Director Compensation: Is This The Calma Before A Storm or Just a Summer Squall? A Handful of Forecasts
By Jim Barrall, Partner, Latham & Watkins LLP
In Calma v. Templeton, the Delaware Chancery Court recently denied a motion to dismiss a lawsuit brought by shareholders against Citrix Systems and its directors which alleged that Citrix’s directors had breached their fiduciary duties by paying the company’s non-employee directors excessive compensation from 2011 through 2013. The key holding of the decision is that Delaware’s “business judgment” rule, which affords directors of Delaware corporations discretion in making business judgments and substantial insulation from liability for their judgments, did not apply in the case because the directors were “interested” in the transaction, which therefore required that their decisions be reviewed under the substantially more demanding “entire fairness” standard. The Court also held that the board’s compensation decisions were not “ratified” by the company’s shareholders, notwithstanding that the shareholder-approved “omnibus equity” plan under which their equity was awarded contained conventional (and very high, IRC Section 162(m) driven) limits on the amount of equity that could be awarded to any individual in a single year, because the limits were not “meaningful.” In our Latham & Watkins Commentary, Director Compensation after Calma v. Templeton: Proactive Steps to Consider, we analyze the Calma decision and describe steps that companies should consider taking in the wake of the decision.
Here are my thoughts on how Calma may affect companies, director compensation and corporate governance practices going forward:
- 1. Simply because the Court in Calma refused to dismiss the shareholders’ lawsuit does not mean that the suit or others like it will survive a likely motion for summary judgment or succeed in a trial on the merits when the directors’ decisions are examined under the “entire fairness” standard. As we have seen in the last five years in lawsuits filed against companies alleging that failures of say on pay votes meant that directors had breached their fiduciary duties in setting officer compensation, and in the follow-on waves of lawsuits alleging that companies made false or misleading proxy statements in their say on pay and equity plan vote proposals, if a few companies aggressively defend these suits and prevail on the merits, the shareholder plaintiffs’ bar may move on to more fruitful targets.
- 2.The safest thing that a company can do to protect itself and its directors from lawsuits like Calma is to have its shareholders approve a director compensation plan that either prescribes the precise terms of formulaic equity awards or which allows the board to determine the terms of the equity awards within shareholder approved limits that are “meaningful,” all as discussed in our Commentary.
- 3. Companies which are in the process of designing new or amended plans for submission to shareholders for approval either to authorize more equity or to satisfy shareholder approval requirements under IRC Section 162(m) should give careful consideration to seeking approval for their director compensation, at least for flexible but meaningful limits, which should not be unduly burdensome in most cases and can be adjusted every few years as plans are submitted for shareholder approval for other reasons.
- 4. Companies which are not now in the process of adopting new plans or submitting amended plans for shareholder approval likely may defer submitting director plans to shareholders for approval of meaningful limits until Calma and any other cases like it proceed to decisions on the merits.
- 5. No matter what happens in the courts, clearly director compensation is now under the same scrutiny from the plaintiff shareholders bar, as well as activist shareholders, as executive compensation has been for years. Companies are likely to respond by making sure that their director compensation plans and programs are designed, drafted and fully disclosed in their proxies, with due regard to their fairness both as to the amount of the compensation and the process by which it was determined. Some ways to do so are discussed in our Commentary and companies should consider them sooner than later, to build the foundation for an “entire fairness” defense if lightening should strike.
- 6. Finally, to conclude with the safest forecast, Calma and cases like it will not result in shorter proxies.
About the Guest Blogger:
James D. C. Barrall is a partner in the Los Angeles office of Latham & Watkins LLP and is the Global Co-Chair of the firm’s Benefits and Compensation Practice. Mr. Barrall specializes in executive compensation, corporate governance, employee benefits, and compensation related disclosure and regulatory matters.
Mr. Barrall is a frequent author, contributing editor, and lecturer on executive compensation, corporate governance, disclosure, and other regulatory matters. He is a co-author of the chapter on extensions of credit to directors and officers in the American Bar Association’s Practitioner’s Guide to the Sarbanes-Oxley Act.
Mr. Barrall has lectured at the UCLA Law School, the UCLA Anderson School of Management, and the Aresty Institute of Executive Education at the Wharton School, University of Pennsylvania. Mr. Barrall is a member of the Board of Advisors of the UCLA School of Law and the Lowell Milken Institute for Business Law and Policy.