In a recent and somewhat surprising decision, the Delaware Court of Chancery narrowly constructed an advance notice bylaw provision and ruled that it applies only to proposals that a shareholder attempts to include on the company’s proxy statement pursuant to SEC Rule 14a-8 and not to other proposals such as those advanced via independently financed proxy materials. JANA Master Fund, Ltd. v. CNET Networks, Inc., No. 3447-CC (March 13, 2008). As a result, the company’s stockholders are now able to make proposals without any advance notice requirement, including proposals from the floor of the meeting. This decision raises questions about the scope of advance notice bylaw provisions in place at many public companies, including companies incorporated in jurisdictions outside of Delaware, and could leave those companies vulnerable to proposals made from the floor at a meeting. In the wake of this decision, companies should review their advance notice bylaws and consider amendments to make certain their advance notice provisions apply to all shareholder proposals.
Background
The lawsuit arose in connection with a proxy contest to gain control of a company’s board of directors. JANA Master Fund, Ltd., a hedge fund owning approximately 11% of CNET Networks, Inc.’s outstanding common stock, sought to gain control of the CNET board by means of an independently financed proxy contest to: (1) replace two directors up for re-election at the annual meeting, (ii) expand the size of the board from eight to thirteen directors, and (iii) nominate five directors to fill the newly created seats. CNET argued this proxy solicitation failed to comply with CNET’s advance notice bylaw provision, which provides:
Any stockholder of the Corporation that has been the beneficial owner of at least $1,000 of securities entitled to vote at an annual meeting for at least one year may seek to transact other corporate business at the annual meeting, provided that such business is set forth in a written notice and mailed by certified mail to the Secretary of the Corporation and received no later than 120 calendar days in advance of the date of the Corporation’s proxy statement released to security holders in connection with the previous year’s annual meeting of security holders (or, if no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than 30 calendar days from the date contemplated at the time of the previous year’s proxy statement, a reasonable time before the solicitation is made). Notwithstanding the foregoing, such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy.
CNET believed that JANA’s proposals could not be considered at the annual meeting because JANA had not held CNET stock for the requisite one year period. JANA brought suit against CNET, contending that the advance notice bylaw provision only applies to Rule 14a-8 shareholder proposals and not to independently financed proxy solicitations.
The Court’s Decision
The Court held that CNET’s advance notice bylaw provision applies only to proposals included on the company’s proxy statement pursuant to Rule 14a-8. The decision, which is currently on appeal to the Delaware Supreme Court, is based on an interpretation of three elements of CNET’s advance notice bylaw provision.
- “Any stockholder . . . may seek to transact other corporate business at the annual meeting”
In the Court’s view, this language does not make sense outside the context of Rule 14a-8. Shareholders are not generally required under Delaware or federal securities law to seek management or board approval to make a proposal unless such proposal is to be included in the company’s proxy statement. The “may seek” language thus implies the entire advance notice bylaw provision only relates to Rule 14a-8 proposals.
- “provided that such business is set forth in a written notice . . . and received no later than 120 calendar days in advance of the date of the Corporation’s proxy statement released to security holders in connection with the previous year’s annual meeting of security holders”
This deadline is tied to the mailing date of CNET’s proxy statement rather than the date of the annual meeting. According to the Court’s logic, it suggests that the provision is designed to give the company time to incorporate the proposal in the company’s proxy statement. Thus, this deadline only makes sense for proposals that are to be included in the company’s proxy statement. The Court also noted that it could not find a permissible advance bylaw provision that set the notice requirement by reference to the release of the company’s proxy statement.
- “Notwithstanding the foregoing, such notice must also comply with any applicable federal securities laws establish the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy.”
In the Court’s view, this last sentence applies all of the Rule 14a-8 requirements to shareholder proposals covered by this provision. In addition, Delaware law includes a “rule of construction in favor of franchise rights” which instructs the court to interpret bylaw provisions “in the manner most favorable to the free exercise of traditional electoral rights.” The Court reasoned that an advance notice bylaw provision extending the requirements of Rule 14a-8 to all shareholder proposals would “unduly restrict the stockholder franchise.” As such, the provision should be interpreted to only apply to Rule 14a-8 proposals.
Our Recommendations
It is important to note that this decision does not necessarily limit otherwise properly drafted advance notice provision bylaws. However, we recommend companies review, and if necessary amend, their advance notice bylaw provisions in light of this decision to ensure they do not include any of the defects found in the CNET provision. It may be advisable to amend the bylaws even while the case is on appeal in order to eliminate the risks this case raises. Companies incorporated outside of Delaware should also review their bylaws. In the absence of statutory or relevant case law, Delaware law could influence the outcome of similar cases filed elsewhere in the country, including states whose corporate law is based on the Model Business Corporation Act and not on Delaware law (examples include Florida, Georgia, Virginia and North Carolina).
Companies should consider the following when reviewing their advance notice bylaw provisions:
- Is the provision explicitly applicable to all shareholder proposals and nominations? If not, consider adding an explicit statement to that effect.
- Does the advance notice provision incorporate Rule 14a-8 requirements without setting them forth? If so, consider amending the provision to specify the information that must be provided to the company without reference to federal securities laws.
- Is the deadline based on the date of the company’s proxy statement? Is it more than a month ahead of the date the company typically files its proxy materials? If either is so, consider revising the deadline so it is based on the date of the annual meeting and appropriate in light of the typical schedule for preparation of a proxy statement. On this point the deadline in Rule 14a-4 regarding discretionary voting may be instructive. Rule 14a-4 confers discretionary voting authority if a company did not have notice of the matter at least 45 days before the date on which the company first sent its proxy materials for the prior year’s annual meeting date. Taking all of these matters into consideration, a deadline of not less than 60 nor more than 90 days prior to the first anniversary of the preceding year’s annual meeting date is appropriate.
- Does the provision contain language requiring management approval outside the context of Rule 14a-8 proposals? If so, consider removing the management approval requirement.
- Does the provision require a holding period for ownership of a specific amount of the company’s securities? The CNET bylaw required a shareholder to beneficially own $1,000 of securities for at least one year. While the JANA Court did not specifically indicate that this type of requirement is problematic, it may have contributed to the Court’s concern with the CNET bylaw provision. We think it is certainly appropriate to require that the shareholder own stock at the time of the proposal and at the time of the annual meeting; however, going beyond this and requiring a holding period may raise questions that the advance notice bylaw provision “unduly restricts the shareholder franchise.” If a company chooses to include a stock ownership and holding period requirement, it is advisable to look to a source other than Rule 14a-8 so that the advance notice provision is not interpreted as applying only to Rule 14a-8 proposals. One way to avoid confusion between the advance notice bylaw requirement and Rule 14a-8 is to use a threshold requirement under state law for shareholder access to records. In Virginia, for example, any shareholder who has been a shareholder of record for at least six months, or any 5% shareholder, is entitled to access records for a proper purpose.
If a public company decides to amend its advance notice bylaw provision, the company is required to disclose such amendment on a current report on Form 8-K.
As noted, the JANA case is on appeal, and could be reversed. We will continue to monitor the case and provide information on any subsequent developments to our clients and via our e-news.
McGuireWoods LLP regularly assists public and private companies with a full range of corporate governance matters, including proxy voting, drafting bylaws, director elections and other issues relating to annual meetings, shareholder relations and other matters.