Delaware Supreme Court Affirms Chancery Court’s Decision in JANA
by By Barry H. Genkin ,Keith E . Gottfried & Jane K. Storero

Last month, the Supreme Court of Delaware1 affirmed the decision of the Delaware Chancery Court issued in March 2008 in JANA Master Fund, Ltd. v. CNET Networks, Inc.2 In a decision that many practitioners found surprising, the Delaware Chancery Court interpreted the advance notice provision3 of a public company’s bylaws to apply only to nominations of candidates for election to the company’s board of directors and other proposals that are intended to be included in the company’s proxy materials pursuant to Rule 14a-8 of the SEC’s proxy rules. SEC Rule 14a-8 provides the conditions under which a shareholder can include a proposal in a public company’s proxy materials, and the procedures with which the shareholder must comply.

For JANA, the Delaware Supreme Court’s decision was just the beginning of what would turn out to be a very good week for this hedge fund. Not only did they score a significant victory in the Delaware Supreme Court, but two days later CNET announced that it had reached an agreement to be acquired by CBS Corporation for $1.8 billion, which represented a premium of approximately 45% to the closing price of CNET’s common stock prior to the announcement that an acquisition agreement had been entered into with CBS. Given that, according to JANA’s most recent Schedule 13D filing with the SEC with respect to the common stock of CNET, JANA owned approximately 16.6 million CNET shares, its stake, acquired at an aggregate purchase price of approximately $164 million, was now worth close to $190 million.

The background of the JANA case is as follows. JANA Master Fund is an investment fund that owns, along with its affiliates, approximately 11% of the outstanding stock in CNET Networks, Inc. CNET currently has a staggered, eight-person board with two directors whose terms would be expiring at the 2008 Annual Meeting. In December 2007, JANA informed CNET of its intention to solicit proxies from shareholders to replace the two directors up for re-election, expand CNET’s board to thirteen seats, and nominate five individuals to fill the newly created board seats. If successful, this plan would result in JANA obtaining control of a majority of CNET’s Board of Directors. CNET took the position that JANA had failed to comply with provisions of CNET’s advance notice bylaw which requires that a shareholder seeking to bring business before the annual meeting (which, in CNET’s view, would include the nominations of directors) beneficially own $1,000 of CNET common stock for at least one year. At the time of CNET’s 2008 Annual Meeting, JANA would have held such stock for only eight months.

The advance notice bylaw provision at the center of JANA’s dispute with CNET provides as follows:

Any shareholder of the Corporation that has been the beneficial owner of at least $1,000 of securities entitled to vote at an annual meeting for at least one year may seek to transact other corporate business at the annual meeting, provided that such business is set forth in a written notice and mailed to the Secretary of the Corporation and received no later than 120 calendar days in advance of the date of the Corporation’s proxy statement released to security holders in connection with the previous year’s annual meeting of security holders (or, if no annual meeting was held in the previous year or the date of the annual meeting has been changed by more than 30 calendar days from the date contemplated at the time of the previous year’s proxy statement, a reasonable time before the solicitation is made). Notwithstanding the foregoing, such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy.(4)

JANA contended that the advance notice provision does not apply to its proposal, because it only applies to nominations made under Rule 14a-8 of the SEC’s proxy rules, i.e., this bylaw only applies to nominations and proposals a shareholder wishes to have included on management’s form of proxy. Because JANA intended to prepare and mail its own proxy materials, it argued that this bylaw was not applicable. JANA also contended that, if this bylaw were read to apply, it is invalid under Delaware law because it is an unreasonable restriction on the shareholder franchise.

While the Delaware Chancery Court declined to consider the validity of the bylaw itself, the Delaware Chancery Court held in favor of JANA and interpreted the advance notice bylaw to not apply outside the context of Rule 14a-8. In other words, because JANA was not requesting that CNET include its proposals or nominations in CNET’s corporate proxy materials, JANA was not required to comply with the advance notice bylaw’s requirements. In discussing how it reached such an interpretation, the Delaware Chancery Court delved into some of the historical and philosophical underpinnings of the adoption of Rule 14a-8.

In its opinion, the Delaware Chancery Court provides three reasons for concluding that CNET’s advance notice bylaw can be read only to apply to proposals made pursuant to Rule 14a-8:

• The language in the first sentence of the advance notice bylaw provision which states that shareholders “may seek to transact other corporate business” could not make sense outside of the Rule 14a-8 context. The court parsed the words “may seek” to imply that a shareholder needed to ask permission as they would in the Rule 14a-8 context when seeking the inclusion of a proposal in the company’s proxy statement.
• The deadline provided in the advance notice bylaw for the receipt of a notice by a shareholder that it intends to transact business at the annual meeting referenced the mailing date of CNET’s proxy statement for the previous year. The court reasoned that “[t]he most reasonable explanation for so requiring is that the bylaw is designed to allow management time to include the shareholder proposal in its proxy materials.” The court went on to declare that “[t]his Court cannot find a single example of a permissible advance notice bylaw that has set the notice required by reference to the release of the company’s proxy statement.
• The language in the last sentence of the advance notice bylaw that reads “[n]otwithstanding the foregoing, such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy” indicates that the bylaws are intended to apply only to situations where shareholders wish to place proposals in the management’s proxy materials under Rule 14(a)-8. The court reasoned that this sentence was intended to graft into the advance notice bylaw all of the requirements of Rule 14a-8 and that there would have been no reason to have done so if this bylaw applied outside the context of Rule 14a-8 proposals.

The Delaware Chancery Court’s decision in JANA left many to wonder whether the Court was aware of the recent amendments to Rule 14a- 8 and fully appreciated the current limitations of Rule 14a-8, in particular, that, as the SEC recently made clear, Rule 14a-8 cannot be used by shareholders to make nominations of directors. Since proposals made pursuant to Rule 14a-8 cannot relate to the nomination or election of directors, it is somewhat confounding that the Court would interpret CNET’s advance notice bylaw as only applying to nominations of directors that are intended to be included in the company’s proxy materials pursuant to Rule 14a-8.

If the JANA decision was not enough to persuade companies to review, with the assistance of counsel, their advance notice and advance nominations provisions and take steps to ensure that their bylaws contain advance notice and advance nominations provisions that are unambiguous, clear as to the circumstances and situations to which they apply, and not susceptible to being misinterpreted, the opinion issued last month by the Delaware Chancery Court in Levitt Corp. v. Office Depot, Inc.5 once again narrowly interpreting a company’s advance notice bylaws, should provide companies with ample justification to immediately commence such a review.

In Levitt, the Delaware Chancery Court interpreted Office Depot Inc.’s advance notice bylaw as being applicable to the nomination of directors, but ruled that no advance notice of intent to nominate candidates for election as directors was required to be provided by the insurgent shareholder, Levitt Corp. The Chancery Court reasoned that no such notice was required because Office Depot had already properly made director nominations an item of business before its annual meeting through the general reference to the election of directors that was contained in the “Notice of Annual Meeting of Shareholders” that the company included in its Annual Meeting Proxy Statement. Accordingly, the Chancery Court ruled that Office Depot could not prevent Levitt from nominating two directors for election at Office Depot’s 2008 Annual Meeting.

While many companies have separate bylaw provisions for advance notice of director nominations and other shareholder proposals (e.g., bylaw amendments, precatory resolutions, etc.), Office Depot’s bylaws did not contain a separate advancenotice bylaw provision for director nominations. Interestingly, earlier versions of Office Depot’s bylaws contained a separate advance-notice bylaw for director nominations and required the nominating shareholder to provide certain information about the nominee, such as his name, age, and address. However, the most recent version of Office Depot’s bylaws contained no such separate advance-notice provision for director nominations and, in fact, made no reference to shareholder nominations of directors. Despite the fact that most practitioners would typically include language in an advancenotice bylaw provision related to the nomination of directors requiring various information about the nominees—including the information required by Regulation 14A—that requirement was omitted from the current version of Office Depot’s bylaws.

Levitt contended, among other things, that since Office Depot’s advance-notice provision made no explicit reference to director nominations, it could not be interpreted to exclude Levitt’s intended nominations. Levitt argued that, comparing the current bylaws with the previous bylaws, the only conclusion that a reasonable shareholder could draw was that Office Depot intended to eliminate the advance-notice requirement for director nominations. Levitt also contended that if Office Depot’s advance-notice bylaw was intended to restrict shareholder nominations, “given the special prominence of the shareholder franchise under Delaware law,” such restriction would have to be “clear and unambiguous” and such was not the case and, accordingly, “restrictions that are not clear and unambiguous should not be interpreted to limit shareholder democracy.”

The Delaware Chancery Court, focusing on the following language contained in Office Depot’s advance-notice bylaw provision, disagreed with Levitt’s contention and viewed the advance-notice bylaw as clearly and unambiguously applying to the nomination of directors, since the advancenotice bylaw purports to apply to any affair or matter to be conducted or considered at an annual meeting:

Section 14. Stockholders Proposals— At an annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be (i) specified in the notice of the meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors or (iii) otherwise properly brought before the meeting by a stockholder of the corporation who was a stockholder of record at the time of giving of notice provided for in this Section, who is entitled to vote at the meeting and who complied with the notice procedures set forth in this Section.(6)

Finding support elsewhere in Office Depot’s bylaws as well as in the Delaware General Corporation Law, the Chancery Court first concluded that “business,” as used in Office Depot’s bylaws, encompasses the election of directors and the related act of nominating directors. Accordingly, the Chancery Court concluded that Office Depot’s advance-notice bylaw applied to the nomination of directors. The Chancery Court next addressed whether Levitt was required to give advance notice of its intention to nominate two directors. Levitt argued that it was not required to give notice because Office Depot had already specified in its “Notice of Annual Meeting” that the business would include electing directors and, accordingly, the business of electing directors was already properly brought before the annual meeting. Office Depot had attempted to argue that its “Notice of Annual Meeting” brought before the annual meeting only the narrow business of voting for or against its slate of directors. The Chancery Court disagreed with Office Depot, and concluded that the “Notice of Annual Meeting” established that the business of electing directors, unrestricted by any limiting qualification, had been properly brought before the annual meeting.

The final issue for the Delaware Chancery Court to resolve was whether the business of electing directors includes the subsidiary business of nominating directors for election. The Chancery Court concluded that it did. In a footnote to its opinion, the Chancery Court noted that a different result may have been obtained in this case had the “Notice of Annual Meeting” been drafted to specifically describe the business before the annual meeting as the election of Office Depot’s twelve nominees for election as directors rather than just generally the election of twelve directors. As was also the case in JANA, the Chancery Court avoided having to consider the validity of any aspect of the advance-notice bylaw itself, including the length of the advance-notice period. However, unlike in the JANA case, the Chancery Court declined to pass on Levitt’s arguments that since the advance-notice period was measured by reference to the date of the release of proxy statements, it should be limited to proposals made pursuant to Rule 14a-8 for inclusion in Office Depot’s proxy materials.

Lessons for Companies from JANA and Levitt

The JANA and Levitt cases, taken together with the affirmation of the Delaware Chancery Court’s decision in JANA by the Delaware Supreme Court, suggest that the Delaware Chancery Court is going to continue to narrowly interpret advance notice provisions. However, in both cases, more careful drafting of the advance notice provisions would have likely significantly improved the odds of a different result in both cases. Among the drafting lessons to be gleaned from the JANA and Levitt cases are the following:

• Companies should include in their bylaws separate advance notice provisions with respect to shareholder nominations of candidates for election as directors and other proposals of business to be brought before the meeting (e.g., bylaw amendments, precatory resolutions, etc.). Companies should also avoid attempting to economize on language by combining any aspects of these provisions even if some, if not much, of the language will be the same in both provisions.
• Companies should explicitly include in their advance notice provisions applicable to the proposals of business, other than nominations of candidates for election as directors, a statement to the effect that notwithstanding anything to the contrary contained in such provision, a shareholder intending to nominate candidates for election as directors must separately comply with the advance notice bylaw provisions specifically applicable to the nomination of candidates for election as directors for such nomination to be properly brought before the meeting.
• To the extent that a unitary advance notice provision is used, companies need to make it abundantly clear that the advance notice provision applies to all shareholder proposals, including proposals to nominate candidates for election to the Board of Directors.
• Companies should also make it abundantly clear that their advance notice provisions apply to all shareholder proposals regardless of whether the shareholder is seeking to have the proposal included in the company’s proxy statement pursuant to Rule 14a-8 or whether the shareholder intends to prepare and mail his own proxy statement.
• Due to the possibility that even a carefully drafted advance notice provision may be misinterpreted by the Delaware Chancery Court, companies should ensure that they are complying with Rule 14a-4(c), so that management retains discretionary authority to vote its proxies against a shareholder proposal.

Companies should also consider, in consultation with their counsel, whether the typical “notice of annual meeting” contained in their annual meeting proxy statement should, in their enumeration of the items of business to be considered, specifically refer to the election of directors as the election to the board of directors of the nominees recommended by the company’s board rather than just the election of directors. We believe the better course of action for ensuring that a shareholder seeking to nominate candidates for election as directors does not escape having to provide advance notice of such nomination is to make the appropriate revisions in the text of the bylaws. However, as noted above, the court did suggest that a different result may have been obtained in the Levitt case had the “notice of annual meeting” been more carefully drafted.

In addition, while the Delaware Chancery Court was able to avoid, in both the JANA and Levitt cases, opining on the validity of any aspect of the advance notice bylaws in question, in JANA, the Court referenced its previous warning that “when advance notice bylaws unduly restrict the stockholder franchise or are applied inequitably they will be struck down.” Accordingly, companies should also have their advance notice and advance nominations bylaw provisions, particularly those that include threshold requirements (e.g., minimum beneficial ownership, period of beneficial ownership, etc.) of who can submit a nomination or proposal (outside of Rule 14a-8 of the SEC’s proxy rules), reviewed to ensure that they do not contain unreasonable restrictions on the shareholder franchise.

While the Delaware Chancery Court’s decision in JANA by itself may not have been reason enough to initiate an immediate and careful review of a company’s advance notice bylaws, the subsequent ruling in Levitt, taken together with the Delaware Supreme Court’s decision to affirm the lower court’s decision in JANA, clearly suggest that companies should, in consultation with their counsel, initiate such an immediate and careful review of their advance notice bylaws in order to avoid repeating the experiences of either CNET or Office Depot of discovering that its advance notice bylaw does not require the advance notice of shareholder nominations that it had been led to assume was required.

Notes

1. See CNET N etworks, Inc. v. JANA M aster Fund, Ltd, 2008 WL 2031337 (Del. S. Ct. May 13, 2008).

2. See JANA M aster Fund, Ltd. v. CNET N etworks, Inc., 2008 WL 60556 (Del. Ch. Mar. 13, 2008).

3. An advance notice provision is a bylaw that requires that any stockholder seeking to propose business, or make a nomination of a candidate for election to a corporation’s board of directors, at an annual meeting of stockholders must first provide proper and timely notice to the corporation of such proposed business or such nomination, as the case may be.

4. Article II, S ection 3 of the Bylaws of CNET Networks, Inc.

5. See Levitt Corp. v. Office Depot, Inc., 2 008 WL 172424 (Del. Ch. April 14, 2008).

6. Article II, S ection 14 of the Amended and Restated Bylaws of Office Depot, Inc.

About the Author

Barry H. Genkin is a senior partner with the law firm Blank Rome LLP. He also serves as one of the officers of the firm and as a member of its Executive Committee. Mr. Genkin’s practice includes shareholder activism, mergers and acquisitions and corporate governance. Mr. Genkin is a former Special Counsel at the SEC where he handled numerous proxy fights and other contested solicitations. He is available at genkin@blankrome.com. Keith E. Gottfried and Jane K. Storero are Partners at Blank Rome LLP (www. blankrome.com). Mr. Gottfried and Ms. Storero represent public companies in connection with preparing for, and defending against, possible proxy contests, consent solicitations and unsolicited takeover bids. They also assist public companies in assessing their vulnerabilities to activist shareholders and unsolicited takeover bids and in the implementation of various strategies to ameliorate such vulnerabilities. They can be reached at Gottfried@Blankrome.com and Storero@Blankrome.com.*