The Potentially Binding Nature of Say on Pay

Say-on-pay, somewhat hollow on its own, could be used as a gatekeeper of sorts for corporate waste claims, argues Steven C. Caywood in Wasting the Corporate Waste Doctrine: How the Doctrine Can Provide a Viable Solution in Controlling Excessive Executive Compensation, 12/2010. A revitalized corporate waste doctrine would allow shareowners to have some meaningful power as a safeguard against a board of directors that excessively compensates executives. Using these two tools in tandem would allow shareowners to address executive compensation concerns while not overburdening corporations with regulation and litigation.

A waste claim is a relatively simple one. It is brought by shareholders against a company’s board of directors alleging that the board wasted company assets. Waste can include any distribution of company assets, but the doctrine, when invoked, is most commonly employed for executive compensation claims. The corporate waste doctrine has been described as an “equitable safety valve,” meaning that it can be used for cases where relief would be otherwise unavailable. Unfortunately, this safety valve is rarely invoked, which allows many seemingly valid excessive compensation claims to go unchecked.

There are several reasons why the doctrine is not used. For one, the standard adopted for the corporate waste doctrine is impossibly high, which often leads courts to dismiss waste claims at the initial stages of litigation. Because of the doctrine’s infrequent use, there is a dearth of academic debate over its use and effectiveness concerning executive compensation. The doctrine has potential for meaning again, however, if used with the proposed say-on-pay legislation.

This Note argues that, in conjunction with the proposed say-on-pay resolution, a revitalized corporate waste doctrine would empower shareholders to curb excessive compensation by making shareholders’ say-on-pay votes effectively binding. Part I discusses the viability of a series of potential solutions, including the corporate waste doctrine, that shareholders could use to address excessive executive compensation. Part II proposes a litigation strategy that would invigorate the corporate waste doctrine by using it in conjunction with the say-on-pay resolution, thereby providing shareholders with a viable solution for enforcing excessive executive compensation claims.

Caywood argues companies most vulnerable would be those where a corporation lost value under the executive’s leadership. Plaintiff shareholders should argue that a failed say-on-pay resolution at least defeats the presumption of rationality with regard to the board’s actions and that the court needs to order discovery to determine if waste was committed. The In re Citigroup court stated that “the plaintiff must overcome the general presumption of good faith by showing that the board’s decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests.”

Failure of a pay package to win at least 50% of shareowner’s vote “should suffice to show that the court cannot reasonably infer that the decision was rational and therefore not wasteful.” Although shareowners may not eventually prevail, a say on pay vote failure should at least ward against early dismissal. “Having a say-onpay resolution helps show that perhaps a reasonable person would not be willing to make that deal and discovery is needed to ensure that no waste was committed.”

In short, “if shareholders bring a waste claim after voicing disapproval through a say-on-pay resolution, it may force Delaware courts to allow cases to pass Rule 23.1 scrutiny and require an evidentiary hearing and discovery.” Caywood wrote the paper while a JD candidate. I would be curious to know what he is doing now and if he was involved in any of the lawsuits this year.

According to Bradley J. Andreozzi and Douglas C. Murray of Drinker Biddle & Reath LLP (Lawsuits in the wake of say-on-pay) there is a fact pattern emerging around allegations filed recently. The targets of complaints typically share these common characteristics:

  1. the company advises shareowners that it maintains a “pay for performance” compensation philosophy;
  2. the board relies in part on the advice of a compensation consultant to
  3. approve an executive compensation plan pursuant to which NEOs receive an increase in compensation, despite
  4. the company’s arguably poor financial results;
  5. directors who are also NEOs receive the compensation increases;
  6. a majority of the shareowners vote “no” in the say-on-pay vote; and
  7. the board fails to rescind the pay increases following the shareowner vote.

Based on this combination of factors, the plaintiffs allege that the directors’ approval of (and refusal to rescind) the compensation plan was irrational, unjustified, a profligate waste of corporate assets, and could not have been the product of a valid business judgment.

Say on pay can be a useful tool, making it even more critical that retail shareowners vote, instead of tossing their proxies. The United States Proxy Exchange recently published Shareowner Guidelines for Say-on-Pay Voting. I highly recommend them. Once you’ve read the guidelines, it will take about 5 minutes to decide how to vote say on pay at any specific company in your portfolio.

Rule 23.1. Derivative actions by shareholders.
(a) In a derivative action brought by one or more shareholders or members to enforce a
right of a corporation or of an unincorporated association, the corporation or association
having failed to enforce a right which may properly be asserted by it, the complaint shall allege
that the plaintiff was a shareholder or member at the time of the transaction of which the
plaintiff complains or that the plaintiff’s share or membership thereafter devolved on the
plaintiff by operation of law. The complaint shall also allege with particularity the efforts, if
any, made by the plaintiff to obtain the action the plaintiff desires from the directors or
comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not
making the effort.
(b) Each person seeking to serve as a representative plaintiff on behalf of a corporation or
unincorporated association pursuant to this Rule shall file with the Register in Chancery an
affidavit stating that the person has not received, been promised or offered and will not accept
any form of compensation, directly or indirectly, for prosecuting or serving as a representative
party in the derivative action in which the person or entity is a named party except (i) such
fees, costs or other payments as the Court expressly approves to be paid to or on behalf of such
person, or (ii) reimbursement, paid by such person’s attorneys, of actual and reasonable out-of-pocket expenditures incurred directly in connection with the prosecution of the action. The affidavit required by this subpart shall be filed within 10 days after the earliest of the affiant filing the complaint, filing a motion to intervene in the action or filing a motion seeking appointment as a representative party in the action. An affidavit provided pursuant to this subpart shall not be construed to be a waiver of the attorney-client privilege.
(c) The action shall not be dismissed or compromised without the approval of the Court, and notice by mail, publication or otherwise of the proposed dismissal or compromise shall be
given to shareholders or members in such manner as the Court directs; except that if the
dismissal is to be without prejudice or with prejudice to the plaintiff only, then such dismissal
shall be ordered without notice thereof if there is a showing that no compensation in any form
has passed directly or indirectly from any of the defendants to the plaintiff or plaintiff’s
attorney and that no promise to give any such compensation has been made. At the time that
any party moves or otherwise applies to the Court for approval of a compromise of all or any
part of a derivative action, each representative plaintiff in such action shall file with the
Register in Chancery a further affidavit in the form required by subpart (b) of this rule.
(d) For the purposes of this Rule, an “unincorporated association” includes a statutory trust,
business trust, limited liability company and a partnership (whether general or limited), and a
“member” includes a person permitted by applicable law to bring a derivative action to enforce
a right or such an unincorporated association.

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