Delaware courts are no stranger to resolving lawsuits brought by activist stockholders. These disputes often arise from a challenge to advanced notice bylaws, which are used as a defensive mechanism that provides a board of directors with notice of director nominations in advance of a stockholder meeting.
These bylaws are “twice-tested” by Delaware courts and, under Kellner v. AIM ImmunoTech, Inc., courts consider whether:
- The bylaws are consistent with the charter, not prohibited by law and address a proper subject matter.
- The board’s adoption, amendment or application was equitable.
The former assesses “facial” challenges to the bylaw, the latter “as applied” challenges. Delaware courts, however, have made it clear that an activist’s challenge to an advanced notice bylaw must be a ripe controversy.
In In re The AES Corporation and Owens Corning, two stockholders (the Challenging Stockholders) — who neither intended to run a proxy contest nor identified a stockholder who was chilled from doing so — attempted an “as applied” challenge to advanced notice bylaws. The Delaware Supreme Court, affirming the Delaware Court of Chancery’s dismissal of the action, explained that there was no “genuine, extant controversy” that was ripe for the court to resolve due to the lack of a concrete nomination dispute.
Moreover, the Delaware Supreme Court stated that “fiduciary review must await the posture in which Delaware courts can assess actual operation and consequences rather than hypothetical future applications.”
Background
After the Securities and Exchange Commission adopted the universal proxy rule, AES and Owens Corning (the Companies) amended their bylaws, believing that the universal proxy rule would lower barriers for activist stockholders.
The bylaw amendments included provisions stating that:
- “[C]ompliance with the advance notice provisions is the exclusive means by which stockholders may nominate directors.”
- “[T]he chair or presiding officer [could] disregard nominations that do not comply with the notice requirements.”
- The term “acting in concert” would include “conduct knowingly undertaken in parallel with another person toward a common goal, and each set of challenged bylaws includes a ‘daisy-chain’ provision deeming a person acting in concert with one actor also to be acting in concert with any third party who is acting in concert with that actor.”
- A stockholder must make disclosures relating to substantial ownerships and relationships, “including disclosures concerning derivative interests, legal proceedings, certain contracts or relationships, and performance-based fees.”
Following books and records demands, the Challenging Stockholders filed complaints alleging that the bylaws were facially invalid and that the directors of the Companies breached their fiduciary duties by adopting these bylaws. Then, on July 11, 2024, the Delaware Supreme Court issued its decision in Kellner, holding that the facial validity of a bylaw turns on “whether the bylaw is contrary to law or the certificate of incorporation and addresses a proper subject matter[.]”
Consequently, the Challenging Stockholders amended their complaints, alleging only equitable challenges.
The Companies moved to dismiss for lack of subject matter jurisdiction. The Court of Chancery dismissed these complaints because there was no “genuine, extant controversy” since the Challenging Stockholders “could not ‘identify a stockholder who either intends to run a proxy contest’ or is ‘chilled,’ and ‘absent any proxy contest threat’ the bylaws’ adoption was ‘not the kind of circumstance’ that would trigger equitable review under Kellner.”
The Challenging Stockholders appealed and posited that:
- The adoption of the bylaws was ripe for review, and enhanced scrutiny can apply even when there was no proxy fight.
- The ripeness question is intertwined with the merits, so the court should have reviewed under Rule 12(b)(6).
The cases were consolidated on appeal.
Legal Analysis
The Delaware Supreme Court held that the Challenging Stockholders’ claims involving “equitable challenges” were unripe. Relying on Kellner, the court explained that advance notice bylaws are “twice tested[,]” and a stockholder’s challenge to a bylaw under the first inquiry is a legal question that is “answerable from the face of the governing documents[.]” For example, the court in Kellner found that a 1,099-word bylaw, which the trial court explained “would choke a horse[,]” was facially invalid for being “indecipherable.” But an “as applied” challenge “typically proceeds on a developed, adversarial record where the challenged action has immediate consequences, not on conjecture about how bylaws might operate in future contests.”
Applying these principles, the court determined that “[t]he Challenging Stockholders’ central problem is the absence of a would-be nominator” and that an “as applied” challenge is justiciable “only when a real nomination controversy exists — i.e., when a stockholder has stepped forward to nominate, or credibly threatened to do so, and the court can assess the bylaw’s operation on a concrete record rather than in the abstract.”
This requirement for an actual nomination controversy, the court explained, was consistent with prior Court of Chancery decisions in In re Allergan, Inc. Stockholder Litigation and Openwave Systems, Inc. v. Harbinger Capital Partners Master Fund I, Ltd.
The court also rejected the Challenging Stockholders’ argument that the adoption was a “trigger for ripeness” because the bylaw was so chilling that a stockholder would never engage in a proxy contest. The court explained that this premise was difficult to square with Kellner. Moreover, the court said, the circumstances would not create a “concrete nomination setting” that would show “who would be swept into an acting-in-concert group, what disclosures would actually be triggered, whether compliance would be feasible on the facts presented, or whether the company would in fact reject a nomination.”
This decision, however, “does not insulate ‘clear day’ bylaws from scrutiny[,]” but emphasizes “that fiduciary review must await the posture in which Delaware courts can assess actual operation and consequences rather than hypothetical future applications.”
The Delaware Supreme Court ultimately held that a Rule 12(b)(1) dismissal was appropriate because there is no “genuine, extant controversy” as a result of the Challenging Stockholders’ failure to plead an actual or threatened nomination controversy. Thus, “the ripeness defect here is antecedent to the merits, not intertwined with them[.]”
Takeaways
- The Delaware Supreme Court continues to rely on the “twice-tested” framework in the advance notice bylaw context. As a result, stockholders are limited in challenging the bylaw on its face (e.g., the “indecipherable” bylaw in Kellner) or, during a concrete nomination controversy, challenging the triggered bylaw for equitable review.
- It appears that the Supreme Court took a potential arrow from the activist’s quiver in the “as applied” context, by effectively declaring the issue unripe and refusing to allow a hypothetical challenge to how a bylaw might be applied. Indeed, the court set a high bar for stockholders to make an “as applied” challenge, requiring a “genuine, extant controversy” and the need for a “concrete nomination setting,” rather than speculation over how a bylaw should operate.
- The Supreme Court also acknowledged that stockholders are not powerless to respond to bylaws that they dislike. Stockholders still retain the power to vote against directors, propose new bylaws, and seek books and records to investigate the directors’ conduct.
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