Contractarian Theory and Unilateral Bylaw Amendments

Author:Albert H. Choi & Geeyoung Min
Position:Professor and Albert C. BeVier Research Professor of Law, University of Virginia Law School/Adjunct Assistant Professor and Postdoctoral Fellow in Corporate Law and Governance, Columbia Law School
Pages:1-44
SUMMARY

Corporate directors have been utilizing a potent mechanism in dealing with shareholder activism and shareholder litigation: the right to unilaterally amend corporate bylaws. Directors have exercised this right, for instance, to impose various requirements on who can nominate a director or call a special shareholder meeting, or to designate an exclusive forum where the shareholders can bring suit. Based on the theory ... (see full summary)

 
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1
Contractarian Theory and Unilateral
Bylaw Amendments
Albert H. Choi & Geeyoung Min *
ABSTRACT: Corporate directors have bee n utilizing a potent mechanism i n
dealing with shareholder activism and shareholder litigation: the right to
unilaterally amend corporate by laws. Directors have exercised th is right, for
instance, to impose various requirements on wh o can nominate a director or
call a special shareholder meeting, or to desig nate an exclusive forum where
the shareholders can bring suit. Ba sed on the theory that corporate charter s
and bylaws constitute a “contract” b etween the shareholders and th e
corporation, courts have blessed many of the bylaws that directors have
unilaterally adopted. This Articl e examines the contractarian th eory by
drawing a parallel between amendi ng charters and bylaws on the one ha nd
and amending contracts on the other; and by comparing the right to
unilaterally amend corporate by laws with the right to unilaterally modify
contracts. The Article shows how cont ract law imposes various limitations on
the modifying party’s discretion. The Article a lso compares the standard
contractual relationship with that of the sh areholders and the corporation
more generally and uncovers several important differences that could m ake
shareholders (particularly, minority shareholders) more vulnerable to
counterparty (directors’ and controll ing shareholder’s) opportunism. For
example, unlike contracting parties who h ave the right to terminate the
contractual relationship or opt out of undesirabl e modifications, shareholders
lack the right of termination or opt-out. As a possible so lution, the Article
considers various mechanisms, inc luding giving the shareholde rs the right of
* Professor and Albert C. Be Vier Research Professor of L aw, University of Virginia Law
School; and Adjunct Assistant Professor and Postdoctoral Fellow in Corporate Law and
Governance, Columbia Law School, respectively. We would like to thank Rick Brooks, Quinn
Curtis, Elisabeth de Fontenay, Zohar Goshen, Larry Hamermesh, Clara Hochleitner, Mike
Klausner, Vice Chancellor Travis Laster, Alex Lee, Ann Lipton, Joshua Mitts, Peter Mol k, Roberta
Romano, Sarath Sanga, Matt Shapiro, David Skeel, Emily Stolzenberg, George Triantis, Fred
Tung, workshop participants at the University of Virginia Law School, and conference
participants at 2018 Corporate and Securities Law Conference at Tulane Law School for many
helpful comments and suggestions. We would also like to thank MacLane Taggart (University of
Virginia Law School, J.D. Class of 2019) and Wenxi Zhang (University of Pennsylvania Law
School, J.D. Class of 2019) for excellent research assistance. Comments are welcome to
achoi@law.virginia.edu and geeyoung.min@gmail.com.
2 IOWA LAW REVIEW [Vol. 104:1
optional redemption, more robust disclosur e, the right to vote (including the
right to elect or replace directors), and subjec ting bylaw amendments to more
active judicial oversight. The Articl e suggests that active judicial o versight,
through the vigorous application of th e proper and equitable purpose test or
imposition of good faith and fair deal ing obligations, would be better in
retaining the desired flexibility and pol icing directors’ and controlling
shareholder’s opportunism.
I. INTRODUCTION ............................................................................... 3
II. CORPORATE CONTRACT AND ITS AMENDMENT .............................. 11
A. CHARTER AND BYLAW AMENDMENT UNDER CORPORATE
STATUTES ............................................................................... 13
B. RECENT DEVELOPMENTS IN CORPORATE BYLAWS ....................... 15
1. Boilermakers and ATP Tour .............................................. 16
2. Subsequent Developments ............................................ 19
III. AGENCY AND CONTRACT LAW IMPLICATIONS ON
CORPORATE CONTRACT ................................................................ 21
A. AGENCY LAWS TREATMENT OF PRINCIPAL-AGENT
CONTRACT .............................................................................. 22
B. HOW CONTRACT LAW DEALS WITH (UNILATERAL)
MODIFICATION ........................................................................ 23
1. Illusory Promise and Indefiniteness .............................. 24
2. Unconscionability .......................................................... 26
3. Interpretation ................................................................ 27
4. Implied Covenant of Good Faith and Fair
Dealing ........................................................................... 28
IV. CHANGE-OF-TERMS CLAUSE VS. RIGHT TO UNILATERALLY
AMEND BYLAWS ............................................................................. 29
V. POLICY IMPLICATIONS ................................................................... 32
A. OPTIONAL REDEMPTION .......................................................... 33
B. MANDATORY PRE-AMENDMENT DISCLOSURE ............................. 35
C. SHAREHOLDER VOTING AND APPROVAL ..................................... 35
D. STRONGER JUDICIAL OVERSIGHT ............................................... 38
1. Proper and Equitable Purpose Test .............................. 39
2. Borrowing from Contract Law Principles ..................... 39
3. Benefits of Stronger Judicial Oversight ........................ 41
VI. CONCLUSION ................................................................................ 44
2018] UNILATERAL BYLAW AMENDMENTS 3
I. INTRODUCTION
Over roughly the past decade, corporate direct ors have been utilizing
one of the most potent mechanisms in dealing with shareholder activism and
shareholder litigation: the right to unilaterally amend corporate bylaws.1
While corporate governance arrangements can be tailored using either the
charter or the bylaws,2 modifying the charter requires shareholder approval,3
which can be time-consuming, costly, and uncertain.4 On the other hand,
directors can unilaterally amend the bylaws quickly, at a low cost, and with
certainty: They can simply convene a board meeting and adopt a necessary
1. See generally Albert H. Choi, Fee-Shifting and Shareholder Litigation, 104 VA. L. REV. 59 (2018)
(providing a brief overview about the concerns over deal-related shareholder litigation, perc eived
to be “out of control,” and how that led corporations to adopt fee-shifting and exclusive forum
bylaws); Lawrence A. Hamermesh, Director Nominations, 39 DEL. J. CORP. L. 117 (2014) (discussing
examples of directors’ adopting advance notice bylaws in response to shareholder activism
regarding director elections).
2. There are exceptions, however. For instance, whether to have a super-majority voting,
to allow the directors to issue certain stock without shareholder approval (“blank check preferred
provision”), to exempt directors fr om personal liability for breach of d uty of care, or to have
cumulative voting must be conta ined in the charter. See DEL. CODE ANN. tit. 8, §§ 102(a)(4 ),
102(b)(4), 102(b)(7), 214 (2018) . A staggered (or classified) board pro vision, though it can be
in the bylaws, requires a shareholder approval. See id. tit. 8, § 141(d) .
3. See id. tit. 8, § 242; MODEL BUS. CORP. ACT § 10.03 (AM. BAR ASSN, revised 2016).
Charter amendment is considered to be a “fundamental” change to the corporation, thereby
triggering shareholder approval requirement. When a proposed charter amendment “adversely
affects” a certain class of shareholders, that class will get to vote on the proposal as a separate
class. See DEL. CODE ANN. tit. 8, § 242(b)(2); MODEL BUS. CORP. ACT § 10.03. For a more detailed
analysis of charter amendments, including the requirements and procedures under the federal
securities laws, see generally Geeyoung Min, Shareholder Voice in Corporate Charter Amendments,
43 J. CORP. L. 289 (2018). For Delaware corporations, there is a small number of exceptions to
the rule. Unless expressly prohibited by the charter, the directors can unilaterally change the
name of the corporation, delete the names of the incorporators, or delete the provisions that
were necessary to effect stock exchange, reclassification, etc., when such changes have become
effective. See DEL. CODE ANN. tit. 8, § 241(b )(1); MODEL BUS. CORP. ACT § 10.05.
4. For a publicly traded company, the company will have to abide by the federal proxy
regulation in securing shareholder approval. See Securities and Exchange Act of 1934, 15 U.S.C.
§ 78(a) (2012); Securities Regulation Section 14A, 17 C.F.R. § 240.14a-8 (2011). Also , influential
proxy advisory firms, such as Institutional Shareholder Services and Glass Lewis, have the policy
of giving negative recommendations at the nex t director election when a firm adopts a charter
provision (materially) adverse to the interests of shareholders, such as staggering the board.
See generally Min, supra note 3 (providing a more detailed analysis). Notwithstanding this, there
are instances where a charter amendment would be more advantageous, especially if the directors
expect little or no shareholder resistance. Because they have the sole power to make an
amendment proposal, they get to d ictate the content and once the amendment has been
adopted, shareholders will be unable to change it unilaterally. DEL. CODE ANN. tit. 8, § 242.

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