On April 30, 2015, the Court of Chancery of the State of Delaware rendered an important case decision in a procedural matter dealing with the equity compensation  of non-employee members of a company’s board of directors (see Calma v. Templeton, Delaware Court of Chancery C.A. No. 9579-CB) (“Calma”).  As we discuss in this blog, companies may wish to evaluate their equity compensation plans and ascertain whether their process regarding non-employee director equity awards needs any adjustments in light of Calma.

In Calma, the plaintiff alleged, among other things, that the company’s non-employee directors had awarded themselves an “excessive” discretionary grant of restricted stock units (“RSUs”) under the company’s stockholder-approved equity incentive plan (the “Plan”) and therefore:

  • had breached their fiduciary duties;
  • had wasted corporate assets; and
  • were unjustly enriched by such RSU awards.

The plaintiff made these allegations even though:

  • disinterested company stockholders had previously approved the Plan;
  • the Plan contained an overall annual maximum limit on the number of shares any individual participant could receive under the Plan; and
  • the Plan expressly provided the company board of directors and compensation committee with broad discretionary authority to administer the Plan including determining the amount and form of awards.

As noted above, the case before the court was procedural in nature and dealt with defendants seeking to procedurally dismiss the complaint.  In ruling for plaintiff and that the plaintiff could potentially recover damages under the breach of fiduciary duty claim and unjust enrichment claim (but not the corporate waste claim), the Calma court examined applicable precedent, discussed the relevant standard of review for this area, and articulated certain principles regarding stock incentive plans that companies may wish to take heed of.  We discuss these items below.

The Calma court opinion discussed several earlier cases involving equity compensation of non-employee directors with particular emphasis on the 2012 Seinfeld v. Slager, Delaware Court of Chancery Civil Action No. 6462-VCG case (“Seinfeld”).  In Seinfeld, the company’s board awarded themselves restricted stock units in accordance with the terms of a stockholder approved stock plan.  The Seinfeld plaintiff alleged that such grants constituted corporate waste whereas the defendants argued that the decisions of the board should be protected by the business judgment rule.  Courts will generally be deferential to the business judgment of the board and under the business judgment rule the plaintiffs will have the burden of showing that directors, in reaching their decision, breached their fiduciary duty.  The Seinfeld court held that because the directors were self-interested by virtue of awarding themselves the compensation in question and because the stock plan lacked sufficient definition in meaningfully limiting the magnitude of equity grants which they could award to themselves, the directors would not be afforded the protection of the business judgment rule.  Rather, the directors would have the burden to demonstrate that the equity grants to themselves were entirely fair.

The Calma court determined that its case was similar to the situation presented in Seinfeld.  Like Seinfeld, in Calma there was a stockholder approved equity compensation plan that provided the company directors with discretionary authority to manage the stock plan but such stock plan mandated only a general grant limit that was not focused on non-employee directors.  The Calma court also discussed the three following alternative standards of review:

  • the business judgment rule in which deference would be afforded to the directors’ decision unless the plaintiff can demonstrate that there was a breach of fiduciary duty or waste;
  • corporate waste in which the plaintiff must show that the board’s decision cannot be attributed to any rational business purpose; and
  • entire fairness in which the directors have the burden to show that the compensation in question was the product of fair dealing and fair price.

The Calma court, after looking at relevant precedent, especially Seinfeld, asserted that stockholder approval of a plan that imposes only general grant limits lacks the specificity to enable interested directors to receive the benefit of the business judgment rule when the directors grant themselves equity compensation awards on a discretionary basis.  That is, to be able to rely on stockholder approval, the stockholder approved plan in question must at least articulate specific limits on the compensation of the particular class of beneficiaries in question.

If there has been stockholder approval of a stock plan with more particularized limits which impose meaningful constraints on the magnitude of the directors’ equity compensation, then under Calma apparently only the doctrine of corporate waste would be available to support a plaintiff’s challenge to the directors’ compensation.  The Calma court ruled that absent such stockholder approval, as was the case in Seinfeld and Calma, it means that the directors’ compensation will be subject to an entire fairness review which places the burden of proof on the directors.  Moreover, the Calma court went on to state that “Specifying the precise amount and form of director compensation in an equity compensation plan when it is submitted for stockholder approval “ensure[s] integrity” in the underlying principal-agent relationship between stockholders and directors “by making the directors suffer the ugly and enjoy the good that comes with a consistent, non-discretionary approach” to their compensation.  Likewise, obtaining stockholder approval of director compensation on an annual or regular basis facilitates the disclosure of inherently conflicted decisions and empowers stockholders with a meaningful role in the compensation of their fiduciaries.”

What’s Next?

With a 2012 Delaware case decision now being reinforced by a 2015 court ruling, companies may wish to re-evaluate their director equity compensation process.  Many/most publicly-held companies have stock plans similar to those in Seinfeld and Calma; i.e., a stockholder approved equity plan in which directors participate on a discretionary basis without specific grant limits for non-employee directors.   This type of arrangement has not always been the fashion of the day.  Prior to the 1996 amendments to SEC Rule 16b-3, only directors who were “disinterested persons” could administer stock plans for purposes of Section 16 of the Securities Exchange Act of 1934.  Such “disinterested persons” essentially could not receive equity grants from the plan in question or from another plan unless it was a formula plan.  Given those constraints, before the 1996 amendments to Rule 16b-3, director equity compensation plans were often separate and apart from employee stock plans and these director plans often were nondiscretionary and specified fixed equity grant awards which were hardwired into the plan.  The 1996 amendments to Rule 16b-3 removed this prohibition of disinterested person plan administrators receiving compensation from the equity compensation plan.[1]  As a result, over time segregated director equity compensation plans became less popular and non-employee directors became integrated into their company’s employee stock plan in which directors are the beneficiaries of discretionary grants that they themselves award.   But, Seinfeld and Calma may portend a call back to past times in which director equity compensation is either segregated or fixed or limited in some meaningful way in the equity incentive plan.

[1] In its adopting release for the amendments to Rule 16b-3, the SEC noted “Although the new rule would not prohibit Non-Employee Directors or the full board from awarding themselves grants of issuer equity securities, such grants would be subject to state laws governing corporate self-dealing.  The Commission believes that traditional state law fiduciary duties facilitate compliance with the underlying purposes of Section 16 by creating effective prophylactics against possible insider trading abuses.”

If you have any questions regarding this information, please contact Greg Schick at (415) 774-2988.


This update has been prepared by Sheppard, Mullin, Richter & Hampton LLP for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Sheppard, Mullin, Richter & Hampton LLP expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.