In Freedman v. Adams, 58 A.3d 414 (Del. January 14, 2013), the Supreme Court of Delaware affirmed the Court of Chancery’s decision that the plaintiff did not adequately state a claim for waste in her derivative suit against XTO Energy, Inc.’s (“XTO”) board of directors.
Susan Freedman (“Plaintiff”) was a stockholder of XTO, an oil and gas company that Exxon Mobile (“Exxon”) acquired in 2010. In 2008, Plaintiff filed a derivative action on behalf of XTO that accused the board of committing waste. Plaintiff alleged that the failure of XTO’s board to adopt a plan that could have made the company’s bonus payments tax deductible cost the company $40 million over a three-year period. Compensation paid to company executives greater than $1 million is only tax deductible if paid according to § 162(m) of the Internal Revenue Code. The XTO board, while allegedly aware of the potential benefits of §162(m), did not wish to be “constrained” by such a plan.
XTO’s board eventually approved a §162(m) plan, but never used it because Exxon acquired the company shortly afterwards. Plaintiff dismissed her initial complaint as moot but filed a motion seeking $1 million in attorneys’ fees. She asserted that her initial complaint “benefitted the company by causing XTO to adopt a Section 162(m) plan.” The Court of Chancery denied the motion.
Normally a claimant in a derivative suit must show, “with particularity, that [a] demand on the board of directors to redress the alleged wrong would have been futile”; however, a successful claim of waste not only denies the board the protection of the business judgment rule, but also negates the demand requirement. Plaintiff therefore only appealed the finding that the complaint did not state a claim for waste.
To state a claim for waste, a plaintiff must allege, with particularity, “that the board authorized action that no reasonable person would consider fair.” Plaintiff argued that “the board's failure to adopt a Section 162(m) plan... amounted to a gift in the form of tax payments that were not required” and that this omission was sufficient to establish a prima facie case of corporate waste. The court did not agree for two reasons. First, the complaint did not allege that any of the actual bonuses paid to XTO executives would have been tax deductible. Second, the board chose not to employ a Section 162(m) plan with full knowledge of the tax implications. The board “believed that a Section 162(m) plan would constrain the compensation committee in its determination of appropriate bonuses.”
The court held that “[t]he decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment.” Even if the decision not to implement the Section 162(m) plan was a bad one, it was not bad enough to meet the “unconscionable or irrational” standard required to show corporate waste.
The primary materials for this case may be found on the DU Corporate Governance website.