Lawsuit Seeks Answer on Shareholders' Power Over Bylaws

Kaja Whitehouse
May 12, 2006

A shareholder lawsuit filed against CA Inc. (CA) Thursday tries to get the Delaware courts to finally address how much power investors have to amend companies' bylaws.

The lawsuit, filed Thursday afternoon in Delaware Chancery Court on behalf of Harvard professor Lucian Bebchuk asks the courts to decide whether the actions Bebchuk seeks in a shareholder proposal are illegal under Delaware law because they would give shareholders the power to decide on an issue normally governed by directors.

Shareholder proposals are typically advisory, but as part of a growing effort by shareholders to gain more control over how public companies are governed, a number of shareholders submitted proposals this year that would be binding. To this end, the proposals seek votes on companies' bylaws, or the rules that dictate how a company conducts its internal affairs.

Bebchuk, a well-known corporate-governance expert and professor at Harvard Law School, submitted a proposal to CA on March 23, asking that shareholders vote to change the company's bylaws on anti-takeover provisions. Under the proposal, CA would be allowed to adopt a poison pill provision only if all the company's directors voted in favor of it. Plus, any poison pill provision approved by the board would expire within one year unless the directors receive shareholder approval to extend it.

CA went to the Securities and Exchange Commission to block the proposal, claiming that it was a violation of Delaware law. The company wants to exclude the proposal from its proxy statement, which is where shareholders learn what issues are open to a vote at the annual shareholders' meeting.

The SEC hasn't yet weighed in on the CA case, but Bebchuk's lawyers say it doesn't matter what the SEC says. "(CA) said they're not including it because it violates state law, so now we have an opportunity to get a ruling as to whether it does" by bringing it straight to Delaware courts, said Jay Eisenhofer of Grant & Eisenhofer, the Wilmington, Del., law firm that filed the lawsuit on behalf of Bebchuk.
The question over shareholders' right to amend bylaws arises when the amendment would conflict with directors' ability to manage a company. Delaware law makes it clear that shareholder-proposed bylaws are allowable, and it also makes clear that boards have a right to manage, said Eisenhofer. What's not clear is whether shareholders have a right to pass bylaws that might impede directors' rights to manage, he said.

"Our position is that there's no reason to say the board's right to manage takes precedence," said Eisenhofer.

CA officials said they received Bebchuk's lawsuit but had no comment on it. "As stated in our letter to the SEC dated April 21, 2006, we believe that the proposed bylaw amendment would violate Delaware law," said Jennifer Hallahan, a spokeswoman for the company.

Bebchuk has submitted similar proposals at a number of companies this year, including Bristol-Meyers Squibb Co. (BMY) and Halliburton Co. (HAL). Bristol-Meyers agreed to amend its bylaws to accommodate Bebchuk's proposal, according to Eisenhofer. Halliburton's shareholders will vote on the proposal at the company's upcoming annual shareholder meeting.

The lawsuit is sure to reignite the long unresolved debate. Well-known corporate attorney Martin Lipton has already penned a letter criticizing proposals that seek to amend bylaws titled, "Deconstructing American Business."

Lipton characterized Bebchuk as the leader of the binding proposal movement, rebuking Bebchuk for "turning these very real companies... into his private 'case studies.' " The proposals "increase shareholder power while reducing or neutralizing the role of the board of directors in safeguarding the interests of the corporation," the letter said.

Lipton takes particular issue with Bebchuk's poison pill proposals, saying they would "effectively substitute the judgment of a single director for the judgment of the full board and potentially render the directors unable to fulfill their fiduciary duties."

(Phyllis Plitch contributed to this article.)
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