In an earlier post, I posed this hypothetical:
Facts: Target company has a bylaw permitting shareholders to nominate directors. Target company also has an advance notice bylaw that, inter alia, requires that potential nominees fill out a questionnaire that “include[s] all information relating to the Proposed Nominee that would be required to be disclosed in connection with the solicitation of proxies for the election of the Proposed Nominee as a director in an election contest.” Activist shareholder informed company it intended to nominate directors and provided answers to the required questionnaire. The target board determined that the answers were inadequate and refused to include the nominees on the proxy statement/card. Activist sues. Court determines that Maryland law requires that it review the board decision under the business judgment rule and holds that plaintiff has failed to show bad faith or uninformed decision, so BJR applies.
The other lesson comes in Sessa Capital’s monthslong battle for control of Ashford, a $300 million market-cap owner of high-end hotels. Sessa, a first-time activist, nominated directors for a majority of the board. It argued that a termination fee owed to Ashford’s external manager — whose chief executive is also Ashford’s CEO — was keeping the company from pursuing a sale that might benefit stockholders.
Ashford sued Sessa, saying the fund hadn’t complied with Ashford’s rules for director nominations. Those rules require anyone seeking board seats to, among other things, “describe any plans or proposals” that would result in a sale of the company or any other major corporate pivot.
Sessa claimed it didn’t have any such plans. But the judge found Sessa had discussed a “gameplan” for a sale of the company and changes to Ashford’s bylaws, and he blocked the fund from moving forward with its board nominees. “In light of the evidence … [Ashford's] board could rationally believe the Sessa candidates had plans they refused to disclose in their questionnaires and thus were ineligible,” Judge David Godbey of the U.S. District Court in Dallas wrote in a decision last week.
The opinion makes two basic moves: (1) the determination of whether the advance notice bylaw was satisfied is one for the board of directors to make and (2) under Maryland law the only available standard of review is the business judgment rule.
As I read the opinion, the second point is clearly correct. Maryland by statute has clearly rejected the Delaware line of cases imposing more intrusive standards of review on decisions of this sort. Indeed, if the case had been decided under Delaware law, it seems clear to me that it would have come out differently. But why?
Mohsen Manesh commented on the earlier post:
Chancellor Allen's reasoning in Blasius v. Atlas suggests that this decision should not be left to the board (i.e. no BJR), but should instead be decided by the courts: "[T]he ordinary considerations to which the business judgment rule originally responded are simply not present in the shareholder voting context.That is, a decision by the board to act for the primary purpose of preventing the effectiveness of a shareholder vote inevitably involves the question who, as between the principal and the agent, has authority with respect to a matter of internal corporate governance.... A board's decision to act to prevent the shareholders from creating a majority of new board positions and filling them does not involve the exercise of the corporation's power over its property, or with respect to its rights or obligations; rather, it involves allocation, between shareholders as a class and the board, of effective power with respect to governance of the corporation.... Action designed principally to interfere with the effectiveness of a vote inevitably involves a conflict between the board and a shareholder majority. Judicial review of such action involves a determination of the legal and equitable obligations of an agent towards his principal. This is not, in my opinion, a question that a court may leave to the agent finally to decide so long as he does so honestly and competently; that is, it may not be left to the agent's business judgment."
Initially that struck me as probably correct.
Christian Walker--a lawyer who's a longtime reader of the blog--wrote via email to suggest an alternative way of solving the problem, however, which I am now persuaded is actually the correct way of approaching the problem:
I have not researched this particular issue, but I believe that the answer for Delaware purposes is that you do not get BJR deference. In the first instance, of course, the board or company will control the decision. But if challenged, the decision will be reviewed based on contract principles, with no deference being given to the board’s interpretation. I believe the Opportunity Partners v. Hill decisions and order (attached) generally address the issue.
In Opportunity Partners L.P. v. Hill Intern., Inc., 2015 WL 3582350 (2015), VA Travis Laster wrote that:
“The bylaws of a Delaware corporation constitute part of a binding broader contract among the directors, officers, and stockholders formed within the statutory framework of the [Delaware General Corporation Law].” Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 939 (Del. Ch. 2013). Accordingly, “bylaws are interpreted using contractual principles.” Id. at 957. The “ ‘plain, common, or normal meaning of language will be given to the words of a contract unless the circumstances show that in a particular case a special meaning should be attached to them.’ ” Nationwide Emerging Managers, LLC v. Northpointe Hldgs., LLC, 112 A.3d 878, 895 n.65 (Del. 2015) (quoting 11 SAMUEL WILLISTON & RICHARD A. LORD, A TREATISE ON THE LAW OF CONTRACTS § 32:3 (4th ed.) (2014)).
In the subsequent opinion in Opportunity Partners L.P. v. Hill Intern., Inc., 2015 WL 3765353 (2015), VC Laster further observed that:
The Company also asserts that the Injunction Order “runs contrary to the Company's own interpretation and its consistent prior practice, as well as the fundamental purposes served by advanced notice bylaws.” Taking these points in reverse order, the Injunction Order did not defeat the “fundamental purposes served by advanced notice bylaws.” The purpose of an advanced notice bylaw is to give a company advance notice of matters to be considered at a meeting of stockholders so that the Company is not surprised by a proposal from the floor. See Openwave Sys. Inc. v. Harbinger Capital Partners Master Fund I, Ltd., 924 A.2d 228, 239 (Del. Ch. 2007). That purpose has been served. Nor, as I understand Delaware's approach to contract interpretation, is past practice or one side's unilateral interpretation controlling. See id. Moreover, if a bylaw is ambiguous, “doubt is resolved in favor of the stockholders' electoral rights.” Id.
On appeal, the Supreme Court of Delaware affirmed. Hill International, Inc. v. Opportunity Partners L.P., 119 A.3d 30 (2015):
The bylaws of a Delaware corporation constitute part of a binding broader contract among the directors, officers and stockholders formed within the statutory framework of the Delaware General Corporation Law. Because corporate charters and bylaws are contracts, our rules of contract interpretation apply.
In sum, under Delaware law the question before the court would be: Did the board of directors breach the bylaw? That question would be resolved by the court applying basic contract law principles. As a result, under Delaware law, the determination of whether the advance notice bylaw was satisfied is not one for the board of directors to make and, accordingly, the board would not be entitled to business judgment review. Indeed, because contract law would control--rather than corporate law fiduciary duties--Blasius would not come into play either.
To be sure, as Keith Paul Bishop notes, many advance notice bylaws try to vest the determination of whether a nomination is proper in the board. He cites an example, which provides that (his emphasis):
Except as otherwise required by law, each of the Board or the chairman of the meeting shall have the power to determine whether a nomination or any other business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in Section 6(a)(ii) above. If any proposed nomination or other business is not in compliance, then, except as otherwise required by law, the chairman of the meeting shall have the power to declare that such nomination shall be disregarded or that such other business shall not be transacted.
A quick Westlaw search turned up no law on point, but I doubt whether such language would preclude judicial review to determine whether the Board or Chairman's use of that power was a breach of the bylaw as a matter of contract law.
On the facts of this case, accordingly, I believe a Delaware court would hold that the question of whether the activist had adequately “describe[d] any plans or proposals” that would result in a sale of the company would be decided by applying contract law principles of interpretation to determine what the language requires.
As for Maryland law, there are a few cases that refer to the bylaws as being contractual, but none of them strike me as dispositive.
There are some other interesting wrinkles in the case that would raise some interesting fiduciary duty issues in Delaware (unlike Maryland where they've apparently been gutted), especially the "proxy penalty" the court notes in passing (more than half the market cap is paid to the outside adviser, controlled by the CEO, upon shareholder election of directors that incumbents don't approve). Surely that would invoke Blasius!