Lewis v. Vogelstein
699 A.2d 327 (1997)
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Rule of Law:
Informed, disinterested shareholder ratification of a self-dealing transaction shifts the standard of judicial review from entire fairness to corporate waste. Directors seeking such ratification must disclose all material terms of the transaction but are not required to disclose speculative "soft information," such as an estimated present value of stock options.
Facts:
- Mattel, Inc.'s board of directors adopted the 1996 Stock Option Plan for its outside directors.
- The plan provided for a one-time grant of options on 15,000 shares of Mattel common stock to each outside director.
- These one-time options were exercisable immediately at the market price on the day of the grant and were valid for ten years.
- The plan also provided for annual grants of options upon a director's re-election for up to 10,000 shares, depending on their length of service.
- These annual options vested over a four-year period.
- The board sought shareholder ratification of the plan and distributed a proxy statement describing its terms.
- The proxy statement did not include an estimated present value of the options that could be granted under the plan, such as a valuation derived from an option-pricing model like Black-Scholes.
- At the 1996 Annual Meeting, Mattel's shareholders voted to ratify the plan.
Procedural Posture:
- Lewis, a shareholder, filed a derivative suit against the directors of Mattel, Inc. in the Delaware Court of Chancery (trial court).
- The complaint alleged breaches of fiduciary duty for (1) issuing a materially misleading proxy statement and (2) approving a compensation plan that constituted corporate waste.
- The defendant directors filed a motion to dismiss the complaint for failure to state a claim upon which relief could be granted.
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Issue:
Does a board of directors breach its fiduciary duty of disclosure by failing to include an estimated present value of stock options in proxy materials seeking shareholder ratification of a compensation plan, and can a shareholder claim that such a ratified plan constitutes corporate waste survive a motion to dismiss?
Opinions:
Majority - Chancellor Allen
No, as to the disclosure claim; Yes, as to the waste claim surviving the motion to dismiss. A board of directors does not breach its duty of disclosure by omitting speculative, estimated present values of stock options from proxy materials, as such 'soft information' is often unreliable and corporate law does not mandate its disclosure. However, even after informed shareholder ratification, a claim that the compensation plan constitutes corporate waste can proceed if the allegations suggest the transaction is so one-sided that no reasonable person could conclude the corporation received adequate consideration. Reasoning (Disclosure): The court determined that estimated present values of stock options are 'soft information' and are inherently problematic. Financial models like Black-Scholes are not perfectly suited for valuing non-transferable, long-term director options, and can produce misleading results. Mandating such disclosures is a technical policy matter best left to expert regulatory agencies like the Securities and Exchange Commission, not for courts to impose through the general fiduciary duty of materiality. Therefore, disclosing the terms and conditions of the plan is sufficient to satisfy the board's duty of candor. Reasoning (Waste): The court affirmed that informed, uncoerced, and disinterested shareholder ratification shifts the standard of judicial review for a self-dealing transaction from 'entire fairness' to the more deferential 'waste' standard. The test for waste is whether the corporation received consideration 'so disproportionately small as to be beyond the range at which any reasonable person might be willing to trade.' While this is a high standard, the court found that the one-time grant of options on 15,000 shares was 'sufficiently unusual' to survive a motion to dismiss. The plaintiff is therefore entitled to present evidence on whether the grants were so egregious as to constitute a waste of corporate assets.
Analysis:
This decision clarifies two critical aspects of Delaware corporate law. First, it sets a clear boundary on the fiduciary duty of disclosure, establishing that directors are not required to provide speculative, model-derived valuations ('soft information'), thereby leaving such mandatory disclosures to the expertise of regulators like the SEC. Second, it reaffirms the powerful cleansing effect of shareholder ratification, which shifts the judicial standard of review for self-dealing transactions from the stringent entire fairness test to the highly deferential waste standard. However, the ruling also preserves a judicial backstop, demonstrating that even under the waste standard, a claim can survive dismissal if the compensation appears facially egregious, ensuring that shareholder ratification is not an absolute shield for excessive director compensation.
