As the 2008 proxy season draws to a close, it seems safe to conclude that the pace of investor activism, including demands for board representation, will continue to increase. Two recent decisions of the Delaware Court of Chancery, the nation’s preeminent business court, concern one of a corporation’s key tools to regulate investor activism: advance notice bylaws, which control the process and timing for shareholder nominations to the board.
Although forms vary, a typical advance notice bylaw requires a stockholder to provide notice of an intention to nominate an individual for election or bring other business before an annual meeting between 60 and 120 days in advance of the anniversary of the prior year’s annual meeting or proxy statement. Some advance notice bylaws impose additional requirements such as a minimum dollar investment or minimum duration of ownership. Delaware courts have upheld advance notice bylaws on the basis that they permit orderly meetings and election contests, and provide fair warning of dissident nominations so that the corporation has sufficient time to respond.
However, there is inherent tension between these permissible purposes and fundamental shareholder franchise rights, which include the right to nominate candidates for election to the board. An advance notice bylaw effectively bars existing shareholders from reacting to developments occurring within two to four months before the annual meeting (which may include year-end earnings announcements) and prevents shareholders who acquire stock after the deadline from making nominations. Due to these competing policy interests, Delaware courts narrowly construe advance notice bylaws and only uphold those that are clear and unambiguous, and provide for a reasonable notice period.
With this legal backdrop, two recent Delaware decisions (CNET and Office Depot) highlight the need for real clarity in drafting advance notice bylaws (and related public disclosures). In CNET, the bylaw stated that a stockholder who owned at least $1,000 of securities for at least one year could nominate directors if written notice was provided at least 120 days prior to the anniversary of the date of the prior year’s proxy statement. Despite this seemingly clear requirement, the Court of Chancery concluded that the bylaw in question did not operate as an advance notice provision and only applied to nominations or proposals sought to be included in management’s proxy statement. This decision, upheld by the Delaware Supreme Court, effectively eliminated the requirement for advance notice when the shareholder sought to elect directors through its own proxy materials.
In Office Depot, the bylaw did not specifically refer to nominations of directors or include technical provisions ordinarily included in a bylaw applicable to director nominations. The bylaw merely stated that any “business” to be raised at the annual meeting be submitted at least 120 days prior to the anniversary of the date of the prior year’s proxy statement. When a shareholder nominated an opposing slate of directors after the deadline, the court found that director nominations constituted “business” covered by the company’s advance notice requirement, but that the notice of the annual meeting obviated the need for advance notice because it stated that one item of “business” was the election of directors generally, without referring specifically to the candidates nominated by the board.
Taken together, these two decisions demonstrate the general reluctance of Delaware courts to restrict the shareholder franchise in the presence of any ambiguity in bylaws or disclosures. As such, the decisions highlight the need for boards to ensure that bylaws provide clarity so that courts will uphold the protections the board intends. Indeed, in the absence of an advance notice provision, the Delaware default rule will apply, and shareholders will have the right to nominate directors or propose other business up to, and at, the annual meeting.
Therefore, directors should take an active role to ensure that:
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Advance notice bylaws and related public disclosures are clear, unambiguous, and written in “plain English.”
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The advance notice deadline and other requirements are reasonable.
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The bylaws, as a whole, are reviewed on a periodic basis to confirm that they continue to operate in their intended manner.