Advance Notice Bylaw Precludes Hostile Bidder’s Slate of Director Nominees

The Delaware Court of Chancery recently enforced an advance notice bylaw to bar nominations made by a hostile bidder.  The court held that the hostile bidder did not comply with two key requirements of the advance notice bylaw.  First, the nomination had to be made by a record holder of the corporation’s common stock.  Although the hostile bidder provided a cover letter from the record holder, the court said it was the hostile bidder making the nomination and its shares were held in “street name.”  Second, the notice had to include a completed director-nominee questionnaire on a form provided by the corporation.  The stockholder failed this requirement by providing its own form of questionnaire.  As a result, the court held that the notice was improper.

Background

Strategic Investment Opportunities LLC v. Lee Enterprises, Incorporated, arose out of Alden Global Capital, LLC’s (“Alden”) unsolicited offer to acquire Lee Enterprises, Incorporated.¹  Under the corporation’s bylaws, notice of director nominations had to be timely given by a stockholder of record.  The bylaw also required the nominating stockholder to, among other things, provide completed director-nominee questionnaires on a form provided by the corporation.

When an affiliate of Alden submitted its nomination notice, it held its shares in “street name” and was not a record holder.  To try to comply with the bylaw, the affiliate provided a cover letter from the record holder, Cede & Co., which stated that “[t]his letter serves as notice to Lee… as to the nomination by [the Alden affiliate]… of nominees for election to the Board.”  The cover letter also made reference to a separate letter from the affiliate containing information about the nominees.  The nomination notice further indicated that the Alden affiliate was in the process of transferring shares that it beneficially owned to record ownership. 

The Alden affiliate also provided its own completed director questionnaire for its nominees.  It had previously requested the corporation’s form of questionnaire, but the corporation refused the request because the affiliate was not a stockholder of record.  The corporation noted that, if the affiliate became a record holder, it should resubmit its request for evaluation by the corporation.  When the nomination was finally received, the corporation’s board of directors rejected it because it was not made by a record holder and it failed to include the corporation’s form of director questionnaire as required by the advance notice bylaw.

Alden’s affiliate brought suit in the Delaware Court of Chancery seeking a declaration that the nominations were valid under the bylaws or that the corporation’s board of directors acted inequitably by rejecting the nominations.  The Court of Chancery held that the record ownership requirement was unambiguous and it was undisputed that the nominating stockholder was not a record owner.  It explained that the Cede & Co. letter did not cure this deficiency.  Although the plaintiff argued that Cede & Co.’s role was purely ministerial, the court focused on the fact that Cede & Co. was not making the nomination.  The court characterized Cede & Co.’s letter as “non-committal and “distanc[ing] itself from having any role in the nomination.”  The court also found that the stockholder failed to comply with the bylaw requirement that it use the corporation’s form of questionnaire.

Having concluded that the stockholder did not comply with the bylaws, the court turned to whether the board acted inequitably by refusing to waive the non-compliance or provide Alden an opportunity to cure the deficiencies.  The court observed that requiring a nomination to come from a record holder was not unreasonable because it “ensures order and gives the corporation certainty that the party attempting to take action based on a right incidental to share ownership is, in fact, a stockholder.”  In response to the stockholder’s argument that the corporation had refused to provide its form of questionnaire when requested, the court said that “if only record holders could make nominations, it seems justifiable that [the corporation] would not undertake the process of providing a questionnaire unless a record holder inquired.”  Although the court did not articulate the exact level of judicial scrutiny being applied, it concluded that the failure to comply with the bylaws was due to the stockholder’s actions, not the board’s.  It also observed that the advance notice bylaw was adopted on a so-called “clear day” and not in response to Alden’s unsolicited takeover bid.

Implications

Courts Enforce Advance Notice Bylaws:  Lee Enterprises is one of several recent examples where courts have enforced advance notice bylaws to bar dissident nominations.  Courts have repeatedly acknowledged that advance notice bylaws are “commonplace.”  At least 97% of S&P 500 companies have some form of advance notice bylaw in place.²  These bylaws serve a valid purpose of providing for an orderly election process and ensuring that the corporation has adequate information about the dissident and its nominees or other proposals.³  Last year, in Rosenbaum v. CytoDyn Inc., an advance notice bylaw was enforced where a dissident stockholder group submitted their notice on the eve of the deadline and failed to include information about who was supporting the group and potential conflicts of interest between a group member and the corporation.⁴  Similarly, in BlackRock Credit Allocation Income Trust v. Saba Capital Master Fund, Ltd., the Delaware Supreme Court held that a dissident had failed to comply with an advance notice bylaw when it refused to respond in a timely manner to additional information requests made by the board.⁵

Record Ownership Requirements:  As in Bay Capital,⁶ the Court of Chancery enforced the requirement that the stockholder be a record holder and not just a beneficial owner of common stock.  While activists may view such a requirement as a technicality and note that Rule 14a-8 proposals can be made by beneficial owners who provide proof of ownership through a brokerage statement, the Court of Chancery acknowledged valid reasons why nominations and proposals outside of Rule 14a-8 should be made by record holders.

Equitable Review of Board Actions:  Even if a stockholder fails to comply with an advance notice bylaw, courts can still review the board’s refusal to grant a waiver or opportunity to cure under equitable principles.⁷  Courts, however, have typically not set aside bylaw requirements when the failure to comply is of the stockholders’ making and not due to any action of the board of directors.⁸  Cases where advance notice bylaws have not been enforced have almost all involved situations where (i) there was an ambiguity or drafting error in the bylaws,⁹ (ii) the board affirmatively manipulated the electoral process in a manner that effectively precluded the dissident’s slate,¹⁰ or (iii) there had been a significant change in circumstances after the advance notice deadline.¹¹

Periodic Review of Bylaws on “Clear Days”:  Courts view advance notice bylaws most favorably when they are adopted on a “clear day” instead of in response to a particular threat.¹²  This does not mean a corporation cannot adopt or amend an advance notice bylaw on a “cloudy day,” but it may give rise to closer judicial scrutiny.  Accordingly, corporations should review their advance notice bylaws periodically, outside of the notice window, to ensure they are state-of-the-art.

D&O Questionnaires:  Many advance notice bylaws require the dissident to provide a completed D&O questionnaire from each of its nominees.  Corporations should review these provisions to make sure that the questionnaire must come from the corporation and that it must be received by the deadline for stockholder nominations.  In addition to providing important information about the stockholder’s nominees, a questionnaire requirement can also provide an early indication of a proxy contest before the notice of nomination is made.

 

¹ Strategic Inv. Opps. LLC v. Lee Enterprises, Inc., No. CV 2021-1089-LWW, 2022 WL 453607 (Del. Ch. Feb. 14, 2022).

² Source: DealPointsData.

³ See Blue Lion Opportunity Master Fund, L.P. v. HomeStreet, Inc., Case No. 18-2-06791-O SEA (Wash. Super. Ct. Apr. 2, 2018).

⁴ Rosenbaum v. CytoDyn Inc., 2021 WL 4775140 (Del. Ch. Oct. 13, 2021).

⁵ BlackRock Credit Allocation Income Tr. v. Saba Cap. Master Fund, Ltd., 224 A.3d 964 (Del. 2020), reh’g denied (Jan. 29, 2020).

⁶ Bay Capital Finance, LLC v. Barnes and Noble Education Inc., C.A. No. 2019-0539-KSJM, trans. ruling (Del. Ch. Aug. 14, 2019).

⁷ See Schnell v. Christ-Craft Indus., Inc., 285 A.2d 437 (Del. 1971).

⁸ See Lee Enterprises, mem. op. at 43 (“Here, nothing—and certainly no actions of the Board—precluded Opportunities from complying with the Bylaws’ requirements.”).

⁹ Levitt Corp. v. Office Depot, Inc., C.A. No. 3622-VCN (Del. Ch. Apr. 14, 2008); JANA Master Fund, Ltd. v. CNET Networks, Inc., C.A. No. 3447-CC (Del. Ch. Mar. 13, 2008); Hill Int’l v. Opportunity Partners, L.P., No. 305, 2015 (Del. July 2, 2015).

¹⁰ See, e.g., Lerman v. Diagnostic Data, Inc., 421 A.2d 906 (Del. Ch. 1980).

¹¹ See, e.g., Icahn Partners LP v. Amylin Pharm., Inc., 2012 WL 1526814 (Del. Ch. Apr. 20, 2012) (finding that “Plaintiffs have adequately alleged that, after the Advance Notice Bylaw prevented Amylin stockholders from submitting Board nominations for the Annual Meeting, the Board radically changed its outlook for the Company”); Hubbard v. Hollywood Park Realty Enterprises, Inc., 1991 WL 3151 (Del. Ch. Jan. 14, 1991) (enjoining enforcement of an advance notice bylaw due to “an unanticipated change of allegiance of a majority of [the board]” that would “foreseeably generate controversy and shareholder opposition”); In re Xerox Corp. Consol. S’holder Litig., 61 Misc. 3d 176 (N.Y. Sup. Ct. Apr. 27, 2018), rev’d on other grounds sub nom. Deason v. Fujifilm Holdings Corp., 165 A.D.3d 501 (N.Y. App. Div. Oct. 16, 2018).

¹² BlackRock Credit Allocation Income Tr. v. Saba Cap. Master Fund, Ltd., 224 A.3d 964, 980 (Del. 2020), reh’g denied (Jan. 29, 2020) (“[W]e are reluctant to hold that it is acceptable to simply let pass a clear and unambiguous deadline contained in an advance-notice bylaw, particularly one that had been adopted on a ‘clear day.’”); Lee Enterprises, Inc., 2022 WL 453607, at *16 (“[T]hough the Board rejected the Nomination Notice under the shadow of Alden’s bid, the Bylaws were adopted on a clear day long before Alden surfaced. Cannell’s withhold campaign had concluded four months before the Bylaws’ adoption, but the Board was not faced with an imminent threat—much less a threat from Alden—at that time.”); Rosenbaum v. CytoDyn Inc., 2021 WL 4775140, at *2 (Del. Ch. Oct. 13, 2021) (“No one disputes that the bylaw was adopted on the proverbial ‘clear day.’”); Rosenbaum v. CytoDyn Inc., 2021 WL 4890876, at *4 (Del. Ch. Oct. 20, 2021) (ORDER) (“[I]n the absence of evidence of manipulative behavior by Defendants that might have affected how Plaintiffs chose to prepare and submit their nomination notice, I determined that Blasius did not apply to my construction and application of an advance notice bylaw validly enacted on a proverbial clear day.”).