Officer and Director Compensation Remains Fertile Grounds for Plaintiffs Counsel*

Popular as an item of discussion in the financial press and subject to new disclosure rules (for CEO compensation) to take effect January 2017, compensation for public company officers and directors will remain fertile ground for plaintiffs’ lawyers. While lawsuits challenging disclosures in proxy statements regarding adoption of or amendments to company long-term incentive plans have become somewhat less popular after plaintiffs’ initial success has been more recently met with a stream of court decisions rejecting those disclosure based claims, a recent decision by the Delaware Chancery Court in Calma v. Templeton et. Al. C.A. No 9579-CB (Del. Ch. April 30, 2015) will likely lead to an increase in challenges by plaintiffs’ counsel at least to the compensation of independent directors. Unlike the first generation disclosure based claims, which have been met with increasing skepticism by numerous courts, these derivative claims will challenge the grant of the compensation itself as a breach of fiduciary duty and will likely only involve disclosure issues when raised as a defense by defendants based on the doctrine of shareholder ratification.

Chancellor Bouchard’s opinion in Calma will encourage derivative litigation both because he ruled that plaintiff’s claims were subject to review under the entire fairness standard and because he found demand excused. While the application of entire fairness should not make it any easier for plaintiffs to overcome the exacting standards necessary to state a claim for waste (“compensation…so one-sided that no reasonable business person could conclude that the company received adequate consideration”), application of the entire fairness standard will make it more difficult for defendants to eliminate claims for breach of fiduciary duty and unjust enrichment at least in the context of a motion to dismiss. That, of course, opens the door in particular to plaintiffs who want to extract a settlement because corporations (many of whom may have high deductible D&O policies) may not want to incur the expense of a full-blown trial even when their director compensation falls squarely within the range of reasonableness.

In Calma, Citrix, the nominal defendant corporation, had a shareholder approved Equity Incentive Plan. The Equity Plan covered directors, officers, employees, consultants and advisors and the only limit contained in the Plan was an outside limit on grants to any individual of 1,000,000 shares or RSUs per calendar year. Plaintiff challenged the grant of RSUs to the company’s outside directors for a three year period contending that the RSUs combined with the directors’ cash compensation constituted excessive compensation in comparison to the directors of certain company “peers.” As such, plaintiff contended that the compensation constituted waste, the grant of which by the compensation committee (comprised of less than a majority of the board) was a breach of fiduciary duty that resulted in an “unjust enrichment” of the directors.

Because it found the directors’ grant of their own compensation was an “interested transaction,” the Court ruled that “entire fairness” was the appropriate standard of review and that the defendants’, therefore, had the burden of proving the entire fairness of the grants. Accordingly, Chancellor Bouchard denied defendants’ motion to dismiss Count One (Breach of Fiduciary Duty) and Count Three (Unjust Enrichment), while granting defendants’ motion as to Count Two (Waste). In so ruling, the Court agreed with plaintiff’s argument that defendants lacked business judgment protection for the grant because there was no “meaningful limits” in the Equity Plan. The Court pointed out that the one million share annual limit per person meant that the Compensation Committee could have awarded $55 million worth of stock to an individual given the Company’s stock price on the date of grant. That defendants had not even remotely approached that number, instead awarding compensation of approximately $300,000 in 2010, $400,000 in 2011, $350,000 in 2012 and $375,000 in 2013 did not affect the Court’s view on the issue of “meaningful limits,” which the Court determined solely on the purely hypothetical extreme upper limit grant permissible under the Plan terms, however unlikely. Among other significant findings, the Court also:

  • Rejected defendants shareholder ratification argument because while generically approving the Plan, stockholders did not approve of “any action bearing specifically on the magnitude of compensation paid to non-employee directors”;
  • Applied the test for demand fatality under the Rales test rather than the Aronson test because the Compensation Committee did not constitute a majority of the board and the Committee action, therefore, could not be imputed to the board as a whole; and
  • Found demand excused as the directors could not fairly and impartially consider whether to initiate litigation challenging their own compensation without regard to the plaintiff’s failure to plead the materiality of that compensation to each director on a personal level.

Guidance

  • Directors need to understand that decisions regarding their compensation may be found under certain circumstances to constitute an “interested transaction,” whether approved by the full board or by the board’s compensation committee, and are therefore subject to review under the entire fairness standard unless certain procedural protections are in place;
  • When approving or amending equity plans, companies should make sure that the plans contain “meaningful limits” on individual grants in a particular year while still providing sufficient flexibility for changed circumstances (by having for example an appropriate range of grants) and should consider limits in terms of sub classes since only outside director compensation is likely to be considered an “interested transaction”;
  • Companies should at least consider obtaining initial shareholder approval for an appropriate range of grants to outside directors (e.g. $300,000 to $500,000 in equity per year) to be made on a set date so that any subsequent grant in that range is more likely to give rise to a business judgment standard of review;
  • Establish a record in connection with grants to outside directors that would help establish entire fairness such as an appropriate number of meetings to discuss and analyze the grants, consultation with appropriate advisors (e.g. outside counsel and independent compensation consultants) and appropriate “peer” group comparisons including differences between the company and its peers at least over a period of time; and,
  • Consider the views of large institutional investors and proxy advisory firms like ISS that has its own equity plan scorecard and a consulting arm to advise companies as to how they would likely score.

* Eric Waxman retired as a partner from SASM&F with over 30 years experience in a wide range of corporate governance issues. The views set forth in this blog are those of the author alone and cannot be imputed to any other individual or organization. (www.ericwaxman.com)

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