May 27, 2008
In the past two months, the Delaware courts have decided two cases addressing the scope of advance notice bylaws, in both cases holding that stockholders did not have to comply with the companies’ advance notice provisions in order to nominate directors. Advance notice bylaw provisions require a stockholder who wants to propose nominations or have other business considered at a meeting of stockholders to submit information to the company about the nominations or business by a specified date prior to the meeting. These provisions implicate the complex interaction of state corporate law and federal securities laws, serving the important objective of providing adequate notice of matters that a stockholder intends to present at a meeting so that a company and its other stockholders have a fair opportunity to evaluate all the matters to be voted upon and the company can address those matters in its own proxy statement.
In addition to the recent Delaware court decisions, a number of other significant developments highlight the need for companies to review their advance notice bylaws to assess whether they are appropriately drafted to minimize any potential ambiguity and clearly outline the processes that stockholders must follow and the information they must provide when proposing director nominations or other business.
Recent Case Law Developments Affecting Advance Notice Bylaws
On March 13, 2008, in JANA Master Fund, Ltd. v. CNET Networks, Inc., the Delaware Court of Chancery found that the advance notice provision in the bylaws of CNET Networks, Inc. applied only to matters that stockholders seek to include in company proxy statements pursuant to the Securities and Exchange Commission’s Rule 14a-8 stockholder proposal process. The bylaw at issue contained the same timing and stock ownership requirements as Rule 14a-8, and stated that proposals had to comply with the federal securities laws establishing the requirements for proposals required to be included in the company’s proxy statement, but the bylaw was not expressly limited to proposals submitted pursuant to Rule 14a-8. Instead of addressing whether the ownership, timing and other conditions set forth in the bylaw were enforceable, the court held that the bylaw did not apply to nominations or other business that stockholders might seek to put forth in their own proxy materials. As a result, the Court further held that the plaintiff stockholder did not need to comply with the requirements of the advance notice bylaw in order to nominate directors or propose other business at CNET’s annual meeting. On May 13, 2008, in a one-page memorandum decision, the Delaware Supreme Court affirmed the Court of Chancery’s decision.
In April 2008, in Levitt Corp. v. Office Depot, Inc., the Delaware Court of Chancery ruled that a stockholder of Office Depot, Inc. who failed to comply with the company’s advance notice bylaw nevertheless could nominate a short slate of two directors at the annual meeting. Office Depot’s bylaws contained a provision stating that to be properly brought before an annual meeting, business must be specified in the company’s notice of meeting, otherwise properly brought before the meeting by or at the direction of the Board, or properly brought before the meeting by a stockholder who complied with the advance notice provisions in the bylaws. The bylaw did not otherwise expressly address director nominations. The Court first rejected the argument that the advance notice bylaw did not apply to director nominations because the bylaw referred only to “business” and concluded that the term “business” was sufficiently broad to encompass director nominations. In reaching this conclusion, the Court relied in part on the language of Section 211(b) of the Delaware General Corporation Law, which states that “an annual meeting of stockholders shall be held for the election of directors” and that “[a]ny other proper business may be transacted at the annual meeting.” However, the Court then ruled that the plaintiff stockholder did not need to comply with the advance notice bylaw because the company’s notice of meeting included with its proxy statement indicated that director elections would be an item of business at the annual meeting.
Other Recent Developments Affecting Advance Notice Bylaws
The CNET and Office Depot decisions are but two recent developments affecting advance notice bylaw provisions. Other recent developments include:
- The growing frequency of hedges, short positions and other arrangements that affect a stockholder’s voting power or economic interest in a company’s shares. Increasingly, activist stockholders, particularly hedge funds, are using economic vehicles such as cash-settled equity swaps, hedges and short positions to: (a) take large economic stakes in companies without formal voting power in order to avoid being subject to SEC beneficial ownership reporting requirements, which are based on voting and investment power; or (b) gain voting power that is disproportionately large relative to the true economic risk associated with their ownership in a company’s stock. These actions make it difficult for a company and its stockholders to ascertain the nature and extent of a stockholder’s interest in the company when the stockholder seeks to nominate directors or propose other business. In order to provide greater transparency about stockholder interests, some companies are beginning to address disclosure of hedges, short positions and other arrangements in their advance notice bylaws.
- The interaction of notice provisions with earlier proxy distribution timeframes under the SEC’s new “e-proxy” rules. The SEC’s new e-proxy rules provide an alternative, optional method for furnishing proxy materials to stockholders based on a “notice and access” model. Under SEC Rule 14a-16, a company can post its proxy materials on an internet website (other than EDGAR) and provide stockholders with a plain-English notice of electronic availability of proxy materials at least 40 days in advance of the annual meeting informing them that the proxy materials are available and explaining how to access the materials. Particularly in light of the fact that the exact date of the annual meeting can vary by a few days or weeks from year to year, companies electing to use e-proxy should set their advance notice deadlines in a manner that allows the company to receive any nominations or other business submitted under an advance notice bylaw well in advance of the 40-day deadline for distributing the notice of electronic availability of proxy materials. If a company wishes to solicit proxies with respect to properly noticed nominations or other business submitted under an advance notice bylaw, the company must include the nominations or business in its proxy statement. Accordingly, the advance notice deadline should allow the company sufficient time in advance of the 40-day deadline to prepare disclosure relating to the nominations or business.
In considering the appropriate time frames for inclusion in an advance notice bylaw, companies should bear in mind that Delaware courts generally have upheld the validity of advance notice bylaws, except in egregious circumstances (for example, in situations where a company provides notice of a meeting after the advance notice deadline has already passed). Typically, time frames range from 45 to 120 days. A different deadline, tied to the public announcement of the meeting, generally applies when a company moves its annual meeting date more than a certain number of days (typically, more than 30 days) from the anniversary of the prior year’s meeting. In CNET, the Delaware Court of Chancery concluded that the fact that CNET’s advance notice bylaw provision tied the deadlines to the mailing date of the company’s prior-year proxy statement suggested that the bylaw was designed to govern stockholder proposals under Rule 14a-8 rather than to operate as an advance notice bylaw. In light of this, it may be preferable for advance notice bylaws to require notice to the company by a specified deadline before the anniversary date of the prior year’s annual meeting.
- The interaction of advance notice provisions with special meeting and majority vote provisions. In the past few years, some companies have amended their bylaws to allow a specified percentage of stockholders (typically 20% or 25%) to call special meetings. If a company allows stockholders to call special meetings, the company’s special meeting provisions should be clear that only the company and the stockholders requesting the meeting may propose business at the meeting.
In addition, many companies over the past several years have adopted bylaw provisions that provide for majority voting in uncontested elections of directors, while plurality voting continues to apply in contested elections. Majority voting bylaw provisions typically have a cut-off date for determining whether an election is contested or not. Cut-off dates vary, with many companies using the record date or a specified number of days before the filing or printing of the proxy statement. A company’s advance notice bylaw should include deadlines that precede, or fall on the same date as, the deadline for determining whether an election will be contested or uncontested. That way, the company will have notice of any nominations that stockholders timely submitted through the advance notice process before the company must determine whether or not an election will be contested.
What Companies Should Do Now
Both the CNET and Office Depot cases illustrate that Delaware courts will construe ambiguous advance notice bylaws in a manner favoring stockholders’ ability to make nominations and introduce matters at an annual meeting. Accordingly, companies should review their bylaws in light of the considerations outlined below. Specifically, companies should:
- Assess whether their advance notice bylaws make clear that the advance notice bylaw process is separate from the SEC’s Rule 14a-8 stockholder proposal process. It is unsettled whether, or to what extent, the eligibility requirements that apply under Rule 14a-8 for determining when a stockholder can require a company to include a proposal and supporting statement in its proxy statement could be applied to other proposals under an advance notice bylaw provision or whether such a bylaw provision can impose additional requirements on proposals submitted under Rule 14a-8. In light of this uncertainty and the result in CNET, an advance notice bylaw should explicitly state that a stockholder seeking to nominate directors or propose business at a meeting must comply with the company’s advance notice bylaw, while a stockholder seeking to include business in a proxy statement prepared by the company must comply with Rule 14a-8.
- Assess whether their advance notice bylaws explicitly address both director nominations and other business. In light of the result in Office Depot, companies should make sure that their advance notice bylaws expressly apply to both director nominations and other business. Because the information that stockholders must provide about director nominations under advance notice bylaws typically differs from that required about other business, many advance notice bylaws address director nominations and other business in separate provisions that outline the information and time frames applicable to each. The provisions should clearly state exactly what information is required to be contained in a stockholder’s notice.
- Consider whether it is appropriate to address the decoupling of economic risk or voting power from share ownership. Companies should consider including provisions directed at disclosure of hedging, short positions and other similar arrangements in their advance notice bylaws so that stockholders must provide information about these arrangements in making a nomination or proposing other business through the advance notice process.
- Review advance notice deadlines to assess how they interact with other bylaw provisions, including special meeting provisions and majority voting provisions. Companies should take a holistic approach in reviewing the various deadlines included in their bylaws and assess whether these deadlines work together and are consistent. In light of the 40-day notice requirements for e-proxy and the common allowance for meeting dates to move by up to 30 days, we expect that companies will move toward a minimum advance notice deadline that is set 70 or 75 days before the anniversary of the prior year’s meeting date.
- Consider adopting an advance notice bylaw that applies in the context of special meetings. Although some companies’ advance notice bylaws apply to special as well as annual meetings, many advance notice bylaws cover only annual meetings. Given the current environment of greater stockholder activism, and the increase in the number of companies giving stockholders the right to call special meetings, companies should consider whether their bylaws are clear that the items to voted on at special meetings that are called by stockholders are limited to the business and/or nominations specified by the stockholder who requested the company to call the special meeting and to matters proposed by the company.
- Review proxy disclosures about the mechanisms available for stockholders to propose director candidates and other business. SEC rules require that companies disclose in their annual proxy statements the deadlines for submitting stockholder proposals under Rule 14a-8 and any deadlines for providing notice of director nominations and other business under advance notice bylaws. Companies should review their disclosures about these deadlines and consider in particular whether the disclosures clearly distinguish between the advance notice process that applies to proposals submitted under Rule 14a-8 and the requirements that apply to any nominations and any other business that a stockholder wishes to present directly at an annual meeting. To the extent that a company has adopted procedures that allow stockholders to submit director candidates for consideration by the company’s nominating/governance committee, companies should take care to see that their proxy disclosures clearly distinguish between these processes – which permit stockholders to “recommend” candidates – and the advance notice procedures, which apply when stockholders nominate candidates directly.
 C.A. No. 3447-CC, 2008 WL 660556 (Del. Ch. Mar. 13, 2008).
 JANA Master Fund, Ltd. v. CNET Networks, Inc C.A. No. 3447 (Del. May 13, 2008).
 C.A. No. 3622-VCN, 2008 WL 1724244 (Del. Ch. Apr. 14, 2008).
 According to sharkrepellent.net, as of April 30, 2008, approximately 60% of S&P 500 companies and approximately 47% of S&P 1500 companies used deadlines of at least 90 days.
Gibson, Dunn & Crutcher’s Securities Regulation and Corporate Governance Practice Group and its Mergers and Acquisitions Practice Group are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or any of the following:
John F. Olson (202-955-8522, [email protected]),
Brian J. Lane (202-887-3646, [email protected]),
Ronald O. Mueller (202-955-8671, [email protected]),
Amy L. Goodman (202-955-8653, [email protected]),
Dennis J. Friedman (212-351-3900, [email protected]),
Jonathan K. Layne (310-552-8641, [email protected]),
David M. Hernand (310-552-8559, [email protected]),
Eduardo Gallardo (212-351-3847, [email protected]) or
Gillian McPhee (202-955-8230, [email protected]).
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