacked the precision and transparency that must accompany stockholder action. For example, the Court found it “far from clear” that Zuckerberg’s deposition testimony was “a definitive ratification of a specific corporate act.” Zuckerberg had testified, “These are the people who I want...and who I think will serve the company best, and I think that the compensation plan that we have is doing its job of attracting and retaining them over the long term.” The Court noted that this statement did not mention the year of the compensation in question nor indicate final approval of a past compensation plan.

In finding Zuckerberg’s approval ineffective to ratify the board’s conflicted decision, the Court also rejected the defendants’ references to general agency principles. The Court critiqued the defendants’ reliance on Lewis v. Vogelstein, 699 A.2d 335 (Del. Ch. 1997), a decision that discussed ratification’s roots in the common law of agency. The Court explained that Vogelstein did not stand “as a wholesale endorsement of importing” agency law into corporate law. Rather, “the decision demonstrates the need to be sensitive to the peculiarities of the corporate context when applying general principles of ratification.”  For example, in a traditional principal-agent relationship, the principal’s ratification “comes at a cost to that principal only,” whereas in a stockholder-board relationship, the conduct of the majority stockholder(s) affects the minority stockholders.

In addition to denying the defendants’ motion for summary judgment on the plaintiff’s breach of fiduciary duty claim, the Court also denied the defendants’ motion for summary judgment on the plaintiff’s claim for unjust enrichment, but granted the motion for summary judgment on the plaintiff’s claim for waste of corporate assets.

The full opinion is available here