By Cydney Posner

You might be interested in taking a quick look at these two recent cases out of Delaware (Chancellor Chandler), rejecting motions to dismiss option backdating derivative claims. While the cases were decided primarily on procedural grounds, the court does stake out territory on the issue of springloading, arguing that springloading involves a "subtle deception," which is the "touchstone of disloyalty or bad faith in a spring-loaded option": "[g]ranting spring-loaded options, without explicit authorization from shareholders, clearly involves an indirect deception. A director’s duty of loyalty includes the duty to deal fairly and honestly with the shareholders for whom he is a fiduciary. It is inconsistent with such a duty for a board of directors to ask for shareholder approval of an incentive stock option plan and then later to distribute shares to managers in such a way as to undermine the very objectives approved by shareholders. This remains true even if the board complies with the strict letter of a shareholder-approved plan as it relates to strike prices or issue dates." The issue is not one of insider trading, but rather of bad faith and breach of fiduciary duty: the court concludes that a "director who intentionally uses inside knowledge not available to shareholders in order to enrich employees while avoiding shareholder imposed requirements cannot, in my opinion, be said to be acting loyally and in good faith as a fiduciary." At the pleading stage, to move beyond the application of the business judgment rule, the plaintiff must allege first, that the options were "issued according to a shareholder-approved employee compensation plan. Second, a plaintiff must allege that the directors that approved spring-loaded (or bullet-dodging) options (a) possessed material non-public information soon to be released that would impact the company’s share price, and (b) issued those options with the intent to circumvent otherwise valid shareholder-approved restrictions upon the exercise price of the options."

The court does note, however, that a "company with a volatile share price, or one that expects that its most explosive growth is behind it, might wish to issue options with an exercise price below current market value in order to encourage a manager to work hard in the future while at the same time providing compensation with a greater present market value. One can imagine circumstances in which such a decision, were it made honestly and disclosed in good faith, would be within the rational exercise of business judgment."

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