A March Delaware Court of Chancery decision, which the Delaware Supreme Court recently affirmed, should forewarn companies with advance notice bylaws to review these provisions to ensure they are interpreted as intended.
In Jana Master Fund Ltd. v. Cnet Networks Inc., the Court of Chancery narrowly interpreted a longstanding advance notice bylaw, holding that it applied only to shareholder proposals and nominations submitted for inclusion in management’s proxy materials pursuant to Rule 14a-8 of the federal securities laws.
The court found that Cnet’s bylaw did not apply to shareholder proposals and nominations that are the subject of an independently financed proxy solicitation.
Jana Master Fund Ltd., an investment fund that had recently purchased 11% of Cnet Networks Inc.’s outstanding common stock, notified the media company in December that it intended to obtain control of its board by soliciting proxies to elect two Jananominated directors to seats up for re-election, expand the board to 13 from eight and fill the five new slots with its own nominees.
Cnet countered that Jana was not permitted to submit the proposals to shareholders at its annual meeting, citing its advance notice bylaw, which dated from the company’s inception and had been approved by a majority of its original shareholders ahead of its 1996 initial public offering.
The bylaw at issue contained not only the typical temporal requirement, under which a stockholder must advise the company within a certain time frame if it intends to initiate business at the meeting, (a provision with which Jana complied), but it also precluded any Cnet shareholder that had not owned at least $1,000 worth of Cnet stock for a minimum of a year from offering resolutions or proposals at the meeting.
The bylaw stated:
“Any stockholder of the Corporation that has been the beneficial owner of at least $1,000 of securities entitled to vote at an annual meeting for at least one year may seek to transact other corporate business at the annual meeting, provided that such business is set forth in a written notice and mailed by certified mail to the Secretary of the Corporation and received no later than 120 calendar days in advance of the date of the Corporation’s proxy statement released to security holders in connection with the previous year’s annual meeting of security holders. ... Notwithstanding the foregoing, such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy.”
Because Jana had only held Cnet stock since October, it did not meet the minimum one-year ownership requirement. Jana filed an action in the Court of Chancery seeking a declaration that the bylaw was inapplicable to its proposals, or alternatively, that it was invalid as a matter of Delaware law as an unreasonable restriction on stockholder voting rights.
The court agreed with Jana’s first argument, holding that Cnet’s bylaw applied by analogy only to shareholder proposals submitted for inclusion in the company’s proxy materials. In doing so, the court rejected Cnet’s argument that it would be illogical to assume the bylaw was initially intended to apply only to Rule 14a-8 proposals, which would leave the company without any advance notice protection in certain instances, particularly independently financed hostile proxy initiatives, where advance notice would seem most useful. The court was unmoved, noting such an eventuality would only coincide with what the applicable default rule permits under the Delaware General Corporation Law in the absence of an advance notice bylaw.
The court based its determination to limit the application of the Cnet bylaw to Rule 14a-8 proposals on three points. First, the court concluded the bylaw’s statement that stockholders “may seek to transact other corporate business,” having satisfied particular conditions, did not make sense outside the context of Rule 14a-8. In the court’s view, the phrase “may seek” suggested the shareholder must ask for permission or approval before making a proposal, a situation consistent with the scheme contemplated by Rule 14a-8, in which a company retains a gatekeeper function and can refuse to include shareholder proposals that fall within any of the Rule’s exceptions. In contrast, the chancellor noted that a stockholder is not otherwise obliged to seek management approval before putting forth a proposal through an independently financed solicitation.
Second, the court noted the Cnet bylaw tied the deadline for advance notice to be submitted to the date management’s proxy statement was to be released. The chancellor found that the “most reasonable explanation” for fixing that deadline in advance of the issuance of management’s proxy was to allow management time to include the shareholder proposal in its proxy materials, an obligation that exists only if the proposal in question was eligible for inclusion pursuant to Rule 14a-8. The court observed that Delaware case law produced by previous challenges to advance notice bylaws offered no example of a provision that fixed its notice deadline to the release of the company’s proxy statement, a provision, which imposes a deadline that falls further in advance of the meeting date than the provisions that had been upheld under Delaware law.
The third factor, which the chancellor identified as the most influential, was the bylaw’s reference to the federal securities laws: “[not]withstanding the foregoing, such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy.” In the court’s view, this provision implicitly incorporated all of Rule 14a-8’s requirements into the bylaw, and served to “remind shareholders seeking to make proposals under the bylaw that Rule 14a-8 sets requirements in addition to those laid out in the bylaw itself.”
The court’s ruling rested at least in part on the invocation of the Delaware rule of construction in favor of franchise rights, a principle that moved the chancellor, given the provision’s lack of clarity, to interpret the bylaw to favor the free exercise of electoral rights and against attempts to restrict it. Because the interpretation Cnet urged would have been more restrictive as applied to the free exercise of the stockholder franchise, the court declined to accept it, endorsing instead the interpretation limiting effect only to the proposals subject to regulation pursuant to Rule 14a-8 and the federal regulatory scheme.
Following an expedited appeal, the Delaware Supreme Court affirmed the lower court’s ruling for the reasons expressed in the chancellor’s opinion, choosing not to issue a separate opinion.
Delaware law has long recognized that advance notice bylaws serve a legitimate, important purpose ensuring an orderly electoral process as long as they do not unduly restrict shareholders rights. The Cnet outcome does not suggest a retreat from that principle is imminent. The decision did not reach Jana’s argument that the bylaw was invalid on its face, an assertion based largely on its restrictions relating to the size and length of the holders’ investment, rather than its advance notice requirement. The court was careful to note that it has upheld reasonable advance notice bylaw provisions in the past.
Nevertheless, companies with bylaws that contain such provisions should carefully review them in the wake of the Cnet opinion to ensure they are interpreted as they are intended. It is particularly important to consider whether the bylaw states explicitly and unambiguously that it applies to all shareholder proposals and nominations; fixes a deadline for advance notice of shareholder proposals a reasonable period in advance of the annual meeting, rather than references the mailing date for the company’s proxy statement; states that any references to Rule 14a-8 or the federal securities laws are intended to apply in addition to the requirements imposed by the bylaw; and excludes language that might suggest management approval is required for nominations or proposals.
Again, the Cnet decision did not address the validity of the provision in Cnet’s bylaw requiring that a proposing or nominating shareholder own no less than $1,000 of stock for one year before submitting a nomination or proposal. Those requirements replicate those contained in Rule 14a-8 for purposes of determining whether management is obliged to include shareholder proposals in its proxy statement, but their validity as a basis for limiting the ability of shareholders to propose or nominate under any circumstance remains an open question.
The Cnet ruling appears to foreshadow at least a limited acknowledgment of the increasing movement to expand shareholders’ influence through measures like “sayon- pay” and enhanced access to companies’ proxy statements. Whether this reflects a growing judicial trend, Delaware corporations and their advisers would be well-advised to assume bylaw provisions, which touch upon and or purport to restrict or curtail shareholder participation in the electoral process, will be judicially scrutinized to ensure the absence of ambiguity. Any such ambiguity will likely result in an interpretation that places the least possible constraint on the free exercise of shareholders’ electoral rights.