Court Opinion

ID: 3133137
Source: CourtListenerOpinion
Date Created: 2015-10-20 22:01:04.47776+00
Date Added: 2024-06-11T09:35:37.573785
License: Public Domain

In the

    United States Court of Appeals
                For the Seventh Circuit
                    ____________________

No. 15-1006
JAN DONNAWELL,
                                                 Plaintiff-Appellant,

                                v.

DANIEL HAMBURGER, et al.,
                                              Defendants-Appellees.
                    ____________________

        Appeal from the United States District Court for the
          Northern District of Illinois, Eastern Division.
          No. 12 C 9074 — George M. Marovich, Judge.
                    ____________________

   ARGUED OCTOBER 1, 2015 — DECIDED OCTOBER 20, 2015
                ___________________

   Before POSNER, MANION, and HAMILTON, Circuit Judges.
    POSNER, Circuit Judge. The plaintiff is a stockholder in
DeVry Education Group, Inc., a Delaware company that
owns and operates a number of for-profit colleges and uni-
versities. See DeVry Education Group, www.devryeducation
group.com (visited October 19, 2015). The suit is a share-
holders’ derivative suit against current and former members
of DeVry’s board of directors. Federal jurisdiction is based
2                                                No. 15-1006

on diversity of citizenship; the substantive law governing
the suit is Delaware corporation law. The appeal is from the
dismissal of the suit with prejudice.
    An incentive plan adopted by the company in 2005 au-
thorized the award of stock options to key employees, in-
cluding the company’s CEO. The plan limited the awards to
150,000 shares per employee per year. Yet the company
granted Daniel Hamburger, who became its CEO in 2006,
options on 184,100 shares in 2010, 170,200 in 2011, and
255,425 in 2012. Later that year the company, discovering its
mistake, reduced each grant under the 2005 plan to 150,000
shares. But at the same time it allocated Hamburger 87,910
additional shares available under the company’s 2003 incen-
tive plan, which held shares that had been authorized to be
allocated but hadn’t yet been allocated. As a result Ham-
burger received options in 2012 far above the 150,000 that
were the most he could receive under the 2005 plan. All
these grants were proposed by the company’s Compensation
Committee to the company’s independent directors (direc-
tors who are not also employees of the company). The inde-
pendent directors approved the award of the additional
shares to Hamburger. At the time, all the members of the
Compensation Committee, and all but two of the members
of the board of directors—one of them being Hamburger—
were independent directors.
    The plaintiff argues that the award is improper because
only the company’s Plan Committee, and not the Compensa-
tion Committee, was authorized to grant stock options un-
der the 2003 plan. But there was no Plan Committee in 2012.
The committee was to consist of members of the board of di-
rectors who were full-time, salaried employees of the com-
No. 15-1006                                                3

pany, and the only full-time, salaried employee of the com-
pany who was also a member of the board of directors was
Hamburger. One supposes that he could have designated
himself the Plan Committee, but he didn’t, so there was no
Plan Committee. In lieu thereof the grant of the 87,910 stock
options was approved by the Compensation Committee, and
in turn by the independent directors as a whole.
    Approval by the Compensation Committee may have
been fairer to stockholders than approval by the Plan Com-
mittee would have been. The Compensation Committee was
made up exclusively of independent directors and its deci-
sions were approved by the other independent directors. In-
dependent directors might be more likely to question a gen-
erous award to the CEO than an employee would be (“I vote
to deny my boss stock options”—not likely!).
    Any decision by the Plan Committee, moreover, would
have required approval of the Compensation Committee to
be valid under the 2003 plan. The Plan Committee (when it
exists) is thus the agent of the Compensation Committee;
and what the agent can do, the principal can do. Further-
more, to obtain favorable tax treatment of performance-
based compensation (which stock options are), a compensa-
tion committee consisting of at least two independent direc-
tors must determine the performance goals on which the
compensation is based and certify that those goals have been
achieved. 26 U.S.C. § 162(m)(4)(C). DeVry’s Compensation
Committee satisfied these criteria, the Plan Committee did
not, and so the Compensation Committee must have had the
final say over whether to award stock options to CEO Ham-
burger as otherwise the tax benefit would have been for-
gone.
4                                                   No. 15-1006

     It may help to think of the case in golf terms. A “mulli-
gan” is the practice of allowing a player who has made a bad
shot to do it over, and the bad shot isn’t shown on his score-
card. Mulligans are commonly allowed in informal golf
matches (as opposed to tournament matches, in which mul-
ligans are never permitted) because no harm is thought to be
done by them in such matches. Likewise no harm was done
by allowing the Compensation Committee to do over, in ef-
fect, the erroneous grant of stock options under the 2005
plan, by invoking the 2003 plan, thus sinking the ball in the
hole. The end result, from the shareholders’ perspective, was
no different from what it would have been had the first shot
been a hole in one.
      The plaintiff further argues that it was error to value the
additional 2012 shares at their price in August of that year,
when the initial grant (later realized to be forbidden) was
made, rather than in December, the month in which the mis-
take was corrected by awarding shares available under the
2003 plan to Hamburger. But the award of shares in Decem-
ber was just a way of fulfilling the intention of the board and
the Compensation Committee in making the initial grant to
Hamburger in August, the grant that violated the 2005 plan.
This is not a case in which shares granted at one time are lat-
er backdated to take advantage of market shifts. See Ryan v.
Gifford, 918 A.2d 341 (Del. Ch. 2007). The board was merely
trying to keep the promise it had made in August by ful-
filling it from a different bank of shares.
    Against all this the plaintiff insists that the Delaware
courts enforce corporate rules with absolute rigidity, indif-
ferent to what is sensible, reasonable, or realistic, and there-
fore that the grant of stock options to Hamburger was inva-
No. 15-1006                                                    5

lid—period—because it was not made by the Plan Commit-
tee. It quotes a decision of the Delaware Chancery Court
which states that “contract interpretation starts with the
terms of the contract. If the terms are plain on their face, then
the analysis stops there.” Sanders v. Wang, No. 16640, 1999
WL 1044880, at *6 (Del. Ch. Nov. 8, 1999). It’s rather insult-
ing to Delaware judges to interpret Delaware law on the as-
sumption that the judges are mindless automata. Drafters of
contracts are not omniscient; they are not gifted with exact
knowledge of what the future holds. Literal interpretation
can produce absurdities when applied to unforeseen occur-
rences, as when an ordinance forbidding unleashed dogs in
a park is sought to be applied to a statue of Lassie.
     The nonexistence of the Plan Committee created an un-
foreseen hole in the 2003 incentive plan, and the company
plugged the hole by substituting the Compensation Commit-
tee—a substitution that might well make the shareholders
better off, and would be very unlikely to make them worse
off, than if there had been a Plan Committee. It makes no
sense to allow a harmless error to drive a judicial decision—
indeed the legal meaning of “harmless error” is an error that
for lack of consequence is to be ignored by the court. We ha-
ven’t found Delaware cases that invoke harmless error in re-
gard to violations by boards of directors of compensation
plans, but that can be of no comfort to the plaintiff in this
case; for the Delaware case law requires, for liability to be
imposed, that the board have violated an unambiguous term
of the plan, and that didn’t happen in this case. E.g., Sanders
v. Wang, supra, 1999 WL 1044880, at *7.
   A further point is that the 2003 plan authorized the Plan
Committee to amend the plan as it saw fit, albeit with excep-
6                                                 No. 15-1006

tions, but the exceptions did not require the committee’s re-
maining the initiating body—and did not even require the
committee’s continued existence. Since the committee could
thus have dissolved itself in favor of the Compensation
Committee without violating the plan, the nonexistence of
the Plan Committee was no bar to the decision in 2012 to
grant shares from the 2003 plan to CEO Hamburger.
     The district judge dismissed the suit on the ground that
the plaintiff had failed to make a demand on the corporation
to correct what she contends was a violation of Delaware
law in awarding Hamburger extra shares under the 2003 in-
centive plan. Such a demand is required by Delaware law
unless it would be futile, which in this context means that
“particularized facts have been alleged to create a reasonable
doubt either that ‘(1) the directors are disinterested and in-
dependent [or] (2) the challenged transaction was otherwise
the product of a valid exercise of business judgment.’”
Friedman v. Khosrowshahi, No. 9161–CB, 2014 WL 3519188, at
*9 (Del. Ch. July 16, 2014), quoting Aronson v. Lewis, 473 A.2d
805, 814 (Del. 1984); see also Wood v. Baum, 953 A.2d 136, 140
(Del. 2008); Brehm v. Eisner, 746 A.2d 244, 256 (Del. 2000);
Westmoreland County Employee Retirement System v. Parkinson,
727 F.3d 719, 724–26 (7th Cir. 2013). Neither futility condi-
tion was satisfied. There is no doubt either that the directors
who approved the Compensation Committee’s recommen-
dation were disinterested or that the recommendation was
the product of a valid exercise of business judgment. Notice
that this is just a roundabout way of saying that the admin-
istration of the 2003 plan by the Compensation Committee,
given the nonexistence of the Plan Committee designated in
that plan, was not “a clear or intentional violation of a com-
pensation plan,” Friedman v. Khosrowshahi, supra, 2014 WL
No. 15-1006                                                    7

3519188, at *12, and the Compensation Committee’s devia-
tion from the literal terms of the plan was, as we said, at
worst a harmless error, though more likely no error at all.
Literalism is not the only valid method of interpreting con-
tracts (and sometimes it is invalid, because it can produce
unforeseen absurdities).
     For completeness we’ll comment briefly on another of
the district judge’s rulings—his denial of a motion by Milton
Pfeiffer to intervene as a plaintiff. Pfeiffer, like Donnawell a
stockholder of DeVry Education Group though he owned
only one share, worth no more than $50, had filed a stock-
holder derivative suit, very similar to the present one, in Illi-
nois state court. The suit was dismissed as moot when the
company corrected the errors in its administration of the
2005 plan, which was before Donnawell had amended her
complaint in the present case to challenge the award of stock
options to Hamburger under the 2003 plan. Although it
dismissed the suit, the Illinois court awarded Pfeiffer non-
trivial attorney’s fees on the ground that his suit had alerted
the company to the errors in the administration of the 2005
plan, leading the company to correct them. One might there-
fore have thought Pfeiffer an appropriate intervenor in the
present case. But the district judge denied the motion on the
ground that Pfeiffer’s claim was identical to Donnawell’s
and Donnawell was adequately representing his legal inter-
est, and so allowing him to intervene would add nothing.
Donnawell was dismissed from the case because of her fail-
ure to make the required demand on the board of directors,
and her dismissal left no one to represent the interest of oth-
er shareholders except Pfeiffer. Yet as the district judge not-
ed, Pfeiffer, like Donnawell, had failed to make a demand on
8                                             No. 15-1006

the board—and in any event has not appealed the denial of
his motion for leave to intervene.
   The judgment dismissing the suit and denying Pfeiffer’s
motion to intervene is
                                                AFFIRMED.