Delaware courts have proven to be very flexible when it comes to issues involving advance notice bylaws, but the Chancery Court’s recent post-trial decision in ATG Capital Opportunities Fund LP v. Lane, (Del. Ch.; 8/26), indicates that there’s a limit to that flexibility when it comes to reading requirements in to advance notice bylaws that aren’t expressly set forth in them.

The case arose out of an activist investor’s efforts to nominate a slate of director candidates to the board of Empery Digital, a digital asset company. The board rejected the activist’s slate, based on suspicions that the activist was coordinating with another investor who wanted to liquidate the company’s Bitcoin assets and the activist’s failure to disclose a “massive short position” in Bitcoin ETFs, which the board concluded created a misalignment between the interests of the activist and those of other investors.

The good news for the board was that evidence was produced at trial suggested that the board was on to something. The bad news for the board was that Vice Chancellor Will concluded that this “something” wasn’t required to be disclosed under the terms of the advance notice bylaw. The defendants argued that coordinated activity between the activist and the other investor constituted an “agreement, arrangement, or understanding” (AAU), and that in prior decisions, the Chancery Court had permitted companies to reject nominees for failing to disclose the existence of an AAU. The Vice Chancellor rejected that argument:

The defendants analogize these facts to precedent where the court held that an undisclosed agreement, arrangement, or understanding (“AAU”) provided contractual or equitable grounds to reject a nomination. Yet there is a significant difference between the bylaws in those cases and the Bylaws at issue here. In prior cases, the bylaws at issue explicitly required a nominating stockholder to disclose AAUs. Empery’s Bylaws do not.

Section 2.5 of Empery’s Bylaws, which governs “Notice of Nominations for Election to the Board,” lacks any provision requiring a nominating stockholder to disclose an AAU concerning Empery or the nomination. This omission is striking because Section 2.4 of the Bylaws, which governs notices of business proposals to be brought before a meeting, requires the disclosure of all agreements, arrangements, and understandings in connection with the proposal. Nor does Empery have a bylaw requiring the disclosure of a Section 13(d) group.

The defendants pointed to other language in the bylaw requiring disclosure of a “participant” in the solicitation. Citing federal case law interpreting the term participant under the federal proxy rules, Vice Chancellor Will observed that these decisions rejected attempts to classify individuals as “participants” unless they either financed the proxy contest or directly participated in the solicitation. Applying this precedent and common law interpretive principles, the Vice Chancellor concluded that the investor was not a participant in the activist’s proxy solicitation.

Vice Chancellor Will’s conclusion that the investor was not a participant in the solicitation proved fatal to another argument put forward by the defendants that the nominations could be rejected. The defendants pointed to a bylaw provision requiring disclosure of any information required to be disclosed in a proxy statement under Schedule 14A. While Item 5(b) of Schedule 14A requires disclosure of the participants in the solicitation, the Court’s conclusion that the investor wasn’t a participant precluded this argument.

The defendants attempted to “pivot” and contended that Rule 14a-9, which prohibits false and misleading statements or omissions in proxy materials required the activist to disclose this information in order to comply with Schedule 14A. Vice Chancellor Will rejected this argument, noting that the letter rejecting the activist’s nominees didn’t cite Rule 14a-9, and that it would not be permitted to subsequently raise that as abasis for rejection:

When a board rejects a nomination, it must give the nominating stockholder sufficient notice of the contractual basis for rejection. Having grounded its rejection in the asserted failure to disclose [the other investor] as a participant, the defendants cannot wait until trial to abandon that basis and advance a different theory of contractual noncompliance. Advance notice bylaws are not moving targets.

The board asserted an independent basis to reject the activist’s nominees based on its failure to disclose the Bitcoin ETF short position and the allegedly related plan to liquidate the company’s Bitcoin holdings. Vice Chancellor Will evaluated this argument under Unocal. She concluded that even assuming the board identified a cognizable threat to corporate policy, rejection of the activist’s nominees was not a reasonable and proportionate response:

Rejection was a disproportionate response to the perceived threat of [the activist’s] plans for Empery. The Board could have informed stockholders of the evidence concerning [the activist’s] and [the other investor’s] relationship, their apparent views concerning Empery’s Bitcoin strategy, and the risks the Board believed a change in control presented.

Those arguments could then have been tested through the electoral process. Nothing in the record suggests that permitting Empery’s stockholders to consider [the activist’s] slate would have prevented the Board from making its case to the electorate or from disclosing the information it regarded as material.

The Vice Chancellor ultimately concluded that the activist had complied with its obligations under the advance notice bylaw, and that its nominees could stand for election at the company’s annual meeting.

– John Jenkins