Sunday, October 07, 2012

Federal Court Holds that Negative Shareholder Say-on-Pay Vote Did Not Negate Business Judgment Rule Presumption

Applying Delaware law, a federal judge rejected a company shareholder’s contention that the company’s approval of an executive compensation package that the shareholders had rejected in a Dodd-Frank mandated advisory vote violated the fiduciary duty of the directors to act in good faith. The shareholder’s argument contradicted the express language of Dodd-Frank and Delaware corporation law, said the court. (Swanson v. Weil, DC Colo, No. 11-cv-02142, Sept. 26, 2012).

The Dodd-Frank Act provides that a shareholder say-on-pay vote does not overrule a decision by a board or crate or imply any additional fiduciary duties to rescind or otherwise respond to such a vote. Delaware law, which Dodd-Frank expressly declined to alter, authorizes directors, not shareholders, to set executive pay, said the court, declining to hold that an adverse say-on-pay vote alone would be enough to rebut the presumed protections of the business judgment rule.

Delaware law also makes clear that shareholder disagreement with a board’s business judgment does not suffice to state a breach of fiduciary duty claim, said the court, since directors may take good faith actions they believe will benefit stockholders even if they know that the stockholders do not agree with them. And this is true even when many or even most of the shareholders do not agree with them and would prefer that the board do otherwise than it has done. All this is so because Delaware provides that the directors rather than the shareholders manage the business of the company.

Delaware courts have long-held that a board’s decision on executive pay is entitled to great deference since the size and structure of executive compensation is inherently a matter of judgment, and indeed the essence of business judgment. While there are outer limits to this rule, noted the court, they are confined to unconscionable cases where directors irrationally squander or give away corporate assets.

Finally, the court noted that an additional reason for rejecting the shareholder’s claim was that the result of an advisory shareholder vote on pay cannot rebut the business judgment rule because it occurred after the board had approved the 2010 executive compensation. Delaware law forbids using events after the challenged action to second guess a board’s business judgment.