The ABA Committee on Corporate laws (of which I am a member) published in the August 2009 issue of the Business Lawyer "Proposed Shareholder Proxy Access Amendments."
The key provisions would amend section 2.06 and the official commentary thereto to provide as follows:
§ 2.06. Bylaws
(a) The incorporators or board of directors of a corporation shall adopt initial bylaws for the corporation.
(b) The bylaws of a corporation may contain any provision that is not inconsistent with law or the articles of incorporation.
(c) The bylaws may contain one or both of the following provisions:
(1) A requirement that if the corporation solicits proxies or consents with respect to an election of directors, the corporation include in its proxy statement and any form of its proxy or consent, to the extent and subject to such procedures or conditions as are provided in the bylaws, one or more individuals nominated by a shareholder in addition to individuals nominated by the board of directors; and
(2) A requirement that the corporation reimburse the expenses incurred by a shareholder in soliciting proxies or consents in connection with an election of directors, to the extent and subject to such procedures or conditions as are provided in the bylaws, provided that no bylaw so adopted shall apply to elections for which any record date precedes its adoption.
(d) Notwithstanding section 10.20(b)(2), the shareholders in amending, repealing, or adopting a bylaw described in subsection (c) may not limit the authority of the board of directors to amend or repeal any condition or procedure set forth in or to add any procedure or condition to such a bylaw in order to provide for a reasonable, practicable, and orderly process.
Official Comment
The responsibility for adopting the original bylaws is placed on the person or persons completing the organization of the corporation. Section 2.06(b) permits any bylaw provision that is not inconsistent with the articles of incorporation or law. This limitation precludes provisions that limit the managerial authority of directors that is established by section 8.01(b). For a list of Model Act provisions that become effective only if specific reference is made to them in the bylaws, see Official Comment to section 2.02.
The power to amend or repeal bylaws, or adopt new bylaws after the formation of the corporation is completed, is addressed in sections 10.20, 10.21, and 10.22 of the Model Act.
Section 2.06(c) expressly authorizes bylaws that require the corporation to include individuals nominated by shareholders for election as directors in its proxy statement and proxy cards (or consent) and that require the reimbursement by the corporation of expenses incurred by a shareholder in soliciting proxies (or consents) in an election of directors, in each case subject to such procedures or conditions as may be provided in the bylaws. Expenses reimbursed under section 2.06(c)(1) must be reasonable as contemplated in the definition of expenses set forth in section 1.40(9AA).
Examples of the procedures and conditions that may be included in such bylaws include provisions that relate to the ownership of shares (including requirements as to the duration of ownership); informational requirements; restrictions on the number of directors to be nominated or on the use of the provisions by shareholders seeking to acquire control; provisions requiring the nominating shareholder to indemnify the corporation; limitations on reimbursement based on the amount spent by the corporation or the proportion of votes cast for the nominee; and limitations concerning the election of directors by cumulative voting. In that respect, the function of such bylaws in a corporation with cumulative voting may present unique issues.
Section 2.06(c) clarifies that proxy access and expense reimbursement provisions do not infringe upon the scope of authority granted to the board of directors *1161 of a corporation under section 8.01(b). See CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227, 235-37 (Del. 2008) (holding that a reimbursement bylaw regulates “procedural” rather than “substantive” matters, and is therefore a proper matter for shareholder action). Section 2.06(c) underscores the model of corporate governance embodied by the Act and reflected in section 8.01, but recognizes that different corporations may wish to grant shareholders varying rights in selecting directors through the election process.
Section 2.06(d) limits the rule set forth in section 10.20(b)(2) that shareholder-adopted bylaws may limit the authority of directors to amend bylaws, by specifying that such a limit will not apply absolutely to conditions and procedures set forth in access or reimbursement bylaws authorized by section 2.06(c). Section 2.06(d) allows directors to ensure that such bylaws adequately provide for a reasonable, practicable, and orderly process, but is not intended to allow the board of directors to frustrate the purpose of a shareholder-adopted proxy access or expense reimbursement provision.
I recently sent my fellow committee members the following comments:
1. The comment to sec. 2.06 will now state that “provisions that limit the managerial authority of directors that is established by section 8.01(b)” are precluded. This limitation should be stated expressly in the statute, preferably in section 2.06(b). It is a critical limitation and we should ensure that it is enshrined in statute, rather than in “mere” commentary. (I explain why in more detail below)
2. I find sec. 2.06(d) awkward. Delaware didn’t include a comparable provision in its legislation. If it must go in the statute, why not add it as an exception to 10.20(b)(2)?
3. Why are we conceding the task of developing shareholder qualifications to the SEC? This is especially pertinent in light of the numerous comments given to the SEC on its proposal urging adoption of minor changes to Rule 14a-8 rather than a more sweeping rule such as originally proposed.
a. We should require that a bylaw amendment under 2.06(c), for example, put forward by a shareholder who has held, say, 5% of the stock for 2 years. Ensuring a higher eligibility requirement will be helpful in preventing short-term investors with an adverse motive to clog a company’s proxy materials with nuisance proposals.
b. In 2003, proposed Rule 14a-11 would have limited eligibility to shareholders who had filed a 13G. Those who filed a 13D were ineligible to nominate directors. I’d like to see that mandated as a condition for a bylaw to be valid, so that it’s clear that the bylaw can’t be used in a control contest.
c. Proposed Rule 14a-11 also provided 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. So I’d like to see us make explicit that the articles can preclude a sec. 2.06 bylaw.
d. In sum, I don’t think we should rely on shareholders to be reasonable about the sort of procedures and conditions outlined in what will now be the fourth paragraph to the comment to sec. 2.06. If we can reach a consensus on a floor set of limitations, we ought to include them in the statute.
4. I propose that sec. 2.06(c) be amended to limit its provisions to public corporations, as defined in sec. 1.40(18A). The whole apparatus seems (a) inapt with respect to close corporations and (b) unnecessary with respect to close corporations in light of the provisions in sec. 7.32(a) authorizing shareholder agreements (for non-public companies) that control how directors are elected.
I think we are basically right to adopt an enabling approach to the problem. At the same time, however, SEC Chair Shapiro’s decision to delay action on the Commission’s proposal gives us an opportunity to consider whether it makes sense to create a floor set of conditions upon which an enabling approach can build on a company-by-company basis.
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Supplemental material on point 1. It seems clear to me that it would be very bad policy for a corporation law statute to authorize shareholders to amend the bylaws in ways that restrict the managerial discretion of the board of directors.
Analysis must begin with the basic precepts of the contractarian model. Shareholders do not own the corporation. Instead, they are merely one of many corporate constituencies bound together by a complex web of explicit and implicit contracts. As such, the normative claims associated with ownership and private property are inapt in the corporate context.
In this model, the directors thus are not agents of the shareholders subject to the control of the shareholders. To be sure, shareholders elect the board and exercise certain other control rights through the franchise. Yet, shareholder voting is not an integral part of the corporate decisionmaking apparatus. Although corporate law grants shareholders exclusive electoral rights, those rights are quite limited. Instead, shareholder voting is merely one accountability mechanism among many—and one to be used sparingly at that. Put another way, the board of directors functions as a sort of Platonic guardian—a sui generis body that serves as the nexus for the various contracts making up the corporation. The board’s powers flow from that set of contracts in its totality and not just from shareholders. The board’s exercise of its discretionary authority therefore may not be unilaterally limited by any corporate constituency, including the shareholders.
The board’s primacy has a compelling economic justification. The separation of ownership and control mandated by corporate law is a highly efficient solution to the decisionmaking problems faced by large corporations. Recall that because collective decisionmaking is impracticable in such firms, they are characterized by authority-based decisionmaking structures in which a central agency (the board) is empowered to make decisions binding on the firm as a whole.
To be sure, this separation of “ownership” and control results in agency costs. Those costs, however, are the inevitable consequence of vesting discretion in someone other than the residual claimant. We could substantially reduce, if not eliminate, agency costs by eliminating discretion; that we do not do so confirms that discretion has substantial virtues. Given those virtues, one ought not lightly interfere with management or the board’s decisionmaking authority in the name of accountability. Preservation of managerial discretion should always have a presumption in its favor.
This line of argument explains much of corporate law. It is the principle behind such diverse doctrines as the business judgment rule, the limits on shareholder derivative litigation, the limits on shareholder voting rights, and the board’s power to resist unsolicited corporate takeovers. Here it justifies strong skepticism as to the validity of shareholder-adopted bylaws that restrict management discretion. Indeed, absent an express statutory command to the contrary, courts should invalidate such bylaws.
All of these problems would go away if state corporation codes treated bylaws the same way as articles of incorporation or, for that matter, virtually every other corporate action. The shareholder power to initiate bylaw amendments without prior board action is unique. It is also a historical anachronism states unthinkingly codified from old common law principles lacking either rhyme or reason. There simply is no good reason to treat bylaws differently than articles of incorporation. But that’s a problem for another day.