Corporate Waste

Although we all think we know what a waste is, the concept of corporate waste has a very specific meaning. As a legal standard, corporate waste claims are – along with good faith claims – among some of the hardest claims for plaintiffs to succeed on. Chancellor Allen observed that a successful waste claim is much like the Loch Ness monster:

[T]he waste theory represents a theoretical exception to the statement very rarely encountered in the world of real transactions. There surely are cases of fraud; of unfair self dealing and, much more rarely negligence. But rarest of all — and indeed like Nessie [of Loch Ness fame], possibly non existent — would be the case of disinterested business people making non fraudulent deals (non-negligently) that meet the legal standard of waste!

- Steiner v. Meyerson, Del. Ch., C.A. No. 13139, Allen, C. (July 18, 1995), Mem. Op. at 2, 1995 WL 441999.

The judicial standard for determination of corporate waste is well developed. A waste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade. Most often the claim is associated with a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift. If, however, there is any substantial consideration received by the corporation, and if there is a good faith judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste, even if the fact finder would conclude ex post that the transaction was unreasonably risky. Courts are ill-fitted to attempt to weigh the “adequacy” of consideration under the waste standard or, ex post, to judge appropriate degrees of business risk (Lewis v. Vogelstein, 699 A. 2d 327, 336 (1997).

Nevertheless, corporate waste claims are not uncommon. In recent years, plaintiffs have brought many corporate waste claims against boards for their executive compensation practices. Few – if any – of these claims are ever successful. To the extent executive compensation levels reflect a disinterested view by boards of directors - advised in good faith by outside compensation experts - such decisions are mere business judgments and, consistent with § 141(a), get the business judgment presumption and the protection of § 141(e). 

As you already know, a disinterested board making an informed decision will receive the protection of the business judgment presumption when the decision to pay an executive a large amount of money is challenged by stockholders. Because it is extremely difficult to plead demand futility in such cases, they are often characterized as “waste” claims in order to access Aronson's second prong (that the decision was not a rational business decision).

Some believe that boards have an obligation to minimize tax liability or to avoid paying taxes and that paying more taxes than the absolute minimum constitutes some sort of fiduciary duty violation or is a corporate waste. Such a view has never been supported by any corporate law doctrine. Nevertheless, that fact does not stop some litigants from bringing fiduciary challenges against board decisions with respect to tax strategy. Such challenges, assuming a disinterested and reasonably informed board are doomed for failure. Consequently, plaintiffs who bring such claims are left to characterize such claims as residual “waste” claims, again with no record of success.

One area where plaintiffs are more successful is in claims against excessive director compensation, rather than executive compensation. Although directors are expressly authorized by statute to set their own pay (DGCL 141(h)), the levels of such pay can give courts pause. Plaintiffs are obviously more successful in such cases because by their nature, directors are interested parties in their own pay. Consequently, plaintiffs are much more likely to succeed in overcoming Zuckerberg's demand futility pleading requirements thus supporting a duty of loyalty claim.