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 Facebook,5 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:
- Boards and compensation committees should act reasonably and thoughtfully in setting director compensation, using appropriate, rigorous and objective peer group data and outside advisers, including independent compensation consultants.
- A company planning to seek stockholder approval of an equity compensation plan in which directors participate should consider including a meaningful or specific limit on non-employee director awards. This consideration should continue to be weighed against the company’s desire for flexibility in setting director compensation. Although years ago many public companies established separate, formulaic director equity compensation programs, in recent years, more companies have granted director equity awards under a more flexible “omnibus” stock incentive plan in which employees and other service providers also participate, often with a generous participant award limitation (required under Section 162(m) of the Internal Revenue Code of 1986, as amended, for covered employees). The Calma case and related precedents suggest that the pendulum may be swinging back towards imposing individual director award limitations. Public companies should also keep in mind that adding or changing director limits in an equity plan may, depending upon plan terms and applicable stock exchange rules, require stockholder approval.
- A company contemplating an increase to the compensation granted to non-employee directors should consider whether to obtain stockholder approval of specific amounts of or limits to director compensation, and if approval is not sought, provide a reasonable and thorough explanation for the change in director compensation in its proxy statement. As a general matter, we would recommend imposing meaningful but flexible director equity award limits in a plan over seeking stockholder approval of specific amounts of director compensation. However, if a stand-alone proposal on director compensation is considered, companies should also be mindful that proxy advisory firms such as Institutional Shareholder Services and Glass Lewis would likely not support a proposal if it is viewed as a mechanism for excessive compensation.