Director Equity Award Limit in LTIPs: How Companies are Addressing it this Proxy Season in Light of Recent Delaware Case Law
This proxy season has revealed an intensifying trend to address limitations on grants to non-employee directors in many long-term incentive plans (“LTIPs”). Based on a review of approximately 50 LTIPs submitted for approval this proxy season thus far by Delaware companies, a majority of such LTIPs now include a director-specific limit on the size of annual non-employee director grants and a handful generally permit grants only in pre-determined amounts as set forth in the LTIPs.
In December 2017, the Delaware Supreme Court announced in In re Bancorp Stockholders Litigation ("Bancorp") that the presence of a shareholder-approved limit to the aggregate number of awards available for non-employee directors in an LTIP did not constitute shareholder ratification of awards later granted under the terms of the LTIP. Consequently, the court applied the plaintiff-friendly “entire fairness standard,” to awards granted in accordance with those shareholder-approved limits rather than the more deferential “business judgment rule.”
The court stated that shareholder ratification is a permissible defense in the following two scenarios, arguably creating a safe harbor: (i) shareholders approve specific grants to directors or (ii) shareholders approve a “self-executing plan” (in this case, an LTIP providing for awards over time based on fixed criteria and with fixed amounts and terms) then shareholder ratification of such awards would apply.
Based on our review of LTIPs submitted for approval, we made the following discoveries:
- The majority of the LTIPs contain an express limit to the annual non-employee director grant (generally expressed as a dollar amount or, in limited cases, a set number of shares). Some LTIPs permit a one-time increased limit (increases varied from 33% to 100% of the normal grant size) if the director is in his or her first year of service, with a few also permitting an increased limit for service as chairman. While such an approach does not go as far as the self-executing plans described in Bancorp, it does go beyond the facts of that case in providing both for a per-non-employee director limit and for such limit to apply annually.
- Some of the LTIPs do not address non-employee director limits explicitly, but include generic limits on the size of the grants to all participants to no more than a set number of shares per year. These limitations may be a holdover (particularly in restated plans where grandfathering concerns may apply) of the limitations required for the exception to the deduction limitation under Section 162(m) of the Internal Revenue Code. Similar to the majority position, these LTIPs generally provide individual limits applicable on an annual basis, but unlike the majority do not provide separate provisions applicable to non-employee directors only.
- Two of the LTIPs include provisions that make the grants to non-employee directors self-executing that call for annuals grants covering a preset number of shares or equivalent to a set dollar amount. While those provisions on their faces would appear to be “self-executing” as described in Bancorp, each LTIP goes on to provide at least some level of discretion to diverge from the pre-determined grant amounts. In the first LTIP, which provides for each non-employee director to receive an annual restricted stock grant valued at a set dollar amount, the Board of Directors or the Compensation Committee may use its discretion to change the terms of awards to non-employee directors, including the type or number of shares covered thereunder. In the second LTIP, which provides for each non-employee director to receive an annual option grant covering a set number of shares, the Board of Directors can increase the number of shares to be granted to a particular non-employee director if needed to induce a director to join or remain on the Board or to reflect an increase in the director’s duties with the company. It is not clear whether the language in either of these LTIPs would meet the “self-executing” standard described in Bancorp, but, similar to the first two bullets above, the language goes beyond, arguably well beyond, that at issue in that case.