Freedman v. Redstone

• Decision Date: 30 May 2014
• Docket Number: No. 13–3372.,13–3372.
• Citation: 753 F.3d 416
• Parties: Robert FREEDMAN, Appellant v. Sumner M. REDSTONE; Philippe P. Dauman; Thomas E. Dooley; George S. Abrams; Alan C. Greenberg; Shari Redstone; Frederic V. Salerno; Blythe J. McGarvie; Charles E. Phillips, Jr.; William Schwartz; Robert K. Kraft; Viacom, Inc.
• Court: U.S. Court of Appeals — Third Circuit

753 F.3d 416

Robert FREEDMAN, Appellant

v.Sumner M. REDSTONE; Philippe P. Dauman; Thomas E. Dooley; George S. Abrams; Alan C. Greenberg; Shari Redstone; Frederic V. Salerno; Blythe J. McGarvie; Charles E. Phillips, Jr.; William Schwartz; Robert K. Kraft; Viacom, Inc.

No. 13–3372.

United States Court of Appeals,Third Circuit.

Argued March 25, 2014.

Filed: May 30, 2014.

Daniel E. Bacine, Esq., Barrack, Rodos & Bacine, Philadelphia, PA, A. Arnold Gershon, Esq., (Argued), Barrack, Rodos & Bacine, New York, NY, Brian E. Farnan, Esq., Joseph J. Farnan, Jr., Esq., Joseph J. Farnan, III, Esq., Rosemary J. Piergiovanni, Esq. Farnan Law, Wilmington, DE, Counsel for Appellant.

Jaculin Aaron, Esq., Stuart J. Baskin, Esq., (Argued), Shearman & Sterling, New York, NY, John P. DiTomo, Esq., Jon Abramczyk, Esq., Morris, Nichols, Arsht & Tunnell, Wilmington, DE, Counsel for Appellees.

BEFORE: FUENTES, GREENBERG, and VAN ANTWERPEN, Circuit Judges.

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

Between 2008 and 2011, Viacom Inc. paid three of its senior executives—Board chairman Sumner Redstone, President and CEO Philippe Dauman, and COO Thomas Dooley—more than $100 million in bonus or incentive compensation. Although the compensation exceeding $1 million paid by a corporation to senior executives is not typically a deductible business expense under federal tax law, a corporate taxpayer may deduct an executive's otherwise nondeductible compensation over $1 million if an independent committee of the corporation's board of directors approves the compensation on the basis of objective performance standards and the compensation is “approved by a majority of the vote in a separate shareholder vote” before the compensation is paid. In 2007, a majority of Viacom's voting shareholders approved such a plan with the intent to render the excess compensation paid by Viacom tax deductible (the “2007 Plan”). One shareholder, appellant Robert Freedman, now claims that Viacom's Board of Directors (the “Board”) failed to comply with the terms of the 2007 Plan. Freedman contends that, instead of using quantitative performance measures, the Board partially based its bonus awards on qualitative, subjective factors, thus destroying the basis for their tax deductibility. Freedman alleges that this misconduct caused the Board to award its executives more than $36 million of excess compensation. Freedman sued Viacom and all eleven members of its Board derivatively on behalf of Viacom for not complying with the 2007 Plan, and directly for allowing an allegedly invalid shareholder vote reauthorizing the 2007 Plan in 2012. On defendants' motion, the District Court dismissed both claims by order entered on July 16, 2013. See Freedman v. Redstone, Civ. No. 12–1052–SLR, 2013 WL 3753426 (D.Del. July 16, 2013). Freedman has appealed from that order but we will affirm.

At the outset we summarize the issues involved in this case and set forth our conclusions. In a requirement familiar to corporate litigators, before bringing a derivative suit on behalf of a corporation a plaintiff must demand that the corporation's board of directors bring the suit itself. If the plaintiff does not make such a demand, the suit may proceed only if the plaintiff shows why a demand would have been futile, either because the board was interested in the challenged transaction or because the board acted outside the protection of the business judgment rule in dealing with the matter in issue. As Freedman did not make a pre-suit demand or present sufficient allegations explaining why a demand would have been futile, the District Court correctly dismissed his derivative claim.

Freedman on his direct claim contends that, as a condition for allowing certain executive compensation in excess of $1 million to be tax deductible, federal tax law requires that the compensation be awarded pursuant to a plan approved in a vote of all the shareholders, even those otherwise without voting rights, thus preempting to this limited extent Delaware law authorizing corporations to issue non-voting shares as Viacom has done. Because we find that federal tax law does not confer voting rights on shareholders not otherwise authorized to vote or affect long-settled Delaware corporation law which permits corporations to issue shares without voting rights, we conclude that Freedman has failed to state a direct claim on which relief may be granted.

II. BACKGROUND

Viacom is a publicly traded entertainment corporation, incorporated in Delaware, with its principal place of business in New York, New York. Viacom's Board of Directors has eleven members, all of whom are defendants in this case. During the 2011 fiscal year, Viacom earned more than $2 billion, and returned a substantial portion of those profits to its stockholders through cash dividends and stock buyback programs.

As we have indicated, Freedman's allegations center on the award of millions of dollars of incentive compensation to three Viacom executives. We reiterate that typically executive compensation exceeding $1 million is not tax deductible, but that 26 U.S.C. § 162(m) provides an exception to the rule of nondeductibility where the corporation pays the compensation as a reward for performance measured by established, objective criteria and an independent compensation committee of the corporation's directors administers the compensation plan. 26 U.S.C. § 162(m)(4)(C)(i); 26 C.F.R. § 1.162–27(e)(2)(i). In order for compensation paid pursuant to the exception to qualify for the favorable tax treatment, the taxpayer must disclose to its shareholders its plan to award such compensation and the plan must be “approved by a majority of the vote in a separate shareholder vote.” 26 U.S.C. § 162(m)(4)(C)(ii).

On May 30, 2007, Viacom's shareholders approved this type of plan—the Senior Executive Short–Term Incentive Plan. The 2007 Plan capped the awards, limiting each executive's eligibility for awards to the lesser of either eight times his salary or $51.2 million per year. As these bonuses vastly exceeded § 162(m)'s $1 million threshold, to ensure that the awards were tax deductible the 2007 Plan included provisions tying bonus awards to the achievement of specific, objective goals relating to Viacom's financial performance. The plan directed the Compensation Committee of Viacom's Board to establish a performance period, designate which executives would participate, select which performance goals to use from a list included in the 2007 Plan, and set a performance target within each goal. At the end of the performance period, the Committee was to certify “whether the performance targets have been achieved in the manner required by Section 162(m).” A. 63. If the targets were satisfied, then the executives earned the award, although the Committee could, “in its sole discretion, reduce the amount of any Award to reflect” its assessment of a particular executive's “individual performance or for any other reason.” A. 63–64.

The Committee selected several performance measures from the 2007 Plan and then set a range of performance goals for each measure. Each executive was eligible to receive a bonus of different amounts, depending on where on the range Viacom's performance ultimately fell. Each executive was assigned a “target” bonus and, depending on Viacom's actual performance, an executive's bonus could be anywhere from 25% to 200% of the target. Because the Committee selected more than one performance measure, the Committee weighted each measure and then combined the weighted percentage with Viacom's performance to calculate each executive's award.

According to Freedman, the Committee failed to comply with the foregoing procedure. He contends that, in addition to the objective performance measures drawn from the 2007 Plan, “the Committee also used subjective, non-financial qualitative factors to determine approximately 20% of the bonus awarded to each Officer,” and “wrongfully arrogated to itself the positive discretion to provide additional compensation based on the accomplishments of each executive in a particular year.” A. 41–42. The Committee allegedly used “positive discretion” to increase the executives' bonuses, resulting in an “excess” award of $36,645,750. A. 42–47.

The complaint quantifies the difference between the “earned” bonus and the actual bonus for each executive in each of the three years at issue (2008, 2009, and 2010). For example, in 2008 the Committee set Dauman's “target bonus” at $9.5 million (significantly less than the maximum bonus awards authorized by the 2007 Plan). The Committee selected two performance goals: Operating Income, weighted at 34%, and Free Cash Flow, weighted at 29%. It also assigned 20% weight to qualitative factors.

The Committee then used these weighted factors—all of which were satisfied—to reduce Dauman's actual bonus to $7,885,000 (83% of the target). Freedman argues that the 20% of the ultimate award attributable to qualitative factors was improper, and thus Dauman received $1.9 million in excess compensation. A. 42–43. Freedman characterizes this metric as a violation of both the 2007 Plan and 26 U.S.C. § 162(m), and calculates the total amount of excess compensation awarded to the three executives to be $36 million.

Treasury Regulations require corporations to obtain stockholder approval of executive compensation plans every five years, 26 C.F.R. § 1.162–27(e)(4)(vi), and Viacom thus sought stockholder approval of its compensation plan in 2012 (the “2012 Plan”). Viacom's certificate of incorporation established two classes of stock: Class A shares, which have one vote per share, and Class B shares, which are not “entitled to any votes upon any questions presented” to Viacom's stockholders. A. 156 (Certificate of Incorporation). Because Redstone owns 79.5% of Class A shares and obviously favored adoption of the plan, Freedman reasonably contends that the passage of the 2012...