The Delaware Supreme Court upheld a Chancery Court determination that a board did not commit waste by consciously deciding to pay bonuses that were non-deductible under Section 162(m) of the Internal Revenue Code (Freedman v. Adams, Del. Supr., __ A.2d __, No. 230, 2012, Berger J. (Jan 14, 2013)). Unlike claims of gross negligence, claims of waste are not subject to exculpation or indemnification by the company and therefore have the potential for personal liability of directors.

The original suit was brought in 2008 by a shareholder of XTO Energy (later acquired by ExxonMobil) as a derivative claim. The suit alleged that XTO’s board committed waste by failing to adopt a plan that could have made $130 million in bonus payments to senior executives tax deductible. The board was aware that, under a plan that qualifies for the “performance based compensation” exception of Section 162(m), the company could have deducted its bonus payments, but, as the company disclosed in its annual proxy statement, the board did not believe that its compensation decisions should be constrained by such a plan. The Chancery Court held that the shareholder failed to state a claim. The Supreme Court agreed, holding that the decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment.

…continue reading: Delaware Supreme Court Upholds Board Compensation Decision

In a decision reaffirming directors’ authority to determine executive compensation, the United States District Court for the District of Oregon has ruled that a suit against bank directors arising out of a negative “say on pay” vote should be dismissed. The court determined that plaintiffs failed to raise a reasonable doubt that the challenged compensation was a reasonable exercise of the board’s business judgment. This is the first federal court decision to dismiss such an action, a number of which have been filed in state and federal courts across the country in the wake of the Dodd-Frank Act. Plumbers Local No. 137 Pension Fund v. Davis, Civ. No. 03:11-633-AC (Jan. 11, 2012).

At issue in Davis was a decision by the compensation committee of Umpqua Holdings Corporation to pay increased compensation to certain executive officers for 2010 — a year in which the bank’s performance had improved and met predetermined compensation targets, but total shareholder return was allegedly negative. In a subsequent advisory “say on pay” vote, a majority of the shares voted disapproved of the 2010 compensation. Plaintiffs claimed that it was unreasonable for the Umpqua board of directors to increase compensation and that the shareholder vote rejecting the compensation package was prima facie evidence that the board’s action was not in the corporation’s or shareholders’ best interest.

…continue reading: Negative Say on Pay Vote Litigation

In dismissing a wide-ranging stockholder challenge to compensation practices at Goldman Sachs, the Delaware Court of Chancery has issued a strong reaffirmation of traditional principles of the common law of executive compensation.  The decision emphasizes that boards are free to encourage and reward risk-taking by employees and that Delaware law protects directors who adopt compensation programs in good faith.  In re The Goldman Sachs Group, Inc. Shareholder Litigation (Oct. 12, 2011).

Shareholders of Goldman Sachs brought suit on a variety of theories, claiming that Goldman’s compensation policies, which emphasized net revenues, rewarded employees with bonuses for taking risks but failed to penalize them for losing money; that the directors allocated too much of the firm’s resources to individual compensation versus investment in the business; that while the firm adopted a “pay for performance” philosophy, actual pay practices failed to align stockholder and employee interests; and that the board should have known that the effect of the compensation practices was to encourage employees to engage in risky and/or unlawful conduct using corporate assets.  In dismissing the claims, the Court relied on basic principles of Delaware law.

…continue reading: Delaware Court Upholds Board Discretion in Setting Compensation Practices

When stockholders deliver a negative vote on say on pay, directors face the question whether to change corporate policy in response – even if their best business judgment tells them that existing compensation programs are well-designed and are working well. In fact, a negative vote on say on pay does not change the board’s fiduciary duty to implement compensation policies that the directors believe are the best way to attract, retain and incentivize top-quality managers:

• The law is clear in all American jurisdictions that setting compensation policy and structuring compensation agreements are decisions reserved for directors and not shareholders. That is why say on pay resolutions are advisory and do not carry mandatory force.
• Dodd-Frank does not affect this basic legal principle. It specifically provides that say on pay votes do not change the board’s fiduciary duties and traditional powers in this area.

…continue reading: Inside the Boardroom: Responding to a Negative Say on Pay Vote

In an important decision, the Delaware Supreme Court has firmly rejected post-merger stockholder claims that directors failed to act in good faith in selling the company, even if it were assumed that they did nothing to prepare for an impending offer and did not even consider conducting a market check before entering into a merger agreement (at a substantial premium to market) containing a no-shop provision and a 3.2% break-up fee. Lyondell Chemical Corp. v. Ryan, C.A. 3176 (Del. Mar. 25, 2009). The en banc decision, authored by Justice Berger, is a sweeping rejection of attempts to impose personal liability on directors for their actions in responding to acquisition proposals, and reaffirms the board’s wide discretion in managing a sale process.

The Court of Chancery had refused to grant summary judgment on claims that the directors of Lyondell had breached their duty of loyalty by failing to act in good faith in conducting the sale process. Lyondell’s certificate of incorporation included an exculpatory provision, as permitted by Section 102(b)(7) of the Delaware General Corporation Law, that shielded the directors from personal monetary liability for any alleged duty of care violations but not for duty of loyalty violations. The Court of Chancery found the board to be independent and disinterested, but held that the directors’ “unexplained inaction” when it appeared that the company would be put “in play” by a Schedule 13D filing created an inference that the directors may have consciously disregarded their fiduciary duties and failed to act in good faith in violation of the duty of loyalty.

In considering the claim under the Revlon standard requiring that the board seek to get the best price available in selling the company, the Supreme Court found that the lower court had misapplied the law in three respects: first, it imposed Revlon duties before the board had decided to sell the company or a sale had become inevitable; second, it misread Revlon as creating a set of specific requirements to be satisfied during the sale process; and third, it treated an arguably imperfect effort to sell the company as equivalent to “a knowing disregard of one’s duties that constitutes bad faith.”

The Supreme Court rejected the view that Revlon duties arise simply because a company is “in play,” holding: “The duty to seek the best available price applies only when a company embarks on a transaction – on its own initiative or in response to an unsolicited offer – that will result in a change in control.” The Court found that the board had appropriately exercised its business judgment by taking a “wait and see” approach in response to a Schedule 13D filing indicating that a party was interested in acquiring the company. The Court ruled that Revlon duties only arose when the directors chose to begin negotiating the sale of the company. The decision thus again makes clear that a board has no duties under Revlon to seek the “best price” in a sale or other transaction simply because a stockholder or other potential bidder tries to put the company “in play.”

…continue reading: Supreme Court rejects post-merger stockholder claims

Three senior partners at Wachtell, Lipton, Rosen and Katz–Andrew Brownstein, Theodore N. Mirvis, and Paul K. Rowe–spoke last week at the Law School’s Law and Finance Seminar on the case against shareholder interference. The speakers began by posing a series of questions and challenges to those seeking governance reforms–and warned against making significant changes to a governance system that, in their view, has performed remarkably well over a long period of time.

The talk built on several articles and memoranda the speakers have published on corporate governance along with their partners William Savitt, Martin Lipton, Eric S. Robinson, and Mark Gordon. Those pieces include Bebchuk’s “Case For Increasing Shareholder Power”: An Opposition; Private Equity and the Board of Directors; Classified Boards Once Again Prove Their Value to Shareholders in Recent Takeover Battle; Deconstructing American Business, and Deconstructing American Business II.

A video of the panel discussion is available online here. The questions and challenges the speakers set forth at the outset of their talk can be found here.

Here is an important address by Marty Lipton, Shareholder Activism and the ‘Eclipse of the Public Corporation‘, which rightly belongs here in the belly of the beast.  Part of the title derives from Professor Michael Jensen‘s famous 1989 piece in the Harvard Business Review, proving at least that there is much back to the future in the field.

Here is a short Memorandum from Wachtell, Lipton, Rosen & Katz on Chancellor Chandler‘s recent decisions on stock option backdating.  The decisions, In re Tyson Foods, Inc. Consol. S’holder Litig., and Ryan v. Gifford, repay reading, even if you read them well after they were written.