The Delaware Court of Chancery rang in the new year with a decision calling into question certain provisions in a company’s advance notice bylaws, which had been adopted in the face of an upcoming proxy fight. On the whole, the Kellner v. AIM Immunotech Inc. decision is yet another reminder of the critical importance of advance notice bylaws and that they are often enforced by Delaware courts. But companies should work with counsel to consider the impact of this decision on their own bylaws, bearing in mind that considerations may change based on the outcome of a now-pending appeal in Kellner.
Kellner represents the latest in a years-long dispute and multiple proxy contests. Most relevant: in 2022, AIM Immunotech Inc. (“AIM”) received a nomination notice that, as the Court put it, was “orchestrated by a felon who had meddled with AIM’s business.” AIM’s board of directors (the “Board”) rejected that 2022 notice for failure to comply with federal securities laws. After that failure, certain involved stockholders resolved to pursue a proxy campaign in 2023 and to submit the “nomination well in advance of the deadline to avert any antics.”
In early 2023, the Board considered its next steps. With advice of counsel, the Board determined to “update and modernize” AIM’s advance notice bylaw provisions and adopted a number of amendments.
On August 3, 2023, despite the plan to submit a nomination “well in advance of the deadline,” Plaintiff submitted his nomination notice the night before the deadline. AIM’s counsel identified several deficiencies in the notice, and after meeting three times to consider the notice and those identified deficiencies, the Board determined to reject the nomination notice. The deficiencies included: (i) undisclosed “agreements, arrangements, and understandings” among Plaintiff, his affiliates, and the nominees; (ii) a failure to disclose the “known supporters” of the nomination; (iii) a failure to disclose information about initial contacts among those involved, and (iv) “other undisclosed information, including adverse recommendations from proxy advisor firms concerning other public company board service as called for in AIM’s form of D&O questionnaire.” Two days later, Plaintiff commenced litigation, arguing that: (1) certain of AIM’s advance notice bylaw provisions were invalid and (2) even if the provisions were valid, they had been applied inequitably to Plaintiff’s nomination.
The Court’s Decision
As the Court stated, the decision reflects a “tale of wins and losses on both sides.” On the one hand, the Court found that certain elements of the advance notice bylaw provisions failed because they “inequitably imperil the stockholder franchise to no legitimate end.” On the other hand, the Court agreed that the nomination notice did not comply with other, valid portions of the advance notice bylaws, and the Board’s rejection of the nomination was proper.
Plaintiff’s Win: Certain Portions of the Advance Notice Bylaws Were Deemed Inequitable
At the outset, the Court reiterated the purposes of advance notice bylaw provisions: “timing and disclosure.” They both set a deadline for a nomination and require the provision of information to ensure that a company’s board and stockholders are fully informed.
Critically, the Court then went on to apply enhanced scrutiny, “Delaware’s intermediate standard of review,” to the adoption of the advance notice bylaw amendments. This was because the Board amended AIM’s advance notice bylaws on a proverbial “cloudy day,” rather than a “clear day”—i.e., a proxy contest was on the horizon. Enhanced scrutiny requires a “context-specific” review of a board’s conduct and most fundamentally focuses on “reasonableness.” Ultimately, the Court held that the Board had identified a “threat to proper corporate objectives,” but that the Board had not shown that certain of the advance notice bylaw amendments were “proportionate in relation to those objectives.”
The Court’s specific findings concerning the six portions of the advance notice bylaws at issue are discussed below. Although Plaintiff asked that the Court invalidate the advance notice bylaw provisions as a whole, the Court refused to do so. Instead, the Court held that four specific provisions—the AAU provision, the consulting/nominating provision, the known supporter provision, and the ownership provision—were unenforceable.
- The Agreements, Arrangements, and Understandings (“AAU”) Provision
The AAU provision required disclosure of all arrangements, agreements, or understandings, whether written or oral, during the prior 24 months, relating to a Board nomination. The Court underscored that the required AAU disclosure, in general terms, “promotes a proper corporate objective: enabling the Company and Board to evaluate who is making and supporting a proposal.”
Two facets of the AAU provision were at issue, rather than the entire provision itself. First was the “bespoke 24-month lookback provision.” The Court held that this was justified, given the 18 months of prior history between AIM and those involved in the nomination, and that 24 months was “neither preclusive nor unreasonable” because a stockholder could “easily understand what it means and disclose information accordingly.”
Second, Plaintiff also challenged the AAU provision requiring disclosure of all AAUs with persons “acting in concert with” the stockholder or any Stockholder Associated Person (as defined in AIM’s bylaws, “SAP”). SAP was defined to include (i) persons acting in concert with the stockholder, (ii) persons controlling, controlled by, or under common control with the stockholder or its Affiliates and Associates (as each was defined in AIM’s bylaws), or persons acting in concert therewith, and (iii) immediate family of the stockholder or its Affiliates and Associates. The Court noted “the interplay of the various terms”—“acting in concert,” “Associate,” “Affiliate,” and “immediate family” within the AAU provision and within the definition of SAP itself. The Court concluded that these terms created an “ill-defined web” containing “vague requirements about far-flung, multi-level relationships.” With no evidence that such broad disclosure requirements were necessary to achieve the Board’s objectives, the Court invalidated the provision.
- Consulting/Nomination Provision
The consulting/nominating provision required disclosure of “AAUs between the nominating stockholder or an SAP, on [the] one hand, and any stockholder nominee, on the other hand, regarding consulting, investment advice, or a previous nomination for a publicly traded company within the last ten years.”
As with the AAU provision, the Court was concerned about the scope of disclosure, noting that it also included “ambiguous requirements across a lengthy term.” The provision “[did] not stop with the present nomination—or even AAUs about AIM. It implicate[d] a decade of AAUs (including ‘advice’ on ‘potential investments’) involving other publicly traded companies as well.” The Court noted that this could be “draconian and would give the Board license to reject a notice based on a subjective interpretation of the provision’s imprecise terms.”
- The Known Supporter Provision
The known supporter provision required the disclosure of “all known supporters” of the nomination, including the support of other stockholders known by SAPs to support the nomination. The Court found the provision’s limits to be ambiguous both in terms of types of support and supporters required (e.g., would an interaction on social media count?).
The Court noted, however, that a similar provision was upheld in CytoDyn, a 2021 decision upholding a company’s enforcement of its advance notice bylaws. There, disclosure was required of others “known by any of the Proposing Persons to support such nominations . . . .” The AIM and CytoDyn known supporter provisions were thus virtually identical, other than with respect to the fact that AIM’s provision required disclosure of the support of other stockholders known by SAPs to support the nomination. But the Kellner Court held that AIM’s known supporter provision was problematic because it was not limited to requiring disclosure of known financial supporters, and it was unclear what degree of “support” would otherwise require disclosure. The Court underscored that information regarding financial supporters was “‘vitally important’ to voting stockholders.” Although the known supporter provision in AIM’s bylaws was held to have gone too far, the Kellner decision underscores that a narrower version of such provision focused on readily identifiable support, like financial support, would likely be enforceable.
- Ownership Provision
The ownership provision required a nominating stockholder to disclose, among many other things, a stockholder’s ownership in AIM stock (including beneficial, synthetic, derivative, and short positions) or the stock of any principal competitor and extended such disclosure requirement to stock owned by SAPs, immediate family members, and any “person or entity acting in concert” with a nominee. The Court explained how similar provisions seeking “to close loopholes in Section 13(d) involving synthetic equity” are generally legitimate. But the Court held that AIM’s provision, “with its 1,099 words and 13 subparts,” “flummoxed this judge” and was “indecipherable.” Consequently, “[a]ny justifiable objectives that might be served by aspects of [the provision] are buried under dozens of dense layers of text.”
- First Contact Provision
The first contact provision required disclosure of the dates of first contact among individuals involved in the nomination effort. The Court upheld this provision, finding that it was not preclusive because the dates of first contact could be determined “from any number of sources,” including a search of the applicable parties’ emails and text messages. Notably, Plaintiff argued that a first contact provision was “unusual,” but the Court noted, “that is not the test.” The Court determined it reflected a proper objective, it was not overly burdensome to comply with, and, therefore, it was enforceable.
- The Questionnaire Provision
The questionnaire provision required that all nominees complete AIM’s form of the D&O questionnaire. The Court noted that requiring provision of such information is standard and enforceable, as it “furthers the information-gathering and disclosure functions of advance notice bylaws.” Notably, Plaintiff raised concerns about the provision allowing five business days for AIM to send the form of the D&O questionnaire to a stockholder, which he believed “might allow the company time to make unfair revisions.” The Court determined that “[i]t would amount to hair splitting . . . to conclude that five days is unreasonable, but a slightly shorter time period (say, three days) is not,” and therefore upheld the questionnaire provision as written.
Defendants’ Win: Rejection of Plaintiff’s Nomination Upheld
The Court then evaluated Plaintiff’s nomination, and the Board’s rejection of the same, under the remaining portions of the advance notice bylaw provisions. This analysis was case specific and rooted in contractual analysis. Plaintiff argued that his nomination notice satisfied AIM’s advance notice bylaw provisions, or alternatively, that the Board’s enforcement of the bylaws to reject his nomination notice was inequitable. The Court rejected both arguments.
- Compliance with the AAU Provision
Much of the Court’s analysis considered whether Plaintiff’s notice complied with the AAU provision. Because the Court had invalidated portions of the Board’s 2023 amendments to the AAU provision, the Court looked to whether Plaintiff complied with the 2016 version of the AAU provision. The Court concluded that, even on this basis, Plaintiff’s notice was deficient. Plaintiff’s notice claimed that before July 2023, when Plaintiff and the proposed nominees flew together for a meeting at their attorney’s office, no decision was made to work together to advance nominees or take any action with respect to AIM. The Court found this statement to be false, because the AAU provision could take the form of a measure or plan before an event and the 2023 effort was clearly a continuation of the 2022 nomination attempt that should have been disclosed.
- Compliance with the Other Provisions
The Court then briefly explained how the notice also failed (1) the first contact provision by omitting even an approximate date of first contact and (2) the questionnaire requirement by failing to disclose prior “withhold” recommendations despite the assistance of “sophisticated counsel.”
- Whether the Rejection of the Notice Was Equitable
Having found that Plaintiff failed to satisfy the bylaws, the Court turned to evaluating whether the rejection satisfied the equities. The Court reminded that, in this context, whether the rejection of a deficient notice was equitable turns on whether a board purposefully used “corporate machinery” to obstruct stockholders from legitimately exercising their rights. This fact-specific application of Unocal considers whether a board has proportionally responded to a threat “to an important corporate interest.”
Here, the Board rejected Plaintiff’s notice after guidance from counsel and based on its experience in the prior year. The Court held that the Board proved its actions in rejecting the nomination notice were reasonable in light of its desire to adequately evaluate a nomination and to allow stockholders to cast informed votes. The Court also found that the Board’s rejection was proportional in light of its objectives. The Court drew particular attention to the fact that the notice followed a prior nomination notice involving white collar criminals—one of whom had become increasingly hostile to AIM and had misrepresented himself as a company representative to third parties.
In sum, the Kellner decision underscores the important role that advance notice bylaw provisions play in corporate governance. It is eminently reasonable for a corporate board to be concerned about a nomination shrouded in secrecy. Under the circumstances in Kellner, this was all the more true, given the parties’ complex history.
The Kellner decision also provides guidance for companies in evaluating their current bylaws. This includes a reminder that it is important for companies to try and craft clear, unambiguous provisions. Companies with advance notice bylaws would be well served to consider this decision—and, ultimately, the Delaware Supreme Court’s decision on appeal—with the benefit of counsel.
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.