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The Rescinded February 2000 Option Agreement (Yarro et al v. Kreidel et al)
Sunday, March 06 2005 @ 04:28 PM EST

Getting back to the Canopy mess, here's the February 29, 2000 Option Agreement, purporting to give Ralph Yarro the right to purchase a 50% interest in the company's holdings then (as per the list on Exhibit A) and any made in the future. Yarro, in his complaint [PDF], says that he voluntarily rescinded this agreement and that it was later replaced with the various agreements now at issue in the litigation.

He submitted it to the court with his complaint presumably to prove that the Noordas intended to provide for him liberally and to show that, according to the document, the company's Board of Directors viewed Canopy's success as largely being due to Yarro's expertise and that Canopy desired "to encourage Yarro to continue in the employ of the Corporation and to continue his actions to increase the value of the Corporation by giving him an incentive to assist the Corporation in selecting appropriate technologies in which to invest, in developing those technologies and in achieving profits as public offerings thereof are made."

This would buttress his argument that he is the better choice to run Canopy and that the court should restore him to his former position.

The Yarro complaint says that this agreement ran into issues with the SEC, and to avoid a deleterious impact on other Canopy portfolio companies that came to light, Yarro agreed to void the agreement. The complaint says that the agreement was drawn up by the Noorda's accountants, financial advisers and outside lawyers, but one can't help but wonder, if that is true, how they all missed the fact that they were creating a document that benefitted Mr. Yarro at the expense of the portfolio companies. And one might objectively wonder where an incentive lies in granting options that can be exercised immediately upon signing of the agreement. But as we read it, what we are looking for isn't current legal impact -- it has none -- but with an eye to seeing if it gives evidence that the Noordas really intended to enrich Mr. Yarro personally to incentivize him to stay with the company, or if this was an early evidence of the fraud that Canopy and the Noordas now accuse Mr. Yarro of.

In corporate documents such as this, the devil is in the details, and there is some complexity here, but I find this document positively riveting. I hope you find it as illuminating as I do. I'll do my best to break it down, to explain what I see in it.

For reference and context, here's the Canopy/Noorda complaint, which asks for the following:

Although the precise amount of damages suffered by virtue of Defendants' conduct is not yet known, Defendants' improper gains alone exceeded at least $20 million. Canopy also seeks the return, termination or rescission of unexercised stock options purportedly acquired by Defendants, including an option held by defendant Ralph J. Yarro III, the company's former President and Chief Executive Officer, pursuant to which he may allegedly acquire forty percent of the company's non-voting shares.

In addition, Canopy and Mr. and Mrs. Raymond J. Noorda, in their capacity as trustees of The Noorda Family Trust, the company's majority shareholder, seek Yarro's removal as a Canopy director pursuant to Utah Code Ann 16-1Oa-809 for fraudulent and dishonest conduct and gross abuse of authority and discretion.

So, we read this Option Agreement carefully, with an awareness that there is an accusation of fraud on the table, and with the knowledge that there were several other agreements later, including an Equity Plan, which covered Ralph Yarro and other employees. This Option Agreement, however, was just for Ralph Yarro. The Canopy/Noorda complaint against Yarro mentions this:

38. Pursuant to a Stock Purchase Agreement executed by Yarro personally and on purportedly on behalf of Canopy on November 17, 2000, Yarro exercised his Class A stock options and acquired 10,000 shares of Class A voting stock, an amount equivalent to that held by the Trust . . . .

54. Between 2000 and the present, Yarro acquired $4,236,670 in compensation from Canopy by exercising options to acquire Class B shares and reselling those shares to Canopy pursuant to the resale provisions in Article 2, Section II of the Equity Plan. . . .

59. Between 1999 and 2004, Yarro took a total of at least $19,535,602 in excessive cash compensation pursuant to the Incentive Plan and exercises of resale rights acquired pursuant to the Equity Plan. This amount does not include the value of options and stock improperly acquired by Yarro pursuant to the Equity Plan. Nor does it include amounts received by Yarro from Canopy as base compensation and annual bonuses, which totaled approximately $275,000 to $300,000 per year, or compensation received by Yarro directly from Portfolio Companies.

These complaints are about the agreements that Yarro claims were created and executed to replace this February 2000 Option Plan he voluntarily gave up, and his complaint says this:

27. On or about February 29, 2000, Mr. and Mrs. Noorda put in place an equity ownership plan for Mr. Yarro (the "February 2000 Option Agreement"). The February 2000 Option Agreement was conceived and prepared by Mr. and Mrs. Noorda's personal accountants, financial advisors and lawyers, including their estate planning attorney, at the direction of Mr. and Mrs. Noorda. Mr. Yarro's involvement with the February 2000 Option Agreement was limited to group discussions in which the outside advisors and Mr. and Mrs. Noorda were present. Mr. Mott's involvement in the February 2000 Option Agreement was only to verify Canopy's investment basis in the various portfolio companies.

28. The February 2000 Option Agreement gave Mr. Yarro the right to purchase one-half of the Canopy owned shares in all Canopy portfolio companies (except MTI) at a price equal to Canopy's basis and it also provided for Mr. Yarro to realize profits and proceeds upon the sale of any Canopy portfolio company. The February 2000 Option Agreement was consistent with Mr. Noorda's repeated statements to Mr. Yarro and others that he wanted to recognize Mr. Yarro as an equal in Canopy, and provide for Mr. Yarro to obtain an equal interest in Canopy upon Mr. Yarro paying one-half of the amount that the Trust paid for its ownership interest in Canopy.

29. Shortly after the February 2000 Option Agreement became effective, it was determined during an SEC review process in connection with the IPO of Caldera Systems (a portfolio company) that, under the February 2000 Option Agreement, Canopy portfolio companies would incur and have to disclose a compensation charge for the difference between the IPO stock price and the underlying Canopy basis for Mr. Yarro's option shares. Under the February 2000 Option Agreement, this charge approximated $70 million for Caldera Systems. Since this charge would have a negative impact on any Canopy portfolio company IPO, Mr. Yarro voluntarily agreed to rescind the February 2000 Option Agreement. Thereafter, Mr. Noorda told Mr. Yarro and others that he was committed to come up with a new equity ownership plan that would benefit Mr. Yarro in a fashion similar to the February 2000 Option Agreement but which would eliminate the detrimental impact on Canopy portfolio companies.

It's an interesting document, not only because Yarro was by then apparently the dominant force acting on his own for the Board of Directors, according to Canopy's complaint against him, which says Noorda stopped actively participating in day to day affairs around 1998 and that both Noordas were unduly influenced by Yarro, so that you could view it that Yarro here is in effect praising himself and rewarding himself, but it also defines "Cause" like this:

"'Cause' means (i) an act or acts of dishonesty by Yarro constituting a felony under applicable law and resulting or intending to result directly or indirectlly in gain to or personal enrichment of Yarro at the Corporation's expense, or (ii) a material act of non-feasance, malfeasance or misfeasance by Yarro or the failure of refusal by Yarro to perform his essential duties as the president of the Corporation; provided, however, that the Board may not claim that Cause exists for termination of Yarro's employment if the failure or refusal to act by Yarro relates to any course of action approved or imposed by the Board which is outside of the normal duties of Yarro as those normal duties exist as of the date of this Agreement. Notwithstanding the foregoing, however, Yarro shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to him a copy of a resolution, duly adopted by the affirmative vote of not less than a majority of the entire membership of the Board at a meeting of the Board called and held for that purpose (after reasonable notice to him has been given or has been made and an opportunity for him, together with his counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, Yarro was guilty of conduct set forth above in the first sentence of this subsection (b) and specifying the particulars thereof in detail."

This isn't the same wording we've seen in other documents. It makes it much more difficult to terminate Mr. Yarro, so it could be viewed as a self-dealing paragraph. Clause 2.3 mentions the "Exchange Act" and Rule 16b-3. I'm not sure what they mean by that, since there is no b-3, but assuming they mean the Securities Exchange Act, here is the Securities Exchange Act of 1934 and here's Rule 16b:

Profits from purchase and sale of security within six months

For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) or a security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act) involving any such equity security within any period of less than six months, unless such security or security- based swap agreement was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security or security-based swap agreement purchased or of not repurchasing the security or security-based swap agreement sold for a period exceeding six months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized. This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security or security based swap agreement (as defined in section 206B of the Gramm-Leach Bliley Act) involved, or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purpose of this subsection.

Clause 3.2 talks about what happens to the options if Yarro is terminated. There are various situations addressed, death, disability, retirement (in the latter, he could still exercise the options for six more years!), but what interests us is termination for cause, in which case he could still exercise his options for 3 more months. Why would any company want a person terminated for cause, which they've already defined as more or less due to fraud or neglect of duties, to be able to continue to exercise options up to 50% of all of the company's holdings for an additional three months? It's so counter to what would be in the companies' best interests, it would seem to me. It's the first indication to me that something isn't right about this agreement.

I also note that 4.1 says that the company has the right to repurchase some of the shares of stock from Yarro at the price he paid, should a trigger event, as mentioned in 4.2 and defined as termination for cause or Yarro's voluntarily leaving the company, either within 10 years of the agreement, occur.

And there is the odd situation created, as discussed at the end of 4.5 that if Yarro felt like it, he could buy a ton of shares on being terminated for cause, after the termination for a period of 3 months, and the company could then pay him to give the shares right back, under this agreement. Hmm.

4.6 is even more odd. Earlier, in 4.5, it says that if Yarro had bought and then sold off some shares prior to his termination, the company had the right to repurchase solely the shares held by Yarro on the date of the repurchase, and they'd have no right to any cash or reinvestment proceeds from any prior sale by Yarro. But if he bought more stock and sold it quickly after termination, then the company could repurchase both the shares in his hand and their right to repurchase also applied to the cash or other reinvestment proceeds from the sale of the shares Yarro quickly bought and sold.

I acknowledge I am puzzled by the clause. To whose benefit does it accrue? The company gets to have a portion of his winnings? Is it that simple? Or is it that they only get back the price he originally paid and he keeps the winnings? If you look at Exhibit A, he got to purchase at an extremely low price. His exercise price per share of Caldera Systems under this agreement was $1.23. For Altiris, the price to Yarro was $0.0007. For Lineo, it was $.009938. Only Troll.tech is at $2,512.56, which seems more normal. Clause 4.6 then adds:

For this purpose, if Yarro has sold any shares of Stock which were acquired by him after his termination of his employment with the Corporation voluntarily or for Cause, the Corporation's repurchase right, upon payment of the purchase price based upon the original price per share paid by Yarro for said shares of Stock, shall relate to an equivalent portion of the proceeds of said sale.

To add to the complexity, 5.2 seems to say that any earlier agreement or later one takes precedence over this one, with respect to compensation and termination:

5.2 Impact on Other Employment Issues. Nothing contained in this Agreement shall impact existing or future compensation arrangements between the Corporation and Yarro. Conversely, nothing herein shall confer upon Yarro any right to continued employment nor shall it interfere in any way with the right of the Corporation to terminate the employment of Yarro at any time.

So, if another document, any other document, conflicts with this one on those issues, it appears that this one loses. If that is a correct interpretation, then Mr. Yarro was very foolish to allow this clause into the agreement. In that sense, it validates the document in a way. A person desiring to set himself up for life at the expense of an old man not paying attention any more wouldn't include such a clause, I don't think.

But maybe it was an oversight. It's the first indication, to my mind, that the document might conceivably have been legitimate and intended. On the other hand, you can't rule out incompetence either, because there is a conflicting clause in 5.6, which says that this agreement "supersedes all prior agreements, representations or understandings between the parties relating to the subject matter hereof. All prior agreements relating to the subject matter hereof, whether written or oral, are hereby merged into this Agreement."

Well, which is it? It can't be both. If I had to guess, and it could only be a guess at this point, I would say that 5.6 is boilerplate language you find in most agreements and contracts, whereas 5.2 is not. On that basis, I'd say 5.2 is what was intended, and some paralegal, or attorney, just included the boilerplate 5.6 without thinking about the fact that it sets up an internal conflicting issue. Conflicting clauses in a contract are exactly the soil from which litigation can spring up and bloom. But the point is, if all the experts Yarro claims were involved in drawing up this document really did so, how could they miss something as simple as this conflict in language? Ray Noorda is renowned for his business skill and acumen. This document doesn't reflect that at all, and that works against Mr. Yarro.

But the clause that made my eyes get wide is 5.10, indemnifying and ratifying Yarro's prior actions:

5.10 Indemnification and Ratification. The Corporation hereby warrants, represents and agrees that, by authorizing the execution of this Agreement, the Board and the Shareholders of the Corporation have expressly confirmed and ratified all prior actions by the Corporation with respect to the acquisition and funding of the Present Holdings, whether said acquisitions and fundings were approved by specific action of the Board in each particular instance or were made pursuant to the general authority granted to the officers of the Corporation by the Board or by the Shareholders. The Corporation hereby agrees to indemnify and hold Yarro harmless with respect to actions taken by him in connection with said acquisitions and funding.

Oh my. Red flag. Why would you need a clause like this in a normal situation in a typical option agreement? If, on the other hand, there were some shady dealings you knew about and you wanted your back covered, what would be a better solution than a clause like this one? It seems to set it up that there is no termination for cause for discovered acts of fraud that precede this agreement. Oh, boy.

I'm trying to think of all the deals done prior to February of 2000. When was Lineo spun off? Altiris wasn't sold until 2002. The Caldera winnings from the DR DOS lawsuit? We know Canopy is accusing Yarro of pocketing the winnings improperly, after they say he interpreted the win as a "trigger event", which they contest, but if it was, then would this paragraph cover that? The language says it indemnifies regarding acquisition and funding. Even if it wouldn't cover the Caldera deal, was that the intent when drafting this language? That DR DOS event, pocketing the litigation proceeds, allegedly happened just days prior to this Option Agreement being signed. Might it not, therefore, have been on someone's mind? You can see the timing of that if you look at the Canopy Memorandum in Support of their Motion to Dismiss Ralph J. Yarro III as Director [PDF], which lists the deals prior to this agreement:

18. In August 1999, without Board review or approval, Yarro and Mott caused Canopy to distribute 5% of the net proceeds of a Triggering Event relating to the Portfolio Company Vinca, Inc. ("Vinca") to five Canopy employees, including Yarro and Mott. The bonus pool from the Vinca sale totaled approximately $2.1 million. Yarro alone received approximately $1.47 million of the bonus amount, and Mott, whom Canopy had hired only a few months earlier, received approximately $42,000.00.

19. In 1999 or early 2000, Caldera, then a Portfolio Company, settled a significant antitrust lawsuit it had filed against Microsoft Corporation.

20. On or about February 25, 2000, without Board review or approval, Yarro and Mott caused Canopy to distribute a portion of the Caldera settlement proceeds to six Canopy employees, including Yarro and Mott, even though the Caldera settlement was not a Triggering Event as that term is defined in the Incentive Plan. The bonus pool from the Caldera settlement totaled approximately $7.6 million, and Yarro caused himself to be paid approximately $6.75 million of that amount. Mott received approximately $227,000.00.

21. On or about February 25, 2000, without Board review or approval, Yarro and Mott caused Canopy to distribute 10% of the proceeds of a Triggering Event relating to the Portfolio Company KeyLabs, even though the Incentive Plan by its own terms provides for a bonus pool of 5%. The bonus pool from the KeyLabs transaction totaled approximately $3.4 million. Yarro alone received approximately $2.9 million, and Mott received $205,320.

The actual date of the settlement between Microsoft and Caldera was January 7, 2000, as you can see from this press release. You might also notice that the firm representing Caldera then is the same firm representing the Yarro team now. KeyLabs isn't listed on Exhibit A of the Option Agreement, so whether it was intended to be a transaction covered by the indemnification or not is unclear. So, if I've understood the language in this Option Agreement, I think Yarro could have argued that the indemnification clause covered these deals, at least the Vinca one, if the agreement had not been rescinded.

And it is this paragraph in the Option Agreement above all the others that makes me become suspicious, more than any other clause in the agreement, and there are several that seem odd. From that standpoint, I am surprised that the Yarro team wanted to produce it. I think it hurts their cause more than it helps. At least it does with me. I can't imagine that Ray Noorda, if he was the businessman everyone says he was, would draft and sign an agreement like this one, and if I were on the jury, that's what I would decide. Feel free to reach your own conclusions, however, as will the judge and the eventual jury in this case. And one final caveat. In litigation, it isn't always the case that you have a good guy and a bad guy. Sometimes both sides are the bad guy. Sometimes, each is a little bit right. Putting all the pieces in place is very much like a jigsaw puzzle, where you can't see the big picture for some time. So, while this agreement smells funny to me, I continue to keep an open mind about other details of the litigation, and I am very much aware that the big picture is still not clearly visible. The hearings beginning on March 8 should provide us with many more pieces of this puzzle.


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