Delaware's Top Five Worst Shareholder Decisions for 2012 (#2: Zucker v. Andreessen & Seinfeld v. Slager)
Some view executive compensation issues as matters for state law. After all, most agree that the board of directors is in the best position to determine the relative merits of executive officers and to award the most appropriate compensation. These decisions, therefore, are typically treated as a matter subject to the board's fiduciary obligations.
Nonetheless, compensation decisions are undergoing a relentless federalization. Whether in SOX (permitting clawbacks and banning loans to directors and executive officers) or Dodd Frank (requiring say on pay, toughening clawbacks, and regulating compensation committees of exchange traded companies), these matters are subject to more and more federal regulation, with no end in sight.
The reason for the increased federalization can be seen from the developments in state law with respect to severance packages paid to departing CEOs. These have sometimes been controversial. Shareholders may view the amount paid as excessive. They may also view the payments as out of place, particularly when a company has suffered poor performance. Others may see the payments as unnecessary where CEOs have already been well paid in prior years.
Delaware courts have made challenges to these types of agreements particularly difficult. Compensation decisions are reviewed under the duty of care, a process standard. As a process standard, the amount and nature of the severance compensation hardly matters. Assuming proper process (independent directors who are informed), shareholders are left with a case for waste.
Yet as two compensation decisions decided in 2012 illustrate, the standard for showing waste has become almost insurmountable, irrespective of the terms of the severance package. In Zucker v. Andreessen, discussed here, here and here, and in Seinfeld v. Slager, discussed here and here, the Delaware Chancery Court all but rendered severance packages paid to departing CEOs unreviewable.
In Zucker, Mark Hurd, the departing CEO, had no employment contract with HP. The board, however, approved a severance package. The package included:
(1) over $12 million in cash; (2) an extension of the expiration date for any outstanding options to purchase 775,000 shares of HP common stock; (3) pro rata vesting and settlement of 330,177 performance-based restricted stock units; and (4) settlement on December 11, 2010 of 15,853 nonperformance-based restricted stock units at a price equal to the lesser of (a) the closing price of HP‟s common stock on August 6, 2010 or (b) the per share closing trading price of HP common stock on December 11, 2010.
Plaintiff alleged that the package amounted to waste. In trying to get past a motion to dismiss, plaintiff asserted that the company had not received any benefit in return for the package and that the amount was excessive. In arguing that there was no benefit to the company, plaintiff pointed out that the payments were not contractually mandated since Hurd had no employment agreement in place.
The court, however, found sufficient consideration to justify the $40 million dollar package. The court noted that the agreement obligated Hurd:
(1) to extend certain confidentiality agreements; (2) not to disparage the Company; (3) to cooperate, among other things, “with respect to transition and succession matters”; and (4) to release all claims he had against the Company.
Plaintiff, however, asserted that Hurd had no claims to release. Nonetheless, the court asserted that the waiver still have value. "Creative 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." In other words, standard provisions such as mandatory confidentiality along with a release of claims that required "creative counsel," were enough to provide benefit for the severence package.
As for plaintiff's challenge on the amount itself, the court summarily dismissed the argument, noting that “'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." It was enough that the amount was approved by independent directors.
In Seinfeld, shareholders challenged a $1.8 million severance payment made to the CEO as a "reward" for his "long service to the Company." Plaintiff challenged the payment as supported by past consideration and therefore provided no benefit to the company. The Chancery Court, however, found that past consideration was sufficient benefit to sustain a severance agreement. The opinion contained sweeping language.
A board of directors may have a variety of reasons for awarding an executive bonuses for services already rendered. For instance, awarding retroactive compensation to an employee who stays with the company may encourage him to continue his employment. In the case of a retiring employee, the award may serve as a signal to current and future employees that they, too, might receive extra compensation at the end of their tenure if they successfully serve their term. Other factors may also properly influence the board, including ensuring a smooth and harmonious transfer of power, securing a good relationship with the retiring employee, preventing future embarrassing disclosure and lawsuits, and so on.
So benefit to the corporation can include confidentiality obligations, waiver of claims, and past consideration. It is hard to imagine any severance package that did not have all or some of these attributes. Thus, effectively, all severance packages are beyond challenge for lacking in benefit to the corporation.
As for the amount, the court in Zucker more or less indicated that this was not a basis for challenging severance compensation, at least where the company was large and the amount was approved by independent directors.
Limits on severance will, therefore, have to come from the federal government. Federal law has already ventured slightly into this area. Say on pay includes certain golden parachutes. To the extent abuses arise in the context of severance packages, the federal government will be under increased pressure to do more. Whether substantive limits, additional process, or shareholder approval requirements, Congress will need to become more involved and to impose the kinds of restraints that state law ought to be but is not imposing.