Delaware responds to the certified questions

In CA, Inc., v. AFSCME Employees Pension Plan the Delaware Supreme Court said yes to both of the SEC’s questions whether (1) a shareholder’s proposed proxy expense reimbursement bylaw was a proper subject for action by shareholders as a matter of Delaware law, and (2) if adopted, would cause the issuer to violate Delaware law. (Here’s some links to the debate on this case.)

The yes answer to question 1 at least partially settled a long debate about the relationship in Delaware between DGCL 109(b) and 141(a). The former allows the shareholders to adopt bylaws, but subject to the latter’s admonition that directors manage the corporation unless otherwise provided in the articles. So how does 141(a) limit 109(b)? 

The court said bylaws have a “process-creating” function. Although this bylaw sounds substantive because it would compel spending money, it's actually process-oriented because “the purpose of the Bylaw is to promote the integrity of [the] electoral process by facilitating the nomination of director candidates by stockholders or groups of stockholders.”

However, the answer to the second question is also yes (and therefore the bylaw is a problem) because it might let the shareholders compel the board to award expenses in a situation where such an award would violate their fiduciary duties -- namely, “in a situation where the proxy contest is motivated by personal or petty concerns, or to promote interests that do not further, or are adverse to, those of the corporation.” This raises an issue under Quickturn and other cases. The court said it doesn’t matter whether the bylaw is supported by a majority of the shareholders or “would create a better governance scheme from a policy standpoint. We decide only what is, and is not, legally permitted under the DGCL.”

So if the shareholders want to shrink the board’s power to manage, they have to do it via certificate amendment (which, of course, must be initiated by the board itself). Otherwise, they need to propose a narrower bylaw that would not present the problem this one does, or get the statute amended.

At first blush, all of this seems right. But here I want to focus on the sensible procedure this case involves, and its federalism implications. As I said more than a year ago,

the SEC should not opine on the merits of proposals, including whether they are permitted under state law: that should be determined by the state courts and legislatures. So the SEC should get out of the business of determining whether a proposal concerns ordinary business, or significant social policy, or even whether it is consistent with state law.

This certification process let the Delaware court decide a sticky question of shareholder bylaw power that a half-century of SEC proxy access decisions had left to federal bureaucrats. The Delaware court's affirmative answer to the first question is not a particularly surprising result either under the statute or politically. After all, the SEC still has the final say on whether to seek certification, and the Delaware court has given it some incentive to do so in the future.

But does the yes answer to the second question suggest that Delaware will use its power to negate shareholder rights?  I don't think so.  The court made it clear that it was not deciding the issue as a matter of policy, and left insurgents alternative procedures.  Thus, the court was careful to present itself as a pragmatic forum that would hear the shareholders out on a case by case basis

More reflections here.