Chancery Rejects Facebook Stockholder Ratification Argument
In Espinoza v. Zuckerberg, a stockholder challenged the Facebook board of directors' unanimous approval of a compensation plan for the company's six non-employee directors. The board consisted of eight directors, with only two of the eight (including Facebook founder and controlling stockholder Mark Zuckerberg) not subject to the compensation plan. The compensation plan included the payment of cash retainers and restricted stock unit grants to the non-employee directors. Ernesto Espinoza filed a derivative action against the Facebook directors asserting claims for breach of fiduciary duty, unjust enrichment and waste. During the litigation, Zuckerberg, a majority holder of Facebook's voting stock, submitted an affidavit and gave deposition testimony indicating that he approved of the compensation plan. Armed with Facebook's controlling stockholder's approval of the compensation plan, defendants moved for summary judgment on the breach of fiduciary duty and unjust enrichment claims.
The defendants did not dispute that a majority of the board approving the compensation plan was interested insofar as they were direct beneficiaries of the plan. Accordingly, entire fairness was the undisputed standard of review to the conflicted board's approval of the compensation plan. However, the defendants argued that the statements approving the compensation plan found in Zuckerberg's affidavit, and subsequent deposition, ratified the board's conflicted approval of the plan and shifted the court's standard of review to business judgment. The defendants contended that the court's analysis of the plaintiff's claims under the more deferential business-judgment standard of review should lead to a dismissal of those claims on summary judgment.
In the face of defendants' argument, the court noted that it was confronted with a matter of first impression: "Can a disinterested controlling stockholder ratify a transaction approved by an interested board of directors, so as to shift the standard of review from entire fairness to the business judgment presumption, by expressing assent to the transaction informally without using one of the methods the Delaware General Corporation Law prescribes to take stockholder action?" In short, the court answered "no." In denying the defendants' motion for summary judgment on the breach of fiduciary duty and unjust enrichment claims, the court held that the formal requirements of Section 228 of the DGCL, requiring that the consent of stockholders be achieved either by a vote at a stockholder meeting or by written consent, must be strictly adhered to for stockholders to ratify an act of the board of directors.
The court arrived at this decision after a thorough analysis of Delaware case law concerning Section 228. Quoting the recent decision in Carsanaro v. Bloodhound Technologies, 65 A.3d 618, 641 (Del. Ch. 2013), the court noted that "because Section 228 permits immediate action without prior notice to minority stockholders, the statute involves great potential for mischief and its requirements must be strictly complied with if any semblance of corporate order is to be maintained." The court noted that "strict compliance" has included enforcing ministerial items such as the dating of written consents. Noteworthy in the court's analysis was that in the cases where stockholder ratification effectively lowered the standard of review to business judgment, the ratification occurred at a formal meeting of stockholders. Of particular interest to the court was the Delaware Supreme Court's decision in Gantler v. Stephens, 965 A.2d 695 (Del. 2009), wherein the Supreme Court incorporated the phrase "fully informed shareholder vote" in defining the concept of ratification. The court found the use of that phrase purposeful "and was not intended to mean something less formal than an actual stockholder vote (or an action by written consent in lieu thereof)." The court was also persuaded by practical considerations in requiring strict adherence to the express provisions of Section 228. For instance, requiring a stockholder vote at a meeting or through an appropriately drafted written consent eliminates the potential for ambiguity regarding what action the stockholder is ratifying. Requiring strict adherence to the statute also ensures that one of its purposes, promptly notifying minority stockholders of the action taken pursuant to Section 228, is promoted. The court noted the concern that if strict adherence to the express provisions of the statute was not required, there was no telling what methods of communication would be acceptable to comply with Section 228. Could an acceptable communication be a press release? Perhaps board meeting minutes would suffice. Or, would simply "liking" a Facebook post satisfy Section 228?
The value to practitioners of this decision is the bright-line rule that the provisions of Section 228 will be strictly construed by the Court of Chancery. Corporate governance counsel and litigators alike can benefit from this knowledge as they can advise their clients with a reasonable degree of certainty regarding challenges to stockholder ratification efforts. From a business perspective, this case highlights the need for boards to not be "penny-wise and pound-foolish" when considering whether to comply with the formal requirements of Section 228. As most litigators will admit, the costs associated with litigation often dwarf the costs associated with legal advice geared to complying with strictly construed statutes similar to Section 228.