Boards Behaving Badly: A Delaware Primer

Letting stand some shareholder claims against infoUSA directors and CEO Vinod Gupta, Chancery Court's Chandler rips 10-K deception and offers a study in board conflicts. Were stock options for President Clinton properly granted?

Added Chandler: “No conceivable definition of candor will shoehorn such payments into services ‘related’ to the use of aircraft.” Signing off on the expenditures in the 10-K as they did, according to the judge, entitles the plaintiffs “to a reasonable inference of bad faith due to the efforts taken by defendants to conceal their true nature.”

Companies often study opinions in Delaware, the nation’s largest state of incorporation, for guidelines on what activities by boards and executives may be challenged in the future. In recent cases, the court has written of its concerns in such areas as director independence and stock-option backdating and “spring-loading” — the granting of options on the expectation that expected positive news will raise the price — for example. In one recent case, Chandler criticized Tyson Foods for inadequate board disclosures about stock options.

In a prepared statement, infoUSA responded: “We are very pleased that the Delaware Chancery Court has agreed that many of the allegations advanced by plaintiffs’ in this lawsuit were insufficient as a matter of law and were dismissed out of hand. With respect to what remains, the Court has held that plaintiffs must now establish that their allegations have a basis in fact. We firmly believe we will be completely vindicated as the legal process unfolds.”

The shareholder derivative action against infoUSA was filed by two institutional holders, Cardinal Value Equity Partners LP and Dolphin Financial Partners LLC. And indeed, plaintiffs also took some buffeting from Chandler. In addition to throwing out several of their claims, the judge noted that plaintiffs “never solidly grapple” with the need to illustrate that a majority of the board was self-interested and lacked independence. That is important, the chancellor wrote, because in Delaware, plaintiffs pressing a derivative case must show that they could not get a fair hearing from the board for some reason, according to a standard called “demand futility.”

Despite plaintiffs’ failure to make their own strong demand-futility case, Chandler wrote, the complaint filed by lawyers for the two holders “contains allegations scattered throughout that allow me to determine that a majority of these directors were either interested or lacking in independence at the time Dolphin filed its first amended derivative complaint.”

Indeed, to an unusual degree Chandler seemed to piece together the case where the plaintiffs hadn’t. The court was presented with “a collection of related-party transactions that, taken individually, might fall within the business judgment of an independent board acting in good faith,” he wrote. “Yet the Court should not be blind to the fact that, in this case, literally dozens of such transactions have taken place, each blessed or passively noted by a board of directors with close personal and professional ties to the principal beneficiary of such largess.”

Going through the board list director-by-director, Chandler himself noted cases in which, for example, significant free office space was provided by infoUSA to two directors for use by their companies. Further, in the case of Prof. Raval, “his remuneration as a board member exceeds the average salary reported for a professor at Creighton University,” Chandler wrote, and “he received a $50,000 grant from the V. Gupta School of Business Administration.” Those factors, “as well as the presence of defendants on other boards that could affect his professional advancement, are sufficient to raise a reasonable inference necessary to call his independence into question.”

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