From Thursday March 12, 2015 to Sunday March 19 2015, the Widener Moot Court Honor Society hosted the 2015 Ruby R. Vale Interscholastic Corporate Competition. Eighteen teams participated in the competition, which is the only corporate moot court competition in the country.
Paul L. Regan, Associate Professor of Law and Associate Director of the Institute of Delaware Corporate and Business Law authored the competition problem.
The appeal challenged a Preliminary Injunction Order by the Court of Chancery that enjoined the application of a corporate bylaw adopted by the board of directors (the “Board”) of Talbot Inc. (the “Company”) (collectively “Appellants”). The Board consisted of nine members, only one of whom—CEO Timothy Gunnison—was an officer of the Company. The Board-adopted bylaw required a dissident shareholder group who launches an ultimately unsuccessful proxy contest to reimburse the Company for reasonable professional fees and expenses incurred in resisting the proxy contest. The bylaw also included the possibility that the Board could waive the fee-shifting after the fact. The Board adopted the proxy contest fee-shifting bylaw in December 2014 in response to a Schedule 13D filing by Appellee Alpha Fund Management L.P. (“Alpha” or the “Alpha Fund”), in which Alpha had disclosed its 7% ownership stake in the Company and its intention to nominate up to four candidates for election to the Company’s nine-person Board at the next annual meeting of stockholders in May 2015. The appeal raised two primary issues for the Delaware Supreme Court: (1) whether the board-adopted proxy fee-shifting bylaw is facially under the Delaware General Corporation Law; and (2) whether the board adopted the bylaw for an inequitable purpose.
Facial Validity of a Board-Adopted Proxy Fee-Shifting Bylaw
Teams representing Appellants were expected to argue that the board-adopted proxy fee-shifting bylaw is facially valid because it is similar to the fee-shifting bylaw upheld as valid in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), the board-adopted exclusive forum bylaws upheld as valid in Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013) and City of Providence v. First Citizens BancShares, Inc., 99 A.3d 229 (Del. Ch. 2014), and other valid board-adopted bylaws affecting the domain of stockholder rights.
First, similar to the fee-shifting bylaw in ATP, the Proxy Fee-Shifting Bylaw is facially valid and enforceable under the DGCL because it merely allocates risks concerning the costs of a proxy contest among the principal parties in a particular context, and therefore satisfies “the DGCL’s requirement that bylaws must ‘relate to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.’” ATP, 91 A.3d at 558 (citing 8 Del. C. § 109(b)). Second, like forum selection bylaws, the Proxy Fee-Shifting Bylaw is a procedural rule for the operation of the Company adopted to facilitate the convenient functioning of business, in this instance, the business of managing a contested election of directors. Appellants relied on the Court of Chancery’s reasoning in Chevron to argue that the Proxy Fee-Shifting Bylaw does not touch on substantive issues and plainly relates to the business of the corporation because it merely enables the Company to be reimbursed for expenses reasonably incurred in resisting a “meritless” proxy challenge. Chevron, 73 A.3d at 951. Finally, the Proxy Fee-Shifting Bylaw is similar to valid Advance Notice Bylaws, Director Qualification Bylaws, and the “Poison Pill” Rights Plan in Moran v. Household International Inc., 500 A.2d 1346 (Del. 1985), because they all have a measure of restrictive influence on a proxy contest. The Proxy Fee-Shifting Bylaw has no greater regulatory effect on a proxy contest than the bylaws and Rights Plan that have been upheld as valid despite the imposition of some degree of regulatory impact on the exercise of the stockholder franchise.
On the other hand, teams representing Appellees were expected to argue that the Proxy Fee-Shifting Bylaw is facially invalid because it has an improper chilling effect on the stockholders’ exercise of their rights to undertake a proxy contest against management, and it disturbs the allocation of authority between the Board and the stockholders by moving beyond the procedural realm of bylaws and impermissibly touching on substantive issues, i.e., the stockholder franchise. The Board improperly limited the stockholders’ fundamental right to nominate and promote (by proxy contest) candidates for election by artificially and substantially raising the financial stakes of an electoral challenge to their incumbency; thus any resulting vote on an uncontested slate would be an empty exercise. The election of directors and the power to oust unsatisfactory incumbent directors who stand for elections is the sole province for stockholders. The enactment of a fee-shifting penalty for not being sufficiently victorious in a proxy contest is therefore an affront to the director-stockholder relationship that violates the DGCL because the directors are effectively intruding into the stockholders’ sphere of power.
Appellees were also expected to argue that the Proxy Fee-Shifting Bylaw is facially invalid because it is fundamentally different and distinguishable from the fee-shifting bylaw in ATP, and that various provisions of the DGCL support a corporate statutory framework designed to protect the stockholder franchise from board interference. ATP can be factually distinguished in a vital way from the Proxy Fee-Shifting Bylaw because there is a fundamental difference between proxy contests, which implicate the stockholder franchise, and mere intra-corporation litigation, which is not a fundamental stockholder right of the same ilk as the stockholder franchise. Because the electoral process is fundamental to the underpinnings of corporate governance, it should be viewed differently, and far more guardedly, than a board adopted fee-shifting bylaw in the litigation context.
In contrast to statutory provisions that require that substantive limitations or restrictions on the rights of stockholders be set forth in the certificate of incorporation, e.g., DGCL Sections 102(a)(4) and 151(a), Section 109(b) only permits the adoption of bylaws “not inconsistent with the law or the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs [etc] . . . .” Because the phrase “relating to” in Section 109(b) confirms that bylaws may only “relate to” stockholder rights and cannot go so far as to impose substantive “qualifications, limitations or restrictions,” the Proxy Fee-Shifting Bylaw is invalid because it does not merely “relate to” a stockholder’s right to conduct a proxy contest, but rather purports to impose substantial financial restrictions on an attempt to exercise that right. Additionally, DGCL Sections 228(a) and 141(d) provide powerful statutory corroboration that any limitation or restriction on the fundamental power of the stockholders to remove, replace, or reelect the board of directors must be set forth in the certificate of incorporation or a stockholder-adopted bylaw.
Appellants were expected to argue that the Proxy Fee-Shifting Bylaw was adopted in an informed manner and for a proper corporate purpose as a legitimate response to concerns over the substantial costs of defending against a proxy contest. The facts showed that, before adopting the Proxy Fee-Shifting Bylaw, the Board had hear presentations from a senior officer, the Company’s general counsel and outside legal counsel. The Court of Chancery has also concluded that the Board was “well-informed” in its decision to adopt the Proxy Fee-Shifting Bylaw.
Any improper purpose was secondary, and not the Board’s primary purpose, and the bylaw’s definition of “success” shows the Board’s intent to distinguish between valid challenges and meritless “nuisance” challenges. Further, even if the Board’s primary purpose was to discourage or perhaps thwart a proxy challenge, the Proxy Fee-Shifting Bylaw should nevertheless be upheld and enforced as valid because mitigating the potential adverse financial impact of proxy contests is a sufficient justification to find that the Board’s adoption of the Proxy Fee-Shifting Bylaw was equitable, and the possibility of waiver embodied in the bylaw is sufficient to cure any inequity in the Board’s initial adoption of the bylaw.
Moreover, this is not a case of “unilateral board action intended to inequitably manipulate the corporate machinery” because stockholders still have a full and fair opportunity to exercise their right to vote at the upcoming May 2015 election. Additionally, at the May 2015 election, Alpha could ask the stockholders to repeal the Proxy Fee-Shifting Bylaw, which would cure any inequity. Finally, the compelling justification standard espoused in Blasius does not apply here because nothing about the Proxy Fee-Shifting Bylaw prevents an insurgent from prevailing in a proxy context or otherwise thwarts the effective exercise of the stockholder franchise.
Appellees, on the other hand, were expected to argue that the Board adopted the Proxy Fee-Shifting Bylaw primarily, if not solely, for the improper purpose of thwarting Alpha’s right to fully and fairly participate in the electoral process when it adopted the bylaw in reaction to Alpha’s Schedule 13D filing. The record showed that four of the nine directors explicitly saw the adoption of the Proxy Fee-Shifting Bylaw as a deterrent to dissuade Alpha from undertaking its proxy contest at all. The Board’s reserved power to waive fee-shifting does not affect the fundamental impropriety of the adoption of the bylaw in the first instance. Further, here, the Board had resolved not to waive the fee-shifting for the expected Alpha proxy contest.
Additionally, the ex-ante deterrent effect of the Proxy Fee-Shifting Bylaw is a complete answer to any asserting that the bylaw would not affect Alpha’s ability to win a proxy contest against the incumbent Board. Because it was adopted primarily for the purpose of interfering with the effectiveness of a stockholder vote, the Proxy Fee-Shifting Bylaw should be reviewed under a compelling justification standard. Here, there is no such compelling justification, and the bylaw should be held unenforceable in equity. Any good faith reason for enacting the bylaw is irrelevant because even well-meaning directors are not permitted to disrupt the exercise of the stockholder franchise.
The teams from the University of Oklahoma College of Law and Ohio State University Moritz College of Law argued before a final bench comprised of the Honorable Karen Valihura and the Honorable James T. Vaughn, justices on the Delaware Supreme Court, the Honorable J. Travis Laster and the Honorable Donald F. Parsons, Jr., vice chancellors on the Delaware Court of Chancery, and Donna M. Nagy, Executive Associate Dean and Professor of Law at Indiana University Maurer School of Law, who delivered the Distinguished Scholar Lecture.
The University of Oklahoma College of Law team, represented by Kendra Norman, David Postic, and Ruthie Stevens, prevailed in the final round. The team from Ohio State University Moritz College of Law, Ryan Edmiston, Katie Kalbacher, and Susan Restrepo, won the second place prize. Michael Mullavey and Caroline Mockler, from the University of Florida Levin College of Law, won the Donald E. Pease Award for Best Brief. Brian Kesten, from Georgetown University Law Center, was named the competition’s Best Oral Advocate.
The competition, now in its 27th year, is named for Ruby R. Vale, who lived in Milford, Del. and practiced law in Philadelphia, specializing in corporation, banking, and insurance law.