April 1, 2013

Delaware Federal Court Dismisses Say-on-Pay Complaint

Holland & Knight Bulletin
Eric S. Almon

In a recent opinion, the United States District Court for the District of Delaware dismissed a derivative complaint brought as a result of a negative shareholder advisory vote on executive compensation. The court found that the plaintiff's claims were based on "flawed premises" and that the plaintiff failed to adequately plead why demand would be futile and failed to state a claim upon which relief could be granted.

The plaintiff, a shareholder of Hercules Offshore, Inc., brought the lawsuit derivatively on behalf of Hercules, alleging that the Hercules board of directors, assisted by a consultant, breached fiduciary duties and securities laws by approving 2010 compensation for Hercules' executives, despite a failed "say-on-pay" shareholder vote.

In March 2011, Hercules issued its proxy statement, which detailed the company's 2010 executive compensation plan as approved by the board of directors. The compensation plan raised executive compensation by between 40 percent and 190 percent at a time when the company had posted negative financial results, including a net operating loss and an almost 13 percent decrease in stockholder equity. As required by the Dodd-Frank Act, the proxy statement provided for a shareholder advisory vote on executive compensation, which the shareholders subsequently rejected. Nevertheless, the compensation increases were implemented. The plaintiff alleged that the board's approval of the compensation plan, despite the failed shareholder vote, violated the company's pay-for-performance policy, was not a product of a valid exercise of business judgment, and caused the company's proxy statement to be false and misleading.

In dismissing the plaintiff's claims, the court stated that the plaintiff both "misconstrues the effect of the shareholder vote" and "mischaracterizes that compensation plan." The court pointed out that the plaintiff's allegations failed to recognize that the Dodd-Frank Act explicitly states that say-on-pay votes "shall not be binding" on the board of directors and may not be construed as "overruling" the board or creating any changes or additions to the directors' fiduciary duties. The court also found that the plaintiff was "selective in his characterization" of the company's compensation plan, ignoring goals such as the retention of executive officers that "may have taken on increased importance precisely because of the difficult financial circumstances in which the company found itself."

The court's decision underlines the advisory nature of the Dodd-Frank Act say-on-pay shareholder vote and recognizes a company's ability to base its executive compensation decisions not only on a retrospective analysis of the company's performance, but also on prospective factors such as the retention, motivation and reward of executive officers.

The opinion is Raul v. Rynd, C.A. No. 11-560-LPS (D. Del. March 14, 2013) and is available at: http://www.ded.uscourts.gov/sites/default/files/opinions/lps/2013/march/11-560.pdf

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