Judge Richard Posner of the Seventh Circuit Court of Appeals is one of the most published and widely quoted judges. Those unfamiliar with his colorful opinions may see why this is true by reading his recent decision in Donnawell v. Hamburger (7th Cir. 2015). In Donnawell, the company adopted an incentive plan in 2005 that authorized the award of stock options to key employees. The plan limited the awards to 150,000 shares per employee per year. Nevertheless, the company granted the CEO options on 184,100 shares in 2010, 170,200 in 2011, and 255,425 in 2012. The company discovered its mistake and reduced each grant under the 2005 plan to 150,000 shares. However, at the same time, the company awarded the CEO 87,910 additional shares available under the company’s 2003 incentive plan, which held authorized but unallocated shares.
All of the grants were proposed by the company’s Compensation Committee to the company’s independent directors. The independent directors approved the award of the additional shares to the CEO. Plaintiffs filed a shareholder derivative action arguing that the 87,910-share award was improper because the 2003 plan provided for awards by the company’s “Plan Committee,” and not the Compensation Committee. There was no Plan Committee in 2012. And here is where it got interesting.
It may help to think of the case in golf terms. A “mulligan” is the practice of allowing a player who has made a bad shot to do it over, and the bad shot isn’t shown on his score-card. Mulligans are commonly allowed in informal golf matches (as opposed to tournament matches, in which mulligans are never permitted) because no harm is thought to be done by them in such matches. Likewise no harm was done by allowing the Compensation Committee to do over, in effect, the erroneous grant of stock options under the 2005 plan, by invoking the 2003 plan, thus sinking the ball in the hole. The end result, from the shareholder’s perspective, was no different from what it would have been had the first shot been a hole in one.
But wait, there’s more.
Against all this the plaintiff insists that the Delaware courts enforce corporate rules with absolute rigidity, indifferent to what is sensible, reasonable, or realistic, and therefore that the grant of stock options to Hamburger was invalid—period—because it was not made by the Plan Committee. It quotes a decision of the Delaware Chancery Court which states that “contract interpretation starts with the terms of the contract. If the terms are plain on their face, then the analysis stops there.” Sanders v. Wang (Del. Ch. Nov. 8, 1999). It’s rather insulting to Delaware judges to interpret Delaware law on the assumption that the judges are mindless automata. Drafters of contracts are not omniscient; they are not gifted with exact knowledge of what the future holds. Literal interpretation can produce absurdities when applied to unforeseen occurrences, as when an ordinance forbidding unleashed dogs in a park is sought to be applied to a statue of Lassie.
This blog has observed the increased tendency of Delaware courts to allow cases involving excessive compensation to proceed because of a “foot fault.” I am not sure this case would have been decided the same way if it had been brought in Delaware. However, it sure makes for interesting reading.