Delaware Court Rejects Facial Challenge to Advance Notice Bylaw

In Siegel v. Morse, the Delaware Court of Chancery rejected a stockholder’s challenge to an advance notice bylaw where there was no pending director nomination or proxy contest. Relying on the Delaware Supreme Court’s decision in Kellner, the Court of Chancery dismissed the action, finding that it did not present a ripe controversy for adjudication. The decision is important because the plaintiffs’ bar has recently brought a number of facial challenges to bylaws.

Take-Aways

• A stockholder challenged the validity of an advance notice bylaw even though there was no director nomination or proxy contest under consideration.
• Similar lawsuits have been brought against numerous other companies.
• The Court held that a facial challenge to a bylaw requires a plaintiff to show that the bylaw cannot operate equitably under any set of circumstances.
• Because plaintiff’s “hypothetical” challenge could not satisfy that standard, the Court dismissed the complaint for failing to present a ripe controversy.
• The decision is significant because it should discourage further lawsuits targeting corporate charters and bylaws in the absence of a real dispute.

Overview

In Siegel, the board of directors amended the corporation’s advance notice bylaw following a presentation from outside counsel to address the SEC’s universal proxy rule and make other changes with respect to the informational and procedural requirements for stockholders to nominate directors. The amendment was done on a so-called “clear day” when the company was not facing a known activist or takeover threat. Almost a year later, a stockholder filed a lawsuit in Delaware challenging the amended bylaw. The plaintiff did not plan to nominate a director and could not identify any other stockholder who was deterred from doing so. Nevertheless, the complaint argued that the bylaw was facially invalid and that the board breached its fiduciary duties in amending the bylaw.

Relying on the Delaware Supreme Court’s decision last year in Kellner v. AIM ImmunoTech Inc., the Court granted the defendants’ motion to dismiss. The Court explained that “[t]o succeed in bringing a facial validity claim, a plaintiff ‘must demonstrate that the bylaw cannot operate lawfully under any set of circumstances.’” It continued that “Delaware law does not permit challenges to bylaws based on hypothetical abuses.” Because there was no specific challenge to the operation of the advance notice bylaw, the Court dismissed this challenge as “hypothetical.”

The Court also rejected the plaintiff’s attempt to recharacterize the litigation solely as a fiduciary duty challenge to the board’s alleged defensive adoption of the bylaw. The Court reiterated that there was no present challenge to the application of the bylaw and that “a few slides [from counsel] with generic references to stockholder activism do not transform this dispute from an ‘imagined’ one to a ‘real-world’ one.” As a result, there was no “genuine, extant controversy.” The Court also distinguished the claim from a challenge to a poison pill, noting that an advance notice bylaw does not present potentially “devastating equity dilution.”

Over the past 18 months, stockholders have filed numerous complaints in the Court of Chancery asserting facial challenges to advance notice and proxy access bylaws. Kellner established a high standard for bringing those claims. As an early application of Kellner to an advance notice bylaw, Siegel is important and indicates that Delaware courts will not conduct an equitable review of a bylaw in the absence of a real controversy.