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Ten Bylaw Amendments That May Lessen Your Company’s Vulnerability to a Shareholder Activist and Prevent It from Being a Sitting Duck This Proxy Season

Wall Street Lawyer (Volume 12, Issue 12)

Given the effect of the current credit crisis on the market valuations of numerous public companies, there will likely be no shortage of attractive targets for activist shareholders when the 2009 proxy season gets underway. Even though there has been extensive coverage in the business media of the numerous companies that have been targeted by activist shareholders, many companies will find themselves blindsided and unprepared. In a number of these cases, had these companies been more proactive, they would have discovered that they had available to them a variety of easy tools to make themselves less vulnerable.

One of the easiest ways to make a company less vulnerable to an activist shareholder is by thoroughly reviewing, with the advice and assistance of counsel, the company’s bylaws. In many cases, a public company’s bylaws may have evolved from when the company was privately, owned and provisions that made sense then may no longer be appropriate for a public company concerned with being targeted by an activist shareholder.  While many companies have their bylaws “upgraded” prior to their initial public offering (IPO) and periodically thereafter, that may not always be the case.  In addition, shareholder activism may not have been as significant a concern when the company’s bylaws were last “upgraded” which, for some companies, may have been at the time of their IPO.  

In this article, we will discuss ten amendments that a company can consider making to its bylaws that could potentially lessen its vulnerability to an activist shareholder.  While our focus here is on the bylaws, we do not mean to understate the importance of a thorough review of the certificate of incorporation as well. While both the board and shareholders can propose amendments to the bylaws, only the board can propose amendments to the certificate of incorporation.  Either way, all amendments to the certificate of incorporation require shareholder approval. Accordingly, provisions intended to shield the company from activist shareholders have a greater protective value when placed in the certificate of incorporation. Since we are focusing here on defensive actions than can be undertaken by the board unilaterally without shareholder approval, we discuss herein only bylaw amendments that do not require shareholder approval. While we believe that a staggered board significantly enhances a company’s position when faced with a proxy contest seeking board representation, since an amendment to the bylaws to implement a staggered board requires shareholder approval, we have not included it in our “top ten” list. The bylaw amendments that we will discuss in this article are intended to accomplish the following:

  1. Require shareholders to provide advance notice of nominations and other proposals;
  2. Require the proposing shareholder to be a record holder of the company’s shares;
  3. Eliminate any requirement for the annual meeting to be held on a fixed date; 
  4. Prescribe qualifications for all nominees for election as directors;
  5. Provide directors with the exclusive right to fill vacancies on the company’s board of directors;
  6. Restrict who can call a special meeting of shareholders;
  7. Limit actions that can be considered at a special meeting of shareholders;
  8. Provide a procedure for setting the record date for actions by written consent;
  9. Define “cause” necessary to trigger shareholders’ right to remove directors for cause; and
  10. Permit the chairman of any meeting of shareholders to adjourn the meeting whether or not a quorum exists.

1.      Require Shareholders to Provide Advance Notice of Nominations and Other Proposals

Avoiding surprises should be a significant priority for any company concerned that it may become the target of an activist shareholder. In general, unless the company’s bylaws provide otherwise, shareholders have the right to make proposals, including nominations for directors, for consideration by their fellow shareholders. These proposals can generally be made as late as the day of the annual meeting—in fact, even during the annual meeting. This means that if a shareholder had voting control over a sufficient number of shares, the shareholder could literally walk into the annual meeting, make its proposal, which could include a nomination of an opposing slate of directors, and vote enough shares to ensure that its slate of nominees is elected and its other proposals are approved.

The inclusion in the company’s bylaws of advance notice provisions prevents management from being caught off guard by the surreptitious planning of an activist shareholder. There is generally no requirement for such bylaw provisions to be submitted for shareholder approval (board approval alone is sufficient). Typically, advance notice provisions spell out who can submit an advance notice, the deadlines that must be met for the submission of the advance notice and what constitutes a proper form of notice. When we speak here of advance notice by a shareholder, we are referring only to proposals made outside of Rule 14a-8 of the Securities Exchange Act of 1934 (Exchange Act) that are not intended for inclusion in the company’s annual meeting proxy materials. Rather, advance notice bylaws are only applicable where the proponent shareholder intends to prepare its own proxy materials and use such materials to solicit proxies to have its nominees elected and its other proposals approved at the company’s annual meeting.

A typical advance notice bylaw provision states that a shareholder can only make a proposal, including nominations of persons for election to the company’s board of directors, if the shareholder provides timely and proper written notice to the corporate secretary of the company.

There are varying formulations of what constitutes a “timely notice” of a shareholder’s intent to submit a nomination for election to the board of directors or other proposals. In many cases, the deadline for the receipt of an advance notice is fixed by reference to the first anniversary of the immediately preceding year’s annual meeting. For instance, the advance notice bylaw may provide that window period for the receipt of advance notices is no earlier than 120 calendar days, and no later than 90 calendar days, prior to the first anniversary of the preceding year’s annual meeting. That window period assumes that the annual meeting is held around the same time as the preceding year’s annual meeting. In the event that the date of the annual meeting is moved to a date that is more than 30 calendar days earlier, or 60 calendar days later than the first anniversary date, the deadline would then shift and may be fixed as to some period following the date of the company’s first public announcement of the annual meeting’s new date.

It is not just sufficient that the notice of proposals and nominations be timely. The notice also needs to be “proper.” A typical proper notice would contain information about the business proposed, the nominees proposed and the proposing shareholder.

With respect to proposals other than the nomination of candidates for election to the board, the advance notice bylaws should require: (i) description of the business desired to be brought before the meeting, including the text of the proposal or business and the text of any resolutions proposed for consideration; (ii) in the event that the proposed business includes a proposal to amend the company’s bylaws, the complete text of the proposed amendment; (iii) the reasons for the business that is proposed to be brought before the annual meeting; and (iv) any material interest of the proposing shareholder in such business, including any anticipated benefit to the shareholder from the approval of such business.

As to each person whom the shareholder proposes to nominate for election or re-election as a director, the advance notice bylaws should require: (i) the name, age, business address and residence address of the director nominee; (ii) the principal occupation or employment of the director nominee; (iii) the class or series and number of shares of capital stock of the company which are owned beneficially or of record by the director nominee; (iv) such person’s executed written consent to being named in the proxy statement as a nominee and to serving as a director if elected; and (v) all other information relating to such person that would be required to be disclosed in a proxy statement or other filing with the SEC required to be made in connection with the solicitation of proxies for the election of directors in a contested election pursuant to the SEC’s proxy rules. 

As to the shareholder giving the notice, the advance notice bylaw should require: (i) the shareholder’s name and address, as they appear on the company’s books; (ii) the class and number of shares of the company which are beneficially owned by such shareholder and also which are owned of record by such shareholder; (iii) any derivative, short, hedged or other economic interest in the shares of the company held by such shareholder (which information should be required to be supplemented by such shareholder not later than ten (10) calendar days after the record date for the meeting to disclose such ownership as of the record date); (iv) whether and to what extent any agreement, arrangement, or understanding has been made, the effect or intent of which is to increase or decrease the voting power of such shareholder with respect to any shares of the capital stock of the company, without regard to whether such transaction is required to be reported or disclosed to the SEC; (v) a representation as to whether the shareholder intends to solicit proxies; (vi) a representation as to whether such shareholder intends to appear in person or by proxy at the annual meeting to bring the proposal before the meeting; (vii) a description of all arrangements or understandings between such shareholder and any other person or persons (including their names) pursuant to which the nomination(s) and other proposals are to be made by such shareholder; and (viii) such other information regarding the shareholder in his or her capacity as a proponent of a shareholder proposal that would be required to be disclosed in a proxy statement or other filing with the SEC required to be made in connection with the contested solicitation of proxies pursuant to the SEC’s proxy rules.

This past spring, the Delaware courts issued a number of significant decisions interpreting advance notice bylaw provisions that were in dispute. These cases provide us with a number of useful lessons with respect to the drafting of the advance notice bylaw provisions, including the following: (i) companies should include in their bylaws separate advance notice provisions with respect to shareholder nominations and other proposals of business (e.g., bylaw amendments); (ii) companies should explicitly include in their bylaws a statement that makes clear that a shareholder intending to nominate candidates for election as directors must separately comply with the advance notice bylaw provisions specifically applicable to the nomination of candidates for election as directors, for such nomination to be properly brought before the meeting; and (iii) companies should also make it abundantly clear that their advance notice provisions apply to all shareholder proposals regardless of whether the shareholder is seeking to have the proposal included in the company’s proxy statement pursuant to Rule 14a-8 or whether the shareholder intends to prepare and mail his own proxy statement.

2.      Require the Proposing Shareholder to Be a Record Holder of the Company’s Shares

Most shareholders, even institutional shareholders, often hold their shares in “street name” and their shares are often not held of record. That means that their shares are registered in the name of a nominee such as Cede & Co. By requiring in the bylaws that only holders of record of the company’s common stock may submit nominations and make other proposals, the activist shareholder would generally have to first transfer some of its shares into record ownership or would have to submit its nominations and other proposals through Cede & Co. Either of these options, while not insurmountable, particularly costly or unduly burdensome, require the activist shareholder to begin its planning earlier, perhaps much earlier, than it would might otherwise prefer. Depending on how efficient and responsive the company’s transfer agent is, the process of obtaining record ownership of the company’s shares could take weeks to complete. While the receipt of a request from an activist shareholder seeking record ownership of 100 shares may not give rise to a definitive conclusion that the activist shareholder is planning on delivering an advance notice of nomination or other shareholder proposal, it should certainly alert the company that it may soon be the target of a proxy contest or other contested solicitation.

3.      Eliminate Any Requirement for the Annual Meeting to Be Held on a Fixed Date

Notwithstanding that Delaware law does not require a company’s bylaws to contain a fixed, predetermined date for when the annual meeting will be held, some bylaws provide for such a fixed, predetermined date. For example, the bylaws may provide that the annual meeting shall be held at the principal place of business of the company at 10:00 am on the last Friday in March of each year. Such a provision unnecessarily limits a company’s flexibility to schedule its annual meeting. Pursuant to Section 211 of the Delaware General Corporation Law (DGCL), if the annual or other regular meeting is not called and held within 30 days after the designated time, the Delaware Court of Chancery may summarily order a meeting to be held upon the application of any shareholder or director. With the date of the annual meeting fixed by the bylaws, the company could find itself a target of a proxy contest or other activist campaign and may be deprived of much needed flexibility in scheduling its annual meeting. If the company attempts to delay the annual meeting, the company may be forced to defend a suit by an activist shareholder seeking to compel the company to hold the annual meeting in accordance with the timing dictated by its bylaws. While eliminating the “fixed date” annual meeting bylaw provides the company with increased flexibility in scheduling its annual meeting and prevents the company from being compelled by the Delaware Court of Chancery to hold an annual meeting on a predetermined fixed date, this additional flexibility is not without its limits. Section 211 of the DGCL provides that if a company fails to hold its annual meeting (or, in lieu thereof, take action by written consent) to elect directors for a period of 13 months after its last annual meeting (or the last action by written consent to elect directors in lieu of an annual meeting), the Delaware Court of Chancery may summarily order a meeting to be held upon the application of any shareholder or director.

4.      Prescribe Qualifications for Nominees for Election as Directors

Section 141(b) of the DGCL provides that the bylaws of a Delaware corporation may prescribe qualifications for directors. Other than indicating that the bylaws or certificate of incorporation may require directors to be shareholders, the DGCL does not provide any guidance on what other qualifications may be prescribed for directors. Notwithstanding that the DGCL expressly permits a company to include qualifications for its directors in its bylaws, few companies prescribe much more than that directors be of adult age. Director qualification bylaws are another opportunity for companies to elicit relevant information about an activist shareholder’s nominee and the activist shareholder that is supporting the election of the nominee. They may also have the effect of discouraging persons who would not want to either compile or divulge such detailed information from participating as a nominee in a contested solicitation. Some companies have adopted director qualifications requiring the completion of a detailed written questionnaire with respect to the background and qualifications of each nominee substantially similar in form to the questionnaire required to be completed on an annual basis by all directors and officers. Others are requiring each nominee to enter into an agreement with the company to confirm, among other things, that such nominee is not a party to any agreement or understanding that will interfere with his fiduciary duties to the company if elected as a director. This should include confirming the absence of any agreement, understanding or commitment with respect to which how such nominee would, if elected, act or vote on any issue or question which voting commitment could limit or interfere with such person’s ability to comply, if elected, with such person’s fiduciary duties under applicable law. Other director qualification provisions state that such nominee would, if elected, be in compliance with and would comply with all applicable publicly disclosed corporate governance, conflicts of interest, confidentiality, stock ownership and trading policies, and guidelines of the company.

5.      Provide That Directors Have the Exclusive Right to Fill Vacancies on the Company’s Board of Directors

If all members of the company’s board of directors are elected annually, then shareholders have the right to remove any and all of them with and without cause. If the company permits shareholders to call special meetings and does not specifically deny them the right to take corporate actions by written consent, then the company is vulnerable to having its directors removed in a multitude of ways. If the company’s bylaws provide that any vacancies created on the company’s board of directors due to the removal of its members by shareholders may be filled by the shareholders, then an activist shareholder can potentially, with one corporate action, remove and replace the entire board of directors. In addition, if the size of the company’s board of directors is fixed in the bylaws, as opposed to the certificate of incorporation, an activist shareholder, again with a singular corporate action, can increase the size of the company’s board of directors such that the majority of the seats are newly created and vacant and then have its nominees elected to the board to fill such newly created directorships. While some of the aforementioned vulnerabilities are optimally dealt with by either (i) implementing a staggered board of directors since the members of a staggered board can only be removed for “cause,” and/or (ii) fixing the size of the board of directors in the certificate of incorporation, both of these “solutions” would require shareholder approval. If our universe of “solutions” is limited to a bylaw amendment that does not require shareholder approval, then a bylaw amendment that provides the board with the exclusive power and authority, pursuant to Section 223 of the DGCL,1 to fill vacancies on the board may remove some of the incentive for an activist shareholder to seek either the removal of board members or an increase in the size of the board. Such a bylaw amendment would provide that in the interim between meetings of shareholders called for the election of directors, vacancies in the board, however arising, would be filled exclusively by the vote of the remaining directors then in office. This bylaw amendment would also provide that the company board’s appointees would serve for the remainder of the removed directors’ full terms.

6.      Restrict Who Can Call a Special Meeting of Shareholders

Pursuant to Section 211(d) of the DGCL, special meetings of shareholders may be called by the board of directors or by such other persons as are authorized by the company’s certificate of incorporation or bylaws.2 Accordingly, the default provision under Delaware law is that only the board of directors has the right to call a special meeting of shareholders, unless either the certificate of incorporation or bylaws provides otherwise. Contrast that with actions by written consent which shareholders have a right to unless such right is specifically denied them in the certificate of incorporation. There are a variety of reasons why an activist shareholder would want to call a special meeting. These could include the replacement of one or more members of the board and/or seeking shareholder approval for a bylaw amendment. Where all members of a company’s board of directors are elected annually and, accordingly, can be removed with or without “cause,” and where the bylaws can be amended with a simple majority vote by the shareholders, the right of a shareholder to call a special meeting can be a useful tool in the hands of an activist shareholder.

If the company’s certificate of incorporation does not contain any provisions relating to the calling of a special meeting, and the right of shareholders to cause a special meeting to be called is only contained in the bylaws, the company’s board of directors can act, without shareholder approval, to amend the bylaws to specifically deny shareholders the right to call a special meeting. Alternatively, the company could continue to permit shareholders to call a special meeting, but raise the ownership threshold that must be demonstrated by the shareholder petitioning to call a special meeting. In addition, any bylaw permitting shareholders to request the calling of a special meeting should require the shareholder to demonstrate record ownership and maintain record ownership through the date of the special meeting that he petitions for. 

7.      Limit Actions That Can Be Considered at a Special Meeting  of Shareholders

In addition to amending the bylaws to limit who can call for special meetings, companies may want to consider an amendment to the bylaws to limit certain actions at a special meeting. Such an amendment to the bylaws would provide that a special meeting would not be required to be held at the request of shareholders: (i) with respect to any matter, within 12 months after any annual or special meeting of shareholders at which the same matter was included on the agenda, or if the same matter will be included on the agenda at an annual meeting to be held within 90 days after the receipt by the company of such request (the election or removal of directors would be deemed the same matter with respect to all matters involving the election or removal of directors), or (ii) if the purpose of the special meeting is not a lawful purpose or if such request violated applicable law. 

These limitations would be intended to prevent shareholders from taking action earlier than the one-year anniversary of a shareholders’ meeting which addressed the same item and would seek to protect the resources of the company from the substantial administrative and financial burdens, and disruptive effects, that serial shareholder meetings on the same matter would impose on a company.

8.      Provide a Procedure for Setting the Record Date for Actions by Written Consent

Under Section 228 of the DGCL, shareholders have the right—except as otherwise provided in the certificate of incorporation—to take any action which may be taken at any annual or special meeting, without a meeting, without prior notice and without a vote, if the shareholders grant consent. The consents must be in writing, set forth the action to be taken, and be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted.3 Accordingly, if the certificate of incorporation is silent with respect to actions by written consent, then the company’s shareholders have the right to take such action. 

In addition to Section 228, the other relevant provision of the DGCL that relates directly to the ability of shareholders to take action by written consent is Section 213. This section provides for how a record date is set for determining which shareholders are entitled to cast their votes in a consent solicitation with respect to a particular corporate action.4 Section 213(b) of the DGCL provides that the record date for determining the shareholders entitled to consent to corporate action in writing without a meeting (when no prior action by the company’s board of directors is required and no record date has been fixed by the board of directors) is the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the company.5

Where a company’s shareholders are permitted to act by written consent and where all members of a company’s board of directors are elected annually, an activist shareholder can initiate a consent solicitation to replace any and all members of the company’s board without cause and can effectively assume control of the company without paying the control premium that would typically be expected to be paid to the company’s shareholders if he were acquiring a controlling interest in the company. Theoretically, the activist shareholder can commence a consent solicitation and gain control even if he holds only one share of the company.

While a company’s vulnerability to a consent solicitation can only be eliminated by an amendment to the certificate of incorporation to eliminate the right of shareholders to act by written consent, a procedural bylaw can be adopted that delays the record date for a consent solicitation and, accordingly, provides the company with additional time to determine how to respond. As noted above, when no prior action is required by the board, the record date is the first date on which a signed consent is delivered to the company.6 The suggested bylaw amendment would require the board to adopt a resolution fixing a record date within ten days of the date on which a request therefore is received and providing that such record date shall not be more than ten days after the date of the adoption of such resolution. Since the activist shareholder would not be able to mail its consent solicitation statement until after the record date has passed, he may have to wait as long as 20 days following the date the company first receives his request to set the record date.

9.      Define “Cause” Necessary to Trigger Shareholders’ Right to Remove Directors for Cause

If all members of a company’s board of directors are elected annually, then, under Section 141(k) of the DGCL, they can each be removed with or without cause by the shareholders.7 However, if the board of directors is classified, with only one-third of its members standing for election each year, then, unless the company’s certificate of incorporation provides otherwise, directors can be removed by shareholders only for cause.8 Since the DGCL does not provide a definition of “cause” applicable to the removal of directors, a number of companies have adopted bylaw amendments to provide such a definition. While the definitions of cause vary, some resemble very closely the definition of “cause” that you may see in an employment agreement for a chief executive officer or other senior officer of a public company. In these cases, cause is defined such that it is a very high threshold to meet or surpass and is tied to either discrete triggering events or objective criteria. Because the definition of “cause” would be used by a shareholder activist to seek the removal of directors, the company’s objective would be to leave little room for a shareholder activist to argue, and possibly litigate, as to whether cause exists. Among the triggering events that could be included in a definition of “cause” are: (i) the director’s conviction (treating a nolo contendere plea as a conviction) of a serious felony involving (a) moral turpitude or (b) a violation of federal or state securities laws, but specifically excluding any conviction based entirely on vicarious liability; (ii) the director’s commission of any material act of dishonesty (such as embezzlement) resulting or intended to result in material personal gain or enrichment of such director at the expense of the company or any of its subsidiaries and which act, if made the subject of criminal charges, would be reasonably likely to be charged as a felony; or (iii) the director being adjudged legally incompetent by a court of competent jurisdiction.

10.  Permit the Chairman of Any Meeting of Shareholders to Adjourn the Meeting Whether or Not a Quorum Exists

There are scenarios where it would be beneficial for the company to be able to adjourn the meeting to solicit additional votes from shareholders. In such a case, the company may want the chairman of the shareholders’ meeting to have the ability to adjourn the meeting whether or not there is a quorum. For a number of companies, the bylaws may only permit a shareholders’ meeting to be adjourned if less than a quorum is present and then only by the majority of the shareholders present and entitled to vote at the meeting. To provide the company with the maximum flexibility to adjourn the meeting, the bylaws would be amended to provide that either the chairman of the meeting or the holders of a majority of the shares present and entitled to vote may adjourn the meeting whether or not a quorum is present.

Conclusion

We have suggested for consideration a number of significant changes to a company’s bylaws that we believe can bolster its defensive position when faced with a proxy contest or other contested solicitation. This is by no means an exhaustive list of such bylaw amendments, just our view of the “top ten” to consider. Many companies would be hesitant to adopt all ten of these at once and in some cases it will be necessary to ascertain how some of these bylaw amendments would be viewed by institutional shareholders and the major proxy voting advisory firms such as RiskMetrics Group and Glass Lewis. In addition, it may not be necessary for a company to adopt all of the bylaw amendments suggested here and the relative importance of some of them may depend on what is contained in a company’s certificate of incorporation. If a company’s certificate of incorporation provides for a staggered board of directors, fixes the size of the board, denies shareholders the right to call special meetings, and does not permit corporate actions by written consent, a number of the suggested bylaw amendments may not be as necessary as they otherwise would be. Irrespective of the provisions contained in the certificate of incorporation, and even if you decide not to implement any of the bylaw amendments included in our “top ten” list, the recent Delaware cases narrowly construing advance notice bylaw provisions are a reminder to all public companies that, on a regular basis, they should have their bylaws reviewed by counsel and upgraded as necessary to ensure that they continue to have the benefit of the protective provisions included therein.

The views expressed in this article are the authors’ and do not necessarily represent the views of the partners of Blank Rome LLP or the firm as a whole. This article is intended to provide a general introductory overview of the issues discussed and is not intended to provide a complete analysis of such issues. This article is not intended to provide legal advice or to establish an attorney-client relationship and readers should not act upon the information contained in it without professional counsel. This article may be considered attorney advertising in some jurisdictions. The hiring of an attorney is an important decision that should not be based solely upon advertisements.

Notes

  1. Delaware General Corporation Law (DGCL); 8 Del C. § 223.
  2. DGCL; 8 Del C. § 211(d).
  3. DGCL; 8 Del C. § 228(a).
  4. DGCL; 8 Del C. § 213.
  5. DGCL; 8 Del C. § 213(b).
  6. DGCL; 8 Del C. § 213(b).
  7. DGCL; 8 Del C. § 141(k).
  8. DGCL; 8 Del C. § 141(k).

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Reprinted from the Wall Street Lawyer, December 2008, Volume 12, Issue 12. Copyright © 2008 Thomson Reuters/West. For more information about this publication please visit http://www.west.thomson.com/.