On October 13, 2021, Vice Chancellor Joseph R. Slights III issued a post-trial decision affirming the CytoDyn Inc. board of directors’ decision to reject a stockholder nomination of directors for failure to supply information required by the company’s advance notice bylaw. This is the first decision from a Delaware court addressing informational deficiencies in such a nomination notice, and provides important guidance for the many public companies with similar bylaws.
CytoDyn has had an advance notice bylaw in place since 2015. These are common provisions which require a stockholder who wishes to nominate directors to provide information about the nominations by a certain deadline before the annual meeting. On July 1, 2021, the day before the pertinent deadline, a group of activist stockholders delivered a nomination notice. On July 7, the board met to discuss the nomination notice and determined to retain advisors. On July 20, the stockholder plaintiffs filed their preliminary proxy materials with the SEC, disclosing for the first time that they had formed a Delaware LLC, CCTV (“CytoDyn Committee to Victory”) to raise funds for their campaign.
On July 30, the CytoDyn board sent a letter rejecting the nominations for failure to comply with the Company’s bylaws. Although many deficiencies were identified, of particular import were two categories:
- Failure to Disclose Those Supporting the Nominations: Although the bylaw mandated disclosure of those “supporting” the nominations, or any “agreements, arrangements, or understandings” regarding the nominations, the stockholders did not disclose the existence of CCTV or those providing funding or other support to the proxy contest;
- Failure to Disclose Conflicts of Interest: One nominee, Bruce Patterson, and one nominating party, Jeffrey Beaty, had potential conflicts of interest relating to their ownership of the common stock of another entity, IncellDx. Patterson is IncellDx’s founder, CEO, director, and the owner of roughly one-third of its common stock; nominating party Beaty is an IncellDx director and owns roughly 2.3% of its common stock. The nominating notice did not disclose that in 2020, Patterson proposed that CytoDyn acquire IncellDx for $350 million – a proposal the company rejected but would have earned Patterson and Beaty roughly $123 million. It also did not explain whether Patterson intended to pursue that transaction if placed on the CytoDyn board.
In early August, CytoDyn sued the stockholders in federal court for violations of the federal securities laws, pointing to these and other deficiencies. In the weeks that followed, to resolve that action, the stockholders provided several pages of additional and corrective disclosures. These included the names of roughly 70 individuals and businesses who provided financial support for their proxy contest (some of whom are IncellDx investors).
On August 24, more than three weeks after the rejection letter was sent, the nominating stockholders filed expedited claims against CytoDyn and its board of directors in the Delaware Court of Chancery. Plaintiffs sought a declaratory judgment that the Board erred in rejecting the notice and an injunction prohibiting the board from disregarding their nominations. Although Plaintiffs sought to preclude any discovery, this was rejected; and the parties engaged in document discovery and depositions, and proceeded to a trial on a paper record.
The Court ruled for CytoDyn and its board in full, rejecting Plaintiffs’ requested declaratory and injunctive relief. As the Court explained,
Where Plaintiffs ultimately went wrong here is by playing fast and loose in their responses to key inquiries embedded in the advance notice bylaw, and then submitting their Nomination Notice on the eve of the deadline, leaving no time to fix the deficient disclosures when the incumbent Board exposed the problem.
Several aspects of the opinion are noteworthy, and provide guidance for other public companies with similar provisions:
Reaffirming Propriety of Advance Notice Bylaws: The Court reaffirmed the “indisputably legitimate purpose” of advance notice bylaws and that the terms of the CytoDyn bylaw at issue “comport[ed] with bylaws our courts have characterized as ‘commonplace.’”
Failure to Supply Information Rendered Notice Deficient: The Court held that the nomination notice “was deficient” because it failed to comply with the “unambiguous terms of the Advance Notice Bylaw.” Each of the above-mentioned omissions rendered the notice deficient: (1) the failure to disclose the stockholders’ “supporters” and (2) the failure to disclose a potential conflict of interest vis-à-vis IncellDx. As to the former, the Court found that “provisions asking stockholders to disclose supporters” are “ubiquitous” and seek “vitally important information.” Although evidence (and, Plaintiffs’ subsequent public disclosures) revealed that multiple individuals had provided the Plaintiffs with financial support, “Plaintiffs elected to say nothing.” As to the latter, the Court held that the “prospect that a nominee may seek to facilitate an insider transaction is the type of potential conflict that stockholders are entitled to know about when voting for directors.” Plaintiffs’ failure to disclose the prior $350 million proposal was doubly problematic due to “evidence [that] clearly reveals that such a transaction was” being contemplated by certain of the nominees on an ongoing basis (e.g., emails stating “we view the 13D as an opportunity to bring this together in a 1+1=3 scenario”).
Key Role of Clear Day Adoption: The Court underscored that when such a bylaw is adopted on a “clear day” – here, six years before the nomination notice was received – there is no basis to challenge the board’s decision to put the bylaw in place. The fact of a longstanding bylaw can also play a role in assessing a plaintiff’s compliance. Discovery revealed that the Plaintiffs had begun analyzing the bylaw months before they submitted the notice, underscoring their ability to have complied (e.g., a March 2021 email sent by one Plaintiff “which summarized the Bylaws pertaining to director candidate nominations” and instructed it was “critical to strictly follow all of these procedures” because otherwise such “nomination shall be disregarded”).
Bylaws Are Interpreted as Contracts, Absent Evidence of “Manipulative Conduct”: In line with the Delaware Supreme Court’s decision last year in Saba Capital, the Court confirmed that “the canons of contract construction apply when construing bylaws.” Although Plaintiffs argued that enhanced scrutiny should apply to the Board’s decision to reject the nominations, the Court refused to do so. Blasius enhanced scrutiny review did not apply to a decision to enforce a bylaw, standing alone. And although Plaintiffs also argued that another form of equitable review applied – Schnell, a famed case holding that what may be legal may not be equitable – that too failed due to the circumstances. To invoke Schnell required Plaintiffs to show that “compelling circumstances” requiring equity to intervene on their behalf. Plaintiffs’ clear failure to comply with the bylaw and otherwise prove facts amounting to those “compelling circumstances” meant this equitable relief was unavailable.
The CytoDyn decision is a reminder of the importance of advance notice bylaws in director elections. It also confirms that reasonable informational requirements will be enforced, absent extreme circumstances that mandate equitable intervention. Public companies would be well served to consider their own such bylaws and whether their informational requirements include the terms at issue in CytoDyn and if they would be well served by amending or augmenting their existing provisions. Adoption of such measures on a clear day is critical: waiting to consider these matters after a nomination has arrived could lead to a different result.
The Sidley litigation team consisted of Andrew Stern, Isaac Greaney, Alex Kaplan, Charlotte Newell, Cassandra Liu, Deborah Sands, and Jordan Duval, and was assisted by members of the Firm’s shareholder activism team (Kai Haakon Liekefett, Derek Zaba, Loren Braswell, Parker Kolodka, Saba Yasmin, and Johnathan Sargent).
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.