Should Proxy Contests Be Fair?
The current surge in stockholder activism raises the interesting question whether proxy contests should be conducted fairly. Should the protagonists only tell the truth in soliciting votes or may they act like some politicians and say almost anything to win, true or not? The Delaware Court of Chancery recently addressed these issues in Kerbawy v. McDonnell, Del. Ch. C.A. 10769-VCP (August 18, 2015).
While the facts in Kerbawy were complicated, a brief summary helps to understand the importance of that decision. Kyle Kerbawy solicited stockholder consents to have his chosen directors replace the incumbent board of ACell Inc. Kerbawy had help seeking those consents. One ACell incumbent director provided Kerbawy with insider information. Another former director, Rodney Bosley, not only aided Kerbawy, but in doing so arguably violated Bosley's separation agreement with ACell that prohibited Bosley from becoming a "participant" in a proxy contest. Moreover, the consent solicitation materials used by Kerbawy were at least questionable in making full disclosures to the other stockholders.
But at the same time, the incumbent ACell directors also were not models of candor in their competing solicitations. For example, they at least implied they had the support of a key ACell director, former CEO and stockholder who was actually supporting their opponent, Kerbawy. This was even more egregious considering that, as incumbent board members, they had a fiduciary duty of full candor to the stockholders.
After a careful review of the facts, the Court of Chancery upheld Kerbawy's consent solicitation and declared that his new board was validly elected as ACell's directors. The court began its analysis by noting the "heavy burden" borne by a party seeking to set aside a stockholder election. That only makes sense for otherwise the court would find itself in the almost impossible circumstance of deciding how the vote would have come out if the contestants had been more truthful or had acted differently. Who can say why stockholders voted as they did in a close contest, particularly one involving active, extensive solicitation? That task would have been particularly difficult in the Kerbawy case because no individual who consented to Kerbawy's solicitation had come forward to complain he had been misled.
That does not mean that the Court of Chancery will never invalidate a stockholder vote. It has done so before. For example, in Agranoff v. Miller (Del. Ch. April 12, 1999), aff'd, 737 A2d 530 (Del. 1999), the court did invalidate written consents because the stockholder voting those consents had obtained his stock wrongfully, by violating a stockholders' agreement that restricted stock transfers. Moreover, as the Kerbawy decision notes, there is a level of deception that will justify invalidating a stockholder vote. Outright lies about something a stockholder would consider material will not be tolerated. The court will judge materiality by an objective standard of what a reasonable stockholder would have relied upon in casting his vote.
To determine what factors will tip the balance and meet that heavy burden required to invalidate a vote, several aspects of Kerbawy are worth noting. First, Kerbawy involved a real contest. Both sides had the opportunity to tell their story. If the cure for misleading statements is the truth, then a true contest will make the court less likely to intervene. While there is no requirement there be a debate before stockholder consents are effective, the ability to counter the other side's statements is important to the Court of Chancery in reviewing a challenge to the vote.
Second, the court will consider if stockholder rights have been violated in some way other than the right to be told the truth. Thus, Agranoff involved the violation of a stockholders' agreement that warranted court relief. But on the other hand, the violation of a separation agreement by a supporter of Kerbawy did not warrant such relief. The different results turned on the nature of the right alleged to be violated. Kerbawy involved management's "right" to not be opposed in a consent solicitation, not the rights of all stockholders under a stockholder agreement. Protecting stockholder rights is more important than management's desire to remain unopposed.
Finally, the Court of Chancery will not intervene when the real dispute between the contestants is over business strategy. The court is not going to run the business of Delaware corporations by taking sides over what business plan is best. Thus, it is useless to argue that a stockholder vote should be set aside because the stockholders are supporting a bad business plan or favoring the short-term over long-range business development.
Kerbawy presents an excellent guide on what not to do to conduct a stockholder solicitation under Delaware law. Activists and management should follow its lessons.