Thursday, December 02, 2010

Delaware Supreme Court Rules Invalid Corporate By-Law Prematurely Shortening Terms of Directors on Staggered Board

The full Delaware Supreme Court has ruled that a corporate by-law passed by target company shareholders at the behest of an acquiror prematurely and materially shortened the three-year terms of directors on the target company’s staggered board and was thus inconsistent with the corporate charter’s intent for directors to serve full three-year terms. It is settled Delaware law, said the Court, that a by-law that is inconsistent with the company’s charter is invalid. The by-law was also invalid because, although it passed, it did not receive the vote of 67 percent of the shareholders required by the charter to amend the staggered board provision or to adopt any bylaw inconsistent with that provision. The Court reasoned that the by-law thus represented the de facto removal of the directors without cause. (Airgas, Inc. v. Air Products and Chemicals, Inc., Del S Ct, No. 649, 2010, Nov. 23, 2010).

The by-law change occurred in the heat of a takeover attempt. After its bids were rejected by the target company’s board, the acquiror company tried to facilitate its takeover attempt by engaging in a proxy contest at the target’s last annual meeting. The target has a board with nine directors, and three were up for election at that meeting. A staggered board, which Delaware law has permitted for over a century, enhances the bargaining power of a target company and makes it more difficult for an acquiror to gain control without board consent. The acquiror elected three members to the target’s board and then proposed a by-law, adopted by the shareholders, that moved up the next annual meeting and effectively reduced the terms of three incumbent directors by eight months.

To implement Section 141 of the Delaware corporation code which allows companies to have staggered boards, many companies provide in their charters that each class of directors serves until the annual meeting of stockholders to be held in the third year following the year of their election, which the en banc Court called the ``annual meeting term alternative.’’ Other companies select a ``defined term alternative’’ under which the charter flatly states that each class of directors must serve for three years. The target company here used the annual meeting term alternative.

Although the Delaware Supreme Court has never been called upon to interpret the annual meeting term alternative specifically, the Delaware cases that have involved similar charter language regard that language as creating a staggered board with classes of directors who serve full three year terms. A federal judge construing Delaware law reached the same conclusion.

The Supreme Court recognized that Delaware corporations have some latitude in setting the date for an annual meeting under Section 211 of the Corporation Code. Thus, a director’s term may properly expire at an annual meeting even though that director only served approximately three years rather than exactly three years. In this case, however, the Court did not have to decide the parameters of an approximate term of three years because twenty-eight months is not approximately three years.

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