Stockholder’s Challenge to $35M Stock Issuance to Freeport-McMoran CEO Dismissed by Delaware Court of Chancery

By Holly Hatfield and James Parks

A stockholder’s claims regarding a $35 million stock issuance to Freeport-McMoran CEO Richard Adkerson were dismissed. Governance changes within Freeport that were thought to have triggered an option in Adkerson’s employment contract that would have permitted him to quit and receive a $46 million severance package allowed the board to preempt that eventuality by issuing him $35 million in stock.

In Shaev v. Adkerson, C.A. No. 10436-VCN (Del. Ch. Oct. 5, 2015), Vice Chancellor Noble, writing for the Delaware Court of Chancery, granted defendant Freeport-McMoran’s (“Freeport” or the “Company”) motion to dismiss plaintiff Victoria Shaev’s (“Shaev” or “Plaintiff”) direct and derivative claims under Court of Chancery Rules 12(b)(6) and 23.1.

This case arose from a 2013 transaction (the “Transaction”) in which Freeport-McMoran (f/k/a Freeport-McMoran Copper & Gold Inc.) acquired Plains Exploration & Production Co. (“PXP”) and McMoran Exploration Co. (“MMR”). Richard Adkerson (“Adkerson”) was, from December 2003 until the time of the Transaction, the sole CEO of Freeport, and had been its President since January 2008. When Freeport acquired PXP, the Freeport board chose to limit Adkerson’s authority to that of CEO of the mining business and appointed James Flores (“Flores”), former chairman, CEO, and president of PXP, as the CEO of the oil and gas business, subordinating both Adkerson and Flores to the authority of the chairman of the board, James R. Moffett. At a December 3, 2012 meeting, Adkerson agreed to the limitations on the scope of his authority and voted at an April 17, 2013 special board meeting in favor of adopting amended bylaws which implemented the new governance structure.

After the Transaction, Freeport’s compensation committee became concerned that these governance changes might have triggered a clause in Adkerson’s 2008 employment agreement resulting in his ability to terminate his employment for ‘good reason’ and thereby collect a $46 million severance package. The clause in question (the “Good Reason” provision) defined “Good Reason” as including “any . . . action that results in a diminution in [Adkerson’s] position, authority, duties or responsibilities,” and said that “[a]ny determination of ‘Good Reason’ made by [Adkerson] in good faith and based upon his reasonable belief and understanding shall be conclusive.”

As a result of these concerns, the compensation committee engaged an outside compensation consultant to assess the viability of a potential Good Reason claim. The expert reported that the governance changes may indeed have triggered the Good Reason provision. Accordingly, on December 10, 2013, the Freeport board agreed, outside the presence of Adkerson, Flores, and Moffett, to grant Adkerson one million restricted stock units (RSUs) “to resolve the asserted good reason claim” and retain Adkerson as an officer of the Company. These RSUs had a fair value of $35,190,000 on the grant date.

The Transaction was the subject of a suit by the Freeport stockholders challenging it and alleging that the Company’s board of directors had breached its fiduciary duties. The stockholder suit eventually settled, and the settlement purported to release all claims. However, Shaev objected to the settlement to the extent that it released her claims. The Company agreed to carve her out from the release, allowing Shaev’s claim to continue. This case represented the last remaining challenge to that Transaction.

In the case at bar, Shaev maintained three claims: (1) a direct claim that the issuance (of one million RSUs to Adkerson) violated the Freeport certificate of incorporation and bylaws; (2) a derivative claim premised on the idea that the issuance was a bad faith breach of fiduciary duty by the Company’s board of directors; and, (3) various claims alleging false and misleading statements and omissions in Freeport’s 2014 proxy statement, rising to the level of a breach of the board’s duty of disclosure.

As to the first claim, the Court granted Freeport’s motion to dismiss under Court of Chancery Rule 12(b)(6) for two reasons. First, Shaev failed to identify any specific provision in either the certificate of incorporation or the bylaws that the Freeport board had breached by making the issuance. Second, the board was insulated by the business judgment rule from an allegation of bad faith for addressing Adkerson’s potential Good Reason claim. The court held that Adkerson’s potential claim was at least arguable and that it was therefore a rational decision, protected by the business judgment rule, for the board to desire to retain Adkerson and avoid litigation by making the issuance.

As to the second (derivative) claim, the Court also granted Freeport’s motion to dismiss, this time under Court of Chancery Rule 23.1. Rule 23.1 says that “a stockholder may not bring a derivative action on behalf of the corporation unless she has made a demand on the board to institute litigation which has been wrongfully refused,” or such stockholder must plead particularized facts producing reasonable doubt that either (1) the directors were disinterested and independent or, (2) the challenged Transaction was otherwise the product of valid business judgment, “thereby demonstrating that any demand would have been futile.” Shaev chose to pursue the derivative suit in a ‘demand-futile’ posture on the basis of two theories: first, that the decision regarding the “Good Reason” claim was a legal decision and not a business decision, and therefore not subject to the Rule 23.1 demand requirements; and second, that the challenged Transaction was so facially egregious that it could not have been the product of valid business judgment.

With respect to the first ‘demand-futile’ basis, the Court held that Shaev’s argument was simply “inapposite” to the present case. It reasoned that, although it is true that a determination concerning the strength of a ‘Good Reason’ claim is essentially legal, the board only formed an opinion as to the ‘Good Reason’ claim with the assistance of an outside expert. It was, therefore, not the legal determination that was the board’s relevant, challengeable decision; rather, “[t]he board’s relevant decision . . . was granting the RSUs in order to avoid potential litigation.” This was a business decision “and accordingly remain[ed] subject to applicable demand futility requirements.”

With respect to the second ‘demand-futile’ basis, the Court again held that demand was not excused. Shaev’s claim here revolved around an allegation that the board had essentially ignored two possible defenses to Adkerson’s potential ‘Good Reason’ claim, an acquiescence defense (based upon Adkerson’s vote for the amended bylaws) and a public policy defense (based upon the idea that the $46 million grant was an illegal penalty), making the issuance of the RSUs the product of bad faith. However, the Court found fundamental infirmities in each of Shaev’s arguments, noting that both defenses were far from perfect on the merits. As a consequence, it was not an exercise of bad faith on the part of the board to make the issuance, in spite of these possible defenses to liability. Because Shaev failed to convince the Court of her legal decision/business decision distinction and failed to show bad faith, she thereby failed to carry her burden as to the demand requirement and her derivative claim was dismissed.

As to the third claim, the Court granted Freeport’s motion to dismiss Shaev’s bad faith breach of the duty of disclosure allegations. Under Delaware law, directors have a duty of disclosure that is an outgrowth of their broader duties of care and loyalty. This duty can be violated by “making a materially false statement, by omitting a material fact, or by making a partial disclosure that is materially misleading.” Shaev alleged four such disclosure violations, two false statements and two omissions. In each case, the Court was unconvinced of the merit of the allegations. Furthermore, it held that even if Shaev’s allegations had been meritorious, her claims failed for want of an applicable remedy. Because Shaev’s claims centered on statements or omissions in the proxy materials leading up to Freeport’s 2015 annual meeting, where the entire board was reelected, her claims were now moot. Citing to In re Transkaryotic Therapies, Inc., 954 A.2d, 346, 360-61 (Del. Ch. 2008), the Court held that once “shareholders have voted without complete and accurate information-it is, by definition, too late to remedy the harm,” and any claim based upon the relevant proxy materials is therefore mooted.

Shaev v. Adkerson, C.A. No. 10436-VCN (Del. Ch. October 5, 2015)

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