Advance notice bylaws: the Delaware Supreme Court weighs in

This is my second blog post this week because I am procrastinating.

Anyway, a while back I blogged about Kellner v. AIM Immunotech, where VC Will invalidated certain advance notice bylaws that had been amended in the middle of a heated proxy contest.  The difficulty was that the case was heard on an expedited basis, in advance of the shareholder meeting, so that Will could determine if the dissident's nominees could stand for election.  And the dissident was ... not great.  The campaign had been orchestrated by a convicted felon who tried to hide his involvement, and the dissident had submitted some false information in response to the bylaw requests.  At the same time, though, the bylaws had been adopted as a blocking mechanism, and some were unintelligible.  

In that context, Will held that four of the amended bylaws failed enhanced scrutiny, but two could stand.  She concluded that the board had acted with a proper purpose - to obtain information so that it could fairly evaluate a director-nominee - but that several of the onerous bylaw amendments were disproportionate to the threat posed.  With respect to one bylaw, which was unreasonably broad, Will blue penciled it back to the original, pre-amendment version and held that the dissident had failed to comply with it.  For that reason, as well as some less important instances of false information submitted in connection with the remaining bylaws, she held that the dissident's nominees could not be considered at the meeting.

On appeal, the Delaware Supreme Court took a different approach and reversed Will's factual findings while denying that it had reversed her factual findings.

First, the Delaware Supreme Court held (and we should all take note of this for future cases) that advance notice bylaws may be evaluated for invalidity, and separately for inequity.  A validity challenge is a facial challenge, and relatively narrow: quoting ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), the Court held "A facially valid bylaw is one that is authorized by the Delaware General Corporation Law (DGCL), consistent with the corporation’s certificate of incorporation, and not otherwise prohibited."  The fact that it might operate inequitably or unlawfully in some circumstances is not sufficient to render the bylaw invalid.

On that analysis, the Court found that one amended AIM bylaw was invalid, because it was unintelligible: "The bylaw, with its thirteen discrete parts, is excessively long, contains vague terms, and imposes virtually endless requirements on a stockholder seeking to nominate directors....An unintelligible bylaw is invalid under 'any circumstances.'"

The other bylaws, however, were found to be facially valid.  But, they still had to be "twice-tested" in equity.  And that test is the enhanced scrutiny test, as articulated in Coster v. UIP Companies, 300 A.3d 656 (Del. 2023).  First, the board must identify a threat and act in good faith; second, the board's response must be proportional.

In this case, the Court found that the totality of the amended bylaws - which were exceptionally broad, required information potentially unknown to the nominee, were ambiguous, unreasonable, and ultimately at odds with the board's stated purpose of information-collection - suggested that the board did not, in fact, act with a proper purpose when amending them.  Instead, the purpose was to block the dissident entirely.  When it comes to proxy contests, boards may try to inform stockholders, but they can't substitute their own judgment for the stockholder vote; therefore, all of the bylaws (including the two that Will did not find to be unreasonable) had to be stricken.  They were all fundamentally tainted by the board's bad faith:

In the middle of a proxy contest, the AIM board adopted one unintelligible bylaw and three unreasonable bylaws. It then used the Amended Bylaws to reject Kellner’s nomination notice...The unreasonable demands of most of the Amended Bylaws show that the AIM board’s motive was not to counter the threat of an uninformed vote. Rather, the board’s primary purpose was to interfere with Kellner’s nomination notice, reject his nominees, and maintain control. As the product of an improper motive and purpose, which constitutes a breach of the duty of loyalty, all the Amended Bylaws at issue in this appeal are inequitable and therefore unenforceable.

So what's funny here is that the Court claims it's relying on Will's own factual findings - she was the one who found the bylaws unreasonable, she was the one who dropped stray comments like "The provision seems designed to preclude a proxy contest for no good reason," which the Delaware Supreme Court repeatedly quoted - to conclude the board acted with an improper purpose.  But that absolutely was not what Will found, after trial!  She explicitly held the opposite:

AIM’s Board had an objective of obtaining transparency from a stockholder seeking to nominate director candidates...The Board made a reasonable assessment, in reliance on the advice of counsel, that this information-gathering objective was threatened...the Board sought to prevent “the types of manipulative, misleading, and improper conduct” experienced in 2022 from happening again.....

The Board has proven that its actions served proper corporate objectives.  Specifically, it sought to obtain full and fair disclosure so that it could adequately evaluate a nomination and that stockholders could cast informed votes....

Anyway. That part is just drama.

The substantive issue is this: Remember Will's dilemma.  Both sides had behaved badly.  If the bylaws were struck entirely, the corporation would be unprotected against a lying bad faith actor.  That's why she felt the need to blue-pencil one bylaw, by restoring an older version, and measure the dissident's compliance against that bylaw.  Which struck me as a very odd solution, and I wondered how the Delaware Supreme Court would address the problem.

The Delaware Supreme Court, however, did not address the problem.  It was not acting in the middle of a proxy contest; by the time of the appeal, the shareholder meeting was over.  So, in light of the fact that Will had found the dissident behaved badly, the Delaware Supreme Court simply said no further relief was warranted:

We also note that, according to the Court of Chancery, Kellner submitted false and misleading responses to some of the requests.  Given the court’s countervailing findings about Kellner’s and his nominees’ deceptive conduct, no further action is warranted. The judgment of the Court of Chancery is affirmed in part and reversed in part. The case is closed.

Okay ... nothing needs to be done because there's no proxy contest anymore.  But what about in future Kellners?  What do you do when both sides behave badly?

Well, the Court says that if the Board acts for a proper purpose, but is overly aggressive, then Chancery can choose to enforce parts of bylaws as equity demands:

if the bylaws were adopted for a proper purpose but some of the advance notice provisions were disproportionate to the threat posed and preclusive, the Court of Chancery has the discretion to decide whether to enforce, in whole or in part, the bylaws that can be applied equitably

.... it may be necessary to assess how bylaws work together, but one problematic bylaw does not invalidate others when the board has a proper motive. Overbroad invalidation would be extreme and unnecessary when the board acted with proper motive to protect a legitimate corporate interest. 

That discretion does not seem to apply, though, if the Board is not acting for a proper purpose, i.e., when it's simply trying to block a dissident - even if the dissident really is a for real threat, in the ordinary (criminal) sense of the word.  Then, the lack of a proper purpose seems to mean defenses, including advance notice bylaws, can't be employed, and stockholder protection is left solely to ... I guess (yikes) the federal securities laws.

Anyway, the takeaways then are: (1) improper purpose will completely kill a defensive strategy, with no room for courts to uphold the strategy in part, and (2) the fact of improper purpose can be inferred from nature of the strategy itself.  This plays out very differently in proxy contests than in tender offers, of course; in tender offers, the desire to block the offeror is not an improper purpose; in the context of proxy contests, blocking a dissident from running the contest (as opposed to educating shareholders), is off the table.