Delaware Court of Chancery Applies Entire Fairness Standard to Director Equity Grants
May 26 2015
The Delaware Court of Chancery recently held that equity grants to non-employee directors of Citrix Systems, Inc. (“Citrix” or the “Company”) approved by the board of director’s compensation committee (the “Committee”) were subject to an entire fairness standard of review, rather than the deferential business judgment rule, because the Committee’s decisions were made (i) by non-employee directors who would receive the compensation and (ii) pursuant to a stock plan which did not include any “meaningful” limits on director compensation payable under the plan. Although the case was before the Court on a motion to dismiss, its holding nonetheless suggests increasing scrutiny by Delaware courts under certain circumstances of equity awards by directors to directors.
The case, Calma v. Templeton et al.1, is a stockholder derivative action challenging restricted stock unit (“RSU”) awards to eight non-employee directors of Citrix, which were granted under the Company’s 2005 Equity Incentive Plan (the “Plan”). The Court denied the defendants’ motion to dismiss the plaintiff’s claim that members of the Company’s board breached their fiduciary duties (and were unjustly enriched) in awarding compensation to directors under the Plan. The Company’s stockholders had previously approved the Plan, which provided for equity awards to eligible officers, employees, consultants and advisors of the Company and, like many public company stock plans, provided that no participant could receive grants exceeding more than, in this case, one million shares (or RSUs) per year. However, the Plan did not impose any other individual limits on awards, including grants to non-employee directors. As a result, the Court held that stockholder approval of the Plan could not act as a ratification of the director equity grants at issue because the Plan did not include enough specificity as to “the magnitude of compensation for the Company’s non-employee directors.2 The Court distinguished the case from other Delaware cases where stockholders approved compensation plans that established specific awards to be granted to directors, imposed ceilings on periodic awards or otherwise included specific details as to the awards to be granted.
In terms of analyzing the entire fairness of the director compensation, the parties focused on whether the Company’s non-employee director compensation practices were in line with those of the Company’s proxy peer group. The Court noted that the Committee, in setting director compensation, relied on a peer group that the plaintiff argued should not have included companies with much higher market capitalizations, revenue and net income than Citrix. The plaintiff contended that if such companies were excluded from Citrix’s peer group, the compensation awarded to Citrix’s non-employee directors would appear excessive in comparison to the compensation awarded to directors at Citrix’s peer companies.
In denying the motion to dismiss, the Court found that the plaintiff “raised meaningful questions as to whether certain companies with considerably higher market capitalizations … should be included in the peer group.”3 Although the Court refused to dismiss the plaintiff’s breach of fiduciary duty and unjust enrichment claims, it did dismiss the plaintiff’s corporate waste claim, agreeing with the defendants that the plaintiff had not established that the director compensation “was so one-sided that no reasonable business person could conclude that the Company received adequate consideration.”4
This case is an important reminder to Delaware companies -- and companies incorporated in many jurisdictions that treat Delaware corporate jurisprudence as persuasive authority -- that director compensation may be challenged under the heightened entire fairness standard, rather than the business judgment standard, unless stockholders have approved meaningful and specific limits on the amount of director compensation. Although Calma and a line of related cases in Delaware address equity awards, the analysis in these cases may apply to cash compensation as well. Given the preliminary nature of the Calma case and a similar derivative action pending in Delaware against Facebook5, we will continue to monitor developments in this area. In the meantime, companies should carefully consider the following when making non-employee director compensation decisions:
1C.A. No. 9579-CB, 2015 WL 1951930 (Del. Ch. Apr. 30, 2015). A link to the opinion may be found here: http://courts.delaware.gov/opinions/(1nwswx45eocieo45fxqykg55)/download.aspx?ID=223030 (May 26, 2015).
2Id. at 38.
3Id. at 41.
4Id. at 42.
5Because the Calma decision resolved a procedural issue, the case, unless settled, will proceed on the merits. In June 2014, a stockholder filed a similar derivative action on behalf of Facebook alleging that the Facebook board breached its fiduciary duties by awarding themselves excessive compensation under Facebook’s equity incentive plan, which included an individual limit of 2.5 million shares but no other meaningful or specific limits on director compensation. Complaint, Espinoza v. Zuckerberg et al., CA No 9745 (Del. Ch. filed June 6, 2014). The Facebook case has not yet been decided on the merits, as the defendants have filed a motion to dismiss and for summary judgment, which is still pending.