The Delaware Supreme Court has held that that a stockholder-proposed bylaw that requires reimbursement to dissidents who elect a short slate of directors is a proper subject for stockholder action and might cause the company to violate Delaware law.
In CA, Inc. v. AFSCME Employees Pension Plan (listen to oral argument here), AFSCME submitted a shareholder proposal to CA, Inc., a public company. The proposal would amend CA’s bylaws to require the board to cause the company to reimburse stockholders for their reasonable expenses incurred in a successful contested election for a short slate of directors.
CA requested a no-action letter from the SEC on the grounds that the proposal could be excluded under Rule 14a-8(i)(1) and (2). The SEC, in turn, certified two questions of law, which tracked the Rule, to the Delaware Supreme Court. That is, the SEC asked first whether the proposal is a proper subject for action by stockholders and, second, whether the proposal would cause the company to violate any Delaware law.
Justice Jacobs, speaking for a unanimous, en banc, court, held “yes” and “yes”. On the first question, Justice Jacobs framed the inquiry as determining the reach of stockholder power to amend bylaws under §109(a) given that the DGCL does not give the stockholders the same kind of broad management power it gives to the board in §141(a). He started by observing that both the board and stockholders may amend the bylaws under DGCL §109(a). But the DGCL does not give the stockholders the same kind of broad management power it gives to the board in §141(a), suggesting that the difference in management power affects the scope of the stockholders’ power to amend bylaws. Thus he held that the stockholders’ power to amend bylaws is not coextensive with that of the board, even though reading §109(a) alone suggests that both groups have identical power to amend.
From here, Justice Jacobs relies on implications from caselaw and citations to several provisions in the DGCL (§§141(b); 141(f); 211(a), (b), and (d); 216; and 222) to conclude that a (not the) function of bylaws is to comprise the process and procedures by which substantive corporate decisions are reached. The discussion at page 13 of the opinion is a very nice one that marshals the DGCL sections dealing with permissible bylaw provisions. With admirable, though slightly indirect, honesty, Justice Jacobs acknowledges that this dichotomy doesn’t resolve the issue because each side plausibly argues that the proposal here is either substantive or procedural. The touchstone for categorizing the proposal is its intent and effect. Both the intent and the effect of the proposal are to regulate the process of electing directors so the proposal is a proper bylaw provision, which may be adopted by the stockholders. The intent is to promote the integrity of the director election process by making it easier for dissident stockholders to nominate directors and that intent is realized by the proposal’s requirement for reimbursement.
On the second question, though, Justice Jacobs held that the proposal would cause the company to violate Delaware law. Because this is a certified question rather than actual litigation, the court must decide whether any possible set of circumstances could render the proposal invalid. There is, indeed, such a set of circumstances. Where the board determines that the dissident stockholders who nominated a successful short slate of directors did not honestly believe that their actions were in the best interest of the corporation, then the board would breach its duty of loyalty if it reimbursed the dissidents. The board would only be relieved of liability if the reimbursement requirement were in the Certificate of Incorporation rather than in the bylaws.
Footnote 14 declines to locate the bright line between the stockholders’ power to make bylaws and the board’s plenary power under 141(a). It is a wonderful tenure-generating footnote and surely the currently untenured corporate law profs will make much of this opportunity relatively quickly. One intriguing question is whether this case is the Erie of corporate law. Will bylaws now be subject to challenge because they contain substantive rules rather than procedural regulations? Justice Jacobs is clear that defining the processes and procedures by which decision are made is a function, not the function of bylaws but he gives no real clue about what other functions the bylaws may properly serve.
On the merits of this decision, I’m not at all sure that the court is correct when it holds (p.14) that the purpose and effect of the bylaw is to regulate the process of electing directors. It’s difficult for me to believe AFSCME’s intent is to reform process rather than to reduce the risk of running a short slate of directors. My guess is that AFSCME want to run (or has a sense that other CA shareholders would run) a short slate but would be much more assured in doing so if it would recoup at least some of its costs should they prevail. It’s not process reform, but substantive reform that the dissidents want. However, the court is not wrong in the way it describes the mechanism by which that reform is to be implemented.
This case could be taught in Chapter 15 after the third full paragraph on page 544. This opinion presents a You Draft It possibility. Redraft the following bylaw to make it clear that it regulates only the procedural aspects of electing directors:
The board of directors shall cause the corporation to reimburse a stockholder or group of stockholders (together, the “Nominator”) for reasonable expenses (“Expenses”) incurred in connection with nominating one or more candidates in a contested election of directors to the corporation’s board of directors, including, without limitation, printing, mailing, legal, solicitation, travel, advertising and public relations expenses, so long as (a) the election of fewer than 50% of the directors to be elected is contested in the election, (b) one or more candidates nominated by the Nominator are elected to the corporation’s board of directors, (c) stockholders are not permitted to cumulate their votes for directors, and (d) the election occurred, and the Expenses were incurred, after this bylaw’s adoption. The amount paid to a Nominator under this bylaw in respect of a contested election shall not exceed the amount expended by the corporation in connection with such election.
This case has generated commentary by Steve Bainbridge (here, there, over there, around here, and right here), Larry Ribstein (here and there), Francis Pileggi (here), and Lisa Fairfax at The Conglomerate (here and there).