As Predicted: The SEC and the Further Denial of Shareholder Access (A Prediction) (Part 5)

We should probably wait to make a prediction but this is Delaware and the outcome is easy to surmise.  This is a traditional battle between the rights of the board in Section 141 and shareholders in 109(b).  The Company argues that the bylaw interferes with the board's authority to manage; shareholders allege that the bylaw addresses the election of directors and is an appropriate subject for a bylaw (whether by shareholders or the board).  In the absence of controlling authority, the Court could come out any way it wants.  Moreover, the fact that payments were capped (to what was paid for the Company's solicitation) and applied only if a shareholder director won (eliminating any real concern that this would result in marginal contests of no value to the Company), much of the concern over the limits on the board's discretion is theoretical and misplaced.

Having said that, the Delaware Supreme Court will agree with CA and find the bylaw a violation of state law or as improper interference in the role of the board.  This can be predicted based upon the race to the bottom.  The race to the bottom predicts that states will alter their law to attract (or retain) companies.  As discussed in my piece, The Irrelevance of State Corporate Law, companies will not alter their state of incorporation because of every change in state corporate law.  That Delaware now permits virtual shareholder meetings will likely not cause companies to reincorporate in the state.

Because it is the board that must decide to reincorporate in the first instance, companies will change their state of incorporation if the law becomes more favorable to management in a significant way.  What kind of changes does management want?  Those that increase the board's discretion (and reduce the authority of shareholders), that decrease the risk of officer/director liability (waiver of liability provisions the best recent example, these are discussed at length in my piece, Opting only In:  Contractarians, Waiver of Liability Provisions and the Race to the Bottom), and those that increase the likelihood of job preservation (broad discretion to use anti-takeover devices the best example).

This bylaw threatens job retention.  If the Delaware court allows it to go forward, it will become a model for shareholder proposals under Rule 14a-8 (and, depending upon the reasoning, a multitude of variations may arise, some of which would not require that the dissident director win before repayment would occur).  Other states may take a contrary position, concluding that it violates state law.  Would a board consider reincorporating in another state to get law that would allow for the exclusion of this type of proposal?  Possibly.  In other words, the Delaware Supreme Court cannot let this bylaw stand without the threat that some companies may choose to go elsewhere.  This the Court will not do.

It is remotely possible that the Supreme Court will find a middle ground, coming up with a factual dispute that makes the issue something that cannot be resolved, leaving the parties exactly where they were before the SEC certified the question.  For example, it may well be the case that the limits on board discretion are less meaningful in large publicly traded companies.  Alternatively, if it finds for AFSCME, it may do so on extremely narrow grounds.  Thus, it could limit its finding to proposals where the repayment is contingent upon the dissident director winning, an occurrence that will be rare and, therefore, unlikely to encourage a significant number of additional contests.  But these are unlikely.  Look for the Court to rule the bylaw invalid for failing to provide the board with any discretion to exercise its fiduciary obligations.