This article is reprinted with permission from the
August 30, 2000
edition of
New York Law Journal.
2000 NLP IP Company.


'Sanders v. Wang': Why Drafting Is Important

By Joseph E. Bachelder


THE DELAWARE COURT of Chancery in Sanders v. Wang et. al., 1999 WL 1044880 (Del. Ch. 1999), held that three senior executives at Computer Associates International Inc. (Computer Associates) were not entitled to keep certain of the shares of that firm's common stock granted to them under the Key Employee Stock Ownership Plan (KESOP).1 The decision highlights the risks associated with the drafting of an executive compensation plan.

In August 1995, the shareholders of Computer Associates approved the KESOP. Section 3.1 provides that "[t]he Committee is authorized to grant up to 6,000,000 shares of Common Stock to the Participants."

Section 3.2 provides that:

  the Committee has initially authorized, subject to shareholder approval, the grant of 2,000,000 shares of Common Stock to the Participants in the following percentages:

Participant           / Percentage:
Charles B. Wang      / 60
Sanjay Kumar           / 30
Russell M. Artzt       / 10

The "committee" refers to "the Compensation Subcommittee of the board formed to act on performance-based compensation for key executives." (KESOP 2.1.4)


Target Price

Section 3.3 of the KESOP requires that the committee makes grants of additional shares (additional grants), provided that certain graduated target prices for the common stock are achieved. Any such additional grants are to be made to the three executives in the same proportions as the initial grant. The higher the target price achieved, the more share grants are to be made. Also, the target price required for given levels of grants increases over the five- year period covered by the schedule. Any applicable target price has to be equaled or exceeded for 30 trading days during the applicable plan year in order for the automatic grant provision to take effect.

Immediately after the schedule setting forth the price targets and corresponding grants, 3.3 contains the following sentence:

The target price shall be appropriately adjusted to reflect any stock dividends, stock splits, recapitalization, reorganization, merger, consolidation, split-up, combination or other similar transactions during the Plan Year.

There is no reference in 3.3 or elsewhere in the KESOP to adjustments to the number of shares on account of stock dividends, stock splits, etc.

According to the court, "in August 1995, June 1996, and November 1997, CA gave all holders of Common Stock one share for every two shares held, amounting to three separate "three for two" stock splits." 1999 WL 1044880 at *2. Since these splits occurred after the initial grant of 2 million shares under the KESOP, the court in Sanders v. Wang agreed with the adjustment of the original 2 million shares to 6.75 million shares.

However, the court disagreed with the position of the committee that the remaining 4 million shares authorized for grant under the plan should be adjusted for the stock splits. The court concluded that 3.1 required the remaining grants (beyond the initial grant of 2 million shares) to be limited to 4 million shares, with no adjustments for stock splits. It referred to 3.1 as "a clear, unambiguous contract provision" and held that the three participants must return an aggregate of 9,750,000 shares to the company.

The court's decision in Sanders v. Wang is at least debatable.

  • In the context of a stock award plan like the KESOP, a provision like 3.1 authorizing 6 million shares does carry with it a degree of ambiguity as to whether adjustments should be made in the number of shares authorized in the event there are stock splits and other capital restructurings. In part this ambiguity exists because stock splits automatically adjust the number of shares held by a shareholder. The draftsman of the KESOP, pursuant to which shares of Computer Associates were granted, may have assumed that shares authorized, whether pre-grant or post-grant, would be automatically adjusted for stock splits, etc. In fact, the plaintiffs in this case differed among themselves over whether adjustments for stock splits should be made on the Initial Grant of 2 million shares.

    Other Provisions

    Section 3.1, on its face, would have been clear and unambiguous, if the draftsman had explicitly stated that the 6 million shares were not to be adjusted for capital restructurings. Without such a statement in the authorizing provision of the plan it seems appropriate to look at the surrounding circumstances, including other provisions in the plan, to determine what was intended. In fact, the court did look at other provisions in the plan as noted below.

    ... [w]hile Section 3.3 explicitly permits any stock splits to be reflected when calculating performance targets, no other provisions or language explicitly support the proposition that the Section 3.1 limit may be contravened or unilaterally adjusted for these same stock splits. The presence of this Section 3.3 authorization and the corresponding and conspicuous absence of a provision authorizing alteration of Section 3.1 reinforces my conclusion that the Plan's clear language provided no power to alter the limitations in Section 3.1 based on any stock split criteria. 1999 WL 1044880, *7.

    It seems a stretch to say that the inclusion of a price adjustment provision in 3.3 implies that there should be no adjustment in the number of shares authorized in 3.1 in the event of a stock split. Price targets do not automatically adjust. A share of stock represents a unit of ownership in the equity of a company and when a stock split occurs, as noted above, the number of shares automatically adjusts.

    The "penalized" executives sit on the CA board which knew it was free to present shareholders with a KESOP that included a recapitalization adjustment provision and free to seek shareholder approval of an amendment of the terms of the KESOP if they believed it to be deficient in achieving the Plan's objectives. 1999 WL 1044880, *11.

    The court ignored the authority of the committee in 8.1 of the KESOP to amend the plan. Section 8.1 provides that "the Committee may prospectively amend or terminate the Plan at any time and for any reason. ..." Arguably, the committee, in authorizing the adjustments in the 4 million shares subject to the additional grants, in fact amended the plan even though it did not explicitly describe its action as an amendment.

    The committee shall be vested with all discretion and authority as it deems necessary or appropriate to administer the Plan and to interpret the provisions of the Plan. Any determination, decision or action of the committee in connection with the construction, interpretation, administration or application of the Plan shall be final, conclusive and binding upon all persons.

    Under circumstances similar to those in Sanders v. Wang, courts in New York and Delaware have recognized that broad discretion should be given to boards and their committees in interpreting and administering executive compensation programs.


    'Amdur v. Meyer'

    In Amdur v. Meyer, 15 A.D.2d 425, 224 N.Y.S.2d 440, (1962), the New York Supreme Court, Appellate Division, Third Department, held that directors' action in adjusting the number of shares under stock options for stock dividends was an appropriate exercise of its discretion. This was so, even though the option agreements did not provide for such adjustments. The court concluded that this action was within the interpretive power of the board under the plan and, in that connection, noted:

    Neither do we find it necessary to determine whether the 1958 action was an "interpretation," "construction" or "modification" of the basic agreements. The directors had the general power to do any act which fell within what properly might be regarded as the management of the ordinary business of the corporation. 224 N.Y.S.2d at 443.


    More Than One Option

    In Stemerman v. Ackerman, 40 Del.Ch.431, 184 A.2d 28 (1962), one of the issues was whether, under a stock option plan, the employer was authorized to grant more than one option to any one participant in any one year. Paragraph 4 of the plan provided:

    "The granting of an option to an employee in any one year will not prevent the granting of an option or options to him in any subsequent year or years." 184 A.2d 28 at 29.

    The plaintiff argued this meant that only one option could be granted to any one employee in any one year. The board concluded that it was not limited to one option grant per employee per year and granted each of two executives two options in the same year.

    The court found that the quoted language from Paragraph 4 of the plan created only an inference that only one option may be granted to an employee each year. The court said: "[i]t is certainly not an express prohibition against the grant of more than one option to an employee in any one year." 184 A.2d 28 at 33.

    The court then looked at other provisions of the plan, including a paragraph that stated that options may be granted under the plan "at any time" and "from time to time."

    The court went on to say:

    If ... the language of paragraph 11 is to be regarded as merely raising an inference of authority to grant more than one option in any one year, then the conflict of inferences so to be drawn must be reconciled, if possible. For this purpose it is necessary to consider the entire instrument and the surrounding circumstances. Id. at 33.

    On this basis, the court held that the board correctly exercised its authority in determining that the plan permitted the grant of more than one option per employee in any one year.

    As in the Stemerman case, the language of 3.1 of the Computer Associates KESOP may raise an inference that the authorization of six million shares of common stock represented an absolute number. On the other hand, an inference may be drawn that it would be subject to adjustment if a stock split occurred. As already discussed, the latter inference springs from the fact that shares of stock automatically are adjusted for stock splits and that there was no statement in 3.1 or elsewhere in the plan to the contrary. If there were an ambiguity of inferences, the authority of the KESOP committee appears broad enough to have resolved the ambiguity.

    In Kuyper v. MGM/UA Entertainment Co., 1986 WL 13466, *3 (S.D.N.Y. 1986), the federal district court considered whether a board of directors, given broad authority to interpret a stock option plan, properly interpreted the plan as authorizing the "cashing out" of stock options unexercised at the time of the merger of the employer corporation into another corporation.

    The plaintiff, a former option holder, claimed that the unexercised options should have carried over to the new corporation. The court sustained the interpretation of the board of the employer corporation directing the cash-out of the options. In so holding, the court commented as follows: "Under Delaware law, a company's Board of Directors is given broad authority to construe and to amend stock option plans, and Delaware courts are reluctant to disturb a Board's considered judgment." Id. at *2.

    The court went on to state:

    Faced with board decisions that only incidentally or implicitly contravene the express terms of an option plan ... Delaware courts have deferred to the Board's judgment. Id. at *3.


    This is not a case ... where the Board attempted simply to defy the obligations it had assumed under an option agreement. Here, the effect of assigning a cash value to the shares covered by the Option Agreement was entirely consonant with the general purpose of the Option Agreement and well within the broad authority delegated to the board by the Option Agreement itself and by the law of Delaware. There is nothing to suggest any improper motive on the part of the board. Consistent with the merger agreement, the board simply wanted to eliminate all outstanding shares of HEG stock. Id at *3


    Concluding Comments

    Considered in the context of a plan authorizing awards of common stock, 3.1 of the Computer Associates KESOP is not a "clear" and "unambiguous" declaration that no adjustments for stock splits are to be made in the number of authorized shares. A share of stock is a unit of ownership representing a percentage interest in the equity of a company. It is not unreasonable to infer that if the units are subdivided, as in a stock split (or reduced, as in a reverse stock split), an adjustment in the authorized number of shares should be made. As noted above, the draftsman could have explicitly excluded adjustments for stock splits, etc., and he did not.

    The shareholders of a corporation delegate to their board of directors the responsibility, among other things, of supervising compensation plans, such as the KESOP at Computer Associates. Proper interpretation of language and its inferences can be very subjective.

    If the Computer Associates KESOP Committee's construction contradicted a clear, unambiguous plan provision, then, indeed, a court should set the matter straight. Otherwise, the court should have deferred to the interpretation of the board committee delegated by the KESOP with the responsibility of interpreting the plan.

    This assumes, as was the case in Sanders v. Wang, that there was no finding of lack of good faith, loyalty or disinterestedness on the part of the independent directors making the interpretation. One wonders whether a court that felt compelled to say that "the three Participants will together still receive nearly $320 million. $320 million is no mere bagatelle. ..." 1999 WL 1044880, *7, was itself entirely objective in this matter.


    Drafting Lesson

    Any stock-based plan, whether a stock option, stock grant or other kind of plan should include an antidilution provision. (The author's questioning of the court's holding in Sanders v. Wang is not intended to excuse what clearly was a drafting oversight.) A draftsman should not rely on the authority of the board of directors, or a committee of the board, to administer the plan, or even to amend the plan, as sufficient authority to provide anti-dilution protection.


    1 The decision was appealed to the Delaware Supreme Court, Bickel v. Wang (Del. Sup. Ct. No. 4, 2000, Jan. 14, 2000), but the matter was settled while the appeal was pending. Under the terms of a Stipulation of Settlement entered into on March 31, 2000 and an Order and Final Judgment entered on June 22, 2000, the three executives agreed to return 4.5 million shares, representing approximately half of the 9.5 million shares which the court had ordered be returned. Sanders v. Wang, CA No. 16640 (Del. Ch., Order and Final Judgment, June 22, 2000). As part of the settlement, the plaintiffs in a related derivative action in the United States District Court for the Eastern District of New York, entitled Computer Associates International, Inc. Derivative Litigation, agreed to dismiss their action. Sanders v. Wang, CA No. 16640 (Del. Ch.) and Computer Associates International, Inc. Derivative Litigation, CA No. 98 CV 4961 (E.D.N.Y.) ([joint] Stipulation of Settlement, March 31, 2000). The settlement did not encompass another action in the United States District Court for the Eastern District of New York in which the plaintiff shareholders sued Computer Associates and the three executives under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, allegingthat misleading press releases and accounting violations had artificially inflated the stock price which triggered the awards at issue in the Delaware case. A motion to dismiss that matter was denied on Nov. 15, 1999, and the case is ongoing. In re Computer Associates Class Action Securities Litigation, CA No. 98 CV 4839 (E.D.N.Y., Memorandum and Order, Nov. 15, 1999).