02.13.2009

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Updates

Proxy statement preparation and planning for annual meetings of stockholders are in full swing.  Along with proxy season comes the possibility that stockholders may submit proposals or nominations for consideration at the annual meeting.  To be prepared, companies should review their bylaws to ensure they operate as intended to provide the companies with adequate notice of and information about any such stockholder proposals or nominations.  Reviewing bylaws now will allow time to identify any advisable bylaw amendments, and for the board of directors to adopt those amendments, prior to mailing the proxy statement for the annual meeting.[1]  Two Delaware Court of Chancery decisions that issued during 2008 illustrate why review of advance notice bylaw provisions is timely.

In JANA Master Fund, Ltd. v. CNET Networks, Inc. and Levitt Corp. v. Office Depot, Inc., the Delaware Court of Chancery narrowly interpreted advance notice bylaw provisions in favor of stockholder activists.  CNET, C.A. No. 3447-CC, 2008 WL 660556 (Del.Ch. Mar. 13, 2008), published at 954 A.2d 335 (Del. Ch. Mar. 13, 2008), aff’d, 947 A.2d 1120 (Del.Supr. May 13, 2008); Office Depot, C.A. No. 3662-VCN, 2008 WL 1724244 (Del. Ch. Apr. 14, 2008).  In each case, the courts permitted stockholders to nominate directors without complying with advance notice provisions in the companies’ bylaws, contrary to the apparent intent of the companies.  These Court of Chancery decisions highlight the need for public companies to carefully review and, if necessary, clarify and expand the advance notice provisions of their bylaws to eliminate ambiguities and establish procedures stockholders must follow and information they must supply.

Advance Notice Provisions in Bylaws Are Intended to Allow Time for Evaluation

The purpose of advance notice provisions is to help ensure orderly business at annual meetings by requiring any stockholder that intends to propose director nominations or have other business considered at the meeting to give timely prior written notice of the proposal (and related information) to the company.  Delaware courts have upheld advance notice provisions as appropriate to give stockholders an opportunity to evaluate the stockholder proposal and to give the board of directors adequate time to make an informed recommendation, so long as the provision does not unduly restrict stockholder rights.

The CNET Decision

Court of Chancery Finds No Distinction From Rule 14a-8 Requirements.  In CNET, CNET and the investment fund JANA disputed whether JANA properly proposed business at CNET’s annual meeting under CNET's advance notice provision.  The court held that the provision applied only to proposals and nominations a stockholder intended to have included in the company’s proxy materials pursuant to Rule 14a-8 of the Securities Exchange Act of 1934 and not where the stockholder put forth its nominations and proposal in an independently financed proxy solicitation.  The Delaware Supreme Court affirmed the court’s decision in a one-page memorandum disposition.

The Court of Chancery based its determination on three different aspects of CNET’s advance notice provision.

  • First, the court found that the use of the phrase “[a]ny stockholder . . . may seek to transact other corporate business” suggests that the provision only addresses situations in which a stockholder is requesting inclusion of a proposal in management’s proxy materials.  Outside the Rule 14a-8 context, a stockholder “simply makes a proposal,” rather than requests permission or approval to make the proposal within the company’s proxy materials.
  • Second, the court found that the notice deadline of 120 days in advance of the release date of proxy materials for the previous year’s annual meeting, which is the same as the timing required by Rule 14a-8, suggested that the provision was designed to govern stockholder proposals under Rule 14a-8 rather than to require advance notice of any proposal.
  • Finally, the court concluded that the bylaw requirement that the notice “must also comply” with any applicable federal securities laws governing stockholder proposals to be included in the company’s proxy materials mandated the conclusion that the bylaw cannot apply to stockholder nominations and proposals brought outside Rule 14a-8.  The court also found it persuasive that the bylaw contained the same ownership and timing requirements as Rule 14a-8.

The Office Depot Decision

Court of Chancery Finds No Separate Notice of Nomination of Directors Is Required Where Company Gives Notice of Election of Directors.  In Office Depot, Levitt, an Office Depot stockholder, filed its own proxy materials with the SEC, seeking to replace two of Office Depot’s nominees with its own candidates, three days after Office Depot filed its definitive proxy materials.  Levitt did not provide the advance notice set forth in Office Depot’s bylaws, which provided that for an item of business to be considered at an annual meeting, it must be properly brought before the meeting in one of three ways:  (1) through inclusion in the notice of the meeting provided by the board of directors; (2) otherwise at the direction of the board; or (3) by a stockholder of record at the time of giving notice who is entitled to vote at the meeting and who complied with the notice procedures set forth in the bylaws.  Like the CNET bylaws, the Office Depot bylaws required that advance notice be given to the company not less than 120 days before the date proxy materials were released in connection with the previous year’s annual meeting.

Office Depot’s advance notice bylaw provision did not specifically address the nomination of directors but referred only to items of business to be proposed by stockholders.  The court determined nonetheless that the election of directors, including the related act of nominating candidates, was an item of business that was to be accomplished at the annual meeting, thus requiring Levitt to comply with the advance notice provisions of Office Depot’s bylaws.  The court found, however, that Office Depot itself had already provided adequate notice by specifying that, “unrestricted by any limiting qualification,” the business of the meeting would include electing directors.  Vice Chancellor Noble noted that Office Depot, “through careful drafting of the Notice, may have separated precisely the business of the election from the business of nomination.  If the Notice had so provided, a different result may have obtained.”  As in CNET, the court avoided the question of whether the bylaw’s advance notice period was unreasonably long.

Practical Tips

In light of CNET and Office Depot, companies should review the advance notice and meeting notice provisions in their bylaws and consider clarifying them, if necessary, so that they operate as intended.  Although these cases were decided by the Delaware Court of Chancery, courts in other jurisdictions may be influenced by these decisions in interpreting advance notice provisions.  Listed below are recommendations to address these issues and other recent developments affecting advance notice provisions in bylaws.
  • Make clear that the advance notice process is separate from and in addition to the requirements under Rule 14a-8.  The CNET court found that an advance notice bylaw provision requiring that stockholder proponents must also comply with Rule 14a-8 limited the bylaws to proposals that stockholders sought to include in the company’s proxy materials.  In light of this finding, advance notice provisions should clearly state that the process for stockholders proposing to nominate directors or other business at the annual meeting is separate from and in addition to the process for stockholders seeking to include proposals in the company’s proxy materials pursuant to Rule 14a-8.
  • Make clear that the process for director nominations is separate from the process for other business to be brought by stockholders.  The Office Depot advance notice provision did not explicitly apply to director nominations, but only to business to be brought before the annual meeting by stockholders.  The court found that Office Depot’s failure to explicitly include language in its advance notice provision that applied to director nominations obviated the need for Levitt to separately provide notice to Office Depot of its nominations.  Accordingly, advance notice provisions should clearly distinguish between stockholder nominations and other business to be brought before the meeting.  This is typically accomplished by having separate bylaw provisions or subsections, one for director nominations and another for other stockholder-proposed business.  The advance notice provisions should also make clear that notice of stockholder nominations must be provided separately in accordance with the separate bylaw provision, and that the company’s notice that directors will be elected at the meeting will not satisfy the stockholder notice requirement.
  • Clarify that the company’s notice of meeting applies only to the election of the company’s slate.  The Office Depot court suggested that it might have reached a different conclusion if the company’s notice of annual meeting had clearly distinguished the business of the election of directors from the business of nomination.  In the company’s notice of annual meeting, consider clarifying that the item for director elections encompasses only the election of the slate nominated by the company.  For further clarity, companies could note that the notice of meeting does not apply to the nomination of directors.
  • Set the advance notice deadline with reference to the date of the previous year’s annual meeting, rather than the date proxy materials were released for the previous year’s meeting.  The CNET and Office Depot bylaws contained the same timing requirements as Rule 14a-8.  Although it is unsettled whether such additional requirements would be found unduly restrictive under Delaware law, the court in CNET warned that none of the advance notice provisions in bylaws found permissible by Delaware courts contained these “burdensome” requirements and noted that, in the several cases upholding advance notice provisions, the deadline was set by reference to the date of the previous year’s annual meeting.  Accordingly, consider tying the advance notice deadline to the date of the previous year’s meeting.  Companies should also use caution in setting the advance notice period to ensure that its length is reasonable and does not serve to disenfranchise stockholders.
  • Establish a "no earlier than" date for stockholder-proposed nominations and other business.  Companies should consider specifying the first day on which submissions will be accepted, such as 120 days before the date of the prior year’s annual meeting, so that the window for stockholder proposals and nominations is defined and any public controversy that might arise from a stockholder submission is limited to a specific period of time.
  • Coordinate the advance notice provision with the e-proxy deadline and other timing requirements.  When setting the advance notice deadline, companies should allow sufficient time to meet the deadline associated with the SEC’s new e-proxy rules.  Pursuant to Rule 14a-16, if notice and access are used to furnish proxy materials to stockholders, the company must provide stockholders with a notice of electronic availability of proxy materials at least 40 days prior to the annual meeting.  In addition, most bylaws allow for meeting dates to move more than 30 days without triggering a new advance notice deadline.  In light of these factors, companies should establish an advance notice deadline of at least 70 to 75 days before the date of the previous year’s annual meeting.
  • Expand required disclosure of ownership information and stockholder interests.  Stockholder activists are increasingly making use of derivative instruments, such as swaps and hedges, that decouple their economic interest or voting power from stock ownership.  These arrangements, which are not now required to be disclosed under the SEC’s beneficial ownership reporting requirements, make it difficult for companies to ascertain the true interests and motivations of such stockholders when they propose nominations or other business for an annual meeting.  The advance notice provisions in bylaws should require disclosure of all ownership interests, understandings and arrangements, including derivatives, hedged positions and other economic or voting arrangements, of the proposing stockholders and their affiliates.
  • Evaluate the standard for special meetings.  Many companies restrict or eliminate the stockholders’ ability to put matters on the agenda for special meetings of stockholders.  However, if stockholders have the right to do so, the advance notice provisions should be applicable to special meetings in addition to annual meetings.  Also, the special meeting provisions should make clear that the items to be voted on at special meetings called by stockholders are limited to those proposed by the company and the stockholders requesting the meeting.


Additional Information

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