Within the past two years there has been considerable debate over the appropriate roles of stockholders and directors in Delaware corporations. To adapt and respond to the continually changing landscape of corporate law and practice, several amendments to the Delaware General Corporation Law ("DGCL") have been proposed in the form of a bill that is currently making its way through the legislative decision-making process. If the bill is adopted by the Delaware General Assembly and approved by the Governor, these amendments would become effective on August 1, 2009. The purpose of this article is to discuss the proposed changes and how they may affect corporate law and practice.
Section 112
Proposed Section 112 authorizes bylaws granting stockholders "access" to the corporation's proxy solicitation materials and sets forth a non-exhaustive list of conditions that may or may not be imposed on such right. Because the statute is quite permissive in nature, the following discussion is limited to a few of its more significant features.
One of the more salient aspects of the proposed amendment is its flexibility. The statute permits the bylaw's author to define the extent of the right granted, conditions upon such right, and procedures governing its implementation. For example, if minimum stock ownership requirements are included, they may be specified in terms of record or beneficial ownership, and stock options or other rights in respect of, or related to, stock may be taken into account.
Bylaws under this section may require that stockholders seeking to gain proxy access disclose "short positions" or other interests that may provide a financial incentive other than maximization of profit or stock price. Additionally, the right of access may be limited to nominations of so-called short slates or, conversely, situations in which the stockholder seeks to nominate a majority of the board.
Finally, the section permits a bylaw to be structured to preclude "bidders" for the company from using the "access" mechanism. In furtherance of this goal, a bylaw under this section could require the nominating stockholder to disclose information about its plans, its relationship to the nominees, and any other information deemed relevant to the election of directors.
Section 113
Proposed Section 113 authorizes bylaws granting to stockholders the right to reimbursement for proxy expenses and sets forth a non-exclusive list of conditions that may or may not be imposed on such right. Section 113 essentially codifies the holding in CA, Inc. v. AFSCME Employees Pension Plan, that bylaws may provide for proxy reimbursement "in connection with the election of directors" without infringing upon the management responsibilities of the board of directors. See CA, Inc., 953 A.2d 227 (Del. 2008). Like proposed Section 112, this proposed section is permissive, not mandatory, and bylaws need not conform to the literal terms of the statute.
It should be observed that the list of conditions contained in proposed Section 113 is not identical to the list contained in proposed Section 112. This incongruity, however, may be of little moment because the omission of a condition from either is not necessarily determinative of whether such condition is valid. Given the overlap in subject matter, stockholders seeking to propose bylaws under proposed Section 113 will likely find the conditions listed in proposed 112 a useful reference.
Section 113 expressly permits reimbursement to be conditioned upon "the proportion of votes cast in favor of one or more of the persons nominated by the stockholder seeking reimbursement." This provision permits reimbursement to be conditioned on the election of the persons nominated; it is less clear whether a proxy reimbursement bylaw could provide for reimbursement when the nominees are not elected.As a general matter, Section 113 allows reimbursement "in connection with the election of directors," which could be interpreted as permitting bylaws requiring reimbursement only when the nominees are elected, or as permitting bylaws requiring reimbursement notwithstanding the results of an election.
Section 145
This amendment essentially reverses the default contractual construction adopted by the Court of Chancery in Schoon v. Troy Corp through language added to the end of Section 145(f). See Schoon, 948 A.2d 1157 (Del. Ch. 2008). In Schoon, the court held that the right to advancement could be altered after the act or omission (giving rise to a potentially indemnifiable claim against a director) occurred but before the suit or claim is made against the director, so long as the bylaw did not provide that the right to advancement "vested" upon the occurrence of the act.
Under the proposed amendment, the right to indemnification or to advancement under a bylaw or certificate of incorporation cannot be eliminated or impaired by an amendment after the act or occurrence unless the bylaw or certificate of incorporation in effect at the time of the act or occurrence "explicitly" allows for such elimination or impairment.
As drafted, the proposed amendment raises several questions. One obvious issue is, what constitutes an "impairment" of the right of advancement? For example, does an impairment arise only when the substance of the advancement obligation is affected, or is it sufficient that an alteration affects the process governing advancement?
Another issue is how the statutory provision will interact with pre-existing bylaws or certificates that contain a provision specifying how and when indemnification or advancement rights vest. The operation of such a pre-existing provision under the new statute may depend upon whether the pre-existing bylaw or certificate "explicitly" allows for the modification of such advancement or indemnification rights applicable to prior acts or occurrences.
Given these ambiguities, and the fact that the effect of the proposed amendment will vary depending on the terms of the bylaw or charter provision in question, careful analysis of existing indemnity and advancement provisions should be undertaken before August 1, 2009, the tentative effective date of the proposed amendments.
Corporations seeking to allow amendments such as those permitted in Schoon (but whose bylaws or certificate is currently silent about vesting) should promptly amend their bylaws or certificate to either (1) allow for such after-the-fact alteration of advancement or indemnification rights or (2) eliminate or impair such rights with respect to past acts. Such an amendment will certainly be effective as to any acts or occurrences postdating the adoption of the bylaw or certificate amendment. It is less clear whether the proposed amendment will affect advancement rights related to acts or occurrences predating the adoption of such bylaw or certificate amendment.
Section 213
Proposed amendments to Section 213, along with conforming amendments to other sections of the DGCL, permit a corporation to set multiple record dates: one for determining the stockholders entitled to receive notice of the meeting, and one for determining the stockholders entitled to vote at the meeting. The purpose of this amendment is to allow a determination of voting rights that more closely reflects the stockholders holding shares at the time of the meeting. This would partially address the larger problem of "empty voting," generally defined as the voting of shares by persons who do not own them at the time of the vote or who may have an economic interest that diverges from the typical profit-maximizing objective of stockholders. This amendment addresses the former problem but not the latter.
Before utilizing the flexibility afforded by this amendment, boards of directors should satisfy themselves that the corporation, its transfer agent, and others involved in the election or voting process can manage a record date set closer to or on the date of the meeting.This amendment does not address the issue of whether the directors of the corporation have any fiduciary duty to make disclosure to those stockholders who are entitled to vote at the meeting but who did not hold shares on the record date set for the mailing of notice and proxy materials. Regardless of whether any duty may arise in that circumstance, a board setting "dual" dates may consider whether some type of supplemental disclosure is possible and cost-effective or whether the materials could be made available over the Internet or upon request. In this regard, what is a best practice may differ from what is a duty.
Section 225
Proposed amendments to Section 225 authorize the Court of Chancery to remove directors under certain limited circumstances. Removal under this provision requires 1) a judicial determination that the director committed a felony or a breach of the duty of loyalty; 2) a judicial determination that the director "did not act in good faith in performing the acts resulting in the prior conviction or judgment"; and 3) a judicial determination that "removal is necessary to avoid irreparable harm to the corporation."
Regarding the first requirement, the director must either have been "convicted of a felony in connection with the duties of such director. . .to the corporation" or have been determined in a "prior judgment" to have "committed a breach of the duty of loyalty in connection with the duties of such director. . .to that corporation." This conviction or judgment must be in an action other than the action seeking the removal of the director. Thus, removal of a director cannot be a form of relief sought in an action brought for breach of fiduciary duty. Rather, the proposed statute states that in case of such a conviction or judgment, a "subsequent action" may be brought by the corporation or derivatively on behalf of the corporation to remove such director.
Regarding the second requirement, it is possible that findings made in connection with the prior conviction or judgment may establish the necessary element of lack of good faith under the doctrine of collateral estoppel. However, lack of good faith is not always a necessary requirement for a felony conviction, and proof of this fact may be required in addition to proof of a prior felony conviction.
Finally, a finding of irreparable harm in this context presumably would require two distinct findings. First, the court must find that the director may or probably will cause irreparable injury to the corporation unless removal occurs (no other judicial remedy will prevent the threatened harm). Second, the court must find either that the stockholders cannot remove the director - i.e., because he or she is a controlling stockholder or there is a staggered board - or they cannot remove the director quickly enough to avoid the threatened harm.
As can be seen from the foregoing, amended Section 225 sets forth a high burden of proof, and judicial removal of directors is thus reserved for extreme cases.
Continuing the tradition of an evolving corporate law, the proposed amendments to the DGCL may be seen as a legislative response to recent debate in the field. Although the amendments will not likely effect a watershed change, they arguably touch upon several core issues.It remains to be seen whether this recasting of the gold standard of corporate law is a prudent departure from past practice.
Published May 4, 2009.
