Friedman v. Dolan: Substituting Ineffective Process for Substance (Part 3)

We are discussing Friedman v. Dolan, C.A. No. 9425–VCN, June 30, 2015.  

In analyzing the claims against the Compensation Committee, the court noted that the decision was presumptive protected by the business judgment rule.  To survive a motion to dismiss, the plaintiff had to “show either that the “committee that approved the compensation lacked independence (in which case the burden shifts to the defendant director to show that the compensation was objectively reasonable), or to plead facts sufficient to show that the board or committee lacked good faith in making the award.” 

Plaintiffs argued for the “entire fairness” standard given the control of the board by the Dolan family.  The Complaint alleged that the Dolan family consisted of a majority of the board.  The court, however, declined to apply the standard.  

  • the Court hesitates to endorse the principle that every controlled company, regardless of use of an independent committee, must demonstrate the entire fairness of its executive compensation in court whenever questioned by a shareholder. It is especially undesirable to make such a pronouncement here, where annual compensation is not a “transformative” or major decision. In light of Tyson and the nature of executive compensation decisions, the Court will apply the business judgment rule initially. 

Instead, the plaintiff had to demonstrate that the directors on the compensation committee were “beholden to” the controlling party. To do so, the plaintiff must establish that the relationship or tie is material.   

  • The fact of compensation, even from both a parent and a subsidiary company, is not enough. Neither long-term board service nor the mere fact that one was appointed by a controller suffices. Similarly, being retired or having attained a certain age does not cast a reasonable doubt on independence. Close familial ties, such as those between parent and child, can prevent a director from acting independently. Again, the test for independence generally asks whether, based on the alleged conflict, “the director is unable to base his or her decisions on the corporate merits of the issue before the board.”  

Even with these factors ruled out, the plaintiff still alleged that the chair of the compensation committee performed “service at other Dolan-controlled entities” and the fact of “a sibling's employment”.  The court summarily dismissed the allegations. “Unfortunately for Plaintiff, long-term service or relationships, compensation itself, and appointment by a controller do not necessarily rebut the business judgment rule.”  Moreover, “[t]here are no allegations of how [the Chair of the compensation committee’s] decisions were tied to his brother's general employment that would lead the Court to deem his discretion sterilized.”  All of these allegations notwithstanding, the court concluded that “Plaintiff's allegations that the compensation committee could not “say no” are conclusory.”

The plaintiff also raised concern about process. According to the allegations, the compensation committee permited participation by the CEO in setting the compensation.  As the Complaint alleged:    

  • the Compensation Committee reviewed and compared the compensation paid to the CEOs at the Company Peer Group companies when setting James’ compensation. However, as described in the Proxies, the Compensation Committee allowed James to “assist the Compensation Committee and its compensation consultant in determining the Company’s core peer group and the peer group comparisons.” 

The court considered the allegations in the context of bad faith.  They were not enough to establish such a claim.  "A board is not forbidden from seeking management's input in compensation decisions, and the Compensation Committee Defendants retained a compensation consultant.The Court has no reason to believe, from the complaint, that the compensation decisions were uninformed, hastily made, or manipulated by James and Charles." 

J Robert Brown Jr.