Ryan v. Gifford
918 A.2d 341 (2007)
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Rule of Law:
The intentional violation of a shareholder-approved stock option plan, coupled with fraudulent disclosures to conceal that violation, constitutes an act of bad faith that is a breach of the fiduciary duty of loyalty, sufficient to rebut the business judgment rule at the pleading stage.
Facts:
- Maxim Integrated Products, Inc. had shareholder-approved stock option plans that required the exercise price of all options to be no less than 100% of the fair market value of the company's stock on the date the option was granted.
- The board or a designated compensation committee was responsible for administering the plans.
- From 1998 to mid-2002, the board and compensation committee granted millions of stock options to the company's CEO and founder, John F. Gifford.
- A subsequent Merrill Lynch analysis revealed that nine specific grants to Gifford were suspiciously timed, having been dated on days with unusually low stock prices, just before sharp increases in market value.
- The statistical analysis showed that the average annualized return on these grants was 243%, nearly ten times higher than the 29% annualized market returns during the same period.
- Walter E. Ryan became a shareholder of Maxim on April 11, 2001, after Maxim acquired his previous company, Dallas Semiconductor Incorporated.
Procedural Posture:
- Walter E. Ryan filed a shareholder derivative action in the Delaware Court of Chancery on behalf of Maxim against certain directors.
- This action was filed after similar derivative lawsuits were filed in the U.S. District Court for the Northern District of California and in California state court.
- The defendants moved to stay the Delaware action in favor of the first-filed California federal action under the McWane doctrine or, alternatively, on forum non conveniens grounds.
- The defendants also moved to dismiss the complaint on several grounds: failure to make a pre-suit demand on the board, lack of standing for claims pre-dating the plaintiff's stock ownership, failure to state a claim upon which relief can be granted, statute of limitations, and failure to state a claim for unjust enrichment.
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Issue:
Does a board's alleged knowing and intentional backdating of stock options in violation of a shareholder-approved plan constitute an act of bad faith sufficient to excuse the pre-suit demand requirement and survive a motion to dismiss for failure to state a claim?
Opinions:
Majority - Chancellor Chandler
Yes. A board's alleged knowing and intentional backdating of stock options in violation of a shareholder-approved plan constitutes an act of bad faith, which is sufficient to excuse pre-suit demand and survive a motion to dismiss. The court reasoned that demand was futile under the second prong of Aronson v. Lewis because the allegations raise a reason to doubt that the challenged transactions were a valid exercise of business judgment. A board's knowing and intentional decision to violate the express terms of a shareholder-approved plan, which limits its authority, cannot be a valid exercise of business judgment. The court found the timing of the grants, supported by statistical analysis, was too fortuitous to be coincidence and created a reasonable inference of knowing manipulation. Furthermore, the court held that deliberately violating a shareholder plan and issuing false disclosures to conceal the conduct is an act of bad faith and a breach of the duty of loyalty, which rebuts the business judgment rule's presumption of validity. The court characterized such conduct as 'disloyal to the corporation' and fundamentally inconsistent with a fiduciary's obligations.
Analysis:
This case is a landmark decision from the mid-2000s stock option backdating scandals. It establishes that intentionally backdating stock options is not merely a failure of due care but a breach of the duty of loyalty through an act of bad faith. This classification is critical because director liability for breaches of loyalty cannot be eliminated by corporate charter provisions under DGCL § 102(b)(7), unlike breaches of care. The decision provides a clear path for shareholder plaintiffs to overcome motions to dismiss in similar cases by framing the issue as one of bad faith, thereby shifting the burden to directors to prove the entire fairness of the transaction.
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