Settlement Rejected by Court in Fairchild Derivative Complaint for Excessive Compensation

By: Cydney Posner

You might be interested in the article below from the Washington Post, which reports that Delaware Vice Chancellor Strine has rejected the proposed settlement in the Fairchild derivative complaint. (See my email of 12/23/04.) In that case, the plaintiffs filed a derivative action against the officers and directors, claiming that they breached their fiduciary duties, including their duty of good faith, and wasted corporate assets by paying or approving the payment of excessive compensation, including:

• payment of legal fees for litigation that they alleged did not involve the company;
• related-party payments to officer-controlled entities for the use of planes and helicopters, Paris apartments and children's tuition (an obvious business expense);
• excessive compensation of multiple employee-family members;
• millions in interest-free loans pursuant to an officer and director loan program;
• excessive base salary and bonuses pursuant to "evergreen" employment agreements;
• millions in advances on retirement benefits under SERPs; and
• tens of millions in payments under single-trigger change-of-control, consulting and non-compete provisions relating to sales of subsidiaries and divisions.

Fairchild Executives' Settlement Rejected
Judge Says Allegations Call for Better Terms For Investor Plaintiffs
By David S. Hilzenrath
Washington Post Staff Writer
Thursday, May 19, 2005

A Delaware judge yesterday rejected as inadequate the agreement that Fairchild Corp. chief executive Jeffrey J. Steiner and his son Eric, the company's president, negotiated to settle an investor lawsuit alleging they received excessive and improper pay.

If the allegations in the lawsuit are true, the judge said from the bench, the proposed settlement amounted to a "cosmetic whimper," the Dow Jones/AP news service reported.

The proposed settlement would not do enough to protect shareholders from "a grotesque lack of controls in a company that also has no profits," Delaware Chancery Court Vice Chancellor Leo E. Strine Jr. said, according to Dow Jones/AP. "You've got a very poorly performing company over time that continually pays the CEO like he's a top slugger."

The judge's action was a departure from the Delaware court's pattern of accepting settlements that seem too lenient, said John C. Coffee Jr., a professor at Columbia Law School. The court has jurisdiction over many of the nation's largest companies because Delaware's legal system makes it a popular place for them to register.

Executive compensation has long been a subject of controversy and litigation at McLean-based Fairchild, which distributes aircraft parts and motorcycle gear. Jeffrey Steiner has regularly ranked among the Washington area's highest-paid executives, and his compensation has drawn repeated criticism from investors over the years.

The Delaware lawsuit challenged such items as interest-free loans, advances on retirement payments, payments for an apartment in Paris and Steiner-affiliated aircraft, and millions of dollars of golden parachute or "change of control" payments that Jeffrey and Eric I. Steiner were awarded. The golden parachutes were triggered when Fairchild sold a major subsidiary in 2002, though both executives remained at Fairchild.

Under the rejected settlement, Jeffrey Steiner would have paid $1.5 million through an advance from a retirement plan and would have cut his $2.5 million salary by 20 percent, while Eric Steiner would have taken a 15 percent salary cut.

The settlement would have shortened the terms of the Steiners' employment contracts, but it would not have prevented the company from renewing the contracts when they expire. Through its stock ownership, the Steiner family controls the company.

The settlement was challenged by I. Joseph Berger, a shareholder from Cleveland who said in a legal filing that the proposed concessions by the Steiners would have been small compared with potential shareholder claims of more than $55 million.

Another point of contention in the lawsuit was $5.5 million that the company spent related to Jeffrey Steiner's defense when he was investigated and prosecuted in France on charges of misusing the funds of a French petroleum company. In 2003, he was given a suspended sentence and ordered to pay a fine of 500,000 euros, worth about $634,000 at the current exchange rate. Fairchild posted a $1.5 million bond with the court on Steiner's behalf, and the French court ordered some of the bond applied to the fine.

The settlement would have established a "conflict committee" of outside directors to review any future transactions between Fairchild and its officers or directors.

The settlement also called for plaintiffs' attorneys to receive $575,000.

According to the rejected settlement, the Steiners denied wrongdoing.

"The company sought an amicable and reasonable resolution of this lawsuit and is disappointed by the vice chancellor's decision," Fairchild said in a statement provided by spokesman Howard Paster. "We will evaluate our options as to the most appropriate course for the company," the statement said.

Attorney Marc Topaz of the law firm Schiffrin & Barroway, who represented shareholders in the case, said his side will try again. The judge scheduled a follow-up hearing in June, according to Dow Jones/AP.

"If we're able to satisfy the judge's concerns and present a satisfactory revised settlement, we will explore that course, and if not, we plan to aggressively pursue our claims," Topaz said.

Lawsuits in the Delaware court and courts in other states have "a long history of settlements that look cosmetic and illusory but are accompanied by the corporation paying a generous award of attorneys' fees," said Coffee, the Columbia law professor.

In past cases where proposed settlements seemed inadequate, the Delaware court approved reduced attorneys' fees, Coffee said, adding that Strine's approach was "instead going to the heart of the problem."

The judge noted that two previous lawsuits did little to change Fairchild or its allegedly "supine" board, according to the Dow Jones/AP report.

"Get something real," he told attorneys in the case, according to Dow Jones/AP.

Fairchild's share price was unchanged yesterday at $2.25 on the New York Stock Exchange.

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