Davis Polk & Wardwell Newsflash

Delaware Court’s Narrow Reading of CNET Bylaws Clears the Way for JANA Proxy Contest

March 17, 2008

By ruling that an advance notice provision in CNET’s bylaws applies only to stockholder proposals under Rule 14a-8 and not to a stockholder-financed proxy contest, the Delaware Chancery Court declined to address the more provocative issue posed by the CNET bylaws: whether a company may validly impose a one-year stock holding requirement on the rights of stockholders to conduct a proxy contest. Chancellor Chandler’s narrow construction of the CNET bylaw provision neatly sidesteps this issue, while underscoring the need for explicit drafting and clear language in bylaws that may be seen as restricting the stockholder franchise.

Advance notice provisions generally require any stockholder that intends to bring business before a stockholder meeting to give timely prior written notice of its proposal (and related information) to the company. They have been upheld by the courts as appropriate to facilitate an orderly meeting process and to inform stockholders, prior to the meeting, of any business proposed to be conducted at the meeting together with the board’s recommendation. The CNET bylaws, by contrast, sought to impose an additional $1,000 common stock ownership and one-year holding requirement on the eligibility of a stockholder to bring business at its annual meeting.

In JANA Master Fund, Ltd. v. CNET Networks, Inc., CNET sought to prevent JANA, a hedge fund known for shareholder activism, from putting forward proposals to expand the size of CNET’s board from 8 to 13 directors and to nominate 5 individuals to fill the newly created positions. CNET argued that, under its bylaws, only a stockholder that has beneficially owned $1,000 of the company’s common stock for at least one year may bring business at the annual stockholder meeting. Since JANA will have held CNET shares for only eight months at the time of CNET’s annual meeting, CNET argued that JANA is not qualified to bring business. The court did not address the broader question of whether a company may place holding requirements on the right of a stockholder to bring business at a stockholder meeting, but instead focused narrowly on three atypical aspects of the CNET bylaw which, in the court’s view, suggest that CNET’s holding period requirement applies only to stockholders seeking to include their proposals in the company’s proxy statement under Rule 14a-8, and not to third parties waging their own proxy contests using independently financed proxy materials:

  1. While a well-drafted advance notice provision typically sets forth the proper procedures by which a stockholder is permitted to bring business before a stockholder meeting, the CNET bylaw purports to set forth the procedures under which a stockholder “may seek to transact other corporate business at the annual meeting.” The court held that this precatory phraseology only makes sense in the Rule 14a-8 context where the stockholder “may seek” inclusion of its proposal in the company proxy, as opposed to an independently financed proxy solicitation, for which the stockholder need not “seek” management’s approval.
  2. The CNET bylaw provision set the advance notice date by reference to a number of days prior to the mailing of the company’s proxy statement, rather than the date of last year’s annual meeting. In the court’s view, this suggested that the bylaw was designed to give management time to incorporate the stockholder’s proposal in its proxy.
  3. The final sentence in the bylaw provision explicitly provided that “such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy” (emphasis added). The court found that this explicit incorporation of the onerous requirements of Rule 14a-8 makes clear that the entire provision was only intended to apply to proposals that stockholders seek to include in the company’s proxy materials.

While Chancellor Chandler’s ruling raises the concern that there will be increased litigation surrounding advance notice provisions, we believe his approach was likely colored by the context of the aggressive one-year holding requirement that CNET sought to impose on shareholders, and should be limited to this case. The three legs of Chancellor Chandler’s opinion are specific to peculiar aspects of the CNET bylaws and do not necessarily mandate any wholesale changes to advance notice provisions that have been otherwise properly drafted. However, we recommend that companies take this opportunity to review their advance notice provisions in light of the CNET ruling, and attach model language for consideration.

If you have any questions regarding this newsflash, please call your Davis Polk contact.

Davis Polk & Wardwell