Will Darden Restaurants Drown Under Mounting Legal Woes?

The tide is fast running out on Darden Restaurants (NYSE: DRI  ) as two groups of shareholders sue the casual-dining chain operator over changes it made to its corporate bylaws. The changes, implemented as a result of activist shareholders reacting to Darden's decision to sell its Red Lobster chain, have created a shareholder revolt that threatens to spiral out of control.

A Teamsters union fund and pension funds for the city of Birmingham, Ala., are going to court to reverse the changes the restaurant enacted to thwart the influence private equity funds could have over its operational decisions. Whereas the financial outfits see merit in the plan to shed the seafood chain, they believe that alone won't change Darden's underperformance and are seeking a broader transformation, but the restaurateur's resistance to their pleas has led Starboard Capital to call for a special shareholder meeting to have a non-binding referendum taken to gauge investor sentiment.

Darden, indignant that the proposal wastes its time and money because it says the spinoff doesn't need shareholder approval, implemented the bylaws amendments, allowing it to delay its annual meeting almost at will while imposing greater restrictions and disclosure requirements on shareholders calling for change. Even major institutional proxy services have recoiled at Darden's heavy-handed tactics and now endorse the call for the special gathering.

In lawsuits filed two weeks ago in Florida circuit court, Teamsters Local 443 Health Services & Insurance Plan and the Birmingham funds allege the changes were made in order to undermine shareholder rights. Both are looking to have to the amendments declared invalid and are seeking class action status for their suits.

When directors of a public company take such brazen action to insulate themselves from stockholder voting on important corporate matters ... the only logical conclusion is that the board is motivated by entrenchment.
-- City of Birmingham, Ala., lawsuit

The legal morass Darden is wading into can only serve as a greater distraction and creates an even bigger sinkhole into which it can pour its limited resources. Not that a company shouldn't defend its decisions, and I don't even necessarily disagree with management's position that the spinoff decision falls wholly within its discretion, but if it was trying to avoid the appearance of holding a vote it intended on ignoring anyway, the optics it created by undermining shareholder rights could hardly have been worse.

Of course, the bylaws amendments were primarily aimed at monied interests and not the regular shareholder, but there's nothing to say the private equity firms would have won the vote anyway, or come out ahead by a wide margin if the vote did go their way. Darden Restaurants has antagonized its shareholders for no good reason and can likely expect its directors to face sharp criticism for their actions.

Institutional Shareholder Services, one of the proxy firms now siding with the forces against Darden, found that over the first six months of 2013 (the latest data available), several dozen companies that adopted poor governance practices saw directors receive less than 50% support from shareholders.

Stubbornness seems to rule Darden Restaurants, and its board may end up bearing the brunt of the backlash that may ensue.

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