Third Circuit Rules For Viacom in Suit Over Compensation For Top Executives

Freedman argued that 26 U.S.C. '162(m) of the federal tax code requires executive compensation to be approved by all corporate shareholders. Therefore, shareholders who own non-voting classes of stock must also approve the compensation plan before it can be implemented. But U.S. District Judge Sue L. Robinson of the District of Delaware rejected Freedman's claims by holding that Congress did not intend for '162(m) to override Delaware's corporate law permitting corporations to set limits on certain stock classes.

“Freedman argues that federal tax law preempts Delaware law with respect to corporate votes but federal law does no such thing,” Senior Judge Morton I. Greenberg wrote in the Third Circuit's unanimous three-judge opinion. “This presumption against preemption is heightened in areas traditionally occupied by the states, such as corporate, 'including the authority to define the voting rights of shareholders.'”

Judge Greenberg authored the opinion on behalf of a panel that also included Judge Julio M. Fuentes and Senior Judge Franklin S. Van Antwerpen. The panel concluded that '162(m) does not provide voting rights to stockholders or even address the mechanics of shareholder voting. In addition, the judges ruled that nothing in the federal statute can displace Delaware's law permitting companies to limit shareholder activity by issuing different stock classes.

“Delaware law presents an obstacle to Freedman's attempt to obtain a judicial result that nonvoting shares be allowed to vote,” the appeals court noted. “Delaware law expressly grants corporations the right to issue stock with limitations, including limitations on voting rights.”

Freedman's attorneys countered that '162(m) enfranchises all shareholders, even those holding nonvoting shares, on a corporation's executive compensation plans. Therefore, the statute conflicts with Delaware law granting corporations permission to issue nonvoting stock. But the appeals court found '162(m) only creates a mechanism for corporations to deduct certain portions of their executive compensation plans from their taxes.

Section 162(m) “does not provide voting rights to stockholders holding nonvoting shares, it does not override Viacom's certificate of incorporation and it does not supersede decades of established Delaware law,” Judge Greenberg wrote. “Accordingly, we do not conclude that Congress has preempted Delaware corporation law and we therefore hold that the district court properly dismissed Freedman's claim.”

The Third Circuit also dismissed Freedman's derivative action against Viacom's directors regarding the executive compensation plan by ruling Freedman failed to make a demand upon Viacom's board as required by the Federal Rules of Civil Procedure (FRCP) and Delaware corporate law. The appeals court noted the court would excuse a plaintiff's failure to make a demand on a corporate board if the plaintiff could prove that such an action would be futile, but Freedman failed to meet his burden.

Viacom's 10-member board is composed of five interested and five disinterested investors. “Although Freedman may disagree with the board's decision to award Viacom's executives substantial short-term incentive compensation, the board, acting through the compensation committee, did not exceed its powers under Delaware law and we may not second-guess its exercise of its business judgment in this matter,” Judge Greenberg wrote. “Freedman was obligated to make a pre-suit demand. Because he failed to do so, the district court properly dismissed his derivative claim under [FRCP] Rule 23.1.”

A. Arnold Gershon of the New York office of Barrack, Rodos & Bacine and Brian E. Farnan of Farnan LLP in Wilmington, DE, represented Freedman.

Viacom was represented by Jaculin Aaron and Stuart J. Baskin of the New York office of Shearman & Sterling. John P. DiTomo and Jon Abramczyk of Morris, Nichols, Arsht & Tunnell in Wilmington, DE, also represented the company.

Jeff Mordock is a Reporter for Delaware Business Court Insider , an ALM sibling of Entertainment Law & Finance .

Viacom gave more than $100 million in bonuses and incentive pay to three of the media company's top executives ' Chairman Sumner Redstone, President/CEO Philippe Dauman, and COO Thomas Dooley ' between 2008 and 2011. Typically, corporate taxpayers are able to deduct executive compensation over $1 million if approved by the board and a majority of shareholders.

Robert Freedman, a Viacom shareholder, filed a lawsuit in the U.S. District Court for the District of Delaware alleging the company's executive compensation program was corporate waste because a portion of it was not a tax-deductible business expense. The lawsuit named all of Viacom's board members as defendants, including Redstone and New England Patriots owner Robert K. Kraft.

The district court ruled in favor of Viacom and the U.S. Court of Appeals for the Third Circuit has affirmed. Under the appeals court's decision, corporations can define shareholder-voting rights by setting limits on certain classes of stock. Freedman v. Redstone, 13-3372. Although the issue had been long settled in Delaware corporate law, the appellate court's precedential decision adopts the regulation as federal law. And lucrative executive-compensation packages with bonus and incentive provisions are common in the entertainment industry.

Freedman argued that 26 U.S.C. '162(m) of the federal tax code requires executive compensation to be approved by all corporate shareholders. Therefore, shareholders who own non-voting classes of stock must also approve the compensation plan before it can be implemented. But U.S. District Judge Sue L. Robinson of the District of Delaware rejected Freedman's claims by holding that Congress did not intend for '162(m) to override Delaware's corporate law permitting corporations to set limits on certain stock classes.

“Freedman argues that federal tax law preempts Delaware law with respect to corporate votes but federal law does no such thing,” Senior Judge Morton I. Greenberg wrote in the Third Circuit's unanimous three-judge opinion. “This presumption against preemption is heightened in areas traditionally occupied by the states, such as corporate, 'including the authority to define the voting rights of shareholders.'”

Judge Greenberg authored the opinion on behalf of a panel that also included Judge Julio M. Fuentes and Senior Judge Franklin S. Van Antwerpen. The panel concluded that '162(m) does not provide voting rights to stockholders or even address the mechanics of shareholder voting. In addition, the judges ruled that nothing in the federal statute can displace Delaware's law permitting companies to limit shareholder activity by issuing different stock classes.

“Delaware law presents an obstacle to Freedman's attempt to obtain a judicial result that nonvoting shares be allowed to vote,” the appeals court noted. “Delaware law expressly grants corporations the right to issue stock with limitations, including limitations on voting rights.”

Freedman's attorneys countered that '162(m) enfranchises all shareholders, even those holding nonvoting shares, on a corporation's executive compensation plans. Therefore, the statute conflicts with Delaware law granting corporations permission to issue nonvoting stock. But the appeals court found '162(m) only creates a mechanism for corporations to deduct certain portions of their executive compensation plans from their taxes.

Section 162(m) “does not provide voting rights to stockholders holding nonvoting shares, it does not override Viacom's certificate of incorporation and it does not supersede decades of established Delaware law,” Judge Greenberg wrote. “Accordingly, we do not conclude that Congress has preempted Delaware corporation law and we therefore hold that the district court properly dismissed Freedman's claim.”

The Third Circuit also dismissed Freedman's derivative action against Viacom's directors regarding the executive compensation plan by ruling Freedman failed to make a demand upon Viacom's board as required by the Federal Rules of Civil Procedure (FRCP) and Delaware corporate law. The appeals court noted the court would excuse a plaintiff's failure to make a demand on a corporate board if the plaintiff could prove that such an action would be futile, but Freedman failed to meet his burden.

Viacom's 10-member board is composed of five interested and five disinterested investors. “Although Freedman may disagree with the board's decision to award Viacom's executives substantial short-term incentive compensation, the board, acting through the compensation committee, did not exceed its powers under Delaware law and we may not second-guess its exercise of its business judgment in this matter,” Judge Greenberg wrote. “Freedman was obligated to make a pre-suit demand. Because he failed to do so, the district court properly dismissed his derivative claim under [FRCP] Rule 23.1.”

A. Arnold Gershon of the New York office of Barrack, Rodos & Bacine and Brian E. Farnan of Farnan LLP in Wilmington, DE, represented Freedman.

Viacom was represented by Jaculin Aaron and Stuart J. Baskin of the New York office of Shearman & Sterling. John P. DiTomo and Jon Abramczyk of Morris, Nichols, Arsht & Tunnell in Wilmington, DE, also represented the company.

Jeff Mordock is a Reporter for Delaware Business Court Insider , an ALM sibling of Entertainment Law & Finance .