Laidlaw v. Beneficial Bancorp, Inc. (Cir. Ct. Balto. Cnty)

Filed:  August 8, 2017
Opinion by: Judge Pamela J. White

Holding: A stockholder can file a derivative claim action against a corporation, without serving a pre-suit demand on a board, if it can shown that a demand would be futile.

Facts: Plaintiff brought suit against company Board of Directors in a derivative suit on behalf of company alleging that the individuals named breached a fiduciary duty owed to the company and were unjustly enriched as a result. After company completed a mutual stock conversion, the Board voted to award themselves more than 1 million shares as a part of a compensation package. The company provided its non-employee directors an average total compensation of $77,521 per non-employee director, while the CEO received $1,712,899 in compensation during the same period. A stock plan was approved by stockholders at the corporations annual meeting. Under the stock plan the Board reserved 3,500,000 shares of company stock. They later awarded themselves 1,043,416 of the reserved stock as a bonus for their role in the mutual-to-stock conversion. The value of the stock due to be disbursed was more than $14 million.

Plaintiff filed suit derivatively on behalf of the company less than a year after the stock plan was approved without making a demand. Defendants filed a Motion to Dismiss.

Analysis:

Plaintiff alleged that the Board breached their fiduciary duty of loyalty to the company by engaging in impermissible self-dealing. He argued that as result the Board was unjustly enriched and disgorgement was warranted. The Defendants argued for a dismissal on the grounds that a pre-suit demand was never submitted on the Board prior to the lawsuit. Plaintiff’s complaint gave inference that the demand would’ve been futile in this case because the board could not have objectively decided on a pre-suit demand due to its’ self-dealing in the stock plan.

“In order to maintain this balance of managerial power, a complaining stockholder generally speaking….must make demand upon the corporate board to commence the action and show that this demand has been refused or ignored before he may file a suit derivatively behalf of the company” Parish v. Md. & Va. Milk Producers Ass’n, 250 Md. 24, 81-82 (1968).  “Failure to serve a pre-suit demand can result in a dismissal of a derivative complaint.” Werbowsky v. Collomb, 363 Md. 581, 620-21(2001).  Here, Plaintiff argued that the demand should be excused because the board was personally and directly conflicted or committed to preserving their self-compensation.

Defendants argued that no member of the board was disqualified because of the fact that a director expected to derive a personal benefit from a corporate transaction. They argued that demand was not futile because the stock award was recommended by the Board’s four-member Compensation Committee and that a bare majority of the nine-member Board  could have fairly considered the Plaintiff’s pre-suit demand.  The Court decided that due to the outsized nature of the award at issue, one could reasonably infer that the Defendants were conflicted to a degree sufficient to excuse demand under Werbowsky.

In its’ analysis of one the counterarguments of the Defendants, the Court went on to state that “the question is whether a majority of the Board has a personal interest in not disturbing the decision that is sufficiently significant to overwhelm their better judgment.” In re Regions Morgan Keegan Securities, Derivative Erisa Litig., 694 F. Supp. 2d 879, 884 (W.D. Tenn. 2010).  Here, each member of the Board has a personal financial interest in the stock award with the stock award being more than four times the salary the President/CEO earned in the year prior to the stock award. The non-employee defendants’ interest in the stock was more than eleven times larger than their compensation from the previous year.

Defendants tried to rely upon the presumption of good faith of the business judgment rule. and that was deemed by the Court to be inapplicable to the circumstances. However since the Board’s actions were not from a disinterested position, they could not enjoy the protection’s of the rule.

The Defendants also argued that because the stockholders ratified the stock award, they were well within their rights to distribute the stock award. Under Md. Code Ann., Corps & Ass’ns § 2-419 (a) & (b)(1)(ii) Maryland law shields transactions between a corporation and its directors against stockholder derivative suits if, after the directors’ interest is disclosed, the “transaction is authorized, approved or ratified by a majority of votes cast by the disinterested stockholders entitled to vote.” The Court stated that the Board abused its power when it adopted the stock award and therefore could not adopt this protection. “The grant of authority for directors to set their compensation, is not a statutory safe harbor for director compensation decisions.” Sample v. Morgan, 914 A. 2d 647, 664 (Del. Ch. 2007). The Court cited that the stock plan did not inform stockholders the Board intended to give themselves a one time stock award of 1 million shares of stock. The Court decided that since stockholders were not properly informed the protection of shareholder approval under § 2-419 would not apply.

The Defendants also failed to provide a defense that would warrant a dismissal of the unjust enrichment claim.

The full opinion is available in PDF.

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.  

Weinberg v. Gold, et al. (Maryland U.S.D.C.)

Filed: March 12, 2012
Opinion by Judge James K. Bredar

Held: In a shareholder's derivative suit, the plaintiff shareholder failed to plead sufficient factual allegations to excuse demand on the corporation under the demand futility exception set forth in Werbowsky v. Collomb, 766 A.2d 123 (Md. 2001).

Facts: Plaintiff Arnold Weinberg (the "Shareholder") brought a derivative suit against various officers and directors of Biomed Realty Trust, Inc. (the "Company") alleging, among other things, breach of fiduciary duty for failing to rescind approval of an executive compensation plan rejected in a "say on pay" vote by the shareholders of the Company. The plan was formulated by a three-member compensation committee of directors and approved by the board. The issue before the Court was whether the Shareholder pled sufficient factual allegations to justify filing the suit without first making a demand on the Company.

Analysis: The Court cited Werbowsky v. Collomb, 766 A.2d 123 (Md. 2001) as the most recent, authoritative exposition of Maryland law on the issue of demand futility. Werbowsky affirmed the demand futility exception but limited it to matters in which the "allegations or evidence clearly demonstrate, in a very particular manner, either that (1) a demand, or a delay in awaiting a response to a demand, would cause irreparable harm to the corporation, or (2) a majority of the directors are so personally and directly conflicted or committed to the disputed decision that they cannot reasonably be expected to respond to a demand in good faith and within the ambit of the business judgment rule."

Recognizing the Werbowsky court's clear statement that mere participation in or approval of the challenged transaction by the directors does not excuse demand, the Court dismissed the Shareholder's argument that demand was futile because each director named in the suit was on the board when the compensation plan was approved, three directors were members of the compensation committee and two of the seven directors were officers of the Company and beneficiaries of the compensation plan. The Court recognized that the two directors who were officers of the Company and beneficiaries of the compensation plan were arguably "so personally and directly conflicted" that they could not reasonably be expected to respond to a demand in good faith and within the ambit of the business judgment rule. However, Werbowsky requires that a majority of the board be so personally disqualified before demand is excused. Likewise, the fact that directors are named in the suit does not mean that prior to the suit demand would have been futile. It if did, the Court opined, the demand requirement would be nullified in every suit that named directors are defendants.

The Shareholder also sought to excuse demand on the basis that the directors' actions were not the product of valid business judgment. Werbowsky, however, implicitly disallows consideration of the merits of the case in analyzing demand futility. While recognizing that a "say on pay" vote can arguably provide the board with an opportunity to reconsider its executive compensation decisions, the Court concluded that it is not the equivalent of a pre-suit demand. Such a vote can, however, be reasonably considered as a non-conclusive factor in the demand futility analysis. The Court also rejected the Shareholder's analysis of the "say on pay" vote under Ohio and Delaware standards for demand futility because neither standard is comparable to the standard set forth in Werbowsky.

The full opinion is available in pdf.