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Court of Chancery Deals a Blow to Use of “Pfizer Type” Majority Voting Policies as a Mechanism for Shareholder Activism

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Prof. Lawrence A. Hamermesh
Ruby R. Vale Professor of Corporate and Business Law

In a very interesting opinion on a matter of first impression, Vice Chancellor John Noble has indicated that the refusal of a board of directors to accept the resignation of a director who fails to obtain a majority vote under a “Pfizer-style” majority vote resignation policy is largely immune from judicial review.

The case – City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc., decided September 29, 2009 – involved something of a collateral issue: namely, whether to permit inspection of documents relating to the board’s decision to reject the proffered resignations of three directors.  In rejecting that demand, however, the court suggested that such a rejection would not ultimately be tested under standards of judicial review more demanding than the business judgment rule.  For reasons explained below, I question whether that degree of deference should prevail as a general rule, especially in the situation where the majority voting rule exists as a requirement in the bylaws, rather than only as a matter of board policy.

The three directors in question, while elected by the required plurality vote as specified in Axcelis’ bylaws, did not receive a majority of votes cast at Axcelis’ 2008 annual meeting.  (The opinion suggests that this shortfall resulted from an ISS recommendation based on the 7-member board’s refusal to support a proposal to dismantle the board’s classified structure).  As a result, and as mandated by a governance policy adopted by the board of directors (a so-called Pfizer type policy), those three individuals were required to submit their resignations.  Under the policy, however, the board of directors had the discretion to reject the resignations.  In announcing the board’s rejection of the three directors’ policy-mandated resignations, Axcelis referred to the experience of the directors, their membership on key committees, and the anticipated need to supervise negotiations with a potential bidder for the company.

Over six months after the annual meeting, and after a very disappointing outcome of the bidding negotiations, the stockholder plaintiff made a formal demand to inspect documents, mostly relating to the board’s dealings with and evaluation of a potential bidder’s acquisition proposals.  The demand also included the following two categories:

6. All minutes of agendas for meetings (including all draft minutes and exhibits to such minutes and agendas) of the Board at which the Board discussed, considered or was presented with information concerning or related to the Board’s decision not to accept the resignations of Directors Stephen R. Hardis, R. John Fletcher, and H. Brian Thompson.

7. All documents reviewed considered, or produced by the Board in connection with the Board’s decision not to accept the resignations of Directors Stephen R. Hardis, R. John Fletcher, and H. Brian Thompson.

The stated purpose for this inspection was apparently to investigate possible waste or mismanagement, a traditionally accepted basis for inspection under Section 220 of the Delaware General Corporation Law.  Under settled Delaware law, all the plaintiff had to proffer to become entitled to the inspection demanded was “some evidence to suggest a credible basis from which [this Court] can infer that mismanagement, waste, or wrongdoing may have occurred.” And as the Vice Chancellor acknowledged, this evidentiary requirement has accurately been described as “‘the lowest possible burden of proof’ in Delaware jurisprudence.”

And yet:  the Vice Chancellor found the facts as described above insufficient to justify the requested inspection, applying reasoning that calls into question whether judicial review of a board’s rejection of a resignation under a board majority vote policy will ever be substantive and substantial.  In essence, the opinion reasons that (i) the three directors were duly elected under the plurality standard prescribed in the bylaws, (ii) the majority vote policy explicitly affords the board discretion to reject a director’s resignation, (iii) the board in the present case simply exercised that discretion, and therefore there was no evidence of wrongdoing.

As the Vice Chancellor saw it, “the plaintiff’s position would require this Court to accept the theory that mere shareholder reliance upon a board-enacted governance policy could effectively rewrite the voting provisions contained in a corporation’s by-laws.”  In a similar vein, the court suggested that the stockholders had no reasonable expectation that a failure to obtain a majority vote would result in the removal of the directors; the court suggested, in fact, that anyone seeking such a result should have instead pursued it directly, by attempting to remove the directors and putting forward an alternative slate of directors.  As the court explained it, reliance on the majority vote policy in lieu of a removal vote was a “poor strategic choice” that “cannot be the basis” for inspection under Section 220.

The court also suggested that the board’s rejection of the resignations did not implicate any standard of judicial review more demanding than the business judgment rule.  A Unocal standard would not apply, the court indicated, because “there was no present threat to control at the time of the May 2008 election.”  Not surprisingly, then, the court also declined to treat the rejection of the resignations as an act of entrenchment requiring a compelling justification under Blasius.  Given that these more demanding standards of judicial review were found not to apply, the Vice Chancellor found insufficient evidence of wrongdoing to justify the requested inspection.

Thus, there is little in the opinion to suggest that the question of evidence of wrongdoing, and the choice of standard of judicial review of the rejection of the resignation, would be treated any differently if the rejection followed a failure to achieve a majority vote required by a bylaw, under which the director would nonetheless continue in office as a holdover director, rather than under a Pfizer type policy, under which the director is actually formally elected.

If the same deference suggested in the Axcelis opinion were to control in the case of a majority vote  bylaw requirement, the directors’ decision to reject a resignation would be essentially immune from judicial review, and even a majority vote bylaw would have little in the way of judicial enforcement to back it up.

That seems unlikely to have been the result anticipated by those who adopted majority vote bylaws.  Undoubtedly, the board needs to retain some discretion to reject a resignation.  The official comment to the Model Business Corporation Act (Section 10.22) discusses some of the reasons why the board’s discretion could plausibly be exercised in favor of rejecting a resignation.

But it would surprise me if rejection of a resignation submitted by a director who was not elected were to be considered the norm, let alone an act effectively beyond judicial review.  As the Model Act comment notes, “given the directors’ consideration of their duties, boards are likely to be hesitant to select [ ] a director” who has failed to achieve a majority vote.  If the Axcelis opinion were read to state the law generally applicable where a director fails to achieve a majority vote required by a bylaw, there would be little reason for directors to “be hesitant” to keep him or her in office based on “consideration of their duties.”

Perhaps a new doctrinal structure is needed to deal with the situation:  perhaps when a director fails to be reelected by a majority of the shares voting, and a previously submitted resignation thereby becomes effective, the remaining directors ought to be charged with carrying some burden (similar to enhanced scrutiny under Unocal) that their decision has been made in good faith and for a proper purpose.  After all, choosing who should stay on as a director despite having failed to be reelected is not, as Blasius has pointed out, purely a matter of business judgment; rather, the matter is one at least partly within the domain of the stockholders’ legal power.

And when it comes to a request for inspection of resignation rejection-related documents, maybe we need a new category of proper purpose:  investigating possible waste or mismanagement doesn’t really describe the problem at issue.  Perhaps seeking the documents simply to evaluate the board’s decision to reject the resignation ought to be viewed as a proper enough purpose to justify at least a limited scope of inspection.

The Vice Chancellor’s opinion expresses concern that allowing the inspection of resignation-related documents would subject the company to an inappropriate “burden.” This burden seems somewhat overrated to me, however:  the matter involves a single, discrete decision by the board, and any request for documents related to that decision ought to be relatively easy to respond to, or a response could at least be limited if the burden truly were excessive.

It may well be that the Vice Chancellor reached the right result in Axcelis.  Perhaps it was significant that the demand for rejection-related documents was merely an appendage to a more extensive demand relating to the board’s strategy for dealing with an acquisition proposal.  Perhaps it was significant that the demand for inspection, which fairly promptly followed an unhappy resolution of that strategy, was not presented until over six months had elapsed following the resignation rejection. Perhaps the doctrine of laches should have informed the question of proper purpose for inspection:  given long-standing policy in favor of prompt resolution of board composition issues, any demand for inspection of documents with a view to judicial review of the decision should be made and pursued promptly after announcement of the rejection, rather than waiting over six months while the directors at issue have continued in office and engaged in significant decision making processes.  Or perhaps most importantly, perhaps a resignation by a duly elected director is qualitatively less compelling or entitled to deference than a resignation by a director who has failed to be reelected in accordance with a majority vote bylaw.

In any event, the Axcelis ruling is now on appeal.  It will be interesting to see how the Delaware Supreme Court handles the highly nuanced, but important, legal issues implicit in the case.

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