In re Investors Bancorp: Delaware Supreme Court Overturns Chancery Court Precedent on Director Compensation Review | Practical Law

In re Investors Bancorp: Delaware Supreme Court Overturns Chancery Court Precedent on Director Compensation Review | Practical Law

The Delaware Supreme Court reversed the Chancery Court's decision in "In re Investors Bancorp Stockholder Litigation," holding that certain board decisions regarding compensation granted to the directors themselves previously thought to be entitled to deference under the business judgment rule would be reviewed for their entire fairness.

In re Investors Bancorp: Delaware Supreme Court Overturns Chancery Court Precedent on Director Compensation Review

by Practical Law Corporate & Securities
Published on 11 Jan 2018 • Delaware, USA (National/Federal)
The Delaware Supreme Court reversed the Chancery Court's decision in "In re Investors Bancorp Stockholder Litigation," holding that certain board decisions regarding compensation granted to the directors themselves previously thought to be entitled to deference under the business judgment rule would be reviewed for their entire fairness.
In In re Investors Bancorp Stockholder Litigation, the Delaware Court of Chancery ruled, consistently with its own precedent dating back to 1999, that stockholder approval of an equity incentive plan that contained "meaningful limits" on the compensation that directors could award themselves would activate the stockholder-ratification defense, insulate the board's compensation decisions from review under the entire fairness standard, and entitle them to deference under the business judgment rule ( (Del. Ch. Apr. 5, 2017)). On appeal, the Delaware Supreme Court reversed the Chancery Court's decision and, in so doing, overturned several years of Chancery Court precedent ( (Del. Dec. 13, 2017)).
The Supreme Court rejected the Chancery Court's distinction between "meaningful limits" and "generic limits" in incentive plans, instead holding that discretionary decisions by directors to award themselves compensation under an equity incentive plan previously approved by the stockholders are reviewable for their entire fairness when the plaintiff stockholders properly allege breach of fiduciary duty, regardless of any "meaningful limits" on awards built into the plan.

Background

The litigation revolves around awards made under an equity incentive plan adopted in 2015 by the board of Investors Bancorp, Inc. and approved by the company's stockholders at the subsequent annual meeting. The incentive plan provided for a certain total number of common shares that would be reserved for restricted stock awards, restricted stock units, incentive stock options, and non-qualified stock options for the company's 1,800 officers, employees, non-employee directors, and service providers. The plan contained further limits within each of those award categories and distinguished between awards to employee and non-employee directors. Overall, the maximum number of shares that could be issued to all non-employee directors totaled 30% of all the reserved-option and restricted-stock shares available for awards. The stockholders were informed in the proxy statement that the number, types, and terms of awards to be made under the plan would be subject to the discretion of the board's compensation committee and would not be determined until after the stockholder vote.
Soon after the vote, the board held several meetings at which it determined to issue to directors that same year restricted stock and stock options under the plan with an aggregate value of over $51.65 million. The plaintiff stockholders brought a derivative action, claiming that the compensation far exceeded both director pay at every peer firm and the directors' own prior compensation, and, contrary to disclosure in the proxy statement, rewarded the directors' past and not future performance.

Chancery Court Dismissal

The Chancery Court granted the directors' motion to dismiss the complaint. In its decision, the Chancery Court, following its own precedent, distinguished between equity incentive plans that merely contain generic limits on the discretion available to directors to award themselves equity compensation and those that contain "meaningful limits." For example, in Seinfeld v. Slager, the court held that stockholder approval of an incentive plan with a single generic limit on awards and no restrictions on how the awards could be distributed to different classes of beneficiaries could not qualify the board for the ratification defense absent "some meaningful limit imposed by the stockholders on the board" (, at *12 (Del. Ch. June 29, 2002)). On that basis, the court ruled in Calma on Behalf of Citrix Systems, Inc. v. Templeton that stockholder approval of an incentive plan that contained generic limits on compensation for all plan beneficiaries did not entitle the directors to the ratification defense, which left entire fairness as the standard of review for material self-interested board decisions (114 A.3d 563 (Del. Ch. 2015); see Legal Update, Delaware Court of Chancery Applies Entire Fairness to Breach Claim Relating to Non-Employee Director Equity Awards). By contrast, in In re 3COM Corp. Shareholders Litigation, the Chancery Court had found "specific ceilings" for "specific categories of service" that contained enough specificity to activate the stockholder-ratification defense (, at *3 (Del. Ch. Oct. 25, 1999)). Similarly in Criden v. Steinberg, the court upheld a ratification defense because the incentive plan in question authorized the directors to re-price the options after stockholder approval of the plan, even though the actual re-pricing decisions were not submitted to the stockholders (, at *4 (Del. Ch. Mar. 23, 2000)).
The Chancery Court here ruled that Investors Bancorp's incentive plan as submitted to the stockholders contained meaningful limits on the board's discretion, thus entitling the board to the ratification defense and cleansing the board's decisions for purposes of the standard of review. The Chancery Court granted the directors' motion to dismiss because the directors' decisions did not constitute waste (the only way to defeat the application of the business judgment rule). The plaintiffs appealed.

Outcome on Appeal

The Delaware Supreme Court reversed the Chancery Court's decision and remanded it for further proceedings. In its decision, the Supreme Court recognized three scenarios that involve the ratification defense in connection with stockholder-approved equity incentive plans and awards made under those plans:
  • When the stockholders approve the specific director awards.
  • When the plan is "self-executing," meaning that the directors have no discretion when making the awards.
  • When the directors exercise discretion and determine the amount and terms of the awards after stockholder approval.
The first two scenarios, in the court's words, "present no real problems." For example, the Chancery Court's decision in Cambridge Retirement System v. Bosnjak, in which the incentive plan did not set forth specific compensation awards but the specific awards were submitted to the stockholders for approval, would be an example of the first scenario (see (Del. Ch. June 26, 2014)). The third scenario is the difficult one, and it is there that the generic- vs. meaningful-limits test for applying the ratification defense had evolved in the Chancery Court.
The Supreme Court here ruled that the Chancery Court's test is not the right approach. Rather, the ratification defense cannot be used to extinguish the entire fairness standard of review when a breach of fiduciary duty has been properly alleged, despite the incentive plan's limits. This is because all director actions (not just compensation awards) are "twice tested" for their legal authorization and for equitable considerations. Consequently, even though stockholder approval provides broad legal authorization to the board, the board must exercise that authorization equitably. The stockholders approve the general parameters of an equity compensation plan knowing that the board must exercise its authority consistently with its fiduciary duties.
Here, the Supreme Court held that the plaintiffs had raised a pleading-stage reasonable inference that the directors had breached their fiduciary duties by making unfair and excessive discretionary awards to themselves. The ratification defense was therefore unavailable, making entire fairness the appropriate standard of review; the case was remanded back to the Chancery Court.

Practical Implications

The decision in Investors Bancorp is significant for boards adopting incentive plans. Many boards, following the Chancery Court's guidance in Seinfeld v. Slager and Citrix, include separate annual limits in their incentive plans on the number of shares (and in many cases the total compensation) that can be subject to director grants for the sake of limiting directors' discretion over their own compensation, in the expectation that the stockholders' approval of the plan insulates the board from attack. The Supreme Court's decision throws out that approach. Now, discretionary grant decisions will continue to be subject to entire fairness review if the awards are so out of line with the company's prior practice or its peer companies' compensation as to raise a reasonable inference of breach of fiduciary duty. These inferences can also be raised if the board's process is materially weak or the disclosure to the stockholders is materially inaccurate or misleading.
Another tack for boards adopting incentive plans is to adopt plans with even tighter limits on discretion so that any subsequent grant will appear so close to self-executing as to be safe from entire fairness review. However, this approach depends on falling inside a grey area between the Supreme Court's second scenario (safe) and third scenario (risky) and hoping to convince the court that the plan in question is closer to self-executing than not.
A final approach for companies to consider is that taken in Bosnjak, in which the stockholders approve the specific awards made to the directors.