Courtesy of the Harvard Law School Corporate Governance Blog , Professor J.W. Verret provides a summary of the oral arguments yesterday before the Delaware Supreme Court on a bylaw issue presented to the Court by the SEC. Here is a short prior post with background on this historic "collaboration" between the SEC and the Delaware Supreme Court.
Professor Verret’s post follows:
AFSCME Employees Pension Plan submitted a shareholder proposal for inclusion in CA’s proxy materials for their annual meeting scheduled to be held on September 9, 2008. That proposal sought to amend CA’s bylaws to require the company to reimburse the reasonable expenses incurred by a dissident nominating a rival slate of directors, provided that at least one nominee from the dissident slate was victorious. CA sought no-action relief from the SEC permitting it to exclude that proposal under Rule 14a-8 as illegal under Delaware law, and the SEC certified the question to the Delaware Supreme Court.
The Court’s opinion stands to re-define the nature of corporate federalism and ring in a new collaborative relationship between the Delaware Courts and the SEC. Indeed, it may encourage the SEC to include more state law carve-outs in future rule-making.
I wrote an essay (available here) on this issue in March predicting that the SEC would certify the bylaw question to Delaware soon. For more on the growing trend of shareholder democracy behind this challenge, see Pandora’s Ballot Box, or a Proxy with Moxie: Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined (available here). For more on bylaws, see Profs. Coates and Faris’s work (Second-Generation Shareholder Bylaws: Post-Quickturn Alternatives, 56 Bus. Law. 1323 (2001) (with B. Faris)) and Prof. Hamermesh’s article (available here). Anticipating that the opinion in this difficult case might make use of dicta guidance, see also my article with Chief Justice Steele on the Delaware Guidance Function (available here).
This post summarizes a very lively oral argument in Dover, Delaware this morning. The Justices and the parties displayed a rigorous command of this intricate subject, working in a very short timeframe. It was a fascinating to watch these masters of the Delaware General Corporation Law at the height of their craft.
Arguing on behalf of Computer Associates was Robert Guiffra of Sullivan & Cromwell. His presentation focused on two key issues: first, he argued that this bylaw does not relate to an election of directors, but merely comes into play after the election, and thus is not protected by the principles in the Blasius line of cases. As a mandated payment of expenses it relates to control of the corporate treasury, part of the business and affairs of the corporation as defined in Rule 141(a). As such, limitations on the Board’s authority may only appear in its Certificate of Incorporation, not its bylaws. Second, he argued that the Board must be permitted to make a determination of whether a reimbursement was consistent with its fiduciary duty, where this bylaw mandated payment under all circumstances.
Arguing on behalf of AFSCME was Michael Barry of Grant & Eisenhofer. His presentation focused on two key issues: first, he argued that this bylaw relates to an election, implicates the shareholder franchise and Blasius review, and is not a part of the ordinary business affairs of the corporation. As such, it does not undermine the Board’s authority under section 141. He also argued that where directors are mandated to reimburse expenses, they cannot be doing so for the purposes of entrenchment, and thus cannot logically do so in violation of their fiduciary duties. He also cited Delaware’s approval of mandatory indemnification bylaws as binding precedent on this issue.
Both Counsel admitted that, though the bylaw was unclear, reimbursement of expenses for the full contest and not just for the successful nominee was anticipated. Both parties also skillfully argued that the Court need not permanently resolve any looming contradiction between section 109 and section 141(a) to rule in their favor. Section 109 of the DGCL grants shareholders the right to adopt bylaws, and section 141(a) reads that “the business and affairs of every corporation…shall be managed by…a board of directors.” Thus, the oft referenced “recursive loop” in which a bylaw adopted under section 109 might limit a board’s authority under 141(a). The Court nevertheless asked counsel’s opinion concerning the intent of the legislature in creating two conceivably conflicting sections of the code.
Questions from the Court during oral argument make any predictions difficult. The Justices pushed counsel for CA over whether the prospect of reimbursement was inextricably linked to the success of an election, and whether the bylaw would be legal if adopted by the Board. The Justices pushed counsel for AFSCME over whether there might be any circumstances under which a bylaw could force inequitable reimbursement and whether the Board’s authority to adopt bylaws was co-extensive with that of shareholders. Interestingly, Justice Berger, when she served as a Vice Chancellor, suggested in dicta that stockholders create a bylaw limiting the board’s power to amend a stockholder adopted bylaw in American Int’l Rent a Car, an opinion from 1984, which may indicate her view on whether the right to adopt bylaws is co-extensive. The Court also questioned whether the “reasonable” qualifier in this bylaw left enough room for board discretion not to reimburse wasteful expenses.
My own prediction is a substantive victory for AFSCME is possible, but the holding would be limited. If the Court allows election bylaws that mandate board action, it may require bylaws mandating board action have a “fiduciary out” clause similar to what we see in deal lock-in measures. This could be accomplished, I think, either by ruling that the bylaw is illegal only for lack of a fiduciary-out or ruling that the bylaw is legal but that a Board could ignore it if it’s fiduciary duty required it (board action which would then be critically reviewed under subsequent challenge, and the standard of that review for such a decision could be formulated in this opinion). The one thing I am most confident about is that the Court is likely to leave open the possibility to rule that other forms of bylaws, especially poison pill related bylaws, run afoul of 141(a).