In Calma, the plaintiff stockholder claimed that the annual grants of RSUs to the non-employee directors of Citrix, Inc. were, when combined with the cash payments they received, excessive in comparison with the compensation received by directors of certain of Citrix’s peers. The plaintiff sought to recover for breach of fiduciary duty and for waste of corporate assets.
As with most plaintiff stockholder litigation, the key issue was the standard of review under which the decision to grant the RSUs should be measured. Generally, a board decision receives the protection of the business judgment rule and the plaintiff must prove that the decision had no rational business purpose. However, if the plaintiff can establish that the board decision was not approved by a majority of disinterested directors, then, unless stockholders ratified the decision, the decision is subject to the entire fairness standard and the directors must prove that the decision was fair.
As is common practice, the decision to grant the RSUs to the non-employee directors was made by the compensation committee of the Citrix board. Members of that committee were beneficiaries of that decision inasmuch as they were part of the group of non-employee directors who received the awards. For this reason, the court found that the decision was an interested transaction and therefore subject to the entire fairness standard unless the stockholders ratified the decision.
The directors argued that the stockholders did in fact ratify the awards when they approved the 2005 Equity Incentive Plan under which the RSUs were granted. Although the plaintiff did not challenge that the stockholders approved the 2005 EIP (or that their vote was uninformed or coerced), the plaintiff claimed that approval of the 2005 EIP as a whole does not equate to ratification of any decision made by the board thereunder even if permitted by the terms of the EIP.
As is common for equity incentive plans of most public companies, the 2005 EIP included a maximum number of equity awards that could be granted to any one participant (which included employees, officers, consultants, directors and advisors) in any calendar year, but did not contain a ceiling on the awards that could be granted to non-employee directors or a formula for such awards.
The court held that, in this case, ratification required approval either of the actual awards or of a plan that included provisions providing for meaningful limits on the amount of compensation that could be paid to the directors:
Thus, in my opinion, upfront stockholder approval by Citrix stockholders of the Plan’s generic limits on compensation for all beneficiaries under the Plan does not establish a ratification defense for the RSU Awards because, when the Board sought stockholder approval of the broad parameters of the Plan and the generic limits specified therein, Citrix stockholders were not asked to approve any action specific to director compensation. They were simply asked to approve, in very broad terms, the Plan itself. For this reason…I cannot conclude that the Company’s stockholders ratified the RSU Awards such that those awards would be limited to challenge under a [business judgment rule] standard.
In my view, Defendants have not carried their burden to establish a ratification affirmative defense at this procedural stage because Citrix stockholders 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. [The 2005 EIP] does not set forth the specific compensation to be granted to non-employee directors…and does not set forth any director-specific “ceilings” on the compensation that could be granted to the Company’s directors.
Another important aspect is that even if a board decision is subject to the entire fairness standard, in order to state a claim, a shareholder must allege some facts that tend to show that the transaction was not fair. The plaintiff met this burden in Calma by claiming that the peer group of companies that the compensation committee used to measure its non-employee director compensation included companies with higher market capitalization, revenue, and net income metrics than Citrix (such as Amazon.com, Google, and Microsoft). The court agreed that there were valid factual questions about the fairness of the RSU awards in comparison to the director compensation practices at public companies that are comparable to Citrix, and therefore the matter could not be resolved at the summary judgment stage.
From a practical perspective, the Calma opinion will likely change future non-employee director compensation practice in an effort to reduce the risk of these type of claims. In this regard, companies may want to:
- Analyze current director compensation arrangements. Among other things, determine whether any compensation arrangements have been approved by stockholders, compare director compensation (both cash and equity) against peers and review the members of the peer group as to their comparability for purposes of director compensation.
- Consider amending existing equity compensation plans to include ceilings on director equity awards and seek stockholder approval. In this regard, factors to consider include the risk of stockholder litigation generally and the benefits of maintaining flexibility in director compensation. If stockholder approval will be sought, a company may also consider conditioning any current director awards grants on receiving stockholder approval. In all cases, companies should assess the likelihood of receiving stockholder approval. Seeking such approval and not obtaining it may flag director compensation concerns and encourage claims.
- The positions that proxy advisory services have historically taken with respect to equity plan amendments may also change. Institutional Shareholder Services has historically said that amendments to equity compensation plans that do not request for additional shares or include another modification that increases potential cost may receive a positive recommendation. In addition, ISS has historically said that a standalone director compensation limit outside of the company’s equity plan is not subject to ISS equity plan review, thereby removing ISS from the equation. Whether ISS maintains these positions in light of a possible new trend to include ceiling limits or stand-alone director compensation plans remains to be seen.
- The Calma case may be a preview of the next wave of stockholder litigation cases, which will, among other things, increase the need to provide clear disclosure of director compensation, including the reasoning in establishing the programs and amounts.