The rights and equitable treatment of shareholders and employees

Shareholder powers

What powers do shareholders have to appoint or remove directors or require the board to pursue a particular course of action? What shareholder vote is required to elect or remove directors?

Under state corporate law, shareholders generally have the right to elect directors (see the Delaware General Corporation Law (DGCL), section 216).

For many years, it was common practice for directors to be elected by a plurality of shareholders that can either vote in favour of, or withhold their votes from, the director candidates nominated by the board; ‘withheld’ votes are not counted. Accordingly, absent a contested election, the candidates nominated by the board are automatically elected whether or not a majority of shareholders vote for them. Relatively recently, shareholders have pressed companies for the ability to veto the election of a particular director nominee or nominees in the context of an uncontested election. This can be achieved through the adoption of charter or by-law provisions requiring that director nominees receive the approval of a ‘majority of the votes cast’ to be elected, or, in lieu of a charter or by-law provision, the adoption of corporate policies that effectively require a director who has not received a majority of the votes cast to resign. In 2006, the Delaware legislature adopted amendments to the DGCL that facilitate both of these options. Specifically, the amended DGCL, section 141(b) expressly permits a director to irrevocably tender a resignation that becomes effective if he or she fails to receive a majority vote in an uncontested election. The amended DGCL, section 216 provides that a by-law amendment adopted by shareholders specifying the vote required to elect directors may not be repealed or amended by the board alone (generally, by-law provisions may be amended by the board).

The proportion of companies in the Standard & Poor’s (S&P) 500 that have adopted some form of majority voting in uncontested director elections has increased dramatically from 16 per cent in 2006 to approximately 90 per cent in 2021.

Shareholders can also nominate their own director candidates either before or at the annual general meeting, although most public companies adopt ‘advance notice’ bylaws that require nominations to be received by the company several months before the annual general meeting. To solicit the proxies needed to elect their candidates, however, at a company that has not adopted ‘proxy access’ a shareholder must mail to all other shareholders, at the shareholder’s own expense, an independent proxy solicitation statement that complies with the requirements of section 14 of the Securities Exchange Act of 1934 (the Exchange Act). Given these constraints, independent proxy solicitations are rare and usually undertaken only in connection with an attempt to seize corporate control.

In addition, shareholders generally have the right to remove directors with or without cause or, where the board is classified, only for cause (unless the certificate of incorporation provides otherwise); the vote required to remove directors is a majority of the shares then entitled to vote at an election of directors (subject to certain modifications, for example, where the company has adopted cumulative voting in director elections) (see DGCL, section 141(k)). However, as many publicly held companies do not permit shareholders to call special meetings or act by written consent, this power can be difficult to exercise in practice.

Shareholders’ liability for corporate actions is generally limited to the amount of their equity investment. In keeping with their limited liability, shareholders play a limited role in the control and management of the corporation. A number of corporate decisions require shareholder approval. In addition, shareholders can typically enjoin ultra vires acts (see DGCL, section 124) and vote on certain issues of fundamental importance at the annual general meeting, including the election of directors (see DGCL, section 216).

Shareholder decisions

What decisions must be reserved to the shareholders? What matters are required to be subject to a non-binding shareholder vote?

Under state corporate law, shareholders typically have a right to participate in the following types of decisions:

  • election of directors, held at least annually (see DGCL, sections 141(d), 211(b) and 216);
  • filling of board vacancies and newly created directorships, if so provided in the certificate of incorporation or by-laws (see DGCL, section 223);
  • removal of directors (see DGCL, section 141(k));
  • approval or disapproval of amendments to the corporation’s certificate of incorporation (which requires prior board approval) or by-laws, although the board is also typically authorised (in the certificate of incorporation) to amend the by-laws without shareholder approval (see DGCL, sections 109, 241 and 242); and
  • approval or disapproval of fundamental changes to the corporation not made in the regular course of business, including mergers, consolidations, compulsory share exchanges, or the sale, lease or exchange of all or substantially all of the corporation’s property and assets (see, for instance, DGCL, sections 251(c) and 271).

 

Other issues that may be brought to shareholder vote include:

  • approval of certain business combinations with interested shareholders that would otherwise be prohibited (see DGCL, section 203(a)(3));
  • approval of conversion to a different type of entity (see DGCL, section 266);
  • approval of transfer, domestication or continuance in a foreign jurisdiction (see DGCL, section 390);
  • approval of dissolution and revocation of dissolution (see DGCL, sections 275 and 311); and
  • ratification of defective corporate acts that would have required shareholder approval (see DGCL, section 204(c)).

 

Shareholders may also be asked by the board to approve certain matters, including:

  • approval of interested director or officer transactions (see DGCL, section 144);
  • the making of determinations that indemnifying a director or officer is proper (see DGCL, section 145); or
  • if so provided in the certificate of incorporation, the making of determinations that the consideration for which shares of stock with or without par value may be issued, and treasury stock disposed of (see DGCL, section 153).

 

Since 2011, the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 has required US public companies to conduct separate shareholder advisory votes on:

  • executive compensation – to be held at least once every three calendar years (annual votes are typical);
  • whether the advisory vote on executive compensation should be held every year, every two years or every three years – to be held at least once every six calendar years; and
  • certain ‘golden parachute’ compensation arrangements in connection with a merger or acquisition transaction that is being presented to shareholders for approval.

 

The rules of the New York Stock Exchange (NYSE) and Nasdaq Stock Market (Nasdaq) also require that shareholder approval be obtained prior to:

  • any adoption of an equity compensation plan pursuant to which officers or directors may acquire stock, subject to limited exceptions;
  • issuance of common stock to directors, officers, substantial security holders or their affiliates if the number of shares of common stock to be issued exceeds either 1 per cent of the number of shares of common stock or 1 per cent of the voting power outstanding before the issuance, with some exceptions including in connection with certain transactions by early-stage companies (NYSE), or could result in an increase in outstanding common shares or voting power of 5 per cent or more (Nasdaq);
  • issuance of common stock that will have voting power equal to or greater than 20 per cent of the voting power prior to such issuance or that will result in the issuance of a number of shares of common stock that is equal to or greater than 20 per cent of the number of shares of common stock outstanding prior to such issuance, subject to certain exceptions; and
  • issuance of securities that will result in a change of control of the company.

 

Disproportionate voting rights

To what extent are disproportionate voting rights or limits on the exercise of voting rights allowed?

Under state law, a corporation may issue classes of stock with different voting rights, limited voting rights and even no voting rights, if the rights are described in the corporation’s certificate of incorporation (see DGCL, section 151). If, however, a corporation issues a class of non-voting common stock, it must have an outstanding class of common shares with full voting rights.

The NYSE and Nasdaq listing rules also permit classes of stock with different voting rights; however, the listing rules prohibit listed companies from disparately reducing or restricting the voting rights of existing shareholders unilaterally.

The Council of Institutional Investors (CII) and the California Public Employees’ Retirement System have expressed their opposition to non-voting shares.

In 2017, two major stock index providers (S&P Dow Jones and FTSE Russell) announced changes to their index eligibility requirements that would exclude most companies going public with multiple classes of stock from the primary indices in the United States. Nevertheless, some companies in the technology industry and other industries have subsequently gone public with dual-class or multi-class stock.

Although it prefers equal voting rights, BlackRock acknowledges that newly public companies may benefit from a dual-class structure but endorses a limited duration through a sunset provision or periodic approval by shareholders.

ISS will generally recommend voting against or withholding votes from the entire board (except new nominees, who should be considered on a case-by-case basis) if, prior to or in connection with the company’s public offering, the company or its board implemented a multi-class capital structure where the classes have unequal voting rights, unless the structure is subject to a reasonable time-based sunset provision. Glass Lewis may issue negative recommendations against directors at the first annual meeting after the company has become public if the company adopts a multi-class capital structure that does not include a reasonable sunset provision. Both ISS and Glass Lewis generally consider a reasonable sunset to be seven years or less. Furthermore, Glass Lewis will generally recommend that shareholders vote in favour of recapitalisation proposals that would eliminate a company’s multi-class share structure to allow for all shareholders to have one vote per share.

Shareholders’ meetings and voting

Are there any special requirements for shareholders to participate in general meetings of shareholders or to vote? Can shareholders act by written consent without a meeting? Are virtual meetings of shareholders permitted?

Generally, all shareholders, at the record date set by the board, may participate in the corporation’s annual general meeting, and are entitled to vote (unless they hold non-voting shares) in person or by proxy (see DGCL, sections 212(b) and (c) and 213). The proxy appointment may be in writing (although there is no particular form mandated by the DGCL) or provided by telephone or electronically.

In addition, section 14 of the Exchange Act and related SEC regulations set forth substantive and procedural rules with respect to the solicitation of shareholder proxies for the approval of corporate actions at annual general meetings and special shareholders’ meetings. Foreign private issuers are exempt from the provisions of section 14 and related regulations insofar as they relate to shareholder proxy solicitations.

Shareholders may act by written consent without a meeting unless the certificate of incorporation provides otherwise (see DGCL, section 211(b)). The majority of companies in the S&P 500 do not permit shareholder action by written consent.

DGCL, section 211 permits a Delaware corporation to hold a meeting of shareholders virtually if it adopts measures to enable shareholders to participate in and vote at the meeting and verify voter identity, and if it maintains specified records. Prior to 2020, a small but growing number of US companies held virtual annual shareholder meetings, typically in one of two formats: exclusively online with no ability for a shareholder to attend an in-person meeting; or a hybrid approach whereby an in-person meeting is held that is open to online participation by shareholders who are not physically present at the meeting. The primary benefits of virtual shareholder meetings are increased shareholder participation and cost savings.

The number of US companies that held virtual-only annual shareholder meetings skyrocketed in 2020 when the covid-19 pandemic made in-person shareholder meetings impossible or inadvisable. Many US companies are considering holdings annual shareholder meetings in virtual or hybrid formats in the future.

Currently, ISS prefers a hybrid approach, but it does not have a policy to recommend voting against directors at companies that hold virtual-only meetings. In April 2020, ISS issued policy guidance that encouraged companies holding virtual-only meetings to explain why and provide shareholders with a meaningful opportunity to participate fully in the meeting (eg, engage in dialogue, ask questions of directors and senior management).

In egregious cases, Glass Lewis may recommend voting against governance committee members or the board chair where a company chooses to hold a virtual-only shareholder meeting but does not provide sufficient disclosure explaining how shareholders can participate in the meeting and engage with the board and management.  

Several large institutional investors (eg, CII, CalPERS, CalSTRS and the New York City Pension Funds) oppose virtual-only shareholder meetings and may vote against directors at companies that hold them.

Shareholders and the board

Are shareholders able to require meetings of shareholders to be convened, resolutions and director nominations to be put to a shareholder vote against the wishes of the board, or the board to circulate statements by dissident shareholders?

Generally, state law provides that every shareholder has the right to petition the court to compel an AGM if the board has failed to hold the AGM within a specified period of time (see DGCL, section 211). Special shareholders’ meetings may be called by anyone authorised to do so in the company’s certificate of incorporation or by-laws. The majority of S&P 500 companies permit shareholders meeting a minimum beneficial ownership requirement (such as 20 per cent or 10 per cent) to call special meetings.

Any shareholder of a reporting company who is eligible to bring matters before a shareholders’ meeting under state law and the company’s certificate of incorporation and by-laws may, at the shareholder’s own expense, solicit shareholder proxies in favour of any proposal including director nominations. Such shareholder proxy solicitations must comply with section 14 of the Exchange Act and related SEC regulations, but need not be approved by the board.

Under circumstances detailed in Rule 14a-8 under the Exchange Act, a reporting company must include a shareholder’s proposal in the company’s proxy materials and identify the proposal in its form of proxy. The shareholder may also submit a 500-word supporting statement for inclusion in the company’s proxy solicitation materials. This allows the proponent to avoid the costs associated with an independent solicitation. To qualify, a shareholder must have continuously held at least US$2,000 in market value or 1 per cent of the company’s securities entitled to vote for at least one year by the date the shareholder submits the proposal. The shareholder must continue to hold those securities until the date of the meeting. The SEC adopted rule amendments in September 2020 that will significantly increase the eligibility requirements for submitting a shareholder proposal to a tiered approach depending on the level of ownership and the relevant holding period: at least US$2,000 if held for at least three years, at least US$15,000 if held for at least two years, and at least US$25,000 if held for at least one year. The heightened standards will apply to any shareholder proposal submitted for an annual shareholder meeting held on or after 1 January 2022.  

Under specific circumstances, a company is permitted to exclude a shareholder proposal from its proxy solicitation, typically after obtaining ‘no-action’ relief from the SEC staff that confirms the company is entitled to exclude the proposal (eg, if the proposal deals with a matter relating to the company’s ordinary business operations).

Since 2011, companies may not exclude from their proxy materials shareholder proposals (precatory or binding) relating to by-law amendments establishing procedures for shareholder nomination of director candidates and inclusion in the company’s proxy materials, as long as the proposal is otherwise not excludable under Rule 14a-8. This amendment to Rule 14a-8 has facilitated the development of ‘proxy access’ via private ordering at companies chartered in states where permissible, as shareholders are able to institute a shareholder nomination regime via binding by-law amendment or request, via precatory shareholder proposal, that such a by-law be adopted by the board. The private ordering process to adopt proxy access has gained considerable momentum since the beginning of 2015.

Shareholders may act by written consent without a meeting unless the certificate of incorporation provides otherwise. The majority of companies in the S&P 500 do not permit shareholder action by written consent.

Controlling shareholders’ duties

Do controlling shareholders owe duties to the company or to non-controlling shareholders? If so, can an enforcement action be brought against controlling shareholders for breach of these duties?

Controlling shareholders owe a fiduciary duty of fair dealing to the corporation and minority shareholders when the controlling shareholder enters into a transaction with the corporation. When a controlling shareholder transfers control of the corporation to a third party, this obligation may be extended to creditors and holders of senior securities as well. A controlling shareholder who is found to have violated a duty to minority shareholders upon the sale of control may be liable for the entire amount of damages suffered, instead of only the purchase price paid or for the amount of the control premium. Minority shareholders can bring claims against a controlling shareholder for breach of fiduciary duty on either a derivative or direct basis, depending on the nature of the harm suffered.

Shareholder responsibility

Can shareholders ever be held responsible for the acts or omissions of the company?

Shareholders’ liability for corporate actions is generally limited to the amount of their equity investment. In unusual circumstances, exceptions may apply.

Law stated date

Correct on

Give the date on which the information above is accurate.

22 May 2020