By Lisa Stark and Mark Hammes
In Ravenswood Investment Company v. Winmill & Co. (C.A. No. 3730-VCS and 7048-VCS (Del Ch. March 21, 2018)), plaintiff Ravenswood Investment Company (“Ravenswood”), a stockholder of Winmill & Co. (the “Company”), brought a derivative suit against the directors of the Company, Bassett, Thomas and Mark Winmill (“Defendants”) alleging that Defendants breached their fiduciary duties in two respects. First, they granted overly generous stock options to themselves (as Company officers). Second, they caused the Company to forgo audits of the Company’s financials and to stop disseminating information to the Company’s stockholders in retaliation for Ravenswood’s assertion of inspection rights. Following a trial, the Delaware Chancery Court entered judgment for Ravenswood as to the first theory and for Defendants as to the second. After finding that there was insufficient evidence to support cancellation, rescission, rescissory damages or some other form of damages, the Court awarded nominal damages to the Company of $1 per Defendant.
In Ravenswood, the Company provided investment management services and its shares were traded on NASDAQ until it was delisted in 2004, and then over-the-counter on the Pink Sheets. During all relevant time periods, Defendants comprised the entirety of the board of directors of the Company. They were also founders, stockholders, and officers of the Company. When the Company’s 1995 stock option plan expired in 2005, Defendants, in their capacity as directors, adopted a new performance equity plan (the “PEP”). Each Defendant, in his capacity as an officer of the Company, received options to purchase 100,000 shares of stock at $2.948 per share under the PEP. At the time, approximately 1.5 million shares were outstanding and the Company’s stock traded at $2.68 per share. The Defendants chose not to hire a compensation consultant, instead relying on their own ad-hoc analysis of comparable companies, many of which were much larger than the Company.
Approximately 18 months later, each of the Defendants exercised options to purchase 66,666 shares. Each Defendant paid $1,532.39 in cash and gave a $195,000 promissory note to the Company for the remainder of the purchase price. Following the exercise, each of the Defendants paid interest on the notes, but a little over a year later, in April 2008, in their capacity as board members, they forgave Thomas’ note entirely and forgave Mark’s note in three tranches over three years. Although Bassett’s note was not forgiven, later he became unable to pay the note when due and entered into a replacement note with a longer maturity. Years later, following his death, his estate finally paid off the note.
In addition, following the Company’s delisting, it continued to prepare audited financial statements until 2011, when, for cost reasons, the Defendants decided not to engage in further audits and ceased distributing financial information to stockholders.
Plaintiffs brought suit on a number of theories, which by the time of the trial, had been reduced to two theories for violation of the Defendants’ fiduciary duty of loyalty: first, that the stock options were improperly authorized and granted, and second, that the Defendants’ decision to cease distributing financial information was an improper decision in retaliation against Plaintiff, who had previously brought an action against Defendants.
After a two-day trial, the Court entered judgment for the Plaintiff on the first theory and for Defendants on the second. As to the first claim, the Court first held that the entire fairness standard applied to the PEP adoption and stock option grants as “[d]irectors who stand on both sides of a transaction have the burden of establishing its entire fairness.” The Court explained that entire fairness requires a showing that directors acted with utmost good faith and the most scrupulous inherent fairness of the bargain. This requires a showing of both fair dealing and fair price.
In analyzing fair dealing, the Court described the Defendants’ process as “neither well-documented nor well-substantiated” and in fact stated that “the term ‘process’ does not really fit here; the evidence reveals that there really was no process.” There were no contemporaneous records and no indication that the board sought the advice of any outside advisor or consulted any literature or other sources. Defendants’ only decision-making tool appeared to be comparing the PEP and proposed options to compensation plans of alleged peer companies, but the Court described this tool as “severely flawed” due to labelling companies as peers in a way that was “simply not credible” because nearly all of them were much larger than the Company. Thus the Court concluded that the stock option grants were not the result of fair dealing.
The Court next analyzed the fairness of the pricing of the options. The Court held that the initial price was fair, but the Company’s actions in forgiving notes resulted in a total payment for the options that was not fair. The Court explained that these decisions may have made perfect sense if this family business were really a family business where the Defendants were the only stakeholders, but in a public company setting these decisions resulted in an unfair price and thus a breach of the Defendants’ fiduciary duties.
The Court denied the Plaintiff’s second theory, explaining that Delaware law presumes that the directors of a Delaware corporation make business decisions on an informed basis and in the honest belief that their decision is in the corporation’s best interests. To overcome that presumption, plaintiffs must show that directors “appeared on both sides of the transaction or derived a personal benefit from a transaction in the sense of self-dealing.” The Court held that since Plaintiff had presented no evidence that the Directors ceased distributing financial information due to an improper motive rather than their claimed rationale of lowering costs and reducing the risk of disclosure-related litigation, Defendants were entitled to the protection of the business judgment rule and did not breach their fiduciary duty with respect to the second theory.
Finally, the Court discussed potential remedies. Plaintiff sough compensatory damages, but the Court held that it failed to present any evidence upon which the Court could award compensatory damages to the Company. Plaintiff also sought cancellation of the shares or rescission, but the Court explained that cancellation and rescission would not be appropriate without returning the parties to the status quo ante, which would require returning to Defendants what money they had paid for the shares. Since the Company lacked the funds to do so, these remedies were not appropriate. Finally, the Court held that Plaintiff had also failed to present evidence on which the Court could award rescissory damages. Thus, with no other measure of damages available, the Court awarded nominal damages to the Company in the amount of $1 per Defendant.
Ravenswood Investment Company v. Winmill & Co., Inc.
