May 11, 2015
IN CALMA V. TEMPLETON, DELAWARE COURT OF CHANCERY
FINDS DIRECTOR COMPENSATION DECISION SUBJECT TO
ENTIRE FAIRNESS REVIEW
To Our Clients and Friends:
On April 30, 2015, Chancellor Bouchard of the Delaware Court of Chancery issued an important
decision regarding the fiduciary duties of board compensation committees in awarding compensation
to non-employee directors. In Calma v. Templeton,[1] the Court, drawing on its prior opinion in
Seinfeld v. Slager,[2] denied the defendants' motion to dismiss, under Rule 12(b)(6), a claim that the
members of Citrix Systems, Inc.'s ("Citrix" or the "Company") board of directors breached their
fiduciary duties in awarding compensation to non-employee directors under Citrix's equity incentive
plan. In reaching this decision, the Court applied the entire fairness standard of review to the
compensation committee of the board of directors' (the "Compensation Committee") decisions
regarding non-employee director compensation, rather than the business judgment rule because the
decisions were made (i) by non-employee directors who would receive the awards and (ii) pursuant to
an equity incentive plan that did not impose any restrictions on the amount of director compensation
that could be paid thereunder. However, the Court noted in its decision that the facts of the case did
not support a claim for corporate waste because it could not be shown that the director compensation
was "so far beyond the bounds of what a person of sound, ordinary business judgment would conclude
is adequate consideration to the Company."
Background
Calma is a derivative action challenging awards of restricted stock units (RSUs) granted to eight nonemployee directors of Citrix. The directors' compensation program consisted primarily of cash
compensation and RSU awards which were granted under the Company's 2005 Equity Incentive Plan
(the "Plan"). The Plan was approved by Citrix's stockholders. Citrix officers, employees, consultants,
and advisors were eligible to receive awards under the Plan. The Plan provided that no participant
could receive grants covering more than one million shares or RSUs per calendar year, but otherwise
did not contain any individual limits on awards. In particular, the Plan did not impose any specific
limits on grants to non-employee directors. Based on the Company's stock price on the day that the
action was filed, a grant of one million shares would have amounted to granting the recipient equity
valued at over $55 million. From 2011 to 2013, the Compensation Committee awarded over one
million dollars in cash compensation and RSUs to each of the Company's returning non-employee
directors. The plaintiff contended that the Citrix board breached its fiduciary duties and wasted
corporate assets because the RSU awards were "excessive" in comparison to the compensation
received by directors at Citrix's peer companies.
The Court of Chancery Analysis
The Court of Chancery focused on two of the plaintiff's claims: (i) breach of fiduciary duty and the
defendants' contention that the grants at issue had been prospectively ratified when stockholders
approved the equity plan in 2005 and (ii) waste.[3] The Court found that the breach of fiduciary duty
claim could not be dismissed under 12(b)(6) given that (a) the Plan's broad restrictions on awards were
not sufficient to indicate stockholder ratification of the specific compensation awards to non-employee
directors, and (b) the plaintiff pleaded sufficient facts concerning Citrix's equity grants to state a claim
for breach of fiduciary duty under the "entire fairness" standard of review. As to the second claim, the
Court found that the plaintiff failed to state a claim for waste.
Breach of Fiduciary Duty
The Court determined that the plaintiff stated a claim for breach of fiduciary duty. In evaluating this
claim, the Court first established that the claim should be reviewed under the entire fairness standard,
as opposed to the business judgment rule. In its analysis, the Court determined that the decisions made
by the Compensation Committee were conflicted since three members of the Compensation Committee
(which was comprised solely of non-employee directors) received grants of RSUs. The Court noted
that "director self-compensation decisions are conflicted transactions that 'lie outside of the business
judgment rule's presumptive protection.'" The Court distinguished director self-compensation
decisions from situations where disinterested directors approve the compensation of other directors,
noting that such decisions from disinterested directors would not rebut the presumption afforded to
those directors under the business judgment rule.
Citrix's directors asserted a ratification defense that the RSU awards were granted under a stockholderapproved Plan. Relying on Seinfeld v. Slager, the Court noted that the Plan established "no meaningful
limits" on the amount of compensation to be awarded a given year. In Slager, the stockholders
similarly approved a plan for the company's directors, officers, and employees, but the plan did not
specify the number of options or RSUs that would be awarded to directors. The Slager Court noted
that a "generic limit applicable to a range of beneficiaries with differing roles" was not sufficiently
specific to support a ratification defense. Applying the reasoning in Slager, the Court of Chancery
focused on the fact that Citrix stockholders did not approve "any action bearing specifically on the
magnitude of compensation for the Company's non-employee directors." Additionally, the Plan did not
set forth the specific compensation to be granted to non-employee directors, or meaningful caps for
director compensation. Accordingly, stockholder approval of the Plan did not indicate the vote of "a
majority of informed, uncoerced, and disinterested stockholders" in favor of "a specific decision of the
board of directors" which would be necessary to show stockholder ratification. As such, the Court
proceeded to use the entire fairness standard in evaluating the breach of fiduciary duty claim.
Under the entire fairness standard, the defendant must show that the transaction was a "product of fair
dealing and fair price" – a standard that is difficult to meet in a motion to dismiss. The defendants
asserted that Citrix's non-employee director compensation practices were entirely fair because the
equity grants at issue were in line with those in Citrix's peer group. The plaintiff countered that the
defendant had not selected the appropriate peer group when making its comparison based on revenue,
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market capitalization, and other metrics. The Court denied the defendants' motion to dismiss, finding
that the plaintiff "raised meaningful questions as to whether certain companies with considerably
higher market capitalizations [ . . .] should be included in the peer group." As such, the Court of
Chancery determined that the plaintiff stated a claim for breach of fiduciary duty.
Waste
The Court determined that the plaintiff failed to state a claim for waste. The Court of Chancery found
that the allegations "fail[ed] to support an 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." The Court distinguished the facts of this case to Lewis v. Vogelstein,[4] where
a compensation plan provided a one-time grant to directors of 15,000 options. Unlike in Vogelstein,
where the options were one-time grants that were three times the size of annual grants, the RSU awards
in this case were annual equity grants to Citrix's non-employee directors and the primary compensation
for the directors on the Board. As such, the Court of Chancery found that the plaintiff failed to plead
that the "RSU awards [were] so far beyond the bounds of what a person of sound, ordinary business
judgment would conclude is adequate consideration to the Company."
Key Takeaways
This case addresses a number of issues that Delaware corporations (and directors of Delaware
corporations) should keep in mind when considering non-employee director compensation and
stockholder approval of equity compensation plans that provide for awards to directors. Most notably:
•
Assure that a stockholder-approved equity plan imposes realistic limits on the maximum
size of non-employee director awards under the plan. Imposing realistic limits on nonemployee director grants under stockholder-approved equity plans at the time those plans are
subject to stockholder approval will help a board of directors establish a ratification defense if
met with litigation in the future regarding non-employee director equity awards. The
stockholder ratification defense is important because if established, a court will only review
such decisions for corporate waste. Stockholder ratification applies only if the company can
show that a majority of its fully informed, uncoerced and disinterested stockholders approved
the specific action. A limit on director compensation that is not specific to non-employee
directors and is not meaningfully limited in amount will not be sufficient to show such
ratification. In this regard, companies and boards should consider imposing dollar value limits
on annual director awards in their equity plans rather than share limits, which may vary
significantly over time with fluctuating company stock prices.
•
Conflicted directors will not likely be able to rely on benchmarking data alone to defeat
challenges to director compensation at the 12(b)(6) stage. Although benchmarking remains
a valuable tool to evaluate director compensation, benchmarking alone is not likely to prove
that compensation is entirely fair at the 12 b)(6) stage, as a stockholder may successfully
challenge the inclusion of specific peer companies, the exclusion of others, or raise other
factual issues sufficient to survive a motion to dismiss.
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•
Adequately document reasoning for one-time large director compensation awards. In
light of Vogelstein, a court is more likely to find that director compensation meets the standard
of waste if it is a large one-time award that is not in line with peer company practices or
previously paid amounts. It is important not to make such one-time awards without proper
substantiation and documentation.
[1] Case No. 9579-CB (Del. Ch. Apr. 30, 2015). All quotations not otherwise attributed come from
this case.
[2] 2012 WL 2501105 (Del. Ch. June 29, 2012).
[3] The Court also considered the plaintiff's claim of unjust enrichment; however, it treated this claim
as an alternative theory of recovery running parallel with the claim for breach of fiduciary duty.
[4] 699 A.2d 327 (Del. Ch. 1997).
Gibson, Dunn & Crutcher's lawyers are available to assist in addressing any questions you may have
about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer
with whom you usually work, or any of the following lawyers in the firm's Executive Compensation and
Employee Benefits and Securities Regulation and Corporate Governance practice groups:
John F. Olson - Washington, D.C. (202-955-8522, jolson@gibsondunn.com)
Brian J. Lane - Washington, D.C. (202-887-3646, blane@gibsondunn.com)
Stephen W. Fackler - Palo Alto/New York (650-849-5385/212-351-2392, sfackler@gibsondunn.com)
Ronald O. Mueller - Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)
Michael J. Collins - Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)
James J. Moloney - Orange County (949-451-4343, jmoloney@gibsondunn.com)
Elizabeth Ising - Washington, D.C. (202-955-8287, eising@gibsondunn.com)
Sean C. Feller - Los Angeles (310-551-8746, sfeller@gibsondunn.com)
Lori Zyskowski - New York (212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee - Washington, D.C. (202-955-8201, gmcphee@gibsondunn.com)
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