When the CEO Has To Go: American Apparel as Case Study

When the CEO Has To Go: American Apparel as Case Study Photo: Raysonho @ Open Grid Scheduler/Grid Engine

It’s hard to think of a more uncomfortable situation for a board of directors than having to fire the chief executive officer. Los Angeles-based American Apparel Inc. had this experience on June 18 when the board announced it would give CEO and founder Dov Charney the boot after years of alleged misconduct toward employees, as well as recently sluggish company earnings.

That was just the beginning of the company’s unpleasant summer. Charney, not exactly an executive known for showing restraint, didn’t go quietly. In a highly public manner, he battled with the board for control of the company, until hedge fund Standard General cut a deal with the company, rescuing it from debt and providing for restructuring of the board. The July 9 deal didn’t allow Charney to reclaim his former title though. He was named a “strategic consultant,” though it’s unclear exactly what that position entails.

Charney’s termination was a particularly public one, and has likely done damage to an already-struggling brand. Perhaps there wasn’t a lot that American Apparel’s leadership could have done to make its CEO’s dismissal go more smoothly. But often there are steps that companies can take to mitigate risk when ousting their top executive.

“It all starts with the initial employment contract, so the end result is only as good as the contract,” James Ryan, a partner at Cullen and Dykman and chairman of its employment litigation practice, told CorpCounsel.com. When the CEO signs on, his or her contract specifies what the expectations are for the role, and may specify what the severance pay would be and what would constitute a “for cause” termination.

Charney’s termination letter cites breach of fiduciary duty, violations of company policy and misuse of corporate assets as reasons behind his firing for cause. However, the company’s recent financial troubles, it has lost nearly $270 million over the last four years, also create an important context for the leadership crisis. In some public companies, bad company performance is written into CEO contracts as cause for termination. “So if, for example, earnings don’t meet expectations for a number of quarters, that can be considered ‘cause,’” Ryan explained.

Beyond the employment contract, the employer also may get the terminated CEO to negotiate and sign a separation agreement. “Generally, the only way to ensure that a company is going to buy peace, and ensure that no litigation will ensue as a result of the termination, is to negotiate a separation agreement,” Diane Katzen of law firm Richman Greer told CorpCounsel.com.

According to Katzen, these agreements can include features like nondisparagement clauses, confidentiality agreements and clauses to protect trade secrets, as well as—and this is essential—a release from potential litigation. What’s important to remember about the release, Katzen said, is that in order for it to be valid, the employee needs to receive some sort of compensation in return, above and beyond what they are already entitled to through other employment agreements and contracts.

Employers also need to take steps to make sure that employees cannot claim they were forced to sign their agreement under duress, Katzen explained. “You always want to make sure there is a provision at the end of the agreement that says that the employer advised the employee to retain counsel,” she said.

Another issue that employers have to keep in mind when they are terminating a CEO, or any employee for that matter, is age. The Age Discrimination in Employment Act (ADEA) requires that, in order to be released from age discrimination claims, employees above the age of 40 need to be given 21 days to consider their separation agreement. In a letter to American Apparel’s board after Charney’s termination, the 45-year-old former CEO’s lawyer chides the board for allegedly failing to give Charney proper ADEA consideration time.

One of several factors that makes the American Apparel case so notable is that Charney is not just the CEO, but the company founder, and at the time of his firing, a major shareholder. While these are all issues to take into consideration, Jonathan Sulds, a shareholder at Greenberg Traurig and cochairman of the firm’s global labor and employment and global human capital solutions practices, told CorpCounsel.com that the board ultimately has the power and the fiduciary duty to act if a CEO is harming the enterprise.

“Certainly, it’s a very nuanced sort of relationship if you’re dealing with a CEO who is a large shareholder or a founder of a company,” he said. “But I think boards in these circumstances recognize their governance responsibility and attempt to act in the best interests of the company overall.”

Now that Standard General has come to American Apparel’s rescue, it’s hard to say what’s next for the company. After firing Charney, the board appointed its chief financial officer interim CEO, and is trying to figure out how to reconstitute its board, which is down to only two members. Such a dramatic change in overall governance during a CEO exit might not be the norm, but experts emphasized that well-run companies always have a succession plan to deal with those changes. “A good board would make sure they are constantly looking for a replacement within and outside the organization,” Ryan said.

LOAD MORE
Practice Area(s):
Industry: