On January 14, 2013, the Supreme Court of Delaware in Freedman v. Adams, et al. upheld the ruling of the Delaware Court of Chancery that a stockholder-plaintiff failed to state a claim for corporate waste in a derivative complaint brought against XTO Energy Inc. and its board of directors. The complaint had alleged that the board's decision to pay $130 million of cash bonuses to certain officers without adopting a plan that could have made those payments tax deductible under Section 162(m) of the Internal Revenue Code (IRC) caused a loss of $40 million in wasted tax savings.

The decision turned on whether the board's failure to take advantage of available tax savings satisfied the standard in the Delaware Supreme Court's 2006 Disney decision for a finding of waste. Under Disney, to recover on a waste claim in the context of payment for assets, the plaintiffs must prove that:

The complaint argued that the board's failure to approve a Section 162(m) plan was similarly "irrational" and therefore enough to deprive the board of the protections of the business judgment rule. The board responded that it was aware of the possibility of qualifying for performance-based exemptions under IRC Section 162(m). The board's compensation committee nevertheless determined that its compensation decisions should not be constrained by attempts to qualify for as many deductions as possible under IRC Section 162(m).

The Delaware Supreme Court sided with XTO Energy and its board. As it explained, "the decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment." Therefore, even if the decision to not adopt a Section 162(m) plan may have been a poor one, it was not unconscionable or irrational. The board of XTO Energy was therefore still entitled to the protections of the business judgment rule.

The Supreme Court's ruling in this case is brief and limited on its face to the board's decision to forego adoption of a Section 162(m) plan. The Chancery Court's decision, on the other hand, made a broader ruling that "there is no general fiduciary duty to minimize taxes." That ruling has already been cited in a more recent Chancery Court decision in Seinfeld v. Slager, (Del. Ch. Jun. 29, 2012). Although the Supreme Court did not explicitly endorse the broader finding, its ruling that a board's sacrifice of some tax savings is a "classic exercise of business judgment" essentially produces the same result.

For more on the business judgment rule and the fiduciary duties of the board of directors, see Practice Note, Fiduciary Duties of the Board of Directors.

For an example of a cash bonus plan designed to comply with the requirements for qualified performance-based compensation under Section 162(m) of the IRC, see PLC Employee Benefits & Executive Compensation, Standard Document, Annual Cash Bonus Plan.