The recent proliferation of Canadian companies adopting shareholder votes on executive compensation (so called "say on pay" votes) has the potential to dramatically alter Canadian corporate governance policies. It also creates potential litigation risk against Canadian companies by enterprising shareholders, law firms, or both. This bulletin discusses the potential litigation implications of say on pay votes. We focus on the experience in the United States with say on pay litigation, the potential application to Canadian companies, and what Canadian companies can do to minimize litigation risk.
What is Say on Pay?
Say on pay is a non-binding, advisory vote by shareholders expressing their approval or disapproval for a company's executive compensation policies. Unlike other countries such as the United States,1 say on pay advisory votes are not mandatory in Canada, and there is no indication that this will change soon.2 Nevertheless, it is increasingly being voluntarily adopted by Canadian companies seeking more transparent corporate governance practices, especially in light of recent public outcry over executive compensation levels3. While the actual impact of say on pay votes on executive compensation levels has been questioned,4 it appears that say on pay is here to stay in Canada.
Recently, Canadian companies have started to experience say on pay failures,5 including the high-profile failure of Barrick Gold Corporation, where a whopping 85% of shareholders rejected the company's proposed plan.6 These rejections have significant potential implications for the Canadian legal landscape. While say on pay voting is not mandatory and the results of such votes are not binding on a company, failed say on pay votes could, as has occurred in the United States, lead to costly shareholder litigation creating business disruption and reputational harm.
Litigation in the United States
Say on pay lawsuits in the United States have been largely unsuccessful; however, the rise in the number of say on pay lawsuits and the evolving tactics used by plaintiffs has made them an interesting study from which Canadian companies can learn. The two classes of cases discussed below provide examples of the approaches taken by plaintiffs in the United States towards say on pay lawsuits.
The first class of cases deals with direct challenges to executive compensation plans based on say on pay votes. As an example, Gordon v. Goodyear7 concerned Navigant Consulting Inc. ("Navigant"), a consulting firm that, ironically, provides risk management and financial advice to government agencies. Navigant was experiencing poor and declining financial performance, and its most recent executive compensation plan was rejected by 55% of Navigant's shareholders. Natalie Gordon, a Navigant shareholder, brought a derivative lawsuit (an action in the name of the corporation) against Navigant's board of directors. She alleged that Navigant's board of directors awarded "excessive executive compensation despite the fact that Navigant shareholders have seen the value of their investment plummet". She further alleged that Navigant's board of directors had breached their fiduciary duties towards Navigant. The Federal District Court of Illinois, applying Delaware law, rejected the plaintiff's claim. The Court held that a company's poor performance combined with a failed (albeit very close) say on pay vote was insufficient to find that the board of directors had not exercised their valid business judgment in reaching its decision. The Court also held that section 951 of the Dodd-Frank Act, the legislation creating mandatory say on pay in the United States, made clear that say on pay votes do not impose additional fiduciary duties on directors.
The second class of cases deals with challenges to the
procedural aspects of say on pay votes. An example of this class of
cases is Gordon v. Symantec Corp.8 The
plaintiff, the same Natalie Gordon as above,9 sought an
injunction restraining Symantec Corporation ("Symantec")
from proceeding with its say on pay vote for failure to disclose
essential information. The allegedly deficient information included
the reasons Symantec changed its compensation consultant, the
reasons Symantec chose particular peers as a basis of comparison,
and a "fair summary" of the compensation consultant's
analysis. Symantec, in turn, filed an expert report from Professor
Robert Daines of Stanford Law School, who submitted a declaration
that Symantec's disclosures were consistent with industry
standards and complied with regulatory requirements. The California
Court, citing Professor Daines' declaration, denied the
plaintiff's motion, finding no precedent for the
Implications for Canadian Companies
Canada has yet to see say on pay lawsuits as in the United States. However, the increased adoption of say on pay voting by Canadian companies, combined with the recent say on pay failures of Barrick Gold Corporation and other companies, may lead to lawsuits in Canada, and Canadian companies and directors should take measures to protect themselves from the potential adverse consequences of shareholder litigation.
There are a few important distinctions between Canada and the United States that warrant consideration. The most obvious is that say on pay is not mandatory in Canada. This means that Canadian companies and directors would not have the same regulatory restrictions and protections afforded to their American counterparts. For example, in Goodyear, the Court held that section 951 of the Dodd-Frank Act made clear that say on pay does not impose any additional fiduciary duties on directors. Further, the lack of a say on pay regulatory regime creates uncertainty as to the requirements a Canadian company must adhere to when adopting say on pay voting.
Another important distinction is the different approach to derivative lawsuits by Canadian and American courts. In most states in the United States, to bring a derivative lawsuit, a plaintiff must demonstrate "demand futility", meaning the shareholder must cast reasonable doubt that (1) the majority of the directors are independent and disinterested; or (2) the transaction was the product of a valid exercise of business judgment. The procedural requirements for bringing a derivative lawsuit in Canada are distinct, and generally require court approval that a plaintiff (1) is acting in good faith; (2) has given notice to the corporation and the corporation has refused to proceed with the action; and (3) that the action is in the best interests of the corporation.10 The procedural hurdle of demonstrating "demand futility" is noticeably absent in Canada, meaning derivative lawsuits may be easier to bring for litigants in Canada.
A final, and perhaps most important, distinction is the existence of the oppression remedy in Canada. The oppression remedy allows shareholders to bring a successful claim against a corporation if the corporation's actions disregard the shareholder's reasonable expectations as a shareholder and unfairly impact the shareholder's interests. The oppression remedy provides an additional mechanism for shareholder litigants to bring so called say on pay lawsuits in Canada. As the Ontario Superior Court recently held in Unique Broadband Systems Inc., Re,11 and as Canadian courts have long held, management fees or compensation paid without proper approval, that are larger than industry norms, or that increase while a corporation is encountering financial difficulties can be oppressive.12 It is not a stretch to imagine shareholders arguing that approval of an executive compensation plan in the face of a failed say on pay vote is evidence of oppressive conduct. While a failed say on pay vote by itself would likely be insufficient to sustain an oppression claim, it can serve as a factor for a Court to consider when faced with such a claim by a shareholder. The existence of the oppression remedy therefore provides an alternative and likely simpler means for a shareholder to seek redress for a failed say on pay vote, and creates an additional factor directors must consider when assessing the results of a say on pay vote.
Minimizing Litigation Risk
The fact that the representative plaintiff was the same person in both the Goodyear and Symantec cases discussed above is no coincidence. Enterprising counsel may attempt to bring opportunistic (and profitable) litigation in the face of a failed say on pay vote using a cherry picked representative plaintiff. Canadian companies should be wary of this risk: in addition to the potential cost of litigation, the legitimate business and operational activities of a company may be disrupted, and the company and its directors may suffer reputational harm as a result of these lawsuits.
The following are some steps Canadian companies can take to minimize potential litigation risk:
- Consider whether a say on pay vote is appropriate for the company, and what the likely outcome of a say on pay vote will be.
- Avoid making definitive statements regarding the outcome and potential actions to be taken as a result of a say on pay vote.
- Ensure that proxy disclosure complies with applicable corporate and securities laws and is clear and precise.
- Keep directors informed of the litigation risk associated with say on pay votes.
- Ensure that any performance based compensation is tied to clearly articulated performance criteria.
- Understand and consider competitors compensation practices to ensure that compensation levels are consistent with industry standards, and address any concerns about current executive compensation programs.
- Review compensation voting policies of proxy advisory firms and key institutional shareholders to identify factors that may influence a "no" vote.
- Ensure that the company's compensation plans and policies are complied with.
1 Countries that have mandatory say on pay include the United Kingdom, Australia, the Netherlands, Sweden and Switzerland.
2 In 2011, the Ontario Securities Commission ("OSC") sought comments on a variety of shareholder rights issues, including say on pay. However, there has been no movement on this front, and the OSC's most recent statement of priorities references say on pay only briefly in the context of improving proxy voting mechanisms.
3 The Shareholder Association for Research and Education ("SHARE") publishes a list of Canadian public companies that have adopted say on pay votes. The number has increased from 71 in 2011 to 99 in 2012 and up to 129 in 2013.
4 See, for example, Before and After Say on Pay: Say on Pay in Canada 2009-2011, Clarkson Centre for Board Effectiveness.
5 Shareholder approval levels as a whole appear to be declining in Canada: a recent SHARE report indicates that 10.6% of Canadian companies received less that 80% shareholder say on pay approval, compared to 1.6% the previous year.
6 Three other Canadian companies have had say on pay failures thus far: QLT Inc., Equal Energy Ltd., and Golden Star Resources Ltd.
7 2012 WL 2885695 (N.D.Ill.) ["Goodyear"].
8 Case No. 1-12-CV-231541 ["Symantec"].
9 The implications of Ms. Gordon being a representative plaintiff in both cases is discussed below.
10 The specific requirements vary amongst the different federal and provincial statutes. For example, see the Canada Business Corporations Act, R.S.C., 1985, c. C-44 s. 239.
11 (2013), ONSC 2953 at para. 180.
12 For a more detailed discussion of this issue, see M. Koehnen, Oppression and Related Remedies (Thomson Canada Limited: Toronto, 2004).
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
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