In a recent decision out of the Delaware Supreme Court—CDX Holdings, Inc. v. Fox, C.A. No. 526, 2015 (Del. June 6, 2016)—Justice Holland, writing for the majority, affirmed a Court of Chancery post-trial decision that found that a company’s board of directors failed to fairly value option holders’ options per a contractual (rather than a fiduciary) obligation under a stock incentive plan. The underlying transaction involved Caris Life Sciences, Inc. ("Caris"), a privately held corporation, and its three subsidiaries: Caris Diagnostics, TargetNow, and Carisome. To secure financing for TargetNow and Carisome while also minimizing taxes, Caris used a spin/merge structured transaction whereby Caris transferred ownership of TargetNow and Carisome to a new subsidiary, spun off that subsidiary to its stockholders (the "Spinoff"), and merged Caris Diagnostics with a subsidiary of Miraca Holdings, Inc. (the "Merger"). The relevant stock incentive plan ("Plan") provided that each option holder be entitled to receive for each share covered by an option the amount by which the fair market value ("FMV") of the share exceeded the exercise price. The Plan required that the Caris Board of Directors ("Board") account for the Spinoff in adjusting the options, defined FMV as an amount determined by the Board, and stipulated that the Board’s good faith FMV determinations be "conclusive unless arbitrary and capricious."

Suing on behalf of the class of option holders, Kurt Fox argued that the Board breached the Plan. Following a three-day trial in the Court of Chancery, Vice Chancellor Laster found in favor of the option holders, awarding approximately $16.3 million. Vice Chancellor Laster concluded that the Board breached the Plan when it failed to determine the FMV of a share of Caris common stock and adjust the options to account for the Spinoff when Caris management separately made the determination rather than the Board. Moreover, after noting that there was arguably no Board "action" because only Caris management acted, Vice Chancellor Laster concluded that the valuation was made in bad faith. Notably, the court did not find the testimony from Caris management to be credible and rejected their "believe-me-now-I-was-lying-then" argument. At trial, Caris management testified that during the time of the Spinoff and Merger, it believed that the options had very little value. However, Vice Chancellor Laster determined that Caris valued the options much higher and instead, their contradictory trial testimony reflected "hindsight bias" or "the tendency for people with outcome knowledge to believe falsely that they would have predicted the reported outcome of an event," citing various law review articles on the topic. Moreover, Vice Chancellor Laster concluded that even if the valuation was made in good faith, it was a result of an arbitrary and capricious process that only used an analysis designed to result in zero corporate-level tax. Finally, although Caris argued that it committed no breach when it withheld a portion of the Merger consideration to fund the option holders’ share of the escrow fund because the Merger Agreement permitted such action, the court concluded that with respect to the options, the Plan was the operative contract—not the Merger Agreement—and the Plan did not permit an escrow holdback.

In a 4-1 vote, the Delaware Supreme Court affirmed Vice Chancellor Laster’s opinion. Justice Holland applied a "clearly erroneous" standard of review and deferred to Vice Chancellor Laster’s fact-finding and determinations of witness credibility. Justice Valihura provided a noteworthy dissent that was critical of the decision, writing that the court should be skeptical of the Court of Chancery’s reliance on "social science studies," such as "hindsight bias." Her Honor concluded that the factual findings lead to the opposite result and disagreed with the Court of Chancery’s conclusion that the Board did not act. Instead, Justice Valihura reasoned that the Board acted in various ways, including by delegating relevant tasks to Caris management.

Justice Valihura’s dissent is noteworthy because it provides an interesting view on what constitutes Board "action." Justice Holland’s majority opinion confirms that for factual issues and questions of credibility, the Supreme Court will generally defer to the trial court’s live determinations because the trial judge was in the best position to evaluate the demeanor of the witnesses. For litigators, this is a reminder of the significance of our witnesses’ credibility to the trial court as it will affect both trial and appellate proceedings.