Friday, August 17, 2012

Federal Courts Hold that Negative Shareholder Say-on-Pay Votes Did Not Negate Business Judgment Rule Presumption


There is a growing consensus among federal courts that, under Delaware law, a negative shareholder say-on-pay vote does not rebut the business judgment rule presumption normally accorded to a company’s board of directors. Applying Delaware law, a federal judge (ND Ill) ruled that a negative shareholder advisory vote on executive compensation did not rebut the business judgment rule and excuse demand in a shareholder derivative action alleging a breach of fiduciary duty by company directors. Section 951 of the Dodd-Frank Act requires public companies to allow a shareholder advisory vote on executive pay at least once every three years. According to the court, the plain language of the statute makes clear that the non-binding shareholder vote does not create or imply any change in the fiduciary duty of the company’s board of directors. (Gordon v. Goodyear, ND Ill., July 13, No. 12 C 369, July 13, 2012)

Reliance by the shareholder on an earlier federal court ruling in the Cincinnati Bell case that shareholders rebutted the business judgment rule presumption was misplaced, noted the court, since that ruling applied Ohio, not Delaware, law.

Under Ohio law, said the court, the business judgment rule is an affirmative defense, not an element of excusing demand on the board of directors. As such, courts applying Ohio law do not analyze the business judgment rule at the motion to dismiss stage. In contrast, under Delaware law, a plaintiff has the burden of rebutting the business judgment rule presumption that company directors acted with informed good faith for the company’s best interest. This presumption must be rebutted through particularized allegations at the pleading stage, said the court, which the plaintiff in this action did not do.

A derivative suit is an equitable remedy in which a shareholder asserts a claim on the company's behalf. Because the directors are empowered to manage the company's business affairs, a shareholder bringing a derivative action must first make a demand on the board, giving the board the chance to examine the alleged grievance to determine if pursuing the action is in the company's best interest. Under Delaware law, one way to excuse demand on the board is to raise a reasonable doubt that the challenged act was a product of the board's valid exercise of business judgment.

In another ruling applying Delaware law in a derivative action, a federal magistrate (ND Calif) held that a 64 percent negative shareholder advisory vote on an executive pay package did not rebut the business judgment rule presumption that company directors acted with informed good faith in the company’s best interest. (Iron Workers Local No. 25 Pension Fund v. Bogart, ND Calif, No. 11-4604, June 13, 2012). The fact that the shareholder’s interpretation of the pay for performance policy did not match the board’s executive decision is not the equivalent of an allegation that the board intentionally misled shareholders. The 64 percent negative vote, on its own, did not rebut the business judgment rule presumption. In so holding, the magistrate adopted the analysis of the court in Laborer’s Local v Intersil (ND Calif), where Judge Davila, after a thorough analysis of the legislative history of the Dodd-Frank Act, concluded that a shareholder vote alone is not enough to rebut the business judgment rule presumption.

While Congress was explicit that the shareholder vote on executive pay is advisory, noted Judge Davila, the Dodd-Frank Act is silent on what consideration courts should give to the shareholder vote. Looking to the purposes of Dodd-Frank, Judge Davila concluded that a shareholder vote on executive compensation under the Act has substantial evidentiary weight and may be used as evidence in determining if demand on a board has been excused because of a reasonable doubt that the board validly exercised its business judgment. Ruling only on the particular facts presented in the case before it, where 56 percent of the shareholders disapproved of the company's executive pay package, the court found that the negative shareholder vote alone was not enough to rebut the presumption of the business judgment rule. Additional facts would be required to raise a reasonable doubt that the decision was not a valid exercise of business judgment. (Laborer's Local v. Intersil, No. 11-CV-04093, Mar 7, 2012).

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