Last week, the Delaware Court of Chancery granted in part, and denied in part, a motion to dismiss a derivative suit with two breach of fiduciary duty claims, an unjust enrichment claim and a corporate waste claim. In Knight v. Miller et. al., the plaintiff, Robin Knight, challenged option awards granted to Universal Health Services Inc.’s directors and officers by its compensation committee at the outset of the COVID-19 pandemic. The defendants (comprised of UHS and various UHS directors and officers) moved to dismiss, generally on the “basis of a fair process and a fair price.”
As background, the compensation committee met on March 18, 2020 (prior to market open) and granted option awards with the strike price equal to the closing price that day – which happened to be the same day that UHS stock hit $67.69 a share, the lowest closing price since September 2013. The stock rebounded to $100.13 per share on March 30, 2020, after various phases of federal Covid-19 relief legislation was announced and enacted. Notably, the compensation committee meeting in question was scheduled at least 6+ months in advance, and the defendants stated that since 2014, the option grants were normally made in March meetings (except for once in April).
Zoning in on the fiduciary duty claims, the plaintiff pled that (1) the compensation committee breached their fiduciary duty in granting these March 2020 awards to the directors and officers, and (2) all defendants breached their fiduciary duties for accepting these March 2020 awards.
Breaking down the claims further by categories of defendants, the Court allowed the breach of fiduciary duty claim against the compensation committee for granting awards to directors (excluding the controlling defendants) to move forward. Since the act of directors fixing their own compensation is intrinsically self-interested (even if allowed by the DGCL), this was subject to an entire fairness standard of review. The Court said (with footnotes removed):
The Complaint pleads the following, implying lack of entire fairness: first, that the Compensation Committee disregarded certain considerations related to the emergence of the COVID-19 pandemic; second, that the Company’s peers even in its self-selected peer group received significantly less compensation; third, that the Company, speaking through its CFO, considered the Company stock a “buy” even at a price over $20 in excess of the strike price established for the March 2020 Awards; fourth, that at least one analyst identified a year-end price target for the Company of $127, using a model that purported to incorporate the effects of COVID-19; and finally, that Alan Miller was “actively lobbying” the federal government via his activities with FAH, and therefore “knew or had reason to know of the timing and extent of federal grants,” including relief that UHS might reasonably expect to receive. These facts are sufficient to raise a reasonably conceivable inference of an unfair transaction at the plaintiff-friendly pleading stage. This finding does not preclude the Compensation Committee Defendants from establishing that the March 2020 Awards were in fact entirely fair.
The Court also allowed the breach of fiduciary duty claim against the compensation committee for granting awards to controlling defendants to move forward. Although neither of the controlling defendants were seated on the compensation committee, they were directors and controlling stockholders who received a non-ratable benefit — so the entire fairness standard applied. However, for the breach of fiduciary duty claim against the compensation committee for granting awards to the executive officers, the Court applied the business judgment rule and granted the motion to dismiss.
As to the fiduciary duty claim against all of the defendants for accepting the equity awards, the Court concluded that “what is required is a defendant’s knowingly wrongful acceptance of compensation, and that the standard must be bad faith. That is, there must be a sufficient pleading of scienter to support a bad faith claim, which serves as a claim based on breach of the duty of loyalty.” The Court didn’t find enough in the record to sustain even a claim that the compensation committee acted in bad faith when making the grants, let alone that the defendants accepted the grants in bad faith — and granted the motion to dismiss.
The Court also granted the motion to dismiss the corporate waste claim, but allowed the unjust enrichment claim to move forward.
— Emily Sacks-Wilner, CompensationStandards.com May 4, 2022