March 11, 2014

Interpreting employment termination agreements in the C-Suite

Posted in Corporate Litigation, Employment Law by Gene Killian |

What makes a good Chief Financial Officer? I recently heard a Villanova Business Professor, Anthony Catanach, say that it comes down to practical knowledge. Good CFOs, according to the Professor, use plain English when communicating; refuse to engage in the chase for the mythical “silver bullet” that leads to business success; and focus upon strategy, process, and transparent performance metrics.  Whether Professor Catanach is correct or not, sometimes CFOs don’t work out. When that happens, attention turns to the CFO’s termination package. And, sometimes, management isn’t particularly enthusiastic about making the required payments.

That was the situation in a recent case, Kohn v. Proteonomix.  Proteonomix describes itself as “the Company for Life’s Journey.”  The company is involved in the development of therapies based upon the use of human stem cells and their derivatives, particularly in the areas of diabetes and cardiac diseases.  In 2009, Proteonomix hired Robert Kohn as its CFO. Kohn signed a three-year employment agreement, which included a signing bonus of 250,000 shares of common stock of the company. Salary of $150,000 per year would accrue but would not be paid until Proteonomix raised $1.5 million in equity financing.

Before he was hired, Kohn told the company’s CEO that he, Kohn, could raise money for the company through his business contacts, and that he could establish and maintain the accounting protocols needed to complete SEC financial statements. According to the company, this turned out to be less than truthful; in fact, according to Michael Cohen, Proteonomix’s CEO, Kohn was “totally inadequate and in fact incompetent.”

Proteonomix fired Kohn. The parties then agreed upon a separation agreement, which provided for deferred compensation of $187,500, plus an additional $37,500 as the value of lost benefits under the employment contract. Payment, again, would be made only on the condition that Proteonomix obtained at least $1.5 million in equity financing. Kohn would make no further claims for compensation. Under the separation agreement, Kohn would retain only 156,250 shares of the common stock of the company, and would return to Proteonomix the balance he had received as a signing bonus.

About a year and a half later, Kohn learned that Proteonomix had gotten the required financing. He wrote to Proteonomix’s attorney seeking payment of the $225,000 due to him under the separation agreement. That’s when the fight started, because Proteonomix refused to pay. Kohn sued, and Proteonomix counterclaimed, arguing that Kohn had procured his employment through fraud, and that no money should be due at all. (Interestingly, the day after Proteonomix filed its answer, Kohn moved for summary judgment. The parties apparently agreed that there were no disputed issues of fact, cutting off an expensive discovery process.)

As unhappy former employers sometimes do , Proteonomix then proceeded to point out all of the perceived shortcomings in Kohn’s job performance. Proteonomix argued, for example, that Kohn had made errors in financial documents, which the company had to spend a lot of money to correct; that there had been delays in filing SEC documents, which delayed Proteonomix from securing necessary funding; and that Proteonomix had breached his fiduciary duty by failing to disclose outside business relationships.

The Court didn’t buy it. First of all, the Court focused upon the fact that there were two separate contracts: the initial employment agreement, and the later separation agreement. This case, according to the Court, involved only the separation agreement.  The Court wrote:

“Defendant did not specifically allege any facts regarding affirmative misrepresentations by plaintiff during the September 2010 negotiations preceding the separation agreement. Rather, defendant contends plaintiff alone knew of the extent of his errors in maintaining accounting protocols and in preparing SEC documents, and he did not reveal that information….[Defendant] cannot prove it reasonably relied on plaintiff’s performance as the CFO when it entered into the separation agreement. Having already come to the opinion that plaintiff’s work was inadequate, defendant cannot claim it expected no further problems with the work done under plaintiff’s supervision.”  (Emphasis mine.)

The Court also rejected Proteonomix’s “conflict of interest” claim, noting that Kohn’s “original employment contract…expressly permitted him to engage in other business activities as long as they did not impair or otherwise affect his duties as CFO of defendant. [Proteonomix’s papers do] not state how plaintiff’s [outside] relationship impaired or adversely affected plaintiff’s job duties.”

Studies show that jurors tend to make up their mind very quickly about which side to support in a trial. Judges are no different. They look for who’s wearing the white hat, and who’s wearing the black hat; then they look for a legal justification to do what they consider to be the “right” thing. Although I’m only relying on the facts cited in the Court’s opinion, and I may not know the whole story, I’ll say this:  Signing off on a separation agreement, and then reneging on that agreement, just looks bad. It’s better for management to pay what it owes and move on with life.

-        Gene Killian