By Corp Law Blog's count, the SEC's shareholder access rule proposal poses over 320 questions for commenters. I will not be answering all of them. As I work up my comment letter to submit to the SEC, however, I will post my answers to those I find interesting.
Today's question:
[A]s proposed, a company would become subject to the security holder nomination procedure in Exchange Act Rule 14a-11 only where the company's security holders have an existing, applicable state law right to nominate a candidate or candidates for election as a director. To eliminate any uncertainties in this regard, the proposed rule would state that the security holder nomination procedure would be available unless applicable state law prohibits the company's security holders from nominating a candidate or candidates for election as a director. If state law permits companies incorporated in that state to prohibit security holder nominations through provisions in companies' articles of incorporation or bylaws, the proposed procedure would not be available to security holders of a company that had included validly such a provision in its governing instruments.
Does state law permit this? A recent Delaware decision suggests an affirmative answer, albeit with qualifications. In Harrah's Entertainment, Inc. v. JCC Holding Co., 802 A.2d 294 (Del.Ch. 2002), the Honorable (and estimable) Leo Strine noted that:
Because of the obvious importance of the nomination right in our system of corporate governance, Delaware courts have been reluctant to approve measures that impede the ability of stockholders to nominate candidates. Put simply, Delaware law recognizes that the "right of shareholders to participate in the voting process includes the right to nominate an opposing slate." And, "the unadorned right to cast a ballot in a contest for [corporate] office ... is meaningless without the right to participate in selecting the contestants. As the nominating process circumscribes the range of choice to be made, it is a fundamental and outcome-determinative step in the election of officeholders. To allow for voting while maintaining a closed selection process thus renders the former an empty exercise." (310-11)
On the other hand, Delaware law also has a fairly strong streak of freedom of contract. A corporation thus may opt out of the default voting -- and nominating -- rules, provided it does so clearly and unambiguously:
When a corporate charter is alleged to contain a restriction on the fundamental electoral rights of stockholders under default provisions of law - such as the right of a majority of the shares to elect new directors or enact a charter amendment - it has been said that the restriction must be "clear and unambiguous" to be enforceable. (310)
Because restrictions on shareholder voting rights, such as a departure from the one share-one vote norm, must be in the articles of incorporation (DGCL § 212), it would be advisable to include a restriction on shareholder nominations in the articles rather than the bylaws. Not only would a bylaw provision be of dubious enforceability, under DGCL § 109(a) the shareholders always retain the right to initiate amendments to the bylaws. For existing companies, getting the shareholders to approve a charter amendment banning stockholder nominations likely will be tough -- probably few would even try to buck the inevitable bad press and institutional investor complaints. Assuming the rule goes through in present form, however, it will be interesting to see how many IPOs include such a provision.
