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August 2008 No. 9
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Delaware Supreme Court Holds That a Bylaw
Mandating Reimbursement of a Dissident Shareholder’s
Proxy Solicitation Expenses Is a Proper Subject for Unilateral
Shareholder Action but as Proposed Violates Delaware Law
On July 17, 2008, the Supreme Court of the State of
Delaware, in CA, Inc. v. AFSCME Employees Pension Plan,1
issued its first decision arising from the certification by the
Securities and Exchange Commission (SEC) to the court
of questions of Delaware law.2 In that case, the court
ruled that a bylaw that had been proposed by a shareholder for consideration and approval by the other shareholders that would require the company to reimburse a
dissident shareholder for its expenses incurred in connection with nominating a “short” slate of candidates (a slate
of director candidates that would not comprise a majority
of the board of directors if so elected) and soliciting proxies in support of their election to the company’s board of
directors, as proposed, is a proper subject for shareholder
action. In so ruling, the court held that the process for
electing directors is a subject in which shareholders of
Delaware corporations have a legitimate and protected
interest and that shareholders are entitled to propose a
bylaw that facilitates the ability of shareholders “to participate in selecting contestants for election to the Board”3
by encouraging “candidates other than board-sponsored
nominees to stand for election.”4 Notwithstanding its conclusion that the proposed bylaw was a proper subject for
shareholder action, the court held that it would nevertheless violate Delaware law if enacted by the company’s
shareholders because the proposed bylaw would, in the
court’s view, “require a board to act or not act in such a
fashion that would limit the exercise of their fiduciary
duties,”5 and because the proposed bylaw “contains no
language or provision that would reserve to [ ] directors
their full power to exercise their fiduciary duty to decide
whether or not it would be appropriate, in a specific case,
to award reimbursement at all.”6
Background
On March 13, 2008, the Employees Pension Plan of
the American Federation of State, County, and Municipal
Employees (AFSCME) notified CA, Inc. (CA) that, pursuant to Rule 14a-8 under the Exchange Act,7 it planned to
present a proposal at CA’s 2008 Annual Meeting of
Shareholders and, accordingly, was seeking to have such a
proposal included in CA’s 2008 Annual Meeting Proxy
Statement and on the related proxy card. AFSCME’s proposal was to have shareholders adopt the following
amendment to CA’s bylaws:
RESOLVED, that pursuant to section 109 of the Delaware
General Corporation Law and Article IX of the bylaws of
CA, Inc., shareholders of CA hereby amend the bylaws to
add the following Section 14 to Article II:
“The board of directors shall cause the corporation to reimburse a shareholder or group of shareholders (together, the
“Nominator”) for reasonable expenses (“Expenses”)
incurred in connection with nominating one or more candidates in a contested election of directors to the corporation’s
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board of directors, including, without limitation, printing, mailing, legal, solicitation, travel, advertising and public relations
expenses, so long as the election of fewer than 50% of the directors
to be elected is contested in the election, (b) one or more candidates
nominated by the Nominator are elected to the corporation’s
board of directors, (c) shareholders are not permitted to cumulate
their votes for directors, and (d) the election occurred, and the
Expenses were incurred, after the bylaw’s adoption. The amount
paid to a Nominator under this bylaw in respect of a contested
election shall not exceed the amount expended by the corporation
in connection with such election.”
In the supporting statement that was included in its letter
to CA, AFSCME attributed the scarcity of short-slate
proxy contests (contests where the slate of director candidates would not comprise a majority of the board if so
elected) to the unavailability, as a practical matter, of reimbursement of direct election campaign expenses for such
proxy contests.8 As AFSCME noted, since a company’s
board of directors approves the reimbursement of expenses incurred by the dissident shareholder in connection
with its direction election campaign, such expenses are, as
a practical matter, only reimbursed when the dissident is
seeking control of the board and is successful in electing
at least a majority of the directors.9
On April 18, 2008, CA notified the staff of the SEC
that it was proposing to exclude the shareholder proposal
that it received from AFSCME from its 2008 annual meeting proxy statement and the related proxy card under various grounds provided for under Rule 14a-8 of the
Exchange Act and asking the staff to confirm in a noaction letter that it would not recommend any enforcement action to the SEC if CA did so exclude such proposal.10 CA cited the following grounds for excluding
AFSCME’s proposal:
1. That the proposal conflicts with the SEC’s proxy
rules, particularly Rule 14a-7, which requires shareholders
to bear the cost of mailing their own proxy solicitation
materials, and, accordingly, may be excluded under Rule
14a-8(i)(3)11;
2. That the proposal relates to a procedure for the
election of directors and, accordingly may be excluded
under Rule 14a-8(i)(8)12;
3. That the proposal was not a proper subject for
action by shareholders under the laws of the State of
Delaware, CA’s jurisdiction of organization, and, accordingly, may be excluded under Rule 14a-8(i)(1)13; and
4. That the proposal would, if implemented, cause
CA to violate the Delaware General Corporation Law
(DGCL) and, accordingly, may be excluded under Rule
14a-8(i)(2).14
On June 27, 2008, the Office of the Chief Counsel of
the SEC’s Division of Corporation Finance responded to
CA’s no-action letter request and indicated that it was
unable to concur with CA’s view that it could exclude
AFSCME’s proposal from its proxy materials in reliance
on either Rule 14a-8(i)(3) (the argument being that the
proposal conflicts with the proxy rules) or Rule 14a-8(i)(8)
(the argument being that that proposal relates to a procedure for the election of directors).15 However, with respect
to the other grounds cited by CA for excluding
AFSCME’s proposal, which relate to issues of Delaware
law, the SEC, taking advantage, for the first time, of its
ability to have the court hear and determine questions of
Delaware law, certified to the court the following questions of law:
1. Is the AFSCME proposal a proper subject for
action by shareholders as a matter of Delaware law?
2. Would the AFSCME proposal, if adopted, cause
CA to violate any Delaware law to which it is subject?
In its decision, the court addressed each question separately.
QUESTION 1: Is the AFSCME Proposal a Proper
Subject for Action by Shareholders as a Matter
of Delaware Law?
In beginning its analysis of the first question presented, the court parsed this question as being whether the
bylaw proposed by AFSCME could be enacted by shareholders without the concurrence of the CA’s board of
directors or, in other words, what is the lawful scope of the
shareholders’ power to unilaterally adopt, amend, and
repeal bylaws. While, pursuant to Section 109(a)16 of the
DGCL, both the shareholders of CA and the board are
empowered to concurrently adopt, amend, and repeal the
bylaws, the court noted that “. . . the DGCL has not allocated to the board and the shareholders the identical, coextensive power to adopt, amend, and repeal the bylaws.”17
According to the court, the shareholders’ power to adopt,
amend, or repeal bylaws pursuant to Section 109(a) of the
DGCL must be reconciled with Section 141(a) of the
DGCL which provides in relevant part as follows:
The 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.
CA had attempted to argue that since, pursuant to Section
141(a), the board possesses the full power and authority to
manage the business and affairs of the company except as
otherwise provided for in such statutory provision, any
shareholder-proposed bylaw that attempts to dilute or
limit such power and authority is not permissible.18 That
is, unless such a limitation of power or authority is includ-
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ed in the company’s certificate of incorporation, it is not
valid. The court was not prepared to accept CA’s proposed line of demarcation with respect to the permissibility of shareholder-proposed bylaws. As the court noted:
. . . Section 109(a) carves out an area of shareholder power
to adopt, amend or repeal bylaws that is expressly inviolate.
Therefore, to argue that the Bylaw at issue here limited the
board’s power to manage the business and affairs of the
Company only begins, but cannot end, the analysis needed to
decide whether the Bylaw is a proper subject for shareholder
action.19
Rather, the court sought to reframe the issue in terms of
whether the proposed bylaw “establishes or regulates a
process for substantive director decision-making, or one
that mandates the decision itself.”20 That is, if the bylaw is
purely procedural in nature, and does not predetermine
the decision for the board, it would not be seen as impermissibly interfering with the board’s power and authority
to manage the business and affairs of the company. As the
court noted:
It is well-established Delaware law that a proper function of
bylaws is not to mandate how the board should decide specific substantive business decisions, but rather, to define the
process and procedures by which those decisions are made.21
The court’s opinion is replete with examples of processoriented bylaws or provisions (e.g., the number of directors on the board, the number of directors required for a
quorum, vote requirements for certain board actions, the
date and place of the annual meeting, conditions for the
calling of special meetings of shareholders, etc.) that do
not improperly encroach upon the board’s managerial
authority under Section 141(a) and, accordingly, are
appropriate for shareholders to propose. Before concluding that the proposed bylaw is a proper subject for shareholder action, the court takes a somewhat tortuous path to
concluding that the proposed bylaw does not mandate a
specific decision by the board and, instead, is actually a
purely procedural bylaw that does not improperly
encroach upon a board’s managerial authority. The court
concedes that the bylaw is “infelicitously couched as a
substantive-sounding mandate” to expend corporate
funds.”22 Nevertheless, the court indicates that the wording of the bylaw, “although relevant, is not dispositive of
whether or not it is process-related” since it could have
been worded differently “to emphasize its process, as distinguished from its mandatory payment component.”23
The court also suggests that a bylaw will not be disqualified as being process-related solely on the basis that it
requires the expenditure of corporate funds.24 In addition
to looking past the proposed bylaw’s mandate to expend
corporate funds and the substantive-sounding nature of
the bylaw, the court adopts a rather broad perspective of
the proposed bylaw in assessing whether it is process-related. “Whether or not a bylaw is process-related must necessarily be determined in light of its context and purpose.”25 Applying its broad perspective of the context and
purpose of the proposed bylaw, the court concludes that
the proposed bylaw had “both the intent and effect of regulating the process for electing directors of CA” by facilitating the ability of shareholders “to participate in selecting contestants for election to the Board”26 and by encouraging “candidates other than board-sponsored nominees
to stand for election.”27 Accordingly, the court held that
the proposed bylaw, being one that relates to the process
of electing directors, is a proper subject for unilateral
shareholder action.28
QUESTION 2: Would the AFSCME Proposal, If
Adopted, Cause CA to Violate Any Delaware
Law to Which It Is Subject?
Having concluded that AFCME’s proposed bylaw
was an appropriate subject for unilateral shareholder
action and that it did not invade the exclusive managerial
authority of the board as provided for under the DGCL,
the next question for the court to answer was whether the
proposed bylaw, if adopted, would cause CA to violate
any Delaware law to which it is subject. The court likened
the proposed bylaw to contractual arrangements (e.g., “noshop” provisions in merger agreements, delayed redemption provisions in shareholder rights plans or “poison
pills,” etc.) that have been invalidated by the court
because they commit the board of directors to take or not
take specific actions, and that prevent the board from taking or not taking other actions, that would otherwise be
required for the board to fully discharge its fiduciary
duties.29 The court articulated a number of situations
where it envisioned that the board’s fiduciary duties could
compel that reimbursement of a dissident shareholder’s
proxy contest expenses be denied and yet the board would
have “contracted” away its right to exercise its discretion
to so act. As the court noted:
It is in this respect that the proposed Bylaw, as written would
violate Delaware law if enacted by CA’s shareholders. As
presently drafted, the Bylaw would afford CA’s directors full
discretion to determine what amount of reimbursement is
appropriate, because the directors would be obligated to grant
only the “reasonable” expenses of a successful short slate.
Unfortunately, that does not go far enough, because the
Bylaw contains no language or provision that would reserve
to CA’s directors their full power to exercise their fiduciary
duty to decide whether or not it would be appropriate, in a
specific case, to award reimbursement at all.30
Accordingly, the court concluded that the proposed
bylaw, as written, would violate Delaware law, if enacted
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by CA’s shareholders. Implicit in the court’s holding was
that the proposed bylaw may have been acceptable if there
were included therein language, similar to what is common today in a merger agreement’s “no-shop” provision,
providing that reimbursement of the dissident’s expenses
is mandatory except where the board determines in good
faith that such reimbursement would cause the board to
breach its fiduciary duties to the company’s shareholders.
In addition, the court indicates, in the second-to-last sentence of its decision, that the substance of the proposed
bylaw would have also been permissible under Delaware
law if it were enacted as an amendment to CA’s certificate
of incorporation.31
bylaws that have the “the intent and effect of regulating
the process for electing directors” are process-oriented,
and accordingly are a proper subject for shareholder
action.35 Nevertheless, the court avoids articulating with
“doctrinaire exactitude” a bright line that divides those
bylaws that shareholders may unilaterally adopt from
those which they may not since they would encroach
upon the board’s power and authority to manage the business and affairs of the company. As the court noted:
We do not attempt to delineate the location of that bright line
in this Opinion. What we do hold is case specific; that is,
wherever may be the location of the bright line that separates
the shareholders’ bylaw-making power under Section 109
from the directors’ exclusive managerial authority under
Section 141(a), the proposed Bylaw at issue here does not
invade the territory demarcated by Section 141(a).36
While Decision Can Be Seen as a Significant
Victory for Dissident and Activist Shareholders,
It Leaves Many Questions Unanswered
In holding that a bylaw that has “the intent and effect
of regulating the process for electing directors” is a proper
subject for shareholder action32 and that shareholders are
entitled to facilitate the exercise of their right to “participate in selecting the contestants for election to the
board”33 by proposing a bylaw that would encourage candidates other than board-sponsored nominees to stand for
election,”34 the court has delivered a significant victory to
dissident and activist shareholders. As a result of this decision, activist shareholders may be emboldened to make
bylaw proposals that facilitate their future proxy contests
against a company, particularly in the context of staggered
or classified boards, where it may take at least two successive annual meetings to obtain sufficient representation
on a company’s board of directors to claim and assert control over the company. While the court ultimately concludes that the proposed bylaw provision mandating reimbursement of a dissident’s proxy contest expenses, if
adopted, would violate Delaware law, it suggests that if the
proposed bylaw contained a “fiduciary out,” a different
result would have ensued. Accordingly, we can expect to
see such a bylaw, as enhanced by the “fiduciary out” reappear in the near future, either as a Rule 14a-8 proposal or
in connection with a proxy contest.
Notwithstanding the significant victory provided to
shareholder activists, the court’s decision does leave many
questions unanswered about the line of demarcation
between permissible bylaw proposals and bylaw proposals
that would be invasive of the Board’s prerogatives to manage the business and affairs of the corporation. As discussed above, the court is willing to carve out procedural
or “process-oriented” bylaws as being types of bylaws that
do not “improperly encroach upon the board’s managerial authority” under the DGCL and is willing to hold that
Accordingly, while we now know that a dissident or other
activist shareholders can unilaterally propose process-related bylaws, which the court holds as including, among others, bylaws that (i) have the “intent and effect of regulating the process for electing directors,”37 or (ii) encourage
candidates other than board-sponsored nominees to stand
for election,38 and that bylaws that mandate the expenditure of funds are not “automatically deprived of their
process-related character,”39 the court deliberately leaves us
with little clarity and certainty as to how to discern
whether a given bylaw is one that is process-related
because it “establishes or regulates a process for substantive director decision-making” and, therefore, is appropriate to be proposed by shareholders, or is one that by mandating the decision is necessarily substantive and, therefore, would be invasive of the managerial prerogatives of
the board. In addition, we are not aided in our quest for
clarity by the court’s tortuous and attenuated path in casting AFSCME’s proposed bylaw as being process-oriented,
even though the court itself concedes that the proposed
bylaw is worded as a substantive-sounding mandate. The
framework created by the court for analyzing the permissibility of shareholder-proposed bylaws will likely have the
effect of creating more questions (and future certifications
of questions of law from the SEC to the court). Given the
substantial number of bylaw amendments that are proposed each year by dissident shareholders, pursuant to
Rule 14a-8, for inclusion in the proxy statements of public companies, the SEC is likely to have its work cut out
for it in deciding whether to concur with a company’s
view that a given bylaw amendment proposal may be
excluded from the company’s proxy statement on the
basis that it is not a proper subject for action by shareholders under applicable law since it fails to meet the
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“test” of being a bylaw that “establishes or regulates a
process.” One can expect that dissident shareholders will
take extra care to wordsmith and couch their bylaw
amendment proposals as either “having the intent and
effect of regulating the process for electing directors” or to
emphasize their procedural nature and deemphasize any
hint that they are, in the least part, substantive in nature
or can be construed as mandating a specific decision.
While this decision represented the first time that the SEC
certified issues of law to the Delaware Supreme Court, it
would not be surprising if the SEC returned to the court
in the very near future for additional clarity on the demarcation between permissible and impermissible bylaw proposals, particularly those that arise in the context of Rule
14a-8 proposals.
Conclusion
As noted above, this case represented the first time
that the SEC certified questions of law for the court to
hear and determine. It would be difficult for anyone not
to be extremely impressed with the court’s ability to issue
its opinion on two complicated issues of law in less than
three weeks after first receiving the SEC’s certification.
Given this new resource that has been made available to
the SEC, the larger question raised by this case is how frequently and under what circumstances will the SEC now
turn to the court to hear and determine questions of law
and under what circumstances will the court accept such
questions on the basis that “that there are important and
urgent reasons for an immediate determination of such
questions by it.”40 Barry H. Genkin & Keith E. Gottfried
1. CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008 (Del. Sup.
Ct. July 17, 2008).
2. In 2007, the Delaware Constitution was amended to authorize the
Securities and Exchange Commission to bring critical and urgent questions concerning Delaware law to the Delaware Supreme Court. The
amendment is intended to provide the SEC with access to expedited
decisions and greater certainty with regards to matters of Delaware corporate law. Previously, only federal courts and other state supreme courts
were able to certify questions of law to Delaware’s Supreme Court. 76
Del. Laws 2007, ch 37, § 1, effective May 3, 2007.
3. CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008, at 17.
4. Id. at 17.
5. Id. at 19.
6. Id. at 23.
6. Rule 14a-8 provides the circumstances under which a company must
include a shareholder’s proposal in its proxy statement and identify the
proposal in its form of proxy when the company holds an annual or special meeting of shareholders. In order to be eligible to submit a proposal, a shareholder must have continuously held at least $2,000 in market
value, or 1%, of the company’s securities entitled to be voted on the
proposal at the meeting for at least one year by the date the proposal is submitted and must continue to hold those securities through the date of the
meeting. Under specified circumstances, the company is permitted to
exclude the shareholder’s proposal from its proxy statement and the related proxy card, but only after submitting its reasons to the SEC and requesting a no-action letter from the staff of the SEC that it would not recommend enforcement action to the SEC if the proposal were excluded for the
stated reasons.
8. Letter from Gerald W. McEntee, Chairman, American Federation of
State, County, and Municipal Employees, to CA, Inc., attaching a shareholder proposal pursuant to Rule 14a-8 of the Securities Exchange Act
of 1934 (March 13, 2008), at 2.
9. Id. at 2.
10. Letter from Sullivan & Cromwell LLP, on behalf of CA, Inc., to the
Office of the Chief Counsel, Division of Corporation Finance,
Securities and Exchange Commission (April 18, 2008).
11. Id. at 8–9.
12. Id. at 3–6.
13. Id. at 6–8.
14. Id. at 6–8.
15. Response of the Office of Chief Counsel of the SEC’s Division of
Corporation Finance of the SEC (June 27, 2008).
16. Section 109(a) of the DGCL provides as follows: “The original or other
bylaws of a corporation may be adopted, amended or repealed by the
incorporators, by the initial directors if they were named in the certificate of incorporation, or, before a corporation has received any payment
for any of its stock, by its board of directors. After a corporation has
received any payment for any of its stock, the power to adopt, amend or
repeal bylaws shall be in the stockholders entitled to vote, or, in the case
of a nonstock corporation, in its members entitled to vote; provided,
however, any corporation may, in its certificate of incorporation, confer
the power to adopt, amend or repeal bylaws upon the directors or, in the
case of a nonstock corporation, upon its governing body by whatever
name designated. The fact that such power has been so conferred upon
the directors or governing body, as the case may be, shall not divest the
stockholders or members of the power, nor limit their power to adopt,
amend or repeal bylaws.”
17. CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008, at 6.
18. Legal Opinion Letter of Richards, Layton & Finger to CA, Inc. (April
17, 2008), at 3.
19. CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008, at 11.
20. Id. at 14.
21. Id. at 12.
22. CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008, at 14.
23. Id. at 15.
24. Id. at 15–16.
25. Id. at 16.
26. CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008, at 17.
27. Id. at 17.
28. Id. at 14.
29. Id. at 19–20.
30. Id. at 23.
31. Id. at 24.
32. Id. at 14.
33. Id. at 17.
34. Id. at 17.
35. Id. at 14.
36. Id. at 12.
37. Id. at 14.
38. Id. at 17.
39. Id. at 15.
40. DEL. CONST. art. IV, § 11(8).
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