BOUCHARD, C.
This action involves derivative claims for breach of fiduciary duty (Count I) and corporate waste (Count II) concerning compensation paid to the non-executive directors of Unilife Corporation ("Unilife" or the "Company") since November 2010. The challenged compensation consists of two components: (1) equity awards the Unilife directors granted to themselves subject to obtaining stockholder approval for those awards and (2) cash compensation the directors paid to themselves without obtaining stockholder approval.
Unilife has moved to dismiss the complaint for failure to make a pre-suit demand upon the Unilife board of directors or to plead facts that excuse such a demand and, as to certain claims, for failure to state a claim upon which relief may be granted. For the reasons set forth below, I conclude that demand is excused under the first prong of Aronson because the claims involve self-dealing transactions implicating a majority of the members of Unilife's board of directors at the time suit was filed. I also conclude that the fiduciary duty claim should be dismissed for failure to state a claim for relief insofar as it relates to the outside directors' equity awards because each of those awards was specifically approved by Unilife's stockholders and that the corporate waste claim fails to satisfy the stringent standard for stating such a claim. Defendants did not seek to dismiss the fiduciary duty claim for failure to state a claim for relief insofar as that claim relates to cash compensation paid to the directors for their services as directors. Thus, that claim survives.
Unilife is a manufacturer and supplier of injectable drug delivery systems, including retractable syringes. In 2002, the Company was founded in Sydney, Australia. In 2008, Unilife moved its operations to York, Pennsylvania. In 2010, Unilife redomiciled from Australia to the State of Delaware and became listed on the NASDAQ Global Market.
Since its formation in 2002, Unilife has failed to turn a profit or to generate significant revenues. During its last three fiscal years,
Plaintiff Cambridge Retirement System is a Massachusetts-based retirement system. It has held Unilife common stock continuously since November 2010, and challenges the compensation paid to Unilife's outside directors during this period.
From November 2010 until November 2012, Unilife's board of directors had seven members, consisting of its Chairman and Chief Executive Officer, Alan Shortall, and six outside directors: Slavko James Joseph Bosnjak, Jeff Carter, John Lund, William Galle, Mary Katherine Wold and Marc Firestone. Firestone left the board in November 2012. As of the date the complaint in this action was filed on December 20, 2013, the board consisted of six directors: Shortall, Bosnjak, Carter, Lund, Galle and Wold.
During the period at issue, Unilife compensated its outside directors through a combination of equity awards and cash compensation. Significant to the pending motion, the Unilife board conditioned its grant of each of the challenged equity awards on obtaining stockholder approval, which the stockholders provided.
On January 8, 2010, in connection with Unilife's redomiciliation from Australia to the State of Delaware, the Company's stockholders approved the adoption of its 2009 Stock Incentive Plan (the "2009 Plan").
At a stockholders' meeting held on December 1, 2010, Unilife's stockholders approved grants of options to directors Wold and Firestone to purchase 100,000 shares of common stock each under the 2009 Plan.
Proposal No. 3 explained that the 100,000 options for Wold would have an exercise price of $6.83 per share based on the closing price of the Company's shares on May 11, 2010 (the date the Unilife board approved the grant), would be exercisable for five years and would vest as follows: 16,667 options would vest within three business days of the Company obtaining stockholder approval, 25,000 shares would vest on the 12 month anniversary and 24 month anniversary of the date of grant and 33,333 shares would vest on the 36 month anniversary of the date of grant. Proposal No. 4 provided the same information concerning the 100,000 options for Firestone except that they would have an exercise price of $6.19 per share based on the closing price of the Company's shares on July 27, 2010, the date the Unilife board approved the grant.
At a stockholders' meeting held on December 1, 2011, Unilife's stockholders approved grants of 45,000 stock-based awards each to directors Bosnjak, Carter, Galle, Lund, Wold and Firestone under the 2009 Plan.
In addition to receiving the foregoing equity awards, the outside directors each received cash compensation during the relevant period consisting of a mix of retainer and meeting fees. The fee structure for the outside directors was disclosed in Unilife's October 18, 2010 proxy statement,
According to the complaint, these amounts not only constitute an extraordinary percentage of the Company's revenues, but are excessive when compared to other companies in Unilife's sector. In particular, Cambridge alleges that, of eleven healthcare companies with market capitalizations between $41 million and $718 million, nine paid their directors, on average, less than $100,000 each in 2012 and eight paid their directors less than $70,000 each. By contrast, Unilife, which has had an average market capitalization of $287.9 million over the past five years, paid its outside directors average compensation of $226,007 in fiscal year 2012.
On December 20, 2013, Cambridge filed this derivative action on behalf of Unilife. The complaint asserts two claims against the director defendants, the first for breach of fiduciary duty and the second for waste of corporate assets. The defendants moved to dismiss both claims for failure to make demand under Court of Chancery Rule 23.1. They also moved to dismiss for failure to state a claim upon which relief can be granted under Rule 12(b)(6) parts of the first claim and the second claim in its entirety.
I first turn to the question whether the complaint alleges facts excusing demand before turning to whether the claims alleged in the complaint state a claim for relief.
Where a decision of a corporation's board of directors is challenged, demand may be excused under either prong of the familiar two-prong Aronson test if particularized facts have been alleged to create a reasonable doubt that "(1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment."
This conclusion is squarely supported by Chancellor Allen's decision in Steiner v. Meyerson.
Defendants attempt to distinguish Steiner on the theory that the loyalty of the outside directors "was otherwise impugned" by virtue of their involvement in other transactions with Telxon's then chief executive officer, Robert Meyerson, which were the subject of other claims in the case.
Defendants press two other arguments in an effort to avoid the straightforward application of the first prong of Aronson to this case. First, defendants argue that a director's interest in his own compensation should not be considered "disabling" under Aronson unless it is alleged that the compensation is material to the particular director in question.
In articulating the two-prong test for determining whether demand is excused, the Supreme Court in Aronson defined "interest" to mean "that directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing."
In Cede & Co. v. Technicolor, Inc. ("Cede II"), the Supreme Court held that a personal financial benefit must be "material" to a director to qualify as a disabling interest, but in doing so, the Court distinguished self-dealing transactions.
The lack of a materiality standard for self-dealing transactions at common law is consistent with § 144 of the Delaware General Corporation Law, which applies to self-dealing transactions. Specifically, § 144 applies to any "contract or transaction [1] between a corporation and 1 or more of its directors or officers, or [2] between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest."
Analyzing the Supreme Court's decisions in Cinerama and Cede II and their interplay with § 144, then-Vice Chancellor Strine determined that the materiality test articulated in those decisions does not apply when a director is deemed interested by virtue of § 144. Rather, a materiality standard only applies when § 144 is inapplicable.
Finally, it bears mention that Chancellor Allen, who articulated the materiality test that was affirmed in Cede II, did not impose a materiality requirement in Steiner, which was decided after Cede II. In fact, the Chancellor found that demand was excused in Steiner despite his observation that the compensation for the directors "seem[ed] quite within a range that could be paid in good faith by a company seeking to attract competent, committed directors."
Defendants base their second argument to avoid a straightforward application of the first prong of Aronson on 8 Del. C. § 141(h). That provision states that "[u]nless otherwise restricted by the certificate of incorporation or bylaws, the board of directors shall have the authority to fix the compensation of directors."
According to defendants, the "only way to give effect to Section 141(h) is to require derivative plaintiffs not only to allege that a majority of directors are interested in their own compensation, but also to allege particularized facts" that would satisfy the second prong of Aronson, i.e., to create a reasonable doubt that the directors' approval of their own compensation was the product of a valid exercise of business judgment.
Section 141(h) was enacted in 1969 in response to early Delaware cases that called into question the ability of directors to receive compensation for their services.
On its face, § 141(h) only speaks to the authority of directors to set their own compensation. It does not address the standard of review applicable to such a decision. Given the plain text of § 141(h), its legislative history and the lack of any authority supporting defendants' novel interpretation of the statute, I reject defendants' invitation to rewrite the disjunctive two-prong test of Aronson to require that both prongs be satisfied when analyzing demand futility regarding a challenge to director compensation that plainly satisfies the first prong.
For the foregoing reasons, I conclude that plaintiff's failure to make a demand is excused.
A motion to dismiss pursuant to Rule 12(b)(6) for failure to state a claim must be denied "unless the plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances."
With one exception discussed below, defendants did not move to dismiss the fiduciary duty claim for failure to state a claim for relief under Rule 12(b)(6) insofar as that claim pertains to the cash compensation Unilife's directors paid themselves. This was a sensible decision. In reversing a subsequent grant of summary judgment in the Steiner case discussed above, the Delaware Supreme Court held that, "[l]ike any other interested transaction, directoral self-compensation decisions lie outside the business judgment rule's presumptive protection, so that, where properly challenged, the receipt of self-determined benefits is subject to an affirmative showing that the compensation arrangements are fair to the corporation."
The one aspect of cash compensation for which defendants have sought dismissal concerns $346,392 and $216,479 that was paid to defendant Carter in fiscal years 2011 and 2012, respectively. These amounts are reported in the Company's proxy statements in a table entitled "Director Compensation" under the subheading "All Other Compensation" and are accompanied by a footnote stating that "Mr. Carter's other compensation includes amounts paid to a consulting entity of which Mr. Carter is the principal."
At oral argument, plaintiff's counsel represented that plaintiff challenges only the compensation paid to the outside directors for their service as directors and does not challenge amounts paid to Carter for consulting services.
In a letter filed after oral argument, defendants' counsel contends that all of the amounts appearing in the "other compensation" line for Carter were paid for consulting services, notwithstanding the text of the footnote, based on an extrapolation of a currency exchange rate between Australian and United States dollars and other disclosures contained in the proxy statement.
Insofar as the fiduciary duty claim pertains to the equity awards the outside directors received, defendants argue that they are protected by the business judgment rule because each of those awards was approved by a disinterested majority of Unilife's stockholders. I agree and dismiss this aspect of the fiduciary duty claim because plaintiff has failed to plead facts to legitimately call into question the validity of the stockholders' approval or to rebut the presumption of the business judgment rule.
In a series of decisions, this Court has dismissed otherwise self-interested transactions involving director compensation because of the effect of stockholder approval of such transactions. In Steiner, discussed above, after sustaining a claim for breach of fiduciary duty challenging the cash payments made to the outside directors of Telxon, Chancellor Allen dismissed that part of the claim challenging stock option grants to them based on stockholder approval of the plan under which the options were granted. He explained that:
Chancellor Allen thus held that, in the absence of any allegation that "the option plan was ultra vires, illegal or fraudulent, the only basis on which the plan may be successfully attacked is that it constitutes a gift of corporate assets or waste."
Several years later, in In re 3COM Corp. Shareholders Litigation, the Court cited Steiner with approval and held that "[d]ecisions of directors who administer a stockholder approved director stock option plan are entitled to the protection of the business judgment rule, and, in the absence of waste, a total failure of consideration, they do not breach their duty of loyalty by acting consistently with the terms of the stockholder approved plan."
Here, as in Desimone, Unilife's stockholders approved each of the specific equity awards challenged in this action. As explained above, in 2010, Unilife stockholders approved the grant of up to 100,000 options to two of the Company's outside directors and, in 2011, approved the grant of up to 45,000 stock-based awards to six of the Company's outside directors.
Plaintiff alleges that these stockholder approvals were not valid because the proxy statements on which the votes were based "omitted or included materially misleading information concerning, inter alia, whether the Unilife's outside director compensation is in line with director compensation paid at comparable firms, the identity of truly comparable companies, and the average director compensation at those firms."
Under Delaware law, "[t]o state a claim for breach by omission of any duty to disclose, a plaintiff must plead facts identifying (1) material, (2) reasonably available (3) information that (4) was omitted from the proxy materials."
In my opinion, the absence of benchmarking information for outside director compensation was not a material omission from Unilife's 2010 and 2011 proxy statements because the proxy statements disclosed all material terms of the precise equity awards that the stockholders were being asked to approve.
The 2010 proxy statement disclosed the exact number of options to be awarded to directors Wold and Firestone (100,000 each), the exercise price for those options ($6.83 per share for Wold and $6.19 per share for Firestone), the exercisability period for the options (five years from the date of grant) and the schedule over which the options would vest. Similarly, the 2011 proxy statement disclosed the exact number of equity awards to be issued to directors Bosnjak, Carter, Galle, Lund, Wold and Firestone (45,000 each), the nature of those awards (shares of common stock of phantom stock units), and the schedule over which those awards would vest. Thus, whether or not the value of these equity awards, viewed in isolation or together with other compensation, were in line with the levels of compensation paid to the outside directors of Unilife's alleged peer companies, Unilife's stockholders cannot legitimately claim they were not made aware of the material terms of what they were being asked to approve.
Because plaintiff has failed to undermine the validity of the stockholder approvals on which the equity awards in question were expressly conditioned, the business judgment rule applies to the board's decision to grant those awards in the first instance. "[W]here business judgment presumptions are applicable, the board's decision will be upheld unless it cannot be `attributed to any rational business purpose.'"
For the foregoing reasons, I grant defendants' motion to dismiss the fiduciary duty claim insofar as it relates to the equity awards that were approved by Unilife's stockholders.
"[A] plaintiff faces an uphill battle in bringing a waste claim, and a plaintiff must allege particularized facts that lead to a reasonable inference that the director defendants authorized an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration."
The complaint alleges that the compensation paid to Unilife's directors since 2010 constitutes an excessive percentage of its revenues during this period (25% and 24%, respectively, in fiscal years 2012 and 2013) and is excessive relative to eleven other healthcare companies with market capitalizations between $41 million and $718 million. These allegations raise questions concerning the fairness of the outside directors' compensation, but they do not rise to the level necessary to establish a complete failure of consideration or that the director defendants authorized an exchange that was so one-sided that no reasonable business person could conclude that Unilife received adequate consideration. Accordingly, the claim for corporate waste fails to state a claim for relief and is dismissed.
For the foregoing reasons, defendants' motion to dismiss Count I is GRANTED insofar as it relates to the equity awards issued to Unilife's outside directors, but DENIED insofar as it relates to the cash compensation paid to the outside directors. Count II is dismissed in its entirety.
