Defending against shareholder proxy access: Delaware's future reviewing company defenses in the era of Dodd-Frank.

• Author: Verret, J.W.

1. INTRODUCTION II. THE DEBATE OVER SHAREHOLDER ACCESS TO THE CORPORATE PROXY A. History of the Theoretical Debate over Shareholder Empowerment B. The Dodd-Frank Act, a Victory for Proxy Access Proponents C. The Costs of Proxy Access III. PROXY ACCESS DEFENSES A. Defenses Related to the Characteristics of the Board 1. Director Qualification Bylaws 2. Director Resignation Policies 3. Permanently Appointed Directors 4. Delegation to Board Committees 5. Withholding Indemnification, Advancement, Directors and Officers Insurance Coverage, and Section 102(b)(7) Protection from Insurgent Directors B. Defenses to Effectively Increase an Insurgent's Costs 1. Contingent Dividends 2. Contested Election Triggers: Golden Parachutes and Tin Parachutes 3. Poison Pills and Proxy Puts Triggered by Proxy Contests 4. Targeted Share Issuances 5. Election Expense Bonds C. Defenses Associated with Structuring Shareholder Voting 1. Chinese Menu Ballots 2. Amending the Charter to Limit the Voting of Conflicted Shareholders 3. Client-Directed Voting D. Additional Defenses 1. Whitemail 2. State Anti-Takeover Statutes IV. THE LEGITIMACY OF PROXY ACCESS DEFENSES UNDER DELAWARE LAW A. Shareholder Voting and the DGCL B. Blasius and Schnell: The Need for Compelling Justification 1. The Progeny of Blasius C. Takeover Defenses and the Unocal Standard D. Blurring the Line: the Blending of Unocal and Blasius E. Proxy Defenses Reconsidered 1. Blasius or Unocal: Which Will Control? 2. Determining the Legality of Proxy Access Defenses Under Delaware Law 3. Additional Considerations V. CONCLUSION The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ensures that a shareholder's ability to place nominees to the board onto the corporate ballot, an objective long advocated by the institutional investor community, will soon be implemented by the securities and Exchange commission. Advocates of proxy access urge that it will help hold boards of directors accountable to owners. critics argue that it will give conflicted shareholders, like unions and state pensions, power that they will use to pursue their political objectives at the expense of ordinary shareholders. The shareholder primacy and director primacy theories of corporate law have framed an extensive debate in the literature. Mounting evidence suggests that the costs of the shareholder proxy access rule promulgated by the SEC will significantly outweigh its purported benefits. Further, regardless of which theory holds force, we can expect boards to implement defensive strategies in the wake of proxy access to limit shareholder power in the same way that boards implemented defensive tactics in response to the hostile takeovers of the mid-1980s. Delaware's review of board proxy access defenses will shape its role in the foreseeable future in much the same way review of board takeover defenses shaped its role over the last 20 years.

   This Article considers what strategies may be useful for boards defending against proxy access and designs novel methods that boards should consider. It also examines how Delaware courts are likely to review those defenses under a vast body of jurisprudence protecting the shareholder franchise known as the Blasius line of cases. Though the Blasius cases protect the shareholder franchise, they do not necessarily prohibit board policies, bylaws, or charter amendments with an incidental effect on the shareholder's federal nomination right. Finally, this Article considers whether the defenses envisioned are likely to be struck down as pre-empted by federal law or prohibited by the federal securities laws or stock exchange listing requirements. The Article offers a roadmap for how boards are likely to respond to proxy access and how Delaware's role as arbiter of the shareholder/manager relationship is likely to evolve in the new environment.

1. INTRODUCTION

   In light of the increasing incidence of takeover bids in recent years, counsel to publicly-held corporations should carefully weigh the degree of takeover protection which may be afforded by defensive charter and by-law provisions.

   --Stephen A. Hochman & Oscar D. Folger, The Business Lawyer, 1978 (1)

   One of the oldest debates in corporate law concerns the role that shareholders play in relation to managers of the companies in which they own shares. Advocates of increasing shareholder power have long urged that shareholders suffer from a collective action problem, limiting the effectiveness of their oversight. Berle and Means, whose work forms the foundation of much corporate law scholarship today, argued in the 1930s that the "separation of ownership from control" in the modern large corporation justified extending the reach of federal regulation of companies. (2)

   The latest iteration of that debate has been whether to let shareholders nominate candidates onto the management proxy card, also known as "proxy access." The Securities and Exchange Commission considered rules to grant shareholders access to the corporate proxy in 2003 and 2006, but ultimately voted not to implement either proposal. The SEC also considered such a rule a third time in 2009, but delayed a final vote on the rule out of concern that the commission may not have the legal authority to implement such a change. The question was finally resolved in the summer of 2010, when the Dodd-Frank Wall Street Reform and Consumer Protection Act specifically recognized the SEC's authority to require publicly traded companies to include shareholder nominees on the corporate proxy. The SEC subsequently adopted a rule in August of 2010.

   Proponents of shareholder empowerment argue that proxy access will make it easier for shareholders to take an active role in monitoring managers and the incumbent board by the threat of replacement. They urge that the relative dearth of contested elections in publicly traded firms proves that the current system is broken. They also argue that the proper source of rules in this area is the federal government, and that pre-emption of state corporate law in this area is justified.

   Critics of proxy access argue that the current system is optimal, and that shareholders remain free to sell their shares if they are dissatisfied with management performance. Critics further warn that the shareholders most likely to make use of proxy access are institutional investors, like unions and state pension funds, that will use proxy access toward political goals that conflict with maximizing long-term shareholder wealth. They also highlight the relative lack of empirical evidence showing that corporate governance reforms like this one result in any share value appreciation, and indeed they show some studies indicating just the opposite.

   With this new development of shareholder access to the company proxy, we can expect boards of directors to develop new defensive tactics to shareholder challenges. If the hostile takeover period of the mid-1980s is any indication, corporate lawyers will innovate to meet a demand for defensive measures. As a result, Delaware corporation law will need to innovate as well to review the new defensive measures. The object of this Article is to consider--and in part to design--novel methods that boards might utilize to defend against a proxy nomination by insurgent shareholders. It will also consider how those defenses are likely to be reviewed in the Delaware courts, and whether and to what extent expected defenses might be struck down by federal courts, the exchanges, or the SEC. This endeavor is supported by the wealth of empirical and economic literature highlighting the costs to proxy access as envisioned by the SEC's new rule.

   Considering defenses boards might use to defend against proxy access and contested elections will require a combination of both strategic and legal analysis. This Article will first consider the strategic advantages of defensive maneuvers. Some of those ideas will actually govern shareholder power, like bylaws to limit the voting rights of conflicted shareholders or require nominating shareholders to post a bond with the company to cover election expenses in the event the nominating shareholders loses. It will also consider even stronger tactics that have a direct effect on the election process, like proxy puts, new poison pill triggers, and golden and tin parachutes triggered upon contested elections. It will also examine tactics that have only an indirect effect on elections, like denying director's liability insurance or indemnification to insurgent directors. It will consider adoption of director qualification bylaws designed to limit the pool of eligible candidates for corporate boards, and it will consider mechanisms to re-design the corporate ballot.

   After considering strategic moves that boards might make, the analysis will turn to a tour of the complex laws and cases governing shareholder voting rights in Delaware. The Article will examine how the Blasius line of cases can be expected to evolve in a postproxy access world and whether Delaware courts are likely to permit the types of board defenses considered in this Article. Lastly, the Article will consider whether federal courts, the SEC, or the stock exchanges will be able to strike down these defenses for failure to comply with federal law.

   Early work on the economics of corporate law by Easterbrook and Fischel argues that corporate law should remain principally an enabling law respecting the freedom of parties to contract around default rules. (3) The principal object of this Article will be to show that despite the wars over proxy access to the corporate ballot finally culminating in passage of proxy access, Delaware state law still leaves open a vast space for limiting or expanding the reach of proxy access. This space is available through corporate governance arrangements that have a secondary effect on the shareholder franchise and the shareholder nomination process envisioned by the SEC's proxy...