Academic journal article Iowa Law Review

Contractarian Theory and Unilateral Bylaw Amendments

Academic journal article Iowa Law Review

Contractarian Theory and Unilateral Bylaw Amendments

Article excerpt

I. INTRODUCTION

Over roughly the past decade, corporate directors have been utilizing one of the most potent mechanisms in dealing with shareholder activism and shareholder litigation: the right to unilaterally amend corporate bylaws.1 While corporate governance arrangements can be tailored using either the charter or the bylaws,2 modifying the charter requires shareholder approval,3 which can be time-consuming, costly, and uncertain.4 On the other hand, directors can unilaterally amend the bylaws quickly, at a low cost, and with certainty: They can simply convene a board meeting and adopt a necessary resolutions and bypass a shareholder vote.6 Directors have deployed this power on numerous occasions. For example, many have attempted to better manage out-of-control shareholder litigation by requiring all shareholder lawsuits to be filed only in Delaware ("exclusive forum bylaw").7 Similarly, some have adopted a bylaw that requires an activist shareholder to provide detailed information about itself and its director-nominees ("advance notice bylaw") to better prepare for a potentially costly proxy fight.8 Other directors have shifted the corporation's litigation expenses onto unsuccessful (or not fully successful) plaintiff-shareholders ("fee-shifting bylaw").9 Even when directors were adopting a bylaw provision in response to shareholders' demands, because they could dictate the contents of the bylaws, directors could devise a system that is potentially more favorable to them, while still showing fidelity to shareholder wishes.10

These bylaw amendments, while facially dealing more with process and rules issues,11 can undoubtedly affect a shareholder's substantive rights. But when shareholders have challenged bylaws in court, the courts have relied on the contractarian principle to uphold the amendments. The Delaware Supreme Court's opinion in ATP Tour, Inc. v. Deutscher Tennis Bund is exemplary. 12 While upholding a fee-shifting bylaw that the directors of ATP Tour, Inc. unilaterally adopted, the Court stated that the charter and bylaws constitute a "contract" between a corporation and its shareholders.13 The court stated that the directors can amend the bylaws by adopting a fee-shifting provision because the ATP's charter grants the directors that right.14 The Delaware Chancery Court applied similar reasoning when validating an exclusive forum bylaw in Boilermakers Local 154 Retirement Fund v. Chevron Corp.15 The court stated that "the bylaws constitute a binding part of the contract between a Delaware corporation and its stockholders,"16 and when the right to amend the bylaws has been granted to the directors the shareholders "will be bound by bylaws adopted unilaterally by their boards."17

To be accurate, the ATP Tour and Boilermakers courts did not state that the shareholders are stuck with the director-adopted bylaws. The Boilermakers court emphasized the fact that if the shareholders are displeased with the adopted bylaw provision, instead of challenging the provision's validity in court, they can either repeal the bylaw, adopt their own bylaw, or even remove directors from the board (probably in the next election cycle).18 Yet, the court imposed little restriction on the director's right to amend bylaws except perhaps where there is "fraud, undue influence, or overweening bargaining power."19 In short, the court seems to indicate that the proper venue for working out disagreements and resolving agency issues is in the boardroom and not the courtroom.

The courts' reasoning in ATP Tour and Boilermakers raises some interesting questions. Does the courts' adoption of the contractarian principle, combined with the fact that shareholders grant directors the right to unilaterally amend bylaws, imply that there should be very little, if any, judicial check on directors' ability to unilaterally amend bylaws? What if company ownership is dispersed and the shareholders can easily sell their shares rather than try to amend the bylaws or wage a proxy fight to remove the current directors? …

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