As Predicted: The SEC and the Further Denial of Shareholder Access (The Actual Result) (Part 19)

We are discussing the Delaware Supreme Court's decision in CA v. AFSCME, an opinion that severely restricted the scope of shareholder bylaws and facilitated the ability of companies to exclude proposals under Rule 14a-8.

The second issue concerned the impact of the bylaw on the board's fiduciary obligations.  The bylaw made repayment mandatory, providing no express fiduciary out.  Relying on Quickturn, the Court concluded that this would violate "the prohibition, which our decisions have derived from Section 141(a), against contractual arrangements that commit the board of directors to a course of action that would preclude them from fully discharging their fiduciary duties to the corporation and its shareholders."

How might the expenditures result in a violation of fiduciary obligations?  The Court reaffirmed the holding of a 1934 case and noted that "where the proxy contest is motivated by personal or petty concerns, or to promote interests that do not further, or are adverse to, those of the corporation, the board’s fiduciary duty could compel that reimbursement be denied altogether."  But what about the fact that the bylaw only allowed for payment where a director actually won the election?  In other words, whatever the motive for the nomination, the nominees could only win by making the case that on policy grounds they were the best candidates.  Despite discussion on the very topic at oral argument, the Court simply ignored the argument. 

Moreover, in illustrating the type of harm that could befall a company if there was no fiduciary out, the Court engaged in bait and switch.  The opinion noted the following:  

• Such a circumstance could arise, for example, if a shareholder group affiliated with a competitor of the company were to cause the election of a minority slate of candidates committed to using their director positions to obtain, and then communicate, valuable proprietary strategic or product information to the competitor.

There are many many problems with this example.  Foremost, the behavior is an outright violation of the elected directors' fiduciary obligations.  Moreover, for directors to be elected with this motive, they would almost certainly violate the duty of candor and Rule 10b-5.  In other words, the fiduciary out was entirely unnecessary to put a stop to this type of behavior. 

In addition, however, was the bait and switch approach.  The Court struck down the bylaw relying on cases that prohibited repayment in the case of nomination made for "personal or petty concerns."  In other words, the focus was not on what the directors did once in office (fiduciary obligations addressed that) but on the reasons for the nomination.  The example by the Supreme Court, however, does the opposite, addressing not so much the motivation of the shareholder but what the nominees will do once in office.  In other words, the Court could not really justify the need for a fiduciary out where a director, nominated for personal reasons, nonetheless won the election.  This is a slight of hand, not consistent with the earlier case law, and difficult to justify given the fiduciary obligations applicable to all directors, even those nominated by a competitor.   

More importantly, however, the Court flatly ignored arguments that the bylaw already contained what essentially amounted to a fiduciary out.  During oral argument, a colloquy took place where it was suggested that reimbursement would be "unreasonable" if it cause the board to engage in illegal conduct.  The Court never addressed why, when addressing a short slate nominated for "personal or petty" concerns, the board couldn't simply conclude that any reimbursement was not unreasonable.  

In addition, at oral argument, counsel for AFSCME conceded that the reimbursement bylaw could be repealed by the board if repeal was consistent with the board's fiduciary duties.  If confronted with the need to reimburse for illegal activity (nominations made for "personal and petty" reasons), the board could have repealed the bylaw.  The Court never addressed this argument either. 

Indeed, avoidance can be seen from the care taken by the Court in addressing the issue.  The opinion concluded that the bylaw "contains no language or provision that would reserve to CA’s directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate, in a specific case, to award reimbursement at all."  This was careful drafting by the court.  True enough there was no language in the bylaw but there didn't have to be.  Under Delaware law, a board confronted with the possibility of an illegal payment could have undone the bylaw in its entirety.  In other words, the fiduciary out was in the statute.  But the Court never addressed the point.

The opinion (and the briefs) are posted on the DU Corporate Governance web site.