Fleming Must Be Read Narrowly

While the Oklahoma Supreme Court's recent decision in International Brotherhood of Teamsters v. Fleming Cos.,[2] was among the most eagerly awaited corporate governance decisions in recent memory, the decision may in fact have much less of an impact than many observers anticipated.  The ruling was limited to the determination of a narrow question of law certified by the Tenth Circuit Court of Appeals – namely the validity of a shareholder-adopted bylaw that restricted the ability of a board of directors to adopt and implement a "poison pill" rights plan.  The Oklahoma Supreme Court's decision merely holds that, under Oklahoma law, a board of directors does not have exclusive authority in the arena of stock options and rights.  The ruling did not address, let alone resolve, the validity of that genre of "stockholder rights bylaws" that recently has been advocated by stockholder activists such as Guy Wyser-Pratte.  Typically, such stockholder rights bylaws require that the board of directors terminate "defensive measures," including existing "poison pills," upon the receipt of an all cash, all shares offer at a specified market premium, unless stockholders vote to support the board's opposition to such offer.[3]

In our view, the Oklahoma decision probably will not alter significantly the existing balance of power between the directors and stockholders of Delaware corporations.  First, while the relevant Oklahoma statutes are similar to their Delaware counterparts, it is unlikely that a Delaware court would reach the same conclusion as the Oklahoma court, primarily because a Delaware court likely would view a Fleming-style bylaw as an impermissible limitation on a board's statutory responsibility to manage a corporation's business and affairs.  Second, even if a Delaware court were to reach the same ultimate conclusion as the Oklahoma court with respect to the narrow issue presented, the implications of such a decision for other forms of stockholder rights bylaws likely would be minimal.

As to the first point, the Fleming decision appears to have missed the mark.  Indeed, the bulk of the commentary critical of the District Court's original oral ruling in the Fleming case pointed out that the court failed to address adequately the interplay between Sections 1013 and 1027 of the Oklahoma General Corporation Act[4] and failed to analyze whether the Teamster's bylaw proposal impermissibly interfered with the board's statutory authority to manage the business and affairs of the corporation.[5]  The Oklahoma Supreme Court's decision is open to much the same criticism.  The Supreme Court's decision, which contains no substantive analysis of Section 1027, focuses almost entirely on whether stockholder adopted bylaws, as a general matter, may impose limitations upon a board's authority to adopt stock option and rights plans.

It may well be, as the Fleming court held, that bylaw amendments requiring stockholder (in addition to board) approval of stock option plans are generally permissible.  While persuasive arguments can be made either way with respect to that proposition, the bylaw proposal at issue in Fleming was specifically directed at a much different situation.  Its sole purpose was to divest the board of the exclusive authority to undertake a particular defensive measure – a "poison pill" rights plan – in response to perceived threats to corporate policy and effectiveness.  The Fleming decision skirts any analysis of the question whether a bylaw with that intended effect and purpose impermissibly infringes on the authority of a board of directors to manage the "business and affairs" of a corporation.

Even assuming that Delaware law generally would validate a bylaw provision granting stockholders veto power over stock option plans, it does not follow that Delaware law also would permit a bylaw that is specifically intended to divest directors of their power and duty to adopt particular measures in response to threats to the corporation.  The Delaware courts have held consistently that Section 141(a) of the DGCL, which provides that directors shall have the authority to manage the business and affairs of a Delaware corporation,[6] vests in the board of directors an affirmative statutory and fiduciary responsibility to protect the corporate enterprise from threats arising in the takeover context.[7]  This responsibility is among the most fundamental of the duties imposed upon a board of directors, and the powers available to a board in carrying out such responsibility specifically include the power to adopt "poison pill" rights plans.[8]

Delaware courts also have adhered steadfastly to the proposition that measures specifically calculated to limit directors in the exercise of core statutory and fiduciary duties are valid only if set forth in the certificate of incorporation in accordance with Section 141(a) of the DGCL.[9]  It is on the basis of this well-settled doctrine that we believe a Delaware court would part ways with the Oklahoma Supreme Court.  While a Delaware court likely would agree with the Fleming court that the issue ultimately boils down to "corporate governance and what degree of control shareholders can exact upon the corporation in which they own stock,"[10] we do not think a Delaware court would go so far as to find that the permissible bounds of shareholder control may extend into matters lying at the heart of the board's management function, such as the power and duty to implement defensive measures in response to a threat to the corporate enterprise.

Even if a Delaware court were to agree with the Fleming court's analysis, however, we do not believe such a ruling would validate the much different Wyser-Pratte style stockholder rights bylaw.  The narrow question of law certified in the Fleming case was "Does Oklahoma law [A] restrict the authority to create and implement shareholder rights plans exclusively to the board of directors, or [B] may shareholders propose resolutions requiring that shareholder rights plans be submitted to the shareholders for vote at the succeeding annual meeting?"  The Oklahoma Supreme Court, therefore, was not asked to opine whether a shareholder bylaw validly could require a board to redeem existing rights;[11] nor does the court's holding resolve the issue of the validity of the Wyser-Pratte style bylaws, which seek to require a stockholder vote opposing a particular acquisition proposal as a precondition to a board's implementation of any "defensive measures" (including the continuation of a "poison pill") in response to such that proposal.

Because they seek to prohibit all "defensive measures" in the absence of an affirmative shareholder vote, Wyser-Pratte style bylaws are even more intrusive, from the standpoint of directorial prerogative, than the type of bylaw at issue in Fleming.  Thus, these bylaws conflict with the established principles of Delaware law discussed above, but to a much greater degree.  While the Fleming-type bylaw can be viewed as placing restrictions on a single (but important) weapon in a board's arsenal of takeover defenses, the Wyser-Pratte bylaws seek to block the board's access to the arsenal altogether.  The existing Delaware authority recognizes that the irreducible minimum of director authority conferred by Section 141(a) necessarily includes the responsibility to protect the corporate enterprise in the takeover context.  It is difficult to imagine that a stockholder-adopted bylaw specifically directed to divesting the board of such authority altogether, at least in connection with takeover proposals meeting certain criteria, would be validated by a Delaware court.

Even those bylaw proposals directed only to the redemption of existing "poison pill" rights (as opposed to the whole panoply of possible takeover defense measures) would appear to limit director responsibilities in a way inconsistent with the existing Delaware case law.  The observations of the Delaware Supreme Court in the recent Quickturn decision are illustrative of that Court's general views in this regard.  While Quickturn addressed the issue from a decidedly different perspective – a measure seeking to preclude directors from redeeming rights – the Court's observations would appear to be equally relevant to the opposite situation in which a stockholder rights bylaw seeks to require the board to redeem rights:

Section 141(a) requires that any limitation on the board's authority be set out in the certificate of incorporation….  While the Delayed Redemption Provision [at issue] limits the board of directors' authority in only one respect, the suspension of the Rights Plan, it nonetheless restricts the board's power in an area of fundamental importance to the shareholders – negotiating a possible sale of the corporation.  Therefore, we hold that the Delayed Redemption Provision is invalid under Section 141(a), which confers upon any newly elected board of directors full power to manage and direct the business and affairs of a Delaware corporation.[12]

Notes:

1. Messrs. Goldman, Wolfe, Morton, and Pittenger are partners of Potter Anderson & Corroon LLP, Wilmington, Delaware.  The views expressed herein are those of the authors and not necessarily those of Potter Anderson & Corroon LLP.  The authors would like to thank Brian C. Ralston for research assistance in connection with this commentary.

2. No. 90,185, ___ P.2d ___ (Okla. Jan. 26, 1999).

3. See, e.g., Lawrence A. Hamermesh, Corporate Democracy and Stockholder-Adopted By-Laws: Taking Back the Street?, 73 Tulane L. Rev. 409, 414-15 n.18 (1998) (describing recent proposals); Jonathan R. Macey, Shareholder Rights Will Be Next Battleground, Nat'l L. J. (Feb. 16, 1998), at A22.

4. Section 1013 of the Oklahoma Act, which is similar to Section 109 of the Delaware General Corporation Law ("DGCL"), authorizes bylaws not inconsistent with law or the certificate of incorporation "relating to" the business and affairs of the corporation or the "rights and powers" of the corporation, its shareholders, or its directors.  Okla. Stat. tit. 18, § 1013.  Section 1027 of the Oklahoma Act, which is similar to Section 141(a) of the DGCL, provides that the business and affairs of a corporation are to be managed by the board of directors except as otherwise provided by statute or the certificate of incorporation.  Okla. Stat. tit. 18, § 1027.

5. See, e.g., Lawrence A. Hamermesh, Corporate Democracy and Stockholder-Adopted By-Laws: Taking Back the Street?, 73 Tulane L. Rev. 409, 425-444 (1998); Michael D. Goldman & Gregory M. Johnson, Recent Developments in Corporate Law, 10th Tulane Corp. L. Institute (1998); John C. Coffee Jr., Bylaw Barricades: Unions and Shareholder Rights, N.Y.L.J., v. 217, no. 58 (Mar. 27, 1997).

6. 8 Del. C. § 141(a).

7. See Quickturn Design Systems v. Shapiro, No. 511, 1998, Opinion at 27-30, ___ A.2d ___ (Del. Dec. 31, 1998) (Holland, J.); Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334, 1345 (Del. 1987); Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 953-55 (Del. 1985); Nomad Acquisition Corp. v. Damon Corp., C.A. No. 10173, Mem. Op. at 16 (Del. Ch. Sept. 16, 1988, revised Sept. 20, 1998) (Hartnett, V.C.).

8. See Moran v. Household Int'l, Inc., 500 A.2d 1346, 1353 (Del. 1985).

9. See, e.g., Quickturn, Opinion at 28-29, 30-31, ___ A.2d at ___; Paramount Communications Inc. v. QVC Network Inc., 637 A.2d 34, 51 (Del. 1994); Lehrman v. Cohen, 222 A.2d 800, 808 (Del. 1966); Chapin v. Benwood Foundation, Inc., 402 A.2d 1205, 1211 (Del. Ch. 1979), aff'd sub nom. Harrison v. Chapin, 415 A.2d 1068 (Del. 1980); Abercrombie v. Davies, 123 A.2d 893, 899-900 (Del. Ch. 1956), rev'd as to another point, 130 A.2d 338 (Del. 1957).

10. Fleming, Opinion at ¦ 14.

11. The bylaw at issue in Fleming did contain a provision that "[t]he Company shall redeem any such rights now in effect."  This aspect of the bylaw, however, was rendered moot when the Fleming board eliminated the existing rights plan prior to the shareholder vote on the Teamster's proposal.

12. Quickturn, Opinion at 27-29, ___ A.2d at ___ (footnotes omitted; emphasis in original).