The April 30, 2015 ruling of the Delaware Court of Chancery in Calma v. Templeton shines a spotlight on how courts may respond to concerns about director compensation. In this preliminary decision on a motion to dismiss, the Court decided that the awarding of restricted stock units (RSUs) in accordance with a company’s compensation plan was subject to the “entire fairness” test, given the circumstances set out below. The decision provides important guidance relating to shareholder ratification of board compensation, which is of particular interest in the context of say-on-pay votes.
Calma concerned the compensation plan of non-employee directors (outside directors) of Citrix Systems, Inc. (Citrix). Adopted in 2005, the plan sought to advance the best interests of the corporation by encouraging stock ownership, including by means of the attribution of RSUs to outside directors. The plan gave the compensation committee complete authority to make all decisions with respect to each award to be granted (or to determine the manner in which such decisions would be made).
The plan did not specify the compensation that the outside directors would receive annually. The only limit was that the total number of shares covered by an award that any beneficiary could receive in a calendar year could not exceed 1,000,000.
Over the years, the plan was regularly amended, and those amendments were approved by a majority of Citrix’s disinterested shareholders in informed and un-coerced votes. The plaintiff shareholder launched a derivative suit challenging the awards of RSUs granted to eight outside directors. The plaintiff argued that, when combined with the cash payments that Citrix’s non-employee directors received, the RSU awards were excessive in comparison with the compensation received by directors at certain of Citrix’s peers. The plaintiff also argued that the 1,000,000-share “limit” on awards per person per calendar year was not in any non-specious sense a genuine limit, given that, at the time the complaint was filed (July 2014), 1,000,000 Citrix shares would have been worth over $55 million.
The plaintiff’s argument was based primarily on an alleged breach of fiduciary duty. In considering whether to dismiss that claim, the Court observed that, because the directors’ self-compensation decisions were conflicted transactions, the business judgment rule did not apply. As a consequence, those decisions would have to pass the exacting “entire fairness” test. The only way to avoid that would be for the directors to show that the shareholders had ratified the compensation decisions – a point that occupied a large part of this ruling. The Court’s discussion of ratification is significant, even from a Canadian perspective. First, the Court identified two key principles regarding the role of ratification as a defence:
- Ratification requires that a majority of informed, un-coerced, and disinterested stockholders vote in favor of a specific decision of the board of directors; and
- If ratification is found to have occurred, then “waste” becomes the standard of review (i.e., majority shareholder approval serves to ratify most board decisions but not those that are so egregious as to constitute corporate waste).
The key consideration turned out, in this case, to be the word “specific” in the first principle. While the Court found that the compensation plan and its amendments had indeed been approved by a vote of a majority of informed, un-coerced and disinterested stockholders, it also found that stockholders “were never asked to approve—and thus did not approve—any action bearing specifically on the magnitude of compensation for the Company’s non-employee directors” (emphasis added). In other words, the stockholders may have voted on a company-wide compensation policy, but that vote (on what was a very broad and high-level policy to begin with) did not have any effect that was specific to directors. For example, it did not establish a “director-specific ceiling” beyond the “specious” 1,000,000-share limit that theoretically applied to everyone. In short, the vote did not amount to “ratification” of a board decision relating to directors’ compensation because no such decision was reflected in the compensation plan that was voted on.
The Court held that, in these circumstances, the entire fairness test was the appropriate standard of review and that it was reasonably conceivable that the RSU awards were not entirely fair (and that they had therefore breached the board’s fiduciary duty). Therefore, the motion to dismiss was denied with respect to the fiduciary duty claim, although it was allowed with respect to the allegation of waste (which, the court stressed, is an exceptional sort of claim that would require more egregious facts than these). Only if and when the suit proceeds to trial will we learn whether the RSU awards met the “entire fairness” standard: the significance of this ruling lies mainly in the court’s analysis of ratification.
In Canada, director compensation is subject to a specific regime under the Canada Business Corporations Act (CBCA) and its provincial counterparts. The regime treats compensation decisions as interested transactions that are subject to procedural and substantive requirements. However, under Canadian corporate statutes, shareholder ratification has a more limited cleansing power than it does under Delaware law inasmuch as it does not bar challenges to the reasonableness or fairness of the transaction. Nevertheless, in Canadian jurisdictions shareholder ratification does serve to correct procedural deficiencies in this type of setting and Calma v. Templeton is therefore not without interest in Canada.