Do Shareholders Have the Right to Make Non-Binding Proposals?

A novel theory endorsed by the new SEC Chair Paul Atkins says that they don't. Is he right?

A Surprising Theory by the New SEC Chair

SEC Chair Paul Atkins has suggested that, contrary to the assumption on which the system has operated for decades, Delaware law does not recognize an inherent right of shareholders to introduce non-binding proposals (“precatory proposals” in the jargon) on the agenda of a shareholder meeting. If this theory is correct, then companies have no duty to include shareholder proposals in the proxy materials distributed to shareholders.

The first step in Atkins’s argument is uncontroversial:

While Rule 14a-8 provides a mechanism for a shareholder to include its proposal in the company’s proxy statement, the rule can only be used for proposals that can properly be brought before a shareholder meeting under state law. If a proposal is not permissible under state law—that is, if it is not a “proper subject” for action by shareholders—Rule 14a-8 permits a company to exclude the proposal from its proxy statement.

This is obviously correct. Rule 14a-8 is about the company’s duty to include shareholder proposals in the proxy statement, a disclosure document regulated under federal securities law. In practice, a proposal that does not appear in the proxy statement is a proposal that almost nobody will be able to see or vote on. Therefore, Rule 14a-8 is what makes shareholder proposals practically meaningful.

However, the duty under Rule 14a-8 depends on the permissibility of the shareholder proposal under state corporate law. The system has operated for many decades on the assumption that precatory shareholder proposals are indeed permissible under Delaware law, the state law governing most U.S. public companies, as well as the corporate laws of other states.

See, for example, SEC Release No. 56160 of July 2007:

In assigning this responsibility to the Commission, Congress demonstrated its “intent to bolster the intelligent exercise of shareholder rights granted by state corporate law.” To identify the rights that the proxy process should protect, the Commission has taken as its touchstone the rights of security holders guaranteed to them under state corporate law. As Chairman Ganson Purcell explained to a committee of the House of Representatives in 1943:

“The rights that we are endeavoring to assure to the stockholders are those rights that he has traditionally had under State law to appear at the meeting; to make a proposal; to speak on that proposal at appropriate length; and to have his proposal voted on.”

Thus, the federal proxy authority is not intended to supplant state law, but rather to reinforce state law rights with a sturdy federal disclosure and proxy solicitation regime. To that end, the Commission has sought to use its authority in a manner that does not conflict with the primary role of the states in establishing corporate governance rights. For example, Rule 14a-8, the shareholder proposal rule, explicitly provides that a shareholder proposal is not required to be included in a company’s proxy materials if it “is not a proper subject for action by shareholders under the laws of the jurisdiction of the company’s organization.”

The next step of Atkins’s argument is to challenge that longstanding assumption. Atkins clarifies that it is not the SEC’s job to say what’s permissible under Delaware law. But then he suggests that shareholder proposals may be impermissible under Delaware law. He cites two authorities on the point: a forthcoming paper by a prominent Delaware attorney (Kyle Pinder, partner of the Delaware firm Morris, Nichols, Arsht & Tunnell) and a remark by former Delaware Chief Justice Leo Strine:

[A]t least one Delaware practitioner has recently concluded that… Delaware law does not confer to stockholders an inherent right to vote on precatory proposals…[I]n 2007, Leo Strine… said “In Delaware, [we] vote on real things…We do not have imaginary voting. We do not have therapy for whoever…We do not have what I call ‘pizza on the wall.’ That is precatory proposals.”

Strine’s quip can hardly be taken as a fully developed theory. Although he has elaborated a bit more on the point elsewhere, he does not seem to have proposed a fully-fledged theory of why shareholder proposals are not allowed under Delaware law.

Pinder’s argument, by contrast, is fully developed. I will summarize it as best as I can.

An Argument Against Shareholder Proposals

Here’s Pinder’s argument as I understand it:

1. Shareholders have the right to vote on some matters, but not on others.

2. On the matters on which the shareholders have the right to vote, they also have a subsidiary right to make a proposal.

3. But on the matters on which the shareholders do not have the right to vote, they do not have a subsidiary right to make a proposal.

4. The DGCL (Delaware General Corporation Law) does not say anything about the right to vote on precatory shareholder proposals or the right to make such proposals

5. Case law does not say anything on these questions either.

6. In the past, Delaware courts have said that shareholders have a right to vote on (1) the election of directors and matters of directorial control, (2) matters on which the law or the company’s organizational documents give shareholders a right to vote, and (3) matters submitted to shareholders by the directors. Therefore, shareholders do not have a right to vote on non-binding proposals regarding matters within the purview of directors.

7. Because shareholders do not have an inherent right to vote on non-binding shareholder proposals, they do not have an inherent right to make such proposals.

Pinder’s argument crucially depends on Premise 6: that shareholders do not have an inherent right to vote on non-binding recommendations to the board. (Premise 3 is equally important for the argument, but I suspect that Atkins and Pinder would be fine with a right to make proposals without a corresponding right to vote on such proposals. Therefore, practically speaking, Premise 6 is where the action is.)

However, the support for Premise 6 is extremely thin. Yes, there is no explicit right to make proposals in the statute, and the case law has not addressed the question in a fully developed manner. But this only means that the question does not have an obvious answer, not that the answer is the one that Pinder suggests.

Yes, some Delaware cases have identified three types of issues in which shareholders have a right to vote (election of directors and directorial power, matters identified by statute, charters or bylaws, and management proposals) but those cases did not purport to provide an exhaustive list of issues on which shareholders have a right to vote.

An Alternative Argument Against Shareholder Proposals

Pinder also proposes an alternative argument against the shareholder right to make precatory proposals. I’ll reconstruct it as follows:

1. Under § 141(a), directors have the power to manage the corporation, which means that any corporate power not explicitly assigned to shareholders must be considered a power of the directors.

2. The law is silent on shareholders’ power to alter the agenda of a shareholder meeting by including non-binding proposals.

3. Therefore, unless the charter says otherwise, only the board has the power to make such proposals.

I see two problems with this alternative argument. First, I don’t think Delaware courts have ever interpreted § 141(a) as establishing a principle of residual directorial powers or, put differently, as negating unenumerated rights of the shareholders.

In fact, courts have in the past identified “common law” rights of the shareholders. For example, in Shaw v. Agri-Mark, Inc. (Del. 1995), the Delaware Supreme Court explained that shareholders’ rights to inspect corporate books and records existed at common law before the enactment of § 220, which explicitly codified them. And in The Williams Companies S’holder Litig. (Del. Ch. 2021), the Court of Chancery held that:

Modern corporate law recognizes that stockholders have three fundamental, substantive rights: to vote, to sell, and to sue. From these fundamental rights flow subsidiary rights, including the right to communicate with other stockholders, nominate directors, and communicate with (and even oppose) management and the Board.

These are not statutory shareholder rights. They are derived from the overall architecture of the governance system designed by the DGCL.

The second problem with the argument is that precatory proposals do not intrude on the power of the board to manage the corporation. They are non-binding recommendations. The board, if it deems it appropriate, can ignore them and choose an alternative course of action.

Intermission: Do Shareholder Proposals Matter?

Why are we having this argument in the first place? If shareholder proposals are precatory and therefore the board can ignore them, why do the SEC Chair, managers, and investors care about them?

People disagree on how to answer this question. I think, however, that the very existence of such a dispute suggests that shareholder proposals matter to some degree. There is some empirical evidence that managerial decisions are affected by the outcome of precaroty proposals that receive majority support or the support of a significant minority.

Some recent examples seem to support this view. In the 2010s, dozens of precatory proposals submitted by institutional investors, asking for annual election of all directors simultaneously (so-called de-staggerization of boards), contributed to major governance changes across a large number of S&P 500 companies.

And in the past few years, significant support for shareholder proposals on social and environmental issues has affected how corporations deal with these topics (at least from an expressive standpoint, if not from a more substantive one), to the point that we are now experiencing a major political backlash against so-called ESG. Although I believe that the whole phenomenon was more symbolic than real, symbolic action matters in politics, including corporate politics. (I examined this recent phenomenon in two papers, Stockholder Politics, and Expanding Shareholder Voice.)

An Argument in Favor of Shareholder Proposals

If the Atkins/Pinder theory is not persuasive, how should we solve the problem? Are shareholder proposals allowed under Delaware law?

Here’s an argument in support of an inherent power of the shareholders to make precatory proposals and to vote on such proposals. It is the kind of argument that constitutional law theorists would call a “structural argument.” In his classic work on the modalities of constitutional interpretation, Philip Bobbitt defined structural argument as “inferring rules from the relationships that the Constitution mandates among the structures it sets up” (Constitutional Interpretation 1991, pp. 12-13).

In other words, a structural argument in constitutional law infers constitutional rules or rights from the overall architecture of the Constitution, rather than from any single clause. The interpreter starts from the institutional relationships the document creates—among the three branches, between the federal government and the states, and between government and the people—and asks what legal consequences must follow if those relationships are to make sense and function as designed. Structural reasoning treats the Constitution as an integrated scheme of government to resolve questions that the text does not answer explicitly.

Structural arguments make sense in corporate law, as well: this is my starting assumption. My structural argument on shareholder proposals starts with the default scheme of corporate governance designed by Delaware law. In a new working paper (The Logic of Ratification), I call this scheme “interposition,” which I distinguish from “delegation.”

In a delegation, the represented party can bypass the representative and act unilaterally, or can give binding instructions to the representative. In an interposition, the intermediation of the representative is a structural feature of the system, and the represented party cannot bypass the representative or give it binding instructions.

The relationship between directors and shareholders (just like the relationship between the people and their elected representatives in representative democracies) is structured according to the scheme of interposition, not delegation. I refer to The Logic of Ratification for a full development of this thesis.

The second step of the argument is the one Bobbitt calls a “structural argument.” If the law is silent on a particular issue concerning the relative powers of directors and shareholders, we should look at the standard structure of interposition for guidance.

In a standard interposition, the represented party does not have the power to give binding instructions to the representative. However, it does generally have the power to provide non-binding recommendations. The specific rules of how these proposals can be introduced may vary significantly, but the basic power to make such proposals seems to be an obvious and essential feature of interposition.

In republican forms of government, citizens typically have a right to petition. Many state constitutions in the U.S. recognize a “right of instruction,” which is typically interpreted as a right to make non-binding recommendations to their elected representatives.

In Delaware corporate law, the existence of such a right has always been considered obvious, precisely because this is how the standard form of interposition typically works. I have already cited the SEC on this point. Here’s the Delaware Court of Chancery in Jana Master Fund, Ltd. v. CNET Networks, Inc., 954 A.2d 335, 344 (Del. Ch. 2008):

[The defendant] is correct that if the [contested advance notice bylaw] is interpreted to apply only to 14a–8 proposals, then “any of [the defendant]’s thousands of stockholders are free to raise for the first time and present any proposals they desire at the Annual Meeting.”Although this may sound daunting, it is the default rule in Delaware.

So the court is saying that the default rule in Delaware is that any shareholder is free to present proposals at the annual meeting. One of the preeminent treatises on Delaware corporate law (Balotti & Finkelstein § 7.7) glosses as follows:

Absent a restriction in a corporation’s governing documents, any of its stockholders “are free to raise for the first time and present any proposals they desire” at stockholder meetings.

The reason why such a right belongs to the overall architecture of interposition is quite intuitive. In interposition, the representative has significant independent authority to make decisions, but at the same time those decisions must aim at the wellbeing of the represented parties. Therefore, while a right of the represented to act unilaterally or give binding instructions is inconsistent with the independent authority of the represented, a right to make non-binding recommendations is not only consistent with the representative’s authority but it is also functionally in line with the representative’s duty to pay attention to what the representaed parties think about certain issues.

To recap:

1. The overall architecture of corporate governance fits the scheme of “interposition,” in which directors enjoy broad independent authority, although they must exercise it for the benefit of the shareholders.

2. Whenever the law is silent on a particular distribution of power between directors and shareholders, we should look at the standard form of interposition for guidance.

3. The represented party’s right to make non-binding recommendations to the representative fits the scheme of interposition and is typically recognized in standard forms of interposition.

4. Therefore, absent anything to the contrary in the statute or in the corporate charter, shareholders have the inherent right, consistent with the overall structure of corporate governance, to make non-binding proposals and to vote on such proposals.

On this view, which has been the implicit theory underlying the entire system for almost a century, a company cannot exclude a shareholder proposal from the proxy statement on the grounds that shareholders do not have a default right to make proposals.

What’s Next?

Two follow-up questions immediately come to mind:

1. Can the right to make precatory shareholder proposals be restricted by the board through a bylaw?

2. Can the shareholders themselves regulate their right to make proposals through a shareholder bylaw? (My colleague John Coates already has some thoughts on this.)

I think the answer to both questions is: yes, within certain limits. I will discuss these two questions more fully in a separate post.