(1) Whether board approval of a supplemental retirement bonus was a breach of fiduciary duty to the extent that it constituted waste and did not qualify for a tax deduction; and (2) Whether a stock option plan for the directors was self-interested and not entitled to the benefit of the business judgment rule.
Francis explains that the court answered those questions as follows:
(1) The Court found a failure to plead demand futility and dismissed the waste claim, and the Court found that Delaware law did not impose a fiduciary duty, per se, to minimize corporate taxes, thus rejecting a related tax argument about the deductibility of the compensation paid to a retiree; (2) The Court found also, however, that the stock option plan for directors did not have sufficient limitations despite shareholder authorization, and therefore, could be considered self-interested and not entitled to the benefit of the business judgment rule.
I suspect that the second holding will get most attention. And deservedly so. As Edward McNally explains, the case raises the difficult practical question of When May Directors Vote Themselves Bonuses? Indeed, not just bonuses, but any compensation.
When directors vote on their own compensation, there is ample Delaware precedent that the vote may be set aside and the directors ordered to return the funds they received to their company. Awards of attorney fees in those cases are also well established. See Valeant Pharmaceuticals International v. Jerney, 921 A.2d 732 (Del. Ch. 2007), and Julian v. Eastern States Construction Service, 2008 WL 2673300 (Del. Ch.).
What, then, may a board of directors do to protect itself from litigation risk when determining its own compensation?
McNally goes on to offer some suggestions.
To my mind, however, it is the first question that is the more interesting one. It reminds me of a New York case, Kamin v. American Express, in which AmEx shareholders challenged the board's decision to structure the disposition of shares Am Ex owned in a firm called Donaldson, Lufken and Jenrette as a dividend of property to the shareholders rather than as sale on the market:
... the complaint alleges that in 1972 American Express acquired for investment 1,954,418 shares of common stock of Donaldson, Lufken and Jenrette, Inc. (hereafter DLJ), a publicly traded corporation, at a cost of $ 29,900,000. It is further alleged that the current market value of those shares is approximately $ 4,000,000. On July 28, 1975, it is alleged, the board of directors of American Express declared a special dividend to all stockholders of record pursuant to which the shares of DLJ would be distributed in kind. Plaintiffs contend further that if American Express were to sell the DLJ shares on the market, it would sustain a capital loss of $ 25,000,000 which could be offset against taxable capital gains on other investments. Such a sale, they allege, would result in tax savings to the company of approximately $ 8,000,000, which would not be available in the case of the distribution of DLJ shares to stockholders.
The court held that the business judgment rule protected the directors' decision from judicial review. The parallel to the Seinfeld case is readily apparent, of course.
My interest arises because Kamin is one of the business judgment rules cases in our Business Associations case book. I spend quite a lot of time on it in class, as illustrated by the following PowerPoint presentation on the case:
As you can see, this case allows the instructor to raise many important business and legal concepts. It is my students' first introduction, for example, to financial statements beyond simple balance sheets and the efficient capital markets hypothesis. That's a lot of educational value from a fairly short case.