On January 14, 2013, the Delaware Supreme Court affirmed a trial court's denial of attorneys' fees in connection with a corporate waste claim filed against corporate board members for the board's decision to pay certain executive bonuses without adopting a plan that could make those bonuses tax deductible and potentially save $40 million for the company. In the complaint, the plaintiff alleged that the company's board committed corporate waste by failing to adopt a so-called §162(m) plan when awarding executive bonuses. Specifically, the plaintiff alleged that compensation awarded to corporate officers in excess of $1 million per year could be tax deductible only if it was paid pursuant to §162(m) of the Internal Revenue Code, but that the company had made payments totaling over $130 million from 2004 to 2007 which were not tax deductible. By failing to award those bonuses pursuant to a §162(m), the plaintiff argued that the company had committed corporate waste.
Shortly after the complaint was filed, the company did adopt a §162(m) plan, but it was never used because the company merged into a new entity several months later. As a result, the plaintiff agreed to dismiss the complaint as moot, but later filed a motion seeking $1 million in attorneys' fees on the grounds that the complaint benefitted the company by causing it to adopt a §162(m) plan. The trial court denied the motion, finding that the complaint was not meritorious when filed because it failed to adequately allege that demand on the board would have been futile. The plaintiff appealed.
The Delaware Supreme Court began its discussion by noting that a valid waste claim would deprive a board of the protection of the business judgment rule and be sufficient to excuse demand. In order to state a valid waste claim, the plaintiff was required to allege, with particularity, that the board authorized an action that no reasonable person would consider fair. In the complaint, the plaintiff alleged that the board was aware of the "tax deduction issue" when forming its compensation plan, but that it did not believe its compensation decisions should be "constrained" by §162(m). However, the plaintiff alleged that §162(m) did not in fact place any constraints on the board and allowed for bonuses based on a variety of objective performance criteria.
The Delaware Supreme Court found the plaintiff's complaint lacking for two reasons. First, although the plaintiff alleged that the benefits of a §162(m) plan were "obvious," the complaint did not allege that any of the bonuses paid between 2004 and 2007 would have been actually tax deductible under a §162(m) plan. Additionally, according to the plaintiff's own allegations in the complaint, the board believed that a §162(m) plan would constrain the compensation committee in determining the appropriate bonuses for the company's officers. The court concluded that the decision to "sacrifice some tax savings in order to retain flexibility in compensation decisions" was a "classic exercise of business judgment," even if it was a poor decision. Thus, because the board's decision was not unconscionable or irrational, the court affirmed the trial court's decision and denied plaintiffs request for attorneys' fees.
The opinion is Freedman v. Adams, No. 230, 2012, and is available at: http://courts.delaware.gov/opinions/download.aspx?ID=183340