Caseflicks

Court of Chancery of Delaware • 2015

Ernesto Espinoza v. Mark Zuckerberg

124 A.3d 47 | 2015 Del. Ch. LEXIS 273

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Takeaway

In short, this case holds that even a controlling stockholder must use the DGCL’s formal voting or written-consent procedures to ratify an interested board transaction and obtain business-judgment review.

Background

Facebook’s eight-member board approved increased compensation for its six non-employee directors in 2013. The package included higher cash retainers for Audit Committee members and annual restricted-stock-unit grants valued at roughly $300,000. The six outside directors received the challenged awards; Mark Zuckerberg and Sheryl Sandberg did not receive board-service compensation. Zuckerberg, Facebook’s founder, CEO, board chair, and controlling stockholder, held approximately 61.6% of Facebook’s voting power through Facebook’s dual-class stock structure.

Ernesto Espinoza brought a derivative action on Facebook’s behalf against all eight directors. He alleged breach of fiduciary duty, waste, and unjust enrichment, contending that the directors had awarded themselves excessive compensation. The parties agreed that, absent a valid stockholder ratification, the directors’ self-compensation decision was a self-dealing transaction subject to entire-fairness review.

After suit was filed, Zuckerberg stated in an affidavit and deposition that he approved the 2013 equity awards and would have voted for them or signed a written consent if given the opportunity. He never actually voted on the awards as a stockholder or executed a written consent under 8 Del. C. § 228. Defendants moved for summary judgment on the fiduciary-duty and unjust-enrichment claims, arguing that Zuckerberg’s statements ratified the compensation and restored business-judgment review. They also moved to dismiss the waste claim.

Issues

Issue #1

Whether a disinterested controlling stockholder may ratify an interested board’s self-dealing transaction through informal statements rather than a stockholder vote or statutorily compliant written consent.

Holding

No. Stockholder ratification that would shift review of an interested-director transaction from entire fairness to the business-judgment rule must be accomplished formally through a stockholder vote at a meeting or a written consent that complies with the Delaware General Corporation Law.

Reasoning

Directors are interested in decisions setting their own compensation because they receive a personal financial benefit not shared generally by stockholders. Accordingly, the Facebook board’s approval of compensation for six of its eight members was presumptively subject to entire-fairness review. A fully informed, disinterested stockholder ratification can change that standard of review, but Zuckerberg’s status as a disinterested controlling stockholder did not eliminate the need for a valid act of stockholder approval.

The DGCL provides two basic mechanisms for stockholders to take corporate action: voting at a stockholder meeting or acting by written consent under Section 228. Both mechanisms impose formal requirements designed to establish precisely what action was approved, verify that the required voting power supported it, and protect stockholders through notice, recordkeeping, and disclosure requirements. Section 228, in particular, requires prompt notice to nonconsenting stockholders after action is taken by less than unanimous consent.

General agency-law principles allowing a single principal to ratify an agent’s act informally do not control in the corporate setting. Corporate stockholders coexist as principals, and a controlling stockholder’s decision can affect the rights of minority holders. The corporate context therefore requires sensitivity to the DGCL’s statutory overlay and to the protections that formal procedures provide to nonassenting stockholders.

The authorities defendants cited did not support informal ratification here. Cases involving formal stockholder votes, acquiescence by an individual claimant, a nonstock corporation, or an LLC did not establish that a controlling stockholder may dispense with the DGCL’s requirements when ratifying directors’ conduct. Delaware precedent instead commonly describes effective ratification as a fully informed stockholder vote and strictly enforces the technical requirements for written consents, even where a single holder possesses all voting power.

Allowing informal ratification would create uncertainty about what words or conduct constitute approval. If an affidavit sufficed, courts might also be asked to treat meeting comments, press releases, private conversations, or other ambiguous expressions as legally operative corporate acts. Zuckerberg’s deposition statement, which generally praised Facebook’s directors and compensation plan, illustrated the problem because it did not clearly identify a definitive approval of the specific 2013 awards.

Zuckerberg’s affidavit and deposition testimony therefore did not ratify the 2013 compensation. The awards remained subject to entire-fairness review, under which defendants bore the burden to establish both fair dealing and fair price. Because defendants relied exclusively on their failed ratification theory and did not establish entire fairness as a matter of law, summary judgment on the fiduciary-duty claim was denied.

Issue #2

Whether the unjust-enrichment claim could be resolved by summary judgment when it rested on the same alleged misconduct as the surviving fiduciary-duty claim.

Holding

No. The unjust-enrichment claim survived because defendants’ sole argument for judgment depended on the fiduciary-duty claim failing, and that claim remained viable.

Reasoning

An unjust-enrichment claim requires an enrichment, a corresponding impoverishment, a relationship between them, lack of justification, and no adequate legal remedy. Defendants did not independently establish that these elements could not be proved. Instead, they argued only that the claim necessarily failed if the fiduciary-duty claim failed.

Because the court denied summary judgment on the fiduciary-duty claim, the premise of defendants’ argument disappeared. The court therefore also denied summary judgment on the duplicative unjust-enrichment claim, while leaving any later remedy issues for a later stage of the case.

Issue #3

Whether allegations that Facebook’s outside-director compensation exceeded peer-company averages stated a reasonably conceivable claim for corporate waste.

Holding

No. The allegations did not meet Delaware’s exceptionally demanding standard for waste.

Reasoning

Corporate waste requires an exchange so one-sided that no person of ordinary, sound business judgment could conclude that the corporation received adequate consideration. It is an extreme doctrine, aimed at a gift or gratuity rather than at a transaction that may simply have been unwise, excessive, or unfair.

Espinoza alleged that Facebook’s directors were paid more than directors at a selected peer group of companies and that Facebook’s financial performance did not justify the awards. Those allegations challenged the amount of compensation, but they did not support a reasonable inference that Facebook received no meaningful value from its directors’ services.

The complaint did not allege that Facebook’s directors lacked talent, performed no work, or provided no consideration in exchange for their compensation. Even allegedly lavish director compensation does not alone constitute waste. The court thus dismissed the waste claim for failure to state a claim.