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Advance notice bylaws are “vital tools” for corporate governance. By setting forth strict requirements for nominating candidates to board seats, advance notice bylaws create an orderly process by which the incumbent board may review the candidates and then make recommendations to stockholders. However, as the Delaware Court of Chancery’s expedited post-trial decision in ATP Capital Opportunities Fund v. Ryan Lane, reveals, strict compliance is expected not only from the stockholder nominating a new slate of directors, but also from the incumbent board. Relevant here, the Court of Chancery will not enforce advance notice requirements which do not exist.
Because board action involving director elections are twice tested—once for compliance with governing documents, and once for equitable principles—imposing nonexistent advance notice requirements exposes the board to fiduciary liability. The Court of Chancery’s ATP Capital decision further demonstrates the risk to boards that fail to strictly comply with a corporation’s advance notice bylaws.
Background and the Court of Chancery’s Decision
In advance of a stockholders’ meeting, ATP Capital Opportunities Fund LP (ATP), a stockholder in Empery Digital Inc. (Empery) submitted a full slate of directors for nomination to Empery’s board. The incumbent board was suspicious of ATP’s motivations and whether ATP had the best interests of the company at heart based on the belief that ATP was coordinating with another stockholder (Tice Brown) and that ATP had a short position on bitcoin (a particular concern for a digital asset treasury, like Empery). In response to ATP’s nomination notice, the board determined to reject ATP’s board nominees, citing three reasons—two of which made it to trial: ATP’s suspected coordination with another stockholder, Tice Brown; and ATP’s nondisclosure of its short position in bitcoin.
Following ATP’s suit and an expedited trial limited to the board election issues, the Court of Chancery reviewed the incumbent board’s rejection of ATP’s director slate under Delaware’s twice-tested rubric: at law; and then at equity.
For the legal analysis, the court considered whether the company’s advance notice bylaws required ATP to disclose whether it had an agreement or arrangement with another stockholder; and (2) whether it held a short position in bitcoin.As to the first point, the court found the bylaws had a “striking” omission when it came to arrangements or agreements with other stockholders and, thus, did not require their disclosure as part of the director nomination process.As to the disclosure of short positions in bitcoin, the court, similarly, found a “contractual silence” in Empery’s bylaws. Taken together, the court held the board lacked contractual grounds for rejecting ATP’s nomination notice and, therefore, the board failed to comply with Empery’s bylaws.
The incumbent board’s failure to comply with Empery’s bylaws also weighed on the second, equitable analysis. Because the board’s conduct related to stockholder franchise, the Court of Chancery applied the enhanced scrutiny standard—first, whether the board faced a real threat to an important corporate interest; and second, whether the board’s response was reasonable in relation to the posed threat and not preclusive or coercive to the stockholder franchise.
Noting, again, that the supposed advance notice requirements the board hung its hat on did not exist, the court remarked that if the board relied solely on purported bylaw violations, the board would fail the first prong of the enhanced scrutiny test. However, and as the court also noted, the board had identified concerns about ATP’s coordination and short of bitcoin positions, which were supported at trial. The court, therefore, assumed without deciding that the first prong was met.
The court reached a different conclusion on the second prong, finding that the board’s response was unreasonable. Again, the court emphasized that the board had failed to comply with Empery’s bylaws. Because ATP had not violated any advance notice bylaw, the board improperly rejected ATP’s director slate. In the court’s view, the reasonable course would have been to allow the nominations, while recommending that stockholders vote against ATP’s slate because of ATP’s suspect motivations. Accordingly, the court held the board breached its fiduciary duties in rejecting ATP’s nomination notice.
Key Takeaways
Compliance with advance notice bylaws is a two-way street.Not only must stockholders strictly comply with disclosure requirements, when nominating directors, but the incumbent board must also ensure its conduct is in conformance with the company’s governing document. The board’s failure to do so will not only result in the insurgent-stockholder’s slate being permitted to stand for election, but it may also subject the board to breach of fiduciary duty liability. Boards and their advisors should ensure that the company’s bylaws include the advance notice protections boards need and desire to fulfill their gatekeeping obligations.
Originally published in ALM's Delaware Business Court Insider
The Delaware Court of Chancery held that boards must strictly comply with advance notice bylaws when rejecting director nominations, and cannot enforce requirements that do not exist in the bylaws, as doing so may result in fiduciary duty breaches.
