Companies should consider a December 2017 Delaware Supreme Court decision, In re Investors Bancorp, Inc. Stockholder Litigation, when structuring equity incentive plans, as the case may result in additional challenges to director compensation. The Delaware Supreme Court held that where (1) a stockholder-approved equity incentive plan allows significant discretion to the directors in awarding compensation under the plan and (2) stockholders properly allege that the directors breached their fiduciary duties when exercising such direction, the directors’ actions will be subject to “entire fairness” review, rather than the more deferential “business judgment” rule.
Typically, the actions of the board of directors are subject to the business judgment rule when “a fully informed, uncoerced, and disinterested majority of stockholders approve the board’s authorized corporate action” – the so-called “ratification defense.” The Delaware Supreme Court noted that the ratification defense has been recognized in matters involving three different types of stockholder-approved equity incentive plans:
- Specific awards to directors as approved by the stockholders;
- Self-executing plans (i.e., the directors have no discretion when making the awards); and
- Plans that allow directors to exercise discretion and determine the amounts and terms of awards after stockholder approval.
The plan in question in In re Investors Bancorp fell within the third category. Prior to this case, a series of Delaware Chancery Court decisions suggested that directors could retain their discretion to make awards after stockholder plan approval, but that if such a plan contained “meaningful limits” on the awards directors could make to themselves, then the ratification defense could be successfully asserted (and the business judgement rule applied) if the awards were challenged. In In re Investors Bancorp, the Delaware Supreme Court addressed this notion by articulating that the directors must exercise such discretion in accordance with their fiduciary duties. Therefore, even if stockholders approve the general parameters of an equity incentive plan, if stockholders can properly allege that the directors’ exercise of discretion within those parameters constituted a breach of their fiduciary duties, the directors then must demonstrate that their actions were entirely fair to the company.
It is worth noting the particular facts of the case, as they arguably are outside the parameters of “meaningful limits.” As a result, the implications of the holding are not entirely clear for stockholder approved equity incentive plans that allow director discretion going forward. First, prior to approval of the plan, the stockholders were told that awards under the plan would be made to incentivize future performance; however, the board instead used the awards to reward past efforts. Second, the rewards were 10 to 20 times higher than the compensation paid to the directors the prior year, 10 times higher than director compensation at similarly sized companies that year, and 8 times higher than director compensation at much larger companies that year. Third, the CEO received an award under the plan that was 3,683% higher than the median award other companies granted their CEOs, and the COO received an award 5,384% higher than the median award to executives at other companies.
Despite the “inordinately” high awards that set the facts of this case apart, boards of directors should still implement best practices when structuring equity incentive plans in light of the In re Investors Bancorp decision. Such practices include:
- Implementing equity incentive plans that provide for specific awards to directors or that are self-executing to ensure the availability of the ratification defense in the event a stockholder challenge to the plan.
- Structuring equity incentive plans that allow for director discretion to include specific limits on amounts of cash and equity compensation that each director may be awarded annually in order to minimize director discretion.
- Establishing a robust process for board determinations of awards, as well as maintaining a clear and detailed record that documents how the board determined such awards and how the awards compare to past compensation and peer companies’ compensation.
- Increased scrutiny by the board’s compensation consultant of the equity incentive plan to determine the appropriate amount of director cash and equity compensation.