New England Biz Law Update
The Massachusetts Appeals Court last month issued a decision in Haskell v. Versyss Liquidating Trust, (2004 WL 2020088, Mass. App. Ct., Sept. 13, 2004), a case about the documentation of stock options for senior corporate officers.1
The facts and decision are instructive for all lawyers who manage corporate record keeping, especially in-house counsel. Indeed, in-house counsel played a significant role in the story of this case.
The ‘Paper Trail’
Versyss, a Delaware corporation, was closely held by Massachusetts standards. It employed 1,000 people and had $100 million in annual revenue. Its founder and leader had recently died. The company was faltering financially and needed a new CEO who could “work out” its problems.
The plaintiff, George Haskell, a business consultant, negotiated for himself a CEO incentive package that included 10 percent of the common stock, one-half vesting at the outset of his service with the remainder vesting subject to the achievement of certain specified milestones. As a board member, he abstained from voting on this arrangement, approved by the remaining two directors.
A similar package with deferred vesting was also arranged for one of the two remaining directors who also abstained from voting on his plan. As to the two directors with the comparable packages, the first, Haskell, filed late his election under 26 U.S.C. §83(b)(2), and the second director failed to file it at all, creating potential tax liabilities for both.
Now comes in-house counsel under the guiding hand of outside counsel. Ostensibly to solve the personal tax problem of the two directors arising from their failure to make timely elections, the directors and their corporate counsel decided to attempt to unscramble the egg.
The conditional grant packages were revoked and recast to provide for the total vesting of the directors’ stock without condition. The problem here was that there had been an explicit understanding with majority shareholders, embodied in the original documentation, that one-half of these grants would remain conditioned on performance.
To achieve the functional equivalent, the two directors signed a side letter directed to the majority shareholders approximating the conditions in the preexisting deal with minor modifications. Failing such conditions, in their letter the directors promised the return of one-half their shares if either left voluntarily before the stock had reached the specified milestone value.
The resulting “paper trail” thus consisted of corporate resolutions making the grants unconditional and the conflicting side letter, which provided for the conditional return of the stock.
As it happened, relations between Haskell and his management colleagues deteriorated. He resigned, but not without first attempting to negotiate a release of the side letter. Remaining board members and major stockholders were unwilling to accommodate his request.
Several months later, the company was sold in a merger transaction effected through a shareholder voting trust. In the lawsuit that followed, the plaintiff, Haskell, insisted that all the shares he held had in fact reached the milestone price before his resignation.
At trial, Haskell relied upon the formal corporate resolutions that granted the stock outright and claimed the side letter was a nullity without consideration, a moral obligation only.
The trial judge enforced the absolute stock grants and concurred in the plaintiff’s view that the side letter was without consideration. The trial court found the absolute grants in the corporate resolutions to be binding on the corporation and also the shareholders, notwithstanding the terms of the side letter.
Side Letter Enforceable
Beneath the formality of the corporate resolutions, the Appeals Court noted the following:
The Appeals Court found that the side letter was enforceable and that only half the stock had been granted unconditionally. The Appeals Court found that fresh consideration for the side letter included certain modest enhancements it made to the milestones for the benefit of the two directors.
The Court also noted that “the replacement of an executory agreement by another such agreement binds the latter where the changes are material, even if modestly so.”
In evaluating the question of consideration, the decision also reflects the court’s sensitivity to the plaintiff’s role as director, “once account was taken of the vulnerability of the resolutions to an attack based on the directors’ self-dealing and its effect on the interests of the shareholders at large.”
The trial judge saw the side letter as the by-product of a tax sham. In response to this concern, the Appeals Court observed that the record contained no evidence as to how the plaintiff ultimately acted with respect to tax reporting obligations.
Perhaps more importantly, the Appeals Court noted that it seems unwise for the court to interpret what the Internal Revenue Service might do, or not do, about such tax implications.
Lesson
If it was not clear before, the Haskell decision confirms the predisposition of Massachusetts courts to look beneath the record of corporate action to assure that form actually follows substance.
Elegant documentation is no substitute for corporate records that fairly and fully reflect the true nature of the actions taken. If such actions cannot be comfortably documented, prudence warrants further reflection about their appropriateness.
FOOTNOTES:
1. The author represented the Versyss Liquidating Trust and the interests of shareholders in the appeal of the case.
John D. Hanify, the co-founder and principal of Hanify & King P.C. (www.hanify.com), directs the firm’s litigation practice. For 25 years, he has tried cases and represented business clients in state and federal courts, before federal and state agencies, and in arbitration. He can be reached at [email protected] or 617-423-0400. Hanify and King, based in Boston, focuses on litigation, bankruptcy and financial restructuring, business and real estate, employment and alternative dispute resolution.
