Last year, the Delaware Court of Chancery issued an opinion that reflects increased judicial scrutiny of equity awards made to non-employee directors. The plaintiffs filed a derivative lawsuit challenging the equity grants awarded to directors based on three theories: breach of fiduciary duty, waste of corporate assets, and unjust enrichment. The directors received equity grants under an equity plan that did not specify the amount or form of compensation to be granted to the company’s non-employee directors, and the non-employee directors who received the equity grants also approved the equity grants. The Delaware court, ruling on a motion to dismiss only, concluded that equity grants to directors were subject to an “entire fairness” standard of review and were not subject to the presumptive protection of the business judgment rule. This ruling follows a 2012 Delaware Court of Chancery case from 2012 that reached a similar conclusion on a motion to dismiss.

These rulings raise the question of whether an equity plan should specify the amount and form of director compensation or include a meaningful limit on annual director compensation.

While there has been no decision on the actual merits, we do recommend that companies that are adopting new equity plans consider imposing a meaningful limit on the number of shares that may be granted to non-employee directors under the plan. For example, a plan can impose an annual share limit on director grants or an annual limit on the fair market value of shares or total compensation to be granted to directors. Similar limits are already imposed on grants to executive officers of most public companies that are subject to IRC Section 162(m).