Proposed Amendments to the Delaware General Corporation Law and the Resulting Reduction in Shareholder Rights

Legislative proposals for changing the General Corporation Law of Delaware have been submitted to the Corporation Law Section of the Delaware State Bar Association for approval.  To the extent approved, they will be submitted to the legislature for approval.  The expectation is that they will become effective on August 1, 2009.

There are a number of posts that warrant particular mention but we will for now discuss one of them.  The amendments would add a new § 112 to permit the adoption of bylaws that will require companies to include shareholder nominees in their proxy statement.  At first blush, this looks like a good thing for shareholders but a bit closer examination reveals that it is designed to undercut shareholder rights.

The Section, however, specifies that the bylaw may include limits on those who can submit nominees and provides a "nonexclusive" list of the limits.  They include:

• require ownership of a minimum number of shares or a minimum duration of ownership;
• require that specified information be provided about the nominee;
• condition eligibility on the number of directors nominated or whether the same shareholders have submitted nominees in the past; 
• prohibit nominees from those seeking to acquire control; and
• require the nominating shareholder to provide indemnification for any loss arising out of false information submitted by the nominating shareholder. 

In considering the impact of this provision, it is necessary to consider its impact on the federal proxy rules.  Currently, the SEC allows companies to exclude nominees to the board from its proxy statement.  The proposed Section 112 would provide for a state law alternative to this provision, allowing companies to put in place some type of guaranteed shareholder access that does not depend upon Rule 14a-8. 

Having said that, however, it is clear that the SEC intends to repeal the prohibition on access.  It is likely, however, that the SEC would only allow access under certain conditions.  Specifically, shareholders would have to own a specified number of shares (the access proposal considered in 2007 put the percentage at 5%, the current SEC would likely adopt a much lower percentage) and would only be able to submit a short slate of directors.  Once this occurs, there will be a federal right to insert nominees into the proxy statement.

Proposed Section 112 allows companies to undercut this developing right.  Companies could, for example, condition the right to submit nominees on much larger share ownership (say 10%) or require a much longer holding period than is in the proxy rules (say 5 years).  Where the SEC allows two nominees, the bylaw could limit it to one. 

It is probably the case that the more restrictive bylaw would override the federal right since companies can exclude any proposal that violates state law.  See Rule 14a-8(i)(1).  Moreover, when the SEC proposed to allow the inclusion of shareholder nominees in the proxy statement back in 2003, it made this proposition explicit.  See Exchange Act Release No. 48626 (Oct. 14, 2003)("To eliminate any uncertainties in this regard, the proposed rule would state that the security holder nomination procedure would be available unless applicable state law prohibits the company's security holders from nominating a candidate or candidates for election as a director. If state law permits companies incorporated in that state to prohibit security holder nominations through provisions in companies' articles of incorporation or bylaws, the proposed procedure would not be available to security holders of a company that had included validly such a provision in its governing instruments."). 

In other words, the provision does not help shareholders, it allows companies to impose more restrictive procedures for nominating directors than will be imposed under federal law.  This is not designed to help shareholders.  It is designed to undercut a federal right to access.  Perhaps this will be another area where TARP ought to impose restrictions. 

For more on under state and federal law, see The SEC, Corporate Governance, and Shareholder Access to the Board Room.  We've copied the relvant provision below. All of the proposed amendments are posted on the DU Corporate Governance web site.

Section 112. Access to proxy solicitation materials.

The bylaws may provide that if the corporation solicits proxies with respect to an election of directors, it may be required, to the extent and subject to such procedures or conditions as may be provided in the bylaws, to include in its proxy solicitation materials (including any form of proxy it distributes), in addition to individuals nominated by the board of directors, one or more individuals nominated by a stockholder. Such procedures or conditions may include any of the following:

(1) A provision requiring a minimum record or beneficial ownership, or duration of ownership, of shares of the corporation’s capital stock, by the nominating stockholder, and defining beneficial ownership to take into account options or other rights in respect of or related to such stock;

(2) A provision requiring the nominating stockholder to submit specified information concerning the stockholder and the stockholder’s nominees, including information concerning ownership by such persons of shares of the corporation’s capital stock, or options or other rights in respect of or related to such stock;

(3) A provision conditioning eligibility to require inclusion on the corporation’s proxy solicitation materials upon the number or proportion of directors nominated by stockholders or whether the stockholder previously sought to require such inclusion;

(4) A provision precluding nominations by any person if such person, any nominee of such person, or any affiliate or associate of such person or nominee, has acquired or publicly proposed to acquire shares constituting a specified percentage of the voting power of the corporation’s outstanding voting stock within a specified period before the election of directors;

(5) A provision requiring that the nominating stockholder undertake to indemnify the corporation in respect of any loss arising as a result of any false or misleading information or statement submitted by the nominating stockholder in connection with a nomination; and

(6) Any other lawful condition.