Director Compensation Subject to Entire Fairness Standard

In Calma v. Templeton, C.A. No. 9579-CB (Del. Ch. April 30, 2015), the Delaware Court of Chancery denied the motion to dismiss filed by Citrix Systems, Inc. (Citrix) and its directors in a derivative suit brought by shareholders. The suit alleged that Citrix's directors breached their fiduciary duty by paying excessive compensation to the company's non-employee directors from 2011 through 2013 in connection with awards of restricted stock units (RSUs) under the Citrix 2005 Equity Incentive Plan (Plan). In a challenge to the business judgment rule, the plaintiffs were allowed to proceed with their breach of fiduciary duty claim, and the court noted that the awards were subject to review under the “entire fairness” standard.

Background

The Plan permitted grants of equity compensation in the form of RSUs, stock options and other types of equity awards. It was approved by Citrix stockholders in 2005. Employees, directors, officers, consultants and advisers of Citrix were eligible to receive awards. The Plan limited the total number of RSUs that a participant could receive in a calendar year to 1 million, but it did not otherwise limit annual compensation or awards under the Plan. The Plan granted authority to the compensation committee to decide how many RSUs to award to participants, subject only to the 1 million RSU per year per participant limit. It contained no sub-limits by position, such as a limit for non-employee directors or officers. Based on the price of Citrix stock at the time the case was filed, a grant of 1 million RSUs to a single participant would have been worth over $55 million.

In 2010, consistent with the board's previously announced director compensation practice, the compensation committee granted 3,333 RSUs and 10,000 options to non-employee directors, along with certain cash compensation. Starting in 2011, the equity compensation for non-employee directors was an annual grant of 4,000 RSUs for returning directors and a one-time grant of 10,000 RSUs for new directors. The directors also received cash compensation but no longer received any options. The changes resulted in an average increase of approximately $100,000 in total annual compensation for the directors. The applicable Citrix proxy statements disclosed the specific compensation that was granted to the directors for the year. The suit alleges that the RSU grants for 2011 through 2013 were excessive and constituted a breach of fiduciary duty, corporate waste, and unjust enrichment.

Demand Requirement

Under Delaware law, shareholders who want to lodge a derivative claim must first demand the board to act unless they can show that such demand would be futile. The court stated that, with respect to a derivative challenge to director compensation, the law is skeptical that an individual can fairly and impartially consider whether to have the corporation initiate litigation challenging his or her own compensation, regardless of whether or not that compensation is material on a personal level. The court held that demand was excused as being futile because all three members of the compensation committee, who approved the awards, received RSUs under the Plan.

Breach of Fiduciary Duty

The court first determined that the merits of the breach of fiduciary duty claim should be reviewed under the heightened entire fairness standard rather than the presumptive business judgment standard. The latter generally shields corporate directors from liability for business decisions if the transactions were made in good faith, with due care, and within the directors' authority. If the business judgment standard applies, stockholders must show that the board's decision cannot be attributed to any rational business purpose. In Delaware, a stockholder can rebut the business judgment standard by establishing that at least half of the directors who approved a business decision are not independent or disinterested. If a stockholder rebuts the business judgement standard, then the entire fairness standard applies, and the burden shifts to the directors to satisfy a court that their decision was the product of both fair dealing and fair price. The court concluded that the entire fairness standard applied given that all three members of the Citrix compensation committee received RSUs.

The Citrix directors raised the affirmative defense that the stockholders approved the Plan under which the RSUs were granted. The court noted that the effectiveness of such ratification depends on the type of notice sent to the stockholders and the sufficiency of the explanation to them of the matter itself, and stated that ratifications involving a “blank check” in which directors can theoretically award themselves as much as tens of millions of dollars per year with few limitations have been routinely rejected by Delaware courts.

In reviewing the jurisprudence under Delaware law related to stockholder ratification in connection with director compensation, the court outlined two key principles. One is that the affirmative defense of ratification is available only where a majority of informed, uncoerced, and disinterested stockholders vote in favor of a specific decision of the board of directors. The second is that valid stockholder ratification leads to waste being the doctrinal standard of review for a breach of fiduciary duty claim, meaning that a stockholder must essentially show that the board's decision cannot be attributed to any rational business purpose.

Applying the foregoing principles, the court concluded that Citrix did not carry its burden, for purposes of the motion to dismiss, to establish a ratification defense because Citrix stockholders were never asked to approve any action bearing specifically on the magnitude of compensation for the directors, and the Plan did not set forth any meaningful director-specific ceilings on compensation. In other words, the Citrix stockholders merely voted in favor of the broad parameters of the Plan and had not voted in favor of any specific awards under the Plan.

After establishing entire fairness as the standard for review and determining that Citrix had not carried it burden to establish a ratification defense, the court concluded that there were meaningful factual questions as to the fairness of the RSU awards. Such questions centered on whether companies with considerably higher market capitalizations, revenue, and net income than Citrix should be included in the peer group used to determine the fair value of compensation to Citrix directors. Since such factual questions cannot be resolved at the procedural stage of the motion to dismiss, the court held that the plaintiff did state a claim for breach of fiduciary duty. Finally, the court noted that at the pleadings stage, the claim for unjust enrichment is duplicative of the claim for breach of fiduciary duty and concluded that plaintiff did state a claim for unjust enrichment.

Waste

Under Delaware law, directors waste corporate assets when they approve a decision that cannot be attributed to any rational business decision. To state a claim for waste, it must be reasonably conceived that the directors authorized an exchange that was so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration. Noting that the 2011 through 2013 RSUs at issue were the primary compensation for the directors for their service on the board, the court distinguished the facts in this case from Lewis v. Vogelstein, 699 A.2d 327 (Del. Ch. 1997), in which a one-time grant was found to be waste because it was a gift in which the company received no consideration. The court concluded that the plaintiff failed to state a claim for waste.

Other Recent Litigation

In Binning v. Ogunlesi, No. 11118 (Del. Ch. filed June 9, 2015), a stockholder of Goldman Sachs Group, Inc. (Goldman) filed a derivative complaint in Delaware Chancery Court for breach of fiduciary duty and unjust enrichment alleging that non-employee directors of Goldman have taken advantage of their unlimited ability to set their own compensation. The complaint indicates that Goldman intends to impose a limit on annual RSU awards tied to fixed amount of $500,000. However, the plaintiff argues that the limit is not meaningful because the fixed amount of $500,000 associated with RSUs is, by itself, more than what Goldman's peers pay their directors in total, and the Goldman directors will also receive cash and other benefits. Thus, plaintiff contends that even Goldman's new practice is manifestly unfair.

Effect on Director Compensation Plans

The cases highlight a number of issues that companies, particularly those in Delaware, should consider with respect to compensation plans for non-employee directors:

• Companies should review their existing director compensation arrangements to determine what, if any, limits have been approved by stockholders.
• Companies should consider having stockholders approve a compensation plan that imposes meaningful limits on equity awards to directors. Such meaningful limits may include annual award limits and/or formula-based awards.
• When seeking stockholder approval of non-employee director compensation plans, companies should carefully review the content of the notice and explanation for sufficiency.
• Stockholder ratification of director compensation plans with meaningful limits is important because a court will review the decisions of a board that has established a ratification defense under the corporate waste standard.
• Companies may consider seeking stockholder ratification of past director compensation under existing arrangements.
• Companies should understand the entire fairness standard and how to meet that burden should they be required to do so.

Ultimately, companies will need to consider and implement more narrowly tailored equity compensation plans to avoid potential challenges reviewed by the courts under the heightened “entire fairness” standard.

David Joffe is a partner and Marc Bussone is an associate in the Nashville office of Bradley Arant Boult Cummings LLP. Joffe practices primarily in the areas of employee benefits, executive compensation and employment law. He is the chairperson of the firm's Employee Benefits and Executive Compensation Group. Bussone advises clients on a broad range of employee benefit and executive compensation matters. They can be reached at [email protected] and [email protected], respectively.

In Calma v. Templeton, C.A. No. 9579-CB (Del. Ch. April 30, 2015), the Delaware Court of Chancery denied the motion to dismiss filed by Citrix Systems, Inc. (Citrix) and its directors in a derivative suit brought by shareholders. The suit alleged that Citrix's directors breached their fiduciary duty by paying excessive compensation to the company's non-employee directors from 2011 through 2013 in connection with awards of restricted stock units (RSUs) under the Citrix 2005 Equity Incentive Plan (Plan). In a challenge to the business judgment rule, the plaintiffs were allowed to proceed with their breach of fiduciary duty claim, and the court noted that the awards were subject to review under the “entire fairness” standard.

Background

The Plan permitted grants of equity compensation in the form of RSUs, stock options and other types of equity awards. It was approved by Citrix stockholders in 2005. Employees, directors, officers, consultants and advisers of Citrix were eligible to receive awards. The Plan limited the total number of RSUs that a participant could receive in a calendar year to 1 million, but it did not otherwise limit annual compensation or awards under the Plan. The Plan granted authority to the compensation committee to decide how many RSUs to award to participants, subject only to the 1 million RSU per year per participant limit. It contained no sub-limits by position, such as a limit for non-employee directors or officers. Based on the price of Citrix stock at the time the case was filed, a grant of 1 million RSUs to a single participant would have been worth over $55 million.

In 2010, consistent with the board's previously announced director compensation practice, the compensation committee granted 3,333 RSUs and 10,000 options to non-employee directors, along with certain cash compensation. Starting in 2011, the equity compensation for non-employee directors was an annual grant of 4,000 RSUs for returning directors and a one-time grant of 10,000 RSUs for new directors. The directors also received cash compensation but no longer received any options. The changes resulted in an average increase of approximately $100,000 in total annual compensation for the directors. The applicable Citrix proxy statements disclosed the specific compensation that was granted to the directors for the year. The suit alleges that the RSU grants for 2011 through 2013 were excessive and constituted a breach of fiduciary duty, corporate waste, and unjust enrichment.

Demand Requirement

Under Delaware law, shareholders who want to lodge a derivative claim must first demand the board to act unless they can show that such demand would be futile. The court stated that, with respect to a derivative challenge to director compensation, the law is skeptical that an individual can fairly and impartially consider whether to have the corporation initiate litigation challenging his or her own compensation, regardless of whether or not that compensation is material on a personal level. The court held that demand was excused as being futile because all three members of the compensation committee, who approved the awards, received RSUs under the Plan.

Breach of Fiduciary Duty

The court first determined that the merits of the breach of fiduciary duty claim should be reviewed under the heightened entire fairness standard rather than the presumptive business judgment standard. The latter generally shields corporate directors from liability for business decisions if the transactions were made in good faith, with due care, and within the directors' authority. If the business judgment standard applies, stockholders must show that the board's decision cannot be attributed to any rational business purpose. In Delaware, a stockholder can rebut the business judgment standard by establishing that at least half of the directors who approved a business decision are not independent or disinterested. If a stockholder rebuts the business judgement standard, then the entire fairness standard applies, and the burden shifts to the directors to satisfy a court that their decision was the product of both fair dealing and fair price. The court concluded that the entire fairness standard applied given that all three members of the Citrix compensation committee received RSUs.

The Citrix directors raised the affirmative defense that the stockholders approved the Plan under which the RSUs were granted. The court noted that the effectiveness of such ratification depends on the type of notice sent to the stockholders and the sufficiency of the explanation to them of the matter itself, and stated that ratifications involving a “blank check” in which directors can theoretically award themselves as much as tens of millions of dollars per year with few limitations have been routinely rejected by Delaware courts.

In reviewing the jurisprudence under Delaware law related to stockholder ratification in connection with director compensation, the court outlined two key principles. One is that the affirmative defense of ratification is available only where a majority of informed, uncoerced, and disinterested stockholders vote in favor of a specific decision of the board of directors. The second is that valid stockholder ratification leads to waste being the doctrinal standard of review for a breach of fiduciary duty claim, meaning that a stockholder must essentially show that the board's decision cannot be attributed to any rational business purpose.

Applying the foregoing principles, the court concluded that Citrix did not carry its burden, for purposes of the motion to dismiss, to establish a ratification defense because Citrix stockholders were never asked to approve any action bearing specifically on the magnitude of compensation for the directors, and the Plan did not set forth any meaningful director-specific ceilings on compensation. In other words, the Citrix stockholders merely voted in favor of the broad parameters of the Plan and had not voted in favor of any specific awards under the Plan.

After establishing entire fairness as the standard for review and determining that Citrix had not carried it burden to establish a ratification defense, the court concluded that there were meaningful factual questions as to the fairness of the RSU awards. Such questions centered on whether companies with considerably higher market capitalizations, revenue, and net income than Citrix should be included in the peer group used to determine the fair value of compensation to Citrix directors. Since such factual questions cannot be resolved at the procedural stage of the motion to dismiss, the court held that the plaintiff did state a claim for breach of fiduciary duty. Finally, the court noted that at the pleadings stage, the claim for unjust enrichment is duplicative of the claim for breach of fiduciary duty and concluded that plaintiff did state a claim for unjust enrichment.

Waste

Under Delaware law, directors waste corporate assets when they approve a decision that cannot be attributed to any rational business decision. To state a claim for waste, it must be reasonably conceived that the directors authorized an exchange that was so one-sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration. Noting that the 2011 through 2013 RSUs at issue were the primary compensation for the directors for their service on the board, the court distinguished the facts in this case from Lewis v. Vogelstein , 699 A.2d 327 (Del. Ch. 1997), in which a one-time grant was found to be waste because it was a gift in which the company received no consideration. The court concluded that the plaintiff failed to state a claim for waste.

Other Recent Litigation

In Binning v. Ogunlesi, No. 11118 (Del. Ch. filed June 9, 2015), a stockholder of Goldman Sachs Group, Inc. (Goldman) filed a derivative complaint in Delaware Chancery Court for breach of fiduciary duty and unjust enrichment alleging that non-employee directors of Goldman have taken advantage of their unlimited ability to set their own compensation. The complaint indicates that Goldman intends to impose a limit on annual RSU awards tied to fixed amount of $500,000. However, the plaintiff argues that the limit is not meaningful because the fixed amount of $500,000 associated with RSUs is, by itself, more than what Goldman's peers pay their directors in total, and the Goldman directors will also receive cash and other benefits. Thus, plaintiff contends that even Goldman's new practice is manifestly unfair.

Effect on Director Compensation Plans

The cases highlight a number of issues that companies, particularly those in Delaware, should consider with respect to compensation plans for non-employee directors:

• Companies should review their existing director compensation arrangements to determine what, if any, limits have been approved by stockholders.
• Companies should consider having stockholders approve a compensation plan that imposes meaningful limits on equity awards to directors. Such meaningful limits may include annual award limits and/or formula-based awards.
• When seeking stockholder approval of non-employee director compensation plans, companies should carefully review the content of the notice and explanation for sufficiency.
• Stockholder ratification of director compensation plans with meaningful limits is important because a court will review the decisions of a board that has established a ratification defense under the corporate waste standard.
• Companies may consider seeking stockholder ratification of past director compensation under existing arrangements.
• Companies should understand the entire fairness standard and how to meet that burden should they be required to do so.

Ultimately, companies will need to consider and implement more narrowly tailored equity compensation plans to avoid potential challenges reviewed by the courts under the heightened “entire fairness” standard.

David Joffe is a partner and Marc Bussone is an associate in the Nashville office of Bradley Arant Boult Cummings LLP. Joffe practices primarily in the areas of employee benefits, executive compensation and employment law. He is the chairperson of the firm's Employee Benefits and Executive Compensation Group. Bussone advises clients on a broad range of employee benefit and executive compensation matters. They can be reached at [email protected] and [email protected], respectively.