In "a tale of wins and losses on both sides," the Delaware Court of Chancery reiterated that advance notice bylaws adopted amid an approaching proxy contest are reviewed through the lens of enhanced judicial scrutiny to determine whether they are a reasonable and proportionate means to defend against potentially abusive and deceptive practices by activists or hostile acquirors, and held that certain provisions that the court found overbroad, ambiguous or ripe for subjective interpretation were not permissible. Kellner v. AIM ImmunoTech Inc., et al., C.A. No. 2023-0879-LWW (Del. Ch. Dec. 28, 2023).

The case concerns the latest chapter in a series of attempted proxy contests related to the board of directors (the "Board") of AIM ImmunoTech Inc. (the "Company"). Beginning in the summer of 2020, one of the Company's stockholders ("Tudor") began repeatedly contacting the Company and certain other stockholders to convey his growing frustration with the Company's management. Previously convicted of securities fraud, Tudor orchestrated another stockholder to nominate two of Tudor's acquaintances to the Board at the Company's 2021 annual stockholders meeting. The notice submitted pursuant to the Company's advance notice bylaws was rejected by the Board for non-compliance with federal securities laws.

The following year, another stockholder acting on behalf of Tudor and his allies (the "Nominating Group") submitted a notice to nominate two directors to the Board. The Board rejected the nomination notice because it failed to disclose that the Nominating Group was behind the nomination notice despite the requirement in the Company's then-advance notice bylaws to disclose "arrangements or understandings ... pursuant to which the nomination(s) are to be made."

In light of the SEC's adoption of the universal proxy rules in August 2022, as well as the 2021 and 2022 Nominating Group's attempted director nominations, the Board amended the Company's advance notice bylaws in March 2023 (the "Amended Bylaws").

In August 2023, a stockholder who was involved in the 2021 and 2022 attempted nominations ("Kellner") submitted a nomination notice that nominated Kellner and two additional individuals as director nominees (the "2023 Nomination"). In rejecting the 2023 Nomination for failing to comply with the Amended Bylaws, the Board relied on several purported deficiencies in the 2023 Nomination, including: (i) undisclosed agreements, arrangements, and understandings between and among Kellner on the one hand, and the director nominees and the other stockholders supporting the 2023 Nomination on the other hand; (ii) failure to disclose known supporters of Kellner's nominations; (iii) failure to disclose the dates of first contact between the Nominating Group members and their affiliates; and (iv) other undisclosed information required by the Company's D&O questionnaire form (the "D&O Questionnaire").

After the Board's rejection of the 2023 Nomination notice, Kellner filed a lawsuit against the Company and Board, alleging that six Amended Bylaws provisions were invalid, that the rejection of the 2023 Nomination notice was unlawful and inequitable, and that the Board had breached its fiduciary duties by adopting the enhanced advance notice requirements in the Amended Bylaws and rejecting the 2023 Nomination notice.

The court premised its analysis of the validity of the substance and enforcement of the Amended Bylaws on the following determinations:

  • Boards of public companies are afforded latitude in adopting and enforcing advance notice bylaws that are reasonably tailored to promote the legitimate corporate purpose of conducting orderly stockholder meetings and election contests.
  • Onerous bylaws that unduly restrict stockholders' voting rights or are applied inequitably will be struck down.
  • The adoption of the Amended Bylaws should be examined under the enhanced scrutiny standard of review because it occurred, in part, in anticipation of stockholder nominations, rather than on a "clear day".
  • The enhanced scrutiny standard of review, which the court applied to both the substance and enforcement of the Amended Bylaws, comprises two inquiries:
    • first, whether the board of directors faced a threat to an important corporate interest or to the achievement of a significant corporate benefit, and
    • second, whether the board of directors' response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the exercise of stockholder franchise.
  • The Board made a reasonable assessment that a legitimate corporate objective—obtaining transparency from a stockholder seeking to nominate director candidates—was threatened given the types of manipulative, misleading, and improper conduct that the Company experienced in connection with its 2022 annual stockholder meeting.

The court then considered whether the challenged Amended Bylaws were a non-preclusive and reasonable means of obtaining enhanced disclosure from nominating stockholders and their nominees. The court concluded that four of the challenged Amended Bylaws unduly restricted the stockholder franchise.

Arrangements, Agreements, or Understandings Provision (the "AAU Provision")

The AAU Provision required the disclosure of all arrangements, agreements, or understandings, whether written or oral, and including promises, relating to a Board nomination. Although the court noted that the AAU Provision furthered a legitimate corporate purpose of enabling the Company, Board, and stockholders to evaluate who makes and supports a proposal or director nomination, the court held that the scope of AAU Provision was not proportionate to its objective. The court explained that the broad scope of persons included within the "Stockholder Associated Person" definition of the Amended Bylaws, and the requirement to disclose arrangements between any Stockholder Associated Person and potentially "any other person or entity," resulted in an ill-defined web of disclosure requirements, and that the AAU Provision, as drafted, imposed overbroad, vague disclosure requirements. Knowing that a proxy contest was coming, the court found that the extensive scope of the relationships required to be disclosed by the AAU Provision suggested an intention to block the dissident's effort, and therefore held it to be invalid.

Consulting/Nomination Provision

An additional challenged bylaw provision required disclosure of any arrangements, agreements, or understandings between a nominating stockholder or a "Stockholder Associated Person" and any stockholder nominee regarding consulting, investment advice, or a previous nomination for a publicly traded company within the past ten years (the "Consulting/Nomination Provision"). The court held that the Consulting/Nomination Provision was unreasonable for two reasons: (i) similarly to the AAU Provision, the Consulting/Nomination Provision created overbroad relationship disclosure requirements; and (ii) the Consulting/Nomination Provision imposed ambiguous disclosure requirements across a lengthy term of 10 years, implicating arrangements, agreements, or understandings involving the Company as well as other publicly traded companies. Citing a director's deposition acknowledging that the benefit to stockholders of the information sought in the Consulting/Nomination Provision was arguable at best, the court held that the Consulting/Nomination Provision was draconian at worst and would arm the Board with license to reject a notice based on a "subjective interpretation of the provision's imprecise terms." Therefore, the court held that the provision was invalid.

Known Supporter Provision

Another challenged bylaw provision required nominating stockholders and director nominees to identify all of their known supporters (the "Known Supporter Provision") by disclosing any sort of support, including that of other stockholders known by Stockholder Associated Persons to support the nomination. Concluding that the limits of the Known Supporter Provision were ambiguous—in terms of the types of both support and supporters that one must disclose—the court found it to impede the stockholder franchise while exceeding a reasonable approach to ensuring thorough disclosure. The court noted that, consistent with Delaware jurisprudence, the Known Supporter Provision would have likely been upheld if it were limited to supporters providing financial support or meaningful assistance.

Ownership Provision

Finally, the court struck down a bylaw provision requiring detailed disclosure of a nominating stockholder's (and each beneficial holder on whose behalf the nomination is made) ownership in the Company's stock and its hedged interests, as well as the ownership and hedging arrangements by Stockholder Associated Persons, immediate family members, and persons acting in concert with a director nominee (the "Ownership Provision"). The Ownership Provision also called for the disclosure of legal, economic, and financial interests in any principal competitor of the Company and the disclosure of performance-related fees that each Stockholder Associated Person was entitled to, including interests held by family members.

The court noted that bylaw provisions that require disclosure of not only beneficial ownership but also synthetic and derivative ownership, short interests, and hedging arrangements may serve justifiable objectives (such as closing loopholes in Section 13(d) of the Securities Exchange Act of 1934). However, the Ownership Provision "sprawled wildly beyond" the purpose of eliciting sufficient information for the Board to make a recommendation about director nominations and stockholders to cast informed votes. In the court's words, "[t]hough I have tried to read and understand it, the bylaw—with its 1,099 words and 13 subparts—is indecipherable." The court largely opted not to provide an analysis of the text of the Ownership Provision but did note two examples of ambiguity within the Ownership Provision—the requirement to disclose interests in a "principal competitor", which was not defined and, if read literally, the requirement to disclose interests in investment funds that are invested in the Company or a "principal competitor" of the Company.

Although it struck down four of the challenged Amended Bylaws, the court upheld other advance notice provisions, which included disclosure requirements of dates of first contact among those involved in a nomination effort (the "First Contact Provision") and a requirement that director nominees complete a D&O Questionnaire.

Next, the court considered whether the 2023 Nomination notice complied with the Company's bylaws. Emphasizing the corporate considerations at risk if a nominating stockholder could conceal arrangements, agreements, or understandings with other parties, the court assessed whether the 2023 Nomination notice complied with a 2016 iteration of the bylaws requiring more focused disclosure of arrangements, agreements, or understandings, which the court concluded did not suffer the same flaws as the stricken AAU Provision. Finding that the 2023 Nomination notice included false representations as to the Nominating Group members' understandings and activities in connection with the 2023 Nomination, the court held that the 2023 Nomination notice failed to comply with the Company's bylaws. The court also found evidence that the 2023 Nomination notice violated the First Contact Provision and that the D&O questionnaires filed by the Nominating Group's director nominees included untrue representations.

The court then undertook an equitable review of the Board's decision to reject the 2023 Nomination notice. The court determined that the Board's rejection served the proper purpose of obtaining transparency from the nominating stockholder and nominees, which was to allow the Board to evaluate a nomination and the stockholders to cast informed votes. The court also concluded that the Board's rejection was proportionate given the Nominating Group's attempted director nominations, and that none of Board's actions prevented the Nominating Group from complying with its advance notice bylaws.

This most recent decision by the Court of Chancery further reiterates that though they remain an important and legitimate tool for incumbent boards to protect the corporation and its stockholders against potentially abusive and deceptive practices by activists or hostile acquirors, advance notice bylaws should be tailored to each corporation according to its needs. Further, this decision underscores the responsibility of boards of directors in ensuring that the breadth of advance notice bylaws does not overreach or prevent the possibility of a contested election.

Additionally, this decision, consistent with the Delaware courts' other recent decisions on advance notice bylaws, is a reminder of the importance of adopting or amending advance notice bylaws on a "clear day." Advance notice bylaws adopted in the context of an activist campaign are more susceptible to review under a heightened degree of scrutiny.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.