The Supreme Court of Delaware's recent decision inKellner v. AIM ImmunoTech Inc. provides important guidance on the limits of a board's authority to amend an "advance notice" bylaw in the context of a live proxy contest, holding that even facially valid bylaws may be unenforceable if adopted primarily for entrenchment purposes.
The Delaware Supreme Court's ruling echoes the concerns recently raised by the B.C. Securities Commission in NorthWest Copper Corp., which cautioned against the improper tactical use of early warning reporting and "joint acting" disclosure rules to stifle legitimate shareholder engagement (see our previous case update on NorthWest Copper, British Columbia Securities Commission Provides Guidance on Early Warning and Joint Actor Rules in Proxy Solicitations). It also echoes concerns raised by the Quebec Financial Markets Administrative Tribunal in Gildan Activewear Inc. v. Browning Westand the Quebec Superior Court in Gildan Activewear Inc. v. Browning West Cayman Fund, which refused a board's request for orders against a shareholder waging a proxy contest. Importantly, however, the Kellner decision also serves as a reminder that courts will scrutinize the behaviour of both sides of a contest: deceptive conduct by shareholders may lead a court to deny them relief, even in the face of potential board overreach.
Background
The Kellner case arose from a protracted proxy contest at AIM ImmunoTech Inc. ("AIM"), a microcap publicly traded company. In 2022, a group of investors made two unsuccessful attempts to nominate directors to AIM's board. AIM rejected both nomination notices for non-compliance with its advance notice bylaws. The second rejection led to litigation in the Delaware Court of Chancery, which upheld AIM's decision.
In 2023, activist investor Ted Kellner, who had ties to the group that sought the earlier nominations, launched a third attempt to nominate a dissident slate. In response, AIM's board adopted "sweeping" amendments to its advance notice bylaws. AIM maintained that the amendments, which imposed extensive disclosure requirements on nominees and nominating shareholders, were tailored to address perceived threats arising from the activists' history of deceptive and, in some instances, fraudulent conduct.
For the 2023 annual meeting, Kellner submitted a nomination notice that sought to comply with AIM's amended advance notice bylaws, but the board rejected it for non-compliance with the amended bylaws. Kellner then filed suit in the Delaware Court of Chancery, challenging the validity and enforceability of the amendments.
Delaware Court of Chancery's Decision
The Court of Chancery invalidated four of the six challenged provisions of the amended advance notice bylaws, finding them to be unreasonably broad, ambiguous, onerous, and – in the case of AIM's 1099-word-single-sentence "Ownership Provision" – "indecipherable". The Court of Chancery concluded these provisions went beyond what was necessary to ensure adequate disclosure and seemed designed to preclude legitimate proxy contests. Nonetheless, the Court of Chancery ultimately upheld the board's rejection of Kellner's nomination notice based on a failure to comply with AIM's pre-existing advance notice bylaw, which it found continued to apply, and the two remaining challenged provisions.
Delaware Supreme Court's Decision
The Delaware Supreme Court addressed an appeal from Kellner and a cross-appeal from AIM. The Supreme Court largely agreed with the Court of Chancery's factual findings, but reversed in part on the legal issues.
The Supreme Court clarified the proper framework for assessing the validity and enforceability of advance notice bylaws. The Supreme Court explained the analysis should proceed in two steps: (1) determining whether the bylaws are facially valid; and (2) if the bylaws are facially valid, assessing whether they were adopted or applied inequitably under the circumstances.
Applying this framework, the Supreme Court held that five of the six challenged bylaws were facially valid, disagreeing with the Court of Chancery's invalidation of four provisions (the Supreme Court agreed, however, that the Ownership Provision was invalid). Turning to the second prong of the analysis, the Supreme Court applied the enhanced scrutiny standard of review that applies where, as here, a board decides to adopt or amend advance notice bylaws in the midst of a live proxy contest. Under this standard, AIM's board bore the burden of demonstrating it acted reasonably and proportionately to address a legitimate threat to an important corporate interest.
The Supreme Court held that, while AIM's board had properly identified a threat stemming from the activist investors' history of deceptive conduct, the board acted inequitably in adopting the amended bylaws. The Supreme Court pointed to the Court of Chancery's findings that the bylaws were "akin to a tripwire," "draconian," and seemingly "designed to thwart an approaching proxy contest" to entrench the incumbent directors. Based on these findings, the Supreme Court had no difficulty concluding that the board's primary purpose was to impede Kellner's nominations rather than to ensure an informed vote (which is a proper basis for adopting an advance notice bylaw). As such, the Delaware Supreme Court held that the challenged bylaws were unenforceable.
A similar result would be expected under Canadian law. There are clear limits imposed upon the scope of permissible advance notice bylaws in Canada as a result of guidance from proxy advisory firms, as well as case law requiring that they can be a "shield" to protect against an ambush, but cannot be used as a "sword" by boards to improperly defeat dissident shareholders.
Notably, despite holding that the amended bylaws were unenforceable, the Delaware Supreme Court declined to grant Kellner any affirmative relief, relying on the Court of Chancery's countervailing findings that Kellner and his nominees had engaged in deceptive conduct by providing false and misleading disclosures in their nomination materials. Specifically, Kellner had failed to disclose the dates on which discussions with the other proposed nominees about the proxy contest had first occurred, and had falsely stated that the nominees had not received any adverse recommendations from proxy advisory firms.
Key Takeaways
While Kellner is a US decision, it offers important insights for both Canadian boards and engaged investors navigating the challenges of shareholder activism and proxy contests. The key takeaways are:
- Advance notice bylaws can be a legitimate tool for promoting informed shareholder decision-making, but they must be adopted for a proper purpose. Bylaws adopted or amended for the primary purpose of interfering with shareholder nominations or entrenching the incumbent board may be unenforceable.
- Boards should proactively review and, ideally, update advance notice bylaws before a contest arises. Bylaw amendments are more likely to withstand scrutiny if adopted on a "clear day" rather than in the midst of a proxy fight. However, boards should still be able to respond to legitimate threats when they arise, provided their response is proportionate and reflects careful deliberation and business judgement.
- Advance notice bylaws should be clear, unambiguous, and not unduly burdensome. Courts may strike down bylaws that are vague, overly broad, or impose unreasonable disclosure requirements not justified by a legitimate corporate interest.
- Both boards and activists must act transparently and in good faith. Courts will closely examine the motives and conduct of all parties to a proxy contest. Deceptive or inequitable conduct by either side may lead a court to deny them relief, even if the other party has also acted improperly.
The Kellner decision underscores the need for boards to carefully balance their obligation to protect legitimate corporate interests with shareholders' fundamental right to participate in director elections. While advance notice bylaws serve an important purpose, namely to ensure the orderly election of directors at meetings of shareholders and prevent an ambush, they cannot be used as a tool to thwart shareholder democracy and to improperly insulate boards from accountability. At the same time, shareholders seeking to nominate directors must play by the rules and ensure their disclosure is accurate and complete.
For further information on these issues, please contact a member of our Capital Markets Group or our Securities Litigation Group.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.