Transcript
Welcome to shareholder Primacy from freefloat media. A podcast about activist investing Securities Law and all the ways, the financial and legal worlds intersect and Collide. In real life. I'm here with an Lipton. A law professor at Tulane in New Orleans who teaches and researches Securities and business law. She holds up the legal end of the podcast and that's Mike Levin, an independent activist investor, and advisor to investors on activists situations, who lives and works in Chicago. He covers the financial side of our podcast. Yes. And there's a lot to talk about today. I know you and I and many others have spent a lot of time thinking about the kind of place. Delaware is for corporations. These days and you've actually written some blog posts on that subject. And a recent significant case would be worth exploring in today's podcast. Yeah, we've also seen many changes in advance notice by laws and how they affect activist investors. So we'll discuss the latest cases in Delaware on these. By law terms. All right, let's um, in this Delaware themed podcast today, let's talk about the first subject about what kind of environment it implies for Delaware. There's a number of things that have taken place and all that we can talk about today and in many future conversations. One specific case, recent case stands out and it's called males is how they title it, in Delaware Chancery Court. Let's talk about it. And let's see how Delaware responded now for everyone, who does not know what Mo Ellis is, what was that case about. Okay? So you actually have to take a step back and start with a little background to understand the case, which is the corporation is a business form. It's very bored. Centric shareholders are very little formal power. They're supposed to elect the board and the board runs the company they do so, usually by pointing a CEO, but then they oversee the CEO. So the board is the central decision maker and to the extent. Are any limits on boards, authority to manage the company. Those are supposed to be in the corporation's Charter, which is its organizational document, kind of like, the Constitution is for the United States, like it. I, I call those the bylaws. Well, actually the charter in the bylaws are different. The bylaws I tell. As I explained in my students, the bylaws are the statutes. The charter is the Constitution which is harder to amend. You can only amend it with a shareholder vote. So it's pretty stable. So if you're going to limit board authority in some way, that's where it's supposed to go. But in recent Years starting in the private sector in VC and private Equity, really they developed this practice of using private contracts, shareholder agreements to give specific investors could control overboard decisions. So it's set up, putting a limit on board authority in the charter. The company would sign a personal contract with the particular investor, like these sea. That's as the board. Can't recommend to merger and less this shareholder approves the board can't declare a dividend and unless this shareholder approves that kind of thing. So just put it on the table. Why? Is that a problem of a shareholder as a contract to control the board's actions because boards have to do Sherry obligations to the shareholders, their ansible, to all the shareholders and if they're controlled by someone who just as a contract, that means the remaining shareholders, who have a proportionally greater stake in the company, have less control over the board and maybe decisions won't be made in their best interests. So this is, this is a fairly Common. Habit or practice, where some private party. Some shareholder gets some extra rights as a result. So it's become so and only relatively recently in these VC and PE firms. It wasn't a really big deal before then. And then when this practice began to develop in the private space, these firms were actually warned that they may not be legal under Delaware law. These contracts because board authority, is supposed to be limited in the charter, and not in these personal contracts, but the companies were private. So, there were really weren't any disputes about it, and the practice grew and grew until the company started going public and like IPO public IPO public and now public shareholders and the public shareholders, have much more of these private shareholders to actually challenge these agreements. And that's exactly what happened in male Ellis. Kenmore Ellis took his company public. He was the founder, he was the chair of the CEO and he also had a stockholder agreement in place that essentially required the board to run. All major decisions through him. First, the board had to seek his approval, to take on new debt, to adopt, a new line of business. To adopt a poison pill to fire the top officers to adopt a budget. So here he became, he had a lot of. He IPO, he sold his company to the public to you and me, but still retained through this side agreement. This this contract not through the charter, through the contract, huge amounts of control that normally would be in the hands of the shareholders. That's exactly right. And he has the board anyway, so, um, the board. So it didn't really matter who you voted for the board. Can well as the guy he was in charge of the company at every level, so shareholders sued and they argued, you can't do that under Delaware law. If you want to limit board authority, it needs to be in the charter where it's stable and it can't be amended without a shareholder agreement and that was. And so, that was the case. So there was a lawsuit from some shareholder. they swayed Morales or the board, or some people and Wow, that lawsuit went through. It wound its way through Chancery Court, clearly in Delaware. Exactly. And when, and what happened, what happened, a couple months ago was the Chancery Court, the vice Chancellor Laster agree with the plaintiffs and said, it doesn't matter. This contract is simply illegal under Delaware law. You cannot put board restrictions on board authority in these personal contracts. And that's sent this huge shockwave through the business Community for a couple different reasons. First because you have all of these companies with these shareholder agreements, some of, which were private some of which were public and now suddenly like their entire governance, Arrangement was being held, just sort of invalid at Inception. So that was the first reason. But the second reason is there's this conceptual issue boards, make contracts all the time and those contracts restrict their ability to take you traction. So, for example, it's really common for a board to agree to take on debt for the company and agree, not to take on new debt. As long as the old debt is outstanding or not sell their assets. As long as the dead is outstanding, and activist shareholders act, you would know. Yeah, frequently settle their beefs with companies by getting the board to agree to include the activist nominees on the corporate proxy and last year was aware of all this when he wrote his opinion and he didn't hold that all of these kinds of agreements would be invalid. But the lines he drew were sort of fuzzy and not necessarily precise and that made a lot of people nervous about. Well, what if maybe this one goes really far? But what about lesser contracts are they all going to be invalidated? It became concerned about whether they'd be able to tell whether anything was legal and so this made a lot of businesses nervous so, essentially this Increasingly widespread practice, I think last year, called it Market practice. He called the market, he called them. Because because when words were protesting, they were saying, well, Market practices Market was actually, it was a subtle dig because last year, and I think he's right. Hell. But the law as it existed, in Delaware would not have permitted, these agreements and I think he's absolutely right about that. You can agree with that law. You can disagree with it but he was correct as far as so, the couple things to conclude for the moment is that last year? Voided, this contract said have these rights and that made a lot of VCS and a lot of other people who do business in Delaware, a little nervous, it made them extremely nervous. So, now what happened? Well, this is going to appeal, but appeal, but before that's even taking place because that's gonna take a while to resolve, there were proposed amendments to the Delaware, Corporate code. They were drafted extremely quickly to get them in before the legislature, recessed, for the summer and the Amendments Amendment would amend the statute or did men the statue to say, actually, you don't have to put these restrictions on board authority in the charter. You can restrict board authority in a private contract. The contract can't go. Further than what the charter will allow. If there are some limits that you couldn't even put in a charter, then you can't put them in a contract. But beyond that, the statutory Amendment said you can contract for things that otherwise would have to go into a charter. And in fact, these amendments, they were drafted, so hastily that. They immediately had to be revised to clean up some problems like typos and stuff. No, no, actually substitute like, people saw them and they substantively were like, wait, you don't mean that? Do you say they went back and they change the, But ultimately where they landed was, you can have private contracts. You can have these private contracts with governance Arrangements. They just can't go any further than what you could, otherwise put in the charter, but it was all very controversial partly because of how fast this was moving and partially. Because these amendments really upend how we think about a corporation. Remember the The idea is that corporations are bored Centric. It's fundamental to corporate Theory. Everything else about corporate law flows from the idea that decisions are made by the board, not in the side agreements. So you had law professors for testing and writing letters some lawyers, who protested by Chancellor Lasser and Chancellor McCormick protested. So, so two judges to judge. It normally are just supposed to like Romaine, presumably a little not a necessary. I mean, people criticize them for that, but the factors there's a long history of Delaware, just waiting it up proposed legislation, so, that's not fair. But yeah, they were concerned that these were two. Hastily drafted that they were well, thought out nonetheless, the legislature passed them. So, now boards are still subject to the fiduciary duties. They have a duty of loyalty and they have a duty of care so they can enter these contracts. But if they do, they must be State mistake proper care. They must act in the best interest of the company and so forth. But unlike what, Vice Chancellor last Harold, they are no longer categorically barred from signing away, governance rights to a particular individual. Okay, so so, the state of play is The this case went down. Everyone got a little worried, everyone, who cares? Got a little worried and but the legislature stepped in was, was the legislative the legis. I mean, other than they made some mistakes along the way. Did the legislature kind of know what they were doing here? Who was usually when I see legislative stuff, there's someone behind it. Yeah. And that would be the Delaware State Bar Association in the corporation because Delaware has this very odd system where the legislature does not propose corporate law. Amendments the State Bar is tasked with the corporation law council is tasked with proposing amendments. And no I actually don't think that the legislature understood it. I think they rubber stamp with the corporation lockout does because some of the comments they had in questions, they had just did not suggest a very deep sophisticated understanding of these things but the Amendments passed anyway. All right, so that so that's the law of the land, the law that Delaware land at least. Yeah, at this point. So this Market practice of being able to bestow on a VC, an investor one or another shareholder. All these extra rights is now kind of returned to what it had been before, the more or less before this case. Out know, again, I would say that the case was right as to what the Law happened. But what happened was in these private companies, this practice developed and that has now been ratified, but what was new. And the reason the case came up in the first place was transferring, these rights to public companies that had been done it, as soon as it was, that's when shareholders began to challenge it. So, one thing to think about about these amendments is sort of on a big picture societal level. These amendments, make it much easier for single individuals to wield unchecked power over all the resources of the corporations and for small corporations, maybe that's not a big deal. Maybe for private corporations, that's not a big deal, but for big public companies, it's a huge deal. I mean, imagine Elon Musk signing a holder. Is this gonna? Is this gonna make musk a little, have a little regret that he that he advocated to move the domicile of Tesla? Well, see, here's the thing. This agreement would almost certainly be illegal in Texas, like it would be an every other State until these amendments. But I strongly suspect that what's going to happen is that Other states are going to follow Delaware's lead. So right now, if Tesla had remained in Delaware, musk would have been able to sign a shareholder agreement. With Tesla. That said, I get final power over how the board develops, artificial intelligence, and he can't do that with Tesla as a Texas company, because Texas would not permit the shareholder agreements. But I'm really expecting other states to start changing their lot. Well, other states tend to follow Delaware. Exactly many respects. Exactly. So, so it's, it's stands to reason that they might start to, you know, other states, you know, my State Illinois, that was not a huge corporate domicile. A New York is a biggie, California is a big East. So they may start to adopt a similar especially New York, which is home to, you know, half of the VC Community or the investment Community. I actually really expect Texas to do it because Texas is not only trying to lure business from Delaware. But I mean there's a long history of States adopting their corporate law to benefit a favorite song. So I would actually be surprised if Tesla was in quietly talking to the Texas legislature to give them the same rights that they would have had if they'd stayed interesting. All right. And so does this kind of Help, you've written. You've written a little bit about the overall environment in Delaware and, and does this kind of help Delaware to gain favor again, with the people who care about that stuff. Okay, go ahead in the short term. Yes, but I think in a long term it's actually pretty dangerous for them. So Short term, this is the benefit one, obviously a lot of VC and PE firms were very unhappy with Delaware and threatening to move out of state. And now, they've been placated, plus, Delaware, sent a signal and the signal is we hear you. We respond to your concerns. We, you know, so, like Delaware made it clear that it will amend. Its law as necessary to keep corporations there and all that makes Delaware an attractive place to do business to incorporate a company, but here's the catch. When you put stuff in the charter, that's governed by Delaware law. That's why you incorporate in Delaware because that we are Charter is governed by Delaware law. These private contracts are not governed by Delaware law. They may not be governed by Delaware law and you can put in the provisions that select that any disputes or whatever other states and will be heard in private arbitration. So if governance moves into private contracts, because of Delaware's changes and because other states follow, then there's no, it doesn't matter where you incorporate because all the governance arrangements are going to be in these contracts and you can pick a completely different states law to govern your contract. So I think that this in some ways really hurts Delaware because why bother incorporating in Delaware, if you can incorporate anywhere else and some other state or some of their forum and your private governance contracts. So short-term they may have kind of short up their reputation with the people who decide on domiciles, but long term. This may have some some significant implications exactly like I think Think it weakens Delaware long term, especially if other states start following it, which I expect them to do. That's interesting. All right, cool. Hey, we're going to take a quick break and we will return momentarily to talk about advanced. Notice bylaws here at shareholder Primacy. This is the free flow media podcast Network, where we cover the, who of the business news? Because investing isn't a, what it's a, who check out our other podcast business pants for fact-based snark covering companies in Executives and the proxy Countdown. The only podcast that treats company meetings like sporting events find them on iTunes Spotify or wherever you get your podcasts back to the show. Welcome back to shareholder Primacy. I'm Ann Lipton here with Mike Levin. So now we're going to talk about advanced, notice bylaws and Mike. What is an advance notice by earlier? We talking about bylaws advance, notice bylaw is a particular set of terms in a company is by law. I like to refer to the bylaws as kind of a contract between the corporation and its shareholders. and, and that, you know, these contracts address all sorts of stuff about how the board meets and you know what the officers the company are well anyway several years ago companies started requiring Shareholders to let them know. Give them advance notice of a shareholder's intent to propose business. At an annual meeting or sometimes a special meeting. So, again, corporations meet once a year, that's the annual meeting where we do proxies, and have coffee and vote on directors and so forth. And shareholders are allowed to make all sorts of proposals, and annual meetings, in addition to asking questions and answers and shaking hands with the directors. Um, well companies wanted to know they wanted a warning if like an activist investor was planning on running competing candidates for the board of directors, they wanted plenty of notice, okay? So, yeah. So but okay, so let's imagine. It's a public company. Yes, they're gonna run an activist investor Camp. If an activists are going to run their own slate of directors meeting, they have to file, like proxy materials with the SEC, right. Why isn't that enough? Notice, because the companies wanted more, the companies wanted to know. So proxy materials tend to get filed like a month or two before the date of an announced meeting companies. Want it and basically state courts agreed, that it was. Okay, companies wanted four five, or more months notice that this was happening. So there's two Dimensions to the advanced. Notice by Alice first is the actual time. So companies had plenty of time to understand and plan ahead and kind of get ahead of the activists and so forth. Second the advanced notice terms in the bylaws also included. Lots of information that the company requested or demanded from the shareholder about what they had planned. So it was kind of routine and proxy materials at the SEC governs, you know, required some of this, but companies, layered on all sorts of other requirements about who the shareholder was. And how many shares they own and where, what kind of business they're in the who they've talked to and give us information about the nominees. So there was this whole long list of requirement of required information that the company had required from shareholders. So what was the basic of it? Go ahead. So what are the companies do with this information? What the purpose of it? Well, presumably That's great question. Presumably they're asking it on behalf of Shareholders, that the company shareholders want to, you know, the board thinks the company shows will want to know all this information about the activists say board nominees, okay? Realistically companies mostly weaponize this information, they mostly, you know, pick through it and look for, you know, damaging or potentially suspicious elements about, you know, a shareholders ownership or if they own some derivatives or something. And they usually just try to make this use this information to kind of discredit and activist. You know, I've said before the advanced notice bias are really designed, you know, presumably there, they're designed to help other shareholders, but they're really designed to make life hard for the activists. Um, so that's kind of the underpinnings of it. And then there was a recent case that you also know about that, that kind of looked over this. Yeah, Kellner. And and you could probably talk about that for a minute but Kellner and activist which was, you know, not a well-known activist. It was kind of an individual encountered. This company Kellner encountered. This company saying, I want to run up, I want to run a proxy contest here. And what the company did is, is very quickly. They imposed all sorts of other requirements they added to their Advanced Noah's bylaw terms. They started requiring the corps. The activists to disclose who its backers were they started. Requiring the activists, just start making disclosures and arguably about its family members, all sorts of additional data. So the, the calendar case challenged, the advanced notice bylaws not because of the timing. They were still, you know, four or five months in advance. But because of the information content that the that the company that aim was the company that the company was requiring. Um and so you know, that kind of pissed off Kellner. Didn't want to start making these additional disclosures. And so, they went and sued aim in in Chancery Court. We're back in Delaware to kind of challenge these These additional advanced. Notice? Bylaws that that am had adopted. That great. I either were they? I mean they were right. No, no killer. The Kellner shareholders, they had like, you know, gotten like someone who had a little bit of a security off violation in their record just candidate. And they, they were, they, they were by no means kind of clean here. So, you know, they and, you know, they were not, you know, they didn't have really high standing with other a, I'm shareholders and so forth. So so there were kind of two, two different parties, the activist didn't look great. And the company certainly didn't look great in all this process and so Delaware. You know, if I filed this case in Delaware, eventually made a ruling that you know, we both read that said that. a lot of the additional information that That am was requiring. In fact was not legitimate. That they that what wasn't a lot. And I didn't remember saying, you remember, some of the, some of the things that yeah, well that it was just far too college, that it was just far too complicated. There was one paragraph that like apparently would take like months to read if you said try to read it like they were just far too complicated and so, so it was really designed more to keep counter from challenge. The directors at all, then it was to provide information to shareholders. Exactly. So so there's usually there's as activists we figured out how these advanced notice bios kind of work. Okay. In addition to making us think months and months ahead of what we you know of what we need to be doing and trying to, you know, develop this volumes and volumes of information that in our experience very few other shareholders, really care about there's a couple of other elements to this that are worth mentioning first. It's the advanced notice bias are sufficiently detailed in Arcane to somehow kind of put off or dissuade shareholders from even trying to comply. So once you see this long list of stuff, you got to submit and sometimes companies require to fill out a questionnaire. There's all sorts of stuff. They make you go through, they gotta, you gotta submit the data again, 10 days before the date of the annual meeting, providing any kind of updates. One of the ideas is that these Advanced are so details. And so, so much of a hassle that we're not Even going to bother well, that doesn't stop me. Even the past me in the future. However, the other point I want to make, is that the advantage known as biologies are? A way to kind of trip up an activist that they're in? This is the paragraph. There was some, the I came out I think it was last or I can't remember who the chancellor was it for this case. It was will actually oh well okay if I answer will had ruled on this and said, you know, there's this 1100 word paragraph that pertains to you know, one bit of data and so forth. The idea there is that if you, if you're an activist and you kind of miss a miss punctuates, something or forget something, okay, that the companies going to say up, you didn't comply because of this technical violation, and it's within our rights to not. Let you resubmit this. Oh, okay. So it's it's just in front of mine called friends of my call it a football or something, a little teeny mistake's. They're just designed to almost make those ineffable, right. Okay. And and and and and will I think kind of recognize this. In her reasoning on this saying, you know you just can't you know, some of these are just so crazy that they're designed to make life hard for activists and and or shareholders and and we and we want to do that. So So the outcome there I think was that most but not all of the additional terms that aam imposed on Kellner were declared. I think invalid. Yes, the chancellor level but then he healed that was gonna you may want to talk about this for a second. So the company am appealed to the Delaware Supreme Court. And so this case, this case was basically, from last fall, I think and kind of went through, went through the court and so forth and and then it was a pill in Delaware Supreme Court, which I think Basically affirmed. The chance there's ruling. Is that correctly in part? Actually agreed with. So she had found that some of the bylaws were enforceable and were reasonable and some were not but the Delaware Supreme Court actually concluded that given all of the facts which is that these new bylaws had dropped, right? When the activists had declared that the campaign and some of them were absolutely unreadable. The Delaware Supreme Court inferred from those two facts. Essentially that these bylaws were not intended to gather information to protect shareholders. These by laws, were intended to prevent a proxy contest entirely and that you're not allowed to do, you are allowed to gather information, to protect shareholders but you're not allowed to just cut off the contest and get that. The Delaware Supreme Court said, none of these bottles are enforceable the entire net because they were all infected by this bad motive. If they had been in good motive but just over zealous, then the court could have said, well, this one's okay, and this one's not okay, but because they were All infected by this poisonous mode of to begin with, they were all invalid. But the proxy contest by now was over and Kellner had conducted himself, so poorly because he submitted false information and whatever, right? And there was that the dollars, never mind. The Kellner activist project was, was not, you know, it was not was not a Exemplar of how activists should be should be handling themselves in my, I mean, there was. Yeah. So both sides did not cover themselves in glory. Exactly. So they don't have all the biological. But also proxy contest is over and we're not giving you any like the Shelby's gone. It's over. We're not gonna give you any relief. Exactly. So, you know, normally normally a chance to read could say, you know, redo this exactly or or your vote don't count. There's all sorts of remedies that that the courts can can order a company to file and and basically I think my sense is to use lay persons tank language you know will kind of just washed her hands of this and said you people go away. It out of my courtroom, she was willing to trim the bad biologies that the other ones are fine and they're and Kellner did not comply and I've submitted false information. Therefore he doesn't get to you know run his candidates and the dollar Supreme Court said well actually, none of the BIOS are enforceable but now that the proxy contest is over Kellner. We dislike you so much that we're not going to do anything for you. So if we so interestingly I think though. As much as. We activists kind of grumble about Delaware. You know, we have bad experience as with, you know, books and Records demands and all sorts of other stuff. This was actually pretty positive. Hmm. for for, I mean, you know, the activists I've talked to and my read of it is this was really kind of a positive development in terms of trying to Deal with the worst of these advanced notice by laws that that the court both at the chance we love and it's Supreme Court. Level basically said yeah, there these advanced notice can go too far. Yeah, and certainly, they gave you at least as much of a road map, that is much better than just not comply and so that it is to submit false information. Yeah. Yes that's Right. So anyway, so that's so that was that was Kellner. I mean you know, there'll be more of this to talk about in the As things ramp up for the end of this year and starting into 2025. But that was a, that was a very interesting. And like I said, you know, pretty much of a positive development for activists and in my estimation. So, all right, okay, so let's wrap up there, there's more we'll cover next time. Yeah, thanks Ann. Um, it's been terrific talking about all this This is Cheryl holder Primacy hosted by Ann Lipton and me Mike Levin. I'm an independent activist investor and advisor to investors about their activist situations and is the Michael M Fleischmann professor in business law, and Entrepreneurship at two lane law school and affiliate of Tulane's Murphy Institute, you can find me Mike at the activist. Investor one word.com and you can find an at law Dutch tulane.edu. Our podcast is produced and distributed by free float media. Thanks for listening and we'll talk again. My mom.