BOUCHARD, C.
This action involves a seemingly increasing area of litigation in this Court: claims challenging the payment of compensation to an officer or director of a Delaware corporation based on an alleged violation of the terms of a compensation plan. Asserting such claims derivatively, stockholders invariably argue that demand is excused on the theory that a violation of an unambiguous provision of a compensation plan raises a reasonable doubt the transaction resulted from a valid exercise of business judgment and, as the plaintiff here put it, "ipso facto establishes demand futility under the second prong of Aronson."
In this case, plaintiff Julie Friedman asserts claims for breach of fiduciary duty (Count I) and unjust enrichment (Count II) concerning the decision of the compensation committee of the board of directors of Expedia, Inc. ("Expedia" or the "Company") to accelerate the vesting of a grant of restricted stock units representing 400,000 shares of Expedia common stock (the "RSU Award") even though one of the original vesting conditions of the RSU Award had not been satisfied. The RSU Award was made to Expedia's chief executive officer Dara Khosrowshahi under the Company's 2005 Stock and Annual Incentive Plan (the "Plan").
Defendants moved to dismiss the complaint for failure to make a pre-suit demand upon the Expedia board of directors or to plead facts excusing such a demand and for failure to state a claim upon which relief can be granted. For the reasons set forth below, I conclude that this case should be dismissed under Rule 23.1 because plaintiff has failed to plead with particularity that making a demand would have been futile. Regarding the second prong of Aronson, I find that defendants have articulated a reasonable construction of the plain terms of the RSU Award whereby the compensation committee was entitled to waive the challenged vesting condition in accordance with their authority under the Plan. At most, plaintiff has identified a potential ambiguity in the RSU Award that the compensation committee was authorized to interpret under the terms of the Plan. Thus, plaintiff has failed to plead particularized facts raising a reasonable doubt that the transaction resulted from a valid exercise of business judgment.
Plaintiff Julie Friedman has been a stockholder of Expedia since 2005.
Expedia, a Delaware corporation, is an online travel company that provides business and leisure travelers with tools and information enabling them to research, plan and book travel. Expedia became an independent publicly traded company on August 9, 2005, when it was spun-off from IAC/InterActiveCorp.
Defendants Dara Khosrowshahi, Barry Diller, Victor A. Kaufman, A. George Battle, Jonathan L. Dolgen, Craig A. Jacobson, Peter M. Kern, John C. Malone, Jose A. Tazon, and William R. Fitzgerald were all members of the Expedia board of directors in August 2012 when the decision was made to accelerate the vesting of the RSU Award. Each of these individuals except Fitzgerald, who left the board in December 2012, was a member of the board when this lawsuit was filed on December 13, 2013. Pamela L. Coe, who is not named as a defendant, joined the Expedia board in November 2012.
Defendants Dolgen, Kern and Fitzgerald comprised the board's compensation committee (the "Compensation Committee" or "Committee") at all times relevant to this action.
On August 8, 2005, Expedia adopted its 2005 Stock and Annual Incentive Plan, which was approved by Expedia's then-sole stockholder shortly before the Company went public. The Plan was subsequently amended in 2007, 2008 and 2009, each time with the approval of the Company's stockholders. The Plan authorizes the Company to grant various stock-based awards to Expedia's directors, officers, employees and consultants.
The Plan is administered by the Compensation Committee, which has "plenary authority to grant Awards pursuant to the terms of the Plan to Eligible Individuals" and the authority, "subject to Section 12, to modify, amend or adjust the terms and conditions of any Award, at any time or from time to time."
The term "Section 162(m) Exemption" is defined in the Plan to mean "the exemption from the limitation on deductibility imposed by Section 162(m) of the [Internal Revenue Code of 1986] that is set forth in Section 162(m)(4)(C)" thereof.
When the Compensation Committee grants an award it may designate the award as a "Qualified Performance-Based Award."
The term "Performance Goals" is defined in Section 1(dd) of the Plan to mean "the performance goals established by the Committee in connection with the grant of Restricted Stock, Restricted Stock Units or Bonus Awards or other stock-based awards."
Although the Compensation Committee must condition a Qualified Performance-Based Award upon the achievement of one or more Performance Goals, nothing in the Plan prevents the Compensation Committee from making a Qualified Performance-Based Award subject to the achievement of other terms or conditions. Rather, Section 11(b) of the Plan states expressly that "[e]ach Qualified Performance-Based Award (other than an Option or Stock Appreciation Right) shall be earned, vested and payable (as applicable) only upon the achievement of one or more Performance Goals, together with the satisfaction of any other conditions, such as continued employment, as the Committee may determine to be appropriate."
Significant to this action, with certain exceptions not relevant here, Section 11(b) prohibits the Compensation Committee from amending a Qualified Performance-Based Award in a way that would cause it to lose its Section 162(m) Exemption:
A Qualified Performance-Based Award would lose its tax-deductible status by virtue of the Section 162(m) Exemption if the Compensation Committee waived any of the Performance Goals it established when the award was granted for the purpose of making the award qualify as a Qualified Performance-Based Award.
On March 7, 2006, the Compensation Committee granted 800,000 restricted stock units ("RSUs") to Khosrowshahi. An award of RSUs is denominated in shares of Expedia common stock that will settle in cash or shares upon satisfaction of whatever vesting conditions the Compensation Committee has established.
The terms and conditions of the RSU Award were initially set forth in a March 2006 Restricted Stock Unit Agreement. Section 1 of that agreement sets forth certain vesting conditions. Specifically, Section 1(b) provides that the RSU Award will vest upon the achievement of both (1) one of two specifically defined "Performance Goals" relating to the Company's EBITA or stock price and (2) an additional goal defined as the "OIBA Target." These goals are defined collectively as the "Combined Goals:"
The term "OIBA Target" is defined in the RSU Award as follows:
On March 13, 2006, shortly after granting the RSU Award, Expedia filed a Form 8-K with the Securities and Exchange Commission summarizing Khosrowshahi's compensation arrangements with Expedia.
Consistent with the text of the RSU Award, the term "Performance Goals" is defined in the Form 8-K as "the Company's achievement of a target increase in the price of the Company's common stock or the attainment of EBITA targets."
On December 20, 2011, Expedia completed the spin-off of its TripAdvisor Media Group into a new, separately traded public company, TripAdvisor, Inc.
Upon consummation of the spin-off, Khosrowshahi became a director of TripAdvisor while maintaining his positions as chief executive officer and a director of Expedia. Expedia and TripAdvisor agreed to divide the RSU Award. Specifically, Khosrowshahi entered into a restricted stock unit agreement with TripAdvisor for 400,000 shares of TripAdvisor common stock. Separately, his RSU Award with Expedia was amended to reduce the number of restricted stock units from 800,000 shares to 400,000 shares of Expedia common stock and to reduce the OIBA Target from $1 billion for a full year to $714.4 million.
The terms of the RSU Award with Expedia, as amended in 2011, are set forth in the Second Amended and Restated Expedia, Inc. Restricted Stock Unit Agreement. Similar to the original agreement, the vesting condition in the amended agreement uses defined terms to explicitly distinguish between targets based on EBITA and the Company's stock price (defined as the "Performance Goals") and based on OIBA (defined as the "Expedia OIBA Target"):
On August 2, 2012, Expedia entered into a new employment agreement with Khosrowshahi.
In a 2013 proxy statement, quoted (in part) in the complaint, the Company stated that the OIBA Target was a "business goal" and that the EBITA/stock price goals included in the definition of the term "Performance Goals" in the RSU Award were designed to satisfy the requirements of Section 162(m):
On February 28, 2013, the Board adopted various amendments to the Plan.
The complaint alleges that the Company "has been and will be damaged" by defendants' actions.
On December 13, 2013, Friedman commenced this derivative action on behalf of Expedia asserting two claims for relief. Count I asserts that defendants breached their fiduciary duty of loyalty by accelerating the vesting of the RSU Award in violation of the Plan because the OIBA Target had not been met and then engaging in efforts to conceal their misconduct by amending the Plan. In Count II, Friedman contends that Khosrowshahi was unjustly enriched when vesting of his RSU Award was accelerated in violation of the Plan.
On January 31, 2014, defendants moved to dismiss the complaint in its entirety for failure to make a pre-suit demand upon the Expedia board of directors or to plead facts excusing such a demand and for failure to state a claim upon which relief can be granted.
For the reasons explained below, I conclude that demand was not excused and that both claims in the complaint should be dismissed for failure to make a pre-suit demand under Rule 23.1. To analyze this question, it is important to first consider the competing interpretations of the RSU Award that have been presented because this issue underlies the fiduciary duty and unjust enrichment claims that have been asserted.
Under Section 162(m), a publicly held corporation can take a tax deduction for performance-based compensation in excess of $1 million paid to certain executives in a taxable year if the compensation is contingent upon the achievement of one or more performance goals as defined by the Internal Revenue Code. Specifically, under Subsection 162(m)(4)(C), "performance-based compensation" in excess of $1 million paid to a "covered employee" shall be tax-deductible if the compensation is "payable solely on account of the attainment of one or more performance goals" and if, among other things, "the performance goals are determined by a compensation committee of the board of directors of the taxpayer which is comprised solely of 2 or more outside directors."
As noted above, Section 1(dd) of the Plan defines "Performance Goals" to mean "the performance goals established by the Committee in connection with the grant of" a stock-based award.
The term "Performance Goals" is defined in the RSU Award to mean "one of two performance goals approved by the Committee . . . relating to EBITA or the Corporation's stock price."
Defendants argue that "OIBA," which means operating income before amortization, is not among the list of twenty-four criteria listed in Section 1(dd) and thus cannot serve as one of the performance goals that may be selected to satisfy the Section 162(m)(4) requirement. However, the list of twenty-four criteria in Section 1(dd) includes "operating income" and, under Section 1(dd), a goal intended to satisfy Section 162(m)(4) need only be "based on the attainment" of a specified level of "operating income."
The critical question is whether the Compensation Committee, when it granted the RSU Award, intended to use the OIBA Target as a performance goal to satisfy the performance goal requirement of Section 162(m)(4) or whether the Compensation Committee intended the OIBA Target to be a separate vesting condition of the Award. This is critical because, as discussed above, Sections 11(b) and 12(d) of the Plan prohibit the Compensation Committee from amending a Qualified Performance-Based Award "in any manner that would cause the Qualified Performance-Based Award to cease to qualify for the Section 162(m) Exemption."
To make the RSU Award qualify for an exemption under Section 162(m), it was only necessary to establish one performance goal.
Defendants argue that the plain terms of the RSU Award make clear that the Compensation Committee did not select the OIBA Target as a performance goal to satisfy Section 162(m) based on the fact that the RSU Award uses separately defined terms to describe the "Performance Goals" (i.e., the EBITA and stock price targets) and the "OIBA Target" (i.e., the operating income before amortization target). According to defendants, the use of these separately defined terms, the first of which tracks the language of Section 162(m), establishes that the EBITA and stock price targets were intended to satisfy the performance goal requirement of Section 162(m) while the OIBA Target was intended to be a separate, additional goal that the Compensation Committee thus had the authority to waive. In my opinion, this is a reasonable construction of the plain language of the RSU Award.
This construction is consistent with disclosures contained in the Company's 2013 proxy statement describing the Compensation Committee's decision to waive the OIBA Target in the RSU Award. In particular, those disclosures differentiate between the "business goal" of the OIBA Target and the EBITA/stock performance goals "which were designed to satisfy the requirements of Section 162(m) of the Code:"
For her part, Friedman argues that the OIBA Target was intended to be a performance goal to satisfy Section 162(m)(4) because this goal satisfies one of the twenty-four criteria within Section 1(dd) of the Plan, which delineates the type of performance goals that can be used to make an award qualify under Section 162(m)(4). As discussed above, I assume for purposes of this opinion that OIBA satisfies one of these twenty-four criteria. In further support of her construction, Friedman notes that the Company referred to the EBITA/stock price goals and the OIBA Target, collectively, as the "RSU Performance Goals" in a 2010 proxy statement discussing the RSU Award.
Regarding the disclosure in the 2013 proxy statement quoted above, Friedman argues that this disclosure was made after defendants had violated the Plan with the intention of concealing their violation. Friedman notes that the same proxy statement sought stockholder approval of certain changes to the Plan, including amendments to Section 11(b) and 12(d) to eliminate the prohibition on the Committee's ability to amend a Qualified Performance-Based Award in a manner that would cause the award to cease to qualify as tax-deductible performance-based compensation under Section 162(m). According to Friedman, defendants attempted to slip these changes by the stockholders by characterizing them as "administrative changes."
In my opinion, Friedman's interpretation cannot logically be squared with the use of separately-defined terms in the RSU Award differentiating between the "Performance Goals" and the "OIBA Target." To my mind, moreover, the disclosure in the 2010 proxy statement characterizing the "OIBA Target" as one of the "RSU Performance Goals," which was not referenced in the complaint,
Whether or not one views Friedman's construction of the RSU Award to be reasonable, at most it shows there may be an ambiguity concerning whether the OIBA Target was intended to satisfy Section 162(m) when the RSU Award was granted. In that regard, another provision of the Plan is salient.
Under Section 2(a)(vii), the Compensation Committee has the authority "to interpret the terms and provisions of the Plan and any Award issued under the Plan (and any agreement relating thereto)."
Friedman makes two arguments in the alternative assuming the OIBA Target was not a pre-established performance goal for purposes of Section 162(m). First, Friedman argues that the OIBA Target was at least a "material term" of the RSU Award and that Section 162(m)(4)(C)(iii) of the Internal Revenue Code would prohibit payment to Khosrowshahi until all material terms of the RSU Award had been satisfied. Second, she argues that if the OIBA Target was an "other condition" as that term is used in Section 11(b) of the Plan, the decision to accelerate the vesting of the RSU Award violated Section 11(b)(i) of the Plan, which requires the satisfaction of any "other condition" before an award may become payable.
Both of these arguments are unavailing for the same reason. They ignore the fact that the Compensation Committee waived the OIBA Target. As a result, the OIBA Target had been eliminated and was neither a "material term" nor an "other condition" of the RSU Award when it became payable.
With the foregoing discussion of the parties' interpretations of the RSU Award in mind, I turn now to the application of the Aronson test.
Court of Chancery Rule 23.1 and Delaware law require that a stockholder initiating a derivative action plead "with particularity" either that demand was made on the corporation to initiate suit on its own, or that such demand "would have been futile."
Under Delaware law, there are two tests for determining whether demand is futile. The parties agree that the two-prong test articulated in Aronson v. Lewis applies in this case.
Here, Friedman asserts that demand would be futile under either prong of Aronson. I disagree for the reasons stated below.
When this action was filed, the Expedia board had ten members, consisting of defendants Khosrowshahi, Diller, Kaufman, Battle, Dolgen, Jacobson, Kern, Malone, Tazon and non-party Coe. Thus, to prevail under the first prong of Aronson, the particularized facts of the complaint must create a reasonable inference that at least five of these individuals would be incapable of considering a demand because they are either interested or lack independence.
Friedman does not challenge the independence or disinterestedness of directors Battle, Jacobson or Tazon. For purposes of my analysis, I assume Khosrowshahi had a material financial interest in the challenged transaction because he received a significant payment as a result of the Compensation Committee's decision to waive the OIBA Target and accelerate the vesting of the RSU Award. Therefore, Friedman must plead particularized facts from which the Court can infer that at least four of the remaining six directors are interested or lacks independence. Plaintiff has failed to make this showing.
Friedman argues that directors Dolgen and Kern, as members of the Compensation Committee that approved accelerating the vesting of the RSU Award, are interested because they face a substantial likelihood of liability. The standard for pleading a substantial likelihood of liability is difficult to meet.
Friedman relies on this Court's decisions in Conrad v. Blank
To the contrary, for the reasons discussed above, I am of the opinion that the members of the Compensation Committee were permitted to waive the OIBA Target in accordance with the terms of the Plan based on a reasonable construction of the terms of the RSU Award. At most, Section 1(b) of the RSU Award was ambiguous, which would negate any inference of a "knowing" violation of the Plan, particularly since the Compensation Committee was authorized under the Plan to interpret the terms of an award in the case of ambiguity. Therefore, I conclude that the members of the Compensation Committee do not face a substantial likelihood of liability and that Friedman has failed to allege particularized facts creating a reasonable doubt concerning disinterestedness or independence of directors Dolgen or Kern.
Friedman argues that directors Malone and Coe will not be able to consider impartially a demand to institute an action against Fitzgerald, who left the Expedia board before this action was filed, based on their "long-standing relationship" with him and because Fitzgerald faces a substantial likelihood of liability as a member of the Compensation Committee that approved the waiver of the OIBA Target.
Regarding Malone, the complaint alleges that Fitzgerald held various positions at Tele-Communications, Inc. from 1996 to 2000 when Malone was either the Chief Executive Officer or Chairman of the Board, and that Fitzgerald was a Senior Vice President at Liberty from 2000 to 2011, which was controlled by Malone, and at Starz from 2011 to 2012, where Malone served as Chairman of the Board.
Regarding Coe, the complaint alleges she provided legal services to Liberty on a consulting basis for at least three years and later served as Liberty's Deputy General Counsel while Fitzgerald was a Senior Vice President of Liberty, and that she, like Fitzgerald, joined Expedia's board as a nominee of Liberty.
I conclude that Friedman has failed to allege particularized facts creating a reasonable doubt concerning the disinterestedness or independence of either Malone or Coe for two inter-related reasons. First, for the reasons discussed above regarding the other members of the Compensation Committee, Friedman has failed to allege particularized facts establishing that Fitzgerald faces a substantial likelihood of liability for approving the waiver of the OIBA Target as a member of the Compensation Committee. Second, as this Court has held, the "naked assertion of a previous business relationship is not enough to overcome the presumption of a director's independence."
For the foregoing reasons, I conclude that Friedman has failed to allege particularized facts to create a reasonable doubt concerning the disinterestedness or independence of at least seven (Battle, Jacobson, Tazon, Dolgen, Kern, Malone and Coe) of the ten members of Expedia's board when this action was filed.
Plaintiff has a "heavy burden" to establish that the second prong of Aronson has been satisfied.
Friedman does not allege that the Expedia board was inadequately informed, but instead contends that accelerating the vesting of the RSU Award was a clear violation of the Plan that could not have been a valid exercise of business judgment.
In Sanders, plaintiffs alleged that the members of the board of directors of Computer Associates International, Inc. breached their fiduciary duties of loyalty and care by awarding certain executives millions of shares more than the board was authorized to award under the company's 1995 Key Employee Stock Ownership Plan (KESOP).
Friedman cites three other cases decided after Sanders in which this Court similarly found demand to be excused under the second prong of Aronson where the board allegedly had violated a compensation plan.
In contrast to Sanders and its progeny, Friedman has not alleged with particularity a clear or intentional violation of a compensation plan in this case. To the contrary, for the reasons explained above, it is my opinion that the Compensation Committee was authorized under the Plan to waive the OIBA Target because, based on a reasonable construction of the RSU Award, the OIBA Target was not intended to satisfy the performance goal requirement of Section 162(m). At most, Friedman's interpretation of the RSU Award raises a potential ambiguity that the Compensation Committee was entitled to interpret and resolve under the Plan. Thus, demand is not excused under the second prong of Aronson because Friedman has failed to allege particularized facts to support an inference of bad faith on the part of any of the defendant directors sufficient to raise a reasonable doubt that the decision to waive the OIBA Target was anything other than the product of a valid business judgment.
Friedman argues, alternatively, that demand is excused under the second prong of Aronson because defendants adopted and asked the stockholders to approve an amendment to Sections 11(b) and 12(d) of the Plan in 2013 to remove the prohibition on amending a Qualified Performance-Based Award in a way that would cause the award to cease to qualify for an exemption under 162(m). According to Friedman, "[d]efendants sought to hide the violation from Expedia's shareholders and thereby breached their duty of loyalty."
In Count II, Friedman alleges that Khosrowshahi was unjustly enriched when he "received unauthorized personal financial benefits by accepting the improperly vested RSU Award in violation of the Plan's express terms."
For the foregoing reasons, defendants' motion to dismiss both claims in the complaint under Court of Chancery Rule 23.1 for failure to adequately plead demand futility is GRANTED. The complaint is dismissed in its entirety with prejudice.
Oral Argument Tr. at 31:21-32:8 (June 16, 2014).
Expedia, Inc., Definitive Proxy Statement (Schedule 14A) 42 (Apr. 27, 2010).
