Your Equity Plan Is A Contract – Follow It Or Else | Newsletters | Legal Update: Overview of Employee Benefits

A recent notice from the Delaware Chancery Court reminds companies and their boards of directors that shareholder-approved equity compensation plans are contracts and that failure to comply with the terms of such a contract could result in costly litigation for shareholders.

In Garfield v. Allen, No. 2021-0420-JTL (Del. Ch. May 24, 2022), a shareholder sued the compensation committee of ODP Corporation (NASDAQ: ODP) for breach of contract and breach of fiduciary duty because the committee approved a stock award that violated the terms of the compensation plan by shares approved by shareholders. Specifically, ODP’s equity compensation plan included “individual award limits” that restricted the number of common shares that could be awarded to any individual in a fiscal year of the company. . In March 2020, the Compensation Committee approved performance share awards to the Company’s CEO which, if above the target level, would have exceeded the plan’s individual award limits by approximately $1.2 million. actions. A shareholder sent a demand letter to the ODP asking it to modify the awards to comply with the individual award limit and to investigate whether there were any other violations of the company’s stock plans. society. The company responded with a letter advising the shareholder that it would not be changing the awards because it interpreted the individual award limits as applying to the target number of shares awarded under an award rather than the maximum number that could be earned if the performance exceeded the target. The shareholder subsequently filed a complaint against the compensation committee and the board of directors alleging, among other things, (1) breach of contract since the awards as issued did not comply with the terms of the equity plan and (2) a breach of fiduciary duty to approve awards in excess of individual award limits and then failing to correct the awards when sending the demand letter. The defendants asked for the complaint to be dismissed and the court dismissed the motion.

With respect to the claim for breach of contract, the defendants argued that the action plan was not a contract. To the contrary, the court noted that it had previously expressly “held that a shareholder-approved equity compensation plan is a contract between the board of directors and its shareholders.” (Garfield at 31.) Defendants also argued that there was a provision in the plan that allowed the compensation committee (as plan administrator) to “interpret, interpret and administer” the plan and because the administrator interpreted the individual award limits as applying only to the target number of shares, the plaintiff had no rights. However, the court found that the defendants could not rely on such language to escape the ordinary meaning of the individual award limit in the plan.

With respect to the allegations of breach of fiduciary duty, the court declined to dismiss under the business judgment rule, noting that the business judgment rule only applies to discretionary decisions that fall within the authority of the board, but does not extend to decisions that are beyond the authority of the board. , and the court found that rewriting the individual award limits in the Equity Plan to justify the March 2020 grants to the CEO exceeded that authority. The court also criticized the defendants’ inaction after receiving the plaintiff’s letter of demand, noting that “a conscious decision to leave in place a decision contrary to law supports [an] inference that the decision-maker acted unfairly and in bad faith. (Garfield at age 65.)

***

This case reminds companies, especially public companies, that stock plans approved by shareholders are considered contracts with the company’s shareholders. Failure to comply with plan terms may result in claims against the board for breach of contract and breach of fiduciary duty. This case also highlights that general statements in an action plan giving the director the ability to interpret the plan cannot be used to “rewrite” the unambiguous terms of the plan. Therefore, it is important to take the time to read your plans and award agreements in their entirety, to ensure that management and the board of directors understand all the terms of the plan in order to avoid issuing awards that violate the terms of the plan and respond appropriately to any allegations. a pending award violates the terms of the plan.

Harry L. Blanchard