Charting a Clear Course: Delaware Supreme Court’s Kellner v. AIM Immunotech Inc. Decision Elucidates Advance Notice Bylaws Standards

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On July 11, 2024, the Delaware Supreme Court (the “Court”) issued a landmark ruling in Kellner v. AIM Immunotech Inc., providing crucial guidance on the standards for evaluating challenges to advance notice bylaws. This decision offers much-needed clarity in an area that has seen increased litigation and uncertainty, particularly in the wake of recent high-profile cases such as Politan v. Masimo Corp. At the heart of the ruling is a crucial distinction between two types of challenges to a company’s advance notice bylaws: facial challenges (i.e., challenges to a bylaw in the abstract) and as-applied challenges (i.e., challenges to a board’s adoption, amendment, or enforcement of a bylaw during a threatened or actual proxy contest – in other words, on a “cloudy day”). The Court affirmed that advance notice bylaws, in line with other corporate bylaws, enjoy a presumption of validity under Delaware law. To withstand a facial challenge, the advance notice bylaws must merely address a proper subject matter, be consistent with the company’s charter, and not be prohibited by law. In essence, a bylaw can only be deemed facially invalid if a plaintiff demonstrates that it “cannot operate lawfully or equitably under any circumstances.” Conversely, the enhanced scrutiny standard of review applies to as-applied challenges. In the event of an as-applied challenge, the court will consider (i) whether the board faced a threat to an important corporate interest or benefit and the board’s motivations in adopting, amending and/or enforcing the advance notice bylaw and (ii) whether the bylaw was disproportionate to the threat posed and preclusive to the exercise of stockholder franchise.

In Kellner, the Court struck down one advance notice bylaw provision as facially invalid due to its incomprehensible nature, while upholding the facial validity of the remaining challenged advance notice bylaw provisions. However, the Court made it clear that when an advance notice bylaw is challenged in the midst of an actual or threatened proxy contest, the bylaw must be twice-tested – first for legal authorization (i.e., facial validity) and second for equity. Consequently, facially valid advance notice bylaws remain subject to as-applied challenges if they are adopted, amended or enforced during a threatened or actual proxy contest. Given that the Court had before it a “genuine, extant controversy” involving a decision by the board of directors (“Board”) of AIM Immunotech Inc. (“AIM”) to amend its advance notice bylaws and enforce those amended bylaws, in each case during a proxy contest, the Court reviewed the remaining amended, facially valid provisions with enhanced scrutiny.  In doing so, the Court found that AIM’s Board had “amended its bylaws for an improper purpose, to thwart Kellner’s proxy contest and maintain control” and thus certain portions of AIM’s amended advance notice bylaws were unenforceable. Despite this holding, the Court found that no remedy was warranted in equity due to the fact that the nominating stockholder submitted false and misleading responses to certain enforceable advance notice bylaw provisions, including AIM’s form of questionnaire for directors and officers (“D&O Questionnaire”).

Background

The Kellner case arose from a series of proxy contests at AIM, a publicly traded biopharmaceutical company incorporated in Delaware. In 2022, AIM faced a proxy contest initiated by a group of dissident stockholders led by Jonathan Jorgl. The dissidents submitted a nomination notice to AIM, seeking to nominate candidates for election to AIM’s Board at the annual meeting of AIM stockholders to be held in November 2022. The Board rejected the dissidents’ nomination notice, citing non-compliance with both AIM’s existing advance notice bylaws and federal securities laws, specifically the disclosure requirements under Section 14(a) of the Securities Exchange Act of 1934, as amended. That rejection led to litigation in the Delaware Court of Chancery (Jorgl v. AIM Immunotech Inc.), in which AIM largely prevailed, with the court upholding the Board’s decision to reject the nomination notice.

Following this litigation and in anticipation of further proxy contests, the Board undertook a significant revision of AIM’s advance notice bylaws in early 2023. These amendments included six key provisions, two of which were upheld: (i) Section 1.4(c)(1)(H), the “First Contact Provision,” which requires disclosure of the dates of first contact among those involved in the nomination effort, and (ii) Sections 1.4(c)(1)(L) and 1.4(e), the “Questionnaire Provisions,” which required director nominees to complete a form of the D&O Questionnaire. The remaining four provisions included:

• Section 1.4(c)(1)(D), the “AAU Provision,” required that the nominating stockholder provide “a complete and accurate description of all agreements, arrangements or understandings” relating to AIM or the nominations between a broadly defined group of people, including any “Holder” and any “Stockholder Associated Person” existing as of the nomination or during the prior 24 months. The defined term “Stockholder Associated Person” (“SAP”) in the bylaws included (i) any person acting in concert with such Holder with respect to the nomination or AIM, (ii) 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 nomination or AIM, and (iii) any member of the immediate family of such Holder or an Affiliate or Associate of such Holder. The term “Holder” was defined as the nominating stockholder and each beneficial owner, if any, on whose behalf the nomination is made or other business is being proposed.
• Section 1.4(c)(1)(E), the “Consulting/Nomination Provision,” required the nominating stockholder to disclose any agreements, arrangements and understandings between each Holder and/or any SAP, on the one hand, and any stockholder nominee, on the other hand, “to consult or advise on any investment or potential investment in a publicly listed company . . . and/or . . . to nominate, submit, or otherwise recommend the Stockholder Nominee for appointment, election or re-election . . . to any officer, executive officer or director role of any publicly listed company . . . during the past ten (10) years . . . .”
• Section 1.4(c)(4), the “Known Supporter Provision,” required the nominating stockholder to disclose the names and contact information of all other stockholders known by any Holder or SAP to support the nomination.
• Section 1.4(c)(1)(H), the “Ownership Provision,” was, as described by the Court, “a 1,099-word run-on sentence of 13 subsections, requiring, among other things, disclosures relating to ownership of any equity interest in AIM and ‘any principal competitor’ of AIM, by a broadly defined group of people,” including SAPs. The court noted that AIM’s Board chair had testified that, had the directors read this particular bylaw “line by line,” they “would still be in the meeting.”

When stockholder Ted D. Kellner subsequently nominated in August 2023 three director candidates to the AIM Board for consideration at the 2023 annual meeting, AIM’s Board rejected the nominations. The Board cited the nomination notice’s non-compliance with the company’s amended bylaws, including undisclosed agreements, arrangements, and understandings among the plaintiff, his affiliates, and his nominees; a failure to disclose the known supporters of the nominations; and a failure to disclose specific dates of first contact between the relevant parties. The Board asserted that he also failed to provide other information, including adverse recommendations from proxy advisory firms concerning other public company board service, that was called for in the company’s form of D&O Questionnaire. Kellner filed suit, arguing that certain of AIM’s amended advance notice bylaws were facially invalid and that, even if the provisions were valid, they had been inequitably applied.

Delaware Court of Chancery’s Decision

In considering Kellner’s challenges to the advance notice bylaws, the Delaware Court of Chancery focused on the “SAP” concept that was used in the AAU Provision, the Consulting/Nomination Provision, and the Known Supporter Provision. With respect to the use of this concept in the AAU Provision, the Court of Chancery stated that the interplay of various terms (i.e., “acting in concert,” “Associate,” “Affiliate” and “immediate family”) within the SAP definition, and the references to SAPs within the AAU Provision, created an “ill-defined web of disclosure requirements” that rendered the AAU Provision “overbroad, unworkable, and ripe for subjective interpretation by the Board.” The Court of Chancery consequently found this provision to be invalid.

The Court of Chancery also found that the Consulting/Nomination Provision and the Known Supporter Provision both suffered the same problem as the AAU Provision insofar as they included references to SAPs. Additionally, the Court of Chancery determined that the Known Supporter Provision was not linked to any identifiable legitimate corporate objective that would render the disclosure necessary. The Court of Chancery noted that limiting disclosure to financial support or meaningful assistance in furtherance of the nomination may have rendered this provision permissible, but as drafted, the provision “impedes the stockholder franchise while exceeding any reasonable approach to ensuring thorough disclosure.” Accordingly, the Court of Chancery also held that these two provisions were invalid. Finally, the Court of Chancery struck down the Ownership Provision, with its 1,099 words and 13 subparts, due to it being “indecipherable.”

In so holding, the Court of Chancery applied enhanced scrutiny when assessing the provisions’ facial validity based upon the fact that the Board amended AIM’s advance notice bylaws on a “cloudy day” (i.e., when a proxy contest was known to be imminent). Two other provisions survived enhanced scrutiny review: the First Contact Provision and the Questionnaire Provisions, which the Court of Chancery found reflected a proper objective and were not overly burdensome.

Nevertheless, the Court of Chancery determined that Kellner’s notice was deficient under the prior version of the AAU Provision, which did not suffer from the same flaws as the amended version, because Kellner failed to disclose certain arrangements or understandings regarding the nominations. In addition, the Court of Chancery found that Kellner’s notice violated both the First Contact Provision (due to a failure to disclose even an approximate date of first contact with a relevant party and “fuzzy” dates of first contact for others) and the Questionnaire Provision (due to the fact that Kellner falsely certified that his completed D&O Questionnaire was accurate even though it failed to disclose certain adverse recommendations from proxy advisory firms concerning other public company board service).

Both Kellner and AIM subsequently appealed the Chancery Court’s decision.

Delaware Supreme Court’s Decision

On appeal, the Court clarified the two standards of review potentially applicable to an advance notice bylaw challenge depending on whether the challenge is a facial challenge (i.e., a challenge to a bylaw in the abstract) or an as-applied challenge during an extant controversy (i.e., a challenge to a board’s adoption, amendment, or enforcement of a bylaw during a threatened or actual proxy contest).

The Court began by affirming that bylaws are presumed to be valid and that courts should not “consider hypotheticals or speculate whether bylaws might be invalid under certain circumstances” when evaluating facial validity claims. Rather, advance notice bylaws are facially valid as long as they (i) are consistent with the company’s charter, (ii) are not prohibited by law and (iii) address a proper subject matter. When challenging a bylaw’s validity in the abstract, without reference to any set of facts surrounding an ongoing proxy contest, a plaintiff must demonstrate “that the bylaw cannot be valid in any set of circumstances.” In other words, in the event of a facial challenge, if there is any “but for” scenario where the challenged bylaw may operate appropriately, the bylaw is valid and the claim should be dismissed. In the context of Kellner’s challenge, the Court held that only one of the challenged advance notice bylaw provisions was invalid on its face because it was “indecipherable” and “unintelligible” (the lengthy Ownership Provision with 1,099 words and 13 subparts), while the other challenged advance notice bylaw provisions were found to be facially valid.

The Court then clarified that, if challenged, a board’s adoption, amendment or enforcement of advance notice bylaws during a proxy contest is subject to heightened scrutiny under the two-step test recently described in Coster v. UIP (“Coster”). Under the first step, the court should determine whether the board “faced a threat to an important corporate interest or to the achievement of a significant corporate benefit. The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal.” Next, the court should consider “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.”

Applying this heightened Coster standard of review to the facts and circumstances of the case, the Court affirmed the Court of Chancery’s decision regarding the three remaining bylaws held to have been unreasonably adopted. Specifically, with respect to the AAU Provision, the Court agreed with the Court of Chancery’s conclusion that the provision functioned as a “tripwire” rather than an information gathering tool and suggested an intention to block the dissident’s effort.  Next, with respect to the Consulting/Nomination Provision, the Court agreed again with the Court of Chancery that the provision imposed ambiguous requirements across an unnecessarily lengthy 10-year term and gave the AIM Board “license to reject a notice” based on subjective interpretation of its imprecise terms.  Finally, with respect to the Known Supporter Provision, the Court agreed with the Court of Chancery that the provision likewise suffered from ambiguous requirements across a lengthy term, impeding stockholder franchise “while exceeding any reasonable approach to ensuring thorough disclosure.”  Accordingly, the Court found that the AAU Provision, the Consulting/Nomination Provision and the Known Supporter Provision failed to meet the first step of the Coster test and that the adoption and enforcement of these amended bylaws was motivated by an improper purpose — namely, to interfere with Kellner’s nomination notice, reject his nominees, and maintain control. This was an impermissible breach of the Board’s duty of loyalty. As a result, all three of these advance notice bylaw provisions were found to be inequitable and therefore unenforceable.

Regardless, the Court upheld the Court of Chancery’s rejection of Kellner’s nomination notice in light of the Court of Chancery’s findings about Kellner’s and his nominees’ non-compliance with enforceable advance notice bylaw provisions, constituting deceptive conduct.

Key Takeaways                                                                    

The Court’s decision should provide comfort to public companies that stockholders will not be successful challenging the facial validity of advance notice bylaws, so long as such bylaws are intelligible, and we generally expect Kellner to result in fewer facial challenges to advance notice bylaws in the absence of an actual or threatened proxy contest. However, companies would be well advised to review their advance notice bylaws (particularly ownership and AAU provisions and related definitions) and ensure that none of the provisions in these bylaws are at risk of being considered “indecipherable” if challenged.

Additionally, the Court’s decision confirms that a company’s adoption, amendment and/or enforcement of an advance notice bylaw will be subject to an enhanced scrutiny standard of review if challenged during a threatened or actual proxy contest. Adopting or amending advance notice bylaws on a “clear day” may make a board less susceptible to a court finding that its actions were driven by improper motives, but the bylaws must nevertheless be reasonable (i.e., designed and applied to assist the board in satisfying its information‑gathering and disclosure functions) and not preclusive to stockholder franchise.  

Companies should also be aware of what precisely constitutes a “clear day” versus a “cloudy day” when considering bylaw amendments. AIM amended its bylaws in between two proxy seasons (between the 2022 and 2023 proxy seasons). It experienced an attempted proxy contest during the 2022 proxy season and continued to receive occasional communications from individuals that had been involved in the 2022 proxy contest (or who appeared to be affiliated with such stockholders) in the lead-up to the adoption of the amended bylaws. On one call, AIM’s counsel was told that the stockholders wanted to “avoid another proxy contest” and instead would be amenable to “mutually agreeable directors” joining the board. The stockholders were otherwise “ready to come out guns blazing” in 2023. Companies are consequently on notice that Delaware courts will likely view the threat of a proxy contest following a proxy contest in the prior year as one “prolonged proxy contest,” which is sufficient grounds for Delaware courts to apply the enhanced scrutiny standard of review to the adoption, amendment or enforcement of their advance notice bylaws to the extent that they are challenged in between proxy seasons.

Finally, if a company’s board adopts or amends advance notice bylaws on a cloudy day (i.e., in the midst of an actual or threatened proxy fight), the board should ensure that the amendment is designed to further an important corporate interest, is reasonable in response to the threat posed by the nominating stockholder, and is not preclusive or coercive to the stockholder franchise.  Furthermore, the enforcement of any properly adopted advance notice bylaw must be reasonable, which means evenly and consistently applied with respect to all nominating stockholders and nominees and equitable under the circumstances.