Last week, just before Thanksgiving, the Delaware Supreme Court issued its opinion in Airgas, Inc. v. Air Products and Chemicals, Inc. (Francis Pileggi has a brief summary of the case here and has posted the opinion here). The issue was whether a bylaw proposed by Air Products at the last annual meeting of Airgas stockholders on September 10, 2010 was valid. Chancellor Chandler upheld the bylaw, but the Delaware Supreme Court has reversed that decision.

The case involves a hostile takeover attempt by Air Products. At the 2010 annual meeting, Air Products succeeded in electing three nominees to the Airgas board of directors, which is a classified board. To gain control of Airgas, Air Products needs to elect at least three more directors to the 10-person board, and Air Products would like to make that attempt as soon as possible. Thus, the bylaw in question provides that the next annual meeting of Airgas stockholders would be scheduled for January 2011, only four months after the 2010 annual meeting.

Whether this bylaw is valid depends on the Airgas charter, which provides that any bylaw "inconsistent with" the staggered board provision of the charter must be approved by "the affirmative vote of the holders of at least 67% of the voting power of all the shares of the Corporation entitled to vote generally in the election of Directors, voting together as a single class." Air Products did not obtain that much support for the bylaw proposal, so the issue narrows to a comparison of the bylaw with the staggered board provision. Are they inconsistent? The charter states that directors "shall be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election." Air Products contends that a term of two years and four months from the year of their election is consistent with this charter provision.

According to Chancellor Chandler, in an October 8, 2010 opinion, the language of the charter is ambiguous. The term of office is defined by reference to annual meetings of stockholders, but the charter does not define "annual" or "third year." In the face of this uncertainty, Chancellor Chandler reasoned that the charter should be "viewed in the light most favorable to the stockholder franchise." In this case, that interpretation would allow the proposed bylaw:

[A] January 18, 2011 annual meeting would be the "2011 annual meeting." 2011 is the third "year" after 2008. Successors to the 2008 class can be elected in the "third year following the year of their election" which is 2011. Thus, the bylaw does not violate Airgas’s charter as written.

The Supreme Court agreed with Chancellor Chandler in concluding that the language of the charter is ambiguous, but held that "overwhelming and uncontroverted extrinsic evidence" supported a reading of the charter that would grant the Airgas directors a term of "approximately three years" ... and "twenty-eight months is not approximately three years."

The interesting thing about these two opinions is that both courts framed the issue as a fairly straightforward contract interpretation, but their divergent paths in the face of ambiguity suggest that what they were actually doing is deciding a profound policy question, namely, who controls the corporation? The stockholders (through a bylaw vote) or the incumbent managers (relying a generous interpretation of an anti-takeover provision in the charter)?

We see in Chancellor Chandler's interpretive standard ("rule of construction in favor of franchise rights") an express desire to empower the current stockholders to the full extent allowed by the charter. The Supreme Court's approach, on the other hand, is more subtle -- after all, we would not expect the Court to announce, "in the face of ambiguity, we favor the incumbent managers" -- but the pro-incumbent bias in the Court's interpretation is difficult to miss. The Court admits that it has no precedent directly on point, but rather than embracing a "rule of construction in favor of franchise rights," the Court looks to "extrinsic evidence."

And how is this evidence "pro-incumbent"? The best evidence it finds involving provisions like the one in the Airgas charter comes from proxy statements describing such staggered board provisions. That's right ... proxy statements! Documents drafted by incumbent managers and filed with the SEC.

The Court refers to these disclosures as embodying "widespread corporate practice and understanding," but the fact that directors on staggered boards created under Airgas-like provisions generally serve three-year terms does not mean that the provision requires three-year terms. The issue in the case is whether that term can be truncated to 28 months, and prior to this case, we had no guidance on that issue. None of the other extrinsic evidence -- including references in practitioner commentaries and an easily distinguishable 50-year-old Court of Chancery decision -- directly confronts this issue.

In the final analysis, we see that the Supreme Court was not compelled by precedent or by rules of contract interpretation to decide in favor of the incumbent managers. And, yet, the Court chose that path, rather than embracing the Court of Chancery's pro-stockholder canon of construction. This is consistent with the Supreme Court's longstanding skepticism regarding the desireability of stockholder governance. While I prefer Chancellor Chandler's brand of corporate law as a policy matter, it is worth noting that both courts are simply deciding the case based on a preferred policy in the face of an ambiguous charter provision. I would be more comforted by this thought if the Delaware Supreme Court would give stockholders more space for effective private ordering.

Corporate Governance, Corporate Law, Delaware | Bookmark

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