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The Plaintiffs' Bar’s Shiny New Object Loses Its Luster: Advance Notice Bylaw Provisions
Lenin Lopez, Esq.
Jul 17, 2024
Most board members would prefer not to have a convicted felon turned activist foisted upon them as a fellow board member—a real possibility, as my colleague Lenin Lopez explains in this week’s blog. While the SEC has worked overtime to make it easier for shareholders to nominate board members, many public companies attempted to impose order on the situation by enhancing the advance notice requirements in their bylaws. However, the Delaware Court of Chancery has not looked favorably on all these enhancements. The result has been numerous plaintiffs sending corporations demand letters and filing lawsuits challenging certain advance notice requirements. Read on to better understand the types of advance notice requirements the plaintiffs’ bar has been challenging, a recent Delaware Supreme Court decision that may help quell trending litigation, as well as important takeaways. – Priya Huskins
In 2021, the Securities and Exchange Commission (SEC) adopted final rules that made it easier for shareholders, including activists who may not have the company’s long-term interests in mind, to put dissident directors on a company’s proxy statement for consideration at the next annual meeting.
In the lead up to the final rules going into effect, there was a movement of sorts that emphasized the need for companies to enhance their bylaws by adopting aggressive advance notice provisions.
On the one hand, as illustrated by the case described below, corporations are right to insist on some guardrails when it comes to shareholder nominations. Most boards don’t want to add a known felon as new director.
On the other hand, at least in the eyes of the Delaware Court of Chancery, some of the companies that adopted enhanced advance notice bylaws went too far. The plaintiffs’ bar took notice as a function of a relatively recent Court of Chancery decision, sent demand letters, and filed lawsuits challenging certain of these advance notice bylaw provisions.
The good news is that the Delaware Supreme Court recently issued a decision that clarifies how Delaware courts should evaluate advance notice bylaw provisions. Even better news is that this decision may make the plaintiffs’ bar think twice before sending demand letters and filing lawsuits challenging advance notice bylaw provisions.
This article will:
- Provide a refresher on advance notice bylaw provisions under Delaware law
- Explain how and why the plaintiffs’ bar is focusing on advance notice bylaw provisions
- Discuss the Delaware Supreme Court decision that provides clarity regarding the validity and enforceability of advance notice bylaw provisions
- Suggest a next step
Advance Notice Bylaw Provisions: A Quick Refresher
One of the fundamental governance rights held by stockholders is the ability to vote for the directors of a corporation, as well as the ability to submit new director nominations. However, Delaware’s General Corporation Law (DGCL) doesn’t prescribe the process for shareholders to submit new director nominations. Instead, the DGCL permits corporations to outline the process in corporate bylaws.
Delaware corporations commonly include provisions in their bylaws that require stockholders who want to nominate a new director candidate to provide a degree of advance notice.
Advance notice bylaw provisions have been described by Delaware courts as helping to ensure “orderly meetings and elections contests and to provide fair warning to the corporation so that it may have sufficient time to respond to shareholder nominations.”
The most recent iteration of advance notice bylaw provisions was described succinctly by Vice Chancellor Lori Will in a recent opinion as follows:
| Advance notice bylaws are an area of renewed focus after the SEC’s November 2021 adoption of Rule 14a-19, which requires registrants to use a universal proxy card in contested elections. Previously, the company and a dissident stockholder nominating director candidates would each distribute separate proxy cards. Now, the company must include the dissident nominees on a universal proxy card, allowing stockholders to mix and match between slates. Numerous public companies have amended their advance notice bylaws to account for the rule change. Many have also taken the opportunity to revisit and enhance other advance notice requirements. Some have gone to extremes. |
| Kellner v. AIM ImmunoTech Inc, 307 A.3d 998 (Del. Ch. Dec. 28, 2023) |
Those types of “extremes” created the current brouhaha and attracted the attention of the plaintiffs’ bar. Oh, and Vice Chancellor Will’s description above was taken directly from the case that is arguably at the center of it all.
The Plaintiffs’ Bar Increased Focus on Advance Notice Bylaw Provisions
In Kellner v. AIM ImmunoTech Inc., Vice Chancellor Will found that four of a company’s six advanced notice bylaw provisions were invalid, noting that “as drafted, [they] do not afford stockholders a fair opportunity to nominate candidates. Rather…these provisions seem designed to thwart an approaching proxy contest, entrench the incumbents, and remove any possibility of a contested election.” Sidley Austin put together a great summary of Vice Chancellor Will’s findings regarding the advance notice bylaw provisions at issue.
Since Vice Chancellor Will’s Kellner opinion was issued in December 2023, the plaintiffs’ bar has made a cottage industry out of making demands and filing complaints against companies that include two types of advance notice bylaw provisions: “wolf-pack” and “daisy-chain” provisions. “Wolf-pack” provisions are those that deem stockholders with parallel goals to be “acting in concert.” “Daisy-chain” provisions provide that stockholders are “acting in concert” with one another by separately and independently acting in concert with the same third party, regardless of whether they are even aware of one another.
The general argument against these provisions is they create disclosure obligations that are impossible for shareholders to meet and they may serve as an unlawful deterrent to those seeking to meaningfully participate in the nomination process.
One might think that if faced with a similar complaint, all a corporation needs to do is revise its bylaws to remove the “wolf-pack” and “daisy-chain” provisions. While that will make the complaint moot, the plaintiffs’ bar will likely demand their pound of flesh in the form of “mootness fees.”
That is, they will argue that they should be compensated for having put the corporation and its stockholders on notice of the problematic language in the corporation’s bylaws.
The plaintiffs do not have to go to the expense of filing a complaint to be entitled to the fee. Rather, a demand letter is sufficient so long as the corporation takes corrective action as a function of having received the letter.
Much to the dismay of the plaintiffs’ bar, the world of advance notice bylaw provisions as we knew it after Vice Chancellor Will’s Kellner opinion has changed. This is because the Delaware Supreme Court’s review of that opinion clarified the appropriate standards when analyzing challenges to advance notice bylaw provisions.
Advance Notice Bylaw Provisions Are “Presumed to Be Valid”: Kellner v. AIM ImmunoTech Inc.
Background
Before diving into practical implications to draw from the Delaware Supreme Court’s decision, the facts underlying Kellner deserve some attention since they involve some very intriguing facts and characters.
AIM ImmunoTech Inc. (AIM), is an immuno-pharma company, whose stock price has fallen precipitously since 2016. As the Delaware Supreme Court decision noted:
“A group of [AIM] stockholders thought that the board of directors was mismanaging the company. They launched an activism campaign and proxy contest to elect new directors. The insurgents included two felons convicted of wire fraud, insider trading, and other crimes. The campaign escalated into two attempts to nominate directors to the AIM board.”
With respect to that second attempt and before it in November 2023, the AIM board publicly announced that they were initiating a process to add two new directors “in response to the feedback [the board] received from shareholders in connection with the recent 2022 Annual Meeting.”
Around this time, the board, with outside counsel, revisited AIM’s advance notice bylaw provisions. Outside counsel proposed a set of amendments in response to “significant activist activity during 2022 in which an activist group…engag[ed] in efforts to conceal who was supporting and who was funding the nomination efforts and to conceal the group’s plans for the Company.”
These amendments, a version of which the board adopted, primarily focused on the advance notice procedures governing shareholder proposals and nominations for director elections.
AIM sent the new advance notice bylaw provisions to the outside counsel of the activist stockholders referenced above. One of those stockholders, Tedd D. Kellner, with the help of outside counsel, submitted a notice of nomination pursuant to AIM’s new advance notice provisions.
The notice outlined Kellner’s intent to nominate himself and two others as director candidates for election at AIM’s 2023 annual meeting (the Kellner Notice). AIM’s outside counsel identified perceived deficiencies in the Kellner Notice and discussed them with the board.
As a result, the board unanimously voted to reject the Kellner Notice.
Kellner followed with a complaint arguing that, among other things, (i) AIM’s advance notice bylaw provisions were unlawful, or in addition and in the alternative, that AIM’s application of the bylaws to reject his notice was unlawful and/or inequitable, and (ii) that certain of AIM’s directors breached their fiduciary duties by adopting the amendments to the advance notice bylaw provisions.
The Supreme Court’s Decision
Just to set the stage, the Delaware Supreme Court’s decision had this gem in its decision: “In this appeal, it is apparent that confusion existed in the Court of Chancery between a “validity” challenge and an “enforceability” challenge.” Not sure about you, but I felt a sting on behalf of the Court of Chancery. The reality is that the Court of Chancery and the Delaware Supreme Court have been inconsistent and imprecise in the way they have worded opinions related to bylaw challenges. Cue in this Delaware Supreme Court decision to set the record straight.
At the heart of the decision is the clarification of the different types of analysis that a court should undertake when presented with a validity challenge and an equitable/enforceability challenge.
Simply, the Delaware Supreme Court confirmed that “bylaws are ‘presumed to be valid’ and must be interpreted ‘in a manner consistent with the law.’” It further explained that when a court is faced with a challenge of a bylaw’s validity based solely on the face of the text, “a court should not consider hypotheticals or speculate whether the bylaw might be invalid under certain circumstances. Instead, the burden is on the party asserting invalidity to demonstrate that the bylaw cannot be valid under any circumstance.” The Court of Chancery in Kellner did consider hypotheticals and did speculate. The result, as noted earlier, was it found that four of six of AIM’s amended advance notice bylaw provisions were invalid.
The Delaware Supreme Court flipped the script and found that all but one of AIM’s amended advance notice bylaw provisions were valid.
This is because (i) the board had the power under AIM’s certificate to adopt, amend or repeal bylaws and (ii) the bylaws were consistent with Delaware law. The one exception was a 1,099-word single-sentence provision that was "indecipherable." It probably didn’t help that AIM’s chairman stated, "that the bylaw was written in such a way that ‘no one would read it."
This brings us to the second part of the Delaware Supreme Court’s analysis, which focused on the circumstances under which the board adopted the amended advance notice bylaw provisions. The Chancery Court had determined that the AIM board didn’t adopt the amended advance notice bylaw provisions on a “clear day” since AIM was amid a proxy contest at the time. The Delaware Supreme Court agreed and ultimately stated the following: “…the board’s primary purpose was to interfere with Kellner’s nomination notice, reject his nominees, and maintain control. As the product of an improper motive and purpose, which constitutes a breach of the duty of loyalty, all the Amended Bylaws at issue in this appeal are inequitable and therefore unenforceable.”
Potential Impact on Trending [Frivolous] Litigation
So, how will the Delaware Supreme Court’s decision impact the plaintiffs’ bar recent proclivity in sending corporations demand letters and filing lawsuits challenging “wolf-pack” and “daisy-chain” provisions? Well, if boards adopt amendments to their advance notice bylaw provisions on a “clear day” (e.g., not amid a proxy contest), then Delaware courts should provide significant deference to those bylaws. As a result, the plaintiffs’ bar should be dissuaded or, at least, think twice before demanding corrective action, either through a demand letter or complaint when it comes to advanced notice bylaw provisions that were adopted on a “clear day.” For those Delaware corporations that adopted amendments to their advance notice bylaw provisions on a “cloudy day,” the heighted level of risk of those bylaws being challenged by the plaintiffs’ bar likely remains.
Suggested Next Step: Review Your Advance Notice Bylaw Provisions
With the above in mind, Delaware corporations (and the plaintiffs’ bar) should now have clear expectations on the standards Delaware courts will use to review bylaws. As a result, for corporations, it is worth considering pressure testing their bylaws against these standards. At the same time, it may be worth considering amending certain advance notice bylaw provisions, especially if it can be done on a “clear day.”
As a reminder, it is best for this type of review to be conducted with the assistance of counsel who can properly document the process.
Parting Thoughts
The search isn’t even that difficult and demand letters can easily be duplicated.
If not for the Delaware Supreme Court issuing its own Kellner decision, advance notice bylaw provisions were likely going to continue to be the shiny new object for the plaintiffs’ bar. Not all heroes wear capes—sometimes they don black robes.
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