More on Chandler on backdating

I’ve now read Chancellor Chandler’s two February 6 opinions concerning stock options: Ryan v. Gifford, CA 2213-N on backdated options and In re Tyson Foods, Inc., C.A. No. 1106-N on springloaded options. I’ll discuss the first here and the second in another post. (Unfortunately, I haven’t been able to find links for these cases).

I've already discussed Steve Bainbridge’s take on Ryan, but there are a couple of other points worth more discussion.

First a little more background. The case involves backdating at Maxim Integrated Products, Inc. that was spotted by a Merrill Lynch Report following the WSJ’s initial big outing of backdating. The Maxim option plan specifically provided for an exercise price of at least the closing price on the date of the grant. The complaint alleges a deliberate violation of the plan plus disclosure violations.

Note that there's also a derivative suit pending in California federal court, which is similar but names additional director defendants and makes other claims, including securities law violations. And there's a similar California state court derivative action which has been stayed.

Chancellor Chandler refused to stay the Delaware action in favor of the California federal action, noting the substantial interest of Delaware courts in overseeing fiduciary duties in Delaware corporations. The Chancellor said:

This question is one of great import to the law of corporations. It encompasses numerous issues, including the propriety of this type of executive compensation, requisite disclosures that must accompany such compensation, and the legal implications of intentional non-compliance with shareholder-approved plans (if such practices are deemed noncompliant), to name only a few. Investors are challenging this very practice in many courts throughout the United States, including this Court. Delaware courts have not as yet addressed these fundamental issues. Nevertheless, Delaware law directly controls and affects many of the option backdating cases. An answer regarding the legality of these practices pursuant to Delaware law plainly will affect not only the parties to this action, but also parties in other civil and criminal proceedings where Delaware law controls or applies. By directly stating the fiduciary principles applicable in this context, Delaware courts may remove doubt regarding Delaware law and avoid inconsistencies that might arise in the event other state or federal courts, in applying Delaware law, reach differing conclusions.

The court also refused to defer on forum non conveniens or comity grounds. As to the latter argument, Chancellor Chandler notes the plaintiff’s argument that “adjudication of the California actions will render the Delaware action moot.” However, he sees no reason why that should be the case.

So might we get divergent results in this case as to the same acts by the same people? Note that the named plaintiffs differ in the two cases, but the real party at interest is the same in both cases – the corporation. It’s to prevent problems like this that we have the internal affairs doctrine – one corporation, one law. But as I argue in my Corporations and the Market for Law, nothing but stare decisis – i.e., no constitutional provision – stops California from applying its own law. The internal affairs doctrine is just a rule on contractual choice of law, and this sort of trumping of choice-of-law contracts happens in other contexts. California should behave and defer to Delaware, but there’s nothing forcing it to do so.

The best result is to ensure that Delaware courts apply Delaware law to the internal governance of Delaware corporations.  Maybe that could be done through a federal statute.  But because the article linked above suggests that similar issues arise outside of corporate internal governance, any such statute should deal with these issues as well.

The court also refuses to dismiss for failure to make a demand, holding that demand would be futile because of the high likelihood of board liability for backdating. The court’s condemnation of backdating as bad faith is discussed in my previous post. Interestingly, Chancellor Chandler notes not only the potential duty of loyalty breach, but also civil and criminal liability under federal law (p. 26, n. 38). I observed in my previous post that state liability makes these other claims less necessary. But the claims do exist, and here we see how federal and state law can play off against each other.

There’s much more in this interesting opinion – the first substantial judicial opinion on backdating – but no time for more in this post.

Comments

[Francis Pileggi]

Thanks for the insightful commentary. By the way, you mentioned that you did not have a link to the full decisions in the cases you mentioned in your post: Ryan v. Gifford and In Re Tyson Foods. At the following link to my blog, you can download both decisions in full:
http://www.delawarelitigation.com/chancery-court-updates-backdated-stock-options-and-springloaded-options-under-delaware-law.html

[jack]

Thanks for that link Francis, and thank you for your analysis professor.