July 27, 2012
Authored by: benefitsbclp
In a decision released on June 29, the Delaware Chancery Court (a trial court) in Seinfeld v. Slager (no, not that Seinfeld) allowed an allegation of corporate waste to survive a motion to dismiss. The allegation: that directors wasted corporate assets by granting themselves restricted stock units in an excessive amount. The case is significant in part because the court is widely regarded as a leading court on corporate governance issues.
This case is interesting because, most often, compensation of non-employee directors is protected under the “business judgment rule” that basically prevents courts from second-guessing the decisions of a board of directors. However, the business judgment rule is generally not available for transactions where directors have a financial interest that could reasonably compromise their independent judgment. In asserting the protection of the business judgment rule, the directors argued that the stock plan under which the awards were granted was stockholder approved and provided a maximum number of 1,250,000 shares that could be subject to an award to any eligible recipient in a year.
This stockholder approval, the defendant directors argued, cleansed their self-interestedness because they were merely implementing the terms of a stockholder-approved plan. In essence, the directors argued that any grants below the stockholder-approved cap were not self-interested because the directors were acting within parameters approved by stockholders. However, the court said, “Though stockholders approved this plan, there must be some meaningful limit imposed by the stockholders on the Board for the plan to be consecrated by [prior case law] and receive the blessing of the business judgment rule [as a result of stockholder approval].” (emphasis in original). With a stock value of $24.79 per share, the maximum meant that each director could receive tens of millions of dollars of compensation and the court did not find that limit to be meaningful enough to survive a motion to dismiss.
Depending on how this litigation progresses through the trial and appellate levels, companies may want to consider including hard-wired grants or maximum share limits, or reevaluating any limits they already have, going forward. If a maximum number of shares or maximum dollar value that non-employee directors can receive in a given year is in the plan, it should be sufficiently tailored so as not to create the ability to grant excessive director compensation. Additionally, if a plan has a maximum number of shares, that number may need to be revisited (and reduced) as the company’s stock price increases.