The Delaware Court of Chancery recently released judgment in Calma v Templeton, a decision that has implications for remuneration committees when selecting a company’s peer group and limits on share plan awards. In this case, a shareholder challenged an award of restricted stock units (RSUs) made to non-employee directors under Citrix Systems, Inc.’s 2005 incentive plan. The Plan, which had been approved by shareholders, allowed the board to award RSUs to directors, officers, employees, consultants and advisors. The Plan limited the remuneration committee to a maximum grant of one million shares per year per individual, valued at the time of judgment as $55 million.
In 2010, the compensation committee had granted shares and options with a fair value of $244,968 to Citrix’s non-employee directors, in addition to cash compensation for a total of between $288,718 and $312,040 per person.
In 2011, the compensation committee awarded $339,320 worth of RSUs to each non-employee director, in addition to cash that brought their total compensation to between $386,716 and $425,570. These amounts were significantly higher than the figures from 2010. Similar awards were made in 2012 and 2013, with maximum compensation reaching $662,935.
The plaintiff alleged that the RSU awards to non-employee directors between 2011 and 2013 were excessive, and constituted a breach of fiduciary duty (the duty to act in good faith and in the best interests of the company), a waste of corporate assets and unjust enrichment. The defendants moved to dismiss the plaintiff’s claims prior to trial.
The defendants argued that the claim for breach of fiduciary duty should be dismissed because the Plan had been ratified by shareholders and thus any awards under the Plan were unimpeachable. The directors were merely acting within the confines of a scheme approved by shareholders.
The Court disagreed. Although it is generally true that when shareholders approve a transaction, the transaction will be largely beyond review, it could not be said in this case that shareholder ratification of the Plan shielded every award under the Plan from scrutiny. For example, a decision to award every director the maximum amount of shares allowable under the Plan would be reviewable by the court. This is because the Plan contained no specific limits on the number of shares that could be awarded to each category of beneficiary. Rather, the one-million-share-limit applied to directors, non-employee directors, and employees alike. In approving the Plan’s general maximum limit, shareholders had not approved a certain magnitude of compensation that could be paid to non-executive directors. Non-executive directors, executive directors and employees would all have very different levels of compensation even though they could all theoretically be awarded one million RSUs each.
The court determined that it was required to review the directors’ actions in awarding shares under the Plan to determine whether the awards were entirely fair to the company, resulting from fair dealing and using a fair price. The court found a reasonable basis for conceiving that the awards to non-employee directors were not entirely fair to Citrix. The problematic transactions under the Plan had been justified by the board on the basis of similar awards being made to Citrix’s peer group, which included companies such as Amazon, Google and Microsoft. The market capitalization, revenue and net income of these three companies are completely different from Citrix. As a result, the court found it was entirely possible that RSU awards made on the basis of a comparison with these “peers” were not entirely fair. Thus, the plaintiff was permitted to continue its action for breach of fiduciary duty, as well as unjust enrichment.
This judgment should provide caution to remuneration committees: select your peer group wisely. Use companies that have similar market capitalization, revenue and net income statistics to your own. If your market cap is 12.74 billion, as Citrix’s was at the beginning of 2011, think again before comparing yourself to Microsoft, whose market cap at the time was 235 billion. Small players who consider Microsoft their peer could be exposing themselves to potential legal liability.
Additionally, remuneration committees should set detailed grant limits under share award plans. There should be a limit for each category of beneficiary entitled to an award. For example, one limit for executive directors, one for non-executive directors and a third for employees. If a company fails to set detailed limits, grants under their incentive plans may be viewed as a breach of fiduciary duty even if the plan itself has been approved by shareholders.
*Thanks to @execpaymatters for alerting me to the decision!