Say-On-Pay Litigation

By Cydney Posner

So here are the facts of the case as articulated in the very first sentence of the order by the US District Court for the Southern District of Ohio: the question raised was whether a shareholder can sue the directors of Cincinnati Bell for breach of the duty of loyalty when the directors grant to the CEO a bonus of $4M on top of salary and other comp of $4.5M in a year when the company incurs a $61.3M decline in net income, a drop in EPS from $0.37 to $0.09, a reduction in share price from $3.45 to $2.80 and a negative annual shareholder return of 18.8%. Can you guess the outcome?

As reported this morning by thecorporatecounsel.net blog, to just about everyone's surprise, one of the say-on-pay lawsuits has actually survived a motion to dismiss. Here is a copy of the court's order.  At the Cincinnati Bell 2011 annual meeting, 66% if the shareholders voted against the company's say-on-pay resolution. In light of this high level of rejection, plaintiffs filed suit, claiming breach of fiduciary duty of loyalty based on the board's decision to approve large pay raises and bonuses (including big retention bonuses) to three executive officers in a year when the company's performance was poor. The defendants moved to dismiss. As you know, the business judgment rule, which would normally serve to protect directors' decisions made with due care, is not available if directors act disloyally. The court concluded that the factual allegations in the complaint raised a plausible claim that the pay hikes violated the company's pay-for performance policy (which linked executive pay to the returns realized by the shareholders) and were not in the best interests of the shareholders. As a result, the pay decisions could constitute an abuse of discretion and/or bad faith, which, if true, would make unavailable the protections of the business judgment rule. The court also held that the plaintiffs stated a claim for unjust enrichment as a result of the board's breach of duty. Of course, while plaintiffs will still need to prove their case at trial, the notion that one of these cases survived a motion to dismiss may provide plenty of encouragement to other potential plaintiffs.

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