Monday, February 2, 2009

Compensation Litigation - Bonuses Under the Microscope

Executive compensation is under attack. It's an easy target for politicians when $20 billion in bonuses were handed out while the economy was in free fall. New York AG Andrew Cuomo has indicated he may attempt to claw back bonuses paid to Merrill Lynch executives in late 2008 that came to light during John Thain's recent ouster from BofA. Some execs are even foregoing their 2008 bonus. If you're an executive in the US right now there are 2 things you should avoid, bonuses and private jet travel. This is especially true if your company has received federal bailout money.

So what can Cuomo do? Apparently the strategy is to attack the Merrill Lynch payments as untimely (they were paid in December as opposed to the normal January) and explore whether shareholders were misled concerning the payments, i.e. securities fraud. A class action has already been filed in the Southern District of New York regarding the BofA/Merrill merger where the 2008 bonuses will likely be scrutinized.

Obviously, publicly traded companies are under heightened scrutiny and standards, but what about private companies? In Texas, companies can choose from a number of business forms, the typical corporation, a partnership, a limited partnership, or even a limited liability company. Often times a limited partnership will have a corporation as its general partner. There are pros and cons for each choice, usually tax considerations drive the decision of what entity to use.

The officers of those entities will owe fiduciary duties to the entity and in some cases, like a general partnership, to their partners. Thus, unreasonable bonuses or compensation are actionable, like a publicly traded company, through a derivative lawsuit or in some cases through a direct lawsuit against the offender usually based on a breach of fiduciary duty claim. The typical defense is the assertion of the business judgment rule, a topic for another day, but what is sound business judgment in these economic times differs from what was acceptable during upswings in the economy.

Does the payment pass the smell test? Payments should not be out of the ordinary. They should be consistent with historical payments tied to personal and company performance criteria. In many cases payments will be contractually mandated. In the case of a private company it would be wise to make sure other owners are informed of any bonuses paid out and the basis for such payments. In other words, avoid any claims of surprise. No matter what, it smells when a company hemorrhaging cash pays big bonuses.