Highlights Potential Vulnerabilities in Classified Board Design
The Delaware Chancery Court has upheld the validity of a bylaw amendment adopted by the stockholders of Airgas, Inc. at its September 2010 annual meeting that accelerates the date of Airgas's next annual meeting to January 2011, barely four months after its 2010 annual meeting was held. The bylaw amendment was proposed by Air Products and Chemicals, Inc., which is aggressively pursuing a $5.5 billion hostile bid for Airgas. At the September 2010 annual meeting, Air Products successfully obtained all three board seats that were up for election on Airgas's nine-member classified board. With the bylaw amendment, Airgas will have the opportunity to elect three more directors to the Air Products board much earlier than it otherwise would have been able to.
The decision turns on the fairly typical wording of the annual meeting and staggered board provisions in Airgas's charter and bylaws. Airgas has appealed the ruling to the Delaware Supreme Court, but unless it is overturned or companies are able to modify their charter or bylaw provisions to address this issue, Chancellor Chandler's decision may substantially weaken the defenses of a number of companies with classified boards—a practice by which only one third of the members of the board of directors is elected at each annual meeting and directors cannot be removed except for cause.
The significance of the bylaw amendment in Airgas's situation is accentuated by the fact that the 2010 Airgas meeting was held late in the proxy season, making the proposed January 2011 meeting only four months away. As a practical matter, a similar bylaw amendment would present less of an issue for companies with classified boards that hold their annual meetings in the spring, since an accelerated January annual meeting would still be seven to eight months away, and, applying Chandler's textual analysis (as discussed below), a court is less likely to uphold an amendment that would cause the company to hold its next annual meeting in the same calendar year.
Annual means "once a year," not "separated by approximately twelve months."
At the heart of the Airgas dispute is whether the company's annual meetings must be held one year apart or once a year, and, if once a year, whether that refers to a calendar or fiscal year. Neither "annual" nor "year" is defined in Airgas's charter or bylaws.
Airgas argued that the bylaw amendment, which received the approval of 51% of the votes cast (representing 45.8% of the shares entitled to vote), was invalidly adopted because it conflicted with the director terms set forth in Article III of the Airgas bylaws and therefore needed the approval of at least 67% of the shares entitled to vote. Article III sets forth the classes and terms of the classified board. It provides that each class of directors shall "hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election" (emphasis added). Article III is protected by a supermajority vote provision in the Airgas charter, which requires that any amendment or repeal of Article III, or the adoption any provision inconsistent therewith, must be approved by the affirmative vote of at least 67% of the outstanding shares. Airgas argued that moving up the 2011 annual meeting would impermissibly shorten the terms of the directors up for election and therefore needed such supermajority approval.
Reasoning that "the operative provisions of Airgas's bylaws and charter in dispute here contain language that may fairly be read to have more than one meaning," and that he must therefore construe the ambiguous terms "in favor of the shareholder franchise" (i.e., in such a way as to support the shareholder-approved bylaw amendment), Chancellor Chandler interpreted Article III to provide that the class of Airgas directors who were elected in 2008 will have their terms expire in 2011— i.e., in the "third year" following their election and not "three years" after their election.
Chancellor Chandler went on to hold that by defining the director terms by reference to their expiration "in the third year" following their election, the drafters of the charter opted not to specify a 36-month or 3-year term, and that therefore the bylaw amendment did not cut short their respective terms. In response to Airgas's argument that the bylaw amendment would require the 2010 and 2011 meetings to occur in the same fiscal year, Chancellor Chandler held that "under the 'rule of construction in favor of franchise rights,' I cannot read the word 'fiscal' into the charter, and must instead construe the ambiguous terms against the board, which leads to my conclusion that Airgas's annual meeting cycle can validly run on a calendar year basis and still be consistent with the charter."
The court adopted a similar approach to statutory interpretation in analyzing whether the bylaw amendment violated Delaware law, holding that "the default rules in Delaware do not require waiting a 'year' or 'twelve months' or any set amount of time from one annual meeting to the next." Noting that DGCL §211(c) explicitly permits the court to require annual meetings to be held within 13 months of the last annual meeting, Chancellor Chandler emphasized that it does not address whether the annual meeting interval may be shortened by any amount of time.
Companies with classified boards should review the specific wording of their relevant charter and bylaw provisions.
We would advise all companies with staggered boards to review closely the text of their charter and bylaw provisions, with a view to assessing their potential exposure on this issue and determining whether revisions to address the decision are possible.
Click here to view Airgas, Inc. v. Air Products and Chemicals, Inc., C.A. No. 5817-CC (Del. Ch. Oct. 8, 2010).