In Facebook Compensation Row, Delaware Corporate Formalities Held Indispensable

Adhering to corporate formalities is often cited as a disadvantage of organizing a business using the corporate form, but those formalities play a crucial role in protecting the corporation’s shareholders. This fact was made clear in the Delaware Court of Chancery’s October ruling in the case of Zuckerberg v. Espinoza, 124 A.3d 47 (Del. Ch. 2015). The case, which involved Facebook, its board of directors, and its founder/CEO, Mark Zuckerberg, presented a question of first impression for the court: “Can a disinterested controlling stockholder ratify a transaction approved by an interested board of directors, so as to shift the standard of review from entire fairness to the business judgment presumption, by expressing assent to the transaction informally without using one of the methods the Delaware General Corporation Law prescribes to take stockholder action?”

At issue was the Facebook board of directors’ approval of compensation for certain outside directors who comprised a majority of the board. In approving their own compensation, members of the board of directors suffered from a conflict of interest requiring the court to judge whether the compensation was entirely fair to Facebook and its shareholders, instead of the more deferential business judgment rule. Ernesto Espinoza, a Facebook stockholder, brought an action challenging the board’s approval of the compensation packages as a breach of fiduciary duty, unjust enrichment, and corporate waste. The director defendants argued that Mark Zuckerberg, who held 61% of the voting power of Facebook’s common stock, approved the compensation in a sworn deposition and affidavit.

In light of Zuckerberg, boards of directors of Delaware corporations need to remain vigilant in ensuring that corporate formalities are observed in ratifying transactions where there are director conflicts of interest.

Chancellor Bouchard found that Zuckerberg’s informal approval of the compensation packages was not enough to shift the standard of review from entire fairness to the business judgment rule. Rather, corporate formalities had to be observed (i.e., a majority stockholder vote). The court observed that stockholders are allowed to take action through personal or proxy vote or through written consent, authorized under Section 228 of the Delaware General Corporation Law (DGCL). The court then explained that even when there is no noticed vote and action is taken by written consent, prompt notice of the action taken by written consent is still required under Section 228. Thus, the DGCL ensures transparency of action for minority shareholders—a key reason to have formal procedures in the first place.

After the opinion was issued, Facebook appealed the ruling to the Delaware Supreme Court. The appeal was never heard and the case settled in early February. The terms of the settlement involved two major components. First, Facebook’s Compensation and Governance Committee will now be required to engage an independent compensation consultant to conduct an annual review of director compensation and then recommend to the board any changes to be made. Second, the board of directors must submit proposals regarding director compensation to the stockholders at the annual 2016 meeting. Such director “say on pay” requirements are rare and place an additional, potentially costly burden on Facebook’s board of directors.

In light of Zuckerberg, boards of directors of Delaware corporations need to remain vigilant in ensuring that corporate formalities are observed in ratifying transactions where there are director conflicts of interest. This is true even in situations similar to Facebook’s, where there is a controlling shareholder that has the ability to singularly ratify corporate actions. Given the potential liability that could result from ignoring corporate formalities, going through the process of a stockholder vote, whether in person, by proxy, or by written consent, is well worth the effort.


The views expressed in this article are those of the authors and not necessarily those of Richards, Layton & Finger or its clients.

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