October 27 2008
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 pre-eminent 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 which acquire stock after the deadline from making nominations. Due to these competing policy interests, Delaware courts narrowly construe advance notice bylaws and uphold only those that are clear and unambiguous, and that provide for a reasonable notice period.
Against 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 which owned at least $1,000 of securities for at least one year could nominate directors if written notice was provided at least 120 days before the anniversary of the date of the prior year’s proxy statement. Despite this seemingly clear requirement, the Delaware Court of Chancery concluded that the bylaw in question did not operate as an advance notice provision and applied only 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 a shareholder seeks 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 required that any 'business' to be raised at the annual meeting be submitted at least 120 days before 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 constitute '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 of disclosures. As such, the decisions highlight the need for boards to ensure that bylaws provide clarity so that courts will uphold the protections that the board intends. 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:
For further information on this topic please contact David B Hennes or John Sorkin at Fried, Frank, Harris, Shriver & Jacobson LLP by telephone (+1 212 859 8000) or by fax (+1 212 859 4000) or by email (email@example.com or firstname.lastname@example.org).
An earlier version of this update was first published in Directorship, September 2008.
ILO provides online commentaries as specialist Legal Newsletters. Written in collaboration with over 500 of the world's leading experts and covering more than 100 jurisdictions, it delivers individually requested information via email to an influential global audience of law firm partners and international corporate counsel. Please click here to register for the service.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription. Register at www.iloinfo.com.