Valeant Pharmaceuticals International v. Jerney
2006 WL 1232521 (2007)
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Rule of Law:
When corporate directors engage in a self-dealing transaction, such as awarding themselves compensation, they bear the burden of proving the transaction was entirely fair to the corporation, encompassing both fair dealing in the process and a fair price in the substance. Failure to meet this stringent standard requires the director to disgorge all benefits received from the unfair transaction.
Facts:
- ICN Pharmaceuticals, Inc. ('ICN'), led by CEO Milan Panic and President Adam Jerney, planned to restructure by spinning off its most valuable asset, Ribapharm, through an Initial Public Offering (IPO).
- Management and the board, all of whom would be recipients, initially proposed awarding themselves a large grant of Ribapharm stock options, with Panic receiving the largest share.
- Following strong investor opposition to the option plan, the board's compensation committee—composed entirely of interested directors with personal and financial ties to Panic—pivoted to a cash bonus plan to be paid by ICN.
- The committee engaged a compensation consultant, Towers Perrin, who had already been advising ICN's general counsel, to justify the bonus amount.
- Towers Perrin's report supported a bonus pool based on a percentage of a high-end, projected Ribapharm valuation of $2.5 to $3 billion.
- The full ICN board, with every director receiving a personal payout, unanimously approved a $50 million cash bonus pool based on this valuation.
- The day after the board's approval, the IPO underwriters informed ICN that market conditions required repricing the IPO at a level that valued Ribapharm at only $1.5 billion.
- Despite legal advice to reconsider the bonus in light of the sharply lower valuation, Panic and the board proceeded with the IPO and paid out approximately $47.8 million in bonuses, of which Jerney received $3 million.
Procedural Posture:
- Stockholders of ICN Pharmaceuticals, Inc. initiated a derivative action in the Delaware Court of Chancery against CEO Milan Panic, President Adam Jerney, and other board members.
- After a change in the board's composition, a special litigation committee decided to realign the corporation as the plaintiff, thereby taking control of the lawsuit.
- The corporation, now renamed Valeant Pharmaceuticals International, reached settlement agreements with all of the non-management director defendants.
- The case proceeded to a bench trial against the two remaining defendants, Panic and Jerney.
- Following the trial, the corporation settled its claims with Panic, leaving only the claims against Jerney for judicial determination.
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Issue:
Does a self-interested cash bonus plan satisfy the entire fairness standard when it was approved by interested directors in a process dominated by the primary beneficiary and the bonus amount was based on an inflated corporate valuation that was not adjusted when the valuation proved to be incorrect?
Opinions:
Majority - Lamb, Vice Chancellor
No, the cash bonus plan fails to satisfy the entire fairness standard because both the process and the price were unfair to the corporation. The court found that the process was fatally flawed by self-interest and improperly dominated by Milan Panic, the primary beneficiary. The compensation committee was neither independent nor disinterested, and its review was not a good-faith negotiation but an exercise in justifying a predetermined outcome. The expert report from Towers Perrin was based on inflated valuation data supplied by management and was used to rationalize an 'unprecedented' award. The price was unfair because the bonus amount was grossly excessive, based on an inflated and unrealistic valuation of Ribapharm. The board's failure to reduce the bonus pool after the IPO was significantly repriced downward cemented the unfairness of the price, as the payout was untethered from the actual value generated. The court rejected Jerney's reliance-on-experts defense, holding that 8 Del. C. § 141(e) is not an absolute shield in an entire fairness case, particularly for an interested director, and that any reliance was unreasonable given the expert report's flawed premises. Consequently, Jerney was required to disgorge the full $3 million bonus he received.
Analysis:
This case strongly reinforces the stringency of the entire fairness standard of review for director self-compensation. It demonstrates that procedural formalities, such as the use of a compensation committee and the retention of outside experts, are insufficient to satisfy the 'fair dealing' prong if the process is substantively controlled by conflicted fiduciaries. The decision serves as a powerful precedent against boards rubber-stamping proposals from a dominant CEO, clarifying that reliance on expert advice is only a defense if it is reasonable and based on sound information. By mandating full disgorgement rather than a partial reduction, the court affirmed that the remedy for a breach of the duty of loyalty in a self-dealing context is not to reform the transaction to what might have been fair, but to rescind the benefit entirely.
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