McDonald's Corporation has joined a growing list of companies that have taken action to forfeit unpaid compensation or demand repayment of compensation previously paid to a former CEO, including equity awards or proceeds from the sale of equity awards, pursuant to company clawback policies. The McDonald's complaint against its former CEO serves as a cautionary reminder to companies and boards that a clawback situation can heighten a company's litigation exposure, trigger embarrassing and potentially damaging publicity, and raise questions about the adequacy of the board's governance and oversight.
In the case of McDonald's, the situation comes at a significant cost of having to litigate to obtain repayment of severance and equity awards paid to the CEO upon his termination of employment, plus the cost of multiple investigations by the McDonald's board of directors following from their initial conclusion that the termination of the CEO should be treated as a termination "without cause" enabling the CEO to receive full severance benefits upon his negotiated termination.
Summary of Complaint
On August 10, 2020, McDonald's filed suit in the Delaware Court of Chancery against its former CEO, Steve Easterbrook, accusing him of lying, concealing evidence and fraud after entering into a separation agreement with Easterbrook on November 3, 2019. In November 2019, McDonald's announced Easterbrook's termination following the board's determination that he violated company policy and demonstrated poor judgment involving a non-physical consensual relationship with an employee (via text messages and video calls), and that the board determined that the termination was to be one "without cause" permitting Easterbrook to receive full benefits under the McDonald's severance plan in excess of $40 million.
The complaint states that in July 2020, McDonald's received an anonymous report alleging that a different McDonald's employee engaged in a sexual relationship with Easterbrook while he was CEO that was separate from the aforementioned non-physical consensual relationship. An internal investigation into this new allegation discovered photographic evidence that, while he was CEO, Easterbrook had engaged in a physical sexual relationship not only with the employee discussed in the anonymous report but with several other employees in late 2018 or early 2019, and evidence that Easterbrook lied during the original investigation into his behavior in October 2019, when independent outside counsel expressly asked him if he had ever engaged in a physical sexual relationship with any McDonald's employee.
The second investigation also showed that Easterbrook approved a special discretionary grant of restricted stock units-worth hundreds of thousands of dollars-to this second employee shortly after their first sexual encounter and within days of their second. McDonald's was not aware of this new evidence of improper conduct before July 2020, and only discovered it in the course of investigating the allegations regarding a relationship between Easterbrook and the second employee. In the complaint, McDonald's alleges that Easterbrook, with the intention of concealing the existence of the evidence of this and other relationships with employees, had deleted the texts and emails regarding his relationship with the second employee and such other relationships from his phone. Unbeknownst to Easterbrook, however, the deletion of the e-mails from the mail application on his McDonald's-issued phone did not also automatically result in the deletion of those e-mails from his McDonald's e-mail account stored on McDonald's servers.
The November 2019 separation agreement, as negotiated and approved after deliberation by the directors prior to their awareness of this new information, provided that Easterbrook's termination would be "without cause" for the purpose of determining the amount of his severance compensation and benefits, allowing Easterbrook to receive substantial severance compensation and benefits provided under his existing compensatory arrangements. The complaint stated that the board would not have agreed to this provision of the separation agreement had it possessed clear evidence justifying a termination of Easterbrook for "cause."
The complaint seeks to recoup the severance payments and benefits paid to Easterbrook as CEO based on language in the McDonald's severance plan that was incorporated into Easterbrook's separation agreement. Under the terms of the severance plan, "if the Plan Administrator determines at any time that a Participant committed any act or omission that would constitute Cause while he or she was employed," [emphasis added] McDonald's "may (a) cease payment of any benefit otherwise payable to a Participant under the Plan and (b) require the Participant to repay any and all Severance Benefits previously provided to such Participant under the terms of the Plan."
"Cause" is defined to include commission of any act "involving dishonesty, fraud, illegality, or moral turpitude," as well as any "serious, reckless or material violation of McDonald's Standards of Business Conduct or other employment policies." The separation agreement also incorporated provisions of the documents governing Easterbrook's 2018 and 2019 equity awards stating that the benefits granted are subject to repayment or forfeiture if "the Company determines, in its sole and absolute discretion, that the [Grantee] engaged in Detrimental Conduct," which is defined to include "willful fraud that causes harm to the Company."
The complaint alleges that Easterbrook told deliberate falsehoods; that he knew and intended that his false denial would induce the company to separate him on terms more favorable than the truth would have warranted. The complaint states that Easterbrook, as McDonald's highest-ranking officer, owed fiduciary duties of loyalty and candor to the company, and that the company justifiably relied on Easterbrook's false denial in approving the separation agreement. The complaint alleges that reliance caused the company injury.
The complaint further alleges that Easterbrook violated McDonald's Standards of Business Conduct by pursuing sexual relations with employees of the company and by making decisions about one such employee's compensation while engaged in an improper sexual relationship with her. Further, Easterbrook violated policy by failing to disclose those violations and instead falsely denying the improper relationships and that Easterbrook's silence, lies and acts of concealment were a breach of the duty of candor and were calculated to induce McDonald's to separate him on terms much more favorable to him than those the McDonald's board would have offered and agreed to had it known the full truth of his behavior. The complaint states that such behavior was a classic breach of the duty of loyalty.
The complaint also avers that the board would not have agreed to the terms of the separation agreement had it then been aware of Easterbrook's physical sexual relationships with three McDonald's employees, his approval of a discretionary stock grant for the second employee while they were in a sexual relationship, and the falsity of his representation to outside counsel that he had never engaged in a physical sexual relationship with a company employee. The complaint alleges that such conduct constituted a clear legal basis to terminate Easterbrook for "cause."
Potential Advancement of Legal Fees
It is expected that Easterbrook, in fighting McDonald's claim for a clawback of benefits paid or payable pursuant to the separation agreement, will claim that McDonald's must advance any legal fees and other costs that he will bear in defending the lawsuit under the company's indemnification policies, similar to the claim and ultimate court determination in the case Hertz Corporation and Hertz Global Holdings v. Frissora.
In that case, the Delaware Chancery Court judge ruled in favor of the former executives on the advancement issue, stating that the former executives were entitled to have their legal defense costs advanced by Hertz because the clawback suit arose from their work as officers of the company and is covered by the broad advancement rights in the bylaws, although noting that the ultimate outcome of the lawsuit could require the former executives to pay back those costs if they are found to have committed negligence. While the allegations supporting the substance of the clawback between the Hertz case and the McDonald's situation differ, a determination of whether Easterbrook may initially make a claim for advancement of legal fees is likely not to have a different outcome.
Key Takeaways
The takeaway from the McDonald's complaint is that a clawback situation-especially after the board has finished an initial investigation which leads to payment of benefits to a departing executive and a determination that such executive should not be terminated for "cause"-is potentially extremely embarrassing to a company and the board, and will likely result in millions of dollars of legal fees. Thus, if a company or board elects to conduct an investigation, especially of allegations with respect to the integrity of the CEO, it should ensure that the investigation is thorough and takes into consideration all available relevant evidence. The board should also strongly consider retaining outside legal counsel who can help provide the requisite objectivity and protect against shareholder challenges to the board's decision.
In addition, the McDonald's case raises the relatively rare scenario where a board is alleging fraudulent statements made by an executive in the course of the investigation itself. These facts will likely provide ample support to institutional investors as they continue to seek expanded adoption and use of clawback tools well beyond the financial matters typically contemplated by clawbacks, to include provisions relating to issues of serious reputational harm, violation of fiduciary obligations and violation of company codes of conduct.
Finally, the McDonald's litigation will serve as notice to companies and their boards of directors that they should reexamine the definitions of "cause" that are used in company employment agreements, cash incentive plans, equity plans and severance plans, review the terms of any existing clawback language or policies, both within specific plans and as a standalone company policy, and review bylaw provisions relating to the advancement of legal fees, in order to avoid the troublesome and costly issues that can arise in situations similar to the one facing McDonald's.
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