January 13, 2015

Delaware: Enjoining Advance Notice Bylaws Requires Radical Shift in Director-Initiated Circumstances

Here’s analysis from Cliff Neimeth of Greenberg Traurig:

In an “under the radar” decision the Delaware Court of Chancery recently denied a TRO seeking to enjoin the operation of Kreisler Manufacturing Corporation’s (“KMC”) advance notice bylaws (“ANBs”). The plaintiff, AB Value Partners LP (“AB Value”), sought to nominate and solicit votes to elect its opposition slate of directors at KMC’s December 18, 2014 annual meeting.

In 2007, KMC adopted fairly “plain vanilla” (older generation) ANBs with a 30-day window period for the submission of insurgent director nominations. To be timely, the notice of nomination was required to be submitted to the Secretary of KMC not earlier than the 90th day nor later than the 60th day prior to the anniversary date of KMC’s 2013 annual meeting (which was held on December 17, 2013). Accordingly, the window period opened on September 18, 2014 and closed on October 18, 2014. AB Value submitted its notice after the October 18, 2014 deadline.

While not disputing that its notice was untimely, AB Value nevertheless sought to have the ANBs set aside because of alleged “material events” that occurred after the window period expired. Namely, AB Value argued that the distribution to four beneficiaries of an approximately 32% KMC voting share block previously held in trust, recently approved compensation increases for KMC’s senior management team, and errors in KMC’s notice of annual meeting, constituted sufficient after the fact “material change” to warrant, in effect, the issuance of a mandatory injunction ordering KMC to waive the ANBs.

AB Value challenged KMC’s use of the ANBs and not their facial validity, relying on the time-tested doctrine announced in Schnell v. Chris-Craft Industries (some 43 years ago) that “inequitable action does not become permissible just because it is legally possible.” Meaning, just because a provision is, for example, authorized under the DGCL or a company’s certificate of incorporation or bylaws, its use in any variety of unfair and inequitable future circumstances, is subject to invalidation as applied.

In AB Value Partners, L.P. v. Kreisler Manufacturing, Vice Chancellor Parsons recognized the decades-long prevalence of ANBs as a valid company defense to ensure the conduct of orderly stockholder meetings (i.e., where insurgent director candidates are sought to be nominated and elected and/or other stockholder business is being proposed) while, at the same time, acknowledging that ANB requirements that “unduly restrict the stockholder franchise or are applied inequitably, . . . will be struck down.” The Vice Chancellor noted that KMC’s ANBs were adopted on a “clear day” and not post hoc in response to a threatened election contest or other threat scenario (which would have animated Unocal, Unitrin and, perhaps, Blasius review).

The Vice Chancellor distinguished two cases (Hubbard v. Hollywood Park Realty Enterprises, Inc. and Icahn Partners LP v. Amylin Pharmaceuticals, Inc.) relied on by the plaintiff where ANBs were enjoined because of the occurrence, after expiration of the advance notice deadline, of material, unanticipated and Board- initiated changes in company circumstances. He noted that those fact-intensive decisions instruct that compelling circumstances must exist before a court exercises the extraordinary remedy of enjoining the operation of an otherwise facially valid ANB. In other words, there must be a “radical shift in position, caused by the directors.” At the end of the day, AB Value did not meet that burden.

It’s important to remember that the ability to freely vote is the most sacrosanct stockholder right in Delaware and practically all states. That said, ANBs do serve the legitimate corporate and policy objective of protecting a company from insurgent ambush with little or no advance warning or information so that a company has a reasonable time to react, vet the situation and inform itself as to any corporate risk implications, and to ensure that stockholders have adequate disclosure of the Board’s assessment and recommendations to fully inform their voting decisions.

Like many things, there is a delicate legal and commercial balancing act here, and provisions that on their face (or as applied) operate inequitably to frustrate or unduly impede the proxy machinery will be highly suspect if challenged. ANB “technology” has evolved quite a bit over the last 10 years and the informational requirements have been expanded significantly since the early generation versions of these bylaws. Borrowing from improvements in rights plan (poison pill) technology , the inclusion in ANBs of requirements to disclose the existence of synthetic securities (and similar derivatives) arrangements is commonplace and, in more rare instances, a few aggressive companies have introduced “wolf pack” disclosure requirements and covenants. Like all organic (or contractual – e.g., rights plans) shark repellents, ambiguities and overreach generally will be construed against the company (most especially because these devices are implemented via unilateral board action). The court reached the correct result.