Pomerantz LLP

Corporate Governance & Therapeutics

Attorney: Gabriel Henriquez
Pomerantz Monitor July/August 2017

On September 16, 2015, Lithia Motors, Inc. filed a Form 8-K with the SEC announcing that Sidney DeBoer, its founder, controlling shareholder, CEO, and Chairman, would step down as an executive officer of the company and would receive annual compensation—for life— in consideration for his past services. According to a “Transition Agreement” between Lithia and DeBoer, the company would pay him $1,060,000 and a $42,000 car allowance annually for the rest of his life, plus other benefits. The payments under the Transition Agreement were in addition to the $200,000 per year that DeBoer receives for continuing to serve as Chairman.

Although the company annually submitted its executive compensation packages to a (non-binding) shareholder vote, it did not do so this time, even though the agreement was tainted by obvious self-dealing by the controlling shareholder. Companies usually appoint a special committee of independent directors to negotiate contracts with a CEO or controlling shareholder; but here, Sidney DeBoer and his son, the current CEO, Bryan DeBoer, negotiated all the material terms. The company’s Compensation Committee, consisting of four directors who are purportedly “independent,” had minimal input into the terms of the Transition Agreement. Once it was handed to them, they rubber-stamped it with only minor changes, which had been mostly proposed by, and favorable to, Sidney DeBoer.

Our client, as well as another one of Lithia’s shareholders, filed derivative complaints on behalf of Lithia in Oregon state court, where Lithia is headquartered. We alleged that the board of directors breached its fiduciary duties by approving the Transition Agreement without any meaningful review, injuring the company and its shareholders. We also alleged that the board was not independent and was conflicted due to the existence of longstanding relationships between the purportedly independent directors and Sidney DeBoer, as well as significant compensation paid to the directors, which they would lose if Sidney DeBoer decided to remove them from the Board. At the time of the approval of the Transition Agreement, Lithia’s Audit and Compensation Committees (both of which reviewed the agreement before it was entered into) had the same four members; the only difference was which director served as chair of the respective committees. Each of the four members had close personal ties to Sidney DeBoer.

Documents obtained by plaintiffs during the discovery phase of the litigation revealed that Sidney DeBoer: routinely attended meetings of the Compensation Committee responsible for setting his compensation and the compensation of Bryan DeBoer; was directly involved in setting compensation for management and the Board; and single-handedly made determinations regarding the composition of the Board, and continues to dominate and hold tight command over Board decisions. If Sidney DeBoer did not agree with how the Compensation Committee would vote on a particular matter, he would instruct to hold off on the vote until each director had a discussion with him first. The consequences of this lack of checks and balances was clear. The directors approved an agreement that committed Lithia to paying lavish sums indefinitely, regardless of whether Sidney DeBoer provided services effectively for Lithia, or even if he provided no services at all.

This circumstance highlights the need to have an independent board of directors able to effectively monitor management and corporate success without undue influence by the CEO, Chairman, controlling shareholder— or all three, as was the case here.

Through extensive litigation efforts, Pomerantz, together with its co-counsel, was able to extract corporate governance therapeutics that provide substantial benefits to Lithia and its shareholders and redress the wrongdoing alleged by plaintiffs. For example, the Board will be required to have at least five independent directors as defined under the New York Stock Exchange rules by 2020; all future life-time compensation contracts for named executive officers exceeding $1 million per year must be submitted to shareholders for approval, and will be reviewed by disinterested members of the Audit Committee; the Audit and Compensation Committees shall each have at least one independent director who is not a member of both committees; a four-consecutive-year term limit shall be imposed for the chair of committees of the Board; a 15-year term for shall be imposed for service as an independent director on Lithia’s Board; Lithia will also publicly disclose, in information accompanying its annual proxy statement and accessible on Lithia’s website, the most recent five years’ compensation of the named executive officers. Finally, but perhaps most importantly with regards to the issue at hand, the settlement calls for the Transition Agreement to be reviewed by an independent auditor who will determine whether the annual payments of $1,060,000 for life toSidney DeBoer are reasonable. Lithia has agreed to accept whatever decision the Auditor makes.