Delaware Developments Likely to Yield More By-law Proposals on Majority-Vote Standard and Rights Plan Restrictions

June 30, 2006

Two new amendments to Delaware law, which become effective August 1, have important implications for corporations and stockholder activists alike in the area of majority voting requirements for director elections.

The amendments do not change the default plurality voting standard for director elections. Nor do they modify the “holdover” rule under which an incumbent who fails to receive the requisite votes for reelection remains in office until resignation or removal. Instead, the amendments empower stockholders to change the default standard for director elections and codify a mechanic for avoiding application of the holdover rule. DGCL Section 216 now establishes that a stockholder-adopted by-law prescribing a voting standard for director elections may not be altered or repealed by the board, and DGCL Section 141(b) establishes that an irrevocable resignation by a director, subject to a condition that the director fails to receive a specified vote threshold for reelection (e.g., a majority of the votes cast), will be enforceable when that director fails to receive the specified vote threshold.

These amendments may motivate boards to adopt majority-vote by-laws, rather than await a stockholder proposal for the same purpose. One advantage of this is that a future board would then have the power to eliminate the provision by a subsequent amendment. On the other hand, the possibility of a future board amendment may concern activists who may still propose a by-law to prevent future board amendments. Because a board probably lacks the power itself to prevent a future board amendment, if it wants to eliminate all uncertainty and the possibility of a shareholder proposal on this topic, it can itself propose that shareholders adopt the appropriate by-law amendment.

In its June 22 decision in Bebchuk v. CA, Inc., the Delaware Court of Chancery also addressed in dicta the ability of a board to amend stockholder-adopted by-laws. The question arose in the context of a challenge to a stockholder-proposed by-law that would restrict the CA board’s ability to adopt and maintain a stockholder rights plan. While the court concluded that the issue was not ripe for disposition, it noted that the board’s ability to repeal a by-law adopted by stockholders remains an open question when the subject matter of the by-law is a restriction on the board.

The fundamental question is the relative priority of two provisions of the DGCL: Section 109, which grants stockholders the right to amend the by-laws and Section 141(a), which authorizes the board to manage or supervise the management of the corporation’s business affairs. In the case of poison pills, the issue is complicated by the specific statutory authorization in DGCL Section 157 for boards to issue rights, which has been found by the Delaware Supreme Court to permit rights plans. Although the authorities cited by the Bebchuk court support the proposition that the board may repeal stockholder-adopted by-laws, the court did not decide the question. In any event, the recent amendments to the DGCL clarify that at least majority-vote by-laws adopted by stockholders are not mutable by the board.

In view of these new amendments and the SEC staff position that no-action relief is not forthcoming in the case of stockholder proposals to amend by-laws, notwithstanding board implementation of a substantially similar policy guideline, we expect activist efforts to amend by-laws to provide for majority-vote standards will continue to escalate. In addition, so long as the legality of by-law restrictions on the board’s power to adopt and maintain poison pills remains unresolved, we also expect to see a continuing stream of stockholder proposals to restrict this power by amending the by-laws. Corporations should be circumspect in deciding how to allocate their resources in anticipated challenges by activists and consider the actions they may take to preempt and best prepare for those battles.

We attach excerpts of the relevant provisions of the DGCL amendments and commentary, as well as the decision in the Bebchuk case. If you have any questions, please feel free to call any of your regular contacts at the firm or any of our partners and counsel listed under Mergers, Acquisitions & Joint Ventures or Corporate Governance in the Our Practice section of our web site.