Later today, Vice-Chancellor Steve Lamb of the Delaware Court of Chancery will hear arguments in Bebchuk v. CA, Inc. The plaintiff -- Lucian Bebchuk of Harvard Law School -- is seeking a declaratory judgment relating to legality of the following bylaw:
It is hereby RESOLVED that pursuant to Section 109 of the Delaware General Corporation Law, 8 Del C § 109, and Article IX of the Company's By-Laws, the Company's By-Laws are hereby amended by adding a Article XI as follows:
Section 1 Notwithstanding anything in these By-laws to the contrary, the adoption of any stockholder rights plan, rights agreement or any other form of "poison pill" which is designed to or has the effect of making an acquisition of large holdings of the Company's shares of stock more difficult or expensive ("Stockholder Rights Plan") or the amendment of any such Stockholder Rights Plan which has the effect of extending the term of the Stockholder Rights Plan or any rights or options provided thereunder, shall require the affirmative vote of all the members of the Board of Directors, and any Stockholder Rights Plan so adopted or amended and any rights or options provided thereunder shall expire no later than one year following the later of the date of its adoption and the date of its last such amendment.
Section 2. Section I of this Article shall not apply to any Stockholder Rights Plan ratified by the stockholders Section 3 Notwithstanding anything in these By-laws to the contrary, a decision by the Board of Directors to amend or repeal this Article shall require the affirmative vote of all the members of the Board of Directors.
This By-law Amendment shall be effective immediately and automatically as of the date it is approved by the vote of stockholders in accordance with Article IX of the Company's By-laws.
If you are interested at all in Delaware corporate law, you should recognize the issue raised by this case as the most important unsettled question of the past decade. Section 109 of the Delaware corporation statute authorizes shareholders to adopt bylaws "not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees." On the other hand, Section 141(a) charges the directors with management of the "business and affairs" of the corporation, "except as may be otherwise provided in this chapter or in its certificate of incorporation." In our article, Toward a New Theory of the Shareholder Role: 'Sacred Space' in Corporate Takeovers, 80 Texas Law Review 261, 318-24 (2001), Bob Thompson and I explain the controversy:
When the statute authorizes shareholder-adopted bylaws only to the extent that they are "not inconsistent with law," does that "law" include the provision granting managerial authority to directors? Similarly, when the statute authorizes directors to manage the firm subject to limitations "otherwise provided in this chapter," does that include limitations imposed by the shareholders through bylaw?
Most commentators who have considered these questions have concluded that the two sections of the Delaware statute cannot be reconciled without appeal to policy arguments....
[T]he issue of whether shareholders are allowed to adopt bylaws is not difficult because the statute expressly grants shareholders that authority. Instead, the difficult issue relating to shareholder-adopted bylaws is defining the point at which the shareholders cross the line that divides shareholders and directors.
In this instance, Lucian has a trump card. This is not just about the infinite loop of Sections 109 and 141(a), but also about Section 141(b): "The vote of the majority ofthe directors present at a meeting at which a quorum is present shall be the act of the board of directors unless the certificate of incorporation or the bylaws shall require a vote of a greater number."
Under this section, the stockholders of CA seem to be on firm ground with respect to the part of the proposed bylaw that requires a unanimous vote of the directors. But the bylaw does not stop there. It also limits the duration of any Stockholder Rights Plan to one year, unless the plan has been ratified by stockholders. Whether stockholders are entitled to adopt such a bylaw depends on how the courts resolve the conflict between Sections 109 and 141(a). Though I am firmly on Lucian's side of the divide, this is lightly charted terrain.
The argument will turn on similar considerations to those that were discussed in Chancellor Chandler's Unisuper opinion, which I criticized here. In that case, Chancellor Chandler concluded that a board of directors could enter into a contract with the stockholders that would limit the board's ability to utilize a poison pill. The holding of Unisuper is that directors can, within the (fuzzy) boundaries established by fiduciary law, delegate (some of) their authority to stockholders. Does it follow that stockholders can seize authority from directors? CA makes a rather lame argument on this point in the pre-hearing brief: "A voluntay contractual agreement by a board of directors to limit its discretion with respect to a stockholder rights plan cannot be compared to a unilateral stockholder mandate like the Proposed By-law." Because ...?
An important facet of the argument is the interface between fiduciary law and statutory law. Can the stockholders adopt a bylaw if implementation of the bylaw impinges of the board's ability to fulfill its fiduciary responsibilities? Lucian's team offers an interesting response to this question: "If a board feels its fiduciary duties require them to act inconsistent with a bylaw and the certificate of incorporation gives them the power to amend the bylaws, then they must amend the bylaws before undertaking the prohibited action." Hmm. I don't find that terribly persuasive because it opens the door to stockholder-adopted bylaws too wide. I think the Delalware courts would be inclined to impose fiduciary limitations on bylaws at the front end, rather than forcing the board of directors to amend the offensive bylaws after the fact. That said, I believe that Lucian's bylaw should pass muster, even under this slightly more stringent review.
In this case, the procedure may be as interesting than the substance. Lucian asked CA to include the bylaw on its ballot for the upcoming annual meeting of stockholders. CA requested a no-action letter from the SEC in connection with its plan to exclude the bylaw proposal from the ballot. The basis for CA's no-action letter is that the bylaw is unlawful in Delaware. (Under SEC Rule 14a-8(i)(2), a company may exclude a shareholder proposal "if the proposal would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject.") Of course, that is the question that Lucian hopes Vice-Chancellor Lamb will answer. But will he?
In 1999, Vice-Chancellor Stine refused to offer an "advisory opinion" on a bylaw that had not yet been adopted by the stockholders. General DataComm Industries, Inc. v. State of Wis. Inv. Bd., 731 A.2d 818 (Del. Ch. 1999). In that instance, however, the SEC had already refused to grant a no-action letter, and the proxy materials were already distributed. The only thing left to do was vote. Interestingly, CA does not challenge the ripeness of the claim.
If you want to dig deeper into the case, Lucian has posted the short complaint on his website. He also sent me the pre-hearing briefs, which I have uploaded here (plaintiff and defendant). Other materials are available on Lucian's Policy and Advocacy Page.
UPDATE: If you have made it this far, you might also be interested in Larry Ribstein's excellent post on the case.
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1. Posted by Jeff Lipshaw on June 16, 2006 @ 5:55 | Permalink
I've not read Lucien's materials, but I used to write the responses to the shareholder proposals on poison pills (see EDGAR DEF14A filings for Great Lakes Chemical Corporation from 2000 to 2002).
Our argument regarding the poison pill (shareholder rights plan) was a little akin to the NRA position - poison pills don't shoot shareholders, directors do. In other words, a poison pill was not a structural impediment to a takeover, nor was it per se evidence of entrenchment. The decision whether to redeem a pill in the face of a hostile takeover was clearly within the fiduciary responsibilities of the board. Moreover, Delaware law shifted burdens on the BJR with respect to the adoption of defensive measures in the face of a hostile takeover (per Unocal). Hence, the use or misuse of the pill fell squarely within the Section 141 responsibilities of the board.
Unocal says the board has "both the power and the duty to oppose a bid it perceived to be harmful to the corporate enterprise. On this record we are satisfied that the device Unocal adopted is reasonable in relation to the threat posed...." Hence, the board is betwixt and between, because a shareholder could claim that it violated it fiduciary duties by NOT adopting a pill in the face of an unfair takeover proposal. Apart from the more difficult issue whether the defensive measure is or is commensurate with the threat, wouldn't a holding that the adoption of a pill falls on the shareholder side of the Section 141 line mean a retreat from the fairly clear holding in Unocal about the affirmative duties of the board?
I have also not studied this, but as I recall when I was in the middle of this, no rights under a rights plan had actually detached, which suggested that boards were either successfully fighting off bids without ensuing litigation, or more likely, were using the pills to leverage more money out of the bidders, and then redeeming. (That was what happened in Harvard Corp. v. Hayes-Albion Corp., E.D.Michigan, 1989, a case in which we fought off an attempt, in the midst of a bid, to invalidate a pill under Michigan law.)
2. Posted by Jeff Lipshaw on June 16, 2006 @ 6:24 | Permalink
Yup, this is CA's argument at pp. 17-20 of its brief.
Which causes me to wonder even more about this if the bylaw were adopted. I put myself in the position of a director who has to decide whether to adopt what appears to be an arguably unfair offer (because I know more than shareholders do about the earning power of the company). Unless the Delaware court makes it absolutely clear that I have no duty ever to consider the adoption of a pill as a defense, I must return to an assessment of what constitutes fulfillment of my fiduciary duty on an ex ante basis, not knowing how it will all shake out in the end. And now with this bylaw, the dynamic in the boardroom changes, because a single director has the power to block the exercise of the fiduciary duty of the other directors to repeal the bylaw and adopt a pill.
This has a Sarbanes-like smell about it - the attempt to square the circle with rules and algorithms when it all comes down to the exercise of fiduciary judgment. I don't think you can be half-pregnant - either pills are completely a shareholder matter or completely a board matter, but you can't direct a director HOW to exercise judgment.
By the way, if the "contract-unilateral" distinction is lame, it's because I'm not sure how, if the foregoing is right, the board can even contract away its fiduciary obligation.
3. Posted by Gordon Smith on June 16, 2006 @ 9:56 | Permalink
"poison pills don't shoot shareholders, directors do"
"the use or misuse of the pill fell squarely within the Section 141 responsibilities of the board."
I don't see that as an answer to anything if the directors' 141 authority can be circumscribed by a bylaw.
"put myself in the position of a director who has to decide whether to adopt what appears to be an arguably unfair offer"
Jeff, the point here is that the directors don't decide whether to accept the offer. The stockholders do that. The directors decide whether to impede the offer, and some stockholders want the directors to get out of the way.
If the Delaware Supreme Court had followed Chancellor Allen's lead in Interco, I wonder whether things would have turned out differently.
4. Posted by Jeff Lipshaw on June 16, 2006 @ 11:05 | Permalink
No, Gordon, I disagree. (By the way "adopt an offer" was a typo; should have been "accept an offer.")
It's true in any acquisition that the shareholders make the decision, whether by vote to approve a statutory merger, or by tender of their shares. But that's not the question. The question is what is the board's duty in that circumstance, and it clearly is not simply "to get out of the way." The duty is to exercise judgment, to make recommendations (or not if that is the result of the judgment), and to take appropriate and measured steps, if necessary, to oppose bids it perceives "to be harmful to the corporate enterprise."
It is rare that a hostile takeover, the only kind that are subject to invocation of defenses, and the form of which would be a tender offer directly to the shareholders, is not preceded by "friendly" overtures (bearhugs, etc.) to management and board. And were the deal to proceed, the directors have to take a position, even though the shareholders will ultimately decide whether to accept. Section 251 says "The board of directors of each corporation which desires to merge or consolidate shall adopt a resolution approving an agreement of merger or consolidation and declaring its advisability."
Let's assume the stock is trading at $30 per share. I, as a director, have just reviewed, cross-examined, and satisfied myself as to the reasonable of a three-year strategic plan suggesting the inherent earning power of the company, presently valued, is $50 per share. The chairman gets a call in which the bidder offers $33 (a ten percent premium) that he and the board view as grossly inadequate. The obligation is not to get out of the way. If they were to accept it they would have to explain why. If they reject it, and bidder starts a hostile, the board is under more than an obligation to get out of the way of a $32 bid, and it doesn't have to start an auction or put the company in play to do so.
Again, somebody made the valid point that if 141 and 109 are in a dewloop, you have to step out of the closed system to resolve the issue. Maybe that's the point of the CA distinction between a "contract" and a unilateral bylaw: maybe as a director I can delegate some of my duties to protect the corporate enterprise back to the shareholders, but shareholders can't take them from me.
BTW, I'm not sure if textual analysis gets us there, but it's not quite a dewloop between 141(a) and 109. Section 141 shall the business and affairs shall be managed...unless otherwise provided in this chapter or in the C/I." Section 109 permits the adoption of bylaws not inconsistent "with this chapter or the C/I." The most mandatory provision in all of that is the SHALL in the board's obligation; you need two levels of bootstrapping to say that the adoption of a non-mandatory bylaw under Section 109 is something "provided in this chapter."
That raises the question whether you could draft or amend a charter to divest the board of its management obligations. Obviously to some extent you could, or the provision would be meaningless. But notwithstanding the literal language of the statute, could a board recommend a charter change, or could the incorporators adopt from an outset a charter provision that says management has no authority whatsover to manage, and all decisions will be carried out by shareholder vote? I suspect not.
The statute appears to say you could have a charter provision in which you provide (a la the Bebchuk proposal) that all board decisions must be unanimous. Martin Lipton's memo (linked on Bebchuk's site) raises the same question I did - yes, the statute appears to say that literally, but would a court of equity really tolerate the tyranny of the minority, and ensuing deadlock, that could create? Effectively in that situation, the board could not operate qua board, and hence could not fulfill its obligation to manage.
The point is that the directors can never just "get out of the way" and still fulfill their duties. That's not the role the statute or the case law envisions for them.
5. Posted by Gordon Smith on June 16, 2006 @ 11:30 | Permalink
Jeff, Looks like you have a jump on your next article! ;-)
By suggesting that directors should "get out of the way," I wasn't implying that they are never in the way, just that they need to move at some point. That was the thrust of Allen's opinion in Interco: pills are ok for awhile -- the board sometimes needs time to gather its wits and construct a response -- but at some point the shareholders need to decide. In my view, the purpose of Lucian's bylaw is to create that situation, with one year as the specified time during which the board can respond. After that, the shareholders get to decide. Seems like a pretty good balance to me, especially if the shareholders vote for the bylaw.
6. Posted by Jeff Lipshaw on June 16, 2006 @ 11:51 | Permalink
When the choice is watch Tiger blow up at the US Open, or write long comments, my natural verbosity takes over. Tigers-Cubs starts in thirty minutes, and then I'm out of here. (You are my muse; I think responding to one of your posts was responsible for the last article.)
You, of course, provoked me at least to skim the "sacred space" article. I agree they need to move, but not necessarily to get out of the way. I don't think the shareholders ought to have an inherent right to vote on a coercive bid. But as a normative manner I would also be comfortable stripping away the 102(b)(7) protection, and having directors put their money (or their insurance) where their mouths are if they've breached their duties by not getting out of the way. (I may have just ended any chance that I will ever be a GC again.)
I'd agree this is a spot for good empirical work, because my intuition is that bad cases (greedy managers a la WorldCom, Adelphia, Tyco) make bad law, and there is less "inherent entrenchment" and more sincere "other-regarding" (as Lynn Stout would say) interest in maximizing shareholder value than one might think or can model easily using the usual individual wealth maximizing assumptions.
7. Posted by Harry Gerla on June 16, 2006 @ 13:33 | Permalink
Is this an opportunity for the old Clark v. Dodge case to make a comeback? A bylaw can slightly impinge on the Board's power, but may not sterilize the Board? The preceding is stated only half in jest.
8. Posted by Paul Gowder on June 16, 2006 @ 13:43 | Permalink
How did Bebchuk get standing? Did he make a corporation?
9. Posted by Paul Gowder on June 16, 2006 @ 13:45 | Permalink
Oh, never mind, Larry's post explains.
10. Posted by Gordon Smith on June 16, 2006 @ 13:45 | Permalink
Paul, Bebchuk owns 140 shares of CA.
Harry, I always liked Clark v. Dodge. Why not?