CDX Holdings, Inc. (f.k.a. Caris Life Sciences, Inc.) v. Kurt Fox, No. 526, 2015 (Del. June 6, 2016) (Holland, J)
In this split decision, a 4-1 majority of the Delaware Supreme Court affirmed the Court of Chancery’s post-trial ruling that Caris Life Sciences’ (“Caris” or the “Company”) board of directors (the “Board”) breached a stock incentive plan by failing to fairly value certain stock options that were cancelled as part of a spinoff/merger transaction. In doing so, the majority upheld the trial court’s $16.3 million judgment in favor of the option holders and confirmed the primacy of a trial court’s factual and credibility determinations on appeal.
The case arose from a transaction whereby Caris, a privately held corporation, sold one of its operating business units to Miraca Holdings, Inc. (“Miraca”) for $725 million (the “Miraca Transaction”). To minimize taxes, the Miraca Transaction was structured using a spin/merge structure in which Caris would spin off certain assets to a subsidiary, and then what remained of Caris would be merged into a wholly owned subsidiary of Miraca.
The Miraca Transaction had the effect of cancelling certain Caris stock options that were issued to Caris employees pursuant to a stock incentive plan (the “Plan”). Under the terms of the Plan, the Company was contractually obligated to provide to the option holders the amount by which the fair market value (“FMV”) of each share covered by an option exceeded the exercise price thereof. The Plan required the Board, as the Plan’s administrator, to determine the FMV. The Plan also provided that the Board’s FMV determinations were conclusive unless they were deemed “arbitrary and capricious.”
The underlying lawsuit commenced when a Caris employee, representing a class of option holders, contended, among other things, that the Company breached the Plan because (i) members of management, rather than the Board, determined the FMV, and (ii) the FMV determination was not made in good faith and resulted from an arbitrary and capricious process. After a three-day trial in the Court of Chancery, the trial court found in favor of the option holders.
The trial court found that the value of the options was determined by the Company’s senior officers through a “bad faith” process that undervalued the options to avoid corporate-level tax. Although the court found that the Board members might have “honestly believed” in the lower FMV calculated by the officers, the trial court ultimately discredited their testimony as the product of hindsight bias because contemporaneous evidence showed that the Board members were not as confident in the valuation before the transaction occurred as they appeared to be at trial. Further, because the trial court found that the Company’s management, as opposed to the Board, determined the FMV, the trial court held that the Company breached the terms of the Plan.
On appeal, the Delaware Supreme Court affirmed in a 4 to 1 vote. Writing for the majority, Justice Holland applied a deferential “clearly erroneous” standard of review, and affirmed the trial court’s decision on the basis that it was supported by the trial record and the product of an “orderly and logical deductive reasoning process.” The Court was especially inclined to defer to the trial court’s factual determinations because the trial court’s findings of fact were “based in part on testimony of live witnesses” whose “demeanor and credibility” the trial judge could evaluate.
In an uncommon dissent for the Court, Justice Valihura strongly disagreed with the majority opinion. The dissent concluded that many of the trial court’s factual findings, particularly the ones based on “hindsight bias,” were “logically disconnected” from the trial record and strained the limits of deference to trial-court fact finding. Justice Valihura cautioned that the Court should be “skeptical of court rulings predicated on social science studies,” like those relied on by the trial court relating to hindsight bias. The dissent would have held that the Company did not breach its obligations under the Plan because the Board’s decision to rely on the senior officers’ FMV determination was not arbitrary or capricious.