Defending Against Shareholder 'Say-On-Pay' Suits

Author:Dechert LLP

Nearly 2,200 issuers held "say-on-pay" votes in 2011.1 Shareholders have overwhelmingly voted in favor of the proposed compensation plans, rejecting management compensation proposals in only about 40 instances. The companies that lost the vote, however, havebeen frequent targets of shareholder derivalitigation. These actions have not yet resulted insubstantive decisions and, until they do, morecases can be expected to be filed. The risk and likely spread of litigation following a non-binding shareholder vote disapproving excompensation thus raises the stakes on say-on-pay votes in an unexpected way.

The Dodd-Frank Act provides that "say-on-pay" votes are non-binding and may not be con-strued as overruling a decision by, or modifying the fiduciary duties of, a board of directors.2

Notwithstanding the non-binding nature of "say-on-pay" votes and the express intent of Congress to avoid challenging a board of directors' fiduciary duties, shareholders have launched lawsuits against at least seven companies, and their senior executive officers, directors and outside compensation consultants, as a result of negative "say-on-pay" votes.3 The share-holder derivative litigation complaints in these actions almost uniformly allege breach of duty by the company's directors and officers, aiding and abetting that breach and breach of contract by the compensation consultants, unjust enrichment of the officers and, in some cases, corporate waste or breach of contract by the directors. With respect to the breach of fiduciary duty, Plaintiffs' theories focus on the duty of loyalty, in some cases mentioning related duties of candor, good faith and/or independence. The fiduciary duty of care has received less emphasis in the com-plaints filed to date. By focusing on loyalty-based duties instead of the duty of care, Plaintiffs have sought to avoid exculpatory provisions and defenses available for the latter type of breach (such as Section 102(b)(7) of the Delaware General Corporation Law).

The facts alleged in the complaints follow a common pattern: (i) a corporation adopts a "pay-for-performance" philosophy or guidelines; (ii) the corpora-tion experiences a decrease in financial performance; (iii) the board of directors and the compensation consultant both recommend an increase in executive compensation despite the decrease in financial per-formance; (iv) the shareholders deliver a negative vote on "say-on-pay"; and (v) the board of directors nonethe-less approves or fails to rescind, alter or amend its recommendation...

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