In R.A. Feuer on behalf of CBS Corporation v. Sumner M. Redstone (C.A. No. 12575-CB (Del. Ch. April 19, 2018)), R. A. Feuer (“Plaintiff”), a stockholder of CBS Corporation (“CBS”) brought a derivative suit against the directors of CBS Corporation (“Board”) alleging corporate waste, bad faith, and unjust enrichment for compensation in excess of $13 million dollars paid to Sumner Redstone, the controlling stockholder, former executive chairman and chairman emeritus of CBS (“Redstone”).  The payments were made under an extreme set of circumstances that resulted in the claims partially surviving a Rule 23.1 motion to dismiss for failure to make a pre-suit demand on the board and a 12(b)(6) motion to dismiss for failure to state a claim upon which relief could be granted.

Redstone had a long standing relationship with CBS and its predecessor corporation, the former Viacom, Inc. (“Viacom”). Prior to the CBS split from Viacom, Redstone served as chairman of the board of directors for 18 years and the CEO for 9 years. Following the split, Redstone served on the Board from January 1, 2006 until his resignation on February 4, 2016.  He is also the controlling stockholder of CBS, holding 79.5% of the class A shares of CBS through a trust in which ownership is traced back to him. Redstone’s compensation was governed by an amended employment agreement that provided he would receive a base salary of $1 million dollars a year plus an annual bonus based on performance goals established by the compensation committee.  The compensation committee was required to review Redstone’s compensation at least annually and could increase, but never decrease, his base salary.  However, the employment agreement was terminable at will by either party.  In 2010, the compensation committee increased Redstone’s salary to $1.75 million dollars.

In the early part of 2014, not long before Redstone’s 91st birthday, the compensation committee approved performance based goals for Redstone that stated Redstone was to act as counsel to the CEO on strategic issues, ensure that strategic plans were up to date and executed, and assist the board in maintaining best governance practices. However, following the setting of these goals Redstone suffered a significant decline in health including multiple hospitalizations and pneumonia.  His participation in Board meetings became limited to only one or two sentences that the other participants could barely understand.

During this period of time there was also case pending challenging Redstone’s mental capacity and tabloid stories about his health and mental state. There was an email communication between two directors questioning Redstone’s condition and stating that he “barely communicates and then is totally unintelligible.”  Two additional directors stated Redstone was “especially vacant and absent” and “appeared out of touch, remote, and non-responsive to the people around him” after meeting with him in October 2015.  During the abovementioned time period the compensation committee approved several payments, which are the subject of this derivative suit, as follows: (1) Redstone’s base salary of $1.75 million dollars and a $9 million dollar bonus based on company performance in 2014; (2) Redstone’s base salary of $1.75 million dollars in 2015; and (3) Redstone’s base salary of $1 million dollars in his new role as Chairman Emeritus which was given to him based one his past service CBS.

Stockholders may not successfully bring a derivative claim on behalf of a corporation unless they “either (1) make a pre-suit demand by presenting the allegations to the corporation’s directors, requesting that they bring suit, and showing that they wrongfully refused to do so, or (2) plead facts showing that demand upon the board would have been futile.” (In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106,120 (Del. Ch. 2009) (citing Stone v. Ritter, 911 A.2d 362, 366-67 (del. 2006))).  Failure to make a pre-suit demand or to show such a demand would be futile will result in the dismissal of a derivative claim.

Under Delaware law there are two tests to determine the futility of a pre-suit demand, the Aronson test and the Rales test. The Aronson test is applicable to decisions made by the board and is triggered when an approved decision can be imputed to the entire board because it was approved by at least half of the corporation’s directors.  The Rales test is used in instances of inaction by the board and applies where a derivative plaintiff challenges a decision approved by a board committee consisting of less than half the board.  Under both tests the plaintiff must challenge the ability of at least half the directors in the office at the time an action is initiated to give impartial consideration to the demand.  If a pre-suit demand is not made or excused a complaint is not allowed to move forward.  However, if a pre-suit demand is excused the complaint will also survive a 12(b)(6) motion as the standard for a 12(b)(6) motion is lower than that of excusing the requirement of making a demand under Rule 23.1.  There is a presumption of good faith underlying the actions of directors. Bad faith will only be found when the decision under attack is so far beyond the bounds of reasonable judgment that bad faith is the only explanation for such action.

The Court found that the Rales test applied to the pre-suit demand requirement and found the demand would be partially futile. As it relates to the $9 million dollar bonus paid in 2014, the pre-suit demand was not excused as the compensation committee comprised of four board members, a minority of the thirteen members, was wholly responsible for the decision to pay the bonus.  Since only four members of the Board faced a substantial threat of personal liability with respect to the bonus payment, Plaintiff could not show that the remaining members of the Board were interested in the decision to litigate such that a demand on the Board would be futile.  However, the Court found that a demand would be futile with respect to the three years of salary payments because all the members of the Board faced a substantial threat of personal liability with respect to the salary payments. Any director could have moved for the termination of Redstone’s employment agreement, which governed the payment of his salary, but there appears to be no record of even a discussion about Redstone’s capacity or if his employment should be continued.  Since the demand is excused for the salary payments, the burden with respect to surviving a 12(b)(6) motion is also met for these claims. As a result the Court permitted Plaintiff to move on to the next stage of litigation to challenge the Board of CBS on a claim of corporate waste, bad faith, and unjust enrichment to Redstone for payments totaling $4.5 million dollars.

Rashida Stevens also contributed to this post.