Corporations Flashcards
(10 cards)
Summary
The voting and litigation rights of the shareholders of Mega are subject to the provisions of the Model Business Corporations Act (MBCA).
The investor’s proposed bylaw provision is not inconsistent with state law. Under the MBCA, shareholders may amend the bylaws when the amendment deals with a proper matter for the corporation’s bylaws, such as procedures for nominating directors.
The Mega board’s bylaw amendment does not preempt the investor’s proposed bylaw provision or the Mega shareholders’ power to approve it. While shareholders can limit the board’s power to amend or repeal the bylaws, the board cannot limit the shareholders’ power.
Whether the investor must make a demand on Mega’s board depends on how the investor frames its claim. If the investor claims a violation of shareholder voting rights, the claim is direct and pre-suit demand on the board is not required. If, on the other hand, the investor claims that the directors violated their fiduciary duties by amending the bylaws to entrench themselves, the claim is derivative and a pre-suit demand is required.
Do shareholders have the authority to amend a corporation’s bylaws with respect to director nominations?
Shareholders may amend the corporation’s bylaws where the proposed bylaw provision relates to procedural matters typically included in the bylaws, such as the nomination of directors.
Rule
Internal affairs of the corporation, such as the conduct of shareholder meetings and election of directors, are subject to the corporate law of the state of incorporation. See McDermott Inc. v. Lewis,531 A.2d 206 (Del. 1987) (applying law of jurisdiction where corporation was incorporated in case involving voting rights). This state’s corporate statute ismodeled on the MBCA.
Under the MBCA, “shareholders may amend . . . the corporation’s bylaws.” MBCA § 10.20(a). Thus, the only question is whether the bylaws can specify the procedures for shareholder nomination of directors.
The MBCA states that the bylaws “may contain any provision that is not inconsistent with law or the articles of incorporation.” MBCA § 2.06(b). In addition, the MBCA was revised in 2009 to address shareholder nomination of directors in public corporations (known as “proxy access”) and specifies that the bylaws “may contain . . . a requirement that . . . the corporation include in its [proxy materials] one or more individuals nominated by a shareholder.” MBCA § 2.06(c)(1); see Committee on Corporate Laws, ABA Section of Business Law, Report on the Roles of Boards of Directors and Shareholders of Publicly Owned Corporations and Changes to the Model Business Corporations Act—Adoption of Shareholder Proxy Access Amendments to Chapters 2 and 10, 65 BUS. LAWYER 1105 (2010).
Application
The inclusion of director-nomination procedures in the bylaws is consistent with practice and is recognized by the Delaware courts, whose views on corporate law carry significant weight. Typically, the procedures for nomination of directors are found in the bylaws. See 1 COX & HAZEN,TREATISEON THE LAWOF CORPORATIONS § 3.12 (3d ed. 2011); see also 4 FLETCHER, CORP. FORMS ANN. PART III, ch. 21 (2013) (including sample bylaws that permit nomination of directors by shareholders). The Delaware Supreme Court has confirmed that the bylaws may “define the process and procedures” for director elections. See CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227 (Del. 2008) (concluding that bylaw amendment requiring reimbursement of election expenses to certain successful shareholder nominators is “proper subject” under Delaware law).
[NOTE: The question of the proper scope of the bylaws can be answered using the more general MBCA § 2.06(b) or the 2009 MBCA revision adding § 2.06(c)(1) (adopted in CT, ME, VA). In addition, some examinees might raise the point that shareholder proposals may not compel the board to take action, such as by including shareholder nominations in the company’s proxy materials, on the theory that the “business and affairs” of the corporation are to be managed by the board. See MBCA § 8.01(b). Although shareholders are generally limited to adopting precatory resolutions that recommend or encourage board action, this limitation does not apply when shareholders have specific authority to take binding action on their own—such as to amend the bylaws.]
Do board-approved bylaws on a particular subject, here nomination of directors, preempt subsequent conflicting bylaw amendments by shareholders?
Shareholders can amend (or repeal) board-approved bylaws. Further, shareholders can limit the board’s power to later amend and repeal a shareholder-approved bylaw.
Rule
Under the MBCA, shareholders have the power to amend the bylaws. See Point One. The board shares this power with the shareholders, unless (1) the corporation’s articles “reserve that power exclusively to the shareholders” or (2) “the shareholders in amending, repealing, or adopting a bylaw expressly provide that the board of directors may not amend, repeal, or reinstate that bylaw.” See MBCA § 10.20(b).
Shareholder-approved bylaw provisions can amend or repeal existing bylaw provisions, whether originally approved by the board or by shareholders. See ALAN R.PALMITER,CORPORATIONS: EXAMPLESAND EXPLANATIONS § 7.1.3 (7th ed. 2012). Thus, the Mega board’s bylaw amendment—which set more demanding thresholds for shareholder nomination of directors than the investor’s proposed bylaw provision—would be superseded (repealed) if Mega’s shareholders were to approve the investor’s proposal.
Further, a shareholder-approved bylaw generally can limit the power of the board to later amend or repeal it. See MBCA § 10.20(b)(2). Thus, if Mega’s shareholders approved the bylaw provision proposed by the investor, Mega’s board could not repeal the provision because it includes a “no board repeal” clause.
Application
The revision to the MBCA in 2009 dealing with shareholder proxy access does not change this conclusion. That revision specifies that a shareholder-approved bylaw dealing with director nominations may not limit the board’s power to amend, add, or repeal “any procedure or condition to such a bylaw in order to provide for a reasonable, practicable and orderly process.” MBCA § 2.06(d). Thus, according to the revision, if shareholders approve a bylaw amendment that limits further board changes, the board would nonetheless retain the power to “tinker” with the bylaw to safeguard the voting process, but could not repeal the shareholder-approved bylaw. The Official Comment to MBCA § 2.06(d) makes clear that the revision is “not intended to allow the board of directors to frustrate the purpose of the shareholder-adopted proxy access . . . provision.” Thus, if Mega’s shareholders were to approve the bylaw provision proposed by the investor, Mega’s board could only amend the provision regarding its procedures or conditions in a manner consistent with its purpose of permitting proxy access for Mega’s shareholders.
[NOTE: The board’s attempted interference with a shareholder voting initiative may also have been a violation of the directors’ fiduciary duties. See Blasius Indus., Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988) (finding that directors breached their fiduciary duties by amending bylaws and expanding size of board to thwart insurgent’s plan to amend bylaws and seat a majority of new directors). The call, however, asks examinees to consider whether shareholders or the board have “precedence” over amending the corporate bylaws. Thus, an examinee’s answer should be framed in terms of “power” and not “duty.”]
Is a suit challenging both management’s refusal to include the proposed bylaw amendment in Mega’s proxy statement and the board’s amendment of the bylaws dealing with nomination of directors a direct or derivative suit?
The investor need not make a demand on the board if the investor states a direct claim, such as an allegation that the board interfered with the investor’s right to amend the bylaws. But the investor must make a demand on the board if the investor states a derivative claim (on behalf of the corporation), such as an allegation that the directors sought to entrench themselves by interfering with the proposed proxy access.
Rule
The MBCA generally requires that shareholders make a demand on the board of directors before initiation of a derivative suit. MBCA § 7.42 (shareholder may not bring derivative proceeding until written demand has been made on corporation and 90 days have expired). A derivative suit is essentially two suits in one, where the plaintiff-shareholder seeks to bring on behalf of the corporation a claim that vindicates corporate rights, usually based on violation of fiduciary duties. PALMITER, supra, § 18.1.1 (6th ed. 2009). The demand permits the board to investigate the situation identified by the shareholder and take suitable action. No demand on the board is required, however, if the shareholder brings a direct suit to vindicate the shareholder’s own rights, not those of the corporation.
Is the suit brought by the investor derivative or direct? The MBCA defines a “derivative proceeding” as one brought “in the right of a domestic corporation.” MBCA § 7.40(1). Thus, the answer to how the investor’s suit should be characterized turns on what rights the investor seeks to vindicate. If the investor frames its claim as one of fiduciary breach by directors—for example, for failing to become adequately informed about voting procedures or for seeking to entrench themselves in office by manipulating the voting structure to avoid a shareholder insurgency—then the suit is “derivative” and the investor must make a demand on the board. See MBCA Ch. 7, Subch. D Introductory Comment (“the derivative suit has historically been the principal method of challenging allegedly illegal action by management”).
Application
If, however, the investor frames its claim as one to vindicate shareholder rights, the suit is direct and no demand is required. For many courts, the direct-derivative question turns on who is injured and who is to receive the relief sought by the plaintiff-shareholders. SeeTooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) (characterizing a merger-delay claim as directbecause delay of merger only harmed shareholders, not corporation). Thus, if the investor claims that management’s refusal toinclude its proposed bylaw amendment in the corporation’s proxy materials violates its shareholder rights to initiate corporate governance reforms, the suit will be direct. Courts have not questioned the ability of shareholders to bring direct suits challenging board action to exclude their proposed bylaw amendments from the corporation’s proxy materials. See JANA Master Fund, Ltd. v. CNET Networks, Inc., 954 A.2d 335 (Del. Ch. 2008) (upholding shareholder’s direct challenge to board’s interpretation of advance-notice bylaw); Chesapeake Corp. v. Shore, 771 A.2d 293 (Del. Ch. 2000) (upholding shareholder’s direct challenge to actions by board that effectively prevented it from proposing bylaw amendments in contest for control).
Is the way that the investor frames its claim conclusive? Courts have permitted shareholder-plaintiffs to challenge a transaction in a direct suit, even though the same transaction could also be challenged as a fiduciary breach. See Eisenberg v. Flying Tiger Line, Inc., 451 F.2d 267 (2d Cir. 1971) (permitting direct suit challenging a corporate reorganization as a dilution of shareholder voting power, even though reorganization may have involved conflicts of interest and thus constituted a fiduciary breach). Thus, the investor’s choice to pursue a claim challenging the legality of management’s decision to exclude the investor’s proposal from the corporation’s proxy materials—rather than a possible breach of fiduciary duty—is likely to be respected. See 3 COX &HAZEN,supra, § 15.3 (describing situations in which a claim can be framed as derivative or direct).
[NOTE:Some issues under Delaware corporate law regarding pre-suit demand are not relevant here. For example, whether the Mega directors are independent and disinterested is not relevant to the MBCA requirement of a pre-suit demand. As the Official Comment to MBCA § 7.42 points out, the MBCA’s requirement of “universal demand” gives the board “the opportunity to reexamine the act complained of in the light of a potential lawsuit andtake corrective action,” even when the directors might be non-independent or have conflicts of interest.
Nor is it relevant to the MBCA pre-suit demand requirement that the statutory 90-day waiting period may be onerous. The first paragraph of MBCA § 7.42 requires a pre-suit demand without exception; the second paragraph of the section imposes a 90-day waiting period before a derivative suit may be brought, which can be shortened if the board rejects the demand or “irreparable injury to the corporation would result by waiting for the expiration of the 90-day period.” The call, as written, asks only whether a pre-suit demand should be made and does not ask examinees to address whether the post-demand waiting period should be shortened under the “irreparable injury” standard.]
