PROXY ACTIVISTS FEAR DELAWARE COULD UPSET THEIR APPLECARTS: RULING UPHOLDS POWER OF BOARDS TO OVERTURN SHAREHOLDER ACTIONS

The Delaware courts may be about to wipe out 15 years of accomplishments by the corporate governance movement.

At stake is the “binding bylaw” shareholder resolution — a proposal by one shareholder that, if approved by a majority of a company’s shareholders, must be followed — one of the most potent tools in the arsenal of shareholder activists.

Recent decisions by the Delaware Chancery Court have corporate governance activists worrying that it may ultimately declare such resolutions illegal. Companies at which such resolutions are proposed are expected to challenge them through the courts later this year.

Because more than half of the companies in the United States are incorporated in Delaware, that would be a major blow to corporate governance activists.

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“If binding bylaw proposals are wiped out, it could mean that the last 15 years of (corporate governance) work is gone,” says Sarah Teslik, executive director of the Council of Institutional Investors in Washington. “The risk is the proxy process becoming meaningless.

“Companies have learned that they can ignore (non-binding) proposals that get 51% of the vote.”

Not all activist investors agree. “I would not view what happens in Delaware (as terrible), regardless of how it comes out,” says Peter Clapman, general counsel of the Teachers Insurance Annuity Association-College Retirement Equities Fund in New York.

“I don’t see it destroying shareholder ability to take actions. I still think the precatory (non-binding) proposal works for us.”

He added: “Most of the companies we deal with take action even before going to a vote.”

Richard Koppes, former general counsel of the California Public Employees’ Retirement System in Sacramento, and now counsel in the Sacramento office of Jones Day Reavis & Pogue, says a court ruling against binding resolutions would be a setback, but not a catastrophic event.

“I don’t think 15 years of work will be thrown away,” he said.

Still, Ms. Teslik isn’t the only one who’s worried.

“Binding bylaw proposals are the only corporate governance tool that makes a difference,” says Kurt Schacht, general counsel of the Madison-based State of Wisconsin Investment Board, which has filed binding resolutions with several companies this year.

“The bottom line on all this is that shareholders could get backed into a corner, where the only thing left would be to get our own directors on the board,” he said.

The Delaware Chancery Court last year invalidated San Jose, Calif.-based Quickturn Design System’s “no hand” poison pill — which said that a new board of directors could not redeem a poison pill for six months.

The court said the pill illegally restricted the board of directors’ power.

Judge Jack Jacobs, vice chancellor of the court, wrote that the board of a Delaware-incorporated company has full power to manage the affairs of the company, subject only to limitations set out in the certificate of incorporation.

The Delaware Supreme Court upheld his ruling .

Shareholder activists are concerned the same logic could cause the court to rule binding resolutions unfairly usurp boards’ power.

A recent article on binding resolutions was published in the December Tulane Law Review by Lawrence A. Hamermesh, associate professor at Widener University School of Law in Wilmington. The article said that while state laws give shareholders the right to adopt bylaws, they don’t allow them to limit the managerial power of the board, particularly in relation to poison pills and other anti-takeover measures.

Although no case has yet come before the Delaware courts, it is likely one will come up later this year.

Should the decision go against them, corporate activists say they’re ready to take on the state of Delaware, where so many companies incorporate because of its corporation-friendly laws.

“Shareholder patience with Delaware is wearing thin,” says Nell Minow, a principal of Lens Inc. in Washington.

“There’s a coalition of institutions ready to vote to have corporations move out of Delaware,” says Guy Wyser-Pratte, a New York-based arbitrageur and shareholder activist. “I’ve said to the Delaware courts: ‘Make my day.’ ”

Crain News Service