In Knight v. Miller et al the Delaware Court of Chancery considered, among other things, whether the acceptance of an equity grant violated fiduciary duties. The case was before the Court on a motion to dismiss.
The case deals with grants of equity compensation made to directors and officers of Universal Health Services, Inc. (“UHS” or the “Company”) during the market volatility taking place in March 2020 at the beginning of the COVID-19 pandemic. UHS stock reached its lowest point on March 18, 2020, closing at $67.69 per share. After announcement of federal COVID-19 relief legislation, the Company’s stock price had rebounded to a closing price of $100.13 per share by March 30, 2020.
The grants in question were made at a meeting of the Compensation Committee on March 18, 2020. The relevant meeting had been scheduled at least six months in advance of that date. The Defendants stated in their opening brief that the Company’s stock option grants, since 2014, have almost always been made at a meeting held in March, except for one meeting held in April.
The Plaintiff asserted that each of the Defendants named in this case had violated the duty of loyalty “by accepting the March 2020 Awards despite knowing that the March 2020 Awards were issued at strike prices that did not reflect the real value of the Company.” The Plaintiff cited two cases for the proposition that a director or officer “can breach fiduciary duties . . . by accepting compensation that is clearly improper.” The Court noted there appeared to be a relative lack of case law fleshing out what might constitute “clearly improper.”
The Court noted Delaware courts have found that actions for breach of fiduciary duty for accepting compensation can survive a motion to dismiss where:
- The compensation awarded was ultra vires, and the recipients knew it, or
- Where compensation was repriced advantageously in light of confidential and sensitive business information which the recipients knew, and which they accordingly used to the company’s detriment.
The Court concluded that that in this circumstance that the Plaintiff must plead bad faith with respect to Defendant’s knowingly wrongful acceptance of compensation. In other words, 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 found there was an insufficient record to sustain even a claim that the Compensation Committee Defendants making the awards acted in bad faith, much less that the recipients’ acceptance violated that standard. All that was alleged was that option awards were made at what proved to be the bottom of the market.
The Court also noted the Plaintiff did not plead nonpublic facts known to the Company and the Defendants that gave rise to an inference of “clearly improper” compensation in the form of the March 2020 awards.