As Predicted: The SEC and the Further Denial of Shareholder Access (Oral Argument and the Illegal Payment Problem) (Part 10)

We have listened to the oral argument in CA v. AFSCME and are providing comments. The oral argument is publicly available and can be found on the Delaware Supreme Court web site.

As we have been discussing, CA argued that the mandatory nature of the bylaw made it illegal under Delaware law, that directors were turned into robots and would be required to make payments even if they violated Delaware law (for proxy contests initiated for personal or political reasons).

The argument, while necessary, was a bit Panglossian. The idea that a nomination would be “entirely” for personal or political reasons is possible. But in the case where the nominee wins, its almost impossible to imagine a candidate getting majority/plurality support on a platform based upon personal grievance or political motives. In other words, while these motivations may influence the decision to go forward with the nomination, it seems clear that the candidate would have to make an argument as to why he or she would be a better director than the incumbent in order to win and that the argument would have to go the merits of managing the corporation. Thus, to win, the candidacy must go beyond personal and political motivations.

It is the position taken by Barry, counsel for AFSCME. He had this exchange with the Court.

• COUNSEL: “I personally cannot fathom a situation where a director nominated by shareholders is elected for other than policy reasons.”
• JUSTICE: “Couldn’t the bylaw itself be read to be an expression of policy that is in the best interests of the corporation to have additional people enabled to run for office and therefore it doesn’t matter whether the person who ultimately gets elected was doing it entirely for personal reasons or not.”
• COUNSEL: “That’s exactly the point.”

The Court would, therefore, have to find that the motivation for the proxy contest controlled and, even though he or she was elected for other than personal or political reasons, conclude that an improper motivation was not cleansed by the director actually winning the election.  Giuffra, counsel for CA, tried to strengthen this possibility by arguing that a nominee could be elected by a plurality, something quite possible if a significant number of shareholders vote for neither and instead withhold their vote. As he noted:

• “You could have a situation where a director was elected with less than 50% of the vote and that would somehow trigger this mandatory requirement to repay. The problem of course is is that the director may well have run because for political reasons. I mean AFSCME is a union. They might have run because of animus toward one of the directors. And that’s something that would not be permissible under Delaware law to reimburse on the board’s side.”

In other words, by winning with a plurality, the cleansing effect of majority approval might not occur. 

But there were other problems with the argument. The bylaw provided that shareholders would be reimbursed for “reasonable” expenses. The requirement of reasonableness provided a way out of the personal/political thicket. The following exchange occurred between the Court and Giuffra.

• JUSTICE: “So is it your position that a reimbursement that’s otherwise impermissible under Delaware law can still be a reasonable expense?
• COUNSEL: “I don’t think it can be your honor.”
• JUSTICE: “Doesn’t that answer the problem then, under the language of this bylaw?”
• COUNSEL: “But this bylaw on its face says shall cause. There’s no fiduciary out in the bylaw.”

In other words, while the board did not have an expressed “fiduciary out,” it did have the right to refuse payment as unreasonable and unreasonable included payments otherwise impermissible under Delaware law. Said another way, a board could refuse to reimburse proxy contests that were commenced for personal or political reasons since to do otherwise would be improper.

This is terribly close to a fiduciary out concept. Its not quite the same. There could be some instances where a board might conclude that reimbursement was not in the best interests of shareholders without the reimbursement amounting to an illegal expense under Delaware law. Nonetheless, for a case where much was made of the possibility that payments would go for contests resulting “entirely” from personal or political motivations, the bylaw in fact provides a way out.

The primary materials, including the briefs, are posted on the DU Corporate Governance web site.