Pfeiffer v. Leedle, C.A. No. 7831-VCP (Del. Ch. Nov. 8, 2013) (Parsons, V.C.)

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In this memorandum opinion denying defendants’ motion to dismiss, the Court of Chancery held that plaintiff alleged particularized facts showing a board of directors breached its fiduciary duty of loyalty by approving the award of stock options to the corporation’s president that was greater than the annual maximum permitted by the corporation’s stockholder-approved stock incentive plan.

Plaintiff, a shareholder of Healthways, Inc. (the “Company”), instituted this derivative action to challenge the award of stock options to the Company’s president.  Plaintiff alleged that the Company’s president was awarded 449,436 and 285,000 stock options in 2011 and 2012, respectively.  Plaintiff also alleged that the annual maximum award for stock options under the Company’s stockholder-approved stock incentive plan was 150,000.  Because the stock options granted in 2011 and 2012 were greater than the stock incentive plan’s annual maximum, plaintiff contended that the Company’s board of directors (the “Board”) breached their fiduciary duty of loyalty in approving the stock options award and by disseminating a materially misleading proxy statement.  Plaintiff also contended that the Company’s president breached his fiduciary duty of loyalty and was unjustly enriched by accepting the excess stock options.  Plaintiff did not make a pre-suit demand on the Board.  Defendants moved to dismiss for failure to establish demand futility under Rule 23.1 and also moved to dismiss for failure to state a claim under Rule 12(b)(6).

The Court denied defendants’ motion to dismiss.  The Court first held that plaintiff had shown demand futility under Rule 23.1.  Based on a concession by defendants, the Court analyzed the plaintiff’s claims under Aronson v. Lewis, 473 A.2d 805 (Del. 1984) and its progeny, which requires a plaintiff to show either (i) that a majority of the board is interested or lacks independence or (ii) that the challenged transactions could not be an exercise of valid business judgment.  Because plaintiff had all but conceded that a majority of the Board was disinterested or independent, the Court focused on the standard’s second prong.  The Court explained that a plaintiff must rebut the business judgment rule by showing that the board’s actions were not informed or were not taken honestly and in good faith.  Citing Sanders v. Wang, 1999 WL 1044880 (Del. Ch.), the Court highlighted that a plaintiff could rebut the business judgment rule by showing a board clearly and unambiguously violated a corporation’s stock incentive plan.  The Court found that plaintiff had pled particularized facts showing the Board clearly and unambiguously violated the Company’s stock incentive plan by awarding the Company’s president more than 150,000 stock options in 2011 and 2012.

The Court then held that under Rule 12(b)(6) plaintiff had sufficiently stated claims for breach of the fiduciary duty of loyalty against the Board by approving the excess stock options and by disseminating a materially misleading proxy statement.  Because a plaintiff who proves demand futility under the second prong of the Aronson standard also rebuts the business judgment rule for purposes of a Rule 12(b)(6) motion to dismiss, the Court reasoned that plaintiff’s claims against the Board could not be dismissed.  The Court also held that plaintiff’s claims for breach of fiduciary duty and unjust enrichment against the Company’s president could not be dismissed.

The full opinion is available here.

Topics:  Board of Directors, Breach of Duty, Compliance, Executive Compensation, Fiduciary Duty, Incentives, Shareholder Litigation, Stock Options

Published In: Business Organization Updates, Business Torts Updates, Civil Procedure Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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