A “Valeant” Effort

Editor’s Note: This post is by Lawrence A. Hamermesh of the Widener University School of Law. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On March 1st, Vice Chancellor Lamb made a significant contribution to the growing body of caselaw involving challenges to executive compensation decisions. The case is Valeant Pharmaceuticals v. Jerney. Fellow guest contributor Broc Romanek has already blogged about the decision, recognizing its educational value on matters of executive pay. (Broc’s post includes a nice summary of the case from Delaware lawyer J. Travis Laster of Abrams & Laster.)

The Valeant opinion is a rare example of a case in which a court awards damages against a director for having approved excessive compensation. The case is not one, however, that blazes a path for challenges to executive compensation decisions made the “kosher” way, i.e., by compensation committees whose members meet stock-exchange-prescribed criteria for independence and who rely on truly independent compensation consultants.

As described by the Vice Chancellor, the challenged decision–payment of $50 million in cash bonuses, including $3 million to Adam Jerney, the named defendant who was both a director and the company’s former President–was a classic parade of procedural horribles. All directors received bonuses, even those directors on the compensation committee ($330,500 each); when they approved the bonuses, two of the three committee members were longtime friends of Milan Panic, the CEO (whose bonus was set at over $33 million), and were in the process of discussing consulting contracts with the company; the committee’s compensation consultant, Towers Perrin, was selected by management; and Towers withdrew a tentative proposal to to reduce the amount of options granted management after a talking-to by Panic.

The remedial aspects of the opinion are the most interesting to me. Let’s be clear about what the Vice Chancellor did. First, and most conventionally, he ordered that the defendant disgorge his $3 million bonus. There’s nothing odd about that (although the court decided, as a matter of first impression, that disgorgement did not implicate liability limitations in Delaware’s Uniform Contribution Among Tortfeasors Law.) Second, he ordered that Jerney pay damages resulting from the Board’s collective decision to approve the bonus pool–specifically, a share of the bonuses paid to non-directors and the costs of the special litigation committee formed in response to the original derivative action brought to challenge the bonus plan.

The latter move had all sorts of interesting implications. First, the Vice Chancellor had to confront the argument that the defendant was protected from liability under DGCL 141(e) in view of his reliance on the report of Towers Perrin, who was retained to advise on the bonus plan. The Vice Chancellor made short work of that argument, pointing out–quite persuasively, I think–that where, as here, the defendant was obligated to establish the entire fairness of the challenged action, Section 141(e) couldn’t be construed to permit an expert’s report to substitute for the requirement in Section 144(a)(3) that the transaction be proved to be fair to the corporation. In short, reliance on an expert’s report may help prove fairness, but it’s not dispositive on the fairness issue.

Holding the defendant liable for bonuses paid to non-directors also required the Vice Chancellor to address the intriguing question as to how to apportion liability–a question that is rarely litigated in the context of judgments against corporate directors. As a joint tortfeasor, Jerney presumably could have been held liable for at least a share of the entire bonus pool, including Panic’s $33 million. The company’s claim was more modest, however: it only sought recovery of a 1/11th share of the non-director bonuses, on the theory that (i) there were ten other equally responsible directors; and (ii) the company had already settled its claims against the other directors with respect to their bonuses. Vice Chancellor Lamb clearly did not hold that this modesty was compelled by law; to the contrary, the opinion goes out of its way to note that the failure to seek liability for a share of the bonuses paid to the other director’s was the company’s decision. On the other hand, he found that a 12th director who received a bonus but did not attend the meeting to vote on the bonuses was nevertheless potentially liable because his acceptance of the bonus constituted a ratification of the vote; therefore, the Vice Chancellor accepted Jerney’s argument that his share of liability for the non-director bonuses should be reduced from 1/11th to 1/12th.

Speaking of fine points: Vice Chancellor Lamb also resolved another rarely addressed issue, namely, how to allocate defense costs among defendants. The company sought to recover from Jerney all defense costs advanced with respect to both him and Panic, the principal force behind the challenged bonus plan. Jerney, in contrast, urged that he be held liable for only a 1/11th share. (This time, the 1/11th figure was apparently derived from the proportional relation between the size of the bonuses received by Jerney and Panic.) The court rejected both positions, and held Jerney responsible for half the defense costs. As a rationale for this “rough justice” approach, the Vice Chancellor invoked the “general principle” of equal contribution among joint tortfeasors, and the difficulty of attributing specific defense costs to any particular defendant.

Finally, the case has an interesting postscript. Francis G.X. Pileggi of Fox Rothchild‘s Delaware office reports that Jerney now lives in Bulgaria, has repudiated his agreement to reimburse the company for advances of attorney’s fees, and does not expect that the judgment against him will be collected. I don’t know whether Bulgaria would recognize and enforce the judgment of an American court. But if it won’t, was the litigation merely a Pyrrhic victory for the company that picked up the prosecution of what started as a derivative suit? After all, the company has presumably paid its own lawyers and experts, and is stuck with the bill for the defendants’ expenses, along with an ostensibly uncollectible judgment. Perhaps the settlements with the other directors made the whole exercise worthwhile to the company. Getting stuck with the bill for defense costs in an otherwise good case, however, is a useful reminder that directors considering a mandatory or ad hoc grant of defense costs have to take into account the prospects for having those costs reimbursed if the defense is unsuccessful.

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One Comment

  1. francis pileggi
    Posted Thursday, March 29, 2007 at 8:18 pm | Permalink

    Thanks for the insightful commentary–and the hat tip.