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E-MailTrevor S. Norwitz and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton memorandum, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).
A recent decision of the Delaware Court of Chancery provides a valuable reminder both of the validity and efficacy of advance notice bylaws, and of the importance of ensuring that they are carefully crafted and judiciously applied in a contested election.
In its ruling, which the companies have appealed, the Court held that two closed-end funds “went too far” in disqualifying board candidates proposed by an activist hedge fund based on its failure to respond to a lengthy supplemental questionnaire within the five-business day deadline stipulated in the funds’ bylaws. (The hedge fund submitted the completed questionnaires “shortly after” this deadline and receiving a notice of disqualification.) Based on a close reading of the bylaws and fact-specific circumstances, and reminding that the bylaws “constitute part of a binding broader contract among the directors, officers and stockholders” and that “[i]f charter or bylaw provisions are unclear, we resolve any doubt in favor of the stockholder’s electoral rights,” the Court overruled the disqualification and allowed the activist hedge fund to run its candidates.
The Court noted that these specific bylaws permitted the Board only to “reasonably” request additional information about a nominee “if necessary” in order “to determine that the Proposed Nominee has met the director qualifications as set out in Section 1 of the bylaws,” which set forth individual, enumerated bylaw-based requirements. In this case, however, about a third of the 95 questions in the questionnaire were not in the Court’s view tied to that specified purpose, but sought to elicit other information (such as whether a nominee had violated federal boycott laws or been accused of sexual misconduct). Although the Court said it was “understandable” that the issuers would want to obtain that information about nominees, it held that this bylaw “only permits inquiries into director qualifications as confined by Section 1” (emphasis added) and that “[b]y including in the Questionnaire a substantial number of questions unrelated to Section 1’s director qualifications, and nonetheless enforcing the strict five-day deadline to invalidate [the stockholder’s] nominations, defendants overstepped their authority under [the bylaws] while demanding strict compliance” from the nominating stockholder. The Court declined to rule on the plaintiff’s claim that the use of the questionnaire unduly restricted the stockholder franchise and thus constituted a breach of the directors’ fiduciary duties.
This case serves as an important reminder that advance notice bylaws are a vital element of a company’s preparedness for shareholder activism or hostile takeover bids, but that they have to be carefully prepared and applied. Companies should review their bylaws and governing documents to satisfy themselves that the information they hope to elicit about potential board nominees is permitted by the advance notice provisions. In the specific context of a contested election, where a company is considering disqualifying potential nominees based on a failure to comply with its advance notice bylaws, close attention should be given to the specific words of the bylaws to ensure that actions taken are not likely to be viewed as an improper restriction.
Companies should not, however, hesitate to carefully review nominations and submissions for compliance and accuracy, consider appropriate action to enforce bylaw requirements and have nominating stockholders and their nominees complete appropriate questionnaires (which may be expressly required under a company’s bylaws to be included as part of the initial nomination notice rather than on a supplemental basis) and submit accurate and complete answers to follow-up inquiries where permitted. An orderly and transparent process, ensuring that nomination requirements are met, the board has all of the information it needs to make an informed recommendation to stockholders and investors are apprised of the eligibility and suitability for service of dissident candidates, benefits the company and all stockholders.
