Director Compensation Pursuant to Discretionary Equity Plans are Reviewed Using the Entire Fairness Standard
The Delaware Supreme Court recently overturned a lower court’s decision to dismiss a stockholder derivative suit against the directors of Investors Bancorp alleging they breached their fiduciary duties by awarding themselves excessive compensation under an equity incentive plan. The Supreme Court held that director compensation awards made pursuant to discretionary equity plans should be reviewed under a standard that requires the directors to prove the fairness of the awards to the company and its stockholders. The ruling is an important development that may lead to increased stockholder challenges to director compensation awards.
In 2015, the board of Investors Bancorp adopted an equity incentive plan (EIP) that reserved a set amount of shares of the company’s stock for restricted stock awards and stock options for the company’s officers, employees, non-employee directors and service providers. The plan also set limits on i) the number of shares that may be issued as stock options or as restricted stock awards, restricted stock units or performance shares and ii) the number of shares that may be awarded to employees and directors. The board received stockholder approval of the plan at the company’s annual meeting.
Following a series of meetings that began three days after the vote, the Compensation Committee approved awards of restricted stock and stock options to all board members which totaled about $51.5 million. The derivative action was filed after the awards were made public and alleged that the directors breached their fiduciary duties by awarding themselves “grossly excessive compensation.”
In April, the Delaware Court of Chancery found the EIP contained “meaningful, specific limits on awards to all director beneficiaries” and the stockholder’s approval of the EIP served to ratify the director awards. This meant the awards were subject to the “business judgment rule” and reviewed for waste, which the plaintiffs did not plead. The lawsuit was therefore dismissed.
Delaware Supreme Court Decision
In a Dec. 13 ruling written by Justice Collins J. Seitz Jr., the Delaware Supreme Court reversed the lower court’s decision and held that the awards were not protected by the business judgment rule. Rather, the court said the “entire fairness standard” should apply.
“[W]hen stockholders have approved an equity incentive plan that gives the directors discretion to grant themselves awards within general parameters, and a stockholder properly alleges that the directors inequitably exercised that discretion, then the ratification defense is unavailable to dismiss the suit, and the directors will be required to prove the fairness of the awards to the corporation.”
The Supreme Court said the facts alleged in the Investors Bancorp case – that the awards were inordinately higher than peer companies and exceeded prior compensation - supported an inference that the directors breached their fiduciary duties in making unfair and excessive discretionary awards. “Because the stockholders did not ratify the specific awards the directors made under the EIP, the directors must demonstrate the fairness of the awards to the Company.”