Delaware Supreme Court Issues Significant Decision Addressing Board Compensation
January 19, 2018
In December 2017, the Delaware Supreme Court issued a significant decision addressing compensation for boards of directors. The opinion also addresses compensation of members of management who serve on the board of directors. This new decision, In re Investors Bancorp, Inc. Stockholder Litigation, seems to reverse several rulings by the Delaware Court of Chancery relating to stockholder ratification of director compensation and could potentially make it easier for plaintiffs to challenge director compensation that has not been specifically approved by stockholders.
Legal Background of Investors Bancorp
Section 141(h) of the Delaware General Corporation Law authorizes the board of directors of a Delaware corporation "to fix the compensation of directors." Delaware case law, however, views directors' awards of compensation to themselves as inherently self-dealing from a fiduciary duty standpoint. As a result, if such awards are challenged, they generally would be subject to the entire fairness standard of review, as opposed to the deferential business judgment rule that would apply if there was no self-dealing. The entire fairness standard can be difficult and requires directors to show that the board's processes and the terms of the award are fair. Until the Investors Bancorp decision last month, the Delaware Supreme Court had not addressed ratification of director self-compensation decisions in 57 years. However, since 1960, the Court of Chancery had developed this area of the law and had established three ways that stockholders could act to ratify director compensation and therefore "restore" the protections of the business judgment rule:
- if stockholders approved the actual, specific director awards;
- if stockholders approved a director compensation or equity award plan that was self-effectuating; or
- if stockholders approved meaningful limits within which directors could grant themselves awards, without approval of specific award amounts. The law around "meaningful limits" has been developed in the Court of Chancery over the last several years and, in our experience, most companies that have addressed this concern have used the meaningful limits approach.
Factual Background of Investors Bancorp
In 2015, the board of directors of Investors Bancorp, and then an overwhelming majority of its stockholders, approved an Equity Incentive Plan that left decisions about specific awards to officers, employees and directors to the discretion of the Compensation and Benefits Committee of the board of directors, but seemingly sought to rely on the "meaningful limits" approach by setting ceilings on the aggregate awards permissible for non-employee directors. However, the non-employee director limits in the Equity Incentive Plan were quite high and would permit directors to receive an aggregate of 30 percent of the shares available for grant under the plan, which shares could be granted in a single year or over the life of the plan. The limits for employees permitted any single employee to receive options for up to 25 percent of the shares available under the plan, plus another 25 percent of the available shares as RSUs or restricted stock awards.
The committee, and then the whole board of directors, held a series of meetings and ultimately approved awards to non-employee directors with an average value of over $2 million—compared to a median of about $87,500 at peer companies that had undergone a mutual to stock conversion, as Investors Bancorp recently had, and approximately $175,000 for peer companies in general. In the same meetings and discussions, the directors also approved awards to the president and CEO, and to the COO and senior executive vice president, of about $16.7 million and $13.3 million, respectively (3,683 percent and 5,384 percent, respectively, higher than the median at peer companies that had undergone a mutual to stock conversion). Both the CEO and COO were members of the board. In its decision, the Court of Chancery had dismissed the complaint against the non-employee directors because the Equity Incentive Plan contained "meaningful, specific limits on awards to all director beneficiaries." The Court of Chancery also dismissed the complaint against the management members of the board because the plaintiffs failed to make a pre-suit demand on the board of directors, which the court viewed as independent and disinterested with regard to management compensation.
Supreme Court Decision in Investors Bancorp
The Delaware Supreme Court reversed, holding that the stockholders' approval of the parameters in the Equity Incentive Plan, without approval of the "specific" awards, was inadequate to bless the directors' use of discretion in this case to make awards to themselves within those parameters. The court also held that the plaintiffs alleged a "pleading stage reasonable inference that the directors breached their fiduciary duties in making unfair and excessive awards to themselves after stockholder approval of the [Plan]." Noting that director action is "twice tested"—first for legal authorization and then by equity—the court found that when stockholders approve the general parameters of a plan, they do so because they know that directors must exercise their authority under the plan consistently with their fiduciary duties. As a result, when a stockholder properly alleges that directors breached their fiduciary duties when exercising discretion under a stockholder-approved plan, "the directors should have to demonstrate that their self-interested actions were entirely fair to the company." The court also held that because the outside directors had approved awards for the CEO and COO in the same meetings and deliberations in which the non-employee director awards were approved, the awards to the CEO and COO should not be viewed independently and the plaintiff could go forward with its challenge to those awards.
As a result of this decision, companies may come under greater scrutiny by plaintiffs' attorneys and stockholders for their director compensation practices, even if the upper limits for director compensation awards have been approved by stockholders. Therefore, companies will want to consider this new case and potential litigation risks, including past involvement with plaintiffs over compensation or governance issues, and whether these risks make it advisable to seek stockholder approval of director compensation. If companies do wish to seek stockholder support, they may consider seeking stockholder approval of actual director compensation (even if directors are given discretion to choose a lower amount for themselves) or of equity plans containing strict formulas that limit director discretion. Boards also may want to consider how to handle decisions concerning compensation for members of management who serve on the board, by, for example, having separate deliberations and approvals for such management awards. In any event, each company will want to consult with its advisors and will need to take into account various factors based on the specific facts at hand in navigating these issues. Whatever the standard of review that may ultimately apply, any board will also benefit from having careful deliberative processes and pay practices.
For more information on the Delaware Supreme Court's decision or any related matter, please contact any member of the corporate governance, securities and governance litigation, or employee benefits and compensation practices at Wilson Sonsini Goodrich & Rosati.