Paragon and Kellner: Decisions provide guidance to Delaware companies on advance notice provisions

A pair of recent decisions handed down by Vice Chancellor Will of the Delaware Court of Chancery toward the end of 2023 in the cases of Paragon Technologies, Inc. v Cryan and, particularly, Kellner v AIM Immunotech Inc. provide useful guidance to boards of directors of Delaware companies with respect to the validity of the advance notice provisions in their bylaws.

While, in both cases, the court permitted the respective boards’ bylaws to prevent activist nominees from standing for election, in Kellner, the court invalidated some bylaw provisions because of their overreach and/or ambiguity.  

Although overall the Paragon and Kellner decisions serve as another reminder that advance notice bylaws are often enforced by Delaware courts (with the outcome of the appeal of Kellner being currently unknown), companies are encouraged to work with counsel to consider the impact of the multifaceted Kellner decision on their bylaws.

Standard of review 

These recent decisions make clear that Delaware courts will evaluate board decisions on advance notice bylaws under the enhanced scrutiny standard, which is Delaware’s intermediate standard of review.  In the case of Kellner, the court applied such standard because AIM Immunotech Inc. (AIM)’s board of directors (AIM Board) amended AIM’s advance notice bylaws on a “cloudy day” (ie, a proxy contest was imminent) rather than a “clear day.”  The standard for enhanced scrutiny is reasonableness and requires a two-step analysis:

• First, an analysis of whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit,” and
  
  
• Second, an analysis of “whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise.”

With respect to this two-step analysis, in both Kellner and Paragon, the court reiterated that advance notice bylaws serve a legitimate corporate interest: ensuring transparency from a nominating stockholder and its nominees so that boards have time to evaluate proposed candidates, stockholders are fully informed, and elections are orderly.  With these purposes in mind, Delaware courts will then evaluate whether a board’s decision concerning an advance notice bylaw was reasonable, including the reasonableness of the actual bylaw provisions and of the board’s enforcement of such provisions against activists.

Enforcement of reasonable, unambiguous advance notice bylaws

The Paragon and Kellner decisions make clear that Delaware courts will enforce what they consider to be reasonable, unambiguous advance notice bylaws after applying the enhanced scrutiny standard.  

In Kellner, the court first determined that the AIM Board had identified a legitimate threat when it adopted the amended advance notice bylaws: the risk that stockholders could be subject to potentially abusive and deceptive tactics.  The Court then upheld those advance notice bylaws it deemed be reasonable and unambiguous.  For example, the court deemed reasonable a “bespoke 24-month lookback provision” with respect to a requirement to disclose all agreements, arrangements, and understandings relating to a director nomination because it clarified the period covered by the requirement and “reduced the risk of gamesmanship through overly narrow readings of the bylaw.”  The court also upheld an unusual provision requiring disclosure of the dates of first contact among those involved in the nomination.  Moreover, the court sustained a requirement that nominees complete a questionnaire in the form provided by the company, finding such provision to be standard and enforceable.  

Finally, in Paragon, the court found other advance notice bylaws to be reasonable, including a provision requiring plans or proposals that would be required to be disclosed pursuant to Item 4 of Schedule 13D, as well as one requiring the disclosure of potential conflicts and “substantial interests” pursuant to Regulation 14D. 

Unenforceability of overly broad or unambiguous advance notice bylaws

Paragon and Kellner underscore that boards adopting or amending advance notice bylaws should consider reviewing the terms for clarity and their overall reach.  For instance, in Paragon, the court questioned the reasonableness of a requirement to disclose “events, occurrences, and/or circumstances involving or relating to the Proposed Nominee that could impact, impede, and/or delay” such nominee’s ability to obtain security clearance.  The court agreed with the plaintiff that “stockholders are left to guess” as to what impediments must be disclosed pursuant to the provision.

In the Kellner decision, the court ruled unenforceable various advance notice bylaws for being overly broad or ambiguous.  To illustrate, the court refused to enforce a provision requiring disclosure of all agreements, arrangements, or understandings that a nominating stockholder or any “Stockholder Associated Person,” which was defined as:

• Any person acting in concert with the nominating holder with respect to the proposal or the corporation
  
  
• Any person controlling, controlled by, or under common control with such holder or any of their respective Affiliates and Associates, or a person acting in concert therewith with respect to the proposal or the corporation, and
  
  
• Any member of the immediate family of such holder or an Affiliate or Associate of such holder, had with any holder, nominee (or immediate family member, affiliate, or associate thereof), person acting in concert with any Stockholder Associated Person, holder, nominee (or immediate family member, affiliate, or associate thereof), or “other person or entity.”

The court observed that the “interplay of the various terms” “acting in concert," “Associate,” “Affiliate,” and “immediate family” within the Stockholder Associated Person definition “cause[d] them to multiply, forming an ill-defined web of disclosure requirements,” undermining “an otherwise reasonable and appropriate bylaw.”  The language used by the court here, however, indicates that Delaware courts would be amenable to enforcing such bylaws that are not overly broad and/or ambiguous.

Additionally, in Kellner, the court found that a provision requiring disclosure of all agreements, arrangements, or understandings between the nominating stockholder or a Stockholder Associated Person, on the one hand, and any stockholder nominee, on the other hand, “regarding consulting, investment advice, or a previous nomination for a publicly traded company within the last ten years” engendered the same problems in relation to the definition of Stockholder Associated Person, “impos[ing] ambiguous requirements across a lengthy term.”  Moreover, the court looked askance upon a requirement to disclose all known supporters of the nominating stockholder and nominees, holding it to be too broad and going beyond the provision the court upheld in its 2021 Rosenbaum v CytoDyn Inc., which was limited to “financial” supporters.  Finally, the court found that the disclosure requirements with respect to ownership interests in respect of AIM’s stock, “including beneficial, synthetic, derivative, and short positions,” of all Stockholder Associated Persons, immediate family members, and persons acting in concert with a nominee, were overbroad and ambiguous.  The court stressed that, while similar provisions seeking “to close loopholes in Section 13(d) involving synthetic equity” are generally legitimate, AIM’s iteration of such provisions, “with its 1,099 words and 13 subparts,” was “indecipherable.”

Enforcement of an otherwise valid advance notice bylaw subject to equitable analysis

Even if a Delaware court finds an advance notice bylaw to be valid, if a company’s enforcement of such bylaw has a preclusive effect on a stockholder’s ability to make nominations, the court may require such company to permit the activist’s nominees to stand for election.  For example, in Kellner, although the court found that the plaintiff failed to satisfy the valid advance notice bylaws, the court then turned its analysis to evaluating whether the rejection of the director nominees was equitable.  The court noted that such analysis hinges on whether a company purposefully used “corporate machinery” to obstruct stockholders from legitimately exercising their rights.  After conducting this analysis, the court upheld AIM’s rejection of the director nominees on an equitable basis.  

Conclusion

The Paragon and Kellner decisions serve as a reminder to Delaware companies to consider drafting clear and unambiguous advance notice bylaw provisions.  In addition, there have been recent DGCL § 220 demand letters from the plaintiff’s bar to companies challenging the “acting in concert” language.  Companies are encouraged to work with counsel to ensure they are properly documenting the process by which their boards evaluate the nature of the advance notice provisions in their bylaws.  If such provisions include “acting in concert” language, Boards may proactively revisit them in light of the enhanced scrutiny standard applied to them in Paragon and Kellner.  By doing so, if a company’s board addresses these issues before receiving a § 220 demand, then it can render such a demand moot.  Therefore, companies with advance notice bylaws are encouraged to review their bylaws with counsel as quickly as possible to consider whether any revisions may be necessary.

Please contact a member of your DLA Piper team to discuss these issues further.