Activist Campaigns Stymied by Board Nomination Bylaw Rulings

Activist investors gunning for board seats face an even steeper climb as the leading US business courts embrace a hands-off approach to onerous nomination bylaws aimed at scaring them away.

Delaware’s judiciary, which sets the nationwide tone on corporate law, has landed on a case-by-case test for the advance-notice provisions that sitting directors at thousands of companies from Albertsons Cos. to Zuora Inc. now routinely deploy against anyone eyeing their seats. The bylaws—reflecting a wave of defensive innovations at the board level—often demand sensitive details about the holdings, intentions, financing, and relationships of shareholders leading a board bid.

The emerging focus on the way the clauses are wielded, rather than how they’re written, is making it all but impossible to know which bylaws are enforceable without challenging them one by one in court, according to Harvard Law research fellow Ben Bates.

“You have a company you think it may be worthwhile to target, but you throw in the litigation costs, and suddenly your thesis is no longer worth executing,” he said.

In the most recent advance-notice bylaw ruling, a judge said last month that it’s premature to sue over an otherwise valid provision without an actual proxy fight on the horizon. The resulting framework threatens to chill activists by forcing them to build the time and expense of a long-shot court fight into campaigns they already had at most a few months to wage between the opening of the nomination window and the vote itself, according to Boies Schiller Flexner LLP partner Renee Zaytsev.

The uncertainty offers an advantage to directors, who can withdraw an overzealous provision if a lawsuit is filed, maximizing the deterrence factor without even having to defend the bylaw. The asymmetry “exacerbates risk and cost,” Zaytsev said.

Universal Proxy

Advance-notice bylaws are nothing new, and they can serve an important corporate governance function by requiring the types of disclosures about conflicts of interest that were once expected from political candidates. The first major batch appeared around 2008, following a significant wave of hedge fund activism. The current generation reflects a response to the 2022 rollout of universal proxy regulations by the Securities and Exchange Commission.

The universal proxy rules require companies holding director elections to provide a single voting card that lists both insiders and insurgents. The move to level the playing field by letting investors opt for mixed slates sparked a scramble to guard against an expected flood of activism with state-of-the-art bylaws.

“Whether the activism surge was real or not, the amendment surge was enormous,” according to Bates, who said the number of bylaw updates spiked from around 100 in a normal year to 300-plus in 2022 and more than 400 in 2023. The initial legal disputes concerned allegations of deadline gamesmanship, but the thornier questions come from legions of disclosure provisions—13 basic types that appear in every conceivable permutation, said Bates, who compiled a database with the advance-notice bylaws of nearly 4,000 companies.

The bylaws invoke the right of board members to access information about their opponents and the need for shareholders to know what they’re voting on. But some “look like they exist purely to give the board a pretext for rejecting a notice, either to gain settlement leverage or make the activist go away,” Bates said. One lawsuit, taking aim at Halliburton Co.'s bylaws, described them as onerous enough to “choke a horse.”

Delaware’s top court confronted the issue in a landmark ruling last year over a proxy fight at AIM Immunotech Inc., saying advance-notice bylaws are unenforceable—even when they’re legal on their face—if their main purpose is to kneecap an activist. Last month’s decision by a Delaware Chancery Court judge came in a case involving AES Corp.

Chilling Effect

Taken together, the rulings foreclose the kind of comprehensive test that would let activists make informed decisions about whether their turnaround theory is strong enough to justify a legal battle, according to Tulane University law professor Ann Lipton, who said the answer is always going to be an unhelpful “it depends.” Less litigation will mean fewer chances to develop a coherent doctrine, she said.

Even if an activist with “one hell of an investment thesis” brings a case, “the outcome isn’t necessarily going to tell you anything about the next one,” Lipton said. “We don’t know what the standards are, and the avenues for finding out seem to be narrowing.”

Hinging the framework on the immediate context—whether the bylaws were adopted on a clear day or in the crucible of a proxy fight—fails to grapple with how they may deter activism in the first place. Zaytsev pointed to parallel legal precedents that already offer a rubric for considering those dynamics, particularly a 2021 ruling rejecting a corporate poison pill adopted by Williams Cos.

It’s logical that the policy of declaring bylaws unenforceable—not striking them down—requires a specific context in which they can’t be enforced. But it would have made more sense for the courts to allow enforceability claims whenever a provision with a narrowly valid purpose poses an unacceptable chance of chilling shareholder activism altogether, Bates said.

The AES ruling may show Delaware’s judges trying to distance themselves from the perceived swing toward minority investors that drove lawmakers in March to enact a major corporate overhaul, state Senate Bill 21, aimed largely at reining in judicial discretion, according to Lipton.

“Despite SB21 being passed in this huge panic, a lot of companies have now put on their proxy that they still want to leave Delaware,” she said. “I could see the Delaware courts not wanting to be too aggressive about limiting directors’ options for protecting themselves against activists.”