In Cincinnati Bell, the United States District Court declined to grant a motion to dismiss a law suit resulting from a failed say-on-pay vote (a copy of the decision is available on thecorporatecounsel.net). A Georgia Court reached the opposite result in the Beazer case (a copy of the decision is available on thecorporatecounsel.net). We have prepared a high-level summary of the differences between the two decisions.
Demand Excused Requirement
A precondition to a derivative suit is plaintiffs must usually make a pre-suit demand on the company’s board that it investigate and evaluate whether to bring the claims or to plead facts demonstrating legal excuse from the demand requirement.
Under Delaware law, shareholders must plead particularized facts demonstrating legal excuse from the demand requirement. While different tests can apply under different circumstances, the plaintiffs here rely on the proposition that the challenged decisions were not the result of a valid exercise of business judgment. Here, the plaintiffs must allege particularized facts that rebut the presumption of the business judgment rule. The plaintiffs appear to hang their hat on the theory that the failed say-on-pay vote constitutes evidence that rebuts the presumption that the Beazer directors’ decisions approving the challenged compensation and recommending the shareholders approve the executive compensation were valid business judgments. The Beazer court rejected this reasoning because:
- The say-on-pay vote had not yet been held when the challenged decisions were made. The outcome of the vote, which was not known, does not therefore suggest the directors failed to act on an informed basis.
- The Dodd-Frank Act explicitly provides that a say-on-pay vote shall not be construed as overruling a decision by the board of directors or create or imply any additional fiduciary duties.
- Plaintiffs cite no authority that the say-on-pay vote is evidence when determining whether the business judgment rule is rebutted.
On another prong of the demand excused test, the Beazer court notes that the plaintiffs have failed to allege facts that a majority of the Beazer board face a substantial likelihood of personal liability. No material undisclosed facts were alleged regarding the challenged executive compensation. The challenged executive compensation was pubic knowledge because it was disclosed in the proxy statement.
Under Ohio law, the plaintiff must point to facts which show that the presumed ability of the directors to make unbiased, independent business judgments about whether it would be in the corporation’s best interests to file the action does not exist. Ohio courts have consistently rejected the idea that demand is always futile when directors are targeted as the wrongdoers of the suit. However demand is presumptively futile where the directors are antagonistic, adversely interested, or involved in the transactions attacked. Here the court found these tests were met where the directors are the same persons who approved the pay hikes and bonuses, and recommended the shareholders approve the compensation. As a result there were sufficient facts to show there is reason to doubt these same directors could exercise their independent business judgment over whether to bring suit against themselves.
Failure to State a Claim
The court dismissed the complaint for failure to state a claim for the following reasons:
- For reasons set forth above, the plaintiffs failed to allege particularized facts rebutting the business judgment rule.
- The plaintiff failed to allege any material omitted facts were withheld from Beazer shareholders or any misrepresentations were made regarding Beazer’s executive compensation policies.
Under Ohio law, the business judgment rule imposes a burden of proof, not a burden of pleading, and that plaintiffs are not obligated to plead operative facts that would rebut the presumption. The court noted that while it must apply federal law on matters of procedure, the federal law is much the came. We have noted our doubts about the court’s analysis here – both as to the shallowness of facts alleged and the analysis under the federal rules. The court also buys into the notion that the say-on-pay vote can provide evidence regarding exercise of business judgment despite the clear language of the Dodd-Frank Act.
Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.
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