Companies Lawyer Up Over Proxy Access – Part 5: Conflict With State Law

In my past four posts, I addressed the issues raised in a four-part letter written by Gibson Dunn lawyers as a no-action request on behalf of Textron (TXT). The letter asked the SEC staff to agree that Textron might exclude the USPX model proxy access proposal from their proxy materials. Let’s now turn to a no-action request by Stinson Morrison Hecker (SMH) lawyers on behalf of Sprint (S), also  in response to the USPX model proxy access proposal.

This letter is more hefty than the the Gibson Dunn letter, weighing in at 27 pages, not including exhibits. It has five parts, but I will address only the second. The first relates to the proponent’s eligibility to submit a proposal. The last three are markedly similar to parts 2, 3 and 4 of the Gibson Dunn letter, so my earlier responses apply.

Part 2 of the SMH letter claims that the proposal can be excluded because is improper under Kansas law and, if it were implemented, would violate Kansas law. As you may surmise, Sprint is incorporated in Kansas. The lawyers’ claims are based on Rule 14a-8(i)(2), which states that a proposal may be excluded if it would, upon implementation, “cause the company to violate any state, federal, or foreign law to which it is subject;” and Rule 14a-8(i)(1), which says a proposal may be excluded “if it is not a proper subject for action by shareholders under the laws of the jurisdiction of the company’s organization …” Part 2 of the letter has two subsections relating to Rule Rule 14a-8(i)(2) and one subsection relating to Rule 14a-8(i)(1).

Subsection 2.A.i has as its header “The Provisions Contemplated by the Proposal May Not Be Validly Included in the Company’s Bylaws” but it vattempts to make a case that the provisions of the USPX model proxy access proposal could not be included in the Company’s articles under Kansas law. It states:

Section 17-6301(a) expressly provides that if there is to be any deviation from the general mandate that the board of directors manage the business and affairs of the corporation, such deviation must be provided in the KGCC or the articles of incorporation … The Company’s articles of incorporation do not (and, as explained above, could not) provide for any such deviation as contemplated by the Proposal.

Looking above in the letter, nothing of the sort is “explained,” so the argument is incomplete.

Next, in that same section, the lawyers take up the question of whether the Proposal could be included in the Company’s bylaws under Kansas law, asserting:

With respect to providing any such deviation in the Company’s bylaws, no Kansas court has analyzed the extent to which a board’s management powers provided under Section 17-6301 (a) may be circumscribed by a corporation’s bylaws adopted by shareholders pursuant to Section 17-6009(b). However, it is well settled that where Kansas courts have not ruled on a particular issue of corporate law, Kansas courts will rely on Delaware decisions for guidance when interpreting the KGCC, which was modeled after the DGCL … In CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227, 234-35 (Del. 2008), the Delaware Supreme Court examined a proposed shareholder proposal bylaw provision relating to the reimbursement of election expenses to shareholders

The lawyers then quote certain carefully selected passages from that CA v AFSCME decision of the Delaware Supreme Court, claiming that these support their contention that the Proposal could not be included in the Company’s bylaws because it would:

1. go beyond specifying procedures for the board to follow and require them to take specific actions, and
2. possibly force the board to violate their fiduciary duty by, perhaps, including shareowner nominees in the Company’s proxy materials whom they consider not in the Company’s best interests.

This is nonsense. Here is what the Delaware Supreme Court concluded in CA v AFSCME:

It is well-established Delaware law that a proper function of bylaws is not to mandate how the board should decide specific substantive business decisions, but rather, to define the process and procedures by which those decisions are made … The context of the Bylaw at issue here is the process for electing directors—a subject in which shareholders of Delaware corporations have a legitimate and protected interest. The purpose of the Bylaw is to promote the integrity of that electoral process by facilitating the nomination of director candidates by stockholders or groups of stockholders … The shareholders of a Delaware corporation have the right “to participate in selecting the contestants” for election to the board. The shareholders are entitled to facilitate the exercise of that right by proposing a bylaw that could encourage candidates other than board-sponsored nominees to stand for election.

The SEC summarized the CA v AFSCME decision as follows  (Release Nos. 33-9046, June 10, 2009, footnote 70):

In CA, Inc. v. AFSCME, 953 A.2d 227 (Del. 2008), the Delaware Supreme Court held that shareholders can propose and adopt a bylaw regulating the process by which directors are elected. In light of this ruling, Delaware recently amended the Delaware General Corporation Law to add new Section 112, effective August 1, 2009, clarifying that the bylaws of a Delaware corporation may provide that, if the corporation solicits proxies with respect to an election of directors, the corporation may be required to include in its solicitation materials one or more individuals nominated by a stockholder in addition to the individuals nominated by the board of directors.

The SMH lawyers acknowledge the new DGCL Section 211 but treat it as irrelevant for interpreting Kansas law, since Kansas has not yet adopted a similar provision. Their conclusion is false. As the SEC indicated, Section 211 did not change Delaware law, it clarified it. Bylaw amendments for proxy access have always been an appropriate topic for shareowner proposals under Delaware law. Since the SMH lawyers claim that Kansas corporate law is modeled after Delaware law, and they can find nothing in Kansas law to suggest proxy access is illegal, by the lawyers’ own reasoning, we can conclude that proxy access can be adopted in a company’s bylaws under Kansas law.

In Subsection 2.A.ii, the lawyers return to their argument that proxy access would possibly force the board to violate their fiduciary duty by, perhaps, including shareowner nominees in the Company’s proxy materials whom they consider not in the Company’s best interests. The lawyers argue that this means the proposal could not be included in the Company’s articles. Again, they acknowledge that Kansas law does not address this issue, so they turn to Delaware law. This renders the entire Subsection 2.A.ii of the lawyers’ letter mute. It argues that proxy access is not legal under Delaware law when we have already shown that it is legal under Delaware law, and always has been.

In section 2.B, the lawyers argue, under Rule 14a-8(i)(1), that the proposal is not a proper subject for action by the company shareholders under Kansas law. They base this on their earlier claim that proxy access is illegal under Kansas law, which I have already shown to be invalid. They also base it on a claim that the Proposal is improper because

1. under Kansas law, a corporation’s board of directors may not unilaterally amend a corporation’s articles of incorporation; and
2. under Kansas law, a bylaw provision may not go beyond governing procedural aspects of the board’s decision making process and remove certain substantive business decisions from the board’s statutorily-granted powers.

The first reason is invalid because the Proposal is precatory. It is left to the board’s discretion how to implement the Proposal. The Proposal makes no mention of the Company’s articles of incorporation. The proposal requests that the Board amend bylaws and governing documents within the context of the law. Therefore, if such articles need to be amended, and the lawyers have provided no evidence they do, the Board could follow established procedures for pursuing such amendments.

The second reason merely invokes arguments about the Proposal’s legality under Kansas law, which the lawyers already made in Section 2.A and that I have already shown to be false. The arguments were invalid in section 2.A; they are invalid in Section 2.B.

Finally, Commission staff generally do not allow precatory proposals to be excluded under Rule 14a-8(i)(1). The USPX model proxy access proposal is precatory. That alone should be sufficient reason to reject the lawyers’ arguments of Section 2.B.