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Protecting Director Equity Grants from Entire Fairness Review

    Client Alerts
  • July 08, 2015

The Delaware Court of Chancery recently held in Calma v. Templeton that the decision by the Citrix Systems, Inc. board of directors to grant equity compensation to its non-employee directors was subject to the entire fairness standard of review, rather than the lesser business judgment rule. In light of this decision, as well as the earlier Seinfeld v. Slager decision, companies should consider whether their director equity compensation plans should be modified to avoid this higher standard of review.

The Calma decision…

The Citrix board’s compensation committee granted restricted stock units to the non-employee directors under its equity incentive plan, which covered several classes of participants, including non-employee directors, and had been previously approved by the company’s shareholders. However, though the plan provided that no participant could receive more than one million shares (or RSUs) in a calendar year, it had no separate sub-limits for non-employee directors.

The Court found that the absence of meaningful limits on the amount of equity compensation payable to non-employee directors subjected the board’s grant decision to an entire fairness standard of review. The Court agreed with the plaintiffs that prior shareholder approval of the plan did not support a “shareholder ratification defense” that might otherwise negate the fact that the recipient directors were on both sides of the grant transaction. The Court noted that the shareholders “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 original)

The implications of Calma

It is reasonable to expect, in light of Calma, that shareholders will increasingly challenge equity grants to non-employee directors made under plans that lack “meaningful” limits on the amount of compensation such directors might receive. An entire fairness standard of review of such grants will require boards of directors to bear the burden of establishing that the grants were the product of both fair dealing and fair price. No director will want to be subject to that burden of proof.

Action Steps…

Companies should review their equity plans to determine how their grant limits work. In many cases, it may advisable to modify the plan to impose more specific, and more meaningful, limits on non-employee director grants. If so, the company also must consider whether such a modification requires further shareholder approval under stock exchange rules or otherwise.