Investors, proxy advisory services and corporate governance watchdogs closely monitor executive compensation, and express their views on executive pay in diverse fora, ranging from advisory Say on Pay votes required under the Dodd-Frank Act to a CEO Salary Watchdog Facebook page. In the absence of stockholder approval, if a stockholder adequately alleges that directors breached their fiduciary duties by awarding themselves equity pursuant to an incentive plan, the directors must prove that the awards are entirely fair to the corporation. In litigation challenging compensation awarded by the board under an equity incentive plan that has been approved by a majority of informed and disinterested stockholders, however, the affirmative defense of stockholder ratification becomes relevant. Otherwise self-interested director compensation awards made within the confines of a fixed plan approved by fully informed stockholders may be subject to the deferential business judgment rule, not the entire fairness standard. The Delaware Supreme Court recently clarified the limits of the stockholder ratification defense in litigation challenging director compensation awarded under the parameters of a stockholder-approved compensation plan. In In re Inv'rs Bancorp Stockholder Litig., 177 A.3d 1208 (Del. 2017), the court recognized a business-judgment safe harbor for directors where the equity awards approved by stockholders are sufficiently specific as to amounts and terms. But when stockholders have approved an equity incentive plan that gives directors discretion to grant themselves awards within general parameters, and a stockholder adequately alleges that the directors inequitably exercised that discretion, a ratification defense is unavailable and the directors must prove the fairness of the awards to the corporation.

Review of Executive Compensation

Unless restricted by the certificate of incorporation or bylaws, §141(h) of the Delaware General Corporation Law authorizes the board of directors to fix compensation for directors and officers of the corporation. When it comes to decisions on executive compensation or severance payments, the business judgment rule affords directors great deference, recognizing that “[i]t is the essence of business judgment for a board to determine if a particular individual warrants large amounts of money, whether in the form of current salary or severance provisions.” Brehm v. Eisner, 746 A.2d 244, 263 (Del. 2000) (internal quotation omitted). At bottom, the personal services of executives and directors are assets bought and sold in a negotiated market. Courts ordinarily will evaluate compensation decisions under the standards applicable to corporate waste, which provide “a residual protection for stockholders that polices the outer boundaries of the broad field of discretion afforded directors by the business judgment rule.” Sample v. Morgan, 914 A.2d 647, 669 (Del. Ch. 2007).

Director decisions regarding how to compensate themselves, including with equity awards, obviously involve self-interest. With limited exception, in order to safeguard against potential dilution resulting from equity-based awards, the NYSE's Listed Company Manual requires that stockholders be given the opportunity to vote on all equity compensation plans and material revisions thereto. Delaware law generally has been understood to extend business judgment deference to directors who administer a shareholder-approved stock incentive plan within its stated terms, including when directors award themselves equity compensation under the plan. In re 3COM, 1999 WL 1009210 (Del. Ch. Oct. 25, 1999). Self-interested directorial compensation decisions made without independent protections such as a stockholder approved plan, like other interested transactions, are subject to entire fairness review. For years, however, courts would nevertheless apply the more deferential business judgment rule to directors' self-compensation decisions if such decisions were made under a plan with meaningful limits approved by the corporation's stockholders. This is known as a stockholder ratification defense. A bright line between a plan with meaningful limits and one which gives discretion to directors has proved elusive.

'Investors Bancorp'

In 2014, annual compensation for the company's non-employee directors averaged $133,340 in cash, without any equity awards. At the 2015 annual meeting, a majority of the Company's disinterested stockholders voted to approve a proposed Equity Incentive Plan (Plan) for director, officer and employee compensation. The stated purpose of the Plan was to incentivize the Company's officers, employees and directors to deliver strong corporate performance, and to attract and retain quality individuals. The Plan imposed limits on (1) the number of shares that could be issued as stock options or as restricted stock awards, restricted stock units or performance shares, and (2) the number of shares that could be awarded to employees and directors. The Plan reserved up to 30 percent of equity awards for the board's non-employee directors. The company proxy disclosed that the “number, types and terms of awards to be made pursuant to” the Plan were subject to the discretion of the Compensation Committee (and subsequent board approval) and these matters would not be determined until after stockholder approval of the Plan. After the plan was approved by stockholders, the Compensation Committee (composed of seven of the 10 non-employee directors) then held four meetings, received input from consultants, and approved awards of restricted stock and stock options to all board members. The non-employee director awards totaled $21,594,000 and averaged $2,159,400, a sixteen-fold increase over the previous year.

Stockholder plaintiffs sued derivatively in the Court of Chancery, alleging breaches of fiduciary duty by the directors for awarding themselves excessive compensation. Plaintiffs alleged, among other things, that although the proxy seeking stockholder approval was reasonably interpreted as describing the Plan as forward-looking, i.e., rewarding Company employees for future performance, not past services, the compensation was in fact “both backward-looking (i.e., a reward for past service rather than to incentivize future performance) and significantly higher than comparable, or even much larger non-comparable, companies' director compensation.” The Court of Chancery dismissed the complaint against the non-employee directors, concluding that the Plan contained “meaningful, specific limits on awards to all director beneficiaries” and therefore subject to review under the deferential business judgment rule. The court also dismissed the claims as to the executive directors for failure to make a pre-suit demand on the board.