Corporate Governance

As Predicted: The SEC and the Further Denial of Shareholder Access (The Anticipated Result) (Part 14)

By J. Robert Brown

We have been listening to the oral argument in CA v. AFSCME and offer some comments. The oral argument is publicly available and can be found on the Delaware Supreme Court web site.

So where will the Court go with this case?  The Court most likely expected this to be a straightforward example of a bylaw that lacked a fiduciary out.  The mandatory nature of the reimbursement (anytime a dissident candidate wins) seemed to interfere with the board's authority to manage the company (by potentially requiring payments of "millions of dollars") and potentially resulting in illegal payments (payments for proxy contests commenced for personal or political reasons).   A fiduciary out clause would allow the board to not make the payments where illegal or not in the best interests of shareholders.  

A holding that the provision required a fiduciary out would eviscerate these types of bylaws.  Shareholders wanting to run a dissident slate would know that reimbursement would depend upon the concurrence of the very group of people challenged in the election.  Dissidents would have to know, therefore, that there was a very real possibility that the reimbursement would not be paid.  In other words, a fiduciary out would likely mean that the reimbursement would not occur (unless the board wanted to try to co-opt the successful director, something that might result in reimbursement even without the bylaw).

But as came out in the oral argument, AFSCME's carefully written bylaw makes this holding difficult.  The Court would have to conclude that reimbursement of expenses for a director nominated for the wrong reasons (personal/political) was not in the best interests of shareholders even though shareholders elected the director.  The Court would have to find that the limitation on the amount of the reimbursement (both to reasonable expenses and to no more than what the company paid for its own solicitation) did not provide the board with sufficient discretion to affect the amount of the payments.  Finally, the Court would have to find that the board's authority to repeal a shareholder adopted bylaw (including this one) does not provide the very "fiduciary out" that CA argued should be there.

Based upon the merits, AFSCME should win.  Moreover, in finding the bylaw valid, the Court would not open the door to innumerable proxy contests.  By limiting reimbursement to contests where the dissidents win, the bylaw is not likely to result in a significant increase in the number of contests (assuming it is even approved by shareholders).  Most dissident slates lose.  Thus, even with this bylaw, most dissidents would know that they have a high probability of never being reimbursed.

But as we have discussed, it is our expectation that CA will win the case.  It is after all Delaware and the law in this area is controlled by the race to the bottom.

Primary materials from the Chancery Court can be found at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on July 15, 2008 (boomark / email).