Directors "can avoid entire fairness review of a self-dealing transaction by demonstrating that the transaction has been ratified by a fully informed and uncoerced vote of a majority of disinterested stockholders, in which case business judgment will apply and plaintiff must meet the standard for pleading a waste claim."
Reprinted with permission from the May 3, 2017 edition of the Delaware Business Court Insider. © 2017 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382).
A recent decision by the Delaware Court of Chancery, In re Investors Bancorp Shareholder Litigation, C.A. No. 12327-VCS, serves as a reminder that boards of directors of Delaware corporations should consider amending their company's director compensation plans to include specific limits on the amount of compensation (both cash and equity) that a director may be awarded in a given year, and obtaining stockholder approval of such compensation plans. As the teachings of the Court of Chancery's decision in Investors Bancorp confirm, doing so can afford a decision by directors to grant themselves compensation under such plans judicial review under the deferential business judgment rule, rather than under Delaware's most stringent standard of review in fiduciary duty actions, entire fairness.
On March 24, 2015, the board of directors (the board) of Investors Bancorp Inc. adopted an equity incentive plan (the plan) governing the company's director compensation. Under the plan, 30,881,296 shares of the company's common stock were reserved for restricted stock awards, restricted stock units, incentive stock options, and nonqualified stock options for the company's officers, employees, nonemployee directors and service providers. The plan imposed limits on: the number of shares the company could issue as stock options (a maximum of 17,646,455) or as restricted stock awards, restricted stock units, or performance shares (a maximum of 13,234,841), and the number of shares the company could award to employees and directors.
Specifically, the plan imposed the following ceilings on awards to employees and non-employee directors:
The plan also provided that the maximum number of shares that may be issued or delivered to all nonemployee directors, in the aggregate, pursuant to the exercise of stock options or grants of restricted stock or restricted stock units is 30 percent of all option or restricted stock shares available for awards.
The plan was put to a stockholder vote on June 9, 2015, at the company's 2015 annual meeting. Of the shares voted at the meeting, 96.25 percent voted to approve the plan, representing 79.1 percent of the total shares outstanding.
Later that month, on June 23, 2015, the board approved an award of stock options and restricted stock for each of the twelve Board members. Each of the 10 nonemployee directors were granted over $2 million worth of restricted stock and stock options, and the two executive directors were granted over $13 million and $16 million worth of restricted stock and stock options, respectively. In total, the grant date fair value of the awards for all 12 board members was approximately $51.5 million.
Following the company's announcement of the awards, certain stockholders of Investors Bancorp brought suit alleging that the directors had breached their fiduciary duties by awarding themselves grossly excessive compensation. The directors moved to dismiss the complaint for failure to state a claim.
The Court's Analysis
As explained below, the court granted the directors' motion to dismiss, finding that the board's decision to grant themselves restricted stock and stock options was subject to business judgment review (even though granting themselves compensation was, by definition, a self-interested transaction) because the plan under which those awards were granted: contained specific limits on the amount of compensation that the directors could grant themselves in a given year; and was approved by a fully-informed stockholder vote.
The court began its analysis by acknowledging that, generally speaking, a decision by directors to grant themselves compensation is a self-dealing transaction subject to entire fairness review. The court went on to explain, however, that, in the director compensation context, the standard of review may be shifted from entire fairness to business judgment, if the decision by directors to grant themselves compensation was ratified by the corporation's stockholders. The court stated that directors "can avoid entire fairness review of a self-dealing transaction by demonstrating that the transaction has been ratified by a fully informed and uncoerced vote of a majority of disinterested stockholders, in which case business judgment will apply and plaintiff must meet the standard for pleading a waste claim."
The key issue in this case, as identified by the court, was whether the plan, which was approved by the stockholders, contained "meaningful limits" on director compensation, such that the subsequent awards of compensation under that plan could be reviewed under the business judgment rule. In analyzing whether the plan had "meaningful limits," the court distinguished between "generic" limits applicable to all plan beneficiaries, and "director-specific" limits (i.e., limitations on how much compensation that directors may receive). The court stated that approval of broader plans with "generic limits" will not warrant business judgment review of subsequent grants of awards made pursuant to that plan, but that approval of plans with "director-specific limits" will be deemed to ratify awards that are consistent with those limits, warranting the application of business judgment review.
The court found that the Plan in this case contained "'specific limits on the compensation of' the nonemployee and executive members of the board," such that the stockholders' approval of the plan ratified the specific awards later approved by the board. The court noted that the plan in this case does not give the Board "blank check" authority for subsequent awards, but rather imposed "meaningful, specific limits on awards to all director beneficiaries." For that reason, the court found that stockholder approval of the plan ratified the subsequent awards made pursuant to that plan and triggered business judgment review, which warranted dismissal of the plaintiffs' claims.
Delaware companies should consider reviewing their director compensation plans.
Based on the guidance in the court's Investors Bancorp decision, companies should review and analyze their director compensation plans. In reviewing director compensation plans, companies should assess what limits are currently in place, whether those limits are generic or specific, and whether the plans, and the limits contained in those plans, have been approved by the stockholders. Companies may also consider comparing the level of compensation that may be granted to directors under such plans (in terms of both cash and equity) against the compensation plans approved by other comparable companies within in the relevant industry to ensure that the companies' director compensation plans are in line with those of their peers. As explained further below, if a company's current director compensation plan is not commensurate with that of its peer companies, does not include director-specific limits, or was not approved by stockholders, the company should consider amending its director compensation plan and obtain stockholder approval of such plan so that it may obtain additional protections against potential lawsuits challenging the company's director compensation practices.
Delaware companies should consider adopting director-specific limits in their compensation policies.
Based on the company's review of its director compensation plans and policies, the company should consider amending its director compensation plans to include director-specific limits on the amount of compensation directors may be granted (whether in cash or equity) in a given year. Although compensation plans generally may be amended without seeking stockholder approval, instituting director-specific limits without obtaining stockholder approval will not trigger application of the business judgment rule, and will accordingly not provide directors with additional protection against claims challenging director compensation. Obtaining stockholder approval of plans that contain director-specific limits, however, may, as it did in Investors Bancorp, afford the protections of the business judgment rule to the board of directors' subsequent decision to grant awards under such plans.
Stockholder approval must be informed to be effective.
As noted in Investors Bancorp, stockholder approval of a director compensation plan will afford the board's subsequent decision to award compensation to directors under that plan review under the business judgment rule only if the stockholders approving the plan are fully-informed. Companies should therefore be sure to fully and fairly disclose all material information within the board's control when they seek approval of the plan from stockholders, including but not limited to, the details of the plan, the scope of any set limits in the plan, how the plan differs from previous compensation plans, and any preconceived intention to grant awards under that plan shortly after the plan is implemented.
Boards of directors of Delaware corporations should consider amending their company's director compensation plans to include specific limits on the amount of compensation (both cash and equity) that a director may be awarded in a given year, and obtaining stockholder approval of such plans. As the teachings of Investors Bancorp confirm, doing so can afford a decision by directors to grant themselves compensation under such plans deferential judicial review under the business judgment rule, and potentially avoid or shortcut costly and protracted litigation challenging director compensation.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.