In a much-anticipated decision, the Delaware Supreme Court echoed the Court of Chancery's pronouncement that advance notice bylaws adopted amid an approaching proxy contest are reviewed through the lens of enhanced judicial scrutiny and clarified the framework for judicial review of advance notice bylaws on both a "clear day" and a "cloudy day." As described in our prior client alert, the case concerned a series of attempted proxy contests related to the board of directors (the "Board") of AIM ImmunoTech Inc. (the "Company") and amendments to the Company's advance notice bylaws (the "Amended Bylaws") adopted in anticipation of a third proxy contest. In light of the impending proxy contest, the Chancery Court applied an enhanced scrutiny to its review of the Board's adoption of the Amended Bylaws and held that four of the six challenged bylaw provisions were unenforceable. Upon review, the Delaware Supreme Court held that all six challenged bylaw provisions were unenforceable but ultimately determined that, in light of the plaintiff's deceptive conduct, no action was warranted as a result of the Board's rejection of his nomination notice.

This case makes clear that challenges to the adoption, amendment, or enforcement of advance notice bylaws "must be twice-tested – first for legal authorization [(i.e., facial validity)], and second by equity" and that the standard applied in equity will depend on whether the board adopted, amended, or enforced the bylaws on a clear or cloudy day.

Facial Validity

Under Delaware law, advance notice bylaws are presumed to be valid and must be interpreted by courts "in a manner consistent with the law." The burden is on the party challenging that bylaw provision to overcome this presumption by demonstrating "that the bylaw cannot be valid under any circumstance." Advance notice bylaws are facially valid if they are:

• authorized by the Delaware General Corporation Law;
• consistent with the corporation's certificate of incorporation; and
• not otherwise prohibited.

The court confirmed that, when considering facial validity, "it is insufficient for a plaintiff to simply assert that 'under some circumstances, a bylaw might conflict with a statute, or operate unlawfully.' Instead, the plaintiff must demonstrate that the bylaw cannot operate lawfully under any set of circumstances." The court held that five of the six bylaw provisions at issue in the Amended Bylaws were facially valid, but the court deemed, as had the Chancery Court, that the "Ownership Provision" was "unintelligible" and, therefore, invalid. The Ownership Provision required disclosure of ownership of various direct, indirect, and derivative interests (both ownership interests and contractual interests) in the Company and, in certain cases, its competitors by the nominating stockholder and certain relatives, associates, or persons acting in concert. Both the Chancery Court and Delaware Supreme Court determined that the provision was indecipherable because of its vague terms and "virtually endless requirements." The Delaware Supreme Court pronounced that "[a]n unintelligible bylaw is invalid under 'any circumstances.'"

Equity

Clear Day

The Delaware Supreme Court noted that "bylaws are still subject to judicial review" after a court determines that challenged bylaw provisions are facially valid as a matter of law because the reviewing court must then review the challenged bylaws in equity. To be equitable, challenged bylaws that were adopted on a clear day must "'be reasonable in their application' and not unfairly interfere with stockholder voting."

Cloudy Day

If challenged bylaws are adopted, amended, or enforced amid a proxy contest (a "cloudy day"), the bylaws are subject to a heightened "enhanced scrutiny" standard of review. This enhanced standard of review is intended to balance the interests of the board in responding to legitimate corporate threats against the interests of stockholders in being fully informed and having "the final say." While Kellner did not involve the review of bylaws adopted on a clear day, the court clearly stated that enhanced scrutiny will apply to the enforcement of bylaws on a cloudy day.

STEP ONE: First, the court must determine:

• if the board faced a real, and not pretextual, threat to an important corporate interest; and
• whether the board harbored a proper motive in adopting, amending, or enforcing the challenged bylaws, which motivation was neither selfish nor disloyal.

If the board had a selfish or disloyal motivation when adopting the challenged bylaws, i.e., to preclude a change of control of the board, then the bylaws are unenforceable in full.

STEP TWO: After discerning the existence of a legitimate threat to a corporate interest and a proper motivation on the part of the board to address that threat, the court next assesses "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." The Delaware Supreme Court explained that a board's response to the threat (adopting, amending, or enforcing the advance notice bylaws) must be tailored and proportionate to the identified threat in order to prevent unfair interference with the stockholder voting franchise. If challenged bylaws "were disproportionate to the threat posed and preclusive," only then does the Chancery Court have the discretion to enforce, in whole or in part, facially valid bylaws that were adopted in the face of a legitimate threat to a corporate interest and with a proper purpose on the part of the board in responding to that threat.

In this case, the Delaware Supreme Court accepted the findings of the Chancery Court that the activist campaign posed a legitimate threat to the Board's information-gathering function. The Delaware Supreme Court, however, also relied on "the Court of Chancery's assessment about the unreasonableness of a majority of the Amended Bylaws…to conclude that the AIM board amended its bylaws for an improper purpose – to thwart Kellner's proxy contest and maintain control." Because of this improper motive, the Delaware Supreme Court held that "[t]he board's conduct fails the first prong of enhanced scrutiny review" and, as the Amended Bylaws were "the product of an improper motive and purpose, which constitutes a breach of the duty of loyalty, all the Amended Bylaws at issue in this appeal [were] inequitable and therefore unenforceable."

Notwithstanding finding that the Amended Bylaws were unenforceable, the Delaware Supreme Court ultimately declined to grant any remedy to the plaintiff stockholder, referencing the deceptive conduct of the stockholder and his nominees found by the Court of Chancery.

This decision reiterates that, though they remain an important and legitimate tool for incumbent boards to protect the corporation and its stockholders against potentially abusive and deceptive practices by activists or hostile acquirors, advance notice bylaws should be tailored to each corporation according to its needs. Furthermore, this decision underscores the responsibility of boards of directors to ensure that the scope of advance notice bylaws does not overreach or prevent the possibility of a contested election, and that bylaws are clear and concise.

Finally, this decision, consistent with the Delaware courts' other recent decisions on advance notice bylaws, is a reminder of the importance of adopting or amending advance notice bylaws on a "clear day," but also taking care to equitably enforce bylaws provisions even if they are adopted on a "clear day."