An advance notice bylaw typically requires that nominations for directors made by a shareholder be submitted to a corporation within a specified time period (say, 60-90 days before the first of anniversary of the previous year’s annual meeting). These provisions provide several benefits to a company, including giving a board time to evaluate the proposed candidates and preventing last minute “surprise attacks” by third parties for control or board representation. Advance notice bylaws have been consistently upheld by the courts. There have, however, been a few instances of successful challenges to these provisions, based on ambiguous formulations or, even more infrequently, a finding that a board’s fiduciary duties require that the provisions be waived under the particular circumstances.
In AB Value v. Kreisler (Dec. 17), Vice Chancellor Parsons refused to issue a temporary restraining order enjoining the advance notice bylaw of Kreisler Manufacturing Corporation so that AB Value Partners, an activist hedge fund that owned 11% of the company’s stock, could run a competing slate of directors at Kreisler’s annual meeting. The decision confirms that a company’s refusal to waive an advance notice bylaw deadline (resulting in a shareholder not being able to submit an opposing slate of director nominees) will be deemed to be inequitable only in an extreme set of circumstances.
The decision clarifies the very limited circumstances under which the court will enjoin enforcement of an advance notice bylaw amendment by reason of changes that occur during the period after the advance notice bylaw deadline has passed and before the annual meeting is held. The court will enjoin an advance notice bylaw (that was adopted on a “clear day” and that is facially valid) only when, at a minimum, (i) the board undertook material unanticipated changes after the bylaw notice deadline and (ii) the changes resulted in a “radical shift in the direction of the company.” (A material change in the likelihood of success of a proxy contest is not a change that will support enjoining an advance notice bylaw.)
Kreisler was operated by two brothers (the Sterns) as co-Presidents, each of whom held 12% of the stock and was also a director. The 4-person board included two independent directors, one owning 19% of the stock (and being the largest shareholder) and the other owning less than 1%. After the advance notice bylaw deadline had passed, a trust, which held 37% of the stock and had been controlled by the Sterns, distributed the stock evenly to the two Sterns and their two siblings, who were the trust beneficiaries. Also, after the deadline had passed, the board announced that it would be increasing the salary of each of the co-Presidents, from $175,000 per year to $275,000 per year. (In addition, there was speculation that the co-Presidents intended to obtain additional substantial salary increases in the future; further, the board added two takeover defensive provisions to its bylaws.) In view of these developments that occurred after the advance notice bylaw deadline had passed, AB Value requested a waiver of the deadline so that it could submit a competing slate of directors. Kreisler refused to waive the deadline; and AB Value sought a temporary restraining order (TRO) preventing enforcement of the notice requirement.
The court dismissed the plaintiff’s motion for a TRO. To obtain a TRO, a plaintiff must demonstrate the existence of a colorable claim, as well as irreparable harm if relief is not granted, and a balancing of the hardships that favors the plaintiff. Here, in what was a quasi-injunction proceeding (as a TRO would grant all of the relief to which the plaintiff might be entitled after a full trial on the merits), the plaintiff would have a higher standard to meet, the court said (possibly either a reasonable probability of success on the merits or an entitlement to judgment as a matter of law on the merits). The court did not decide the specific standard that the plaintiff would have to meet, as the court concluded that the plaintiff had not met even the lowest standard of making a “colorable claim”.
When will the court enjoin an advance notice bylaw?
- If the bylaw is adopted or applied to thwart a dissident stockholder by making compliance impossible or extremely difficult. The scenario under which a court would be most likely to enjoin an advance notice bylaw, the court stated, would be when a board, “aware of an imminent proxy contest, imposes or applies an advance notice bylaw so as to make compliance impossible or extremely difficult, thereby thwarting the challenger entirely.” That was not the situation in AB Value, the court ruled. Instead, Kreisler had adopted the bylaw on a “clear day” long before the AB Value proxy contest had been contemplated, and the validity of the bylaw on its face was not in question.
The court cited the following Chancery Court precedents as reflecting a scenario where a board, aware of an imminent proxy contest, tried to use an advance notice bylaw to entirely thwart a dissident stockholder by making compliance impossible or extremely difficult:
- Mesa Petroleum v. Unocal (1985), where the court found inequitable a board’s interpretation of a 30-days’ notice bylaw to effectively require 90-days’ notice under the circumstances—a requirement that the dissident stockholder could not possibly comply with.
- Lerman v. Diagnositc Data (1980), where the court held that a 70-days’ notice bylaw was inequitable in a situation where the board had announced the annual meeting only 63 days before it was to occur, rendering compliance impossible.
- Linton v. Everett (1997), where the court set aside an election of directions after the company, having not called an annual meeting for several years, then announced a meeting on 30-days’ notice, thus triggering a 10-day window in which the plaintiffs could propose alternative directors.
- If the bylaw is ambiguous. The court may enjoin an advance notice bylaw if the bylaw is unclear, so that it is uncertain whether it applies to a particular stockholder, whether the stockholder complied with it, or how it is to be applied. Those issues were not present in AB Value, the court noted. Rather, AB Value was aware of the bylaw and admittedly did not comply with it.
- If the board causes a material change in circumstances after the notice deadline. The court emphasized that only “compelling facts” would meet the “high standard” required for a finding that equitable relief would be needed to afford stockholders an opportunity to nominate an opposing slate after not having complied with an advance notice bylaw. Those facts would have to include evidence that, because of action taken (or inaction) by the board after the notice deadline, circumstances at the company “had materially or radically changed”.
When will a change in circumstances meet the high standard required for equitable relief?
- The changes cited by AB Value did not raise a colorable claim. The court found that the changes at Kreisler during the period between the notice deadline and the annual meeting had not been caused by the board and/or were not sufficiently material to have represented a “radical shift” in the direction of the company. AB Value had argued that the following changes supported equitable relief: (a) shares that had been held in trust were distributed to the trust beneficiaries, with the result that two other Stern siblings (rather than the co-Presidents) now each controlled 10% stakes in the company; and (b) the board had increased the annual salary for the two co- Presidents from $175,000 per year to $275,000.
The distribution of the trust shares, the court said, had not been effected by the board; was merely a change in stockholder composition (in the court’s view, a common occurrence for companies); and in no way “substantially alter[ed] the direction of the company.” Although the change was viewed by AB Value as material, because it altered the likelihood of success of a proxy contest (as there were now more shares not controlled by the co-Presidents), the Vice Chancellor stated that he was not convinced that this type of change was a relevant consideration for the court. The salary increase was a somewhat more relevant development, the court said, particularly as other allegations indicated that there had been some dissension on the board regarding executive compensation issues. The court noted, however, that the board had unanimously approved the increase, and concluded that “neither the operations of the Company nor its business direction [were] changed” as a result of the increase.
- Precedents that reflected a “radical shift” in the direction of the company. The Vice Chancellor distinguished two precedents, in which the Chancery Court had granted equitable relief after finding that changes by the board during the post-deadline/pre-annual meeting period constituted a “radical shift” in the direction of the company—involving, in one case, a board’s sudden support for a new dissident director’s plan to transform the company, and, in the other, a board’s sudden change of view regarding a sale of the company.
In Hubbard v. Hollywood Park, the court had found that the action taken by the board after the advance notice bylaw deadline had passed represented an unanticipated and material change of allegiance of a majority of the board, supporting an insurgent plan that would “alter substantially the direction of the company’s business”. Hubbard, an insurgent stockholder, had joined the board in a settlement agreement with the company. He then convinced a majority of his fellow directors to support his plan to dramatically change the direction of the company and the way it did business. He then joined that new board majority in presenting themselves to stockholders as the management slate. The now-minority directors sought to enjoin the advance notice bylaw deadline so that they could submit their own competing slate. The AB Value court said that the insurgent in Hubbard “arguably had acquired board control without ever having received shareholder approval of his agenda,” and that the “material change in circumstances” and “radical shift in position” caused by the directors after the deadline had passed—on an issue that would have forseeably generated shareholder controversy and opposition—imposed on the board the duty to waive the advance notice requirement.
In Icahn v. Amylin, the court had granted a motion to expedite in a case in which the plaintiffs sought to enjoin an advance notice bylaw on the grounds that the board had inexplicably refused to engage with a potential acquiror offering a substantial premium. Relying on Hubbard, the court found that the plaintiffs had articulated a sufficiently colorable claim, in part because of their allegation that the board had “radically changed its outlook for the Company” after the notice deadline had passed. The court had found it relevant that the board refused to sell the company when, according to the plaintiffs, a sale was a “key element of the investment thesis in [the Company].” Thus, the AB Value court said, the board’s unanticipated change of view after the notice deadline had passed “resulted in a radical change in the Company’s direction”—meaning that the stockholders could have been “denied the opportunity to exercise their voting rights at an arguably critical time.”
- Advance notice bylaws are beneficial to corporations; and their adoption and enforcement are routinely upheld by the courts.
- Advance notice bylaws should be adopted on a “clear day”. When possible, advance notice bylaws should be adopted on a “clear day”—that is, before there is any indication that a proxy contest may be imminent. An advance notice bylaw adopted in the face of an imminent proxy contest should be valid if compliance by the stockholder is feasible.
- Advance notice bylaws should be unambiguous. Advance notice bylaws should be clear and unambiguous. In our experience, advance notice bylaw provisions have sometimes been internally inconsistent or have conflicted with other bylaw provisions—often with respect to the calculation of the notice period.
- Changes made during the period between the notice deadline and the annual meeting will be problematic only in extraordinary circumstances. AB Value confirms that actions taken (or inaction) by a board during the post-deadline/pre-annual meeting period generally should not be deemed by the court to constitute a “radical shift in the direction of a company” such that they would support a claim for equitable relief from an advance notice bylaw. Nonetheless, boards should be sensitive to the possible implications for enforcement of an advance notice bylaw if changes are made during the post-deadline/pre-annual meeting period that are extreme, highly unusual, or may have an extraordinary impact.