ADW Draft 2/16/12

AP edits 4/2/12

Chapter 14 Shareholder Voting Rights

Primary Sources Used in This Chapter

DGCL §§ 109, 141, 228, 262, 271

MBCA §§ 12.02, 13.03

Exchange Act Rule 14a-8

Auer v. Dressel

CA, Inc. v. AFSCME Employees Pension Plan

Campbell v. Loew’s, Inc.

Blasius Industries, Inc. v. Atlas Corp.

Quickturn Design Systems, Inc. v. Shapiro

Concepts for this Chapter

•What and how of shareholder voting rights

–Rights in fundamental transactions

• Voting rights

• Appraisal rights

–Compare: merger, sale of assets, tender offer

•Power of shareholders to initiate

–Shareholder resolutions

–Bylaw amendments

–Removing directors / filling vacancies

•Judicial protection Protection of voting rights

–Blasius: board packing

–Quickturn: dead-hand/deferred poison pills

Introduction

Chapter 14 begins the sixth module of the book, this on one focusing on corporate governance. This chapter looks at one of a shareholder’s basic methods of self-protection: voting.

A. Basics of Shareholder Voting

Question: As a review, what are shareholders’ three basic methods of self-protection?

Answer:

•Vote

–Approve fundamental transactions

–Elect directors (annually, special meetings)

–Remove directors / fill vacancies

–Initiate action (amend bylaws, adopt resolutions)

•Sue

–Enforce fiduciary duties (derivative suits)

–Protect rights (disclosure, voting, appraisal, inspection)

•Sell

–Liquidity (except insider trading)

–Takeovers (tender offer)

Although shareholders are often called owners, they have a limited role in corporate governance because of centralized management through the board of directors. The “fundamental transactions” on which shareholders are allowed to vote require initiation by the board of directors, and have to be submitted to a shareholder vote by the board. Even then, such transactions are limited to

  • mergers
  • sales of significant business assets
  • voluntary dissolution, and
  • amendments to the articles of incorporation

1. Shareholder Meetings

Question: When do shareholders have meetings (during which they can act)?

Answer: Shareholders have regularly scheduled annual meetings, and special meetings convened for particular purposes. At a regularly scheduled annual meeting, the only matter required to be addressed is the election of members of the board of directors. Even then, shareholders have a limited ability to remove or replace directors

Question: Can other matters be considered at annual meetings?

Answer: Yes. A board of directors often seeks shareholder approval of other matters such as the ratification of decisions that the board has made during the past year. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, public corporations are also required to hold an advisory (non-binding) shareholder vote approving or disapproving on past management compensation. With the first such “say on pay” vote, each corporation’s shareholders also chose state their preference for how often (1-3 years) to hold such “say on pay” votes.

Question: What happens if a corporation does not hold an annual meeting?

Answer: If there is no annual meeting in the previous 15 months (13 in Delaware), shareholders can bring a judicial action seeking to require an annual meeting.

Question: Can shareholders act in the absence of a meeting?

Answer: Yes. They can act by written consent – sending their votes to a “gatherer” who delivers them to the company, instead of voting at a meeting. Some states require such consent to be unanimous. In Delaware a majority (whatever vote would be required if shareholders voted at a meeting) is requiredsufficient .

2. Shareholder Voting Procedures

Question: What sort of notices must be provided to hold a shareholders’ meeting?

Answer: Shareholders are entitled to written notice, at least 10 days (but no more than 60 days) in advance. Notice should include the time and place of the meetings. If it is a special shareholders meeting, notice should also include the purpose of the meeting.

Question: Which shareholders are entitled to vote?

Answer: The board sets a date - the “record date” - before sending out the notice of a meeting. All shareholders on that date (according to the corporation’s records) are entitled to get notice of the meeting and to vote, even if they sell their shares before the meeting. For this reason, pre-meeting purchasers of shares will sometimes ask the seller to cast the shares as instructed (an irrevocable proxy).

Question: How many shareholders have to show up to have a shareholders’ meeting

Answer: Normally a meeting is possible when there is a quorum represented. A quorum is usually equal to a majority of shares entitled to vote on the record date. A corporation can adjust the percentage in its articles of incorporation or bylaws, though usually not below a third.

Question: What is the purpose of a quorum requirement?

Answer: It prevents a minority of the shareholders from calling a meeting and taking some action against the interests of the majority of the shareholders.

Question: Do shareholders have to attend a shareholders’ meeting in person?

Answer: No. They can vote by proxy.

Question: What is a proxy?

Answer: A proxy is a document that the shareholder signs that appoints an agent to vote for him/her/it. It can either specify how the agent should vote the shares, or leave it to the agent’s discretion.

Question: How long does a proxy last?

Answer: If it is revocable, until the shareholder submits a notice of revocation, signs a later date proxy or appears in person at a meeting. Whether revocable or irrevocable, proxies are usually limited to 11 months. In closely held corporations, however, irrevocable proxies can be important planning tools and will often last more than 11 months.

3. Shareholder Voting Requirements

Question: How do shareholders vote?

Answer: One share/one vote.

Question: What percentage of shareholders’ votes are needed to approve something at a shareholders’ meeting?

Answer: It depends on the state statute. In some states, shareholders have to approve certain fundamental transactions by a simple majority vote: the number of “yes” votes exceeds the number of “no” votes. In other states (e.g. Delaware) shareholders have to approve certain fundamental transactions by an absolute majority vote: the majority of outstanding shares entitled to vote must vote “yes”.

Example 14.1 on p. 366 illustrates this concept:

ABC Corporation

100 shares outstanding, 60 “represented” at the meeting

  • Simple majority: 31
  • Absolute majority: 51

Question: How do shareholders elect directors?

Answer: Normally directors are elected using plurality voting, so the top vote getters for any open directorships are elected. As explained on p. 366, this means that if 5 people are nominated for 5 slots, a single vote will be sufficient to elect each of them. An alternative is to use majority voting in director elections, which would require a director to receive a majority of votes cast to be seated.

Question: Why do directors often get reelected?

Answer: As explained in the Breakout Box at the bottom of p. 366, the shareholder meeting and voting process strongly favors incumbents because they exercise financial control over the voting mechanism. Challengers, also called insurgents, have to use their own money to try to get proxies from shareholders, and only get reimbursed if they win.

Question: Can shareholders remove directors?

Answer: Yes. Shareholders can remove directors either for or without cause. The articles of incorporation may restrict the right to removal without cause, but not for cause.

Question: What is a “staggered board” ?

Answer: As explained in the Breakout Box on p. 366, in a corporation with a “staggered board” (also called a “classified board”), directors are elected for multiple-year terms (e.g., 3 years) with some proportion (e.g., one-third) up for election each year.

Question: Who does a staggered board favor?

Answer: The incumbent board, because it would take a challenging (“insurgent”) group multiple years to replace the board.

Question: What is “cumulative voting”?

Answer: As explained in the Breakout Box on p. 366, cumulative voting arrangements let shareholders concentrate their votes for a particular director candidate.

B. Shareholder Rights in Fundamental Transactions

1. Shareholder Voting and Appraisal Rights

Question: What do shareholders get to vote on?

Answer: Shareholders can use their vote to:

  • Choose directors
  • annual election
  • removal / replacement of directors
  • not easy to remove
  • approve fundamental changes (usually after board initiation)
  • amendments to articles of incorporation
  • mergers
  • sales of all/substantially all assets
  • corporate dissolution
  • initiate and approve bylaw changes
  • can be done without board initiation
  • this is major battlefield in capitalism currently
  • adopt resolutions
  • advise board on what to do, but are not binding

Question: What do the “fundamental changes” have in common?

Answer: They all involve transactions that change the corporation’s legal form, scope or continuity – but changes to the corporation’s business, even significant ones, do not constitute “fundamental changes.” For example, if IBM decides to stop selling personal computers and focus exclusively on consulting services, the change is not fundamental and does not require a shareholder vote.

Question: What happens when a shareholder disagrees with a fundamental transaction, but is nevertheless outvoted?

Answer: A shareholder can basically “opt out.” A dissenting shareholder can demand that the corporation cash him out at the “fair value” of the shares (as determined by a court in an appraisal proceeding).

In this manner, appraisal provides an “exit right” for dissenting minority shareholders and provides a “floor” on the value of those shares.

States statutes vary with respect to the specific types of transactions that trigger voting and appraisal rights.

2. Shareholder Rights in Corporate Combinations

One area in which voting and appraisal rights often arise is in the case of a corporate combination, or merger. In such a transaction, the business operations of two or more corporations are placed under the control of one management.

a. Statutory Merger

In a statutory merger:

  • P (the acquiring corporation) and T (the corporation to be acquired) start out as separate legal entities, and end up as a single entity
  • The boards of directors of both corporations adopt a “plan of merger” that specifies
  • The plan of merger is approved by the T, and possibly P, shareholders
  • The plan of merger is filed with the secretary of state and becomes effective
  • The shares of T are converted into the shares of P, which ends up with all of the assets and liabilities of T

The Breakout Box on p. 369 illustrates a statutory merger.

Question: What is included in a plan of merger?

Answer: Specific arrangements such as

  • Which corporation is to survive
  • The terms and conditions of the merger
  • How the shares of T will be converted into shares of P (or other property such as cash or bonds)
  • Any necessary amendments to P articles of incorporation

Question: What happens when the plan of merger is submitted to the shareholders, and which shareholders have to approve it?

Answer: The T shareholders almost always vote on a merger, but only get appraisal rights if there is not a public market for their stock (a so-called “market out”). Appraisal rights involve a judicial valuation of the stock.

The exception to T (and P) shareholder voting is when it is a “short-form” merger.

The P shareholders vote if the merger will change the number of shares it has after the merger. P shareholders normally do not vote if it is a “whale-minnow” situation or if there is not a “dilutive share issuance” (i.e. it increases the number of shares by less than 20%). “Dilutive share issuances” are discussed in the Breakout Box on p. 370.

State statutes vary with respect to shareholder approval of a statutory merger. Delaware requires an absolute majority of shareholders of both P and T to approve most statutory mergers.

Question: What is a “short form” merger?

Answer: As explained in the Breakout Box on p. 369, a short form merger is when P already owns at least 90% of T’s stock prior to the voted. In this situation, the T shareholders do not get to vote.

Question: What is meant by “appraisal rights”?

Answer: Appraisal rights refer to the process by which dissenting shareholders can seek fair value for their stock. It is a kind of protection beyond just voting by which shareholders actually go to court, and get a judicial valuation, and then are able to force the corporation to buy their stock.

In a statutory merger, P stockholders do not have appraisal rights, but T shareholders may.

Question: What is the “market out” exception?

Answer: Under the MBCA, T shareholders cannot seek appraisal rights if their stock was publicly traded before the merger and they receive (or retain) cash or marketable stock in the merger.

Under Delaware law, shareholders of both P and T are prevented from seeking appraisal if their stock was publicly traded before and will be publicly traded after the merger.

Of course, both approaches assume that the stock price reflects the value of the stock, which may not be a safe assumption.

Question: Which approach provides weaker protection for shareholders – MBCA or Delaware?

Answer: The MBCA, which would deny appraisal rights to acquired company (T) shareholders more often than Delaware law. Under the Delaware law approach, in a stock-for-cash deal, T shareholders would get appraisal rights; Under the MBCA approach, but T shareholders would not.

Question: What if the merger goes through, and a shareholder still does not like it?

Answer: The shareholder may argue that the directors breached their fiduciary duties, perhaps that they had a conflict of interest.

Question: What are some advantages and disadvantages of statutory mergers?

Answer: An advantage of a statutory merger is the fact it makes it easy to transfer assets. A disadvantage is that it exposes P to unknown or contingent liabilities in T’s business. When the statutory merger is complete, P (the surviving corporation) holds the assets and liabilities of both P and T.

b. Triangular Merger

In a triangular merger:

  • P and T agree to combine
  • P incorporates S: a wholly-owned subsidiary (an acquisition vehicle)
  • P transfers the consideration that is needed for the deal (to pay T’s shareholders) to S
  • P gets 100% of S’s shares in exchange
  • S and T engage in a statutory merger and S acquires all of T’s assets and liabilities

The Breakout Box on p. 372 illustrates a triangular merger.

Isn’t the illustration in the breakout box a reverse triangular merger? Yep, it is! I sometimes point out that “deal lawyers” conceive of corporate acquisitions with the same diagrams and boxes as used in the book. Hence, a “reverse triangular merger” is one in which Target is “reversed into” the dummy subsidiary.

Question: What is a “reverse triangular merger”?

Answer: In a reverse triangular merger T is the survivor of the merger with S. Keeping the acquired corporation (T) alive may be helpful for business reasons (e.g., brand name, a contract that might be voidable if T is acquired). T ends up as a subsidiary of P.

Question: What are some advantages and disadvantages of triangular mergers?

Answer: From P’s perspective, an advantage of a triangular merger is that P is not directly exposed to T’s liabilities. From the perspective of P’s shareholders, however, a disadvantage of a triangular merger is the fact that P’s shareholders to not get to vote on the merger. Their shares are not affected by the merger, and P is not a party to the statutory merger (S is). An exception to that under the MBCA is the situation in which P puts more than 20% of its shares into S. In that case, that dilutive effect will trigger a P shareholder voting right.

Similarly, P shareholders do not have appraisal rights in a triangular merger. T shareholders do have appraisal rights, subject to the “market out” exception.

c. Sale of Assets

When a combination is structured as a sale of assets:

  • P and T agree to sale of assets
  • T shareholders approve (vote on) the sales agreement
  • P buys the assets of T using cash, stock or other securities as consideration

The Breakout Box on p. 374 illustrates a sale of assets.

Question: How do T shareholders’ rights differ in a sale of assets under the MBCA and Delaware law?

Answer: Under the MBCA, T shareholders have appraisal rights, subject to the “market out” exception. Under Delaware law, T shareholders do not have appraisal rights. T shareholders have voting rights with respect to the transaction under both approaches.

Question: What is meant by “sale of assets”? How many assets?

Answer: For purposes of the need for shareholder approval, a sale of assets refers to “all or substantially all” assets of T. Example 14.2 on p. 373 illustrates this principle, as it is set out in DGCL § 271:

§ 271. Sale, lease or exchange of assets; consideration; procedure.

(a) Every corporation may at any meeting of its board of directors or governing body sell, lease or exchange all or substantially all of its property and assets, including its goodwill and its corporate franchises, upon such terms and conditions and for such consideration, which may consist in whole or in part of money or other property, including shares of stock in, and/or other securities of, any other corporation or corporations, as its board of directors or governing body deems expedient and for the best interests of the corporation, when and as authorized by a resolution adopted by the holders of a majority of the outstanding stock of the corporation entitled to vote thereon or, if the corporation is a nonstock corporation, by a majority of the members having the right to vote for the election of the members of the governing body and any other members entitled to vote thereon under the certificate of incorporation or the bylaws of such corporation, at a meeting duly called upon at least 20 days' notice. The notice of the meeting shall state that such a resolution will be considered.

Do we need to addGimbel v. Signal Cos., 316 A.2s 599 (Del. Ch. 1974) aff’d per curium 316 A.2d 619 (Del. 1974)? It’s in the breakout box at p. 373. Or do you mean, is this still worth having. I think so. It’s still foundational Delaware law.

Example 14.3 on p. 374 contrasts this with the approach of the MBCA, which requires T shareholders’ approval “if the disposition would leave the corporation without a significant continuing business activity.” MBCA §12.02

MBCA § 12.02. Shareholder Approval of Certain Dispositions.

(a) A sale, lease, exchange, or other disposition of assets, other than a disposition described in section 12.01, requires approval of the corporation's shareholders if the disposition would leave the corporation without a significant continuing business activity. If a corporation retains a business activity that represented at least 25 percent of total assets at the end of the most recently completed fiscal year, and 25 percent of either income from continuing operations before taxes or revenues from continuing operations for that fiscal year, in each case of the corporation and its subsidiaries on a consolidated basis, the corporation will conclusively be deemed to have retained a significant continuing business activity.