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Equity Plans

—Jeffrey W. Apel

As our clients continue to grow their businesses, RMZ is frequently asked to draft an equity incentive plan to enable the client to reward and incentivize certain employees with a stake in the company.  There is often a long list of business issues that must be addressed in order to draft an equity incentive plan fit for a particular client.  But as evidenced by a recent opinion from the Delaware Chancery Court, Calma v. Templeton, C.A. No. 9579-CB (Del. Ch. Apr. 30, 2015), the mechanics of implementing an equity incentive plan can also prove to be critically important.

The Calma case focuses on the issue of stockholder approval for the equity incentive plan at Citrix Systems, Inc. (largely known for its GoToMeeting software), albeit at the motion to dismiss stage of the lawsuit.  Citrix’s board of directors, officers, consultants, and advisors were all beneficiaries under the plan, which was approved by a majority of the company’s disinterested stockholders.  The only limit on compensation imposed by the equity plan was that no beneficiary could receive more than 1 million shares (or RSUs) in any given calendar year, roughly equivalent to $55 million per year at the time of the lawsuit.  During the years 2011 to 2013, each of the non-employee directors at Citrix received between $250,000 and $350,000 in RSUs, far below the limits imposed by the equity plan approved by the stockholders.  Yet the plaintiff stockholders sued the company and its directors alleging that the compensation was excessive, seeking to hold the directors liable under theories of breach of fiduciary duty, waste of corporate assets, and unjust enrichment.

Among other reasons, an equity incentive plan is submitted to a company’s stockholders for approval because ratification by fully informed stockholders generally reduces a court’s standard of review from entire fairness (or a corporate “waste” standard of review) to business judgment where courts are more hesitant to second guess a company’s decisions.  By way of background, Delaware courts generally examine the merits of a claim for breach of fiduciary duty under three standards of review, ranging from most to least favorable to a company’s decision-making: business judgment, enhanced scrutiny, and entire fairness.  Faced with a shareholder lawsuit, a company would clearly prefer that its decision-making be reviewed by a court under the business judgment rule.

Although the equity plan was approved by a majority of stockholders and the awards were within the limits provided in the plan, the court found that the plan did not have any “meaningful limits” on the annual stock-based compensation (e.g., the $55 million yearly threshold was not a meaningful limit with respect to any given individual) and that the directors issuing the equity awards had a conflict of interest when making the compensation decisions.  As a result, the awards issued by the board were never specifically ratified by the stockholders and were therefore subject to the entire fairness test, meaning that it was the company’s burden to show that the awards were the product of both fair dealing and fair price.  The company failed to impose meaningful limits in the plan approved by stockholders, leaving it open to attack in the lawsuit. Failing to implement an equity incentive plan may require specific procedural mechanics to guard against potentially troublesome court review at a later date.  We are here to get both the business issues and the mechanics right.

The information in this article is for informational purposes only and does not constitute formal, legal advice.  Consult with one of the attorneys from Roberts McGivney Zagotta LLC for advice about your particular circumstance.