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Court Sustains 'Bad Faith' Claim Challenging Compensation Paid to Allegedly Incapacitated Executive

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April 25, 2018
K. Tyler O'Connell

In Feuer v. Redstone, (Del. Ch. Apr. 19, 2018), the Delaware Court of Chancery considered a motion to dismiss derivative claims challenging compensation CBS Corp. paid to nonagenarian Sumner Redstone after he allegedly became physically and mentally incapacitated and ceased rendering meaningful services. Based on the “extreme factual scenario” alleged, the court declined to dismiss certain claims stemming from CBS’s board of directors’ alleged failure to consider terminating Redstone’s “at will” employment, resulting in his continued receipt of millions of dollars in salary payments.

Background

Redstone was the longtime chairman and CEO of Viacom Inc., a media conglomerate. In 2006, Viacom split into two companies. One retained the Viacom name; the other was CBS. Redstone continued as CBS’s executive chairman. His employment agreement provided that either party could terminate his employment “at will.” The agreement set a $1 million minimum annual base salary, and contemplated merit increases that, once granted, could not be reduced in subsequent years. Under the compensation committee’s charter, it had exclusive authority to set Redstone’s compensation. Before the pertinent time period, the committee had raised Redstone’s base salary to $1.75 million per year.

After obtaining documents through a books and records demand under 8 Del. C. Section 220, the stockholder-plaintiff challenged Redstone’s compensation beginning in 2014, when he turned 91. The court’s opinion recounts in detail allegations about Redstone’s hospitalizations, difficulty communicating and loss of independence during this period. The court discussed inter alia news articles describing Redstone’s diminished capacity; averments in other lawsuits concerning that issue, including allegations made on his behalf describing his vulnerability to elder abuse; and internal CBS communications among directors expressing concern with his health and the potential loss of confidence in the marketplace his decline could cause. With respect to job performance, the plaintiff alleged that beginning in mid-2014 Redstone never physically attended board meetings and, although present by phone, he remained silent or spoke only to introduce himself. In February 2016, Redstone resigned as executive chairman but stayed on as chairman emeritus, at an annual salary of $1 million.

The Parties’ Arguments, and the Court’s Analysis

The stockholder-plaintiff brought suit challenging several different payments to Redstone: a $9 million bonus for 2014 that the compensation committee approved in early 2015; $1.75 million annual salary payments as executive chairman from 2014 until his February 2016 resignation from that position; and the $1 million annual salary paid thereafter in his capacity as chairman emeritus. The defendants moved to dismiss inter alia pursuant to Rule 23.1 for failure to plead demand futility.

The court first ruled that, because the plaintiff did not challenge specific decisions by CBS’s board of directors, the Rales test rather than Aronson applied to determine whether a demand would have been futile. The court reasoned that authority over the amount of Redstone’s compensation was delegated exclusively to the compensation committee, whose members comprised a minority of the board; and the plaintiff otherwise challenged the board’s failure to consider terminating Redstone rather than a specific board decision. Under Rales, the inquiry is whether a plaintiff’s allegations create a reasonable doubt that the full board could have exercised “disinterested and independent business judgment in responding to a demand,”  Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993).

While the independence of CBS’s directors was not challenged, the plaintiff argued they could not disinterestedly consider a demand because they faced a substantial threat of personal liability. The plaintiff argued the payments at issue constituted “waste” and were not made in “good faith,” in violation of the directors’ duty of loyalty. The court reasoned the “waste” and “bad faith” standards were similar, in that both required the plaintiff to show that the board’s conduct “was so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests,” quoting White v. Panic, 783 A.2d 543, 554 n. 36 (Del. 2001).

The court first held that a demand would not have been futile with respect to the $9 million bonus payment for 2014. That payment was approved by the compensation committee, which had been delegated exclusive authority to set Redstone’s compensation. The directors who were not on the committee composed a majority of the board and could have considered a demand. The court also noted that the company met its performance goals for 2014, which made Redstone eligible for a bonus under a management incentive plan, and that Redstone concededly was able to perform his duties for five months of that year.

Redstone allegedly became incapacitated in mid-2014. The parties agreed that the full board had at least concurrent, if not exclusive, authority to decide whether to terminate Redstone’s employment. The allegations supported that “Redstone was providing no meaningful services” beginning in late 2014 or early 2015 and that his contributions were “so negligible and inadequate in value that no person of ordinary, sound business judgment would deem them worth the millions of dollars in salary” he was paid, such that the alleged failure “to inquire into Redstone’s health or to at least consider terminating” his employment was “reflective of a conscious disregard of the directors’ fiduciary duties.” The court emphasized that while Redstone “was entitled to be treated in a dignified and respectful manner” upon falling ill, the plaintiff alleged the directors “made no effort to reckon with the financial consequences of Redstone’s severe incapacity for approximately 20 months,” an “extended period of inaction.”

Although the directors disputed that characterization, and noted in part the significant decreases in Redstone’s compensation after 2014, the court found it important that “none of the many documents” the defendants “chose to place in the record” from their Section 220 production to the plaintiff reflected that Redstone’s “physical or mental capacity or his ability to perform any substantive tasks was discussed in any meaningful sense.” The court found “glaringly absent,” for example, any “memorandum or other writing candidly assessing Redstone’s capabilities and the pros and cons of terminating” his employment.

With respect to salary paid after Redstone became chairman emeritus in February 2016, the court acknowledged that too was set by the compensation committee, not the full board. As a practical matter, however, the court reasoned that its prior finding that the full board faced a substantial likelihood of personal liability for not terminating Redstone’s employment as executive chairman would compromised the directors’ ability to consider this claim in a disinterested manner. That is, the directors defending that claim, for which demand was excused, could not realistically “be expected to criticize a subsequent decision [by the compensation committee] to pay a $1 million annual salary … to that same, allegedly incompetent person.”

Finally in pertinent part, the court rejected defendants’ arguments that the chairman emeritus salary payments were not “waste” under precedent recognizing that reasonable compensation, even in greater amounts, may be paid in consideration of past service. The court distinguished those precedents as involving “one time events, typically as part of a severance or retirement arrangement.” Here, by contrast, Redstone was to be paid an annual salary in exchange for services the board allegedly knew he could not render.

Key Takeaways

The court made clear that its decision sustaining aspects of the plaintiff’s claims at the motion to dismiss stage was driven by the “extreme factual scenario” alleged: millions of dollars in salary payments to a man widely reported to be in failing health whom directors allegedly knew was incapable of providing meaningful services. The opinion nonetheless provides useful guidance to counsel advising directors on compensation issues.

Among other things, the court’s analysis of demand futility with respect to Redstone’s 2014 bonus payments—set exclusively by the compensation committee pursuant to its charter—supports that such delegations of authority may help shield similar decisions from derivative challenges. Absent other conflicts of interest, the members of the full board would normally be expected to be able to consider a demand regarding such matters in a disinterested and independent manner, rendering a stockholder challenge subject to dismissal under Rule 23.1.

Also important, the absence of information where the Court expected to see it—CBS’s board minutes and other internal documents produced in response to the plaintiff’s Section 220 demand—supported the pleadings-stage inference of “bad faith.” Although Redstone was present by phone at board meetings, the minutes reflected no substantive contributions by him to help undermine the “waste” claim. Similarly, although the defendant directors pointed to potential good faith business justifications for the payments—including avoiding litigation risks associated with terminating Redstone’s employment due to a disability, as well as other obligations that may be triggered by a termination decision—the court was struck by the absence of contemporaneous board materials weighing these issues. This court’s analysis supports that more fulsome documentation of such matters may help bring an early end to “waste” claims.

Finally, the court’s contrast of the “salary” payments to Redstone as chairman emeritus, found to be actionable, against one-time end of career payments made to departing executives in consideration of past services that previously have been found to be nonactionable, may be instructive in structuring such compensation.  In the event of a challenge, the form and manner in which consideration is paid may assume significance.

Delaware Business Court Insider, April 25, 2018

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