Plaintiffs’ Firms Are Once Again Targeting Advance Notice Bylaws

Stockholder plaintiffs’ law firms have recently filed several virtually identical complaints in the Delaware Court of Chancery challenging often used public company advance notice bylaws as facially invalid. Against this backdrop, Delaware corporations should undertake a review of their advance notice bylaw provisions.

Recent lawsuits have challenged common bylaw provisions governing stockholder nominations of directors that specifically require the proposed nominee to provide the board with an irrevocable letter of resignation, subject to acceptance by the board in the event that, at some later date, the board determines that the nominee made untrue statements in connection with their advance notice submission to the company.

These resignation requirements are often required in public company advance notice bylaws as a condition to a stockholder-nominated director becoming eligible for election. According to the complaints, such a resignation requirement is contrary to, inter alia, the Delaware General Corporation Law, which vests the power to remove directors solely in the hands of the stockholders.

While the complaints have only recently been filed—and it is a long way from a court reaching any conclusion as to the facial validity of the resignation requirements—public companies should take notice of the filings and initiate a review of their own bylaws for similar provisions. If such provisions ultimately are determined to be invalid, undertaking such a review now may serve as insurance against stockholder demands that will be sure to follow if this litigation is successful.

Like many jurisdictions, Delaware law permits the Court of Chancery to award a stockholder’s counsel a fee, to be paid by the corporate defendant, if the stockholder succeeds in conferring a benefit upon the corporation and its stockholders by, for instance, causing the corporation to remedy defective provisions in its bylaws as a result of litigation. In those cases, the fee is not a function of the stockholder’s counsel’s time spent on the matter at an hourly rate. Rather, the court may calculate the fee based upon an estimation of the dollar value of the “benefit” conferred on the corporation by the litigation.

That potential fee appears to be what is motivating the lawsuits here, none of which appear to arise from any active director nomination process concerning the companies that are named as defendants. Rather, the lawsuits are posed in the abstract as facial challenges, motivated by a novel legal theory of invalidity and, undoubtedly, the fees that might be awarded to the law firms should the suits be successful.

Notably, Delaware does not require that a stockholder file a legal action as a means to causing a corporate defendant to correct a putatively illegal provision in the bylaws as a condition to counsel receiving a fee. Rather, a law firm can seek a fee simply by serving a letter upon the corporation that identifies the issue and states a claim that would survive a motion to dismiss, so long as the letter is thereafter the proximate cause of the corporation taking corrective action.

Should the litigation challenging the resignation requirements succeed, public corporations with these or similar provisions in their bylaws are expected to receive stockholder demand letters seeking to cause the corporation to take corrective action. The recipient of such a letter will have little to argue by way of defense should the Court of Chancery in the present litigation find that the provisions are facially invalid.

However, if a corporation first initiates its own review and analysis of such a provision before receiving a stockholder demand, the stockholder (or rather, the stockholder’s counsel) may not be able to prove that the demand was the cause of the change to the bylaws. Accordingly, corporations may wish to initiate a review of their bylaws and determine whether to modify or repeal resignation requirements, should they ultimately be determined facially invalid in the present litigation.

Corporations should document the initiation of such review in nonprivileged communications that can be used defensively should the corporation receive a stockholder demand. Doing so may prevent the corporation from needing to pay fees down the road, as the benefit of the corrective measures will have been caused by the corporation’s monitoring of the Court of Chancery docket, and not at the initiation of a stockholder.