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New Provision of Delaware Corporate Law Addresses Bylaw for Proxy Access
Corporate Alert

by William Gleeson, C. Kent Carlson Aaron A. Ostrovsky . April 24, 2009

The Delaware General Corporation Law (DGCL) has been amended to add a new provision addressing bylaws that provide stockholders access to a corporation’s proxy statement in order to include the stockholders’ nominees for director. This amendment is effective August 1, 2009, which means that such bylaws, if they are adopted or proposed, could be contentious issues in the 2010 proxy season.

Section 112
New Section 112 of the DGCL allows, but does not require, a Delaware corporation to adopt bylaws that provide that if the corporation solicits proxies for the election of directors, stockholders have the right to include stockholders’ nominees for director in the corporation’s proxy materials, including the form of proxy. The section allows the bylaw to include any “lawful” procedure or condition to limit the stockholders’ access to the corporation’s proxy materials and sets forth a non-exclusive list of such procedures and conditions, including the following:

• A minimum number, value, or percentage of shares owned of record or beneficially and/or duration of ownership of shares. It is unlikely that any board-adopted bylaw under Section 112 would allow the relatively low thresholds (ownership of $2,000 of stock for one year) that stockholders must satisfy under Rule 14a-8 under the Securities Exchange Act of 1934, a federal provision that allows for proxy access for shareholder proposals as opposed to nominations.
  
  Section 112 imposes no upper limits on the number, value, or percentage of shares owned or on the duration of ownership that a bylaw may set as minimum thresholds.
  
  The U.S. Securities and Exchange Commission (SEC) has twice proposed rules that would allow stockholders to propose bylaws allowing proxy access for nominations. While no rules were ever adopted, the proposals are useful reference points for assessing the outcome of the inevitable debate as to the appropriate requirements for the ownership of shares, duration of ownership, and other procedures and conditions. In 2003, the SEC proposed rules providing that if a triggering event occurred, a shareholder or group of shareholders holding 5% or more of the company’s stock for at least two years could nominate directors and the company would be required to include in its proxy materials the names of the nominees and certain information about the nominees. Under the proposed rules, triggering events were a 35% withhold vote for a company nominee or a shareholder proposal to enable proxy access for nominations that was proposed by a 1% shareholder and received 50% of votes cast. In 2007, the SEC proposed an amendment to Rule 14a-8 that would allow shareholders to include in the corporation’s proxy materials proposals to establish proxy access mechanisms for nominations if those proposals were submitted by shareholders holding at least 5% of the company’s stock for at least one year.
• A requirement that the nominating stockholder submit specified information concerning the stockholder and the stockholder’s nominees, including information concerning ownership of the corporation’s capital stock, or options or other rights in respect of or related to such stock. This provision may be seen as providing specific support for the validity of requirements in second generation advance notice bylaws that the shareholder provide information beyond the requirements of applicable federal proxy rules, including information about derivatives and 13(d) groups, as a condition of making a proposal or nomination at a stockholder meeting.
• Eligibility limitations based on the number or proportion of directors nominated by stockholders. This limitation in Section 112 could, and in all likelihood would, be used to limit proxy access to “short slates” as opposed to proxy contests for control.
• A provision precluding nominations by any person if such person, any nominee of such person, or any affiliate or associate of such person or nominee, has acquired or publicly proposed to acquire shares constituting a specified percentage of the voting power of the corporation’s outstanding voting stock within a specified period before the election of directors. Such a limitation could be used to prevent a stockholder from taking advantage of proxy access if he has proposed to acquire shares pursuant to a tender offer as a step toward a takeover but did not do so because of the failure of the board of directors to provide approval under the Delaware antitakeover statute (Section 203 of the DGCL) or to redeem a poison pill. This limitation could also be used to prevent proxy access by a stockholder who has recently purchased a block (whether or not in excess of the 15% threshold in Section 203) with a view to pressuring the company into selling to a third party.

State Corporate Law Precedent for Proxy Access for Nominations
Delaware is the second state to legislate in the area of proxy access for nominations. In 2007, North Dakota mandated for publicly traded corporations proxy access by statute (as opposed to, in the case of Delaware. permitting bylaws to be adopted requiring proxy access). The North Dakota statute provides that a shareholder or group owning 5% of the stock for a period of two years can include nominees in the corporation’s proxy statement. Under the North Dakota statute, the corporation is very limited in the information it can require from the shareholders and may not impose additional conditions and procedures on the shareholder.

The Future of Proxy Access Bylaws
There are, at this point, a number of questions about the operation and effectiveness of Section 112 that only the passage of time can answer: Will boards adopt bylaws in hopes of preempting stockholder action? If so, will the board-adopted bylaws with procedures and limitations so restrictive as to render make proxy access unavailable in practice? Will stockholders initiate proposals in the absence of board action or to overrule board-adopted bylaws deemed to be too restrictive? What types of procedures and limitations will be acceptable to the proxy advisors and the major pension funds? Will such procedures and limitations be acceptable to hedge funds or will they demand less restrictive provisions? Will proxy access bylaws lead to a higher level of activism regarding board membership? Will the major pension funds become more active in this area? Given the number of directors appointed as a result of activist pressure or elected in short slate contests, is a proxy access bylaw really necessary or useful?

It is likely that other states will follow the lead of Delaware in amending the corporation statutes to address bylaws for proxy access for nominations.

Rationale for Adoption of Section 112
Prior to the adoption of Section 112, it was unclear under Delaware law whether stockholders could adopt a proxy access bylaw because the Delaware courts had not resolved the tension between Sections 109 and 141 of the DGCL. Section 109 provides that “[a corporation’s] bylaws may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees,” and Section 141 provides “[t]he business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” The interplay of the sections is not entirely clear and as a result, prior to the new amendments, the permissible areas for stockholder-enacted bylaws were not clear.

Interplay with Rule 14a-8
Under Section 112, a proxy access bylaw can be adopted by the board of directors or the stockholders. Under the SEC’s current interpretations of Rule 14a-8, a stockholder could not take advantage of Rule 14a-8 to include in the company’s proxy statement a proposal to adopt a proxy access bylaw under Section 112. A stockholder proposing such a bylaw would be required to solicit proxies, using and paying for his own proxy materials.

Even before Delaware’s adoption of Section 112, there was considerable support within the SEC for revisiting proxy access for nominations. The adoption of Section 112 has added to impetus for such action. The chair of the SEC has indicated that in May, 2009 the SEC will propose several proxy access alternatives to allow shareholders to nominate director candidates to appear on management proxy statements. It is likely that the proposals will include a “direct access” rule and a mechanism to allow shareholders to file access bylaw proposals at companies.

Contacts:
William Gleeson, +1.206.370.5933, william.gleeson@klgates.com
C. Kent Carlson, +1.206.370.6679, kent.carlson@klgates.com