Last week on CompensationStandards.com, I blogged about the Delaware Chancery Court’s decision in Ayers v. Foley, which involved challenges to director compensation – both the compensation of all the non-employee directors and a special equity award to the company’s chairman. Vice Chancellor Will notes in the decision that “Delaware courts have yet to interpret” subsection (d)(2). Section 144(d)(2) is the newly added heightened presumption of disinterestedness for independent directors of listed companies. University of Colorado Law Prof Ann Lipton says on the Business Law Prof Blog:

With respect to the award to the board, the defendants conceded that this was an interested transaction, with no cleansing mechanisms, and demand was excused; the only argument they made was that plaintiffs’ complaint did not make it “reasonably conceivable” that the compensation was not entirely fair.  That argument was a heavy lift, and VC Will rejected it; those claims will proceed. The real action concerned the grant to the company founder and chair.

For demand to be excused for the founder grant, she had to determine whether a majority of the board was disinterested. (Nine of 11 were determined by the board to be independent under NYSE rules.) So the novel question she had to tackle was whether Section 144(d)(2)’s new presumption of disinterestedness applies beyond Section 144’s purview (transactions with controlling stockholders and interested directors and officers) and, specifically, whether it applies to demand excusal. As Ann notes:

DGCL 144 does not in any way incorporate or reference [Court of Chancery] Rule 23.1 [governing pleading requirements for derivative actions.]  It even uses different terminology than the caselaw developed under Rule 23.1: Rule 23.1 caselaw distinguishes between “independence” and “disinterestedness,” and while DGCL 144 clearly includes both concepts substantively, it combines them under a single rubric, “disinterest” [. . .]

On the other hand, from a judicial perspective, it is uncomfortable to have a definition of independence for cleansing purposes that is distinct from the definition of independence for the purposes of demand excusal, each of which is subject to a distinct particularity standard.

It is even more uncomfortable when you consider that demand excusal is, as a practical matter, an inquiry into whether a particular type of decision was cleansed – the decision whether to bring a lawsuit.  That is, most potentially “interested” board decisions involve actual contracts – to buy something, to sell something, to grant compensation.  In the demand context, it’s a different type of potentially interested board decision – the decision whether to sue.  Either way, though, we’re talking about what is sufficient to cleanse that decision such that the court will defer to it. Viewed that way, there is no reason the cleansing procedures for the two – actual transactions/contracts, versus decisions whether to bring a lawsuit – should differ at all.

Ultimately, VC Will determined that the General Assembly intended the presumption to apply broadly, including to demand excusal. Ann says this raises the question of whether all of Section 144’s cleansing procedures apply to demand excusal, which could significantly affect the construction and use of special litigation committees.

– Meredith Ervine