In Calma v. Templeton, et al., C.A. No. 9579-CB, (Del. Court of Chancery, April 30, 2015), the stockholders of Citrix Systems, Inc. (the “Company” or “Citrix”) had previously approved a compensation plan with few limits; however, the stockholder approval did not extend to approval of specific grants to directors. Plaintiff initiated a derivative suit alleging excessive director compensation.
In his recent decision, Chancellor Bouchard determined: (i) there was “reasonable doubt” as to whether the directors who received the challenged compensation can be sufficiently disinterested to consider impartially a demand to pursue litigation challenging their own compensation; (ii) shareholders did not receive sufficiently specific information about director compensation such that approval of a restricted stock plan could be considered ratification of the grants in question; and (iii) as a result, the entire fairness review would apply, shifting the burden to the directors and allowing the plaintiff’s claim for unjust enrichment to survive a motion to dismiss. The Court stated that “I also conclude that it is reasonably conceivable that the defendants were unjustly enriched by the RSU Awards.” Opinion at 3.
The Court dismissed the plaintiff’s claim that the grants in question constituted corporate waste.
Background Plaintiff initiated derivative litigation challenging the award of restricted stock units (“RSU”) to eight non-employee directors of the Company from 2011–2013. These RSUs made up the majority of the directors’ compensation, and were granted pursuant to the Company’s 2005 Equity Incentive Plan (the “Plan”). The Plan established a Compensation Committee with “complete authority, in its discretion,” to grant awards of RSUs under the Plan. The Plan was approved by disinterested shareholders and was subsequently amended several times without stockholder approval. The only limit placed on compensation was that no beneficiary could receive more than 1 million RSUs per calendar year, which at the time the complaint was filed translated to more than $55 million of value.
For the three years 2011 to 2013, the non-employee directors who served on the board during that time period each received aggregate compensation of approximately $1.2 million.
Plaintiff asserted claims for breach of fiduciary duty, waste of corporate assets, and unjust enrichment based upon the directors’ compensation.
The Demand Requirement Was Excused The Court held that demand on the board was excused as being futile because the three members of the Compensation Committee each received RSUs under the Plan. The entire Board did not approve the RSUs, only the Compensation Committee, consistent with its authority.
In analyzing demand futility, the Court applied the test set forth in Rales v. Blasband, 634 A.2d 927 (Del. 1993), which is usually applied when the challenged action was not made by the board currently in place at the time of the complaint. The Court did not apply the test articulated in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), which is applicable when a plaintiff challenges the decision of a board upon which plaintiff must make demand.
The Court determined that Rales was the appropriate analysis because only a subset of the board – the Compensation Committee comprised of three directors – made determinations on director compensation. The Compensation Committee’s decisions could not be imputed to the entire board of nine directors because fewer than half of the Board members served on the Compensation Committee.
Shareholder Approval of the RSU Plan Was Insufficient to Ratify the Specific Grants Challenged The directors asserted that because shareholders had ratified the Plan, the grants were merely the result of the directors “administering” a shareholder approved plan; therefore, to be found liable, the plaintiff would need to establish corporate waste to prevail, and the directors would enjoy the more lenient business judgment rule standard.
The Court rejected the defendants’ ratification defense. After reviewing relevant Delaware case law stretching back to 1952 concerning ratification as an affirmative defense, the Court held that ratification was ineffective in this case because “the Company did not seek or obtain stockholder approval of any action bearing specifically on the magnitude of compensation to be paid to its non-employee directors.” Opinion at 3. The Court reasoned as follows:
[T]he Delaware doctrine of ratification does not embrace a “blank check” theory. When uncoerced, fully informed, and disinterested stockholders approve a specific corporate action, the doctrine of ratification, in most situations, precludes claims for breach of fiduciary duty attacking that action. But the mere approval by stockholders of a request by directors for the authority to take action within broad parameters does not insulate all future action by the directors within those parameters from attack.
Opinion at 30, quoting Sample v. Morgan, 914 A.2d 647, 663 (Del. Ch. 2007) (emphasis in Opinion).
Chancellor Bouchard distinguished Cambridge Retirement System v. Bosnjak, 2014 WL 2930869 (Del. Ch. June 26, 2014), an opinion that he authored just last year. Chancellor Bouchard explained that in Bosnjak, “Unilife’s stockholders approved each of the specific equity awards challenged.” Opinion at 34 (quoting Bosnjak, 2014 WL 2930869, at *8) (emphasis in Opinion). In his review of the caselaw, Chancellor Bouchard also observed that shareholder ratification of plans with “meaningful limit[s] imposed by the stockholders on the Board,” such as “specific ceilings…based on specific categories of service,” has been applicable. Opinion at 27, 33 (quoting In re 3COM Corp. S’holders Litig., 1999 WL 1009210, at *3 n.9 (Del. Ch. Oct. 25, 1999), and Seinfeld v. Slager, 2012 WL 2501105, at *12 (Del. Ch. June 29, 2012)).
Here, the shareholder vote imposed no such meaningful limitations on the Compensation Committee’s discretion in awarding RSUs, and the compensation awards were not approved by disinterested directors. Thus, the affirmative defense of ratification was not available, and the awards are subject to the entire fairness standard of review. Plaintiff’s breach of fiduciary duty claim thus survived the directors’ motion to dismiss, and the defendants now have the burden to establish that the compensation decisions were the product of fair dealing and fair price.
The Claim for Corporate Waste Was Dismissed; The Claim for Unjust Enrichment Was Duplicative But Survived The Court dismissed plaintiff’s claim for waste, holding that “Plaintiff’s allegations ‘do not remotely support the inference that Citrix’s non-employee director compensation was so one-sided that no reasonable business person could conclude that the Company received adequate consideration.’” Opinion at 42. Because the director compensation could be attributed to a “rational business purpose,” the claim for waste was dismissed.
The Court held that where an unjust enrichment claim is entirely duplicative of a breach of fiduciary duty claim, it is treated in the same manner as that claim when resolving a motion to dismiss. Here, the claims were duplicative because no distinct behavior was being challenged. As a result, the Court denied the directors’ motion to dismiss this claim.
- To shield their decisions from an entire fairness review, directors must place specific compensation parameters before shareholders for ratification. Blank check approval is not sufficient. Shareholder ratification of specific amounts of compensation for specific directors remains effective. In addition, the defense of shareholder ratification of plans with specific and narrow limitations will likely be available.
- Boards should always follow best practices when adopting or recommending director compensation plans. Consider peer company analysis, use of compensation consultants, consideration of the nexus between director compensation and shareholder returns, and company performance.
- Evaluate what board actions should be delegated entirely to a committee, as contrasted with actions that should be recommended by a committee for approval by the entire board.
Client Alert 2015-112