Although executive compensation has been under significant scrutiny for many years, directors’ compensation has flown somewhat under the radar. That may be about to change: in Calma v. Templeton, a Delaware court recently held that the level of compensation granted to non-employee directors should be reviewed under the “entire fairness” standard rather than under the more lenient “business judgment” standard. The court concluded that the stricter standard was appropriate because:
- the directors had a conflict of interest when they were deciding whether to award themselves any equity compensation; and
- the company’s shareholders did not “ratify” the directors’ equity awards when they approved the plan under which the awards were granted, since the plan did not include “meaningful limits” on the potential awards.
Citrix Systems, Inc., sponsored a fairly typical incentive plan, under which eligible directors could receive cash awards and/or various forms of equity compensation, including restricted stock units (RSUs). Citrix’s shareholders approved the plan in 2005.
Under the plan, no individual director could receive awards with respect to more than one million shares (or units) of Citrix stock in any calendar year. There were no sub-limits or other restrictions that applied to directors, and the plan did not specify the compensation that a non-employee director would receive annually. When the case was filed, Citrix stock was trading at $55 per share, meaning that an award of one million RSUs would be worth $55 million.
Starting in 2011, the Citrix’s Board of Directors began awarding returning non-employee directors an annual grant of 4,000 RSUs. The grant date value of these RSUs from 2011-2013 ranged from $253,360 to $339,320. (The directors also received additional cash compensation of between approximately $50,000 and $105,000 each year.) These amounts were far below the one million RSUs that the Board could have granted the non-employee directors under the plan.
The Lawsuit and the Court’s Decision
In the spring of 2014, the plaintiffs filed the lawsuit derivatively on behalf of Citrix. The principal allegation was that the directors had breached their fiduciary duties to the company because the 2011-2013 RSU grants constituted “excessive and improper” compensation. The non-employee directors moved to dismiss the lawsuit.
As with many court decisions, the threshold─and most critical─issue for the court was determining the appropriate standard of review. Under Delaware law, a court presumptively reviews breach of fiduciary duty claims under the “business judgment” (or “waste”) standard. Under this standard, the court upholds a board’s decisions unless they lacked “any rational business purpose.” By contrast, if the plaintiffs overcome the presumption that the business judgment standard should apply, the court will review a breach of fiduciary duty claim under an “entire fairness” standard, which requires the directors to show that “the transaction was the product of both fair dealing and fair price.”
Because Citrix’s directors all received RSU grants, the court held that this conflict of interest generally would rebut the presumption that the compensation should be reviewed under the business judgment standard. However, the defendants argued that the business judgment standard nonetheless should apply because Citrix’s shareholders had “ratified” the directors’ compensation when they approved the incentive plan in 2005.
The court ultimately concluded that shareholder approval of the plan did not ratify the directors’ compensation, at least not for purposes of a motion to dismiss, because the shareholders were not asked to approve “the magnitude of compensation for the Company’s non-employee directors.” The court noted that the plan did not set forth the specific amount of compensation to be granted to directors or include “director-specific ceilings” on how much could be awarded. In the court’s judgment, “upfront stockholder approval of the Plan was not a ‘blank check’ or ‘carte blanche’ ratification of any compensation the Compensation Committee might award the Company’s non-employee directors.”
What the Decision Means
This decision is a ruling of one trial court on a motion to dismiss; it is not a ruling of an appellate court and is not a final ruling on the merits. As a result, it is difficult to determine its significance at this stage, other than that the Citrix case will continue and likely proceed to discovery.
However, other companies might wish to review their own directors’ plans in light of this decision. If a plan does not specify the level of compensation, or provide a ceiling on the amount of compensation, for non-employee directors, the company should consider whether it would be appropriate to take any action. For example, the company might consider amending the plan to add limits, adopting a policy limiting directors’ compensation, or asking shareholders specifically to ratify the non-employee directors’ compensation.