Freedman v. Adams
2013 WL 144638, 2013 Del. LEXIS 18, 58 A.3d 414 (2013)
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Rule of Law:
A corporate board’s intentional decision to forgo potential tax deductions by not adopting a Section 162(m) plan for executive compensation, made to retain flexibility in compensation decisions, does not constitute corporate waste unless the decision is so one-sided that no reasonable business person would consider it fair or it can be attributed to no rational purpose.
Facts:
- XTO Energy Inc. was a Delaware corporation in the business of oil and gas production.
- Section 162(m) of the Internal Revenue Code makes executive compensation exceeding $1 million tax deductible only if paid pursuant to a qualified plan.
- From 2004-2007, XTO paid executive bonuses totaling more than $130 million.
- These bonus payments were not tax deductible, potentially resulting in approximately $40 million in foregone tax savings for XTO.
- The XTO board was aware that, under a qualified Section 162(m) plan, these bonuses could have been tax deductible.
- The XTO board intentionally chose not to implement a Section 162(m) plan, stating it did not believe its compensation decisions should be 'constrained' by such a plan.
Procedural Posture:
- Susan Freedman, a stockholder of XTO Energy Inc., filed a derivative action in the Court of Chancery (trial court) in 2008, alleging XTO’s board committed corporate waste by failing to adopt a Section 162(m) plan.
- Shortly after Freedman filed her complaint, XTO’s board approved a Section 162(m) plan, which was subsequently approved by its stockholders at XTO’s 2009 annual meeting.
- XTO Energy merged with and into a subsidiary of ExxonMobil Corporation on June 25, 2010.
- Freedman agreed to dismiss her complaint as moot on April 5, 2011, as the original issue of the board failing to adopt a plan had been addressed.
- Freedman then filed a motion in the Court of Chancery seeking $1 million in attorneys’ fees, arguing that her complaint had benefitted the company by causing XTO to adopt a Section 162(m) plan.
- The Court of Chancery denied Freedman’s motion for attorneys’ fees, finding that the complaint was not meritorious when filed because it did not adequately allege that demand on the board would have been futile.
- Freedman (appellant) appealed the Court of Chancery's denial of her attorneys' fees motion to the Delaware Supreme Court.
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Issue:
Does a corporate board's decision to forgo potential tax deductions by not adopting a Section 162(m) plan, in order to maintain flexibility in executive compensation, constitute corporate waste, thereby excusing demand on the board in a derivative suit?
Opinions:
Majority - Justice Berger
No, a corporate board's decision to forgo potential tax deductions by not adopting a Section 162(m) plan to maintain flexibility in executive compensation does not constitute corporate waste. To state a claim for waste, a stockholder must allege, with particularity, that the board authorized action so one-sided that no business person of ordinary, sound judgment would conclude that the corporation received adequate consideration, or that the directors irrationally squandered or gave away corporate assets. The court found two reasons why the complaint failed to state a claim for waste: first, it did not allege that any of the bonuses would have been tax deductible under such a plan, only that they could have been. Second, the XTO board was aware of the tax law but intentionally chose not to implement a plan, believing it would constrain compensation decisions. The decision to sacrifice some tax savings for flexibility in compensation is a classic exercise of business judgment. Even if the decision was poor, it was not unconscionable or irrational, and thus is protected by the business judgment rule. This rigorous standard for waste means the board's decision will be upheld unless it cannot be attributed to any rational purpose.
Analysis:
This case significantly reinforces the demanding standard for proving corporate waste, particularly when challenging board decisions that involve an intentional strategic choice rather than outright malfeasance. It underscores the robust protection afforded to corporate directors under the business judgment rule, emphasizing that even decisions resulting in foregone financial benefits, like tax deductions, are immune from waste claims if they are based on a rational business purpose, such as maintaining compensation flexibility. The ruling makes it exceptionally difficult for shareholders to successfully challenge executive compensation strategies solely on the grounds of tax inefficiency, requiring proof that the board's decision was utterly irrational or unconscionable.
