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Corporate Alert: Shareholder Advisory Vote Bill, Standard for Director Liability in Oversight Cases, Debt of Cybersquatter Non-Dischargeable in Bankruptcy, MP3 Patent Infringement Case Could Have Industry-Wide Impact
March 2007
Authors: Edward B. Stevenson, Irwin A. Kishner

Shareholder Advisory Vote Bill Put to the House as Major Companies Consider the Vote

On the heels of a decision in February by Aflac Insurance to give its shareholders an annual advisory vote on executive compensation, House Financial Services Committee Chairman Barney Frank and 21 other representatives introduced a bill to the United States House of Representatives that would require public companies to give shareholders a non-binding advisory vote on executive pay plans and compensation. Titled the "Shareholder Vote on Executive Compensation Act," the bill allows shareholders to cast votes of approval or disapproval, with the ultimate decision-making resting with the board in light of the vote. A similar bill was introduced in 2005, mandating shareholder approval of any "golden parachute" payments in connection with an acquisition. The current version of the bill calls only for an advisory vote. A hearing on the bill will be held in March, with Chairman Frank expecting passage as soon as April, 2007.

Although the bill is still pending, following Aflac's announcement, other large companies have expressed the possibility of voluntarily offering their shareholders advisory votes. A working group comprised of various companies including Pfizer, Colgate-Palmolive, JPMorgan Chase, Intel and Prudential is in place to discuss offering such a non-binding vote to its shareholders. Aflac shareholders may exercise their advisory voting rights beginning in 2009, by which time, many or all public companies may have followed suit, whether by choice or under federal law.

Delaware Supreme Court Specifies Standard for Director Liability in Oversight Cases: Conscious Disregard of Duty of Loyalty

In Stone v. Ritter, 911 A.2d 362 (Del. 2006), the Delaware Supreme Court formulated the standard for holding directors liable in "oversight" cases (cases in which plaintiffs attempt to hold directors personally liable for failing to properly oversee corporate activities): plaintiffs must show that directors have a conscious disregard for the good-faith exercise of their fiduciary duty of loyalty. The Court also clarified its view of the difference among the duties of care, loyalty and good faith in oversight cases, an area of the law which the Court acknowledged in In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 63 (Del 2006) is not well-developed.

It has been established that "absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists." However, prior to Stone, there was no formulation of the legal standard that should govern directors' obligations to supervise or monitor corporate activities absent any conflicts, self-dealing, or bad faith. The standard was discussed but not determined by the Delaware Chancery Court in In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 971 (Del. 1996): "only a sustained or systematic failure of the board [of directors] to exercise oversight—such as an utter failure to attempt to assure [that] a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability." The Court in Stone expressly adopted the standard articulated in Caremark.

When discussing the triad of the duties of care, loyalty and good faith, it is important to make distinctions among them because, according to the Court in Stone, only directors' violations of the duty of care or the duty of loyalty can result in their liability. In oversight cases, a showing of bad faith bears on directors' duty of loyalty and is necessary in establishing director liability. In addition, as the Court stated in Disney, a conduct that is subject to due care may overlap with conduct that is subject to good faith, "but from a legal standpoint those duties are and must remain quite distinct." While Disney clarifies the duty of good faith (and consequences of bad faith), Stone clarifies the directors' standard of conduct and the standard by which their potential liability will be assessed; namely, the directors must demonstrate a conscious disregard for their responsibilities, such that they breach their duty of loyalty by failing to exercise that duty of good faith.

Debt of Cybersquatter Non-Dischargeable in Bankruptcy

In a case recently decided by the United States Bankruptcy Court for the Central District of California, (In re Scott William Wright, Bankruptcy No. RS 05-13967 PC (Bankr. C.D. Cal. Oct. 24, 2006)) a cybersquatter's debt to a hotel franchisorstemming from a judgment under the Anticybersquatting Consumer Protection Act (the "ACPA") was ruled non-dischargeableon grounds of willful and malicious injury by the debtor. Following a finding in the district court that debtor's use of certainInternet domain names constituted service mark infringement under the ACPA, the hotel franchisor was awarded royalties anddamages and debtor was subsequently forced into Chapter 7 bankruptcy.

In holding that the debtor's judgment-related debt should be non-dischargeable, the Bankruptcy Court took the position that thedebtor's cybersquatting activities constituted willful and malicious injury under Section 523(a)(6) of the Bankruptcy Code.The Court relied on a definition of cybersquatting as the "deliberate, bad-faith, and abusive registration of Internet domainnames in violation of the rights of trademark owners."

In ruling for the hotel franchisor, the Court reasoned that as the debtor's cybersquatting activities had previously been found by the district court to be in violation of the ACPA and to constitute a bad faith intent on the part of the debtor to profit from the use of the infringing domain names, and as the circumstances surrounding the debtor's conduct suggested a substantial certainty of willful intent, the "willfulness" and "malice" requirements of Section 523(a)(6) of the Bankruptcy Code were necessarily met by the debtor's behavior. As a consequence, debtor was denied discharge.

MP3 Patent Infringement Case Could Have Industry-Wide Impact

In a trial watched closely by many technology companies and content providers, a jury in the Federal district court in San Diego has found that Microsoft wrongfully used MP3 digital audio-compression music technology without the permission of Alcatel-Lucent, which owns patents in the technology. MP3 technology is commonly used by technology companies and content providers for music and sound files that can be played by digital music players such as Microsoft's Windows Media Player or Apple's iTunes on a computer, mobile phone or portable music device. In finding that Microsoft violated Alcatel-Lucent's patents by using the MP3 technology in conjunction with Microsoft's Windows Media Player, the jury awarded $1.5 billion in damages to Alcatel-Lucent, the largest sum ever awarded in a patent dispute. The damages were based on the average selling price of every Windows-based personal computer sold worldwide since May 2003 multiplied by the total number of Windows-based personal computers sold worldwide during that time. Microsoft has stated that it will appeal the verdict.

Microsoft claimed that Alcatel-Lucent's claims were unfounded because Microsoft has been licensing the technology from Germany-based Fraunhofer Institute for Integrated Circuits IIS. Fraunhofer helped develop the MP3 technology with Bell Labs, which was once part of Lucent Technologies Inc. Lucent was acquired by Alcatel SA in 2006. Microsoft to date has paid Fraunhofer $16 million for a license to this technology. With its victory over Microsoft, Alcatel-Lucent may move forward with additional legal action against hundreds of other companies that rely on MP3 technology. Many large technology companies and content providers, such as Apple, Creative and RealNetworks, also currently license MP3 technology from Fraunhofer.

For more information on these issues or other corporate matters, please contact:

Irwin Kishner at 212.592.1435 or ikishner@herrick.com
Edward Stevenson at 973.274.2025 or estevenson@herrick.com 

Copyright © 2007 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.