The Delaware legislature is reviewing a slew of proposed amendments to its Corporation Law, including several that could sharply tilt the balance of power toward shareholders.
One proposed amendment would smooth the way for shareholders to place nominations for corporate directors in the company proxy statement. Another would provide reimbursement for proxy fights. Both ideas are loathed by Corporate America, but the financial crisis is pressuring Delaware—a vital state, since so many large businesses are incorporated there—to climb aboard the governance reform bandwagon, experts say.
Grossbauer
The Delaware Bar Association, which submits amendment proposals to the state legislature, “thought there was a need to move pretty quickly this year to make sure that Delaware still has a voice out there and is able to participate in a meaningful way,” says John Grossbauer, of the law firm Potter Anderson & Corroon.
Charles Elson, director of the Corporate Governance Center at the University of Delaware, agrees. “It happened to be a good time for this to come out,” he says.
If approved by state lawmakers, the amendments would take effect Aug. 1.
The most significant change would be the addition of a new Section 112, which would allow Delaware corporations to adopt bylaws that let investors place director nominations in the proxy statement. The proposed amendment says corporations may impose “reasonable restrictions” such as requiring the investor to own at least a certain amount of stock, or to hold the shares for a certain period of time. Companies could also limit proxy access to short slate elections, where less than a majority of director seats are contested.
Similarly, a proposed new Section 113 spells out how companies could structure bylaws that allow shareholders to be reimbursed for proxy fights. Bylaws could impose conditions such as reimbursing expenses only for short-slate contests. Section 113 also would limit reimbursements based on the amount incurred by the corporation in soliciting proxies for the same election.
Olson
“That I think is going to result in some proposals along those lines being on the ballot in Delaware corporations in 2010 if the Delaware legislature adopts this provision,” John Olson of Gibson Dunn & Crutcher, tells Compliance Week in a podcast.
The Section 113 proposal appears to be in response to the 2008 court decision CA v. AFSCME, when the Delaware Supreme Court said that software giant CA could indeed exclude a shareholder proposal on reimbursement for proxy fights from the proxy statement.
If adopted by the legislature, the provision would clarify that “such proposals can be considered if they’re properly prepared in connection with the Delaware Supreme Court’s opinion and presented to shareholders,” Olson says.
Despite their pro-shareholder slant, not everyone believes the amendments would be a boon to shareholders if Delaware lawmakers do approve them; many activists would prefer Congress or the Securities and Exchange Commission to address the same problems at a national level. “Some of the activists are concerned that these state law provisions … would result in Congress backing away form these issues, and the SEC backing away from these issues,” Olson says.
CA vs. AFSCME
The following excerpt clarifies the decision in CA vs. AFSCME:
II. The two questions certified to us by the SEC are as follows:
Is the AFSCME Proposal a proper subject for action by
shareholders as a matter of Delaware law?
Would the AFSCME Proposal, if adopted, cause CA to violate any
Delaware law to which it is subject?
III. The First Question: Analysis
The shareholders of a Delaware corporation have the right “to participate in
selecting the contestants” for election to the board. The shareholders are entitled to facilitate the exercise of that right by proposing a bylaw that would encourage
candidates other than board-sponsored nominees to stand for election. The Bylaw
would accomplish that by committing the corporation to reimburse the election
expenses of shareholders whose candidates are successfully elected. That the
implementation of that proposal would require the expenditure of corporate funds
will not, in and of itself, make such a bylaw an improper subject matter for
shareholder action. Accordingly, we answer the first question certified to us in the
affirmative.
That, however, concludes only part of the analysis. The Delaware General Corporation Law also requires that the Bylaw be “not inconsistent with law.” Accordingly, we turn to the second certified question, which is whether the proposed Bylaw, if adopted, would cause CA to violate any Delaware law to which it is subject.
IV. The Second Question: Analysis
AFSCME contends that it is improper to use the doctrine articulated in QVC
and Quickturn as the measure of the validity of the Bylaw. Because the Bylaw
would remove the subject of election expense reimbursement (in circumstances as
defined by the Bylaw) entirely from the CA’s board’s discretion (AFSCME
argues), it cannot fairly be claimed that the directors would be precluded from
discharging their fiduciary duty. Stated differently, AFSCME argues that it is
unfair to claim that the Bylaw prevents the CA board from discharging its fiduciary duty where the effect of the Bylaw is to relieve the board entirely of those duties in this specific area.
That response, in our view, is more semantical than substantive. No matter
how artfully it may be phrased, the argument concedes the very proposition that
renders the Bylaw, as written, invalid: the Bylaw mandates reimbursement of
election expenses in circumstances that a proper application of fiduciary principles
could preclude. That such circumstances could arise is not far fetched. Under
Delaware law, a board may expend corporate funds to reimburse proxy expenses
“[w]here the controversy is concerned with a question of policy as distinguished
from personnel o[r] management.” But in a situation where the proxy contest is
motivated by personal or petty concerns, or to promote interests that do not further, or are adverse to, those of the corporation, the board’s fiduciary duty could compel that reimbursement be denied altogether.
It is in this respect that the proposed Bylaw, as written, would violate
Delaware law if enacted by CA’s shareholders. As presently drafted, the Bylaw
would afford CA’s directors full discretion to determine what amount of
reimbursement is appropriate, because the directors would be obligated to grant
only the “reasonable” expenses of a successful short slate. Unfortunately, that
does not go far enough, because the Bylaw contains no language or provision that
would reserve to CA’s directors their full power to exercise their fiduciary duty to
decide whether or not it would be appropriate, in a specific case, to award
reimbursement at all.
In arriving at this conclusion, we express no view on whether the Bylaw as
currently drafted, would create a better governance scheme from a policy
standpoint. We decide only what is, and is not, legally permitted under the DGCL.
That statute, as currently drafted, is the expression of policy as decreed by the
Delaware legislature. Those who believe that CA’s shareholders should be
permitted to make the proposed Bylaw as drafted part of CA’s governance scheme, have two alternatives. They may seek to amend the Certificate of Incorporation to include the substance of the Bylaw; or they may seek recourse from the Delaware General Assembly.
Accordingly, we answer the second question certified to us in the
affirmative.
QUESTIONS ANSWERED.
Source
Text of CA v. AFSCME Decision (Aug. 15, 2008).
Elson
Elson has a different point of view. “I think it’s a very pro-investor approach all the way through, and I think that’s the point of Delaware’s strength over the years,” he says. “To me, making these changes to give investors potentially greater power, and create greater accountability for investors, is a real positive.”
Grossbauer sees the amendments as a win-win for all parties. “Consistent with the philosophy of the statute, the changes are enabling ones, designed to give actual freedom to companies and management and to stockholders to design the systems of election and voting that fit individual companies,” he says.
Other Changes
Among other changes is a proposed amendment to Section 213(a), which seeks to prevent “empty voting” by stockholders—a practice where investors exercise the vote of shares they control, but don’t necessarily possess; critics say it can cause some investors to vote in ways that enrich themselves but hurt the company.
“By permitting companies to put the record date for voting, and for determining who gets to vote, closer to the date of the meeting, you have less turnover in the stockholder base,” Grossbauer says.
Another change would extend director indemnification for individuals after they depart the company. The revision overturns another Delaware court decision, Schoon v. Troy, where the Chancery Court ruled that a company could retroactively sever legal protections to directors after they leave the board.
“What the new statute is going to say is that, unless your bylaws expressly let you do it, the rules for indemnification and advancement for former directors are the rules that were in place when the challenged conduct occurred,” Grossbauer says.
Another amendment would give the Chancery Court authority in extreme cases to remove directors if found guilty of breaching their “duty of loyalty.” An example might be if they were found to have stood on both sides of a transaction involving their company. However, Grossbauer says, “I wouldn’t anticipate that [rule] being used very much.”
All of the changes “should be viewed as part of Delaware’s effort to maintain a best-in-class corporation law,” and to stay ahead of the governance curve, Grossbauer says. Paying attention to case law and market developments “enable people to have a full toolkit to deal with these issues going forward.”
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