Advance Notice Bylaws and the Increasing Number of Stockholder Director Nominations That Are Rejected by the Target Companies

This year’s proxy season saw a significant increase in the number of companies rejecting director nominations by dissident stockholders due to purported non-compliance with the company’s advance notice bylaws.

Although the reason for the increase is not entirely clear at this time, companies may be emboldened by recent Delaware case law upholding rejection of nominees at several companies. In any event, the increase underscores the importance of having state-of-art advance notice bylaws in place prior to a dissident surfacing. From the nominating stockholders’ perspective, compliance with advance notice bylaws cannot be taken lightly.

It will be interesting to see if this increase becomes a new trend or just a one-year blip.

Stockholder Director Nomination Rejections

Advance notice bylaws require stockholders to submit a formal notice of their director nomination, along with detailed information about the stockholder and the nominee, within a specified period before the annual meeting. These provisions provide the board with sufficient time and relevant information to evaluate the candidates, allow board members to knowledgably make recommendations, and ensure that stockholders cast well-informed votes.

Between January 2022 and July 2023, 17 companies rejected stockholder director nominations for failure to comply with advance notice bylaws.[1] The most common reasons for the rejections were:[2]

• Failure to make required disclosures under the bylaws: For example, Primo Water Corporation rejected Legion Partners Asset Management, LLC’s nomination due to its failure to disclose a pending lawsuit for fraud allegations against one of its nominees.
• Failure to correct omissions before close of advance notice window: For example, First Foundation Inc. rejected Driver Management Company LLC’s director nomination. Despite being notified that its nomination notice was deficient, Driver failed to submit the required information before the close of the advance notice window.
• Misrepresentations: For example, George Norcross, Philip Norcross, and Gregory Braca provided the required notice under Republic First Bancorp Inc.’s bylaws to nominate director candidates but, among other things, misrepresented the identity of the record holder of the shares.

One potential reason for the rise in the number of nomination rejections for advance notice bylaw non-compliance: The increase in the number of first time or occasional activists. These are firms/individuals who do not have significant experience seeking to affect change at a company, including navigating the complexities of the advance notice bylaws.[3] This lack of experience may have led to some of the rejections.[4]

Resulting Lawsuits and Delaware Case Law

Approximately 70% of the rejections resulted in litigation, of which four have settled. Two of these cases settled in favor of the dissident,[5] allowing its nominees to stand for election, while the other two cases resulted in the dissident withdrawing its nominations.[6]

Delaware courts have decided several cases involving non-compliance with advance notice bylaws, including a few recent notable examples: Jorgl v. AIM ImmunoTech Inc. (2022),[7] Strategic Investment Opportunities LLC v. Lee Enterprises, Inc. (2022),[8] and Rosenbaum v Cytodyn, Inc. (2021).[9]

In AIM Immunotech, the court upheld the board’s rejection of a dissident stockholder’s nomination notice because the stockholder failed to disclose “all arrangements or understandings” that the stockholder had with the proposed nominees. In Lee Enterprises, the court upheld the board’s rejection of a dissident stockholder’s nomination notice, which was submitted on the eve of the nomination deadline, because the notice was not submitted by a stockholder of record and the stockholder did not use the company’s director nominee questionnaire forms. And in Cytodyn, the court upheld the board’s rejection of a dissident stockholder’s nomination notice, which was also submitted on the eve of the nomination deadline, because the stockholder failed to disclose that an entity was in part funding the stockholder nomination and that one of the nominees might seek to facilitate an acquisition by the company of a business in which the nominee was a significant stockholder.

Although these cases show some disagreement among the court concerning the exact standard of review to be applied to a board’s rejection of a stockholder nomination, it has become well settled that compliance with advance notice bylaws should be strictly construed and Delaware courts will uphold clear, unambiguous advance notice bylaws that were adopted on a clear day—i.e., when the board was not facing an imminent threat—that the board applies reasonably in its decision to reject a stockholder nomination.

Considerations for Companies

The surge in rejections of stockholder director nominations this proxy season and recent Delaware case law underscores the importance of having state-of-the-art advance notice bylaws. To that end, here are a few key takeaways that we recommend public company boards take into consideration:

• Review the company’s bylaws and, in particular, advance notice provisions regularly. The recent introduction of the “universal proxy card” provides a good point of departure for a bylaw review, if one has not been undertaken already.[10]
• Adopt any changes to the advance notice bylaws on a “clear day,” if possible, i.e., before any dissident stockholder surfaces.
• Advance notice bylaws should be clear and unambiguous, as any ambiguity or lack of clarity may be resolved in favor of the dissident.
• The board must act reasonably when it considers whether a stockholder nomination complied with the advance notice bylaws. “Inequitable acts towards stockholders do not become permissible because they are legally possible.”[11]
• Advance notice bylaws should be in line with market standards. Courts see standard advance notice bylaws as commonplace and as serving a legitimate purpose. However, if they are overly aggressive or burdensome compared to market standards, they may be subject to challenge.[12]

Considerations for Stockholders

For stockholders planning to nominate director candidates, these recent developments also suggest several important guidelines:

• Be sure to read the bylaws thoroughly and take note of all timing and information requirements.
• Account for adequate time to collect the necessary information from director nominees and prepare the notice of nomination.
• Conduct appropriate due diligence to discover any conflicts of interest or other potentially disqualifying factors before submitting the notice.
• Do not assume that any level of non-compliance will be overlooked.
• If possible, submit the notice of nomination well in advance of the deadline to allow sufficient time to cure any defects.

[1] Deal Point Data. (1) Firsthand Technology Value Fund, Inc. rejection of Seven Corners Capital Management, LLC; (2) Avantax (f.k.a. Blucora, Inc.) rejection of Engine Capital Management, LP; (3) Tax Free Fund for Puerto Rico Residents, Inc. rejection of Ocean Capital LLC; (4) AIM ImmunoTech Inc. rejection of Jonathan Jorgl; (5) Republic First Bancorp, Inc. rejection of George E. Norcross, III, Philip A. Norcross, and Gregory B. Braca; (6) Necessity Retail REIT, Inc. rejection of Blackwells Capital, LLC; (7) Global Net Lease, Inc. rejection of Blackwells Capital, LLC; (8) Warner Music Group Corp. rejection of Dorothy Carvello; (9) First Trust Dynamic Europe Equity Income Fund rejection of Bulldog Investors, LLP; (10) First Foundation Inc. rejection of Driver Management Company LLC; (11) CPI Card Group Inc. rejection of Steamboat Capital Partners, LLC; (12) AmeriServ Financial, Inc. rejection of Driver Management Company LLC; (13) Primo Water Corporation rejection of Legion Partners Asset Management, LLC; (14) Genworth Financial, Inc. rejection of Seven Corners Capital Management, LLC; (15) Medalist Diversified REIT, Inc. rejection of Robert V. Wallace and TPG Holdings, LLC; (16) HF Foods Group Inc. rejection of Irrevocable Trust for Raymond Ni, Weihui Kwok, Yuanyuan Wu; (17) Lifeway Foods, Inc. rejection of Edward and Ludmila Smolyansky.

[2] It is worth noting that about half of the 17 rejections provided no specific reasoning or justifications for why the notice was deficient.

[3] Out of the 17 rejections, we identified three rejections where the dissident was an occasional or a first-time activist: (1) Warner Music Group Corp’s rejection of Dorothy Carvello’s nomination; (2) Republic First Bancorp, Inc.’s rejection of George E. Norcross, III, Philip A. Norcross, and Gregory B. Braca’s nominations; and (3) Lifeway Foods, Inc. rejection of Edward and Ludmila Smolyansky.

[4] The Rise of the “Occasional Activist” | Morrison Foerster (mofo.com).

[5] See (1) Driver Opportunity Partners I LP v. Max Briggs et al., 2023-0287 (Del. Ch. Mar 07, 2023) and (2) Primo Water Corporation’s rejection of Legion Partners Asset Management, LLC.

[6] See (1) Global Net Lease, Inc. v. Blackwells Capital LLC et al., 22-CV-10702 (JPO) (S.D.N.Y. Feb. 6, 2023) and (2) The Necessity Retail REIT, Inc. v. Blackwells Capital LLC, et al., 22-CV-10703 (JPO) (S.D.N.Y. Feb. 22, 2023).

[7] Jorgl v. Aim ImmunoTech Inc., C. A. 2022-0669-LWW (Del. Ch. Oct. 28, 2022).

[8] Strategic Investment Opportunities LLC v. Lee Enterprises Inc., C. A. 2021-1089-LWW (Del. Ch. Feb. 14, 2022).

[9] Rosenbaum v. Cytodyn Inc., C. A. 2021-0728-JRS (Del. Ch. Oct. 13, 2021).

[10] Preparing for the Mandatory Universal Proxy Card and Its Potential Impacts on Shareholder Activism and Proxy Contests | Morrison Foerster (mofo.com).

[11] In re Invs. Bancorp, Inc. S’Holder Litigation, 177 A.3d 1208 (Del. 2017).

[12] For example, in a recent lawsuit brought by a dissident shareholder against Masimo Corporation, the dissident shareholder challenged Masimo’s very aggressive advance notice bylaws, which required a dissident shareholder to identify (among other things) the names of the dissident shareholder’s passive limited partners and their families’ investment holdings in the company’s competitors or litigation counterparties, and any plans the dissident has to nominate directors to other public company boards in the next twelve (12) months. Politan Capital Management LP, 2022 WL 14813970 (Del. Ch.). Masimo ultimately eliminated the bylaw provisions in question.