Filed: January 28, 2016
Opinion by: Stuart R. Berger
Holdings: (1) A majority-disinterested and majority-independent board of directors’ unanimous decision to refuse a shareholder demand is not subject to the “special litigation committee” (“SLC”) exception but enjoys the protection of the business judgment rule. (2) Absent a particularized rebuttal, statements made by a majority-disinterested and majority-independent board of directors within a letter refusing demand are presumed true and may properly be considered by the court. (3) In a derivative action, a shareholder’s right of discovery as to the issue of whether a board of directors acted appropriately in refusing demand is denied unless shareholder has met her burden of proof under the business judgment rule of showing bad faith, bad judgment, or lack of independence.
Facts: Defendant-Appellees (“Appellees”) include a registered Maryland corporation and its current and former Board of Directors (“Board”) and members of senior management. Appellants are two shareholders (“Shareholders”).
In 2009, Appellees sought and obtained shareholder approval of an executive compensation plan which issued additional shares of common stock to (1) ensure the ability to settle existing performance-based awards in shares instead of cash, and (2) thereby reduce Appellee’s tax burden. Following a near-miss of share price performance targets in late 2010, Appellees became concerned that certain key employees might leave for better-paying opportunities with competitors. After a 6-month review, the Board converted the performance-based awards to service-based awards. The modification reduced the award amount by 25% and apportioned it into three installments over the years 2012 to 2014, so long as the employee remained employed.
In 2013, Shareholders issued a demand letter requesting Appellees to investigate and institute claims against responsible persons relating to the award modifications. Shareholders demanded rescission of all shares issued under the 2009 plan, forbearance from issuing any additional shares-as-compensation, and any other appropriate relief due to damages sustained from the Board’s misconduct.
In response, the Board formed an investigative committee of a single, outside, non-management director. The Board also retained outside counsel which was not then otherwise representing Appellee or its Board members. After thorough review, the committee recommended refusal of Shareholders’ demand. The Board unanimously voted to refuse the demand and informed Shareholders that the proposed litigation was not in the corporation’s best interest because Appellee would likely lose, suffer substantial harm, pay both sides’ legal fees, and incur substantial costs even in the event it won due to the millions of dollars required to generate new executive compensation awards.
In 2014, Shareholders began the instant litigation, alleging three derivative claims (breach of fiduciary duty, waste, and unjust enrichment) and two direct claims (breach of contract and promissory estoppel). Appellees moved to dismiss, contending that because all five counts were essentially derivative claims and because Shareholders had failed to plead sufficient facts to overcome the presumption that the Board had acted in the best interest of the company, the Board was entitled to the protections of the business judgment rule. Appellees further asserted that were the court to reach the merits, Shareholders had failed to state a claim on any of the five counts. The circuit court agreed and dismissed Shareholders’ complaint in its entirety. Shareholders timely appealed.
Analysis: On appeal, Shareholders sought to establish that the circuit court had erred in two areas: first, by granting motion to dismiss the derivative claims, and secondly by dismissing those claims styled as direct claims.
A derivative action requires the corporation’s board of directors to conduct an investigation into the shareholders’ allegations to determine whether pursuing the demanded litigation is in the best interests of the corporation. Should the corporation fail to so litigate and the shareholder bring a “demand refused” action, the court is typically tasked with reviewing whether the board acted independently, in good faith, and with sound business judgment.
On this point, Appellees sought the protections afforded by the presumption of business judgment rule. Meanwhile, Shareholders argued that the court should apply an exception to the rule developed by the Court of Appeals in Boland v. Boland. The Shareholders maintained that because the Boland court had established that a demand refusal was not entitled to business judgment rule protection, then Shareholders were entitled to discovery as to the process by which the Board had made its decision not to litigate leaving the burden to fall on Appellees to provide evidence of acting in good faith and reasonableness. However, the court distinguished the instant case from Boland, noting that the demand refusal there was made by a special litigation committee (“SLC”) appointed in light of a minority of disinterested directors. In this case, the decision to refuse demand was made unanimously by a board consisting of a majority of disinterested and independent directors. As a result, the court found the business judgment rule to apply, and not the Boland exception.
So finding, the court placed the burden on Shareholders to establish sufficient facts that the directors had failed to act on an informed basis, in good faith, and with honest belief that actions taken were in the best interests of the corporation. In each instance, the court found Shareholders’ arguments unpersuasive. Shareholders’ allegation that the demand rejection was tainted by one director having received benefits under the contested executive compensation plan was insufficient because the other 5 directors remained disinterested. Shareholders’ bald allegations of impropriety in the demand investigation were also insufficient in light of the committee’s 40 years of business experience and use of highly respected and experienced outside counsel. Further, allegations of a mere personal friendship, outside business relationship, or compensation for services – standing alone – were insufficient to raise an inference of lack of independence.
The court was similarly unpersuaded by Shareholders’ next contention that the Board had acted in contravention of authority granted by shareholders in the 2009 plan. Finding express discretionary language in the text of the 2009 plan, Appellees were clearly entitled to modify the 2008 executive compensation awards. The court then doubled down: assuming arguendo that the compensation plan modification was improper, the Board acted properly because any remedy would have been detrimental to the best interests of the corporation by incurring considerable additional compensation or tax liabilities.
Shareholders next maintained the lower court had erred by considering facts contained within the Board’s letter refusing demand, arguing that the court should have permitted discovery or, at minimum, made independent factual determinations. Finding no Maryland precedent, the court looked to Delaware law; pursuant to the business judgment rule, statements contained within a letter refusing demand are presumed true absent a particularized rebuttal. Here again, the SLC exception did not apply because the demand refusal was approved by Appellee’s majority-disinterested and majority-independent Board. Because a court’s decision to grant discovery in a demand-refused derivative action would undermine the business judgment rule by obviating the Board’s authority to decide whether litigation was pursuant to the corporation’s best interest, the lower court did not err by denying discovery. Accordingly, Shareholders failed to meet their burden of establishing sufficient facts and the court held that the lower court did not err by granting motion to dismiss the derivative claims.
Finally, the court turned to the “direct” claims. Here, the court noted that to maintain direct claims, shareholders must allege sufferance of an injury separate and distinct from that suffered directly by the corporation or derivatively by the shareholder due to injury to the corporation. Because the injuries allegedly suffered would have been sustained by the corporation (by incurring compensation or tax liability), any claims would have properly been derivative. The court further found no merit to either claim because the 2009 proxy statement did not constitute a contract, and because no detriment could have been avoided by its enforcement (nullifying a claim of promissory estoppel). The remaining “direct” claims were therefore derivative and properly subject to dismissal.
The full opinion is available in PDF.