Delaware Supreme Court Answers Certified SEC Shareholder Proposal Questions
In the first test of a new process allowing the SEC to certify questions to the Delaware Supreme Court, the Court said that, while a shareholder proxy proposal requiring the company to reimburse the reasonable expenses incurred by stockholders running a slate of director nominees is a proper subject for action by shareholders under Delaware law, the proposal’s adoption would cause the company to violate Delaware law. Justice Jacobs wrote the opinion for the full Delaware Supreme Court.
A change in the Delaware Constitution allows the SEC to certify questions to the Court. The provision is effected by Rule 41 of the Court’s rules. As required by the rule, the Court found that there were important and urgent reasons for an immediate determination of the questions the SEC certified. The Court cited Rule 41(b), which suggests that unsettled questions relating to a state statute should be certified.
The company asserted that it could exclude the shareholder proposal from its 2008 proxy materials in reliance on two bases provided by the SEC proxy rules. The first ground for exclusion is that the proposal is an improper subject for shareholder action under Delaware law. (Rule 14-8(i)(1), which allows exclusion if the proposal is not a proper subject for shareholder action under laws of the state of the company’s organization). The second basis for exclusion is that, if adopted, the proposal would cause the company to violate Delaware law. (Rule 14a-8(i)(2), which allows exclusion if the proposal’s implementation would cause the company to violate any state law to which it is subject).
On the first question, the Court ruled that, even though infelicitously couched as a substantive-sounding mandate to expend corporate funds, the proposal had the intent of regulating the process for electing directors and was thus a proper subject for shareholder action. The court noted that the process for electing directors is a subject in which shareholders of Delaware corporations have a legitimate and protected interest.
Further, the shareholders of a Delaware company have the right to participate in selecting the contestants for election to the board. They are entitled to facilitate the exercise of that right by proposing a bylaw encouraging candidates other than board-sponsored nominees to stand for election. The bylaw would accomplish that by committing the company to reimburse the election expenses of shareholders whose candidates are successfully elected. That the implementation of that proposal would require the expenditure of corporate funds will not, in and of itself, make such a bylaw an improper subject matter for shareholder action.
But since the directors would breach their fiduciary duties if they complied with the bylaw, continued the court, it would violate the prohibition against contractual arrangements that commit the directors to a course of action that would preclude them from fully discharging their fiduciary duties to the company and its shareholders. This binding bylaw imposed involuntarily on the directors in the specific area of election expense reimbursement is one that would also prevent the directors from exercising their full managerial power in circumstances where their fiduciary duties would otherwise require them to deny reimbursement to a dissident slate.
That such circumstances could arise is not far fetched. Under Delaware law, a board may expend corporate funds to reimburse proxy expenses when the controversy is concerned with a question of policy. But in a situation where the proxy contest is motivated by personal or petty concerns, or to promote interests that do not further or are adverse to, those of the company, the board’s fiduciary duty could compel that reimbursement be denied altogether. Such a circumstance could arise, for example, if a shareholder group affiliated with a competitor of the company were to cause the election of a minority slate of candidates committed to using their director positions to obtain, and then communicate, valuable proprietary strategic or product information to the competitor.