Delaware Court Of Chancery Denies Motion To Dismiss Fiduciary Duty Breach Claims Related To Repricing Of Stock Options
On June 13, 2019, Vice Chancellor Kathaleen S. McCormick of the Delaware Court of Chancery largely denied a motion to dismiss a derivative action for breach of fiduciary duty and unjust enrichment against directors and officers of a biosciences company (the “Company”) in connection with the alleged repricing of stock options shortly before the company announced the issuance of a “key” patent to its subsidiary. Howland v. Kumar, C.A. No. 2018-0804-KSJM (Del. Ch. June 13, 2019). Plaintiff, a stockholder in the Company, alleged that the directors and officers were aware of the patent issuance yet delayed the public announcement until after the board’s compensation committee approved the reduction in the strike price of more than 2 million stock options primarily held by defendants. The Court held that pre-suit demand on the board was excused, because a majority of the board was “interested by virtue of having received the repriced options.” Applying an “entire fairness” standard of review, the Court found that it was reasonably conceivable from the pleadings that the process and price were unfair and, therefore, denied the motion to dismiss.
According to the complaint, the CEO, who was also the board chairman, and another officer defendant received notice on August 3, 2017 that the patent would be issued on August 22, 2017, which did in fact occur. The CEO allegedly informed the board of the issuance or the likely issuance, but the board “did not immediately announce this information to the public.” Instead, the CEO allegedly called a special meeting of the compensation committee to reprice director and officer stock options. At the special meeting on September 6, 2017, the compensation committee members in attendance, two directors who each held options, approved the repricing to $0.67, which was the closing price for the Company’s stock that day (from original strike prices that ranged from $0.82 to $5.30). The Company publicly disclosed the repricing on September 8, 2017. Ten days later, the Company issued a press release announcing the patent, and its stock price closed at $1.28.
The Court held that the entire fairness standard of review applied, because the compensation committee members approved their own compensation in connection with the repricing, “rendering themselves interested in the transaction.” Under that standard, the Court found that it was reasonable to infer from the complaint that the repricing was “the product of an unfair process” and that this “affected the price.” As to the alleged futility of a pre-suit demand on the board to pursue the claims, the Court concluded that four of the five board members were not disinterested, because they held options subject to the repricing and that it was reasonably conceivable that the compensation benefit was material to each of the four.