December 13, 2005
Bally Total Fitness & Shareholder Control
Posted by Gordon Smith


Bally Total Fitness is in trouble. Its two largest stockholders -- Pardus Capital Management L.P. and Liberation Investment Group  LLC -- are seeking big changes, and things have gotten nasty.

The dissidents have launched a proxy contest for the election of three directors to Bally's board, and they are seeking stockholder approval for several provocative corporate governance proposals.

One set of proposals calls for amendments to Bally's bylaws that would authorize the company's stockholders to remove the Chief Executive Officer and President by majority vote and prevent the board of directors from subsequently reappointing the officer. Another proposal would remove Paul Toback, the company's current CEO and President. Still another proposal prohibits amendments to specified sections of Bally's bylaws by the board of directors. The specified sections are those adopted by Bally's stockholders.

Can they do all of that? Last week, Chancellor Chandler of the Delaware Court of Chancery declined to decide the Delaware corporate law issues, stating that those issues can be addressed if the stockholder proposals are adopted at the annual meeting of stockholders on January 26. Whether this will happen is still unclear. The bylaw amendments require an affirmative vote of not less than 75% of the votes entitled to be cast by the holders of all outstanding shares of Bally stock that is entitled to vote. That's a pretty steep hurdle.

I would be surprised if the Delaware courts sanctioned the removal of senior officers by stockholders. That is a quintessential board function, and I suspect that a bylaw purporting to share that authority with stockholders would be invalid.

I also would be surprised if the Delaware courts allowed shareholder bylaws that prohibit amendments by the board of directors. The Model Business Corporation Act expressly provides for such bylaws, but the Delaware code does not. My friend Larry Hamermesh has written about such bylaws and argued that the Delaware courts would not approve:

If the board of directors derives unqualified authority to amend the by-laws from the certificate of incorporation, as it almost invariably does, and the by-laws may not contradict the superior provisions of the certificate of incorporation, a by-law purporting to limit authority conferred upon the directors by charter provision should be suspect, to say the least.

That seems right to me, though I would limit subsequent amendments though fiduciary duty or by some inherent limitation on board action. (See here for my argument with Bob Thompson based on our notion of "sacred space.")

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