The rights and equitable treatment of shareholders and employees
Shareholder powers
What powers do shareholders have to appoint or remove directors or require the board to pursue a particular course of action? What shareholder vote is required to elect or remove directors?
Under state corporate law, shareholders generally have the right to elect directors (see the Delaware General Corporation Law (DGCL), section 216).
For many years, it was common practice for directors to be elected by a plurality of shareholders that can either vote in favour of, or withhold their votes from, the director candidates nominated by the board; ‘withheld’ votes are not counted. Accordingly, absent a contested election, the candidates nominated by the board are automatically elected whether or not a majority of shareholders vote for them. From the mid-2000s onward, shareholders have pressed companies for the ability to veto the election of a particular director nominee or nominees in the context of an uncontested election. This can be achieved through the adoption of charter or by-law provisions requiring that director nominees receive the approval of a ‘majority of the votes cast’ to be elected, or, in lieu of a charter or by-law provision, the adoption of corporate policies that effectively require a director who has not received a majority of the votes cast to resign. In 2006, the Delaware legislature adopted amendments to the DGCL that facilitate both of these options. Specifically, the amended DGCL, section 141(b) expressly permits a director to irrevocably tender a resignation that becomes effective if he or she fails to receive a majority vote in an uncontested election. The amended DGCL, section 216 provides that a by-law amendment adopted by shareholders specifying the vote required to elect directors may not be repealed or amended by the board alone (generally, by-law provisions may be amended by the board).
The proportion of companies in the Standard & Poor’s (S&P) 500 that have adopted some form of majority voting in uncontested director elections has increased dramatically from 16 per cent in 2006 to nearly 90 per cent in 2022. The source of the S&P 500 company data referenced in this chapter is the 2022 Spencer Stuart Board Index.
Shareholders can also nominate their own director candidates either before or at the annual general meeting (AGM), although most public companies adopt ‘advance notice’ bylaws that require nominations to be received by the company several months before the AGM. To solicit the proxies needed to elect their candidates, however, at a company that has not adopted ‘proxy access’ a shareholder must mail to all other shareholders, at the shareholder’s own expense, an independent proxy solicitation statement that complies with the requirements of section 14 of the Securities Exchange Act of 1934 (the Exchange Act). Given these constraints, independent proxy solicitations are rare and usually undertaken only in connection with an attempt to add designated directors to the board and/or seize corporate control. In November 2021, the SEC adopted changes to the federal proxy rules to require the use of ‘universal’ proxy cards, which allow shareholders to vote for a mix of management and dissident nominees in a contested director election. The rules are now effective for shareholder meetings held after 31 August 2022.
In addition, shareholders generally have the right to remove directors with or without cause or, where the board is classified, only for cause (unless the certificate of incorporation provides otherwise); the vote required to remove directors is a majority of the shares then entitled to vote at an election of directors (subject to certain modifications, for example, where the company has adopted cumulative voting in director elections) (see DGCL, section 141(k)). However, as many publicly held companies do not permit shareholders to call special meetings or act by written consent, this power can be difficult to exercise in practice.
Shareholders’ liability for corporate actions is generally limited to the amount of their equity investment. In keeping with their limited liability, shareholders play a limited role in the control and management of the corporation. A number of corporate decisions require shareholder approval. In addition, shareholders can typically enjoin ultra vires acts (see DGCL, section 124) and vote on certain issues of fundamental importance at the AGM, including the election of directors (see DGCL, section 216).
Shareholder decisions
What decisions must be reserved to the shareholders? What matters are required to be subject to a non-binding shareholder vote?
Under state corporate law, shareholders typically have a right to participate in the following types of decisions:
- election of directors, held at least annually (see DGCL, sections 141(d), 211(b) and 216);
- filling of board vacancies and newly created directorships, if so provided in the certificate of incorporation or by-laws (see DGCL, section 223);
- removal of directors (see DGCL, section 141(k));
- approval or disapproval of amendments to the corporation’s certificate of incorporation (which requires prior board approval) or by-laws, although the board is also typically authorised (in the certificate of incorporation) to amend the by-laws without shareholder approval (see DGCL, sections 109, 241 and 242); and
- approval or disapproval of fundamental changes to the corporation not made in the regular course of business, including mergers, consolidations, compulsory share exchanges, or the sale, lease or exchange of all or substantially all of the corporation’s property and assets (see, for instance, DGCL, sections 251(c) and 271).
Other issues that may be brought to shareholder vote include:
- approval of certain business combinations with interested shareholders that would otherwise be prohibited (see DGCL, section 203(a)(3));
- approval of conversion to a different type of entity (see DGCL, section 266);
- approval of transfer, domestication or continuance in a foreign jurisdiction (see DGCL, section 390);
- approval of dissolution and revocation of dissolution (see DGCL, sections 275 and 311); and
- ratification of defective corporate acts that would have required shareholder approval (see DGCL, section 204(c)).
Shareholders may also be asked by the board to approve certain matters, including:
- approval of interested director or officer transactions (see DGCL, section 144);
- the making of determinations that indemnifying a director or officer is proper (see DGCL, section 145); or
- if so provided in the certificate of incorporation, the making of determinations that the consideration for which shares of stock with or without par value may be issued, and treasury stock disposed of (see DGCL, section 153).
Since 2011, the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 has required US public companies to conduct separate shareholder advisory votes on:
- executive compensation – to be held at least once every three calendar years (annual votes are typical);
- whether the advisory vote on executive compensation should be held every year, every two years or every three years – to be held at least once every six calendar years; and
- certain ‘golden parachute’ compensation arrangements in connection with a merger or acquisition transaction that is being presented to shareholders for approval.
The rules of the New York Stock Exchange (NYSE) and Nasdaq Stock Market (Nasdaq) also require that shareholder approval be obtained prior to:
- any adoption of an equity compensation plan pursuant to which officers or directors may acquire stock, subject to limited exceptions;
- issuance of common stock to directors, officers or substantial security holders if the number of shares of common stock to be issued exceeds either 1 per cent of the number of shares of common stock or 1 per cent of the voting power outstanding before the issuance, with some exceptions including if the issuance is a cash sale for a price that is at least a specified minimum price (NYSE), or could result in an increase in outstanding common shares or voting power of 5 per cent or more (Nasdaq);
- issuance of common stock that will have voting power equal to or greater than 20 per cent of the voting power prior to such issuance or that will result in the issuance of a number of shares of common stock that is equal to or greater than 20 per cent of the number of shares of common stock outstanding prior to such issuance, subject to certain exceptions including any public offering for cash or if the issuance is in connection with an acquisition of the stock or assets of another company and the issuance alone or when combined with any other present or potential issuance of common stock in connection with such acquisition is equal to or exceeds the 20 per cent threshold; and
- issuance of securities that will result in a change of control of the company.
Disproportionate voting rights
To what extent are disproportionate voting rights or limits on the exercise of voting rights allowed?
Under state law, a corporation may issue classes of stock with different voting rights, limited voting rights and even no voting rights, if the rights are described in the corporation’s certificate of incorporation (see DGCL, section 151). If, however, a corporation issues a class of non-voting common stock, it must have an outstanding class of common shares with full voting rights.
The NYSE and Nasdaq listing rules also permit classes of stock with different voting rights; however, the listing rules prohibit listed companies from disparately reducing or restricting the voting rights of existing shareholders unilaterally.
In 2017, two major stock index providers (S&P Dow Jones and FTSE Russell) announced changes to their index eligibility requirements that would exclude most companies going public with multiple classes of stock from the primary indices in the United States. Nevertheless, some companies in the technology industry and other industries have subsequently gone public with dual-class or multi-class stock.
Although it prefers equal voting rights, BlackRock acknowledges that newly public companies may benefit from a dual-class structure but endorses a limited duration through a sunset provision or periodic approval by shareholders.
The Council of Institutional Investors (CII) and the California Public Employees’ Retirement System have expressed their opposition to non-voting shares. The CII is part of the Investor Coalition for Equal Votes, which was launched in June 2022 by the UK pension fund Railpen and several US pension funds, which encourages IPO companies with dual-class stock structures to include a reasonable time-based ‘sunset’ provision (ie, seven or fewer years) on the super-voting shares.
ISS will generally recommend voting against or withholding votes from individual directors, committee members or the entire board (except new nominees, who should be considered on a case-by-case basis) if the company employs a common stock structure with unequal voting rights. There are certain limited exceptions to this policy, including for newly-public companies with a sunset provision of no more than seven years from the date of going public.
Glass Lewis believes multi-class voting structures are typically not in the best interests of common shareholders. In the case of a board that adopts a multi-class share structure in connection with an IPO, Glass Lewis will generally issue negative recommendations against directors at the first annual meeting after the company has become public if the company does not submit the multi-class structure to a shareholder vote or adopts a multi-class capital structure that is not subject to a reasonable sunset provision (ie, generally seven years or less). Furthermore, Glass Lewis will generally recommend voting against the governance committee chair at companies with a multi-class share structure and unequal voting rights if the multi-class share structure is not subject to a reasonable sunset provision.
Glass Lewis will generally recommend that shareholders vote in favour of recapitalisation proposals that would eliminate dual-class share structures. Similarly, Glass Lewis will generally recommend voting against proposals to adopt a new class of common stock.
Shareholders’ meetings and voting
Are there any special requirements for shareholders to participate in general meetings of shareholders or to vote? Can shareholders act by written consent without a meeting? Are virtual meetings of shareholders permitted?
Generally, all shareholders, at the record date set by the board, may participate in the corporation’s annual general meeting (AGM), and are entitled to vote (unless they hold non-voting shares) in person or by proxy (see DGCL, sections 212(b) and (c) and 213). The proxy appointment may be in writing (although there is no particular form mandated by the DGCL) or provided by telephone or electronically.
In addition, section 14 of the Exchange Act and related SEC regulations set forth substantive and procedural rules with respect to the solicitation of shareholder proxies for the approval of corporate actions at AGMs and special shareholders’ meetings. Foreign private issuers are exempt from the provisions of section 14 and related regulations insofar as they relate to shareholder proxy solicitations.
Shareholders may act by written consent without a meeting unless the certificate of incorporation provides otherwise (see DGCL, section 211(b)). The majority of companies in the S&P 500 do not permit shareholder action by written consent.
DGCL, section 211 permits a Delaware corporation to hold a meeting of shareholders virtually if it adopts measures to enable shareholders to participate in and vote at the meeting and verify voter identity, and if it maintains specified records. Prior to 2020, a small but growing number of US companies held virtual annual shareholder meetings, typically in one of two formats: exclusively online with no ability for a shareholder to attend an in-person meeting; or a hybrid approach whereby an in-person meeting is held that is open to online participation by shareholders who are not physically present at the meeting. The primary benefits of virtual shareholder meetings are increased shareholder participation and cost savings.
The number of US companies that held virtual-only annual shareholder meetings skyrocketed in 2020 when the covid-19 pandemic made in-person shareholder meetings impossible or inadvisable. Virtual shareholder meetings, both virtual-only and hybrid format, are becoming commonplace practice as companies and service providers gain more experience.
Currently, ISS prefers a hybrid approach, but it does not have a policy to recommend voting against directors at companies that hold virtual-only meetings. ISS will generally vote for management proposals allowing for virtual meetings so long as they do not preclude in-person meetings. ISS encourages companies holding virtual-only meetings to disclose the circumstances under which virtual-only meetings would be held, and provide shareholders with comparable rights and opportunities to participate electronically as they would have during an in-person meeting. ISS will vote case-by-case on shareholder proposals concerning virtual-only meetings, considering the scope and rationale of the proposal, and concerns identified with the company’s prior meeting practices.
Similarly, Glass Lewis prefers a hybrid approach. In egregious cases, Glass Lewis may recommend voting against governance committee members where a company chooses to hold a virtual-only shareholder meeting but does not provide sufficient disclosure in its proxy statement assuring shareholders will be afforded the same rights and opportunities to participate as they would at an in-person meeting.
Some large institutional investors (eg, CalPERS and the New York City Pension Funds) oppose virtual-only shareholder meetings and may vote against directors at companies that hold them.
In March 2022, the CII updated its corporate governance policies to give companies more flexibility with respect to the format of their shareholder meetings. The updated policies state that companies should acknowledge that many investors prefer in-person meetings but should have ‘the flexibility to choose an in-person, hybrid or virtual-only format depending on their shareowner base and current circumstances.’ Companies should use virtual technology ‘as a tool for broadening, not limiting, shareowner meeting participation’ and should disclose the circumstances under which a virtual-only meeting would be held and provide shareholders participating virtually with comparable rights and opportunities as those whom attend in person.
In January 2022, the SEC staff issued updated guidance for conducting shareholder meetings in light of covid-19 concerns. The staff encourages companies to provide shareholder proponents or their representatives with the ability to present their shareholder proposals through alternative means (eg, by phone) if they are unable to appear at the meeting to present them in person.
In 2022, Delaware made a number of changes to the DGCL impacting shareholder meetings. First, Delaware amended section 219 of the DGCL such that the list of shareholders entitled to vote is no longer required to be available during the course of the shareholder meeting. Instead, companies will need to make the list available for examination for a 10-day period ending on the day before the meeting date, either on a reasonably accessible electronic network or during business hours at the company’s principal place of business. Second, Delaware amended section 222 of the DGCL to clarify that notice of a shareholder meeting is governed by section 232 of the DGCL, which expressly allows for the electronic delivery of notices. Section 222 was also amended to permit adjournments taken to address technical failures and continue a meeting remotely.
Shareholders and the board
Are shareholders able to require meetings of shareholders to be convened, resolutions and director nominations to be put to a shareholder vote against the wishes of the board, or the board to circulate statements by dissident shareholders?
Generally, state law provides that every shareholder has the right to petition the court to compel an AGM if the board has failed to hold the AGM within a specified period of time (see DGCL, section 211). Special shareholders’ meetings may be called by anyone authorised to do so in the company’s certificate of incorporation or by-laws. The majority of S&P 500 companies permit shareholders meeting a minimum beneficial ownership requirement (such as 20 per cent or 10 per cent) to call special meetings.
Any shareholder of a reporting company who is eligible to bring matters before a shareholders’ meeting under state law and the company’s certificate of incorporation and by-laws may, at the shareholder’s own expense, solicit shareholder proxies in favour of any proposal including director nominations. Such shareholder proxy solicitations must comply with section 14 of the Exchange Act and related SEC regulations, but need not be approved by the board.
Under circumstances detailed in Rule 14a-8 under the Exchange Act, a reporting company must include a shareholder’s proposal in the company’s proxy materials and identify the proposal in its form of proxy. The shareholder may also submit a 500-word supporting statement for inclusion in the company’s proxy solicitation materials. This allows the proponent to avoid the costs associated with an independent solicitation. The SEC adopted rule amendments in 2020 that increased the eligibility requirements for submitting a shareholder proposal to a tiered approach depending on the level of ownership and the relevant holding period: at least US$2,000 if held for at least three years, at least US$15,000 if held for at least two years, and at least US$25,000 if held for at least one year.
Under specific circumstances, a company is permitted to exclude a shareholder proposal from its proxy solicitation, typically after obtaining ‘no-action’ relief from the SEC staff that concurs that there is a legal basis to exclude the proposal under Exchange Act Rule 14a-8 (eg, if the proposal deals with a matter relating to the company’s ordinary business operations).
In November 2021, the SEC’s Division of Corporation Finance issued guidance that makes it more difficult for companies to exclude shareholder proposals under Rule 14a-8. New Staff Legal Bulletin No. 14L (CF) rescinds prior interpretive guidance and offers useful insight into how the Division staff will evaluate future no-action requests seeking exclusion of shareholder proposals on the basis of the widely-used ‘ordinary business’ and ‘economic relevance’ exceptions. The new guidance will likely result in the exclusion of fewer shareholder proposals, particularly those that raise human capital-related issues that have a broad societal impact (even if not significant to the company) or that request companies to adopt targets and timeframes to address climate change as long as they do not dictate how management must do so.
In July 2022, the SEC proposed rule amendments that would update three of the substantive bases for exclusion of shareholder proposals: the ‘substantial implementation’ exclusion in Rule 14a-8(i)(10), the ‘duplication’ exclusion in Rule 14a-8(i)(11), and the ‘resubmission’ exclusion in Rule 14a-8(i)(12). The proposed amendments would provide the following:
- A proposal may be excluded as substantially implemented if ‘the company has already implemented the essential elements of the proposal.’
- A proposal ‘substantially duplicates’ another proposal if it ‘addresses the same subject matter and seeks the same objective by the same means.’
- A proposal constitutes a resubmission if it ‘substantially duplicates’ a prior proposal, using the same test proposed in the previous bullet.
Since 2011, companies may not exclude from their proxy materials shareholder proposals (precatory or binding) relating to by-law amendments establishing procedures for shareholder nomination of director candidates and inclusion in the company’s proxy materials, as long as the proposal is otherwise not excludable under Rule 14a-8. This amendment to Rule 14a-8 has facilitated the development of ‘proxy access’ via private ordering at companies chartered in states where permissible, as shareholders are able to institute a shareholder nomination regime via binding by-law amendment or request, via precatory shareholder proposal, that such a by-law be adopted by the board. The private ordering process to adopt proxy access has gained considerable momentum since the beginning of 2015.
In November 2021, the SEC adopted changes to the federal proxy rules to require the use of ‘universal’ proxy cards. The new rules change the methods by which public companies and shareholders have solicited proxies for decades, and allow shareholders to vote for a mix of management and dissident nominees in a contested director election. The new rules will reshape the process by which hostile bidders, activist hedge funds, social and environmental activists, and other dissident shareholders may utilise director elections to influence corporate governance and policy at public companies. The new rules also amend certain forms of proxy and disclosure requirements relating to voting options and standards that apply to all director elections, whether or not contested. The rules are now effective for shareholder meetings held after 31 August 2022.
Shareholders may act by written consent without a meeting unless the certificate of incorporation provides otherwise. The majority of companies in the S&P 500 do not permit shareholder action by written consent.
Controlling shareholders’ duties
Do controlling shareholders owe duties to the company or to non-controlling shareholders? If so, can an enforcement action be brought against controlling shareholders for breach of these duties?
Controlling shareholders owe a fiduciary duty of fair dealing to the corporation and minority shareholders when the controlling shareholder enters into a transaction with the corporation. When a controlling shareholder transfers control of the corporation to a third party, this obligation may be extended to creditors and holders of senior securities as well. A controlling shareholder who is found to have violated a duty to minority shareholders upon the sale of control may be liable for the entire amount of damages suffered, instead of only the purchase price paid or for the amount of the control premium. Minority shareholders can bring claims against a controlling shareholder for breach of fiduciary duty on either a derivative or direct basis, depending on the nature of the harm suffered.
Shareholder responsibility
Can shareholders ever be held responsible for the acts or omissions of the company?
Shareholders’ liability for corporate actions is generally limited to the amount of their equity investment. In unusual circumstances, exceptions may apply.
