Garfield v. Allen, et al., C.A. No. 2021-0420-JTL (Del. Ch. May 24, 2022) (Laster, V.C.)

In this memorandum opinion, Vice Chancellor Laster, denied defendants’ Rule 12(b)(6) motion to dismiss a complaint alleging a breach of the duty of loyalty against directors for authorizing a compensation award in violation of the Company’s equity compensation plan. The Court also analyzed a “novel theory,” that directors breached their fiduciary duties by failing to fix the challenged awards in response to a demand letter, concluding such a “theory is sound” under Delaware law despite the “disquieting” nature of “a plaintiff manufacturing a claim against directors by acting as a whistleblower and then suing because the directors did not respond to the whistle.”

Plaintiff challenged equity awards to the CEO of The ODP Corporation (the “Company”) by a committee of the Company’s board (the “Committee”) pursuant to an equity compensation plan (the “Compensation Plan”).  Plaintiff alleged the Committee granted performance shares to the CEO in violation of the express terms of the Compensation Plan (the “Challenged Awards”) and alleged a breach of the Compensation Plan.  In addition, plaintiff brought derivative claims for breach of fiduciary duty in connection with the approval and acceptance of the Challenged Awards. Both claims survived pleading-stage review.

Plaintiff also brought breach of fiduciary duty claims against all members of the Company’s board (the “Board”), for not fixing the Challenged Awards after plaintiff sent a letter demanding the Board modify the Challenged Awards to comply with the Compensation Plan (the “Demand”).  The Court analyzed this “novel theory” and surveyed the history of why making a demand had not given rise to a new cause of action due to the tacit-concession doctrine.  Under the pled theory, the failure to comply with a plain and unambiguous Compensation Plan, and the failure to address an obvious problem, supported a pleadings-stage inference of bad faith that differentiated the allegations from the earlier decisions that had looked at the issue.  The Court compared the analysis to a Caremark claim, stating “Delaware law treats a conscious failure to act as the equivalent of action, so if a plaintiff brings a clear violation to the directors’ attention and they do not act, then it is reasonable conceivable that the directors’ conscious inaction constitutes a breach of duty.” 

Through its holding, the Court noted this “novel theory” is likely rare and in light of the policy implications that claims of this sort present, “future decisions must consider carefully any attempts by plaintiffs to follow a similar path.”  For example, the Court cautioned against future plaintiffs using this theory to circumvent a laches defense by sending a demand letter and then suing the directors for failing to fix the problem.  The “novel theory” could also “enable plaintiffs to expose directors to litigation risk by presenting them with a problem they did not create and asserting that they failed to fix it.”  As a result, such a claim should only apply in rare situations, and even then, the Court described the “other difficulties for the plaintiff to overcome,” such as the existence of damages.

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