In this recent case, Kellner v. AIM ImmunoTech, the Delaware Supreme Court articulated a two-part framework for judicial consideration of advance notice bylaws in the event of a challenge to their adoption, amendment or enforcement. If the bylaws are contested, they must be “twice-tested—first for legal authorization, and second by equity”: first, a court must evaluate “whether the advance notice bylaws are valid as consistent with the certificate of incorporation, not prohibited by law, and address a proper subject matter”; second, a court must evaluate “whether the board’s adoption, amendment, or application of the advance notice bylaws were equitable under the circumstances of the case.” Also, it’s a good idea to make the bylaws “intelligible.” In this case, the Court held that “(1) one ‘unintelligible’ bylaw is invalid; (2) the remaining amended advance notice bylaws subject to this appeal are valid because they are consistent with the certificate of incorporation, not prohibited by law, and address a proper subject matter; and (3) the AIM board acted inequitably when it adopted the amended bylaws for the primary purpose of interfering with, and ultimately rejecting, Kellner’s nominations. Thus, the remaining bylaws challenged on appeal are unenforceable.” Nevertheless, Kellner’s deceptive conduct meant that his nominations notice would not stand.
Background. As described by the Court, AIM ImmunoTech, Inc. is a publicly traded pharmaceutical company, incorporated in Delaware, that develops treatments for immune system disorders, viral diseases and cancers. Ted Kellner, a major stockholder, and several others—including two felons convicted of wire fraud, insider trading, and other crimes—sought to nominate a slate of directors to serve on the AIM board in 2023. A version of the group had previously made two attempts to nominate directors, but were rejected under AIM’s then existing bylaws. Following those two attempts, and amid warnings that the another effort was possible, in 2023, the board adopted amendments to the company’s advance notice bylaws “intended to respond ‘to significant activist activity during 2022 in which an activist group . . . engag[ed] in efforts to conceal who was supporting and who was funding the nomination efforts and to conceal the group’s plans for the Company,’ and to modernize and bring the bylaws in line with recent amendments to the Delaware General Corporation Law… and federal law.” Kellner provided a notice to AIM submitting his own name and two others as director candidates at the 2023 annual meeting. The notice included lengthy disclosures, but, in the board’s view, failed to disclose all arrangements, agreements and understandings (AAUs) involving other parties, including those with “troubling backgrounds,” regarding the nominations and made other material misstatements and omissions. The board unanimously rejected Kellner’s nomination notice for failing to comply with the amended bylaws. Kellner sued.
The Chancery Court “invalidated four of the six main advance notice bylaws and reinstated the 2016 version of one of the invalidated bylaws,” ultimately upholding the “board’s rejection of the third nomination notice because it failed to comply with the two advance notice bylaws left standing, including the reinstated 2016 bylaw provision.” (Note that the Supreme Court later held that because the AAU Provision was “still valid, even if unenforceable,” a “reversion to the 2016 bylaw is not possible.”) While “many of the provisions in the Amended Bylaws were invalid,” the Chancery Court held that “the board’s rejection of Kellner’s nominations was nevertheless equitable.” Among other things, the notice submitted by Kellner omitted information and the D&O responses were false in failing to disclose that all three of the nominees had prior adverse recommendations from proxy advisors. “In light of the noncompliance with the prior version of the bylaws,” the Chancery Court held, after applying enhanced scrutiny, “the board acted reasonably when it rejected Kellner’s notice.” In addition, the Chancery Court found that the “board’s actions were not manipulative nor was the rejection ‘preordained,’ and the nominees were the ones engaging in manipulative conduct.” Kellner appealed.
Opinion. On appeal, the Supreme Court relied “on the facts as found after trial” and reviewed the Chancery Court’s legal conclusions de novo. As noted above, the Supreme Court underscored that, when corporate action regarding “the adoption, amendment, or application of bylaws” is challenged, “it must be twice-tested—first for legal authorization, and second by equity.”
According to the Court, with regard to the legal (facial) challenge, “bylaws are ‘presumed to be valid.’” To be facially valid, a bylaw must be “‘authorized by the Delaware General Corporation Law (DGCL), consistent with the corporation’s certificate of incorporation, and not otherwise prohibited.’” When a bylaw is challenged, the “burden is on the party asserting invalidity to demonstrate that the bylaw cannot be valid under any circumstance.” (Apparently, according to the Supreme Court, there was some confusion at the Chancery Court, which inappropriately employed enhanced scrutiny, as opposed to a validity analysis, to declare four of six bylaw provisions invalid; the Supreme Court clarified that enhanced scrutiny does not apply to the facial challenge.) Here, except for one provision in the bylaws, the Court had “no trouble concluding that the Amended Bylaws are valid.” The provisions were within “the broad subject matter permitted by the General Assembly.” What was the one provision deemed invalid? The ownership provision—a 1,099-word single-sentence with 13 discrete parts, vague terms and “endless requirements”—was determined to be “indecipherable.” AIM’s Chair testified that “if the directors had started reading it ‘line by line’ during their March 2023 board meeting, they ‘would still be in the meeting.’”
On to step two. With regard to the equitable challenge, the Court observed that “[a]dvance notice bylaws can be misused to thwart stockholder choice and entrench the existing board of directors. To pass judicial review, bylaws must, as a matter of equity, ‘be reasonable in their application’ and not unfairly interfere with stockholder voting.” In this case, however, the Chancery Court had determined that the amendments to the advance notice bylaws were not adopted on a “clear day.” In that context, the Supreme Court determined that, in the event that a board adopts, amends or enforces advance notice bylaws during a proxy context—that is, not on a clear day—the court assesses the equity claim under “enhanced scrutiny,” which “ensures that a board’s actions are sufficiently tailored to the threat at hand such that the act does not unfairly impede the free exercise of the stockholder franchise.” The two-prong enhanced scrutiny review is “meant to balance the legitimate concerns of the board to respond to real threats with the equally legitimate concern of allowing fully-informed stockholders to have the final say.”
Under enhanced scrutiny, for the first prong, the court must “review whether the board faced a threat ‘to an important corporate interest or to the achievement of a significant corporate benefit.’ The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal.” If the bylaws were adopted “for a selfish or disloyal motive—meaning for the primary purpose of precluding a challenge to its control—the remedy is to declare the advance notice bylaws inequitable and unenforceable.” For the second prong, assuming the board’s action passes the first prong, the court must assess whether “the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise.” If advance notice bylaws “were adopted for a proper purpose but some of the advance notice provisions were disproportionate to the threat posed and preclusive, the Court of Chancery has the discretion to decide whether to enforce, in whole or in part, the bylaws that can be applied equitably.” The Court noted here that ”[j]ust as the Court of Chancery will not endorse a tripwire against an activist stockholder, it should not endorse a reverse tripwire by the activist.”
The Supreme Court agreed with the Chancery Court that, in light of “the insurgents’ troubling history,” there was a “threat to the board’s information-gathering function, and that the AIM board identified an important corporate objective in amending its bylaws—transparency in board elections.” But the Chancery Court had also found “that the AIM board likely acted with an improper purpose when adopting the Amended Bylaws.” That is, “when the AIM board adopted various advance notice provisions in the Amended Bylaws, their actions ‘seem[ed] designed to thwart an approaching proxy contest, entrench the incumbents, and remove any possibility of a contested election.’”
The Supreme Court considered “these findings dispositive on appeal to the enhanced scrutiny motive inquiry,” leading the Court “to conclude that the AIM board amended its bylaws for an improper purpose—to thwart Kellner’s proxy contest and maintain control. The board’s conduct fails the first prong of enhanced scrutiny review.” Thus, while the bylaws (except one) were valid, all were inequitable and unenforceable.
The Court then analyzed several of the specific provisions. The Court agreed with the Chancery Court that the AAU provision acted as a “‘tripwire’ rather than an information-gathering tool and ‘suggest[ed] an intention to block the dissidents’ effort.’” Generally, that provision required disclosure of oral or written AAUs regarding the nomination between a “Holder,” its affiliates and associates, and any “Stockholder Associated Person [SAP],” broadly defined to include control persons, immediate family members and persons acting in concert. The Court viewed the AAU provision to require a “nominator to disclose not only personal knowledge but also to take steps to gather information about agreements and understandings between any members of potentially limitless class of third parties and individuals unknown to the nominator.”
The Court also agreed with the Chancery Court that the consulting provision—a provision requiring “disclosure of AAUs spanning a ten-year window ‘between the nominating stockholder or an SAP, on 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’”—imposed “ambiguous requirements across a lengthy term; sought only marginally useful information; gave the board ‘license to reject a notice’ based on a subjective interpretation of its imprecise terms; and, at worst, was ‘draconian.’”
Similarly, the Court agreed that the known supporter provision—requiring “the nominator and nominees to list any person who acted in ‘support’ of a stockholder proposal”—“‘impedes the stockholder franchise while exceeding any reasonable approach to ensuring thorough disclosure.’” The decision does not address the question of whether all or any of these provisions would be similarly unpalatable if adopted on a clear day.
The Court concluded that “[i]n the middle of a proxy contest, the AIM board adopted one unintelligible bylaw and three unreasonable bylaws. It then used the Amended Bylaws to reject Kellner’s nomination notice…. The unreasonable demands of most of the Amended Bylaws show that the AIM board’s motive was not to counter the threat of an uninformed vote. Rather, the board’s primary purpose was to interfere with Kellner’s nomination notice, reject his nominees, and maintain control. As the product of an improper motive and purpose, which constitutes a breach of the duty of loyalty, all the Amended Bylaws at issue in this appeal are inequitable and therefore unenforceable.” But—and it’s a big but—“according to the Court of Chancery, Kellner submitted false and misleading responses to some of the requests.” In light of these findings of “deceptive conduct, no further action is warranted.” In other words, Kellner’s deceitful behavior—“unclean hands” some might say—meant that he was not entitled to relief on his challenge in equity.
