January 22, 2015
Shareholder activism continues to dominate the corporate landscape and attract daily headlines in the financial press. And, as the pace of activism accelerates in 2015, a number of legal battles over the last two years between companies and activists has put in the spotlight the permissible scope and function of advance notice bylaws–a term that we broadly define for these purposes to cover bylaw provisions establishing timing, procedural and informational requirements for shareholders seeking to present director nominations and other business proposals to a shareholder vote.
A typical advance notice bylaw requires that shareholders submit to the corporate secretary notice of all director nominations and business to be put to a vote at an annual meeting within a thirty-day window that opens and closes on specified deadlines preceding the anniversary date of the prior year’s annual meeting date (or, less common, related proxy statement). Such a notice often must be accompanied by information about the nominee or business, and the proposing shareholder. This information is generally intended to enhance the board’s ability to advise shareholders regarding the nominee or proposal, as well as potential sources of conflict between the proponent and other shareholders.
High Bar to Enjoin Application of Advance Notice Timing Requirement Due to Factual Developments
In April 2012, Vice Chancellor Noble of the Delaware Court of Chancery issued an opinion in Icahn Partners LP v. Amylin Pharmaceuticals, Inc. granting a motion to expedite a claim by Carl Icahn that Amylin Pharmaceuticals, Inc. (Amylin) directors breached their fiduciary duties by not waiving Amylin’s advance notice bylaw. Following the passage of the bylaw deadline, Icahn sought to nominate candidates for election to Amylin’s board of directors in the wake of his learning of Amylin’s recent rejection of an unsolicited takeover proposal from a third party. The Court found that Icahn made a "sufficiently colorable claim" of irreparable injury as a result of the Board’s decisions to reject the third-party proposal and his request to waive the advance notice deadline and re-open the nomination process. The Court’s decision gave rise to concerns regarding the potential challenges to the application of advance notice bylaws under changing factual circumstances following the closing of the nomination window. However, a more recent Delaware opinion should alleviate some of those concerns.
On December 16, 2014, Vice Chancellor Parsons of the Delaware Court of Chancery issued an opinion in AB Value Partners, LP v. Kreisler Manufacturing Corporation, et al. denying a motion for a temporary restraining order (TRO) that would have enjoined the advance notice bylaws of Kreisler Manufacturing Corporation (Kreisler). The Court’s decision clarifies that under Delaware law, advance notice bylaws will only be enjoined in cases that pass the relatively high bar of "inequitable circumstances."
In early December 2014, AB Value Partners, LP (AB Value) sought to propose a competing slate of directors at Kreisler’s annual stockholder meeting. Kreisler’s bylaws–which had been adopted years before–contained an advance notice provision requiring stockholders to submit director nominations prior to October 18, 2014. No stockholder nominations were received prior to such date. AB Value filed motions for expedited consideration and a TRO in an effort to attempt to elect its nominees at the 2014 annual stockholder meeting that was to be held in December. AB Value did not challenge the validity of the advance notice bylaws on their face. Instead, AB Value contended that material events that occurred after the October 18, 2014 advance notice deadline rendered enforcement of the advance notice provision inequitable. AB Value specifically pointed to the following events: (1) the distribution of a 37.2% voting bloc, previously held in trust, to the four trust beneficiaries; (2) recently approved salary increases for key management; and (3) alleged errors in the Company’s 2014 meeting notice to stockholders. The Court disagreed, finding AB Value failed to meet even the low threshold of a colorable claim for a TRO to succeed.
Applying relevant precedent, the Court found that AB Value needed to provide "compelling facts" indicating that enforcement of the advance notice bylaws was inequitable. To make such showing, AB Value had to proffer evidence demonstrating that, because of action or inaction by the Board that occurred after the advance notice deadline, "circumstances at [Kreisler] had materially or radically changed such that equitable relief would be needed to afford the stockholders a fair opportunity to nominate an opposing slate." The Court focused its analysis largely on whether the Board took any action resulting in a "radical" change in the Company’s direction in the short window between the advance notice deadline and the annual meeting. While the Court reaffirmed that a sufficiently compelling issue could warrant the "unusual remedy" of enjoining the advance notice bylaw provisions to enable a last-minute proxy contest, that threshold was not met based on the facts of the case.
This latest guidance from Delaware reaffirms that while Delaware courts will go to significant lengths to uphold stockholder voting rights, the enforcement of bylaws’ timing requirements for the delivery of advance notice of shareholder nominees or proposals will only be enjoined if the plaintiff has cleared the high hurdle of demonstrating inequitable circumstances; the Delaware courts will not grant a TRO for actions that fall short of a material or radical change standard. In light of this high hurdle, we expect future advance notice bylaw challenges to focus on the informational requirements discussed below.
Expanding Scope of Informational Requirements
As the investment strategies of activists have expanded over the last few years, so have the informational requirements under advance notice bylaws designed to capture stock ownership and other information regarding the submitting shareholder, such as derivatives and short interests. These requirements typically extend to include information that the board may deem to be relevant to other shareholders but–some may argue–does not otherwise have to be disclosed under the federal securities regulations. Furthermore, as companies have responded to pressure by activists and governance groups by allowing shareholders to call special meetings and act by written consent, boards have deemed it prudent to establish comparable procedural and informational requirements for shareholders seeking to initiate a request for a special meeting or written consent solicitation, so that shareholders using these tools are on the same footing as shareholders seeking to use the advance notice process.
The Courts of Delaware and other U.S. jurisdictions have long recognized the legitimate corporate purpose that is served by a reasonable and well-crafted advance notice bylaw to further an orderly and informed shareholder meeting or consent solicitation. Companies, however, need to remain mindful that courts and regulators may take pause and question advance notice bylaws that, rightly or not, appear to serve no legitimate corporate purpose or eviscerate the right of shareholders to exercise their franchise.
In a closely watched case last year, Chancellor Andre Bouchard of the Delaware Court of Chancery, while not ruling on the substance of the case, referred to a set of bylaws governing the procedures and other requirements to call a special meeting by shareholders as "quite a horse-choker of a bylaw." The Chancellor had previously noted that, although he was not prejudging any of the issues on the merits, he was satisfied the plaintiffs had stated a "colorable claim" that the disclosure requirements in the bylaws may had been so onerous as to conflict with the company’s charter, which expressly allowed the holders of 25% of the outstanding shares to call a special meeting.
In a different case, an arbitration panel that included former Delaware Chancellor William Chandler ruled in August 2013 that an additional requirement in the bylaws of CommonWealth REIT, a Maryland public REIT, that purported to require that a shareholder own three percent of the company’s stock for three years in order to initiate a written consent solicitation was invalid as a matter of law in light of the company’s charter, which gave shareholders the right to act by written consent. The entire board of CommonWealth REIT would be removed seven months later.
Given that legal challenges to advance notice bylaws are likely to accelerate in the coming months, in evaluating the appropriateness of their advance notice bylaws and their application, companies should give careful consideration to the business and legal rationale for the various informational and procedural requirements and avoid a "kitchen sink" approach that could backfire if a shareholder opts to formally challenge the relevant set of bylaws. It is also important for companies to periodically review their advance notice bylaws, including the informational requirements. As a threshold matter, changes adopted "on a clear day" (i.e., in advance of a specific threat) are likely to be more favorably viewed in hindsight by a reviewing court than those adopted in direct response to a specific activist overture. Also, it is important to note that as more companies adopt special meeting and written consent rights, such periodic review is of heightened importance so that the informational requirements in the advance notice bylaw are up-to-date and well-drafted. That way, they can be incorporated without the need for significant changes into special meeting or written consent provisions if and when these are adopted.
Companies and their advisors should aim for a thoughtful approach that balances the need to provide shareholders with full and complete disclosure about the matters before them and conduct an orderly vote, on the one hand, with the realities of a complex and inter-related marketplace, on the other hand.
 See Client Alert, Gibson, Dunn & Crutcher LLP, Delaware Court of Chancery Expedites Proceedings to Enjoin Enforcement of Advance Notice Bylaw (May 17, 2012), http://www.gibsondunn.com/publications/pages/DelawareCt-EnjoinEnforcement-AdvNoticeBylaw.aspx.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert:
Eduardo Gallardo – New York (212-351-3847, firstname.lastname@example.org)
James Hallowell – New York (212-351-3804, email@example.com)
Elizabeth Ising – Washington, D.C. (202-955-8287, firstname.lastname@example.org)
Gillian McPhee – Washington, D.C. (202-955-8201, email@example.com)
Stephenie Gosnell Handler* – Washington, D.C. (202-887-3517, firstname.lastname@example.org)
Please also feel free to contact any of the following practice group leaders and members:
Mergers and Acquisitions Group:
Barbara L. Becker – New York (212-351-4062, email@example.com)
Jeffrey A. Chapman – Dallas (214-698-3120, firstname.lastname@example.org)
Stephen I. Glover – Washington, D.C. (202-955-8593, email@example.com)
Securities Regulation and Corporate Governance Group:
Brian J. Lane - Washington, D.C. (202-887-3646, firstname.lastname@example.org)
Ronald O. Mueller – Washington, D.C. (202-955-8671, email@example.com)
James J. Moloney - Orange County, CA (949-451-4343, firstname.lastname@example.org)
Elizabeth Ising – Washington, D.C. (202-955-8287, email@example.com)
Lori Zyskowski – New York (212-351-2309, firstname.lastname@example.org)
Securities Litigation Group:
Jonathan C. Dickey – New York/Palo Alto (212-351-2399, 650-849-5370, email@example.com)
Robert F. Serio – New York (212-351-3917, firstname.lastname@example.org)
Meryl L. Young – Orange County (949-451-4229, email@example.com)
Thad A. Davis – San Francisco (415-393-8251, firstname.lastname@example.org)
* Ms. Gosnell Handler is not yet admitted to practice in the District of Columbia, and currently practices under the supervision of the Principals of the Firm.
© 2015 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.