March 24, 2008

Delaware: Advanced Notice Bylaw Limited to Rule 14a-8 Proposals

From Travis Laster: A few weeks ago – in Jana Master Fund Ltd. v. CNET Networks – Chancellor Chandler holds that an advanced notice bylaw applies only to Rule 14a-8 precatory proposals and not to all stockholder proposals to conduct business at an annual meeting. Given that the ruling clears the way for a proxy contest for control over a Delaware corporation, the decision is likely to be appealed. If it holds up, I predict that a lot of Delaware corporations will be amending their advanced notice bylaws.

The ruling interprets an advanced notice bylaw that many practitioners will likely view as industry standard and non-controversial. The bylaw does not say that it is limited to Rule 14a-8 proposals. It instead says that any stockholder who wishes to propose business to be conducted at a meeting of stockholders must (i) own at least $1000 of stock for at least a year, (ii) propose the business 120 days before the one year anniversary of the mailing of the prior year’s proxy statement, and (iii) include with the proposal the information required by the federal securities laws.

Jana, which had held the requisite stock for only 8 months, made proposals to pack the CNET board. CNET responded that the proposals were not validly made under its bylaw. Jana then filed suit in the Court of Chancery. Rather than taking on the fiduciary duty issues implicated by a bylaw that limits the right to make director nominations to a stockholder owning a certain amount of stock, the Court of Chancery construed the bylaw as applying only to Rule 14a-8 proposals. The Court identified three reasons for its interpretation.

First, the Court cited the language of the bylaw which referred to a stockholder who “may seek to transact other corporate business” at the meeting. The Court held that this language must refer to a Rule 14a-8 proposal, since stockholders generally do not need to “seek” permission “to transact … business” at an annual meeting. This holding would seem to beg the question of whether a corporation can enact an advance notice bylaw in the first place. Since Delaware courts have previously answered that question “yes,” it follows that for a stockholder to comply with an advance notice bylaw, it must “seek to transact” business in compliance with the bylaw. If a stockholder fails to comply with the bylaw, it logically may not “transact business” at the meeting. It is thus not clear that anything necessarily follows from the “may seek” language, which seems rather standard.

Second, the Court focused on the timing requirement of 120 days before the one year anniversary of the prior year’s proxy statement. The Court viewed this language as consistent with the timing of a Rule 14a-8 proposal that would go in management’s proxy statement rather than a proposal that would be made at the meeting and be the subject of a stockholder’s own solicitation. Having been on both sides of arguments about the 120 day anniversary issue, I have traditionally viewed the fighting issue there as the length of the advance notice period (which typically works out to about 200 to 230 days). I have not previously seen anyone argue that this language was a constructive limitation to Rule 14a-8 proposals.

Third, the Court cited the requirement 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,” finding that this language silently incorporated Rule 14a-8. This also strikes me as relatively typical language designed to make sure the corporation has access to at least the same types of information about any proposal that it would be entitled to under a Rule 14a-8 proposal.

Based on these three factors, the Court concluded that the CNET bylaw only applied to Rule 14a-8 proposals. As a result, JANA or any other stockholder would be free to make proposals at the annual meeting without any advance notice requirement, including proposals made from the floor of the meeting.

As you can tell from my commentary, I would not have bet on this outcome. I thought the case might go either way under a fiduciary duty analysis, a reasonableness analysis, or a statutory interpretation of Section 109 of the DGCL. The Rule 14a-8 interpretation surprises me.

I suspect that many Delaware corporations will find that their advance notice bylaws contain each of the three features cited by the Court, or language closely paralleling them. I also suspect that many Delaware corporations do not believe that their advance notice bylaws are limited to Rule 14a-8 proposals. Under the Jana ruling, however, assuming it holds up on appeal, these Delaware corporations may find themselves vulnerable to an argument that they really have no advance notice bylaw protection at all. This in turn renders them vulnerable to proposals made for the first time from the floor of a meeting, particularly if a majority of their outstanding voting power is highly concentrated among a few holders.

Bottom line: Unless the Delaware Supreme Court goes in a different direction, it’s time for a new generation of advance notice bylaws that (i) explicitly apply to all stockholder proposals, (ii) return to a reasonable 60-120 day advance notice period before the meeting date, rather than a date keyed off the prior year’s proxy mailing, and (iii) specify the information that must be provided without incorporating federal securities requirements by reference.

Practice Pointers in the Wake of Jana Master Fund

Here is some guidance from Cleary Gottlieb:

What action should companies take in response to this decision? The advance notice deadline specified by the by-laws of most companies about to host a 2008 shareholders’ meeting has likely already passed. For such a company, unless it has reason to believe there is a specific risk of a last-minute proxy contest, we would not recommend a rush to amend the advance notice by-law. This controversial decision may be reversed on appeal or not followed where different by-law language exists or specific additional or different facts can be presented to the court.

Accordingly, in the absence of concern about a potential proxy contest, we recommend that companies whose advance notice deadlines have passed not take any action now, but watch to see if yesterday’s decision is appealed and, if so, whether the Chancellor’s opinion is reversed or clarified on appeal. Then the board can decide whether an amendment would be appropriate. At the same time, however the appeal is decided, the board may wish to consider other amendments to the advance notice provision, including a requirement that a shareholder proponent make appropriate disclosure regarding short positions or other derivative positions relating to the company’s shares, and to update that information as well as beneficial ownership information through the time of the annual meeting.

A company, whose advance notice deadline has passed and has reason to believe a last minute proxy contest is possible, should of course immediately review its specific situation with counsel and its proxy solicitor – including the language of the by-law, prior disclosure regarding the by-law, the timing of the meeting, the extent and nature of the proxy contest risk, and its shareholder profile – before deciding how best to proceed.

Finally, companies whose advance notice deadlines have not yet passed should consider a by-law change to eliminate the risk that their advance notice provisions would be interpreted as in this decision.

We are posting memos about this case in our “Annual Stockholders’ Meetings” Practice Area.

Wow! What a Difference a Week Makes…

I go on a week-long vacation without email access for the first time in years and wow, the world goes topsy-turvy. The Fed pushes JPMorgan Chase to bail out Bear Stearns in a mind-blowing deal that isn’t yet done and whose consideration may now be quintupled. This wouldn’t be the first time the government has pushed a company into a deal that went sour (eg. the Department of Defense “encouraged” Lockheed Martin to buy Northrop Grumman a few years before I went to work for Lockheed; after the deal was inked, the Department of Justice stopped the deal on anti-trust grounds – go figure, right?).

The deal’s initial consideration was 6% of what Bear Stearn’s market cap was – and the deal was struck just days after Bear Stearn’s CEO said that liquidity was not an issue. There are loads of other crazy stuff on this deal in my in-box and posted on numerous blogs, etc. I’m in the process of catching up and possibly setting up these future webcasts:

– Risk management and the responsibilities of various parties (ie. boards, internal auditors, outside auditors)
– How the credit crunch is impacting debt covenants and other financing arrangements
– Analyzing the novel Delaware law aspects of the Bear Stearns deal

Let me know if you (or someone you know) might fit on one of these panels.

Jamie Dimon: CEO Extraordinaire?

Then there is the whole Jamie Dimon angle to the Bear Stearns story. Who will play Jamie in the movie? George Clooney? Russell Crowe? Or Will Ferrell? Here is a poll to express your opinion:

Opinion Polls & Market Research

– Broc Romanek