Delaware Supreme Court answers questions posed by SEC in CA, Inc. v. AFSCME Employees Pension Plan
By Cydney Posner
The Delaware Supreme Court has issued its decision regarding the questions certified to the court by the SEC in CA, Inc. v. AFSCME Employees Pension Plan.
Background
As you may recall (see 6/30/08 posting), AFSCME had submitted to CA a shareholder proposal that would amend CA's bylaws to require CA to reimburse the reasonable expenses incurred by a stockholder or group of stockholders in running a short slate (under 50%) of director nominees in a contested election, provided that at least one nominee on the short slate was elected to the board. (Because the board approves payment of expenses, expenses are, as a practical matter, reimbursed only when the contest results in the election of a majority of directors and a change of control.) CA submitted a no-action request to the SEC, seeking to exclude the proposal from its proxy statement. CA argued that, because the proposed bylaw would be binding, it would require that reimbursement be provided in all future contests meeting the proposed criteria, without the possibility of the exercise of any discretion by the board of directors. As a result, the bylaw would deprive the CA board of its statutory authority to manage the use of the company's funds with regard to contested elections, in violation of state law. Among other things, AFSCME argued that Delaware law confers broad authority on stockholders to adopt bylaws, provided they do not violate the certificate of incorporation or Delaware law, including bylaws constraining the board's ability to act with respect to the expenditure of corporate funds. While Corp Fin denied CA's request to omit the proposal from its proxy on some grounds, it did not address the Delaware law issues. Instead, with respect to CA's argument that the proposal could be excluded as improper under state law (rule 14a-8(i)(1)) and as a violation of law (rule 14a-8(i)(2)), the SEC certified these state law questions to the Delaware Supreme Court under a new procedure available under Section 11(8) of Article IV of the Delaware Constitution.
Decision of the Court
The specific questions certified were (1) whether the proposal is a proper subject for action by stockholders as a matter of Delaware law, and (2) whether the proposal, if adopted, would cause CA to violate any Delaware law to which it is subject. The questions presented were issues of law which the court decided de novo. The court concluded that, while the proposal was a proper subject for action by the stockholders, if adopted, it would cause CA to violate Delaware law. As a result, presumably, the SEC will permit CA to exclude the AFSCME proposal from CA's proxy statement. The court stated that, to make the proposed bylaw as drafted part of CA’s governance scheme, AFSCME would have two alternatives: it may seek to amend the Certificate of Incorporation (which requires board approval) to include the substance of the bylaw or it may seek recourse from the Delaware General Assembly.
Court's Analysis
As to the first question, the court noted that the DGCL empowers both boards and shareholders to adopt, amend or repeal the corporation’s bylaws. However, that concurrent power is not coextensive; the power of the shareholders to amend bylaws is limited by the broad management power statutorily allocated to the board to manage the business and affairs of the corporation (Section 141(a)). However, determining the scope of the shareholders' power when the bylaw would the limit the directors' authority, the court lamented, can be an "elusively difficult task." For guidance, the court looked to relevant case law, in particular, the "well-established Delaware law that a proper function of bylaws is not to mandate how the board should decide specific substantive business decisions, but rather, to define the process and procedures by which those decisions are made." The court concluded that the bylaw, "even though infelicitously couched as a substantive-sounding mandate to expend corporate funds, has both the intent and the effect of regulating the process for electing directors of CA." The wording of the bylaw should not necessarily be dispositive; rather, whether or not a bylaw is process-related "must necessarily be determined in light of its context and purpose." Here, the context of the bylaw was "the process for electing directors— a subject in which shareholders of Delaware corporations have a legitimate and protected interest." The bylaw's purpose was to "promote the integrity of that electoral process by facilitating the nomination of director candidates by stockholders or groups of stockholders." Accordingly, the court determined that the bylaw was a proper subject for shareholder action.
As to the second question (which, because of the peculiar context, was considered without the usual presumption of validity of the bylaw at issue), the court decided that, under at least one potential circumstance, the directors would breach their fiduciary duties if they complied with the bylaw. Accordingly, the court concluded that the bylaw would violate the prohibition, derived from Section 141(a), "against contractual arrangements that commit the board of directors to a course of action that would preclude them from fully discharging their fiduciary duties to the corporation and its shareholders." Looking to past decisions, the court decided that the bylaw, as an internal governance contract, would "prevent the directors from exercising their full managerial power in circumstances where their fiduciary duties would otherwise require them to deny reimbursement to a dissident slate," such as in proxy contests that were motivated by personal or petty concerns or to promote interests that do not further, or are adverse to, those of the corporation. While the bylaw afforded some measure of discretion to determine the reasonableness of expenses, it contained no provision that "would reserve to CA’s directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate, in a specific case, to award reimbursement at all.'
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