The Delaware Law Series

Stockholder Nominees Barred For Noncompliance With “Clear Day” Advance Notice Bylaw

Andre G. Bouchard, Krishna Veeraraghavan, and Steven J. Williams are partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul, Weiss memorandum by Mr. Bouchard, Mr. Veeraraghavan, Mr. Williams, Scott A. Barshay, Jaren Janghorbani, and Laura C. Turano, and is part of the Delaware law series; links to other posts in the series are available here.

In Rosenbaum v. CytoDyn Inc., the Delaware Court of Chancery, in an opinion by Vice Chancellor Slights, upheld a board’s decision to exclude stockholder nominees from being considered at CytoDyn’s annual meeting based on deficiencies in the stockholders’ notice required by the company’s advance notice bylaw. The court found that the board had not engaged in any manipulative or inequitable conduct in rejecting the nominees. Even though the board waited almost one month before notifying the stockholders of deficiencies in their nomination notice, the court emphasized that the stockholders had not submitted their notice until close to the deadline, which left no time to fix the deficiencies, and that the bylaw did not in any event require the board to engage in an iterative process with the proponent to fix deficiencies.


Plaintiff stockholders of CytoDyn provided advance notice of their nominations to CytoDyn’s board the day before the advance notice deadline in CytoDyn’s “commonplace” advance notice bylaw. One month after the deadline, the board sent a deficiency letter to the plaintiffs regarding the disclosures in their nomination notice. The deficiencies identified by the board included the plaintiffs’ failure to disclose (i) the identity of a limited liability company formed by one of the plaintiffs (who was also a nominee) to fund the proxy contest, as well as the limited liability company’s donors, and (ii) the plaintiffs’ support of an acquisition by CytoDyn that had been previously considered and rejected by the board, pursuant to which CytoDyn would acquire a company with ties to two of plaintiffs’ nominees and employ one of the nominees who also had patent disputes with CytoDyn. Plaintiffs attempted to address the deficiencies shortly after their receipt of the deficiency letter, but well after the advance notice deadline. Upon the continued rejection of their nominations by the CytoDyn board, the plaintiffs filed suit in the Court of Chancery, seeking an injunction requiring the board to place the plaintiffs’ nominees on the ballot for the CytoDyn annual meeting scheduled for October 2021. The court considered the matter after a trial on a paper record.


Optimizing The World’s Leading Corporate Law: A 20-Year Retrospective and Look Ahead

Lawrence A. Hamermesh is Executive Director of the Institute for Law and Economics at the University of Pennsylvania, and Emeritus Professor at Widener University Delaware Law School. Jack B. Jacobs is Senior Counsel at Young Conaway Stargatt & Taylor, LLP, and former Justice of the Delaware Supreme Court and Vice Chancellor of the Court of Chancery. Leo E. Strine, Jr. is the Michael L. Wachter Distinguished Fellow at the University of Pennsylvania Carey Law School; Senior Fellow, Harvard Program on Corporate Governance; of counsel, Wachtell, Lipton, Rosen & Katz; and former Chief Justice and Chancellor, the State of Delaware. This post is based on their paper forthcoming in The Business Lawyer, and is part of the Delaware law series; links to other posts in the series are available here.

In our article, Optimizing The World’s Leading Corporate Law: A 20-Year Retrospective and Look Ahead, we look back at a 2001 article (Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law) in which two of us, with important input from the other, argued that in addressing issues like hostile takeovers, assertive institutional investors, leveraged buyouts, and contested ballot questions, the Delaware courts had done exemplary work but on occasion crafted standards of review that unduly encouraged litigation and did not appropriately credit intra-corporate procedures designed to ensure fairness. Function Over Form suggested ways to make those standards more predictable, encourage procedures that better protected stockholders, and discourage meritless litigation, by restoring business judgment rule protection for transactions approved by independent directors, the disinterested stockholders, or both.

Our current paper examines how Delaware law responded to the prior article’s recommendations, concluding that the Delaware judiciary has addressed most of them constructively, thereby creating incentives to use procedures that promote the fair treatment of stockholders and discourage meritless litigation. The continued excellence and diligence of the Delaware judiciary is one of Delaware corporate law’s core strengths.


M&A/PE Update

Gail Weinstein is senior counsel and Philip Richter and Steven J. Steinman are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. Steinman, Randi Lally, Roy Tannenbaum, and Maxwell Yim, and is part of the Delaware law series; links to other posts in the series are available here.

Court Finds No “Material Adverse Effect” from Drastic Reduction in Medicare Reimbursement Rate for Company’s Sole Product—Bardy v. Hill-Rom

In Bardy Diagnostics, Inc. v. Hill-Rom, Inc. (July 9, 2021), the Delaware Court of Chancery found that a more than 50% reduction in the Medicare reimbursement rate payable for the target company’s sole product did not constitute a “Material Adverse Effect” (MAE) under the parties’ merger agreement, primarily because it did not have “durational significance.” Although the target’s revenues dramatically declined due to the rate decrease, the court emphasized that the company had continued to grow.

Background. After performing extensive due diligence, Hill-Rom, Inc. agreed to acquire Bardy Diagnostics, Inc. for $350 million plus additional compensation through an earnout based on 2021 and 2022 revenue. Hill-Rom believed that Bardy had significant growth potential, but did not expect that Bardy would be profitable for several years. Bardy’s sole product was a medical patch used to detect heart problems; and its largest source of revenue was Medicare reimbursements for the patch. The Medicare reimbursement rate for the patch was set by a private entity authorized by Medicare to fulfill this function. For almost a decade, the rate had been about $365 per patch. In late January 2021, two weeks after the merger agreement was signed, the rate was reduced by about 86%.

Hill-Rom claimed that Bardy had suffered an MAE as a result of the rate reduction and refused to close. Bardy brought suit seeking specific performance of the agreement and damages for Hill-Rom’s failure to close. By April 2021, the reimbursement rate for the patch was increased to $133 (about three times the January rate, but still less than half the historic rate). Vice Chancellor Joseph R. Slights III held that Bardy had not suffered an MAE. The court ordered Hill-Rom to close and awarded damages to Bardy in the form of prejudgment interest on the deal price.


Books and Records Demands

Edward B. Micheletti and Jenness E. Parker are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

The right of stockholders to seek corporate books and records is a well-established feature of corporate law in Delaware, where most big American companies are incorporated. But the number of statutory records demands has spiked in recent years, and the scope of the requests has broadened, as Delaware courts have limited companies’ defenses and taken companies to task for aggressively resisting shareholder requests.

For boards and their companies, this has potential consequences. Stockholders, many with an eye toward litigation, are sometimes able to access emails, texts and other material through a records demand that can lay the grounds for a suit. What used to be a simple matter of granting access to formal, board-level books and records reflecting board decisions now has the potential to be more expansive and disruptive if casual communications that directors and executives assumed would not be part of the “official” corporate records are revealed to potential adversaries.

Below is a primer for directors on the evolving nature of these requests and what it means for boards.


Taking Corwin Seriously

Itai Fiegenbaum is a Visiting Assistant Professor at Willamette University College of Law. This post is based on his recent paper, forthcoming in the Lewis & Clark Law Review, and is part of the Delaware law series; links to other posts in the series are available here.

Friendly sales of control are a well-known breeding ground for corporate agency costs. Managers, for instance, might be tempted to push through a transaction with a favored bidder instead of exploring an overture organized by a party against whom they hold a grudge. Or they might offer the buyer a sweetheart deal with the anticipation (if not expectation) of lavish compensation from the newly-sold entity. Both situations leave shareholders shortchanged.

Delaware law is aware of incumbents’ predilection to stray from shareholders’ interests and accordingly subjects friendly sales to a heightened standard of review. The Revlon standard, so named for the iconic case in which it was unveiled, stands for the proposition that usual business judgement rule deference is no longer warranted in a sale scenario. The courts are instead instructed to evaluate the board’s decision making process in an attempt to uncover deviations from the proper goal of shareholder value maximization. The standard used to have actual bite, as evinced by high profile transactions that were invalidated by the courts. While the doctrinal directive has remained essentially constant for three decades, its application today is quite different. Judges are loathe to nix a firm offer to purchase a company. Egregious misdeeds will at most be remedied by additional disclosure and a slight delay before the deal is sent to the shareholders for their approval. And under the powerful Corwin doctrine, a positive shareholder vote restores business judgment rule review, thereby insulating the transaction from judicial oversight.


Delaware Supreme Court Clarifies the Standards for Demand Futility

Heather Benzmiller Sultanian is an associate at Sidley Austin LLP. This post is based on her Sidley memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

A pair of opinions released by the Delaware Supreme Court in a single week have revisited longstanding precedent governing shareholder suits that claim corporate wrongdoing. As discussed in a companion post on this blog, the first of those opinions, Brookfield Asset Management Inc. v. Rosson, restricted the ability of shareholders to bring direct claims under certain circumstances, instead forcing them to pursue more procedurally challenging derivative suits. In the second case, United Food & Commercial Workers Union & Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, the Delaware Supreme Court adopted a new three-part demand-futility test that clarifies the standard shareholders must meet to file such derivative suits, without first taking their complaints to the company’s board of directors.


United Food arose from a vote by Facebook’s board of directors in 2016 to pursue a stock reclassification plan that would allow CEO Mark Zuckerberg to sell most of his Facebook stock — which Zuckerberg planned to do to fulfill the “Giving Pledge,” under which he had committed to giving the majority of his wealth to philanthropic causes — while still maintaining voting control over the company. Days after Facebook announced the reclassification plan, several investors filed class action suits to block the plan, alleging that it was a self-interested deal that put Zuckerberg’s interests ahead of Facebook’s in violation of the board of directors’ fiduciary duties. Shortly before trial was scheduled to begin, Facebook abandoned the reclassification plan and mooted the pending litigation.


Direct vs. Derivative Standing

Andrew W. Stern is partner at Sidley Austin LLP. This post is based on his Sidley memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

Every once in a while, a court admits it made a mistake. And, in even rarer circumstances, that admission comes from a court as prominent as the Supreme Court of Delaware. But that’s exactly what happened last week in Brookfield Asset Management, Inc. v. Rosson, in which Delaware’s highest court overruled its own 2006 holding in Gentile v. Rosette that certain claims of corporate dilution are “dual-natured” and may be pursued both as derivative claims and as direct claims by stockholders. The Court’s decision to revisit a much-criticized decision is likely to restore some predictability and analytic consistency to the resolution of an important and threshold question frequently presented in stockholder litigation: whether a claim is properly characterized as direct (on behalf of one or a class of a company’s stockholders) or derivative (on behalf of the company itself).

Rosson arose from a private placement of common stock issued by TerraForm Power, Inc., at the time a public company controlled by a 51% stockholder. The controller purchased all of the newly issued stock, increasing its economic interest and voting power to 65.3%. Plaintiffs TerraForm common stockholders filed a derivative and class action complaint alleging that the stock had been issued for inadequate value, diluting the financial and voting interests of the minority stockholders and also damaging the company. Subsequent to the filing of the complaint, the controller acquired the balance of TerraForm shares that it did not already own, which under well-established Delaware precedent extinguished the ability of former TerraForm stockholders to pursue derivative claims. On defendants’ motion to dismiss the remaining direct claims, Vice Chancellor Sam Glassock noted that the type of claim at issue was classically derivative under Delaware jurisprudence: “the quintessence of a claim belonging to an entity: that fiduciaries, acting in a way that breaches their duties, have caused the entity to exchange assets at a loss.”


Boeing: Rejecting Early Dismissal of Claims Against Directors for Inadequate Risk Oversight

Gail Weinstein is senior counsel and Steven Epstein and Mark H. Lucas are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. Lucas, Erica Jaffe, Shant P. Manoukian, and Roy Tannenbaum, 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 Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

The Boeing Company Derivative Litigation (Sept. 7, 2021) is another in a series of cases in recent years in which the Delaware Court of Chancery has found, in the wake of a “corporate trauma” relating to product safety issues, that the company’s independent directors may have personal liability to the stockholders, under the “Caremark doctrine,” for a failure to have overseen management of the corporation’s core risks. In the Boeing opinion, Vice Chancellor Zurn echoes a number of themes from other recent cases involving so-called “Caremark claims,” and thus provides important guidance with respect to best practices for directors in fulfilling their oversight responsibilities (as discussed in “Practice Points” below).

Key Points

  • In recent years, the Delaware courts, at the pleading stage of litigation, have more frequently rejected dismissal of Caremark claims against directors. The express articulation of the standard for pleading a valid Caremark claim has not changed and the courts continue to characterize these claims as among the most difficult upon which a plaintiff might hope to succeed. Also, importantly, each of the recent cases has presented a particularly egregious factual context. Nonetheless, directors should be mindful that, unlike in the past, there is now a trend of decisions in which the court has rejected early dismissal of Caremark
  • Plaintiffs’ increased success in Caremark claims surviving the pleading stage is attributable to their more frequent use of books and records demands. With the courts more often granting stockholders’ demands under DGCL Section 220 for inspection of the corporate books and records, and the courts more often granting expansive access to the corporate books and records, stockholder-plaintiffs have been able to uncover information that has helped them craft more particularized pleadings substantiating their claims of lack of board oversight.
  • Recent Delaware decisions provide specific guidance for directors in fulfilling their Caremark duties.  Most critically, directors should understand that there is a board-level responsibility to oversee legal and regulatory compliance and other risks relating to the company’s “mission-critical” operations. It is not sufficient to delegate management of these critical risks to senior officers of the company. The oversight process with respect to these types of risks should be formally established and the board’s monitoring of the process should be well documented.


Court of Chancery Upholds Enforcement of Advance Notice Bylaw

William Savitt, Ryan A. McLeod, and Anitha Reddy are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Court of Chancery this week upheld a board’s use of an advance notice bylaw to reject a dissident slate from running a proxy fight.  Rosenbaum v. CytoDyn Inc., C.A. No. 2021-0728-JRS (Del. Ch. Oct. 13, 2021).

The case concerns a battle for control of the board of CytoDyn, a pharmaceutical company.  Years ago, CytoDyn adopted a customary advance notice bylaw that required any stockholder seeking to nominate directors to provide information about its nominees at least 90 days before the stockholder meeting.  As is typical, the bylaw required disclosure of, among other things, the nominees’ backers and whether the nominees had financial interests in any potential transactions involving the company.  One day before this year’s nomination deadline, a group of CytoDyn stockholders submitted nomination materials for a rival slate.  A month later, CytoDyn rejected the nominations as deficient for failure to disclose others who were supporting the nominees behind the scenes and to disclose that at least one of the nominees might seek to facilitate a self-interested merger if elected.  The dissident stockholders commenced expedited litigation in Delaware, arguing that the board was improperly interfering with the election process.


Delaware Decision Deals with Director Independence

Gail Weinstein is senior counsel, and Steven J. Steinman and Brian T. Mangino are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Andrew J. Colosimo, Mark H. Lucas, and Erica Jaffe, 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 Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

BGC Partners, Inc. Derivative Litigation (Sept. 20, 2021) involved a merger between entities that were controlled by the same person, Howard Lutnick, through his control of Cantor Fitzgerald, L.P. (“Cantor”). Lutnick had a far larger economic interest in the target company, Berkeley Point Financial LLC (“Berkeley Point”), than in the acquiring company, BGC Partners, Inc. (“BGC”). The plaintiffs claimed that he therefore caused BGC to overpay for Berkeley Point (receiving himself 42% of the alleged overpayment, which amounted to $125 million, at the expense of the other BGC stockholders). The transaction was approved by a special committee of BGC’s four outside directors, after months of negotiation with BGC. (BGC’s minority stockholders did not vote on the transaction.) The plaintiffs sued Lutnick, Cantor, and BGC’s directors for breach of fiduciary duties in improperly approving the related-party transaction.

The court found, despite evidence that it characterized as “not overwhelming,” that two of the outside directors may not have been independent of Lutnick. As a result, the court held that: (i) the plaintiffs were excused from not having made a litigation demand on the board to bring the litigation (as demand would have been futile); (ii) the burden of proof under entire fairness review would not shift to the plaintiffs (as the transaction was not approved by a special committee comprised of a majority of independent directors); and (iii) the plaintiffs had validly pled a non-exculpated fiduciary claim against one of the non-independent directors (as that director may have taken actions that furthered Lutnick’s self-interest, violating the duty of loyalty).


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