In response to the Delaware Chancery Court’s 2012 and 2015 decisions in Seinfeld v. Slager and Calma v. Templeton and Facebook’s 2016 settlement of Espinoza v. Zuckerberg, public companies that are adopting or amending equity-based compensation plans should consider adding a separate annual sublimit on director equity awards.

In both Seinfeld and Calma, the Chancery Court refused to grant board members of the companies at issue the protection offered by the business judgment rule because their shareholder-approved equity compensation plans did not impose meaningful limits on the amounts the directors could award themselves under the plans. The Chancery Court’s failure to review the challenged director equity awards using the deferential business judgment rule standard meant that both shareholder derivative actions could proceed to trial under a more plaintiff-friendly standard of review.

In reaching its decision in Calma, the Chancery Court drew upon the principles set forth in its ruling in the earlier Seinfeld case. As issue in Calma was the equity plan of Citrix, Inc. The Citrix plan provided that the maximum number of shares that could be awarded to any one participant (including any director) during any one year under the plan was 1,000,000. The plan did not impose a separate sublimit on director equity awards and, based on Citrix’s stock price at the time plaintiffs brought suit, the Chancery Court noted that the board could have awarded each director $55,000,000 worth of restricted stock unit awards. Even though the Citrix equity plan was approved by the Citrix shareholders, Citrix did not ask its shareholders to take “any action bearing specifically on the magnitude of compensation for the Company’s non-employee directors.” The Citrix equity plan did not “specify any amounts (or director-specific ceilings)” on the amounts the directors could receive under the equity plan independent from the generic annual limits applicable to other equity plan participants.

In January of this year, Facebook settled Espinoza, a case where plaintiffs challenged the process that Facebook used to set the compensation of its non-employee directors. As part of the settlement, Facebook agreed to implement the following corporate governance reforms: (i) amend its compensation committee charter to require the compensation committee to: (a) conduct an annual review of the all cash and equity compensation payable to non-employee directors; (b) engage an outside compensation consultant to annually review the amounts payable to the non-employee directors, taking into account the compensation payable to non-employee directors of peer group companies; and (c) recommend to the board whether any changes to the compensation payable to the directors should be made; (ii) on an annual basis, the board must conduct its own review of the director compensation program, taking into account the recommendations of the committee; and (iii) at its 2016 annual meeting, Facebook was required to ask its shareholders to approve an annual compensation program for directors that included a specific sublimit on director equity awards along with the annual cash retainer payable to the directors.

Although the Chancery Court did not specify what it meant by “meaningful limits” or the appropriate “guidance as to the total pay that can be awarded” the Calma case and the settlement in Espinoza make it clear that equity plans that do not establish limits on the amounts payable to directors are susceptible to attacks by litigious plaintiffs. Accordingly, the questions for public companies to consider in light of Seinfeld, Calma, and Espinoza are whether to: (a) add a separate annual limit for director equity awards; and (b) ask the shareholders to approve the limit to afford business judgment rule protection for challenged actions.

A recent survey of Fortune 500 companies by Willis Towers Watson indicates that public companies are taking note of plaintiff friendly decisions like those described in this article. In this regard, the survey notes the following relative to limits on director equity awards:

• 28% of equity plans sponsored by Fortune 500 companies include a director-specific annual award limit.
• 82% of the director-specific limits have been added by the Fortune 500 companies since 2013.
• For Fortune 500 companies expressing the limit on a per share basis, the median multiple of the limit relative to the size of the annual director equity award is 4.4x the annual director award.
• The median limit for the Fortune 500 companies expressing the limit on a cash basis is $500,000.