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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