Delaware Supreme Court Rules Proxy Expense Reimbursement Proposal Invalid
July 21, 2008
The Delaware Supreme Court on Thursday ruled that a shareholder-proposed bylaw requiring a company to reimburse dissidents for reasonable expenses incurred in a successful “short-slate” proxy solicitation (i.e., for less than 50% of the board seats) violated Delaware law. The Court held that proxy reimbursement is a proper subject for action by shareholders since it relates to the process for the election of directors, but found that the bylaw in question was invalid because it mandated reimbursement by the board of directors even in circumstances where the directors, in the exercise of their fiduciary duties, might consider reimbursement to be inappropriate.
CA, Inc. had sought the right to exclude the proposal, submitted by the AFSCME Employees Pension Plan, from its proxy statement under Rule 14a-8 on the grounds that it was “not a proper subject for action by the shareholders” and the proposal, if implemented, “would cause the company to violate [a] state law.” Presented with conflicting legal opinions submitted by counsel for CA and AFSCME, the SEC certified the issues to the Court under the recently adopted Delaware constitutional amendment authorizing such certification.
The Court found that although the bylaw was couched as a substantive-sounding mandate to expend corporate funds, its purpose was in fact to regulate the process for electing directors—a subject in which the Court noted “shareholders have a legitimate and protected interest”—by facilitating the nomination of director candidates by stockholders, and it was therefore a proper subject for shareholder action. While the Court appeared to stretch to categorize this bylaw as procedural rather than substantive, it is unclear whether it would do this in a different context. The Court repeatedly underscored the case-specific nature of its holding and the particularly sensitive context posed by the process for electing directors. In a footnote, the Court (quoting Blasius) noted that “matters involving the integrity of the shareholder voting process involve consideration[s] not present in any other context in which directors exercise delegated power.”
However, the Court went on to rule that the bylaw, if adopted, would violate Delaware law because it would prevent CA’s directors from fully exercising their fiduciary duties. Specifically, although the proposal specified that only “reasonable” expenses should be reimbursed, the Court noted that the bylaw did not reserve to CA’s directors the power to decide whether or not it would be appropriate, in a specific case, to award reimbursement at all. For example, under the proposed bylaw, CA’s board would have no power to deny reimbursement to successful stockholder candidates if it determined that the proxy contest were “motivated by personal or petty concerns, or to promote interests that do not further, or are adverse to, those of the corporation.”
While the decision represents a clear win for CA in striking down this particular bylaw, the Court appears willing to bless an otherwise identical bylaw, provided it reserves a fiduciary out for directors. Given the limited circumstances in which a board of directors would feel justified in denying reimbursement to a properly elected shareholder nominee based on fiduciary grounds, shareholder activists may well find sufficient incentive to pursue such bylaws, the adoption of which could further fuel the growing number of short-slate proxy contests.
In light of the Court's emphasis on the case-specific nature of its holding, issuers, shareholder activists and their advisers will to some extent continue to be left to ponder its applicability to other shareholder-proposed bylaws. Shareholder activists may propose other binding bylaws on the basis that they too are process-orientated (e.g., a bylaw mandating that the process for adopting a poison pill shall include shareholder approval). However, it remains to be seen whether the Court will permit shareholders to further encroach upon the board’s management power via “process-regulating” proposals in other contexts.
If you have any questions regarding this newsflash, please call your regular Davis Polk contact.