Delaware Supreme Court Imposes New Limits on Stockholder Ratification Defense In Connection With Equity Incentive Plans
In In re Investors Bancorp, Inc. Stockholder Litigation, No. 169, 2017, 2017 WL 6374741 (Del. Dec. 13, 2017), the Delaware Supreme Court limited the ability of directors to assert the stockholder ratification defense when facing a challenge to their implementation of equity incentive plans (“EIP”). When properly invoked, the stockholder ratification defense entitles directors to have a court review their conduct under the more deferential business judgment rule standard, rather than the more stringent “entire fairness” standard. The Delaware Supreme Court held that where stockholders approve an EIP containing general parameters that afford directors discretion to determine specific awards, and their exercise of discretion is properly challenged as a breach of fiduciary duty due to alleged self-dealing, a board must prove that its actions were entirely fair to the corporation and its stockholders. This ruling has the important effect of shifting the burden from complainant stockholders to defending directors and subjects their awards of grants to stricter scrutiny.
Investors Bancorp’s stockholders approved an EIP that left to the discretion of directors the authority to allocate options or restricted stock shares, including grants to themselves. The board then provided itself awards that stockholders argued were inordinately higher than peer companies. This included, plaintiffs alleged, compensation to each non-employee director of more than $2.1 million in 2015, which allegedly eclipsed director pay at every Wall Street firm. The board also issued awards to its director-employee CEO and COO that were 3,683% and 5,384% higher, respectively, than the median award other companies granted similar employees in similar circumstances, according to plaintiffs. In addition, the stockholders alleged that language in the company’s proxy statement led them to believe the awards would be for future performance, not rewards for past conduct, as plaintiffs claimed these were. The directors argued they acted within general parameters that were ratified by stockholders when they approved the EIP, so the stockholder ratification defense and the business judgment rule should apply.
Previous case law suggested that, under similar circumstances, directors could assert the stockholder ratification defense and benefit from the presumption of good faith and due care afforded by the business judgment rule. However, Delaware’s Supreme Court rejected that line of cases, holding that the relevant question is not whether the directors acted within some meaningful limit imposed by stockholders, but whether a breach of fiduciary claim has been properly alleged. If so, the directors bear the burden of proving their decisions were entirely fair as to both process and price.
As a result of this decision, directors can no longer expect to benefit from the deferential business judgment rule when fashioning and proposing EIPs that afford them some degree of self-interested discretion in the EIPs’ implementation. Instead, directors contemplating the inclusion of such discretionary features should consider whether their anticipated post-approval conduct would be perceived as entirely fair to the company and its stockholders before resolving to submit such a plan to stockholder vote.