Maryland Attorney General Opinion 95 OAG 062

62 [95 Op. Att’y

CORPORATIONS

E XECUTIVE C OMPENSATION – W HETHER E XECUTIVE

C OMPENSATION M AY C ONSTITUTE A “W ASTE” OF

C ORPORATE A SSETS AND H OW S UCH C OMPENSATION M AY

B E R EGULATED

March 8, 2010

The Honorable Jamie Raskin

The Honorable James Brochin

Maryland Senate

You have asked about the law governing executive

compensation at Maryland corporations. In particular, you have

asked whether payment of excessive executive compensation can

constitute a waste of corporate assets. You have also asked whether,

in such circumstances, any State official would have standing to

initiate a quo warranto action under Annotated Code of Maryland,

Corporations & Associations Article (“CA”), §1-403(d) to challenge

the payment of such compensation. Finally, you have asked whether

the General Assembly could lawfully restrict executive

compensation through legislation. Your questions were prompted

by concerns about certain executive compensation practices at

Constellation Energy Group (“CEG” or “the Company”) and, more

specifically, the compensation paid or owing to the chief executive

officer of CEG.

Our conclusions as to the law are as follows:

i Excessive executive compensation may constitute a

“waste” of corporate assets.

i The courts usually defer to decisions of a board of

directors on an issue such as executive compensation

under the “business judgment rule,” also referred to by

the Court of Appeals as the “principle of non-

intervention.” This principle depends in part on whether

the directors acted in good faith.

Gen. 62] 63

i Allegations of corporate waste are typically litigated in

the context of a shareholder derivative action, rather than

a quo warranto action.

i CA §1-403(d) was part of the Model Business

Corporation Act, as adopted in Maryland some years ago.

Under that statute, the Attorney General retains authority

to seek injunctive relief or dissolution of a corporation

that engages in unauthorized or “ultra vires” actions.

There are few cases in the last century in which state

Attorneys General have exercised this authority and none

challenging corporate decisions as to executive

compensation.

i The General Assembly has authority to enact legislation

regulating executive compensation at Maryland

corporations and businesses. There will be issues of

retroactivity and vested rights to the extent such

legislation attempted to alter compensation due under

existing agreements.

I

Background

Executive compensation at American corporations has

generated controversy during the past two decades. Some critics

have pointed to the fact that the pay of American CEOs has grown

rapidly in recent years and exceeds the compensation of similarly

situated executives in other countries. For example, during the

period 1990 through 2003, CEO compensation increased by 313%

while the average worker’s pay increased by 49% and inflation was

41% for the same period. See Interfaith Center on Corporate

Responsibility at <www.iccr.org/news/press-releases/2004/

pr_ceopay041504.htm>. A 2005 study of executive pay in 26

countries found that American executives made twice as much as

comparable executives in Western European countries. Id. More

recently, another study found that, compared to other western

industrialized countries, the United States had the greatest disparity

between CEO compensation and the compensation of average

workers. Heather Landy, Behind the Big Pay Days – Growing Sense

of Outrage Over Executive Pay, Washington Post (November 15,

2008) at p. A08.

64 [95 Op. Att’y

The full extent of executive compensation can be elusive as it

may take numerous forms, including base salary, benefits,

incentive awards, perquisites, and other elements, each with its

own formula. Moreover, a significant portion of many CEOs’

compensation consists of pension benefits, though they are

not as readily understood as direct compensation. Failure to

consider the design and value of such a plan can lead to an

underestimate of the CEO’s actual compensation and an

overestimate of the extent to which that compensation is actually

linked to performance of the company. See L. Bebchuk & R. Jackson,

Putting Executive Pensions on the Radar Screen, Harvard John M.

Olin Discussion Paper No. 507 (March 2005).

In response to such criticism, boards of directors and

compensation committees have increasingly sought to validate their

decisions concerning executive pay through reliance on outside

experts and data. Thus, they have made greater use of compensation

consultants and labor market studies involving “peer” companies.

Some argue that the reliance on compensation consultants and

compensation studies may actually have contributed to the increase

in CEO pay in recent years. See Simmons, Taking the Blue Pill: The

Imponderable Impact of Executive Compensation Reform, 62 SMU

L. Rev. 299, 352-53 (2009) (describing the “Lake Wobegon effect”

in which compensation committees tend to set pay at the 75 th

percentile of comparable organizations with the result that all

executives are considered “above average”).

To allow for an informed critique of such decisions of

compensation committees, and the opinions and data on which they

rely, the Securities and Exchange Commission (“SEC”) has required

more detailed disclosure by public companies concerning

the elements of executive compensation, the board or

committee’s philosophy underlying its decision, and the references

used to justify those decisions. To some extent, enhanced

disclosure has exposed flaws in the system by which some

companies set compensation. For example, since the SEC required

identification of peer groups in 2006, several studies have

concluded that the selection of peer groups for benchmarking

executive pay is subject to manipulation. See, e.g., M. Faulkender

& J. Yang, Inside the Black Box: The Role and Composition of

Compensation Peer Groups (working paper -Washington

University and Indiana University 2008) (firms forgo lower paid

industry peers in favor of higher paid peers from outside industry);

A. Albuquerque, G. DeFranco, & R. Verdi, Peer Choice in CEO

Compensation (Boston University 2009) (finding that firms

appear to be self-serving when selecting peers for executive

Gen. 62] 65

compensation decisions). However, enhanced disclosure alone may

not be the entire cure. See Cioppa, Executive Compensation: The

Fallacy of Disclosure, 6:3 Global Jurist Topics (Berkeley 2006)

(arguing that even the enhanced disclosure has not disciplined

compensation decisions). To decipher disclosures made concerning

the disparate elements of executive compensation, one must be “part

attorney, part accountant, and part archeologist.” S. Thurm, For

CEO Pay, a Single Number Never Tells the Whole Story, Wall Street

Journal, p. A2 (March 6-7, 2010) (quoting compensation consultant

Brian Foley).

In the face of such evidence, one of the foremost judicial

proponents of economic analysis of legal problems has concluded

that the fiduciary duties of corporate directors, even coupled with

enhanced disclosure, should not insulate compensation decisions

from judicial review for reasonableness. Jones v. Harris Associates,

L.P., 537 F.3d 728, 730 (7 th Cir. 2008), cert. granted, 129 S.Ct. 1579

(2009) (Posner, J., dissenting). “...[E]conomic analysis [of

compensation decisions] ... is ripe for reexamination on the basis of

growing indications that executive compensation in large publicly

traded firms is excessive because of feeble incentives of boards of

directors to police compensation. Directors are often CEOs of other

companies and naturally think that CEOs should be well paid. And

often they are picked by the CEO. Compensation consulting firms,

which provide cover for generous compensation packages voted by

boards of directors, have a conflict of interest because they are paid

not only for their compensation advice but for other services to the

firm – services for which they are hired by the officers whose

compensation they advised on.” Id. (citations omitted).

II

Challenging Executive Compensation

Decisions under Current Law

A. Whether Excessive Executive Compensation May Constitute

a Waste of Corporate Assets

A Depression-era Supreme Court case supports the proposition

that excessive compensation of corporate executives may constitute

a waste of corporate assets and be challenged in an action brought

by a shareholder. In Rogers v. Hill, 289 U.S. 582 (1933), a

shareholder of the American Tobacco Company challenged a

corporate bylaw approved by the shareholders, setting the

compensation of the top executives of the company, as providing

66 [95 Op. Att’y

unreasonably large compensation.1 The bylaw provided that the six

top executives would receive, in the aggregate, 10% of the amount

by which the company’s earnings exceeded a baseline figure –

obviously, a performance incentive. For example, in 1930, the

president of the corporation received $168,000 in salary, $273,000+

in “cash credits”, and $842,000+ in bonus under the bylaw.

After dealing with procedural issues, the Court first held that

the shareholders had authority to adopt such a bylaw under New

Jersey corporation law and the corporation’s charter. The Court then

turned to the plaintiff’s contention that the compensation was “not

equitable or fair.” It analyzed the issue as follows:

As the amounts payable depend upon the

gains of the business, the specified

percentages are not per se

unreasonable....Regard is to be had to the

enormous increase of the company’s profits in

recent years....

While the amounts produced by the

application of the prescribed percentages give

rise to no inference of actual or constructive

fraud, the payments under the bylaw have by

reason of the increase in profits become so

large as to warrant investigation in equity in

the interest of the company. Much weight is

to be given to the action of the stockholders,

and the bylaw is supported by the presumption

of regularity and continuity. But the rule

prescribed by it cannot, against the protest of

a shareholder, be used to justify payments of

sums as salaries so large as in substance and

effect to amount to spoliation or waste of

corporate property.

1

In a companion case, the shareholder also challenged a stock

subscription plan embodied in another bylaw that allocated large

quantities of stock to the company president and directors for a

subscription price less than one-fourth of the market price – with an

estimated value at that time for the president of $1,169,000. This case

also reached the Supreme Court, which dismissed it, over the dissents of

Justices Stone, Brandeis, and Cardozo, on jurisdictional grounds. Rogers

v. Guaranty Trust Co., 288 U.S. 123 (1933).

Gen. 62] 67

289 U.S. at 591 (emphasis added). The Court endorsed a standard

suggested in a dissenting opinion in the Second Circuit when the

case was before that court:

If a bonus payment has no relation to the value

of services for which it is given, it is in reality

a gift in part, and the majority stockholders

have no power to give away corporate

property against the protest of the minority.

Id. at 591-92. The Court remanded to the district court to determine

whether the bonuses constituted a waste and misuse of corporate

assets. The case ultimately resulted in a settlement under which no

past compensation was paid, the amount of corporate income that

would trigger executive bonuses was doubled, and the bonus

percentage was reduced by 50%. See 1 Cox & Hazen on

Corporations §11.05 at p. 569 & n.39.

As you noted in your letter, the Delaware Chancery Court – a

frequent forum for litigation concerning corporate governance – has

recently recognized the possibility that a compensation package to

be paid to the departing CEO of a major corporation could constitute

waste of corporate assets. In re Citigroup, Inc. Shareholder

Derivative Litigation, 964 A.2d 106 (Del. Chan.Ct 2009). That case

was a shareholder derivative action against Citigroup, in which the

court rejected a number of claims, including claims of corporate

waste related to the company’s purchase of subprime loans, its buy-

back of $645 million of the company’s shares, and its investment in

assets that were unable to pay off maturing debt. The court held that

the plaintiffs failed to raise a reasonable doubt that the challenged

transactions were the product of a valid exercise of business

judgment.

However, the Chancery Court allowed a claim of waste related

to executive compensation to go forward. It articulated the

following standard:

The directors of a Delaware corporation

have the authority and broad discretion to

make executive compensation decisions. The

standard under which the Court evaluates a

waste claim is whether there was “an

exchange of corporate assets for consideration

so disproportionately small as to lie beyond

the range at which any reasonable person

68 [95 Op. Att’y

might be willing to trade.” It is also well

settled in our law, however, that the discretion

of directors in setting executive compensation

is not unlimited. Indeed, the Delaware

Supreme Court was clear when it stated that

“there is an outer limit” to the board’s

discretion to set executive compensation, “at

which point a decision of the directors on

executive compensation is so

d is p r o p o r ti o n a t e l y la rg e a s to b e

unconscionable and constitute waste.”

964 A.2d at 138 (footnotes omitted). The compensation package

was set forth in a letter agreement under which the former CEO was

to receive $68 million upon his departure from Citigroup, including

bonus, salary, and accumulated stockholdings. In addition, he was

to receive an office, administrative assistant, and car and driver for

5 years (or until he commenced full time employment with another

employer). In return for the compensation package and perquisites,

the former CEO would sign a non-compete agreement, a non-

disparagement agreement, a non-solicitation agreement, and a

release of claims against the company.

The Delaware court said that it needed more information to

determine whether this compensation package constituted “waste”

– in particular (1) how much additional compensation the CEO

received as a result of the letter agreement and (2) the real value of

the promises made by the CEO. Without that information it could

not decide whether the compensation package was “beyond the outer

limit.” 964 A.2d at 138.

Corporation law treatises acknowledge that excessive

executive compensation may constitute a waste of a corporation’s

assets, but generally articulate a stringent test that appears difficult

to satisfy. See 1 Knepper & Bailey, Liability of Corporate Officers

and Directors §3-14 (unless the directors approving the

compensation have a personal interest, a plaintiff alleging corporate

waste in executive compensation must demonstrate that no

reasonable business person would find that the corporation had

received adequate consideration); 1 Cox & Hazen on Corporations

§11.05 (approval of executive compensation by disinterested outside

directors may present an “unsurpassable barrier” to an action

alleging waste of corporate assets). The stringent test is a result of

the deference generally accorded decisions of corporate directors

under what is called the “business judgment rule.”

Gen. 62] 69

B. Business Judgment Rule

Assuming that the facts suggest excessive executive

compensation, the primary hurdle in any case alleging that such

compensation constitutes a waste of corporate assets is the “business

judgment rule.” Under this doctrine, courts generally defer to the

judgment of a disinterested board of directors. The business

judgment rule is also reflected in the Maryland statute setting forth

the standard of care to be exercised by a corporation’s directors. CA

§2-405.1.

The Court of Appeals most recently referred to the business

judgment rule under Maryland law in Tackney v. United States

Naval Academy Alumni Ass’n, Inc., 408 Md. 700, 971 A.2d 309

(2009). That case concerned the propriety of applying the “principle

of non-intervention” in a case involving a dispute among members

of a voluntary membership organization. The Court traced this

principle to several different sources, depending on whether the

organization is incorporated and the place of incorporation. With

respect to Maryland corporations, the principle derives from the

business judgment rule under Maryland law:

If the voluntary membership organization is

incorporated in Maryland, the business

judgment rule applies to decisions regarding

the corporation’s management. The business

judgment rule insulates business decisions

from judicial review absent a showing that the

officers acted fraudulently or in bad faith. The

rationale for the business judgment rule is

that:

Although directors of a corporation have a

fiduciary relationship to the shareholders, they

are not expected to be incapable of error. All

that is required is that persons in such

positions act reasonably and in good faith in

carrying out their duties... Courts will not

second-guess the actions of directors unless it

appears that they are the result of fraud,

dishonesty or incompetence.

408 Md. at 712-13 (quoting NAACP v. Golding, 342 Md. 663, 679

A.2d 554 (1996)). The Court applied the business judgment rule in

the case before it and affirmed the circuit court’s decision declining

70 [95 Op. Att’y

to referee a dispute over the tenure and selection of the

organization’s board of trustees.

A Fourth Circuit decision concerning a Maryland corporation

illustrates the application of the business judgment rule in a

challenge to executive compensation. In McQuillen v. National

Cash Register Co., 112 F.2d 877 (4th Cir. 1940), shareholders of a

Maryland corporation challenged various actions of the corporation,

including a generous grant of stock options to a former chief

executive of the company. The Court looked to Maryland law and

affirmed the following standard for assessing such claims:

It is obviously not the province of a court of

equity to act as the general manager of a

corporation or to assume regulation of its

internal affairs. If the chosen directors,

without interests in conflict with the interests

of stockholders, act in good faith in fixing

salaries or incurring other expenses, their

judgment will not ordinarily be reviewed by

the courts, however unwise or mistaken it may

appear ...

112 F.2d at 884 (quoting standard set forth in the district court

decision).2 The court emphasized that a very generous compensation

package would not necessarily be wasteful:

In situations of this kind, courts must

distinguish between compensation which is

merely excessive and is thus lawful, and

compensation which is actually wasteful and

is thus unlawful. Courts cannot here condone

2

The Court qualified this statement by noting that a court might take

action if the directors were personally interested in a particular decision:

but this is far from saying that equity will refuse to

redress the wrong done to a stockholder by action

or policy of directors, whether in voting

themselves excessive salaries or otherwise, which

operates to their personal advantage, without any

corresponding benefit to the corporation.

112 F.2d at 884.

Gen. 62] 71

on the part of those in control of a corporation

either actual bad faith or a total neglect or

even utter indifference to the rights of

stockholders. Necessarily, much must be

entrusted to the discretion of corporate

directors and courts should intervene here if,

and only if, there has been so clear an abuse of

this discretion as to amount legally to waste.

Id. In the case before it, the Court found that the compensation

package for the chief executive had been authorized by appropriate

corporate action in the proper form and that the directors had acted

in good faith. It also found that nothing in the contract was contrary

to the corporate charter or the corporation law of Maryland and that

the options grant was therefore not illegal or ultra vires. Id; see also

Mona v. Mona Electric Group, Inc., 176 Md. App. 672, 700-5, 934

A.2d 450 (2007) (applying business judgment rule in context of

shareholder derivative action based in part on allegations of

excessive executive compensation).

As indicated above, the business judgment rule has been

recognized in statute in Maryland:

(a) A director shall perform his duties as

a director, including his duties as a member of

a committee of the board on which he serves:

(1) In good faith;

(2) In a manner he reasonably

believes to be in the best interests of the

corporation; and

(3) With the care that an ordinarily

prudent person in a like position would use

under similar circumstances.

(b) (1) In performing his duties, a

director is entitled to rely on any information,

opinion, report, or statement, including any

financial statement or other financial data,

prepared or presented by:

(i) An officer or employee of the

corporation whom the director reasonably

72 [95 Op. Att’y

believes to be reliable and competent in the

matters presented;

(ii) A lawyer, certified public

accountant, or other person, as to a matter

which the director reasonably believes to be

within the person’s professional or expert

competence; or

(iii) A committee of the board on

which the director does not serve, as to a

matter within its designated authority, if the

director reasonably believes the committee to

merit confidence.

(2) A director is not acting in good

faith if he has any knowledge concerning the

matter in question which would cause such

reliance to be unwarranted.

(c) A person who performs his duties in

accordance with the standard provided in this

section shall have the immunity from liability

described under §5-417 of the Courts and

Judicial Proceedings Article.

* * *

(e) An act of a director of a corporation

is presumed to satisfy the standards of

subsection (a) of this section.

* * *

(g) Nothing in this section creates a duty

of any director of a corporation enforceable

otherwise than by the corporation or in the

right of the corporation.

CA §2-405.1(a) - (c), (e), (g).3

3

A version of the business judgment rule was first codified in 1976.

Chapter 567, §4, Laws of Maryland 1976.

Gen. 62] 73

The business judgment rule thus establishes a formidable

hurdle to any effort to challenge a decision of a board of directors

concerning compensation of corporate officers. If the board

members or committee members make those decisions in good faith

in a reasonable belief that they are acting in the best interests of the

corporation and with reliance on consultants and other professionals

they believe to be reliable, those decisions likely will be immune

from challenge. Thus, one who challenges a decision concerning

executive compensation at a private corporation as a waste of

corporate assets must be able to demonstrate that the directors’

decision was self-interested – in bad faith – or the result of neglect

or incompetence.

C. Shareholder Derivative Actions

As the cases outlined above suggest, a claim that excessive

executive compensation constitutes a waste of corporate assets

would typically be asserted in an action by one or more shareholders

on behalf of the corporation – commonly called a shareholder

derivative action. In Werbowsky v. Collomb, 362 Md. 581, 766 A.2d

123 (2001), the Court of Appeals discussed in detail shareholder

derivative actions under Maryland law. The case before the court

involved, among other things, an allegation of corporate waste and

breach of fiduciary duties by the directors in connection with a

transaction between the corporation and an affiliated corporation.

In an opinion discussing the circumstances under which a plaintiff

shareholder is excused from making a pre-suit demand on the

corporation to remedy the matter, Judge Wilner discussed the largely

common law basis for shareholder derivative suits in Maryland.

Executive compensation was not an issue in the case.

D. Quo Warranto Actions

You specifically inquired about the possibility that a State

official could challenge executive compensation under CA §1-

403(d), which is sometimes referred to as a “quo warranto” action.4

That provision authorizes the Attorney General to seek to enjoin a

corporation from engaging in “unauthorized business” on the ground

that it legally lacks the power or capacity to do so. See also CA §3-

513 (State Department of Assessments and Taxation may authorize

Attorney General to seek, in public interest, forfeiture of corporate

4

The Latin translates as “by what authority.” See Black’s Law

Dictionary (9th ed. 2009) at p. 1271.

74 [95 Op. Att’y

charter for abuse, misuse, or failure to use corporate powers). While

quo warranto has a common law pedigree and has been part of

Maryland’s corporation statute for six decades, we did not find any

case in which it was used to challenge executive pay decisions of a

private corporation.

Common Law Writ of Quo Warranto

This provision is derived from the common law writ of quo

warranto. The history of that writ was discussed at some length in

a recent Supreme Court decision that did not concern executive

compensation or corporate governance. In Cuomo v. The

Clearinghouse Ass’n, LLC, 129 S.Ct. 2710 (2009), Justice Scalia

distinguished “visitorial” powers of state banking regulators that

have been preempted by federal law from the “law enforcement”

powers of the state Attorneys General that are not preempted. In the

course of the opinion, he traced the “visitorial” powers of state

regulators to the 19 th century notion that a state was the “visitor” of

all companies incorporated within that state. The writ of quo

warranto was one means by which the state exercised those powers.

Justice Scalia explained:

Historically, the sovereign’s right of

visitation over corporations paralleled the

right of the church to supervise its institutions

and the right of the founder of a charitable

institution “to see that [his] property [was]

rightly employed.” ... By extension of this

principle, “(t)he king [was] by law the visitor

of all civil corporations. A visitor could

inspect and control the visited institution at

will.”

...A State was the “visitor” of all

companies incorporated in the State, simply by

virtue of the State’s role as sovereign: The

“legislature is the visitor of all corporations

founded by it.”

This relationship between sovereign and

corporation was understood to allow the States

to use prerogative writs – such as mandamus

and quo warranto – to exercise control

“whenever a corporation [wa]s abusing the

power given it, or, ...or acting adversely to the

Gen. 62] 75

public, or creating a nuisance.”... State

visitorial commissions were authorized to

“exercise a general supervision” over

companies in the State.”

129 S.Ct. at 2715-16 (Citations omitted).5 He also described the use

of writ of quo warranto by the federal government to determine

whether a national bank “is acting in excess of its charter powers.”

Id. at 2717.

The Court of Appeals of Maryland discussed quo warranto

powers under Maryland law in Insurance Commissioner v. Blue

Shield of Maryland, 295 Md. 496, 456 A.2d 914 (1983). In the

course of describing the visitorial powers of the Insurance

Commissioner over insurance companies under Maryland state law,

the Court reviewed the common law concerning the State’s right of

“visitation” over corporations and stated that “‘visitation’ has no

fixed meaning, at least in this state.” 295 Md. at 519. The Court

derived the scope of visitation over corporations from three

corporation law texts that were in general agreement that “the old

power of visitation survives only in the modern and more limited

right of the State and its courts to interfere in cases of abuse or

misuse of the charter.” Id. at 522. In the case before it, the Court

held that the Insurance Commissioner lacked authority to order

changes in participation agreements that the Commissioner had

previously approved.

Older Maryland cases recognized quo warranto as a valid

cause of action against a corporation when the corporation had

violated its own charter or State law. For example, in State v.

Easton Social Literary & Musical Club, 73 Md. 97, 20 A. 783

(1890), the Court held that the State could seek the forfeiture of the

corporate charter of an incorporated social club that was selling

alcoholic beverages to its members in violation of State law. “A

corporation may no more violate a law with impunity than an

individual can; and if the unlawful acts be of a nature to be

detrimental to the public, and be done by and for the corporation by

5

The dissenting opinion (Thomas, J.) contains a similar, though

longer, description of common law visitorial powers of states over civil

corporations and argues that those powers were broad enough to

encompass law enforcement powers. (In the context of the case before the

Court, this would mean that the state Attorney General’s law enforcement

powers were also preempted by the federal statute).

76 [95 Op. Att’y

its authorized agents, there is such abuse and misuse of its powers

and franchises as will justify the state in recalling such corporate

powers and franchises, and annulling and vacating the charter.” 20

A. at 785. In remanding the case to the lower court, the Court noted

that the lower court could withhold a decree of forfeiture to give the

corporation an opportunity to correct the violations. Id.

Maryland Quo Warranto Statute

The Maryland statute, CA §1-403(d), is based upon §7 of the

1951 version of the Model Business Corporation Act.6 When the

6

The statute reads:

(a) Unless a lack of power or capacity is

asserted in a proceeding described in this section,

an act of a corporation ... is not invalid or

unenforceable solely because the corporation

lacked the power or capacity to take the action.

(b) (1) Lack of corporate power or capacity

may be asserted by a stockholder in a proceeding

to enjoin the corporation from doing an act ...

(2) If the act ... sought to be enjoined is

based on a contract to which the corporation is a

party and if all parties to the contract are parties to

the proceeding, the court may set the contract

aside and enjoin its performance.

(3) The court may award compensatory

damages to any party who suffers a loss because

of the action of the court. However, the court may

not award compensatory damages for loss of

anticipated profits to be derived from performance

of the contract.

(c) Lack of corporate power or capacity may

be asserted by the corporation in a suit brought in

its name by the corporation or its receiver ..., or in

a representative suit brought by a stockholder

against its present or former officers or directors.

(d) Lack of corporate power or capacity

may be asserted by the Attorney General in a

proceeding for the forfeiture of the charter of the

(continued...)

Gen. 62] 77

Model Business Corporation Act was first developed in 1951, it

eliminated much of the common law doctrine concerning ultra vires

actions of corporations. Prior to the Model Act, the outcome of

cases deciding the contractual obligations of corporations frequently

turned on the question of whether the corporation had the power or

capacity to enter into the contract in the first place. See Note, Ultra

Vires Contracts of Corporations in Maryland, 1 Md. L. Rev. 145

(1936) (reviewing Maryland cases on enforceability of corporate

contracts in light of ultra vires doctrine) 7 ; see also Note,

Corporations - Ultra Vires – Distinction between Powers and

Objects in Articles of Incorporation, 46 Harv.L.Rev. 1337 (1933);

Note, Statutory Modification of the Doctrine of Ultra Vires, 44

Harv.L.Rev. 280 (1930). Some asserted that the inconsistencies in

the case law could be traced to confusion as to the theory underlying

the doctrine. See Carpenter, Should the Doctrine of Ultra Vires be

Discarded?, 33 Yale L.J. 49 (1923). While the Model Act

eliminated many of those issues by circumscribing use of the

doctrine, it explicitly retained the ability of a state Attorney General

to pursue quo warranto actions against corporations for misuse of

their powers.

The commentary to the Model Act states:

The doctrine of inherent incapacity is

eliminated and it is unnecessary for persons

dealing with a corporation to inquire closely

into the limitations on the purposes and

powers of the corporation. The early theory

was that corporations could not act outside the

narrow purposes and powers customarily

stated in their articles together with the powers

necessarily incidental thereto, and that anyone

who dealt with a corporation acted at his peril

6

(...continued)

corporation or to enjoin it from transacting

unauthorized business.

CA §1-403 (emphasis added).

7

Notably, this article observes that one of the arguments in favor of

not enforcing contracts on the basis of the ultra vires doctrine – the public

interest in ensuring that corporations chartered for a specific purpose do

not transcend that purpose – is particularly strong with respect to public

service corporations. 1 Md. L. Rev. at 154 & n.47A.

78 [95 Op. Att’y

in that regard. The result of that theory was a

large volume of litigation in which the courts

were forced to consider at great length the

scope of purposes, and express and incidental

powers of corporations....

Section 7 [i.e., CA §1-403] protects the

shareholders of a corporation against

unauthorized acts by providing that they may

enjoin unauthorized acts and the officers and

directors may be held liable for damages

resulting therefrom....The interests of the state

are protected by providing that the attorney

general may bring proceedings to enjoin the

transaction of unauthorized business or to

dissolve the corporation if it has done

unauthorized acts.

..........

Section 7, being limited to the defense of

lack of capacity or power, does not affect the

defense of illegality. Ultra vires and illegality

have been confused in some cases.

...........

Model Business Corporation Act Annotated §7 at pp. 278-79 (1971).

Thus, the purpose of §7 (i.e., CA §1-403) was to eliminate corporate

disputes based on the ultra vires doctrine. See also 1 Cox & Hazen

on Corporations, §4.07 (noting that modern corporation law relies on

business judgment rule to determine permissible corporate activities

rather than ultra vires doctrine with “an inflexible inquiry into the

relative proximity of the challenged activity to the corporation’s

stated purposes”). The savings clause in CA §1-403(d) retained the

ability of the State to assert that a corporation was acting ultra vires

in a quo warranto action. It is presumed that the State would

undertake such an action when ultra vires actions of a corporation

“menace the public welfare.” Id., §4.09.

Gen. 62] 79

Our research has not uncovered any cases in which states have

exercised this power in the approximately 60 years since it originally

appeared in the Model Business Corporation Act.8

E. Authority of State Agencies with Respect to CEG Executive

Compensation

You also asked what State agencies might have authority to

take some action with respect to executive compensation at CEG.

One of CEG’s subsidiaries, Baltimore Gas and Electric (“BGE”), is

a regulated public service company in Maryland. The Public Service

Commission (“PSC”) is charged with regulating public utilities.

PSC has exercised its jurisdiction under Annotated Code of

Maryland, Public Utility Companies Article, §4-208 to require

public utilities, such as BGE, to report costs that have been allocated

to them by their corporate parents. See COMAR 20.40.02.07.

Although the General Assembly has expressed clear concern about

the impact on a utility’s capital structure of transactions entered into

by the utility’s corporate parent, it is not clear (and beyond the scope

of this letter) whether the PSC has authority to disallow particular

cost allocations to the public utility from its corporate parent on the

sole basis that the PSC deems such costs to be excessive. It is clear,

however, that the PSC has jurisdiction to disallow the inclusion of

costs in the utility’s rate base for rate making purposes. See Public

Service Commission, In the Matter of the Current and Future

Financial Condition of Baltimore Gas and Electric Company, Case

No. 99173 ( Phase II), Order No. 82986 (October 30, 2009) at pp.

30-31 (questioning “the wisdom of paying anyone millions of dollars

per year given CEG’s recent history,” but finding its role limited to

regulating the portion of executive compensation assessed to

ratepayers). In other words, although it is unclear whether under

current law the PSC could protect BGE ratepayers from indirect

harms associated with the weakening of BGE’s capital structure as

a result of the utility bearing the costs of excessive executive

compensation, the PSC undoubtedly may protect ratepayers from

having to bear those costs directly.

8

A survey of the states in the mid-1980s uncovered no use of the

provision in recent memory. See Schaeftler, Ultra Vires – Ultra Useless:

The Myth of State Interest in Ultra Vires Acts of Business Corporations,

9 J. Corp. L. 81, 91 (1984).

80 [95 Op. Att’y

F. Summary

Excessive executive compensation may constitute a waste of

corporate assets. To the extent that decisions concerning executive

compensation come before the courts, they are litigated through the

mechanism of a shareholder derivative suit. However, the business

judgment rule insulates most such decisions from review by the

courts.

While the Model Business Corporation Act, and its Maryland

version (CA §1-403(d)), preserved the ability of a state Attorney

General to bring a quo warranto action to forfeit a corporate charter

or enjoin unauthorized actions of a corporation, we are aware of no

precedent for such an action challenging the decisions of the board

of directors of a private corporation relating to executive

compensation. CA §1-403(d) is a remnant of the ultra vires doctrine

that allows reversal of corporate action not authorized by a

corporation’s charter or governing law. Any action brought under

that statute must be based on a corporate action that can be

characterized as ultra vires – not just unlawful – and that implicates

a public interest at stake in the particular decision. While the

decisions concerning executive compensation at CEG may perhaps

be criticized on fairness and policy grounds, the clearest public

interest at stake is the effect of such compensation decisions on BGE

ratepayers. Under current law, the assessment of that issue is a

matter, in the first instance, for the PSC.

III

Power of the General Assembly

to Regulate Executive Compensation

You asked whether the General Assembly could lawfully

restrict executive compensation at a company like CEG. The

General Assembly may certainly amend Maryland law in ways that

can regulate executive compensation at Maryland corporations.

Such legislation could take a number of forms – enhanced disclosure

requirements, elimination of favorable tax treatment or imposition

of adverse tax consequences related to executive compensation, or

explicit caps on certain types of compensation.

For example, the Legislature could adopt enhanced disclosure

requirements for public utilities. Alternatively, as has been proposed

several times in recent years in the General Assembly, it could

eliminate deductions from corporate taxes for expenses associated

Gen. 62] 81

with excessive executive compensation. See, e.g., Senate Bill 472

(2009). Or it could devise a tax that targets excessive compensation.

There are other possible measures that might impose some limits on

executive compensation at a company like CEG – for example, a cap

on ratepayer contribution to executive compensation or a statute

clearly establishing the PSC’s authority to disallow cost allocation

to a public utility from its corporate parent.

The Legislature might also enact specific guidelines for

executive compensation at corporations or at specific classes of

corporations. For example, it has provided for State oversight of

compensation decisions at nonprofit health service plans. See

Annotated Code of Maryland, Insurance Article (“IN”), §14-139.

Such entities have a public mission to “provide affordable and

accessible health insurance ... [to] assist and support public and

private health care initiatives for individuals without health

insurance; and [to] promote the integration of a health care system

that meets the health care needs of all the residents ...” IN §14-

102(c). Under the statute, an executive of such an entity may only

receive “fair and reasonable compensation in the form of salary,

bonuses, or perquisites for work performed for the benefit of the

corporation.” IN §14-139(c). The statute requires the compensation

committee of such an entity to develop compensation guidelines to

be approved by its board of directors and provided to the entity’s

regulator, the State Insurance Commissioner. IN §114-139(d). The

Insurance Commissioner is to review the compensation actually paid

to executives and may prohibit payment if the Commissioner finds

that the pay exceeds the statutory guidelines. Id. If the statute is

violated, the Commissioner can take enforcement action that could

result in the assessment of monetary penalties and payment of

restitution. IN §14-139(f).9

9

Acting under the authority provided by this statute, the Maryland

Insurance Commissioner prohibited CareFirst, Inc., from paying part of a

proposed past-termination payment to its former CEO. Insurance

Commissioner v. CareFirst, Inc.,et al., MIA-2007-10-027 (July 14, 2008),

available at http://www.mdinsurance.state.md.us/sa/documents/

MIA-2007-10-027-CareFirstFinalOrderall07-08.pdf. The Baltimore

County circuit court later reversed that decision and the case is now on

appeal.

Last year, the Commissioner upheld a decision of the board of

CareFirst, Inc. to deny payment of a SERP and other post-employment

compensation to one of the entity’s former executives. In re: Investigation

(continued...)

82 [95 Op. Att’y

We caution that a bill designed to restrict compensation at a

single corporation may raise equal protection issues 10 or a question

as to whether it is a special law forbidden by the State Constitution.

See Maryland Constitution, Article III, §33. An effort to undo

existing compensation arrangements at a particular company may

also raise issues as to whether it impairs contracts or vested rights.

See 88 Opinions of the Attorney General 11, 18-24 (2003)

(analyzing impairment of contract and vested rights issues with

respect to “anti-bonus” provision in law governing conversion of

non-profit health service plans to for-profit status).

Should you wish to introduce legislation, the Attorney

General’s Office is willing, of course, to review any such proposals

and advise whether specific proposals may be susceptible to

constitutional challenges.

IV

Conclusion

In summary, based on the analysis above, the answers to the

legal questions you posed are as follows:

i Excessive executive compensation may constitute a

“waste” of corporate assets.

i The courts usually defer to decisions of a board of

directors on an issue such as executive compensation

under the “business judgment rule,” also referred to by

the Court of Appeals as the “principle of non-

intervention.” This principle depends in part on whether

the directors acted in good faith.

9

(...continued)

of Proposed Post-Termination Payment by Care First, Inc., to Leon Kaplan

(February 5, 2009), available at http://www.mdinsurance. state.md.us/sa/

documents/MIA-2009-02-002-CareFirst-Kaplan.pdf.

10

Such issues are likely to be assessed on a rational basis standard.

See Retail Industry Leaders Ass’n v. Fielder, 435 F.Supp. 2d 481, 498-501

(D.Md. 2006), aff’d, 475 F.3d 180 (4th Cir. 2007).

Gen. 62] 83

i Allegations of corporate waste are typically litigated in

the context of a shareholder derivative action, rather than

a quo warranto action.

i CA §1-403(d) was part of the Model Business

Corporation Act, as adopted in Maryland some years ago.

Under that statute, the Attorney General retains authority

to seek injunctive relief or dissolution of a corporation

that engages in unauthorized or “ultra vires” actions.

There are few cases in the last century in which state

Attorneys General have exercised this authority and none

challenging corporate decisions as to executive

compensation.

i The General Assembly has authority to enact legislation

regulating executive compensation at Maryland

corporations and businesses. There will be issues of

retroactivity and vested rights to the extent such

legislation attempted to alter compensation due under

existing agreements.

Douglas F. Gansler

Attorney General

Robert N. McDonald

Chief Counsel

Opinions and Advice

Editor’s Note:

This opinion was originally issued as a letter of advice with

appendices that contained factual information about the chief

executive officer’s compensation.

Jones v. Harris Associates, L.P., mentioned in Part I of this

opinion, was later vacated and remanded by the Supreme Court.

2010 WL 1189560 (March 30, 2010), consistent with the dissenting

opinion quoted in the text.