Good News for Compensation Committees

With executive compensation under fire from seemingly all directions these days, it’s nice to get some good news occasionally. In this case, that news comes via the Delaware Chancery Court’s recent decision in Friedman v. Dolan, which confirmed the application of the business judgment rule (rather than the “entire fairness” standard) to the actions of an independent compensation committee of a controlled public company.

The Dolan decision

In Dolan, a stockholder of Cablevision System Corp. had alleged that both the CEO and Chairman (each a member of the Dolan family) had received excessive compensation that had been approved by the compensation committee. The plaintiff noted that the Dolan family accounted for ten of the sixteen board members, held more than 70% of Cablevision’s voting power and voted as a bloc pursuant to a voting agreement. In addition, the CEO had consulted with the compensation committee regarding the compensation in question.

The complaint alleged that the compensation committee and certain members of management had breached their fiduciary duties by awarding and accepting the challenged compensation. Furthermore, the plaintiff asserted that the entire fairness standard of review (rather than the typical business judgment rule) should apply to those actions because the CEO and Chairman controlled the board of directors.

The court determined that the compensation committee was, in fact, independent and rejected the plaintiff’s claim. In doing so, the court stated its reluctance 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.”

The court further held that:

“Delaware courts are hesitant to scrutinize executive compensation decisions…. Entire fairness is not the default standard for compensation awarded by an independent board or committee, even when a controller is at the helm of the company. The significance of an independent committee is well-recognized by our case law.”

Although the plaintiff has appealed this decision to the Delaware Supreme Court, I would be surprised to see anything other than an unqualified endorsement of the lower court’s decision.

Takeaways…

Although this decision is no surprise, the fact that the case was brought in the first place and continues to work though the Delaware courts is a good reminder of some important principles:

  • Be sure the independence of your compensation committee is unassailable. This can be particularly tricky in a controlled company situation, where personal relationships can sometimes be closer.
  • Adhere to best practices regarding compensation deliberations and decision-making, including appropriately limiting controlling stockholder participation and thoroughly documenting the review and voting process. Although the Dolan court was not bothered by the CEO consultating with the compensation committee, such things can create bad after-the-fact optics and should be handled carefully.
  • Note that these types of controlling stockholder issues can arise even where the stockholder has less than majority control, depending on the nature of the company’s ownership structure and other control arrangements.

All the best,

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