Oliveira v. Sugarman (Ct. of Appeals)

Filed: January 20, 2017

Opinion by J. Adkins

Holding:  (1) The traditional business judgment rule applies to a disinterested and independent board of directors' refusal of a stockholder litigation demand, not the modified business judgment rule established in Boland v. Boland, 423 Md. 296 (2011). (2) Conversion of a performance-based incentive plan approved by stockholders to a service-based incentive plan approved by a board of directors does not give rise to a direct stockholder claim. (3) An incentive plan approved by stockholders does not constitute a contract unless such plan contains language "indicating a clear offer and intent to be bound." (4) Even when a corporation owes a direct duty to its stockholders, a stockholder must have suffered an injury distinct from the corporation to bring a direct claim.

Facts:  The board of directors of a Maryland corporation (the "Company") granted performance-based restricted stock (the "Original Awards") to certain of its executives and employees; however, the Company did not have enough common stock authorized to pay these Original Awards if they vested. In a letter to stockholders from the CEO, accompanied by the annual proxy statement, the CEO asked stockholders to approve the proposed long-term incentive plan (the "Plan"). The mailing also included a copy of the Plan, which authorized the issuance of an additional eight million shares of common stock. The Plan was approved at the annual meeting. The Company, however, did not meet the performance metrics for the Original Awards to vest until eight trading days past when the Original Awards were to vest. The board of directors and its compensation committee, in consultation with its advisors, decided to convert the Original Awards to service-based awards (the "Modified Awards") to balance rewarding management’s performance and enforcing the terms of the Original Awards.

Plaintiffs, trustees of a stockholder of the Company, made a demand to the board of directors to investigate the Modified Awards and institute claims on behalf of the Company against "responsible persons." The board of directors appointed an outside, non-management director to serve as the demand response committee. After investigation that included assistance from outside counsel, the demand response committee recommended the board of directors refuse the stockholder demand, which it did after a unanimous vote. Plaintiffs filed suit against the members of the board of directors and senior management alleging breach of fiduciary duty, unjust enrichment, waste of corporate assets, breach of contract and promissory estoppel arising from the Modified Awards. The Court of Special Appeals affirmed the trial court’s dismissal of Plaintiffs’ claims, holding that the trial court correctly applied the business judgment rule and Plaintiffs’ failed to plead facts sufficient to overcome the presumption of the business judgment rule.

Analysis: The Court refused to expand the modified business judgment rule established in Boland to all board of director decisions refusing a stockholder litigation demand, regardless of whether a majority of the directors are disinterested or the board used a special litigation committee ("SLC"). After a discussion of the development of the business judgment rule in Maryland, the Court distinguished this case from Boland because a majority of the board of directors of the Company were disinterested and independent as only one of the six directors at the time the Amended Awards were made actually stood to financially benefit from the board's decision (even Plaintiffs agreed that the board consisted of a majority of disinterested and independent directors when it approved the Amended Awards). Plaintiffs argued that, by refusing to extend the modified business judgment rule to any denial by a board of directors of a stockholder litigation demand, enhanced scrutiny by the courts would be limited "to those rare instances when shareholders are not required to make a demand on the board before bringing suit" and thus the modified business judgment rule would be rarely applied. The Court explained that Boland was not concerned with the feasibility of stockholder derivative suits and was intended to address those situations where a board of directors does not have a disinterested majority and appoints an SLC because the courts wanted to ensure the SLC was not "serving as a puppet for the interested board."

Turning next to whether the claims asserted by Plaintiffs were direct or derivative, the Court held that Plaintiffs did not suffer "a 'distinct injury' separate from any harm suffered by the corporation." Plaintiffs claimed they suffered three harms giving rise to a direct claim. First, they claimed to have suffered harm when the Original Awards were converted to the Modified Awards because the Company could no longer take advantage of the tax exemption provided for under § 162(m)(4)(C) of the Internal Revenue Code because, unlike the Original Awards, the Modified Awards were no longer made in connection with a stockholder-approved performance plan. Even though the Court noted that this alleged increased tax cost actually resulted in damages to the Company, not Plaintiffs’, they maintained that the Plan granted them contact rights that they could enforce directly. Applying New York law (the Plan was approved in New York and expressly provided it was governed by New York law), the Court held that the Plan was not a contract because it contained no offer to stockholders. The Court also held that, under Maryland law, the Plan was not part of a larger "intra-corporate contract" between directors and stockholders.

Second, Plaintiffs claimed as a direct harm that the actions of the board of directors caused them to make an uninformed vote. Relying on the doctrine of promissory estoppel, Plaintiffs argued that the board promised them the Original Awards would vest only if the performance metrics outlined in the Plan were met and that this promise induced Plaintiffs to vote to approve the Plan. The Court acknowledged that the language in the letter to stockholders that accompanied the proxy statement did urge approval of the Plan and stated that the Original Awards would vest "only if performance conditions are achieved." The proxy statement contained the same assurance and, the Court found that "[t]his language could constitute a clear and definite promise on the part of the Board." The Court also found that the board of directors had a reasonable expectation that its promises to stockholders regarding the vesting of the Original Awards would induce stockholders to approve the Plan because, in language in the letter to stockholders, the board stated its belief that "the significant shareholder returns required in order to meet the performance hurdles of these proposed equity incentive awards…make the overall compensation strategy a compelling one for shareholders." Further, the stockholders did in fact approve the Plan. However, the Court held that Plaintiffs’ were unable to meet the fourth element of their promissory estoppel claim. Looking to Delaware law, the Court held that casting an uninformed vote in and of itself is not sufficient harm to support a claim for promissory estoppel – Plaintiffs’ would need to show individual damages resulting from their uninformed vote, which they had not done.

Plaintiffs next claimed that they suffered a direct harm because the Plan diluted the value of their shares in the Company. The Court agreed that, under certain circumstances, "financial harm due to stock dilution could support a direct shareholder claim"; however, the Court held that such a circumstance did not exist in this case. Plaintiffs had not alleged share dilution in their complaint and, while they argued dilution on appeal, they failed to allege any facts detailing the financial or other impact of the alleged dilution.

Finally, Plaintiffs claimed that, even if they had not suffered a distinct harm, the Plan created a direct duty owed to stockholders by the board of directors and thus they should be able to bring a direct claim. While the Court acknowledged that a stockholder may bring a direct action if the board of directors breached a duty owed to stockholders, it held that the breach of duty alone is not sufficient to bring a direct claim – there must be some separate harm suffered. Therefore, to bring a direct claim, a stockholder would have to show that it suffered a harm distinct from the corporation as a result of the breach of duty owed by directors to stockholders.

The full opinion is available in PDF.  The author of this post is an attorney at Venable LLP, which represented the Company.