Tuesday, May 31, 2022

‘With admitted trepidation,’ court allows claim that defendants breached fiduciary duties

By R. Jason Howard, J.D.

The Delaware Court of Chancery has ruled that the claims in a complaint brought by a shareholder are ripe for consideration following allegations that the ODP Corporation’s board of directors ignored issues raised in a demand letter and violated the express terms of the company’s 2019 compensation plan (Garfield v. Allen, May 24, Laster, T.).

2019 plan. Shareholders of the ODP Corporation approved an equity compensation plan in 2019 that authorizes a grant of awards of performance shares, performance units, restricted stock, restricted stock units, nonqualified stock options, incentive stock options, stock appreciation rights, and other forms of equity-based compensation to officers, employees, non-employee directors, and consultants by the company's board. The plan limits the number of performance shares that can be awarded to any single individual in the same fiscal year.

In March 2020, the company’s CEO received two grants of performance shares, which entitle the CEO to receive a variable number of performance shares over a three-year period ending in 2023. If the company performs well, then the aggregate number of shares the CEO is entitled to retain will exceed the limit in the 2019 plan. By a demand letter dated March 18, 2021, the plaintiff asked the board to modify the performance share awards by lowering the maximum potential payout to conform with the 2019 plan. In a letter dated April 9, 2021, the company’s board refused.

Complaint. On May 13, 2021, the plaintiff filed the three-count complaint. Count I asserts a derivative claim alleging that the board members breached their fiduciary duties by approving the awards, the CEO breached his fiduciary duties by accepting the awards, and all members of the board violated their fiduciary duties by failing to fix the awards in response to the demand letter. Count II asserts a derivative claim for unjust enrichment against the CEO in the form of a right to receive shares in excess of the 2019 Plan limitation, and Count III asserts a direct claim against the four board members who approved the awards.

Breach of fiduciary duty. Here, the plaintiff argued that all of the board members, even those who did not approve the awards, breached their fiduciary duty in not fixing the obvious violation following the demand letter, which called the issue to their attention. On this, the court stated that there is “something disquieting about a plaintiff manufacturing a claim against directors by acting as a whistleblower and then suing because the directors did not respond to the whistle,” but, according to the court, the logic of the plaintiff’s theory is sound as Delaware law treats a conscious failure to act as the equivalent of action. It is therefore reasonably conceivable, according to the court, that the directors’ conscious inaction constitutes a breach of duty.

The court cautioned, however, that there are obvious policy issues associated with such a claim. Sending a demand letter and then suing based on a failure to fix the problem “could undermine salutary doctrines such as laches that force plaintiffs to bring claims in a timely fashion,” and it could also enable plaintiffs to “expose new directors to litigation risk by presenting them with a problem that they did not create and asserting that they failed to fix it.” The court also noted the lack of precedent for the theory as the wrongful rejection of a demand letter has historically “affected only the question of who controls the derivative claim,” and “does not appear to have been analyzed as a separate fiduciary wrong.”

Nevertheless, the court stated that the plaintiff pleaded “what seems like one of the strongest possible scenarios for such a claim.” The limitation in the 2019 Plan is plain and unambiguous and, under established precedent, the board members’ failure to comply with the unambiguous restrictions in the stockholder approved 2019 Plan supports an inference that the directors acted in bad faith. The CEO, a fellow fiduciary and recipient of the awards, faced the same duty to fix the issue.

According to the court, “if there was ever a time when all of the directors had a duty to take action to benefit the Company by addressing an obvious problem, it is reasonably conceivable that this was it.” Therefore, the court stated that it was with admitted trepidation about knock-on effects, but its decision permits the claim to survive.

Conclusion. The court rejected the defendants’ arguments as they ignored established precedent, conflicted with the 2019 Plan, and contradicted the company’s own shareholder disclosures. The plaintiff’s claims, according to the court, are ripe and the complaint states claims for breach of contract, breach of fiduciary duty, and unjust enrichment. The defendants’ motion to dismiss was denied.

The case is No. 2021-0420-JTL.