May 23, 2022

Volume XII, Number 143


May 23, 2022

Subscribe to Latest Legal News and Analysis

Recent Ruling Allows a Shareholder Lawsuit to Proceed After a Negative Say-on-Pay Vote: Quirk or Harbinger?

During the 2011 proxy season many public companies conducted their first “say-on-pay” vote, as compelled by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and related Securities and Exchange Commission (SEC) rules.1 Section 951 and related SEC rules required most public companies to obtain a separate advisory vote on the compensation of executive officers as disclosed in the proxy statement.

Approximately 1.5% of the companies that have disclosed voting results as of September 30, 2011 reported a negative say-on-pay vote. Some of the companies who suffered a negative say-on-pay vote also drew shareholder derivative lawsuits in the wake of the negative vote. The shareholder lawsuits were based on a variant of the theory that, if compensation failed to garner shareholder advisory approval and executive compensation increased in a year when company performance declined, the directors who approved the compensation must have been derelict in observing their fiduciary duties.

It is not unusual for a court to dismiss a shareholder derivative claim based on a compensation decision by a board of directors at an early stage of litigation. Dodd-Frank Section 951 does not compel a different result as it states that the say-on-pay vote is to be non-binding and cannot be construed to create or imply any change or addition to a company’s or board’s fiduciary duties. Dodd-Frank thus leaves to state law the ultimate question of whether compensation decisions by directors could be challenged. Under state law, most particularly Delaware law, compensation decisions are the province of the business judgment of directors. Challenges to such decisions have generally been dismissed.

But now one court’s ruling not to dismiss upfront a lawsuit filed after a negative say-on-pay vote may breathe life into shareholder claims challenging executive compensation and increase the costs associated with defending such claims.

Though Dodd-Frank Say-on-Pay Requirement Does Not Alter Fiduciary Duties, Lawsuits Are Being Filed After Negative Votes

Under traditional corporate law principles, the board of directors is charged with the responsibility of managing the affairs of the corporation and overseeing the management that the board appoints. The courts rightly shield decisions by the board from many shareholder challenges by invoking the business judgment rule. As articulated by the courts in Delaware (which is the domicile to a majority of public companies), the business judgment rule creates a “presumption that in making a business decision, the directors…acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”2 As compensation is one of the most crucial tools that directors have for disciplining and rewarding management, courts often find that compensation decisions by a board fall within the protections of the business judgment rule, even when the compensation facially appears to be very generous pay for less than stellar performance. The Delaware Supreme Court has even noted that “It is the essence of business judgment for a board to determine if a particular individual warrant[s] large amounts of money, whether in the form of current salary or severance provisions.”3

While Dodd-Frank has given public shareholders a method for registering their say on the directors’ decisions on pay, Section 951 makes it clear that the say-on-pay vote is advisory and non-binding. Even more importantly, the say-on-pay vote cannot be construed as overruling a company’s or board of directors’ decision and does not create, change or add to a company’s or board of directors’ fiduciary duties.

Nonetheless, shareholder derivative lawsuits have followed in at least seven out of the approximately 40 negative say-on-pay votes occurring thus far in 2011.4 These shareholder plaintiffs have generally claimed breaches of the directors’ fiduciary duties, aiding and abetting the directors’ fiduciary breaches and breach of contract by the compensation consultant and unjust enrichment of the executives. A few of these shareholder plaintiffs have also claimed corporate waste. As Section 951 preserved the pre-existing state law fiduciary duty framework, many expected that even after negative say-on-pay votes, lawsuits challenging compensation decisions by a board would be dismissed.

Cincinnati Bell Say-on-Pay Litigation

Recently, however, one Federal District Court has declined to dismiss at an early stage of the litigation shareholder claims challenging compensation decisions that were the subject of a negative say-on-pay vote.5

Background. At the 2011 annual meeting of shareholders of Cincinnati Bell Inc., an Ohio corporation, approximately 66% of shareholders voted against the 2010 compensation of the company’s named executive officers disclosed in the proxy statement.

Shareholder complaint. Following the negative advisory vote, a shareholder filed a derivative lawsuit against a majority of the directors, certain of the named executive officers and Cincinnati Bell’s compensation consultant. The complaint repeatedly referenced the negative vote as direct evidence that the 2010 executive compensation was not in the best interest of shareholders and, therefore, that the directors breached their duty of loyalty when approving the compensation and that pre-suit demand on the board was excused. The complaint further alleged that the executive officers were unjustly enriched and that the compensation consultant aided and abetted the directors’ breach of fiduciary duty.

The plaintiff did not present any specific, persuasive allegations that the directors acted in bad faith, were conflicted or were negligent in approving the 2010 executive compensation. The plaintiff merely claimed that (1) during 2010 the executive officer defendants received increases in total compensation ranging from 54.3% to 80.3% despite Cincinnati Bell’s net income declining 68.4% and an annual shareholder return of negative 18.8%, (2) the company had a pay-for-performance policy, (3) the directors approved the 2010 executive compensation and recommended it to shareholders for approval and (4) shareholders voted against the compensation. 

Judge Black’s ruling. Ohio Federal District Court Judge Timothy Black denied the defendants’ motion to dismiss the plaintiff’s complaint for failure to state a claim upon which relief could be granted. Judge Black acknowledged that, under Ohio law, directors face liability for a breach of the duty of loyalty only if there is clear and convincing evidence that their actions were undertaken with “a deliberate intent to cause injury to the corporation” or “reckless disregard for the best interests of the corporation.” Thus, as with most states, under Ohio law, director decisions on executive compensation are generally protected by the business judgment rule. However, Judge Black noted that the business judgment rule was a presumption that may be rebutted by evidence that the board acted disloyally. He also found that the plaintiff did not need to plead operative facts to rebut the presumption that the directors acted in good faith, but that it need only plead non-conclusory factual allegations. This finding is inconsistent with Delaware law, which requires shareholders that file derivative lawsuits without making a pre-suit demand of the board to allege particularized facts in the complaint demonstrating legal excuse from the demand requirement.

Judge Black found that the plaintiff had pled sufficient factual allegations to support its claims apparently based on the belief that the negative say-on-pay vote provided “direct and probative evidence” that the 2010 executive compensation was not in the shareholders’ best interest. Moreover, the same factual allegations that were sufficient to support a claim for breach of fiduciary duty were also found to support a claim for unjust enrichment. Accordingly, Judge Black refused to dismiss the complaint, allowing the plaintiff’s claims and the defendants’ defenses to stand the test of summary judgment or trial. Most interestingly, while Judge Black acknowledged that the say-on-pay vote is non-binding and did not alter a director’s fiduciary duties, without any substantive explanation he waived aside Section 951’s express language along with concerns by some commentators that the say-on-pay voting requirement would lead to frivolous litigation. Instead, Judge Black appeared to side with other commentators that believe a negative say-on-pay vote provides evidence to support a finding of a breach of a fiduciary duty.

Judge Black excused the plaintiff’s failure to meet the usual pre-suit demand requirement in shareholder derivative cases that the board of directors themselves bring a lawsuit. He found that the plaintiff had sufficiently pled facts to cast doubt on the ability of the directors to make unbiased, independent business judgments about whether to sue because the directors devised and approved the contested executive compensation, recommended shareholder approval of the compensation and suffered a negative shareholder vote on the compensation.

Judge Black did, however, deny the plaintiff’s request for a preliminary injunction to enjoin the board from effectuating the 2010 executive compensation and to place the compensation in a constructive, interest-bearing trust.6 One of the more interesting aspects of the injunction ruling was Judge Black’s finding that although the plaintiff presented plausible claims for breach of fiduciary duty and unjust enrichment, he was unable to conclude that the case had a substantial likelihood of success on the merits.

Is Cincinnati Bell Significant?

It would be tempting and quite easy to regard Cincinnati Bell as an aberration for a variety of reasons. The case is at an early stage and the ruling is not one on the merits but rather on the standard for pleading these types of claims. Also, Cincinnati Bell is an Ohio, rather than Delaware, corporation and Judge Black denied a request for a preliminary injunction finding that the plaintiff did not show a substantial likelihood of success on the merits. Dodd-Frank has provided public shareholders with a forum for airing their view as to the total executive compensation scheme approved by directors, but it did not topple the very architecture of corporate law, which vests the ultimate decisions as to compensation in the board. A board may well conclude that the fluctuations of current stock price or financial performance should not dictate compensation; it may well conclude that such measures, or any others, should be taken into account. At a summary judgment stage, the defendants in Cincinnati Bell should have the weight of the case law on their side.

Moreover, of the derivative lawsuits filed in 2011 following a negative say-on-pay vote, only one other court has issued a ruling. The Superior Court of Fulton County, Georgia recently granted the defendants’ motion to dismiss a shareholder derivative lawsuit involving Beazer Homes USA (which is a Delaware corporation) based on the plaintiffs’ lack of standing for failure to satisfy Delaware’s “contemporaneous ownership” requirement, failure to adequately allege an excuse for the failure to make a pre-suit demand on the board and failure to state a claim upon which relief can be granted as to any of the alleged causes of action.7 Most importantly, the ruling rejected the plaintiffs’ argument that a negative say-on-pay vote rebuts the presumption that the directors’ decisions regarding the challenged compensation reflected valid business judgments as the argument is not supported by Delaware law or Dodd-Frank.

That said, the practical result of the recent ruling in Cincinnati Bell should make companies consider how they attempt to avoid a negative say-on-pay vote as well as how they react to a negative, or even a close, vote. Even if the Cincinnati Bell defendants ultimately succeed on the merits, they face continued shareholder litigation, including its attendant discovery, and the usual pressure to settle. As discussed in more detail in footnote 4, one company settled a consolidated shareholder derivative lawsuit following a negative say-on-pay vote in 2010 for $1.75 million. Moreover, Judge Black’s ruling may embolden plaintiff lawyers to file more shareholder derivative lawsuits following negative say-on-pay votes in the hope of extracting settlements out of companies that would prefer not to face the uncertainties of litigation.8 As the settlement discussed above suggests, a settlement could be extremely costly. If other courts follow Judge Black’s approach of allowing claims to survive an early-filed motion to dismiss just because of a negative say-on-pay vote coupled with evidence of increased executive pay in the same year as decreasing company performance, we would expect that similar cases could proliferate, at least for a time.

Did ISS Win the Cincinnati Bell Case?

Perhaps the biggest winner in the Cincinnati Bell case is ISS. ISS’ scoring of, and pronouncements concerning, compensation plans and arrangements, already influential, will be even more closely watched in the hope that a negative or close vote can be avoided if ISS’ compensation guidance is faithfully followed. We would be the last to suggest that ISS guidance should be ignored. However, we also know that boards must manage for the long term, regardless of the latest trends and fads and regardless of examples that might not be directly relevant to the companies they manage. We firmly believe that cases like Cincinnati Bell should not dissuade a board from designing compensation plans to best fit the company, its industry and its strategy.

What Should Boards Do?

In an effort to avoid costly shareholder litigation, boards are well advised to consider how to prevent a negative say-on-pay vote as well as how they react to a negative or close vote. We have a few suggestions:

  • Instruct investor relations to engage with shareholders to seek their feedback on executive compensation matters and to determine what caused negative or close advisory votes on executive compensation in 2011. Shareholder feedback can provide valuable guidance on pay practice design and ways to enhance executive compensation disclosure in the proxy statement.
  • Be familiar with the compensation guidelines established by ISS and the other proxy advisory firms when making compensation decisions. This familiarity will not only assist those that seek to make compensation decisions in compliance with the guidelines, but will also enable those companies that deviate from the guidelines to provide a thoughtful explanation for such deviation in the proxy statement.
  • Use Compensation Discussion and Analysis (CD&A) as a venue for clearly articulating the basis for executive compensation decisions and for describing precisely why compensation fits the circumstances of your company. If you disclose having a pay-for-performance policy, be sure that the CD&A adequately and accurately describes how that policy was applied to executive compensation decisions. Think of the CD&A as your proactive answer to forestall or respond in advance to any lawsuit.
  • Allow sufficient time to solicit votes between the filing of the proxy statement and the date of the annual meeting. Communicate early and often with the proxy soliciting firm regarding voting results, and follow up promptly on negative votes or abstentions.  A number of companies filed proxy supplements in 2011 with talking points regarding executive compensation. Some companies engage a proxy solicitor to provide year-round advice well in advance of the annual meeting.
  • Prepare to respond immediately to any negative voting recommendations issued by ISS or other proxy advisory firms. Engagement with the proxy advisory firms could result in a negative voting recommendation being reversed. If a negative voting recommendation cannot be avoided or reversed, prepare to reach out to shareholders to explain why the recommendation should not be followed. Personal calls and meetings between shareholders and directors (or the chair of the compensation committee) may increase votes in favor of executive compensation.
  • Prepare to address, if possible, any compensation decisions that result in a negative or close vote. That does not mean changes should invariably be made in the wake of a negative or close vote. But if you decide that the compensation plans and arrangements are appropriate and no changes or only small changes are required, then consider whether you have articulated the basis for your decisions with sufficient clarity in the CD&A. While unfavorable results of a vote should not necessarily lead to a wholesale change in compensation policy, the results signal that the company should more fully describe the reasons supporting compensation decisions and the tie between strategy, performance and compensation.
  • Fully disclose any change to executive compensation made after a vote and, more importantly, any decision not to make changes in the following year’s CD&A. Also, consider whether any changes or decision not to make changes should be publicly disclosed earlier, such as in the Form 8-K announcing the voting results. A recent ISS survey indicated that, on a cumulative basis, 72% of investors indicated that a board of directors should provide an explicit response regarding pay practice improvements if say-on-pay opposition exceeds 30%.9
  • Remain vigilant and consider the suggestions above even if shareholders approved say-on-pay in 2011 as they may not provide the same level of support in subsequent years if performance declines (especially stock price performance in the current volatile markets).10 Moreover, even if say-on-pay was approved in 2011 and will not be on the ballot in 2012, shareholders might instead voice their displeasure with executive compensation matters by launching a “withhold” or “vote no” campaign against directors, especially compensation committee members.


1. Smaller reporting companies were not required to conduct a say-on-pay vote this year. Smaller reporting companies will not be required to hold their initial say-on-pay advisory vote until the first shareholder meeting for the election of directors held on or after January 21, 2013.

2. Brehm v. Eisner, 746 A.2d 244, 264 n.66 (Del. 2000) (internal citation omitted).

3. Brehm at 263 (internal citation omitted).

4. Companies facing shareholder derivative lawsuits following a negative say-on-pay vote include Beazer Homes USA, Inc., Cincinnati Bell Inc., Dex One Corporation, Jacobs Engineering Group Inc., Janus Capital Group Inc. and Umpqua Holdings Corporation. Institutional Shareholder Services (ISS) attributes the failed votes to concerns with pay-for-performance decisions. See 2011 U.S. Postseason Report, at The Council of Institutional Investors engaged a consultant to conduct a study of advisory votes at many of the companies that received a negative vote in 2011. The study found, among other things, that 92% of the investors surveyed cast advisory votes against executive compensation due to a disconnect between pay and performance. See Say on Pay - Identifying Investor Concerns (Sept. 2011), at

Two other companies that received negative say-on-pay votes in 2010, before Dodd-Frank Section 951 took effect, faced shareholder derivative lawsuits over executive compensation matters. One of the companies settled its consolidated lawsuit by agreeing to certain corporate governance reforms related to executive compensation matters and the payment of $1.75 million to the plaintiffs’ attorneys for fees and expenses (this amount includes $5,000 to be paid to the plaintiffs). The other company settled one of the three shareholder lawsuits on undisclosed terms and the other two lawsuits were dismissed with prejudice. Both companies received positive say-on-pay votes in 2011.

5. Order Denying Defendants’ Motion to Dismiss, NECA-IBEW Pension Fund v. Cox, No. 1:11-cv-00451 (S.D. Ohio Sept. 20, 2011).

6. Order Denying Plaintiff’s Motion for a Preliminary Injunction, NECA-IBEW Pension Fund v. Cox, No. 1:11-cv-00451 (S.D. Ohio Sept. 26, 2011).

7. Order Granting Defendants’ Motion to Dismiss the Complaint, Teamsters Local 237 Additional Security Benefit Fund v. McCarthy, No. 2011-cv-197841 (Ga. Super. Ct., Fulton Cty. Sept. 16, 2011).

8. In fact, Cincinnati Bell has already been cited as authority by a plaintiff in the Umpqua Holdings say-on-pay litigation pending in the United States District Court for the District of Oregon.

9. See 2011-12 Policy Survey Summary of Results (Sept. 2011), at

10. Umpqua Holdings received over 90% support for its say-on-pay vote in 2010, but received a negative vote in 2011 that was followed by a shareholder derivative lawsuit.

Copyright © 2022, Hunton Andrews Kurth LLP. All Rights Reserved.National Law Review, Volume I, Number 279

About this Author

Jeff C. Dodd, Andrews Kurth Law Firm, Securities Attorney

Corporate, Securities and Corporate Finance: experience in diverse domestic and international corporate transactions, including representing issuers and underwriters (and investment bankers) in connection with public and private securities offerings (including IPOs and secondary offerings); representing venture capital and other investment groups or funds, as well as portfolio companies, in private debt and equity financing transactions; representing various participants (buyers, sellers, financing sources) in merger and acquisition and change of control transactions, public...

J. Wiley George, Finance Litigation Attorney, Andrews Kurth Law FIrm

Through the years, Wiley has resolved a wide variety of complex commercial disputes through trial, arbitration, motion practice and settlement. He has considerable first-chair experience handling cases involving mergers and acquisitions, commercial fraud, contract disputes, franchise disputes, lender liability, insurance coverage, legal malpractice, trademark infringement and unfair competition. Wiley has been named multiple times as a Texas Super Lawyer by Texas Monthly magazine.