Corporate Governance and the Problem of Executive Compensation: State Law Redux (Zucker v. Andreessen) (Part 3)
We have been looking at the problem of executive compensation. In that regard, we are discussing the most recent Delaware decision on the subject, Zucker v. Andreessen, 2012 Del. Ch. LEXIS 135 (Del. Ch. June 2012). The case addresses the standard for waste under Delaware law.
Plaintiff had sufficiently alleged that the severance agreement was not required. The complaint, according to the court, also alleged that the board “could have avoided paying Hurd severance under the Company's general executive officer severance policy by terminating him for Cause.” Nonetheless, this was not enough to allege waste.
Although the Board could have elected to pay Hurd nothing, determining whether it should have done so, or whether making the deal it did constitutes waste, involves a broader legal analysis. While "the discretion of directors in setting executive compensation is not unlimited," "[i]t is the essence of business judgment for a board to determine if 'a particular individual warrant[s] large amounts of money, whether in the form of current salary or severance provisions.'" The "outer limit" necessary to sustain a claim of waste is "executive compensation . . . so disproportionately large as to be unconscionable," but a finding of waste is inappropriate "[s]o long as there is some rational basis for directors to conclude that the amount and form of compensation is appropriate and likely to be beneficial to the corporation."
But, of course, Plaintiff alleged more than just the payment of compensation that was not required. Plaintiff also challenged the justification for the severance. Plaintiff argued that the heart of the consideration for the severance, the agreement by Hurd to give up any claims against the company, had no value.
The court, however, bent over backwards to conclude that the release had some value. It took resort to "creative counsel." As the court reasoned: had Hurd been dismissed by the board, “[c]reative counsel advocating on Hurd's behalf could have claimed that he, in fact, was entitled to severance under HP's general executive officer severance plan notwithstanding the expense report violations.” Thus, “even if the release was worth relatively little, Plaintiff overstates his case to say it was worthless.” Moreover, the court added a justification for the compensation that was not apparently one actually used by the board. Id. (“even if the Board terminated Hurd for Cause, it arguably still could have compensated him for his past stewardship of HP.”).
Most extraordinary, however, was the court's willingness to accept consideration, not by Hurd, but by other directors. Since two directors initially opposed the dismissal of Hurd, it was a "reasonable inference" from the facts to conclude that "the directors who initially dissented also would have opposed terminating Hurd for Cause and ultimately agreed to vote with the rest of the Board only because Hurd received the severance benefits he did."
In other words, the court found (based upon its own fact finding) that the severance was reasonable because it was necessary to ensure a unanimous board decision. Moreover, the court engaged in further fact finding and found that the failure to pay severance could have harmed the company because it "could have undermined its efforts to attract outside executive talent."
The court's reasoning supports a conclusion that consideration by the person receiving the severance is entirely unnecessary. The company can pay severance merely to avoid spooking future candidates for the CEO position or to ensure a harmonious board. In any event the severance can be justified on the basis of past service.
As for the amount paid to Hurd, the court more or less created a big company exception to the waste doctrine. Without making any attempt to ascertain whether the amount paid (estimated at $40 million) was even remotely connected to the benefits received by the company (by, for example, determining the value of a harmonious board), the court simply concluded that big payments were acceptable for big companies.
Having found that the Severance Agreement reflects at least some element of bilateral exchange and that there were rational bases for the Board to agree to it, Plaintiff's waste claim reduces to his belief that $40 million was just too much. Be that as it may, "the size of executive compensation for a large public company in the current environment often involves large numbers," and "amount alone is not the most salient aspect of director compensation" for purposes of a waste analysis.
The case shows the weakness in the doctrine of waste as a safety valve designed to provide an outer limit for compensation. The court is willing to accept almost any argument concerning benefit to the company, including arguments not made by the board or benefits not provided by the person receiving the compensation. At the same time, courts will not consider the relationship between the benefits, however modest or weak, and the amount paid.
With waste not sufficient to restrain compensation, Delaware effectively has no limits on the amount of compensation that the board can pay (assuming proper process). It is this problem of compensation without limits that has greatly encouraged federal intrusion into an area historically left to the states.