Brief Fact Summary. It was argued by CA, Inc. (CA) (Plaintiff) that a bylaw amendment proposed by a CA shareholder, AFSCME (Defendant), that instructed CA’s board of directors to pay back proxy expenses, failed in being the proper subject of shareholder action and sought a no-action letter from the Securities and Exchange Commission (SEC). Two questions were certified by the SEC to the state’s highest court.
Synopsis of Rule of Law. (1) A proper subject for action by shareholders is a bylaw amendment that directs corporation’s board of directors to pay back proxy expenses.
(2)Â When a bylaw amendment, proposed by shareholders, fails to allow the directors to keep their full power to exercise their fiduciary duty in determining if reimbursement is proper and instead directs a corporation’s board of directors to pay back proxy expenses, the corporation is in violation of the law.
One of the fundamental principles of the Delaware General Corporation Law statute is that the business affairs of a corporation are managed by or under the direction of its board of directors.View Full Point of Law
Issue. (1) Is a proper subject for action by shareholders a bylaw amendment that directs corporation’s board of directors to pay back proxy expenses?
(2) When a bylaw amendment, proposed by shareholders, fails allow the directors to keep their full power to exercise their fiduciary duty in determining if reimbursement is proper and instead directs a corporation’s board of directors to pay back proxy expenses, is it in violation of the law?
Held. (Jacobs, J.) (1) Yes. A proper subject for action by shareholders is a bylaw amendment that directs corporation’s board of directors to pay back proxy expenses.Â The issue is if a bylaw like that can be passed by shareholders lacking agreement of the board.Â A legally sacrosanct power is vested in the shareholders by state law to adopt, amend, or repeal bylaws, only the legislature can alter this law. Still, the power of the shareholder is not equal with the concurrent power of the board to adopt, amend, or repeal bylaws and is restricted by the board’s management rights as per state law that state that the affairs and business of each corporation shall be managed by the direction of a board of directors. The exceptions being management is otherwise offered by law or in the certificate of incorporation. Based on this information, the concern becomes what establishes the scope of the bylaw powers of the shareholders and other provisions of the state law give the answer. As stated in one provision, any provision that is not contradictory with the law or certificate of incorporation that relates to the business of the corporation, the conduct of its affairs, and its rights or powers, or those of its stockholders, directors, officers, or employees may be contained in the bylaw. Depending on this provision, AFSCME contended that the Bylaw â€œrelates toâ€ the right of the stockholders to partake profoundly in the procedure of electing directors. It was opposed by CA, stating that this provision cannot be read separate from another, which states that the certificate of incorporation may include all provisions for the management of the business and for the conduct of the corporation’s affairs, along with any provision restricting the directors powers. Argued by CA that this statutory provision anticipates that any provision that restricts the broad statutory power of the directors needs to be included in the certificate of incorporation and that because the Bylaw restricts the substantive authority of CA’s board to make decisions, like whether to spend corporate monies for a specific reason, the Bylaw is not considered a permissible bylaw. The premise of all bylaws that could ever be seen as restricting the power of the board automatically falls outside the range of permissible bylaws is implied in this argument, if taken to the extreme though, this could be utilized to destroy shareholders’ right to pass bylaws entirely, seeing as bylaws, by definition, lay down procedures and rules binding a corporation’s board and shareholders. So, the issue is what kind of bylaws shareholders are allowed to pass without intrusion to the power of the directors’ to manage the business and affairs of the corporation. Bylaws are not to dictate how a board determines particular substantive business decisions but are to clarify the procedures and process used in the decision making, procedural bylaws like this do not intrude inappropriately upon the managerial authority of the board. In this case, while the Bylaw is written as a “substantiveÂ sounding mandate” to spend corporate funds, it intends to regulate the director electing process and so is basically a procedural bylaw. Therefore, it is an appropriate subject for shareholder action. The Bylaw could have been written to emphasize process rather than as a broad directive. Just because a bylaw requires the spending of corporate funds does not remove any of its process related characteristics. The question is answered in the affirmative.
(2) Yes. When a bylaw amendment, proposed by shareholders, fails allow the directors to keep their full power to exercise their fiduciary duty in determining if reimbursement is proper and instead directs a corporation’s board of directors to pay back proxy expenses, the corporation is in violation of the law.Â As it’s written, the bylaw could cause the directors to breach the statutory ban against contractual agreements that force the board of directors to a course of action that would prevent them from discharging their fiduciary duties in full to the corporation and its stockholders. A board is not permitted to expend corporate funds to pay back proxy expenses when they involve personnel, management or petty issues but instead when they involve a question of policy.The Bylaw, as written, would stop the directors’ from employing their fiduciary duty in a situation such as this, even though it provides directors complete discretion regarding the reimbursement amount, the range is not expansive enough seeing as it includes no provision or language to reserve to the CA’s directors their total power to employ their fiduciary duty in determining if reimbursement would be appropriate at all. Either amending CA’s certificate of incorporation to contain the Bylaw’s substance or to have the statutory law altered by the legislature is AFSCME’s only recourse. The answer to the question is in the affirmative.
Discussion. In this case, the Bylaw was interpreted as procedural by the court due to the context of the Bylaw being the process for director election. Promoting the integrity of that electoral process by enabling the nomination of director applicants by stockholders is the purpose of the Bylaw, for before the Bylaw, only board sponsored nominees for election were repaid their election expenses. Unless successful in replacing almost the entire board, dissident applicants were not, so the Bylaw would have encouraged the nomination of non-management board applicants by guaranteeing reimbursement of the nominated stockholders’ proxy expenses if one/multiple of its applicants were elected. The shareholders had a legitimate interest in the nomination of non-management applicants, as found by the court, because under the Bylaw, they could exercise their right to select candidates, without it their right to vote is worthless. One court stating, “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 closedselection process thus renders the former an empty exercise.” Harrah’s Entm’t v. JGC Holding Co., 802 A.2d 294 (Del. Ch. 2002).