Will Stockholder Approval of “Meaningful” Director Compensation Limits No Longer Serve as a Defense?

On December 13, 2017, the Delaware Supreme Court in In re Investors Bancorp, Inc. Stockholder Litigation issued a decision having significant ramifications on director compensation.  The case increases the risk of plaintiff stockholder claims against directors based on a breach of fiduciary duties where directors grant themselves equity awards pursuant to a plan providing the directors with general discretion to determine the amount, terms, and conditions of the awards – even if the plan includes a stockholder-approved limit in the plan on the size of the awards that may be granted to directors.

Breaking Down the Decision

The decision largely rejects prior Delaware case law holding that the directors’ self-interested compensation decisions could benefit from review under the deferential business judgment rule where stockholders have approved meaningful directors’ compensation limits (although as noted in our earlier blog, the lower court placed little emphasis on the requirement that a limit be “meaningful”).

Instead, where plaintiffs allege facts leading to a “reasonable inference that the directors breached their fiduciary duty in making unfair and excessive discretionary awards,” the stockholder ratification defense will not be available unless stockholders have approved:

  1. the directors’ awards, or
  2. a director compensation plan that is self-executing or formulaic, such that the directors have no discretion when making awards.

Without the ratification defense, directors will have to demonstrate that the director compensation is fair to the corporation — based on the fact-intensive “entire fairness” standard of review — which makes it more difficult to win a motion to dismiss a plaintiff stockholder’s claim for breach of fiduciary duty.

However, through its emphasis on the rather extreme facts of the case, including that the contested director awards far exceeded director compensation at peer companies, the court’s decision suggests that it may remain possible to defeat a breach of fiduciary claim where the directors made discretionary grants consistent with peer group levels under a stockholder-approved plan imposing meaningful limits. Such different facts may make it difficult for plaintiffs to successfully plead that director awards were unfair and excessive. In contrast, the generous plan limits and egregious award terms in Bancorp enabled the plaintiffs to successfully plead that the discretionary awards were unfair and excessive.

Impact On Director Compensation Decisions

Companies that previously obtained stockholder approval of annual individual director compensation limits, but provided directors with the authority to determine the terms and conditions of the awards within such limits, may need to reconsider whether this approach sufficiently insulates them from potential plaintiff claims. This is particularly a concern for companies providing director compensation that is substantially higher than director compensation at peer companies.

Finally, although Bancorp was decided in the context of equity-based compensation, there is no reason to believe that the law established in this case would not apply equally to cash compensation payable to directors.

Victor Flores is a partner in Baker McKenzie’s Employment & Compensation Practice, with a focus on Executive Compensation and Employee Benefits. Victor advises global US and non-US companies – both public and private – on all aspects of executive compensation and benefits matters, including the corporate, securities and tax law, and ERISA issues arising in the implementation and administration of compensation programs. He regularly helps clients with the design and implementation of equity and non-equity based incentive compensation programs and nonqualified deferred compensation programs. Victor also has extensive experience advising on compensations and benefits issues in mergers and acquisitions, corporate reorganizations, private equity and other corporate transactions.
Sinead Kelly is a partner in Baker McKenzie's Compensation practice. She advises on US executive compensation and global equity and has practiced in the compensation field for over 13 years. Sinead advises US and non-US public and private companies on all aspects of equity compensation plans and arrangements, including plan design, administration, and global implementation, as well as compliance with federal and state corporate, securities and tax laws, stock exchange rules, accounting rules, and non-US tax and regulatory requirements. Sinead also advises on the drafting and administration of nonqualified deferred compensation arrangements, director compensation programs, severance arrangements, change in control plans, employment agreements, short and long-term bonus plans, and other executive compensation arrangements.