Implications of Lee for a Board’s Decision to Reject a Nomination Notice

Gail Weinstein is senior counsel, and Steven Epstein and Philip Richter are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. Richter, Warren S. de Wied, Brian T. Mangino, and Matthew V. Soran, and is part of the Delaware law series; links to other posts in the series are available here.

In Strategic Investment Opportunities v. Lee Enterprises (Feb. 14, 2022), the Delaware Court of Chancery reviewed the decision by the board of directors of Lee Enterprises, Inc. (“Lee”) to reject the director nominations notice provided by its dissident stockholder Strategic Investment Opportunities LLC (“Opportunities”). Opportunities is an affiliate of hedge fund Alden Global Capital LLC, which is in the midst of a hostile takeover bid for Lee. The court found, first, that the nomination notice plainly did not comply with the technical requirements of Lee’s advance notice bylaw. The court then applied an enhanced scrutiny standard of review to determine whether Lee’s directors had breached their fiduciary duties by not waiving, or allowing Opportunities to cure, any technical defects in the nomination notice. The court found that the directors’ actions had been “reasonable and appropriate” under the circumstances and upheld their rejection of the nominations.

Key Point

The decision emphasizes that, generally, a stockholder must comply precisely with the technical requirements of advance notice bylaws—but also reaffirms that a board must act in good faith and equitably in rejecting even a plainly non-compliant nomination notice. Reaffirming long-standing principles relating to the validity of advance notice bylaws, the court stressed that Lee’s advance notice bylaw was adopted on a “clear day,” far in advance of Alden’s takeover bid and the nomination notice; that the bylaw requirements were unambiguous and reasonable; and that Lee had not interfered with Opportunities’ ability to comply. The court endorsed a corporation’s “genuine interest in enforcing its Bylaws so that they retain meaning and clear standards that stockholders must meet” and readily found that Opportunities’ notice did not comply with “the letter” of Lee’s bylaw. The decision serves as a reminder, however, that a board must act in good faith and equitably when deciding to reject a nomination notice, even when the notice is non-compliant with the bylaw, is submitted outside a takeover context, and/or involves nominations for a minority of the board seats.

Background. Lee’s advance notice bylaws required that (a) only a stockholder of record could make a nomination and (b) a nomination notice must include a completed questionnaire for each nominee, in the form that Lee would provide within ten days after request therefor from a stockholder of record. The deadline for submission of nominations for Lee’s 2022 annual meeting was November 26, 2021.

On Friday, November 19, 2021, Alden decided to make a hostile takeover bid for Lee. Over that weekend, Alden strategized with its financial advisor, who recommended possible director candidates for Lee’s 8-person classified board. On Monday, November 22, Alden delivered its acquisition proposal to Lee; Opportunities asked its broker to transfer the Lee shares it beneficially owned from Cede & Co.’s name so that it would become a record holder; and Opportunities requested that Lee provide it with the questionnaire form. On November 23, Lee rejected the request for the questionnaire as Opportunities was not a record holder. (The mechanics for the transfer of shares into Opportunities’ name were not completed until December 2.) On November 24, Lee adopted a shareholder rights plan. On November 26, Opportunities submitted a nomination notice for two director candidates. The notice was accompanied by a letter from Cede as the stockholder of record. The notice provided extensive information about the nominees (although not on the form questionnaire). Lee rejected the nominations on the basis that the nomination was not made by a record holder and the notice did not include completed questionnaires. Vice Chancellor Lori W. Will, after an expedited trial on a paper record, found that the notice did not comply with the advance notice bylaw requirements and upheld Lee’s rejection of the nominations.

The Subsequent Lawsuit. Immediately after the decision, Alden announced that it would launch a “vote no” campaign against two of the incumbent nominees. Opportunities filed a new lawsuit (the “Subsequent Lawsuit”), seeking to enjoin the upcoming March 10 director elections, on the basis that Lee was improperly still applying a plurality voting standard for the election (applicable, under Lee’s bylaws, to a contested election) while the election now involved only incumbent nominees (thus, the default majority voting standard should apply). Lee argued that it had set the voting standard when the election was contested and that the bylaws did not require it to revert to the other standard. On February 28, 2022, in a transcript ruling, the court refused to enjoin the stockholder vote. The court stated that, although Opportunities’ arguments were potentially valid, an injunction was inappropriate given that Lee had rejected the nominations in November but Opportunities  never raised the voting standard issue until sixteen days before the upcoming meeting date. The court indicated also that Opportunities could seek relief in a post-election suit if the directors were re-elected without majority support.

Discussion

The court found that Opportunities’ nomination notice did not comply with the record holder requirement in Lee’s advance notice bylaw—even though the notice was accompanied by a letter from the record holder and the transfer of shares to Opportunities’ name was in process. Opportunities delivered a letter to Lee (self-defined as the “Nominations Letter”) stating that it was submitting nominations for two director candidates. A separate letter from Cede, delivered at the same time, stated that Cede was the record holder and it “understood” that Opportunities would be delivering a letter with Opportunities’ nominations. The court stated that separate letters from a record owner and the beneficial owner regarding nominations could satisfy an advance notice bylaw’s record owner requirement. However, in this case, the letters did not satisfy the requirement, the court found, because both letters stated that the nominations were being made by Opportunities (not by the record holder).

As the court noted, Cede did not even know who the nominees were. When Cede had asked Opportunities for a copy of the nomination notice to transmit with its letter, Opportunities had declined to provide it. Opportunities had then acceded to Cede’s insistence under those circumstances that its letter be redrafted so that, rather than stating that it was “attaching” the nominations, it stated that Cede “understood” that Opportunities would be providing a separate letter with respect to the nominations. The court viewed this language as “non-committal” and indicating that Cede had “distanced itself from having any role in the nomination.” The court concluded: “Simply put, Cede provided a cover letter for Opportunities’ nomination.” As Opportunities was not a record holder when the notice was provided, the notice did not comply with the bylaws.

The court found that Opportunities’ nomination notice also did not comply with the questionnaire requirement of Lee’s advance notice bylaw—even though Opportunities had provided extensive information about the nominees. Opportunities argued that it had provided equivalent information to what the form questionnaire would have required and was unable to complete the form only because Lee had not provided it (i.e., that Lee had interfered with its ability to submit the form). The court stated that Lee’s corporate secretary, after consulting with the executive committee of the board, had properly rejected Opportunities’ request for the form because Opportunities was not a stockholder of record when it made the request. Further, the court stated, even if Opportunities had been a record holder, pursuant to the bylaw provisions, Lee only would have been obligated to provide the form within ten days of the request—while the deadline for nominations was well before that. The court concluded that Lee, therefore, did not interfere with Opportunities’ ability to provide the questionnaires.

The court emphasized that a stockholder’s strict adherence to “the letter” of advance notice bylaws is required for a nominations notice to be considered compliant—but also noted that a board’s “formalistic adherence” to bylaw requirements could be improper. With respect to the record holder requirement, Opportunities had argued that its noncompliance should be excused because Cede operates as a neutral party and only acts to transmit beneficial holders’ nominations. Lee responded by submitting examples of Cede, in other situations, having “submitt[ed]—rather than deliver[ed]—nominations” on behalf of beneficial stockholders. The court noted this information but characterized it as “beside the point,” given that the bylaws required that a stockholder of record make the nominations, that Opportunities had “made” the nominations, and that Opportunities was not then a stockholder of record. With respect to the questionnaire requirement, the court acknowledged that Opportunities had provided “extensive, detailed” information about the nominees, but stated that that was “meaningless” in determining “whether the Nomination Notice satisfied the letter of…the Bylaws.” At the same time, however, and notably, the court stated in a footnote that, “the outcome might be different” if Opportunities had been a record holder when it requested the form, or Cede as the record holder had requested the form, and Lee had refused to provide it. “In that scenario,” the court wrote, “one would question the purpose of the Board’s formalistic adherence to the bylaws” when detailed information about the nominees had been submitted and the board’s rejection would have been simply “for failure to use Lee’s own ‘form.’”

The court indicated that the  enhanced scrutiny standard of review would have applied to the board’s rejection of a nomination notice even absent the takeover threat context. Lee had argued that business judgment review should be applicable as the board simply had rejected a non-compliant nominations notice, not as a defensive action and without acting manipulatively or in bad faith. The Vice Chancellor stated, first, that “Opportunities’ nominations were part and parcel of Alden’s hostile bid to acquire Lee” and therefore, under Unocal, the court could not ignore “the defensive mindset in which the Board was operating when it rejected the Nomination Notice.” The Vice Chancellor stated, further, however, that she viewed enhanced scrutiny as the appropriate standard “whether labeled as Unocal or Blasius,” given the “inherent conflicts of interest that arise” when a “board’s actions could have the effect of influencing the outcome of corporate director elections or other stockholder votes having consequences for corporate control.” “That is so here,” the Vice Chancellor wrote, “even though a minority of the Board members were at risk of losing his or her board seat.” Thus, the court’s approach indicates that rejection of a non-compliant nominations notice generally would be subject to enhanced scrutiny–even when not in a control threat context and even when the directors acted in good faith and not manipulatively.

The court found that the Lee board’s actions met the enhanced scrutiny standard. The court concluded that the Lee board’s actions were reasonable, taken in good faith, and not inequitable. First, the bylaw requirements were adopted on a “clear day, long before Alden surfaced”; were unambiguous; and were not “empty formalism” but were reasonable and had a valid purpose. The record holder requirement was intended to ensure that nominations were made by parties with “skin in the game” and that the director election process was orderly, the court wrote. Citing the recently published ninth edition of our Fried Frank M&A treatise (Takeover Defense: Mergers and Acquisitions, by Arthur Fleischer, Jr., Gail Weinstein, and Scott B. Luftglass), the court noted that advance notice bylaw provisions provide several benefits to a company, including giving a board time to evaluate proposed candidates and preventing last-minute “surprise attacks” by third parties for control or board representation. Finally, the court emphasized that a corporation has a “reasonable expectation” that its stockholders will comply with its bylaws. The court stressed that Opportunities’ non-compliance had resulted from its own delay, “wait[ing] until the weekend before the nomination deadline to consider the Bylaw’s nomination requirements” and “begin[ning] the process of transferring shares into record name…three days before the deadline.”

Practice Points

  • A board should: when possible, adopt advance notice bylaw provisions on a “clear day”; adhere precisely to the corporation’s obligations under the bylaw; and not unfairly interfere with a stockholder’s efforts to comply with the bylaw. A board should carefully and in good faith consider its decision whether to accept or reject a nomination notice and should not act inequitably or manipulate the process to disadvantage the nominating stockholder.
  • In drafting an advance notice bylaw: (i) A board should state in the bylaws that any nomination notice not complying with the bylaw will be rejected. (ii) A board should take care to draft the bylaw requirements so that they are unambiguous (as ambiguous provisions may be interpreted by the court in the stockholder’s favor). (iii) A board should consider the time period for its obligation to provide nominee questionnaire forms after a request therefor. A longer (but still reasonable) time period would require that a stockholder plan further in advance of the deadline for nominations in order to be in technical compliance. Note, however, the court’s suggestion, in a footnote in Lee, that, in some circumstances, a board’s insisting on adherence to a questionnaire requirement could be improper if the stockholder has provided the same information just in a different form.
  • A board should carefully review a nomination notice to determine whether it complies with the advance bylaw requirements. Lee is one in a string of recent cases illustrating the risks a stockholder takes by making delivering a nomination notice at or very close to the deadline for making nominations, as there may be no opportunity to satisfy an advance notice bylaw’s requirements or cure defects in the notice after the deadline has passed.
  • If a beneficial holder and record holder together submit a nomination, the board should carefully consider whether the submission complies with any record holder requirement in the advance notice bylaw. We would suggest that if a record owner (such as Cede) states that it is making the nominations, a company still could challenge whether, as a matter of substance, the nominations actually are being “made”—rather than merely delivered—by the record holder. This would be particularly so if the record owner had nothing to do with selecting the nominees and if, as in Lee, the nominations coincided with a takeover bid by the beneficial owner.
  • Additional considerations for a board: The court’s decision in the Subsequent Lawsuit indicates that a board should clarify in its bylaws whether a plurality vote standard for contested elections would or would not revert to a majority vote standard if the contested election turned out to be uncontested for any reason. Other recent Delaware decisions indicate that advance notice bylaw requirements may not be enforceable to the extent they (or the stockholder meeting date, where the advance notice bylaw deadline is tied to that date) are not accurately disclosed in the company’s proxy statement; and that the court may not enforce advance notice bylaw requirements if, after the advance notice deadline has passed, the board causes an unanticipated and material “changed circumstance” to occur (such as a change in board-level strategy) that may generate stockholder controversy or opposition.
  • A board should regularly review and update the company’s advance notice bylaw to reflect market practice and evolving activist stockholder tactics.
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