The case for employee referenda on transformative transactions as shareholder proposals.

• Author: Bodie, Matthew T.

In an earlier article in the Washington University Law Review, (1) I made the case for a unique addition to the corporate law framework. I proposed that employees at a company involved in a corporate combination, such as a merger or sale of substantially all assets, would be entitled to vote in a nonbinding referendum about the transaction whenever shareholders were also voting. The structure was fairly straightforward. The employees--defined by tax law or some other bright-line test--would vote up or down on the proposed merger in a firm-wide election. The corporation would conduct the balloting after the combination's announcement but before the shareholders' vote, and the company would be required to inform shareholders of the election results. Since the vote would have no binding effect on the combination or the company, its primary purpose would be to provide information about the employees' views on the proposed transaction.

The original article proposed that the referendum would be most appropriately situated as part of the state corporate law firmament. (2) Although Congress could implement the proposal, states made more sense. (3) State law controls not only the basic structure of the corporation, but also the approval process for mergers and other transformative transactions. Moreover, many prominent corporate law theorists have celebrated the competition between states to achieve the "best" corporate law. (4) If implemented through state law, the referenda could be treated as experiments and tinkered with over time to achieve the most efficient design. (5)

As it turns out, however, I neglected to suggest a third possibility for the implementation of these nonbinding employee referenda--namely, shareholder proposals. (6) These proposals, which are made through SEC Rule 14a-8, (7) have become an increasingly important part of the corporate governance landscape. Under Rule 14a-8, shareholders can use the company's proxy materials to propose a "recommendation or requirement that the company and/or its board of directors take action." (8) Any shareholder who meets the holding requirements (9) can submit a proposal of no more than 500 words to be included on the annual proxy materials. A "yes" or "no" vote on the proposal is then included on the proxy ballot. Because the company pays for and distributes the proxy materials, Rule 14a-8 makes it much easier for shareholders to raise governance issues. Without that process, shareholders would be left to distribute the proxy materials on their own dime. (10)

Although shareholder proposals often concern broader social issues, they have increasingly been used to promote corporate governance reforms. Many of these proposals endeavor, in a variety of ways, to restrict the board's ability to mount takeover defenses against hostile bidders. (11) other proposals seek to make it easier for non-incumbents to run for seats on the board by providing either access to the corporate proxy (12) or reimbursement of proxy expenses. (13) Yet another set of corporate governance proposals seeks to facilitate direct shareholder participation by making it easier to amend bylaws or to submit additional proposals down the road. (14) Rule 14a-8 proposals have become the new front in the battle between corporate boards and shareholder activists. (15)

Many of these proposals have failed to ever reach a proxy ballot, however, because companies have legally excluded them. Rule 14a-8 provides thirteen substantive reasons for excluding proposals from the ballot. (16) A board may exclude the proposal based on one of these reasons after informing the proposing shareholder and providing its justification to the SEC. (17) The SEC then provides an action letter on the company's decision, either agreeing that it will take no action against the exclusion or refusing to so agree. If the shareholder disagrees with the company's exclusion, the shareholder can bring suit against the company to require that it be included. (18)

The nonbinding employee referendum would be an ideal candidate for a shareholder proposal. (19) The referendum is useful as a check against CEO and board overreaching in the context of transformative transactions. (20) The CEO and other top officers are generally responsible for negotiations regarding such transactions. Once negotiations are complete, management then must sell the idea to the board. After the board announces the combination, it believes in the merger and is primarily interested in selling it to shareholders. Employees, however, may disagree with the board's decision. An employee "no" vote may provide shareholders with a reason to go beyond the board's optimism to a more realistic assessment. (21) However, it is important to keep in mind that the...