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Kerbs v. California Eastern Airways

Supreme Court of Delaware

July 17, 1952

KERBS et al.
v.
CALIFORNIA EASTERN AIRWAYS, Inc.

Reargument Denied Aug. 28, 1952.

See 91 A.2d 62.

Page 653

[Copyrighted Material Omitted]

Page 654

[33 Del.Ch. 71] Arthur G. Logan and Stephen E. Hamilton, Jr. (of Logan, Marvel and Boggs), Wilmington, for appellant.

David F. Anderson (of Berl, Potter & Anderson), Wilmington, and Walter R. Barry, James E. Hughes and George F. Mason, Jr. (of Coudert Brothers), New York City, for appellee.

WOLCOTT and TUNNELL, Justices, and LAYTON, Judge, sitting.

WOLCOTT, Justice.

This is an appeal from the denial after final hearing of an application by the appellants (hereinafter called plaintiffs) to enjoin the appellee corporation (hereinafter called defendant) from putting into effect a stock option plan and a profit-sharing plan. The plaintiffs are stockholders of the defendant.

The defendant, a Delaware corporation, is engaged in the business of owning, operating and leasing aircraft. From the time of its incorporation in 1946, the defendant lost money in its operations until by the end of 1947 it was in a precarious financial position, having lost over $726,000. In December, 1947, Mr. de Saint-Phalle, the present Chairman of the Board, accepted the office of president. He made substantial changes in the business and operations of the defendant but, in May of 1948, on his recommendation, the defendant petitioned the United States District Court of Delaware for an order under Chapter XI of the Bankruptcy Act, 11 U.S.C.A. § 701 [33 Del.Ch. 72] et seq., and was allowed by the court to continue in possession of its property. Immediately thereafter, under the direction of Mr. de Saint-Phalle, the defendant dismissed 85% of its personnel, stopped operating its aircraft, leased them to other concerns, and converted its aircraft from freight to passenger carriers. By September of 1948, the defendant's operations had become profitable. In 1949, the defendant's net profits amounted to $212,435 and in the summer of that year it made a substantial payment to creditors.

In May of 1949, a plan of arrangement with creditors, having been approved by the District Court, Mr. de Saint-Phalle persuaded Messrs. Solomon, Grace and Robinson to become directors of the defendant. They were elected in August, 1949 and, thereafter, Mr. Solomon became president of the defendant.

In the first part of 1950, the aircraft of the defendant were improved so as to make them capable of overseas flights in contemplation of their use in passenger service to Rome for the Holy Year celebration. Meanwhile, however, the Korean War broke out and the defendant obtained contracts with the United States for the use of some of its planes in the Tokyo airlift. This operation was extremely profitable

Page 655

In September, 1949, the new Board of Directors met and appointed a committee of three to make salary recommendations to the Board. This report was submitted by disinterested directors to the Board at a meeting on December 16, 1949 recommending that certain salaries be allowed, but stating that additional compensation in another form would be the subject of a further report. Thereafter, at a meeting of the Board in October, 1950, a stock option plan and a profit-sharing plan were adopted and a special meeting of stockholders called for the purpose, among others, of submitting the stock option plan to the stockholders for ratification. A letter was sent to each stockholder giving information concerning both plans. At the special meeting of stockholders thus called, a majority of the stock of the defendant was voted in favor of the stock option plan.

[33 Del.Ch. 73] The stock option plan provides that 250,000 shares of the defendant's unissued stock be made subject to options to purchase at the price of $1 per share, [1] to be granted in designated amounts to named executives of the company. Each option to be granted is exercisable at any time within a period of 5 years from the date of issuance but not later than 6 months after the termination of the employment of the executive to whom it is issued. Each is exercisable for either the full number of shares subject to the option or for any part thereof. Each is required to be exercised by the executive to whom it is granted. Each is non-transferrable, except by will. In the event of the death of the optionee, each is inheritable in accordance with the applicable laws of descent.

The profit-sharing plan provides that when the quarterly earnings of the defendant exceed $30,000 before federal income taxes, 10% of any additional quarterly earnings shall be distributed among named officers and executive personnel of the defendant in accordance with a percentage scale. If during any quarterly period earnings should be less than $30,000, then the cumulative deficiency plus any operating loss is to be carried forward to succeeding quarterly periods. The named beneficiaries of the stock option plan are also the named beneficiaries of the profit-sharing plan with substantially the same proportional interest.

Both the stock option plan and the profit-sharing plan were adopted at a meeting of Directors held October 24, 1950, at which eight directors were present, of whom five were beneficiaries under the plans. The plaintiffs accordingly attack both plans on the ground that the votes of interested directors were required for their adoption and that, therefore, the action of the board was illegal.

A majority of the stockholders, however, at the beforementioned special meeting called for that purpose ratified the stock option plan. That ratification cures any voidable defect in the action of the Board. Blish v. Thompson Automatic Arms Corp., 30 Del.Ch. 538, 64 A.2d 581. Stcokholders' ratification of voidable [33 Del.Ch. 74] acts of directors is effective for all purposes unless the action of the directors constituted a gift of corporate assets to themselves or was ultra vires, illegal, or fraudulent. Keenan v. Eshleman, 23 Del.Ch. 234, 2 A.2d 904, 120 A.L.R. 227; Rogers v. Hill, 289 U.S. 582, 53 S.Ct. 731, 77 L.Ed. 1385.

There is nothing in the record before us suggesting that the action of the Board of Directors of the defendant, in adopting the stock option plan, was actually fraudulent or of such illegality as to be absolutely void. The interested character of the directors who voted for the stock option plan makes their action voidable only and thus subject to stockholders' ratification. Cf. Continental Securities Co. v. Belmont, 206 N.Y. 7, 99 N.E. 138, 51 L.R.A., N.S.,

Page 656

112. The attack, therefore, of the defendant upon the stock option plan is limited to the question of whether or not it constitutes a gift of corporate assets to executives. If that be the fact, then its defects will not be cured by stockholders' ratification unless such ratification was unanimous.

The validity of a stock option plan under which selected personnel of a corporation may acquire a stock interest in the corporation depends directly upon the existence of consideration to the corporation and the inclusion in the plan of conditions, or the existence of circumstances which may be expected to insure that the contemplated consideration will in fact pass to the corporation. Rosenthal v. Burry Biscuit Corp., 30 Del.Ch. 299, 60 A.2d 106; Sandler v. Schenley Industries, Inc., Del.Ch., 79 A.2d 606.

What is sufficient consideration to validate a plan depends upon the facts and circumstances of the particular case. Sufficient consideration to the corporation may be, inter alia, the retention of the services of an employee, or the gaining of the services of a new employee, provided there is a reasonable relationship between the value of the services to be rendered by the employee and the value of the options granted as an inducement or compensation. Wyles v. Campbell, D.C., 77 F.Supp. 343; McQuillen v. National Cash Register Co., D.C., 27 F.Supp. 639; Sandler v. Schenley Industries, supra.

In the case before us, the record demonstrates that Mr. Solomon,[33 Del.Ch. 75] one of the beneficiaries of the plan, entered the employ of the company believing that he would be given the opportunity to purchase stock. The same is true with respect to Mr. Robinson. The record also demonstrates that both the directors and Mr. de Saint-Phalle regarded his salary as only partial compensation for his services. While it is not clear with respect to the other beneficiaries of the plan that there was any specific undertaking to afford them compensation through the means of stock options, it may, nevertheless, be fairly assumed from the record that they, as well as Messrs. de Saint-Phalle, Solomon and Robinson, were valued employees whose services had been in the past and were reasonably expected to be in the future valuable to the corporation. We think, however, that in order to dispose of this appeal, we are not required to decide whether, under the record before us, a reasonable relationship of value between such services and the stock options is the fact in this cause.

We think that the stock option plan, as adopted by the directors and as ratified by the majority of the stock, is deficient because it is not reasonably calculated to insure that the defendant will receive the contemplated benefits. The Chancellor recognized that stock option plans adopted by the exercise of proper business judgment [2] and in good faith will not be interfered with by the courts if the provisions of the plan, or the facts and circumstances surrounding it, are such as to reasonably insure that the contemplated benefit will inure to the corporation. The Chancellor found such conditions to be present in this case but we are unable to agree with him.

It would probably unduly limit legitimate corporate action to attempt to lay down a minimum set of prescribed requirements that must be contained in every compensatory stock option plan. The payment of additional compensation by such means is currently fashionable with corporate management. It is probable that it will [33 Del.Ch. 76] continue to be the vogue as long as the present Section 130A of the Internal Revenue Code, 26 U.S.C.A. ยง 130A, remains the law. This section provides under certain conditions for the non-taxability as ordinary income of shares acquired by an employee pursuant to options. In view of the different ...


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