Michelson v. Duncan

• Decision Date: 02 October 1979
• Parties: A. Elihu MICHELSON, Plaintiff Below, Appellant, v. Louis C. DUNCAN, G. R. Ellis, Thomas D. Flynn, Joseph W. James, Mitchell P. Kartalia, Paul C. Nagel, Jr., Gordon P. Osler, Arthur E. Rasmussen, George W. Rauch, A. O. Steffey, James W. Tait, Robert C. Trow, Miller Upton, William E. Wehner, John C. Whitehead, D. C. Clark, John T. Gurash and Household Finance Corporation, Defendants Below, Appellees.
• Court: United States State Supreme Court of Delaware

Page 211

407 A.2d 211

A. Elihu MICHELSON, Plaintiff Below, Appellant, v. Louis C. DUNCAN, G. R. Ellis, Thomas D. Flynn, Joseph W.

James, Mitchell P. Kartalia, Paul C. Nagel, Jr., Gordon P.

Osler, Arthur E. Rasmussen, George W. Rauch, A. O. Steffey,

James W. Tait, Robert C. Trow, Miller Upton, William E.

Wehner, John C. Whitehead, D. C. Clark, John T. Gurash and

Household Finance Corporation, Defendants Below, Appellees.

Supreme Court of Delaware.

Submitted March 15, 1979.

Decided Oct. 2, 1979.

Upon appeal from the Court of Chancery. Affirmed in part; Reversed in part.

Bertram Bronzaft, of Garwin & Bronzaft, New York City, and Joseph A. Rosenthal of Morris & Rosenthal, P. A., Wilmington, for plaintiff-appellant.

A. Gilchrist Sparks, III, S. Samuel Arsht and Craig B. Smith, of Morris, Nichols, Arsht & Tunnell, Wilmington, and Hubachek, Kelly, Rauch & Kirby, Chicago, Ill., of counsel, for individual defendants-appellees.

David B. Ripsom and Rodman Ward, Jr., of Prickett, Ward, Burt & Sanders, Wilmington, for defendant-appellee Household Finance Corporation.

Before HERRMANN, C. J., QUILLEN and HORSEY, JJ.

HORSEY, Justice:

Plaintiff appeals the Court of Chancery's grant of summary judgment in a derivative shareholder's suit brought to set aside stock options granted by the defendants, officers and directors of Household Finance Corporation (hereafter, "HFC") to key employees, including themselves. The source of the controversy between the parties is action taken by the directors in 1971-1974 to modify the Company's 1966 stock option plan (sometimes hereafter, "the Plan") and their issuance of stock options under the Plan as modified. The principal issue on appeal is whether a 1977 non-unanimous shareholder ratification of the earlier modifications of the Plan and of the options granted under the modified Plan entitled defendants to a grant of summary judgment.

For the reasons hereafter stated, we affirm in part and reverse in part the holdings of the Vice Chancellor. More specifically, we hold (1) that the Complaint states a claim for gift or waste of corporate assets; (2) that such claim was not waived or conceded by plaintiff before the court below; (3) that ratification cured or overcame attack on the options granted under the Plan as modified on the ground of lack of director authority but does not dispose of the claim of gift or waste; and (4) as to the latter, trial is required as to the issue of existence and adequacy of consideration for the grant of the new or modified options, but shareholder ratification shifts the burden of proof of failure or inadequacy of consideration from defendants to plaintiff.

The relevant facts are lengthy but are set out in detail in the opinion below, Michelson v. Duncan, Del.Ch., 386 A.2d 1144 (1978) and need not be repeated here, except those that are pertinent to this decision.

In 1966, the Board of Directors of HFC authorized a stock option plan whereby certain key employees, including a number of the directors, were granted options to purchase stock in HFC following a two year waiting period after grant. Purchases under the non-tax qualified portion of the 1966 plan, with which we are concerned, were to be made at 90% Of the market price at the time of grant. A grant limit of 5,000 shares per year per optionee, later raised to 15,000 shares, was imposed. The options could be exercised at a rate of 10% A year after the second year with the final 30% Exercisable following the ninth anniversary of the grant. The Plan was described in proxy materials, but not set out in toto, and was overwhelmingly approved by the shareholders at their 1966 annual meeting.

The transactions in question relate to conduct of the Board of Directors from 1971 to 1974. In 1971 and again in 1973 the Board, acting on the recommendation of the Compensation Committee, ^* amended the rate of exercise limit to increase that limit from 10% Per year to 331/3% Following each of the second, third and fourth anniversaries of a grant. The net effect of this modification was to reduce the minimum time necessary to exercise an entire option from nine years to four years.

In 1974, following a dramatic decline in the market price of HFC stock, the Board of Directors in order to restore incentive to exercise the options, developed and adopted a plan (sometimes hereafter referred to as "the Amended Plan") whereby the existing options would be cancelled and new options issued in their place at the current lower market price. The exercise price of the new options was some.$7.00 to $18.00 below the price of the old options. At the same meeting of the directors, 304,900 old options were exchanged for new options and 25,000 new options were issued without exchange. During the next year an additional 71,800 options were granted without exchange.

The Complaint attacks the options granted after December 31, 1973, and specifically the exchange options granted in April, 1974 on essentially two grounds: (1) lack of authority of the Board of Directors to grant the options as modified without prior shareholder approval; and (2) the options issued were void for lack of consideration.

More specifically, plaintiff claims that the Board lacked authority: to grant options in excess of 15,000 shares per optionee per 12 month period; to reduce the option purchase price below that provided under the 1966 plan; to increase the yearly percentage limit of options exercisable; and to exceed the total number of shares available for option under the 1966 Plan. The Complaint seeks (a) cancellation of all the options issued to all optionees, including defendants; (b) an accounting by the individual defendants for all profits realized by them under any options received; and (c) recovery from the individual defendants of all losses and damages sustained by HFC.

Admitting generally the amendments to the 1966 Plan but claiming that they were not contrary to the Plan, defendants, shortly after answer and before any extensive discovery had been undertaken by plaintiff or defendants, moved for summary judgment. In their opening brief filed with their motion, defendants argued: (1) that the cancellation of existing stock options in exchange for the issuance of new stock options at reduced prices is permissible under Delaware law as stated in Dann v. Chrysler Corp., Del.Ch., 41 Del.Ch. 438, 198 A.2d 185 (1963); aff'd sub nom. Hoffman v. Dann, Del.Supr., 205 A.2d 343 (1964), cert. denied 380 U.S. 973, 85 S.Ct. 1332, 14 L.Ed.2d 269 (1965); (2) that there was consideration for the new grants in that the optionee-employees were induced to remain with the corporation for an additional two years; and (3) that the grant of the new options in exchange for the old was not in violation of the terms of the 1966 Plan.

Plaintiff countered with a cross-motion for summary judgment asserting a contrary position; but in his opening brief below, plaintiff did not argue lack of consideration for the options granted or that they represented gifts or waste of corporate assets. Instead, plaintiff limited his argument to alleged lack of director authority.

Defendants then proceeded to obtain from the shareholders of HFC at its up-coming 1977 annual meeting a ratification that was less than unanimous of the actions of the directors complained of in this lawsuit concerning the Amended Plan and stock options issued thereunder by the directors over the period 1971-1974. More or less simultaneously with this shareholder action, defendants filed their reply brief in support of summary judgment, referred to the recently accomplished shareholder ratification and argued that such shareholder action constituted a complete defense to the instant action and in particular to plaintiff's claim of lack of shareholder authority for the Amended Plan and options issued thereunder. Defendants argued that the director action was, at most, voidable, rather than void, and as such, any alleged defect that was the subject of the Complaint was curable by shareholder ratification. Defendants added that plaintiff had, in his briefing of the cross summary judgment motions, abandoned any claim of gift or waste of corporate assets which might have constituted a non-ratifiable action.

Plaintiff responded by supplemental memorandum that the HFC shareholder ratification action had injected a new fact element into the litigation not present at time of filing of his answering brief; that he had not abandoned his claim that the new options were granted without consideration and constituted gifts or waste of corporate assets; and plaintiff proceeded to argue that non-unanimous shareholder ratification was not a legal defense to a claim of gift or waste of corporate assets, even if it were a defense to his claim of lack of shareholder authority.

The Vice-Chancellor, following oral argument, granted summary judgment on defendants' motion and denied summary judgment on plaintiff's cross-motion. The Vice-Chancellor stated that while he would have been required to deny defendants summary judgment had plaintiff alleged gift or waste of corporate assets and presented sufficient evidence in support of such claim, he concluded that plaintiff had failed to plead, or, if pleaded, had later abandoned any claim that the Amended Plan and options granted thereunder amounted to gift or waste of corporate assets. He then found the 1977 shareholder ratification of the directors' 1971-1974 actions to have been fair and complete and thus, the ratification to be "intrinsically valid." The Vice-Chancellor further found no evidence of breach of fiduciary duty by the directors in delegating authority to grant options to the compensation Committee of the Board; and the Vice-Chancellor concluded that the 1977 shareholder ratification cured all remaining challenges to the acts of the defendants-directors. It is that decision which is appealed by plaintiff, A. Elihu Michelson.

I

Michelson contends that the Court...