July 11, 2008
Oral Arguments in CA v. AFSCME
Posted by Lisa Fairfax

I had a chance to listen to the Delaware Supreme Court's oral arguments in CA v. AFSCME.  As you can imagine, there were a lot of interesting questions and conversations circling around the question of whether a shareholder approved by-law provision mandating the reimbursement of proxy expenses for successful shareholder-nominated candidates would violate Delaware law.  Interestingly, some questions focused on whether the provision would require reimbursement of all nominees' expenses regardless of their success so long as one was elected as a director or if the corporation would somehow have to pro-rate the expenses, which could prove difficult.  But many of the justices questions and the ensuing conversations focused on whether and to what extent the by-law provision at issue would constitute a violation of Delaware law by improperly undermining directors' discretion.

I found two strands of conversation particularly interesting; both revolved around the impact of the mandatory nature of the by-law.  First, counsel for CA appeared to be arguing that the fact that the by-law was mandatory and unqualified violated Delaware law because, by requiring the reimbursement of all successful candidates, it improperly took away directors' discretion to determine how to allocate corporate funds.  Indeed, counsel indicated that the by-law would be improper even if the board approved it.  When they were questioned on this issue, counsel for AFSCME insisted that such mandatory payments did not violate Delaware law, but instead were consistent with other forms of payments required to by made by the corporation such as those indemnifying directors and officers.  Related to this issue was a conversation about whether a distinction should be made between provisions in the by-law and those in the charter.

Second, counsel for CA argued that the by-law provision improperly took away directors' discretion to determine whether the payment of expenses in any particular instance would be inconsistent with directors' fiduciary obligation.  This conversation focused on the hypothetical situation of a successful candidate who runs exclusively for personal reasons.  At one point there seemed to be some type of consensus building for the notion that payment of such a candidate's expenses would violate a director's fiduciary obligations, prompting justices to ask why it made sense to approve a by-law provision that could lead to a director violating her fiduciary duty.  However, as the conversation evolved, two counter arguments were raised.  First, counsel for AFSCME contended that since the by-law provision was mandatory, it did not implicate a director's fiduciary duty because it did not involve the exercise of any judgment.  Second, it was suggested that the relevant inquiry for fiduciary duty purposes was not whether a particular payment violated a director's duty, but rather if a directors' rationale for approving the by-law itself comported with her fiduciary responsibilities.  On this question, Justice Berger asked whether or not it would be appropriate for a director to decide that it was in the best interest of the corporation to reimburse proxy expenses because such a reimbursement could facilitate people running for the board.  In addition, there was some discussion regarding the impact of the fact that any expenses paid had to be "reasonable."  That is, could it be argued that a payment that would violate a director's fiduciary duty would not be reasonable?  If so, then the fact that the by-law provision only mandated the payment of "reasonable" expenses may do away with any concerns regarding a director's fiduciary duty in making the payment.

Ultimately, it was a very engaging set of conversations that had me rethinking the issues as the arguments progressed.  In fact, I initially thought that perhaps the issue could be resolved with some re-drafting of the by-law provision.  Thus, some of the initial questions posed hypotheticals about whether a different kind of provision would be more appropriate, such as one that mandated expenses so long as they were consistent with a director's fiduciary duty.  Yet I later got the sense that AFSCME would argue that the exercise of discretion in this area would be problematic both from a practical standpoint (i.e., what is to prevent directors from challenging the payment of every successful candidate) and from a substantive one (i.e., apparently it is the very lack of discretion that supports the claim that the provision is valid). 

As is often the case with oral arguments, after the first line of questions I thought I had a good sense of how the justices were leaning.  However, by the end of the arguments, I could only say that I had a good sense of the issues, rather than how they would ultimately be resolved. And since that is not too far away, I will keep you posted.

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