On his way through the San Francisco International Airport with the hopes of boarding his flight to China, Silicon Valley former employee Jing Zeng was not greeted by the friendly faces of a flight crew, but rather the handcuff-wielding agents of the FBI. Detained on charges of stealing trade secrets, Mr. Zeng will have to remain in the US and explain the behavior that led up to his August 20th airport arrest. The Wall Street Journal explains that Mr. Zeng, a new employee with Machine Zone, maker of Game of War: Fire Age (you may have seen the ads prominently featuring model Kate Upton sporting medieval garb), sought to change teams and work under a different boss. His request was denied and the company eventually asked Mr. Zeng to leave. Mr. Zeng then allegedly began to download highly valuable user data from a proprietary database in an attempt to leverage his possession of the information for a more lucrative severance agreement. The company contacted the FBI, and Mr. Zeng’s arrest followed. Now, Mr. Zeng finds himself in the custody of federal authorities, although his LinkedIn profile indicates that he is “ready for next venture.”
Indemnification and advancement are intended to protect individuals from claims asserted against them by shareholders or regulators by virtue of their position with a business entity. A minimum level of protection is guaranteed by statute for corporate officers and directors. As we covered in this post, statutory backstops do not exist for employees of alternative business entities, such as limited partnerships (“LPs”), limited liability partnerships (“LLPs”) and limited liability companies (“LLCs”). Because these alternative business entities offer different advantages, they are chosen as frequently as corporations when a new business is formed. Therefore, protection of individuals working for these entities will be a growing issue.
Alternative business entities are desirable because, among other things, the laws under which they are formed are designed to favor flexibility. Management of an alternative business entity is principally controlled by the operating agreement among the stakeholders, which may contain whatever provisions the stakeholders deem appropriate. For example, the Delaware Limited Liability Company Act (the “DLLCA”), which governs the formation and operation of Delaware limited liability companies, specifically provides that “it is the policy of this Chapter to give maximum effect to the principal of freedom of contract and to the enforceability of limited liability company agreements.” 6 Del. C.§ 18-1101(b). The Delaware Revised Uniform Limited Partnership Act (“DRULPA”) has a similar policy statement, 6 Del. C.§ 17-1101(c). However, if the agreement pursuant to which the alternative entity was formed does not expressly create a right to indemnification and advancement, employees may not have protection or resources to mount a proper defense in a time of need.
We’ve frequently discussed the well-established indemnification and advancement rights of corporate directors and officers (see here and here, for example). These benefits protect individuals from claims asserted against them by shareholders or regulators. Corporate charters and bylaws typically expand these rights to the fullest extent permitted by law, but these provisions are merely an overlay to the statutory provisions which guarantee basic indemnification protections for directors and officers.
However, that isn’t the case for alternative business entities, such as limited partnerships (“LPs”), limited liability partnerships (“LLPs”) and limited liability companies (“LLCs”). Those entities don’t always have a statutory back stop that guarantees indemnification and advancement for their employees. In recent years, founders are just as likely to choose these alternative structures for their new business as they are to choose the corporate form. Therefore, protection of these key employees will be a growing issue.
We recently discussed the SEC’s proposed rules pursuant to the 2010 Dodd-Frank Act regarding the clawback of executive compensation under various circumstances related to accounting restatements. Now it seems Hertz’s former CEO, Mark Frissora, may become one of the first test cases should these rules survive the comment period. According to Footnoted, upon Frissora’s resignation last September, he received over $10 million plus other benefits. But the company recently filed a 10-K for 2014 that not only included restated results for 2012 and 2013, but also made a disclosure that could suggest a possible future effort to claw back Frissora’s severance package. The disclosure blamed Frissora for creating an environment that “in some instances may have led to inappropriate accounting decisions and the failure to disclose information critical to an effective review of transactions and accounting entries.” Perhaps another interesting twist is whether any potential clawback will have an effect on Frissora in his new role as CEO of Caesar’s Entertainment, a position he assumed two weeks ahead of Hertz’s delayed filings.
California is known for its skeptical treatment of employers’ efforts to enforce non-competes, but it may not be as friendly toward all employees as originally suspected, according to The National Law Review. In 2014, California resident Stacey Sabol-Krutz left her position with Quad Electronics, a Michigan-based employer, to take a position with a rival company, which was also based in Michigan. Sabol-Krutz had started working for Quad in Michigan, and signed her employment contract there, but moved to California in 2011. Her employment contract specifically named her new employer as a company that Sabol-Krutz wouldn’t join for 12 months after leaving Quad. After Quad found out about Sabol-Krutz’s new job, it sued her for breach of contract. She, in turn, filed suit in California, attempting to invalidate the agreement under California law. The California court, noting the absence of a choice of law provision in the agreement, found that Michigan law applied, using a “governmental interest” test. Although courts may refuse to apply a choice of law provision when construing restrictive covenants (as we illuminated here), Sabol-Krutz’s move to California to work for an out-of-state employer did not win her the protection of California law.
The legal saga of American Apparel and its founder and former CEO, Dov Charney, has more twists and turns than the latest season of Game of Thrones. We’ve previously blogged about the sundry clashes between the two, including Charney’s ongoing arbitration for severance, the sexual harassment allegations against Charney, and a lender’s threat of default on a major loan after Charney was fired.
Now, Charney and American Apparel are battling in two separate cases in Delaware Chancery Court. In the first, American Apparel has sued Charney for violating a standstill agreement by becoming involved in shareholder suits and commenting to the press. The second case is a follow-on to the first: Charney has sued to force the company to advance his fees for the standstill lawsuit. In this Game of Thrones, you win or you pay for your defense out of your own pocket.
On July 1, the SEC issued long-awaited proposed rules pursuant to the 2010 Dodd-Frank Act. As we've discussed in prior posts here and here, Section 954 of Dodd-Frank required the SEC to direct national security exchanges not to list any company that does not adopt a policy requiring recovery of incentive-based pay received by executive officers in excess of what would have been received under an accounting restatement. Although the new rules are only proposals and they could change after public comment, it's not too early for executives to begin to plan for the financial issues they will face in the event their company issues a financial restatement, as 746 companies did in 2014.
Clawbacks of executive compensation after a financial restatement are not new, of course. After the 2002 Sarbanes-Oxley Act authorized the SEC to claw back one year’s worth of incentive compensation from a CEO or CFO whenever there has been a financial restatement resulting from "misconduct," companies began voluntarily adopting clawback policies applicable to financial restatements. And after the Emergency Economic Stabilization Act of 2008 required clawback policies for companies receiving financial assistance under TARP that applied to "any bonus, retention award, or incentive compensation... based on statements of earnings, revenues, gains or other criteria that are later found to be materially inaccurate," additional companies adopted or expanded their clawback regimes. Today, most Fortune 100 companies have a clawback policy applicable to restatements (although they differ widely as to the triggering events, the types of compensation subject to clawback, whether the executive must have caused or contributed to the false or incorrect financial reporting, and the board's discretion to forgo a clawback, among other variables). But many large companies and most mid-cap and small companies have not adopted clawback policies, and virtually no company has implemented a clawback policy as severe as the Dodd-Frank legislation’s mandate. Most have been waiting for the SEC's proposed rules.
Benjamin Wey immigrated to Oklahoma from China as a teenager with scant dollars in his pocket. He parlayed ambition and ties to Chinese businesses into a lucrative investment firm engaged in the controversial practice of reverse mergers. According to the Washington Post, this so-called “Wolf of Wall Street” hired a beautiful Swedish model, Hanna Bouveng, to serve as his assistant, and used her Swedish contacts to further his business interests while heaping monetary rewards on her to seemingly win her affections. According to Bouveng, Wey pressured her into a sexual relationship, and when she refused his advances, he allegedly terminated her employment, waged war on her reputation through social media, stalked her, and threatened her with further ruin. Ms. Bouveng fought back in Manhattan federal court where she sued Wey for sexual harassment, retaliation and defamation. The jury returned an $18 million verdict in favor of Ms. Bouveng. While Ms. Bouveng likely feels vindicated, Wey is claiming victory on his twitter account.
National employers sometimes include choice-of-law provisions in their employment agreements, selecting one particular state’s law even for employees who don’t work in that state. For example, a company based in Massachusetts might ask its California employees to sign agreements selecting Massachusetts law. Applying one state’s law to all of the employer’s relationships can make outcomes more predictable, especially when the employer knows that law well.
But not always, as the New York Court of Appeals held earlier this month in Brown & Brown, Inc. v. Johnson. In Brown & Brown, the Court of Appeals refused to apply an employment agreement’s selection of Florida law, holding that New York law should determine whether a customer non-solicitation provision in that same agreement was enforceable.
In our last post, we discussed differences between “pay to stay” arrangements, which face stricter scrutiny in bankruptcy cases, and “Produce Value for Pay” plans, which provide incentives for executives based on strong corporate performance. As promised, we now examine two cases that illustrate acceptable ways for companies to motivate their executives to perform through a Chapter 11 bankruptcy.
The first is the case of Chassix Holdings, Inc., which manufactures parts for approximately two-thirds of automobiles made in North America. After a sequence of unfortunate financial and operational setbacks during 2014, Chassix found itself a petitioner under Chapter 11 of the bankruptcy code last month. Included among the operational setbacks was the fact that approximately 1,100 employees voluntarily left Chassix during 2014. Since it was critical to have a work force with the proper experience, skill, and know-how to manufacture the auto parts, Chassix found itself exploring ways to enhance its compensation options prior to the petition date in order to retain more of its employees. Unfortunately, it didn’t finish these plans prior to the petition date.
Chassix took a couple of important steps in designing its KERP and seeking authority from the bankruptcy court to implement it. First, and foremost, it limited its KERP to a pool of employees who were not company “insiders.” Therefore, the bankruptcy court applied the more liberal standard of business judgment when it evaluated the plan, even though Chassix had not established and regularly implemented the plan before its bankruptcy petition. Under this standard, and considering the pre-petition employee turnover and the support of the various creditor constituencies, the bankruptcy court approved the KERP.
At the outset, the answer to the question posed in this article seems simple: employers should just pay their employees as much as is reasonably possible. However, when a corporation finds itself in Chapter 11 reorganization, the Bankruptcy Code restricts the use of some traditional motivational methods. Simultaneously, competitors might make tempting job offers to quality employees, inducing them to leave the business. This combination of factors can distract employees from the main task of getting the debtor through the reorganization process.
To provide sufficient compensation and persuade employees to remain with the business, a debtor can attempt to adopt a key employee retention plan (KERP for short), also known as a “pay to stay” arrangement. This is in contrast to a “Produce Value for Pay” plan that provides incentives for strong corporate performance.
Section 1514A of the Sarbanes-Oxley Act shields a whistleblower from retaliation if he reports “conduct [that he] reasonably believes” violates certain laws, including Securities and Exchange Commission regulations. Last month, the Sixth Circuit held that the question of a whistleblower’s “reasonable belief” is a “simple factual question requiring no subset of findings that the employee had a justifiable belief as to each of the legally-defined elements of the suspected fraud.” Rhinehimer v. U.S. Bancorp Investments, Inc., No. 13-6641 (6th Cir. May 28, 2015). Based on this principle, the court affirmed a $250,000 verdict in favor of the plaintiff, Michael Rhinehimer.
According to the Court’s opinion, Rhinehimer was a financial planner for U.S. Bancorp who helped his elderly customer, Norbert Purcell, set up a trust and a brokerage account. In November 2009, Rhinehimer went on disability leave, and asked a colleague not to conduct any transactions with Purcell. The colleague didn’t follow the instructions, and instead put Purcell into investments that Rhinehimer believed were unsuitable. (Unsuitability fraud under the securities laws occurs when a broker knows or reasonably believes certain securities to be unsuitable to a client’s needs, but recommends them anyway.) Rhinehimer complained about the trades, but his superiors warned him that he should “stay out of the matter” and stop criticizing the colleague. After Rhinehimer hired a lawyer, he was placed on a performance improvement plan and fired after he failed to meet it.
Big Brother is watching you, or at least tracking your movements through your smartphone. According to the Washington Post, employers have steadily increased their use of GPS-enabled technology to track the movements and location of “field employees” like salespeople and delivery drivers. In fact, a 2012 study by the Aberdeen Group cited an increase of over 30% in the tracking of employees over the previous 5 years. Legitimate reasons exist to track field employees, such as making sure that drivers take the best routes and sales calls are conducted efficiently. But it’s more tricky to justify the tracking of employees who are off the clock. For example, Myrna Arias, a former sales executive with Intermex, was allegedly fired for disabling a tracking app called Xora StreetSmart when she was off duty. Now Ms. Arias has sued the company, alleging wrongful termination and invasion of privacy. Jay Stanley, a senior policy analyst at the ACLU, cautions employers against collecting off-the-clock data, because it opens the door to discriminatory practices. Mr. Stanley wondered, "What happens if an employer doesn't like the choices a worker makes in their personal lives and retaliates professionally?"
We discussed emerging trends in the c-suite recently, and found that companies are increasingly tying executive compensation to performance. For those that do not, we can imagine a corporate shareholder version of peasants storming the castle with pitchforks in hand, thanks to say-on-pay voting. In the case of JP Morgan CEO Jamie Dimon’s 2014 compensation, the shareholders’ rebellion led to a relatively low approval rate for Dimon’s and other executives’ compensation. According to USA Today, 61.4% of shareholders approved the payouts, which starkly contrasts with an average 90% approval rating for companies that seek shareholder input on salary and bonus plans. Advisory firm ISS encouraged shareholders to rebuke the plan when they learned of Dimon’s $7.4 million cash bonus. ISS advised that “[t]he reintroduction of a large discretionary cash bonus in the CEO’s pay mix, without a compelling rationale, has substantially weakened the performance-basis of his pay.” If corporate leadership can provide a strong rationale for a big bonus, it’s more likely that the shareholders will drop their pitchforks and fall in line.
Earlier this month, we posted about the U.S. District Court for the Northern District of Ohio’s decision that a credit union’s insurance policy was not invalid from the start because of its employee’s misrepresentations on the application. The decision, National Credit Union Administration Board, as Liquidating Agent of St. Paul Croatian Federal Credit Union v. CUMIS Insurance Society, Inc., also illustrates other arguments that insurers may make in denying coverage for claims under D&O policies or reserving their rights to litigate later. In this post, we explore how the court determined whether St. Paul “discovered” the loss more than two years before it filed suit against its insured, in which case its lawsuit would have been barred by a suit limitations period.
To briefly recap the facts of the case, St. Paul Croatian Federal Credit Union (“St. Paul”) and its insurer, CUMIS, agreed that a St. Paul bank manager, Mr. Raguz, had engaged in fraud by creating fake loans and accepting bribes. St. Paul eventually collapsed and was taken over by regulators. The liquidator appointed to administer St. Paul’s assets made a claim for its losses against CUMIS under a bond policy it had issued in favor of St. Paul. CUMIS responded not only by claiming that the bond policy was invalid from its inception because Mr. Raguz made material misrepresentations in obtaining and renewing it, but also because the policy stated that “legal proceedings” to recover loss from CUMIS had to be “brought within two years of Discovery of Loss.” Under the policy, “Discovery occur[ed] when [St. Paul] first become aware of facts which would cause a reasonable person to assume that a loss of a type covered under this Bond has been or will be incurred, regardless of when the act or acts causing or contributing to such loss occurred.”
To support its contention that St. Paul was aware of the loss long before it brought suit, CUMIS argued that the St. Paul board of directors were aware of two “critical facts” about the fraud, which would have led a reasonable person to assume a loss. First, CUMIS claimed that the delinquency rate of zero for the loan portfolio was unreasonable given its size, and that the directors should have known this fact more than two years before the lawsuit. In addition, CUMIS claimed that the directors should have known of the fraud more than two years in advance because the loan portfolio included $131.2 million of loans that were purportedly secured by deposits, even though in fact there were only $122.5 million of deposits securing the loans.
Federal prosecutors recently indicted David Colletti, a former VP of marketing with MillerCoors LLC, on charges relating to a scheme to embezzle $7 million from the beer brewing giant. Mr. Colletti, a thirty-year veteran of the company, allegedly broke bad by conspiring with others to defraud the company through fictitious invoices for promotional and other events that were never held. According to Law 360, MillerCoors sued its former marketing executive for $13.3 million last year in an effort to recover for the alleged fraud. Prosecutors claim that Mr. Colletti and his co-conspirators used the proceeds to purchase collectible firearms, golf and hunting trips, and—perhaps inspired by Pink Floyd—even bought an arena football team.
Nanoventions Holdings is a Georgia company that designs and manufactures microstructure technology used to prevent the counterfeiting of such things as currency, driver’s licenses, and event tickets. In 2011, $2 million went missing, and an investigation revealed that that its CFO, Steve Daniels, allegedly forged checks and converted funds to his own use as owner of a company called BIW Enterprises. In an interesting twist, BIW is engaged in the business of growing and distributing marijuana in California. According to Courthouse News Service, the company is suing Mr. Daniels for compensatory, treble and punitive damages under Georgia RICO statutes, and related causes of action. If the allegations are true, one might find a historical equivalent to these events in the 1920s, when the president of the Loft Candy Company stole thousands of dollars to buy Pepsi-Cola out of bankruptcy. Loft Candy ended up owning Pepsi on the basis that it was a stolen corporate opportunity. If Georgia shared Colorado’s stance on marijuana legalization, would the court award ownership of the pot business to Nanoventions? Oh what a difference a century makes.
Last May, we covered a decision by a Michigan federal court that torpedoed Debourah Mattatall’s claims against her former employee, Transdermal Corporation. Now, thanks to a recent decision by the U.S. Court of Appeals for the Sixth Circuit, Mattatall’s claims have been brought back to life.
To briefly recap the facts, Mattatall used to own a company called DPM Therapeutics Corporation. She sold it to Transdermal and entered into a Stock Purchase Agreement and Employment Agreement with that company. According to Mattatall, Transdermal didn’t comply with its obligations, and she sued it in federal court. But the court quickly granted summary judgment, finding that Mattatall gave up her claims in a settlement agreement that resolved other litigation against her.
In that litigation, DPM’s minority shareholders challenged the sale to Transdermal, and Transdermal countersued those shareholders. The parties to the litigation, including Mattatall, resolved the dispute and entered into a settlement agreement and a general release. The release stated that “Transdermal, DPM, [another controlling owner], and Mattatall and each [minority shareholder] … release[d], waive[d] and forever discharge[d] each other” from any claims arising before the agreement was signed. In Mattatall’s subsequent lawsuit against her employer, Transdermal, the district court ruled that this language released all claims that any party to the agreement had against any other party – even though Transdermal and Mattatall were on the same side in the shareholder litigation, and Transdermal reassured Mattatall that she wasn’t releasing her unrelated claims against it before she signed. Because her claims against Transdermal fell within the “unambiguous” and “broadly worded” terms of the release, this evidence was irrelevant, and Mattatall was out of court.
The recent decision in National Credit Union Administration Board, as Liquidating Agent of St. Paul Croatian Federal Credit Union v. CUMIS Insurance Society, Inc., from the U.S. District Court for the Northern District of Ohio, is yet another case illustrating how important the precise terms of a policy can be in determining the coverage. As we’ve previously discussed on this blog (here and here), a D&O insurance policy is reliable protection for the indemnification rights of the officers and directors in times of financial distress. Many policies also offer coverage to the entity for injuries caused by misdeeds of its employees. The St. Paul case illustrates what can happen when the employee charged with procuring the insurance policy on behalf of the entity is also the party engaging in fraudulent conduct.
St. Paul Croatian Federal Credit Union (“St. Paul”) was established in 1943 to serve members of St. Paul Croatian parish in Cleveland, Ohio. For more than 53 years it operated from a single branch with about 3 employees. In 1996, a manager retired and one of the tellers, Anthony Raguz, was promoted to fill his position. The credit union grew tremendously over the next fifteen years, and by March 31, 2010, St. Paul had total assets of $250 Million and a loan portfolio of $240 Million.
Doug Parker, the Chairman and CEO of American Airlines, has just joined a small cadre of executives who earn no salaries. Before anyone starts a GoFundMe page for Mr. Parker, consider that his 2015 compensation consists of 207,672 restricted stock units, the value of which will depend upon the airline’s performance. According to the Wall Street Journal, the stock units could amount to compensation in the range of $10.7 million if calculated using the current stock price of $51.40. By comparison, Mr. Parker earned $12.3 million in 2014, 40% of which was cash in the form of a $700,000 base salary and annual cash incentives. Mark Reilly, head of Verisight, Inc., a firm of executive compensation consultants, told the Journal that this type of compensation structure is more often found in companies facing financial hardship, and the lack of salary is offset by more generous stock awards. In the case of an executive in an established, mature industry, the message seems to be that Mr. Parker believes in the stock and that he is willing to tie his compensation to its performance. Given US Airways’ performance since its merger with American in 2013, this wouldn’t seem like an incredible risk on his part. The combined company “has soared to record profit and its stock has climbed 42% in the past year.”
After firing its head patent attorney, Steven Trzaska, L’Oreal is now under fire from Trzaska in New Jersey federal court. On April 16, 2015, Trzaska sued L’Oreal, claiming that his firing violated New Jersey’s Conscientious Employee Protection Act (“CEPA”).
In his complaint (available at Law360), Trzaska alleges that L’Oreal had a quota for its New Jersey office of 40 filed patent applications in 2014. But, Trzaska contends, an outside consultant had previously found that many of L’Oreal’s patent applications were purely cosmetic, saying that “the vast majority of its inventions were of low or poor quality.” Trzaska alleges that his superiors pressured him to file applications to meet the quota. However, he told them that “neither he nor the patent attorneys who reported to him were willing to file patent applications that the attorneys believed were not patentable.” Soon after, L’Oreal terminated him, saying that it was hiring a new “head of patents of the Americas.” Trzaska claims that this explanation was pretext and that the company in fact fired him because he refused to file applications that were not patentable.
How do Trzaska’s claims line up with CEPA?
Companies buy directors & officers (“D&O”) insurance policies with the intention of providing protection for key individuals in a corporate structure. The recent decision BioChemics, Inc. v. AXIS Reinsurance Co., from the U.S. District Court for the District of Massachusetts, illustrates the importance of the terms of the policy in determining what is covered, what is not, and when you should notify the insurer of a potential claim.
As we’ve previously discussed, an insurance policy can provide more reliable protection for the indemnification rights of the directors and officers in times of financial distress, because corporations plagued by regulatory or other legal problems frequently suffer financial setbacks. However, when a corporation is the subject of an official investigation, determining exactly what constitutes the start of a covered “claim” may be a matter of some delicacy.
Ellen Pao may not have won her gender discrimination case against Kleiner Perkins, but she may have inspired numerous women working in Silicon Valley who identified with her cause. According to Fortune, employment lawyers are seeing a heightened awareness among women that the workplace issues they face, and that Ms. Pao articulated in her case, are perhaps more widespread than not. This “Pao Effect” has Kay Lucas, a San Francisco-based employment law attorney, fielding twice as many calls each week from potential clients with workplace gender discrimination concerns. Kelly Dermody, a partner at Lieff Cabraser Heimann & Bernstein, has litigated gender discrimination cases for a decade, and told Fortune that her clients now have a heightened willingness to speak out. Lucas also said that companies are more inclined to settle instead of allowing information to become public, and as we observed with the Pao trial, highly publicized. Lucas noted that many of her clients’ complaints share similar themes involving exclusion from important meetings and denied access to the circles of influence. Yet, she said to Fortune, “these women are not particularly angry; they’re ambitious. They’re not victims; they want to be participants.”
A quick search of legal news gives this “Pao Effect” additional credibility. According to Law 360, Heather McCloskey recently sued Paymentwall, Inc. for sexual harassment, discrimination, retaliation and failure to take reasonable steps to prevent harassment and discrimination. Ms. McCloskey alleged that executive Benoit Boisset routinely harassed her, calling attention to her physical appearance in a demeaning manner. As she became more vocal in her objections, Boisset used expletives when referring to her, and ultimately terminated her employment. McCloskey also described the workplace environment as young, predominantly male and lacking any formalized set of rules or policies. Kelly Dermody cited these kinds of workplace dynamics as partially to blame for the volume of complaints arising from Silicon Valley. She opined to Fortune that many tech companies take off “really quickly without a lot of attention to human resources.” Consequently, “you have a lot of young managers who make young managers’ mistakes,” which might encompass many of the alleged missteps in the Paymentwall case.
We cover a broad range of issues that arise in employment disputes. Occasionally, we also spotlight other topics of relevant legal interest, ranging from health care to white-collar defense to sports, just to keep things interesting.
Led by Jason Knott and Andrew Goldfarb, and featuring attorneys with deep knowledge and expertise in their fields, Suits by Suits seeks to engage its readers on these relevant and often complicated topics. Comments and special requests are welcome and invited. Before reading, please view the disclaimer.