As Predicted: The SEC and the Further Denial of Shareholder Access (Oral Argument and the Payment of Money) (Part 12)

We 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.

The Court will have a tough time concluding that the bylaw can, without a fiduciary out, potentially result in payments that are illegal or improper.  To do so, it will have to conclude that approval by shareholders does not cleanse the improper motive, that the requirement that the expenses be "reasonable" does not prevent illegal payments, and that the power to repeal the bylaw does not substitute for a fiduciary out.  That's a lot of law to make and the Court isn't likely to make it. 

The second, conceptually distinct argument made by Giuffra, counsel for CA (although the two arguments were often combined), is that the bylaw is invalid because it makes mandatory the payment of money.  It is up to the board to determine expenditures.  Any bylaw that makes expenditures mandatory violates Section 141(a) by interfering with the board's day to day oversight authority.  See 8 Del. C. § 141 (2008)("The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors,"). As one Justice characterized:

• “This is the expenditure of money which is traditionally a managerial judgment. And this bylaw is restricting management’s discretion in appropriating money and in that way infringes upon management’s exercise of it’s fiduciary duties. Without some clear unambiguous authority to do that they say your bylaw’s invalid."

Barry, counsel for AFSCME, challenged the position, asserting that it would mean that "any bylaw that required the expenditure of money would be invalid.”  Barry noted the existence of other bylaws used by companies that required mandatory payments. 

It was this position that Giuffra chose to raise on rebuttal. First he reiterated the view that the requirement that the company make expenditures was invalid unless there was a fiduciary out.

• “Our view is is that it is a traditional management function for the board to decide the expenditure of money an amount here that could be millions of dollars. This bylaw is mandatory. It has no fiduciary out. It requires reimbursement even if the short slate successful director was motivated purely by political or personal reasons and that violates Delaware law.”

He took issue with the references in the AFSCME brief to other bylaws that purported to show that boards routinely adopted bylaws that required mandatory payments or expenditures.  He essentially argued that the discretion provided in the bylaws left the board with something akin to a fiduciary out.   

• "The bylaws that were referenced in AFSMCE’s brief. There was one about how directors and committee members are entitled to reasonable compensation. Well, 141(h) allows the board to decide what the compensation would be and that’s what the board would do in that case. One of them says you have to have D&O insurance. The board would obviously decide how much D&O insurance to get. Another was you need to have an office in Atlanta Georgia. The board would have to decide what type of office in Atlanta Georgia.”

In other words, the bylaws imposed mandatory obligations on the board (i.e. to obtain D&O insurance) but left it to the discretion of the board to determine the amount and extent of the payments. For Justice Berger, this was too much. She noted that the AFSCME bylaw, while making reimbursement mandatory, also gave to the board the discretion to determine the reasonableness of the expenses. 

• JUSTICE: “Isn’t that analogous to saying the bylaw says we have to have an office in Atlanta. But what size office and how much we’re going to actually going to expend on that office is still up to the directors? Similarly, if someone is successful in getting on the board, we have to reimburse but we decide what’s reasonable.”
• COUNSEL: “There would have to be a judgment as to what reasonableness is. But The reimbursement is mandatory. It says shall cause.”
• JUSTICE: “Just like you have to have an office in Atlanta.”
• COUNSEL: “But in the case of for example the office or in the case of the compensation there is something in the Delaware Corporation Law that specifies that that’s something that can be in a bylaw.”

The absolutist position by Giuffra goes way too far.  That a bylaw requires the payment of some money without board approval (and a fiduciary out) does not automatically violate Delaware law.  In fact, it is hard to imagine bylaws that do not requires some collateral expenditures in order to be implemented.  In the early access proposals, some made the argument to the Commission that they interfered with the board's authority because they required additional expenditures to implement.  The expenditures? The increased length of the proxy statement.

The argument is, therefore, more subtle.  While this bylaw makes expenditures mandatory, it is the extent of the expenditures that intrudes into the board's authority.  This is the issue that raised the conflict between 109(b) and 141(a). Presumably a provision permitted under 109(b) because it relates to the election of directors would nonetheless violate 141(a) because it excessively circumscribed the board's ability to allocate funds. Thus, if the proposal said that the board had to pay to shareholders who ran a competing slate all of the profits of the company, this would presumably violate 141(a).

Giuffra did note that the expenditures here could result in the payment of millions of dollars but he was nonetheless locked into his position that any bylaw providing for mandatory expenditures would be invalid.  As a result, oral argument provided the Court with no real guidance on when the nature and size of the expenditure might result in interference with the board's managerial authority under Section 141(a).  The Court tried to get to this with the following exchange:

• JUSTICE:  “Is there a logical principal way of separating the nomination process from the actual election?”
• COUNSEL:  “This only focuses on what happens after the election is over after the votes have been counted after the director from the short slate is sitting in the board room.”
• JUSTICE:  “Well I understand that but isn’t it logical to assume that one of the issues in submitting nominations on a short slate or a full slate is the expense of doing so. And if the corporation is mandated to pay the expenses of a successful contest at least to a certain threshold, doesn’t that facilitate nominating persons for election of directors and isn’t that inextricably linked to the election process
• COUNSEL:  "Your honor in fact before the SEC AFSCME took the position that this bylaw had nothing to do with the election of directors. . . .  The premise behind the bylaw is that I think that if people know they’re going to get paid after the election is over more people will run. But that is a principal that I think if anything that should be put to the legislature number one and put in the Delaware Corporation Law or something that should be in the certificate of incorporation. The problem here is that the premise which is that more people will run goes to the question of whether that is good for the corporation. And it would be our position Your Honor that the judgment as to whether to pay these expenses is something that is inexorably linked and vested in the board of directors.”

In other words, the argument did not provide the Court with a basis for separating these expenses (either in amount or in in their purpose) from other expenses that would necessarily be imposed by a bylaw affecting the election process (an access bylaw for example).

To the extent that the Court strikes down the bylaw because the potential size of the reimbursement interferes with the board's discretion, it will have to overcome two uncomfortable facts.  First, as already discussed, it will need to find that the board's ability to repeal the bylaw does not effectively provide a fiduciary out. 

Second, it will need to address the provision in the bylaw that caps total expenses by providing that the amount paid "shall not exceed the amount expended by the corporation in connection with the election."  In other words, the board has considerable discretion to control the size of the payments made to the dissidents by reducing its own expenditures.  So, to avoid the payment of "millions of dollars" that Giuffra asserts could be required under this bylaw, the board need only reduce its own expenses to less than "millions of dollars."  In other words, the argument here is that it is reasonable for the board to spend millions of dollars on its own proxy solicitation but not reasonable to reimburse a similar amount to dissident shareholders.   

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