Advance Notice Bylaw Provisions
A recent Delaware case, Saba Capital Master Fund, Ltd. v. Blackrock Credit Allocation Income Trust, highlights the importance of advance notice bylaws and the careful application of the terms of such bylaws by public companies who may be subject to activist campaigns.
As backdrop, following Delaware cases in 2008 (Jana Master Fund Ltd. vs. CNET Networks, Inc. and Levitt Corp. vs. Office Depot, Inc.) which interpreted ambiguous advance notice bylaw provisions in favor of insurgent shareholders attempting to nominate their own slate of director nominees, a large number of public companies (particularly large-cap companies and public companies incorporated in Delaware) amended their advance notice bylaw provisions to eliminate perceived vulnerabilities in their advance notice bylaws and expand the information required to be provided by shareholder proponents (known as second generation advance notice bylaw provisions).
While the focus on advance notice bylaw provisions (including the law firm commentary on this subject) has waned over the last decade, advance notice bylaws remain an important aspect of a public company’s preparedness for shareholder activism.
Various jurisdictions, including the Delaware courts, have recognized the legitimate business purposes provided by reasonable and thoughtfully crafted advance notice bylaw provisions. Advance notice bylaws provide public companies with notice of shareholder director nominations or proposals in advance of an annual or special meeting, as well as establish a deadline for a shareholder to submit such nominations or proposals to public companies. By obtaining information regarding shareholder proponents and shareholder director nominations or proposals in advance of a shareholders meeting, boards can consider and appropriately respond to shareholder nominations and proposals.
In Saba, the defendants were two affiliated closed-end funds who sought to disqualify the director nominees of an activist shareholder because the activist shareholder did not comply with the requirements of the advance notice provisions of the defendants’ bylaws. As allowed pursuant to the bylaws of the funds, the defendants had requested a response to a supplemental information request from the activist shareholder before a five-business day deadline. The activist shareholder did not provide its response to the supplemental request until after the five-business day deadline had already passed, and the defendants sought to disqualify the activist shareholder’s nominees on those grounds. Among other arguments, the activist shareholder argued that the scope of the supplemental information request went beyond the specific bounds outlined in the defendants’ bylaws.
Ultimately, the Delaware Court of Chancery agreed with the activist shareholder and found that the supplemental information request exceeded the scope of the director qualification standards articulated in the defendants’ bylaws, and thus allowed the activist shareholder’s nominees to stand for election. The court’s holding was grounded on the fact that the bylaws of the defendants only allowed the board to “reasonably” request information about a stockholder nominee “if necessary” to determine that the nominee met the director qualifications set forth in the bylaws, and determined that many of the questions in the questionnaire exceeded this scope.
From a planning perspective, it is critical for companies to adopt appropriate advance notice bylaw provisions well in advance of the appearance of an activist shareholder, because courts are more likely to defer to the board’s decision to adopt or revise advance notice bylaw provisions “on a clear day,” or in other words, if the decision was not a defensive response in order to entrench the board.
Moreover, the adoption of customary second generation advance notice bylaws by public companies will typically not result in significant scrutiny from proxy advisory firms or institutional shareholders. As such, we advise those public companies that have not already adopted second generation advance notice bylaws to do so, and that public companies otherwise continue to monitor developments in this area. Moreover, Saba illustrates that advance notice bylaws will not always be interpreted as written, and that courts (including Delaware courts) will interpret ambiguous bylaw provisions in favor of stockholders.
We also highlight trends in proxy access bylaws, which allow for shareholders to include director nominations in a public company’s proxy statement. While proxy access bylaws generally have provisions that are independent from advance notice bylaws provisions, the interaction between these provisions should still be considered, and the adoption of proxy access bylaws may present an opportunity to refresh or update second generation advance notice bylaw provisions. In this regard, in the past few years, adoption of proxy access provisions has become a widespread practice amongst large-cap public companies, and adoption is expected to continue to increase among other public companies as well.
Proxy access provisions allow long-term shareholders, or a group of long-term shareholders, to include a limited number of director nominees in a company’s proxy materials for the company’s annual meeting of shareholders. While shareholder proposals requesting that companies adopt proxy access were not as prevalent in 2018 as they were between 2015 and 2017, larger public companies that have not yet adopted proxy access are still at risk of receiving a shareholder proposal on the topic.
For companies that have adopted proxy access, it has become market to include an ownership threshold of 3%. Likewise, a holding period of three years has become a nearly universal market standard. With other aspects of proxy access however, there is slightly more diversity in the provisions adopted by companies, including, among other provisions, limitations on the number of nominees, limitations on the size of the nominating group, the nomination deadline, and the information required from nominees and nominating shareholders.
The determination of whether it is advisable for a public company to proactively adopt proxy access will be company-specific and based on various factors, including the market capitalization of a particular company and the perceived likelihood to becoming subject to a shareholder proposal on this subject.