As boards of directors of public companies prepare for their 2023 annual meetings and, relatedly, consider the voting results from 2022 annual meetings, we are being asked for advice concerning (a) the duties of directors of Maryland corporations and (b) the policies and current practices of the proxy advisory services relating to stockholder proposals, director elections and Say-On-Pay votes.
We are often asked to advise boards of directors of Maryland corporations on their duties in connection with (a) precatory proposals approved by shareholders, (b) directors who fail to receive majority support at annual meetings and (c) Say-On-Pay votes. For many years, we have consistently responded that Maryland law does not require a board to follow a request from the stockholders on an agenda item (including a shareholder proposal, director nominee failing to receive majority support or a failed Say-On-Pay vote) even if approved by a majority or significant majority of the votes cast or the votes entitled to be cast.
Section 2-401(a) of the Maryland General Corporation Law (the "MGCL") provides that "[t]he business and affairs of a [Maryland] corporation shall be managed under the direction of a board of directors." Section 2-401(b) confers on the board "[a]ll powers of the corporation . . . except as conferred on or reserved to the stockholders by law…." In discharging his or her duties as a director of a Maryland corporation, Section 2-405.1(c) of the MGCL requires each director to act "[i]n good faith," "[i]n a manner the director reasonably believes to be in the best interests of the corporation," and "[w]ith the care that an ordinarily prudent person in a like position would use under similar circumstances." Further, Section 2-405.1(g) unambiguously provides that: "An act of a director of a corporation is presumed to satisfy the standards of subsection (c) . . . ." Pursuant to Section 8-601.1 of the Maryland REIT Law, these standards also apply to acts of trustees of Maryland real estate investment trusts.
The United States District Court for the District of Maryland has held that there is no duty for directors of a Maryland corporation to follow the wishes of holders of a majority of the shares. See Martin Marietta Corp. v. Bendix Corp., 549 F. Supp. 623, 633 n.5 (D. Md. 1982), quoted in Mountain Manor Realty, Inc. v. Buccheri, 55 Md. App. 185, 197-98, 461 A.2d 45, 52-53 (1983). The court in Martin Marietta rejected the contention that an earlier Maryland case, Cummings v. United Artists Theatre Circuit, Inc., 237 Md. 1, 204 A.2d 795 (1964), prohibits the board of directors of a Maryland corporation from taking actions that it knows are disapproved by a majority of the shareholders. Martin Marietta, 549 F. Supp. at 633 n.5. Instead, the court held that "there is no reason to believe that a Maryland corporation's directors, even [when] faced with a request from a majority shareholder, must always accede to that request." Id. Moreover, the Court of Appeals of Maryland, our highest state court, has stated: "As a general rule, the stockholders cannot act in relation to the ordinary business of the corporation, nor can they control the directors in the exercise of the judgment vested in them by virtue of their office." Warren v. Fitzgerald, 189 Md. 476, 489, 56 A.2d 827, 833 (1948) (quoting People ex rel. Manice v. Powell, 201 N.Y. 194, 201, 94 N.E. 634, 637 (1911)). "Shareholders are not ordinarily permitted to interfere in the management of the company; they are the owners of the company but not its managers." Werbowsky v. Collomb, 362 Md. 581, 591, 766 A.2d 123, 133 (2001). Even earlier, the Court of Appeals held that a resolution purporting to express "the will of the members" is not binding on the directors. Mutual Fire Ins. Co. v. Farquhar, 86 Md. 668, 674-75, 39 A. 527, 529 (1898). See also James J. Hanks, Jr., Maryland Corporation Law §§ 6.1a and 7.1 (Supp. 2021, updated annually).
We believe that these cases follow, almost necessarily, from Section 2-401(a)'s delegation of power to the board to oversee the management of the corporation's business and affairs and are relevant in the shareholder-proposal context. We emphatically reject any claim that the board of a Maryland corporation has a legal obligation to implement a shareholder-approved precatory proposal or respond in any particular way to a director nominee failing to receive majority support or to a failed Say-On-Pay vote.*
Policies at Proxy Advisory Services
Institutional Shareholder Services Inc. ("ISS") will consider recommending against committee members or the entire board if the board fails to act on even just one shareholder proposal that received the support of a majority of the votes cast in the previous year. If the board does not implement such a proposal, ISS will examine, among other things, the outreach efforts of the board, any disclosure regarding why the proposal was not implemented, the subject matter of the proposal, the level of support for and opposition to the proposal in past meetings, action taken by the board in response to the vote (including engagement with shareholders) and the continuation of the underlying issue as a voting item on the ballot. Despite the fact that ISS says its evaluation is case by case, we are not aware of any instance where a board decided not to implement a majority shareholder-approved proposal and ISS did not subsequently follow with a recommendation against the incumbent nominees.
The default standard under the MGCL provides that nominees for election as a director are elected by a plurality of votes cast. Thus, in an uncontested election, all nominees will be re-elected. However, most public companies have adopted some form of majority voting. This typically entails (a) a bylaw provision requiring that, in an uncontested election, each nominee for election as a director must receive a majority of all votes cast for or against (or withheld as to) that nominee and (b) a bylaw or, more typically, a corporate governance guideline (or policy), requiring that an incumbent nominee who fails to receive the requisite majority vote in an uncontested election but who, under state law, continues to serve must offer his or her resignation to the nominating and governance committee of the board of directors, which will recommend to the board whether to accept or reject the offer to resign.
At companies with majority voting, incumbent nominees failing to receive a majority of votes cast remains rare, but it does happen a handful of times each year. ISS will consider recommending against committee members or the entire board if "at the previous board election, any director received more than 50 percent withhold/against votes of the shares cast and the company has failed to address the issues(s) that caused the high withhold/against vote." Despite ISS's assertion that its evaluation is case by case, we are not aware of any instance where a board decided to not accept a director's offer to resign or did not make a change in its policies relating to the low support and ISS did not subsequently follow with a recommendation against the incumbent nominees.
ISS states that it will vote "case by case" on compensation committee members if the previous Say-On-Pay vote "received less than 70 percent of the votes cast." ISS expects "the highest degree of responsiveness" if the "support level was less than 50 percent." When making a voting recommendation, ISS says it will consider a company's disclosure of (i) its engagement efforts, (ii) dissident stockholder's concerns and (iii) specific and meaningful actions taken to address stockholders' concerns. ISS will also examine recent compensation actions taken by the company, whether the issue is recurring or isolated, and the company's ownership structure. In our experience, if the prior Say-On-Pay vote was not approved with at least majority support, ISS will almost certainly recommend against incumbent compensation committee members at the following annual meeting unless the company can disclose changes, satisfactory to ISS, made to the compensation program in response to the vote. Merely disclosing outreach efforts in these situations would likely not be enough.
For any annual meeting agenda item, Glass Lewis & Co. ("Glass Lewis") expects boards to "demonstrate some level of responsiveness to address the concerns of shareholders" if "20% or more of shareholders… vote against" management's recommendation. This includes anytime 20% or more of votes cast are voted in favor of a stockholder proposal, vote against (or withhold as to) a director nominee or vote against the Say-On-Pay proposal. Glass Lewis clarifies "while the 20% threshold will not automatically generate a negative vote recommendation [in the future], it may be a contributing factor to our recommendation to vote against management…." Glass Lewis further states that "clear action is warranted when such proposals receive support from a majority of votes cast."
If a company received a shareholder proposal that was approved at an annual meeting or the company received low levels of support for a director nominee or Say-On-Pay resolution, it may be useful to conduct shareholder outreach before the board makes a final decision on any corporate action, as conversations with shareholders, especially large shareholders who voted against management's recommendation, may provide more insight than just the vote result. If a board decides against making any changes after a ballot item received significant votes against management's recommendation, we believe that the decision should be reached after at least some, preferably significant, shareholder outreach and that outreach should continue after the decision in order to explain the board's thinking on why changes were not implemented, discuss any other responses the board may be considering and get a sense of any possible voting or other shareholder reactions at the next annual meeting. Often, shareholders will be satisfied with a thoughtful response. In addition, it is our experience that it is helpful to be able to describe shareholder outreach in the next year's proxy statement, especially if the company can say that holders of a substantial percentage of shares expressed satisfaction with the board's response. While disclosing shareholder outreach is likely not enough to stave off a negative recommendation by ISS or Glass Lewis if a company does not address the issue at all, it could make a difference if the company makes a partial response.
While there is no legal obligation for a board to react in any particular way to the situations discussed above, we recommend that directors of Maryland corporations, as part of their ordinary prudence duty quoted above, give appropriate consideration to any proposal approved by stockholders (or even receiving a significant vote), to a director nominee failing to receive majority support or to a failed Say-On-Pay vote. Depending on the nature of the agenda item, it may be appropriate to refer the matter to the governance committee or other committee of independent directors to seek expert advice on the matter or to engage in shareholder outreach related to the proposal. In the end, however, as stated above, it is each director's duty to act in a manner that he or she reasonably believes to be in the best interests of the corporation.
While the policies and influence of proxy advisory services such as ISS and Glass Lewis are a reality for public companies, directors of Maryland corporations should be wary of taking or refraining from taking any action solely because of its possible impact on their re-election or the recommendation of a proxy advisory service.
* * * * *
As always, our colleagues and we are available at any time to discuss these or other matters.
* The Dodd-Frank Act unambiguously states that Say-On-Pay votes do not alter any duties (which includes the duties of a director of a Maryland corporation under MGCL Section 2-405.1, discussed above) applicable to directors and that results of a Say-On-Pay vote do not imply a breach or violation of any duties.