In my TCS column on shareholder-initiated bylaws that seek to limit the power of the corporation's board of directors, I mentioned the pending proposals at Bally Total Fitness. One of the Bally bylaws being proposed would limit the power of the board to amend the bylaws.
This proposal raises a very interesting question of the allocation of power between boards of directors and stockholders; namely, who has inherent power to adopt and amend bylaws?
As I explained in my book Corporation Law and Economics, the corporation’s initial bylaws are adopted by the incorporator or the initial directors at the corporation’s organizational meeting. At early common law, only shareholders had the power to amend the bylaws. Many states thereafter adopted statutes allowing shareholders to delegate the power to amend the bylaws to the board of directors. DGCL § 109(a) typifies this approach: It provides that only shareholders have the power to amend bylaws, unless the articles of incorporation expressly confer that power on the board of directors. An article provision authorizing the board to amend the bylaws, moreover, does not divest the shareholders of their residual power to amend the bylaws.
The original or other bylaws of a corporation may be adopted, amended or repealed by the initial directors if they were named in the certificate of incorporation, or, before a corporation has received any payment for any of its stock, by its board of directors. After a corporation has received any payment for any of its stock, the power to adopt, amend or repeal bylaws shall be in the stockholders entitled to vote, or, in the case of a nonstock corporation, in its members entitled to vote; provided, however, any corporation may, in its certificate of incorporation, confer the power to adopt, amend or repeal bylaws upon the directors or, in the case of a nonstock corporation, upon its governing body by whatever name designated. The fact that such power has been so conferred upon the directors or governing body, as the case may be, shall not divest the stockholders or members of the power, nor limit their power to adopt, amend or repeal bylaws.
In contrast, the Model Business Corporation Axt (MBCA) reflects a modern trend of vesting the power to amend the bylaws in both the directors and the shareholders. MBCA § 10.20(b) allows the directors to amend the bylaws unless (1) the articles of incorporation give that power solely to the shareholders or (2) the shareholders amend the bylaw in question and provide that the directors cannot thereafter further amend the bylaw. By implication, MBCA § 10.20(a) authorizes the shareholders to amend the bylaws even though the directors also have that power.
Notice that amendment of the bylaws is one of the few corporate actions the shareholders are entitled to initiate. Unlike the articles of incorporation, where an amendment must first be recommended by the board, no prior board action is required on a bylaw amendment. The concurrent power of both shareholders and boards to amend the bylaws raises the prospect of cycling amendments and counter-amendments. Suppose the shareholders adopted a bylaw limiting the number of terms a board member can serve. Disliking that limitation, the board repeals the new bylaw provision using its concurrent power to amend the bylaws. The MBCA allows the shareholders to forestall such an event. As noted, MBCA § 10.20(b)(2) authorizes the board to adopt, amend, and repeal bylaws unless “the shareholders in amending, repealing, or adopting a bylaw expressly provide that the board of directors may not amend, repeal, or reinstate that bylaw.” In the absence of such a restriction, however, the board apparently retains its power to amend or even repeal the bylaw. If the board does so, the shareholders’ remedies presumably are limited to readopting the term limit amendment, this time incorporating the necessary restriction, and/or electing a more compliant board.
Delaware § 109 is more problematic, as it lacks any comparable grant of power to the shareholders. Worse yet, because the board only has power to adopt or amend bylaws if that power is granted to it in the articles of incorporation, a bylaw prohibiting board amendment would be inconsistent with the articles and, therefore, invalid. In American Int’l Rent a Car, Inc. v. Cross, 1984 WL 8204 (Del. Ch. 1984), the Delaware chancery court suggested that, as part of a bylaw amendment, the shareholders “could remove from the Board the power to further amend the provision in question.” Dicta in several other Delaware precedents, however, is to the contrary. In General DataComm Industries, Inc. v. State of Wisconsin Investment Board, 731 A.2d 818, 821 n.1 (Del. Ch. 1999), for example, Vice Chancellor Strine noted the “significant legal uncertainty” as to “whether, in the absence of an explicitly controlling statute, a stockholder-adopted bylaw can be made immune from repeal or modification by the board of directors.” In Centaur Partners, IV v. National Intergroup, Inc., 582 A.2d 923, 929 (Del. 1990), the Delaware supreme court addressed a shareholder-proposed bylaw limiting the number of directors. As proposed, the bylaw contained a provision prohibiting the board from amending or repealing it. Noting that the corporation’s articles gave the board authority to fix the number of directors through adoption of bylaws, the supreme court opined that the proposed by law “would be a nullity if adopted.” Consequently, it seems doubtful that restrictions on the board’s power over the bylaws will pass muster in Delaware or other states likewise lacking a MBCA-style provision.
On the other hand, board amendments to bylaws adopted by the shareholders may run afoul of the Delaware supreme court’s famous holding in Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437, 439 (Del. 1971), that “inequitable action does not become permissible merely because it is legally possible.” To be sure, Schnell dealt with a slightly different problem. The board had amended the bylaws to change the date of the corporation’s annual meeting, which was a legally permissible amendment, for the equitably impermissible purpose of defeating a proxy contest in which insurgent shareholders sought to oust the incumbent board. Yet, many courts have applied the principle in a variety of contexts. Under Schnell, a court thus likely would examine the purpose for which the board amended or repealed the shareholder-adopted bylaw. If the board did so to disenfranchise shareholders and/or entrench itself in office, for example, the action likely would not pass muster.