CURRENT MONTH (May 2022)
Delaware Court of Chancery Sustains “Novel Theory” Against Board for Failure to Fix a Contractual Violation Following Demand Letter
In Garfield v. Allen, the Court of Chancery denied defendants’ motion to dismiss a complaint. The Court held that a stockholder plaintiff stated reasonably conceivable direct and derivative claims against board committee members for approving an equity award to the company’s Chief Executive Officer (“CEO”) that exceeded the cap on such awards in violation of the express terms of an equity compensation plan (the “Plan”). The plaintiff also brought, and the Court declined to dismiss, a separate fiduciary duty claim against the entire board for failing to correct the equity award after the plaintiff had brought the violation of the Plan to their attention.
The Court of Chancery refused to dismiss the claims against the committee members who approved the initial award. After rejecting, as a matter of “settled law,” the defendants’ argument that the claims were not ripe, the Court held that neither the directors who approved the award nor the CEO who received the award were entitled to business judgment rule protection. The Court held that their allegedly approving and receiving an equity award that “violate[d] an express limitation in the plan” supported a claim that they had “acted knowingly and intentionally” creating a duty of loyalty breach that rebuts any business judgment rule protection.
The Court then proceeded to validate—although admittedly with some trepidation—the plaintiff’s “novel theory” that all directors—including directors who had not approved the original equity award to the CEO—had violated their fiduciary duty by refusing to rectify a clearly improper award that been brought to their attention. One year after the board committee had originally approved the equity award to the CEO, the plaintiff sent the entire board a letter demanding that they rectify the equity award to comply with the express terms of the Plan. The board refused to fix the award and, instead, took the position that it had adopted a policy interpreting the award to the CEO as valid, because the award did not exceed the cap expressly imposed by the Plan. The plaintiff claimed that the board’s response to its demand letter constituted a separate breach of their fiduciary duty. The Court agreed. The Court held that it was “reasonably conceivable that by attempting to validate the [challenged equity award by adopting an ex ante policy] the Board [had] acted in bad faith.” Moreover, even had the board not adopted such a policy, the board members were collectively chargeable with a separate breach of fiduciary duty under a theory of “conscious inaction.” The Court held:
[S]ettled precedent establishes that a decision-maker acts disloyally and in bad faith by consciously disregarding a limitation in an equity compensation plan. Because conscious inaction is functionally the same as action, it follows that a conscious decision to leave a violative award in place supports a similar inference that the decision-maker acted disloyally and in bad faith.
In upholding this claim on this “novel theory,” the Court candidly acknowledged the policy issues such a claim might generate, i.e., “the artifice of sending a demand letter and then suing based on the failure to fix the problem[,]” as well as the hazard that such a claim could expose directors who did not participate in the initial award to litigation risk. Although the Court indicated (for those reasons) that such a claim would have at most a narrow application this fact pattern presented “one of the strongest possible scenarios” for such a claim.
Takeaway: By validating a novel theory of liability in the executive compensation area, Garfield adds another reason why companies and their boards should proceed with caution when approving equity compensation awards to ensure the awards comply with the underlying equity compensation plan’s express terms. And, should a board learn that an award it approved does not comply with the equity compensation plan’s express terms, the board should take steps to remedy the noncompliance to avoid further exposing themselves to liability for failing to do so.
Second Circuit Narrowly Construes Definition of Transportation Worker Under FAA to Determine Exemption
By Leslie A. Berkoff, Partner at Moritt Hock & Hamroff LLP, Chair of Dispute Resolution Department
In the recent case of Bissonnette v. LePage Bakeries Park St., LLC (2d Cir. 2022), the Second Circuit determined that commercial truck drivers who delivered baked goods were not exempt from being required to arbitrate under the Federal Arbitration Act (FAA) the wage and hour claims brought by the Plaintiffs pursuant to the Fair Labor Standard Act (FLSA). In this case, the Plaintiffs had filed a class action lawsuit in federal district court in Connecticut against Flowers Foods, Inc. along with two of its subsidiaries (collectively, “Flowers”). Flowers’ parent is in the business of manufacturing nationally known bread products such as Wonder Bread, and its subsidiaries maintain exclusive distribution rights within defined geographic areas. The Plaintiffs were independent distributors who had purchased from the subsidiaries the distribution rights to both market and sell the baked goods. As independent distributors, they were responsible to pick up product from locations in Connecticut and then deliver, rotate, and remove stale product to and at stores within their specific territories. They were also allowed to solicit and develop new territories in order to maximize sales, as well as to acquire delivery vehicles, maintain equipment and insurance, distribute Flowers’ advertising materials and develop their own materials (with prior approval by Flowers), retain legal and accounting services, and hire help, among other things.
In response to the Plaintiffs’ FLSA claims, the Defendants moved to dismiss the lawsuit and compel arbitration, asserting that the claims should be governed by the FAA. The Plaintiffs argued that the Defendants were transportation workers (or more aptly, the workers engaged in “interstate commerce”) and therefore exempt from the mandatory arbitration under the FAA. FAA, 9 U.S.C. Section 1. The District Court held that the independent distributors were not transportation workers exempt from the FAA and dismissed the case, granting the Defendants’ motion to compel arbitration. In a sharply divided 2–1 decision, the Second Circuit affirmed.
The Court held that the exemption for transportation workers should be narrowly construed to encompass only those workers who are actually involved in the transportation industry—workers actually moving goods or passengers—and where such movement is the predominant source of revenue. (In so doing the Court followed the Fifth and Eleventh Circuits). Here the movement of the baked goods and bread was incidental to the main source of commerce at issue, which was the maintenance of the routes, the advertising, the equipment, and other described tasks. As such, the Second Circuit found that the Plaintiffs were not subject to exemption from the FAA. Given the narrow reading of “transportation worker” in this instance, and considering similar decisions in other transportation cases involving GrubHub and Doordash, when coupled with the Supreme Court’s overall focus on the FAA over the past year or so, we may see more decisions on the interstate commerce clause in the near future.
2022 WL 1641802, at *54 (Del. Ch. May 24, 2022). ↑
Id. at *2 ↑
Id. at *1. ↑
Id. at *2. ↑
Id. at *2, *31-35. ↑
Id. at *9. ↑
Id. at *10. ↑
Id. at *31. ↑
Id. at *28. ↑
Id. at *31-32. ↑
Id. at *32. ↑
Id. at *2. ↑
Id. at *3. ↑
The Court noted that “it matters that the contractual counterparties on both sides of the [equity award] . . . had a fiduciary duty to fix the violation.” Id. at *32. ↑