In two separate decisions issued on February 6, the
Delaware Chancery Court weighed in for the first time on
issues directly relating to the current wave of stock option
matters. While the two decisions are highly fact-specific,
both the tone and approach adopted in those cases suggest
that shareholders are likely (at least in the short term)
to pursue litigation more vigorously in Delaware than in
Among other things, the new cases reflect a reluctance
(if not unwillingness) at the pleading stage to apply the
business judgment rule to actions resulting in allegedly
inaccurate dating of option grants, which makes it easier
for shareholders to skirt the requirement of making pre-suit
demand on the board of directors. In that respect, they
stand in contrast to recent decisions in other courts – most
notably, state and federal courts in California. The new
Delaware cases also signal a more flexible approach to the
statute of limitations.
In Ryan v. Gifford, No. 221-N (Del. Ch. Feb. 6, 2007), a
derivative action purportedly brought on behalf of Maxim
Integrated Products, Chancellor Chandler found that
plaintiffs' claims were sufficient to survive the pleading
stage notwithstanding defendants' arguments that: (1)
pre-suit demand was not excused because a majority of
Maxim's directors were disinterested and independent;
(2) the allegations of backdating were not supported by
particularized facts, and in any event the acts in question
were within the scope of the business judgment rule; and
(3) the claims were barred by the applicable statute of
limitations, inasmuch as the purported backdating had
occurred more than three years prior to commencement of
Based largely on the perceived statistical improbability that
the grants were appropriately timed (i.e., the grant prices
were supposedly "too fortuitous to be mere coincidence"),
the court concluded that plaintiffs had adequately alleged
violation of an express provision of the option plans, and
that – if ultimately proven – such conduct could not be
viewed as a valid exercise of business judgment. The court opined that "backdating options" might qualify as an
act "so egregious on its face that board approval cannot
meet the test of business judgment..." Because a majority
of the Maxim board either granted such options (while
serving on the compensation committee) or received them,
demand was excused. Moreover, the court found that
the alleged violations of the option plan, and purportedly
false disclosures regarding grant dates, were sufficient to
state a claim for breach of the duty of loyalty. Defendants'
argument that the claims were time-barred was rejected.
Even though the alleged misconduct ended in 2002, the
court reasoned that representations that the options were
priced as of the date of grant could constitute fraudulent
concealment. The court also refused to stay the litigation in
favor of a duplicative (and previously filed) case pending in
federal court in California, noting Delaware's strong interest
in deciding important questions of its laws.
On the same day, Chancellor Chandler denied defendants'
motion to dismiss in In re Tyson Foods, Inc. Consol.
Shareholder Litig., No. 1106-N (Del. Ch. Feb. 6, 2007). That
case involved, inter alia, averments that Tyson's board
breached its fiduciary duties by granting "spring-loaded"
stock options to insiders (i.e., granting options shortly
before the announcement of positive news that increased
the company's stock price). While conceding that granting
spring-loaded options may be permissible where the
decision is "made honestly and disclosed in good faith," the
court held that "the facts alleged in [Tyson] are different."
Based on its conclusion that plaintiffs had adequately
alleged Tyson's directors approved grants while in
possession of material non-public information and "with the
intent to circumvent otherwise valid shareholder-approved
restrictions upon the exercise price of the options," the
court found that such alleged conduct was not protected
by the business judgment rule. As a result, demand was
excused and a cognizable claim was stated. As in Ryan,
the court also rejected defendants' statute of limitations
By contrast to the two Delaware decisions, a number
of courts elsewhere have been unwilling to jettison the
business judgment rule or traditional standards of demand
futility in analyzing derivative lawsuits based on purportedly
improper option grants. For example, in In re Linear
Technology Corp. Derivative Litig., C-06-3290-MMC (N.D.
Cal. Dec. 7, 2006), Judge Chesney of the Northern District
of California applied the same test ostensibly employed
in Ryan, but noted (correctly) that under Delaware law
plaintiffs bear the burden of pleading particularized facts
creating a reasonable doubt that a majority of the directors
are disinterested or independent. Despite plaintiffs'
averments that seven grants were dated "just after a sharp
drop" in Linear's stock price and "just before a substantial
rise" – which plaintiffs characterized as a "striking pattern
that could not have been the result of chance" – the court
held that such allegations were insufficient to show that
the directors faced a substantial likelihood of liability.
Furthermore, the court rejected the argument that plaintiffs'
allegations of backdating or inaccurate disclosures
necessarily placed the directors' conduct beyond the scope
of the business judgment rule; indeed, the court found that
plaintiffs' allegations were inadequate to overcome the
rule's presumption that the directors acted in good faith.
The court accordingly found that plaintiffs failed to show
that a majority of the board was interested or otherwise
incapable of considering a pre-suit demand, and dismissed
the complaint with leave to amend.
While plaintiffs' lawyers have chosen to litigate many
options-related cases in courts outside Delaware, Ryan
and Tyson may well prompt a new trend. Not only do the
results of those cases suggest the possibility of a more
(and perhaps unduly) forgiving attitude in applying the
traditionally rigorous pleading standards for derivative
lawsuits, but the opinions are indicative of a mindset that
indiscriminately appends the same label to an entire array
of widely divergent conduct. The term "backdating" has
been applied to acts ranging from intentional misconduct
to inadvertent errors by administrators to sloppy
documentation. Yet Tyson opines that, "[a]t their heart, all
backdated options involve a fundamental, incontrovertible
lie: directors who approve an option dissemble as to the
date on which the grant was actually made." Equally striking
is Tyson's assertion that spring-loading "implicate[s] a much
more subtle deception," when there is often little or no basis
for concluding that the proximity of a grant and market moving
information involves any deception whatsoever. It may well be that, once the Chancery Court sees more of these cases and develops greater perspective, such
sweeping pronouncements will end. But until that time,
more and more corporations may find themselves litigating
in Delaware – even if, as in Ryan, litigation has already been
For further information, please contact:
Kevin P. Muck, Co-Chair, Securities Litigation Group
Christopher Walton, Associate, Litigation Group
This update is intended by Fenwick & West LLP to summarize
recent developments in the law. It is not intended, and should
not be regarded, as legal advice. Readers who have particular
questions about these issues should seek advice of counsel.
© 2007 Fenwick & West LLP. All Rights Reserved.