The Wachtell Bylaw: A Balanced Perspective


In a free-swinging and provocative attack, Brandon Gold, a graduating Harvard Law School student, argues (1) that third party bonuses, paid by hedge funds or others soliciting proxies, to their director nominees are acceptable and even desirable, and (2) that a proposed bylaw, drafted by Wachtell, Lipton, that would disqualify nominees who were parties to any such agreement or understanding or who have received such compensation from third parties is invalid.  Only the second of these questions involves much nuance, but both are worth exploring.

Mr. Gold’s first assertion that such “pay for performance” compensation arrangements for directors are desirable relies on two subsidiary claims that are both highly problematic. First, he asserts that it is harder to recruit nominees for insurgent slates than for management slates and thus the former should be paid more to incentivize them to undertake this less popular role.  This is an argument that proves too much.  Its premise is shaky, as director compensation has increased enormously over the last few years (and now even exceeds $1 million per year in a few cases).  Moreover, the nominees to the Hess board waived their bonus compensation and still continued as nominees. Nor is it clear than an insurgent nominee will suffer social isolation or blacklisting, as there may be many insurgent slates next year (given the relative success of hedge fund proxy solicitations this year).

Second, Mr. Gold asserts that if shareholders elect the insurgent nominees, their election implies that shareholders have approved the incentive compensation from the hedge fund.  But that conclusion simply does not follow.  In reality, two issues have been bundled:  (1) Should the insurgents be elected, and (2) Should the bonus compensation be paid.  Shareholders could rationally believe (1) that a board needed some outsiders focused on shareholder value maximization and (2) that third party compensation was undesirable.  In a given case, they could decide that (1) outweighed (2).

In overview, the fundamental issue in third party payments to directors is whether any perceived shortfall in compensation justifies introducing a strong conflict of interest.  By analogy, suppose it were clear that judges disliked hearing complex patent cases and often delayed deciding them.  Would that justify a party in a patent case offering a “pay for performance” bonus to a judge hearing his case, where the party made clear that the bonus would be paid if there were a timely decision, regardless of the outcome.  I suspect most of us would still consider that too close to a bribe to be tolerable.

Third party bonuses, if permitted, will be used not just by hedge funds, but by many “M&A” players whose incentives are even more clearly in conflict with those of the shareholders.  Suppose a company intent on acquiring a target firm announces a hostile tender offer and also launches a proxy fight for a majority of the board.  It agrees to pay its nominees $3 million if the acquisition is approved by a shareholder vote.  After the acquirer succeeds in its proxy fight, its nominees redeem the target’s poison pill and are about to approve a squeeze-out merger at the same price as the tender offer.  Assume further, however, that the target company is in the mining and minerals business and the price of its principal commodity has just shot through the roof.  Are these specially compensated directors sufficiently independent to be able to approve the squeeze-out merger in light of these new circumstances?  A host of variations on this theme can be imagined, and in most the special compensation aggravates the independence problem.

Possibly with these kinds of conflicts in mind, the Council of Institutional Investors (“CII”) has this month rejected both third party payments bonuses and performance-based compensation for directors. In a May “Governance Alert,” it concluded:

“CII policies do not support differential incentive pay by outsiders for directors once they are seated.  CII’s policies say board pay should be set by the board’s compensation committee and consist solely of cash retainer and equity-based compensation.  In addition, while CII is a strong advocate of performance-based incentives in executive compensation, it opposes performance measures in director compensation.  ‘Performance-based compensation for directors creates potential conflicts with the director’s primary role as an independent representative of shareholders,’ Council policy states.”[1]

The CII “Governance Alert” went on to analyze the Wachtell bylaw as a relevant response to this problem, but it did not expressly endorse it.

This brings us to the Blasius issue.  A board-passed bylaw disqualifying the insurgent slate, adopted after the proxy fight begins or is clearly in view, does seem vulnerable under Blasius Industries Inc. v. Atlas Corp.[2]  But that conclusion does not follow in the case of a bylaw adopted by the board today, nearly nine months before the start of the traditional proxy session.  Almost every case that has followed Blasius has involved challenges to board conduct taken after a control fight materialized (e.g., postponements of the meeting day, revision of board size, etc.).  If a board cannot impose any qualifications on director nominees, even before a contest materializes, then Section 141(b) of the Delaware General Corporation Law has been effectively repealed.

Mr. Gold’s position seems to be that everything should be left up to the shareholders to decide and that any restriction on their choice inherently violates Blasius.  But Section 141(b) seems to say the opposite.  Also, as earlier noted, a shareholder vote to elect a slate does not truly approve a compensation policy.  Because any restriction adopted under Section 141(b) applicable to directors necessarily limits shareholder choice, a narrower test needs to be used.  For example, a board-passed bylaw disqualifying convicted felons from board service restricts shareholder choice, but still seems highly likely to be upheld.

The first rule of corporate governance is that the business and affairs of the corporation are to be managed by its board of directors.  A bar on third party bonuses is not unreasonable (as CII has just agreed), and it should only be invalidated when its adoption was clearly intended to frustrate the shareholder’s actual choice of directors.

[1] See CII Governance Alert, “Special Pay Plans for Hedge Fund Nominees Spark Controversy” (Vol. 18 No. 18, May 16, 2013).

[2] 564 A.2d 651 (Del. Ch. 1988).


  1. Pingback: The Marketplace of Ideas: Professor Coffee and Brandon Gold on the Wachtell Bylaw | CLS Blue Sky Blog

  2. Kirk Hartley

    Interesting article, but disappointing that the alert cited in footnote 1 is not publicly available. According to the CII web site, it is only accessible to CII members.

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