July 28, 2023
Court of Chancery Declines to Enjoin Advance Notice Bylaw in Sternlicht v. Hernandez
In Sternlicht, et al. v. Hernandez, et al., C.A. No. 2023-0477-PAF (Del. Ch. June 14, 2023), Plaintiff stockholders and former directors of Cano Health, Inc. (“Cano”) sought to enjoin Cano’s annual stockholder meeting and the enforcement of an advance notice bylaw. Plaintiffs had resigned six weeks after the deadline to submit director nominations and argued that enforcing the advance notice bylaw would be inequitable in the face of an alleged “radical change in circumstances” at Cano. Looking to the doctrine detailed in Schnell v. Chris-Craft Industries, Inc. (Del. 1971), as applied to advance notice bylaws by Hubbard v. Hollywood Park Realty Enters., Inc. (Del. Ch. July 31, 1997) and its progeny, the Court of Chancery rejected Plaintiffs’ claims, finding that the alleged changes in circumstances were not sufficiently radical or material to merit waiver of the advance notice bylaw. In addition, the Court looked to Plaintiffs’ own conduct and intentional delays, determining that any harm suffered by Plaintiffs was of their own making, and the balance of equities did not support granting the relief Plaintiffs sought.
Background
Cano is a Delaware health company that owns and operates medical centers and delivers healthcare services through affiliate relationships with other providers. Dr. Marlow Hernandez has been CEO since Cano’s inception. In June of 2021, Cano went public through a de-SPAC with a company for which Barry Sternlicht was the chairman. At the time of the merger, Sternlicht also personally invested $50 million in Cano and joined the Board. Plaintiffs collectively controlled stock representing 35.7% of Cano’s voting power. Following the merger, the Board consisted of Plaintiffs Sternlicht, Dr. Lewis Gold, and Elliot Cooperstone, and Defendants Hernandez, Solomon Trujillo, Angel Morales, Kim Rivera, Alan Muney, and Jacqueline Guichelaar.
In the year and a half following the merger, the price of Cano’s stock declined precipitously, from approximately $15 per share immediately following the merger to under $2 per share by the end of November 2022. During this time, disputes began to arise among Board members and Cano executives relating to loans taken out by Hernandez. In August 2021, Hernandez pledged approximately 22 million shares of Cano stock to secure a loan used to purchase Cano stock on margin. When the margin calls came, Hernandez ultimately borrowed $46 million from four individuals connected with companies either acquired by or otherwise in business with Cano.
Sternlicht was the most vocal critic of Hernandez throughout this time period, and pushed for investigation of Hernandez’s conduct, particularly related to the various loans. At the same time, Plaintiffs expressed a strong desire to see Cano sold. When potential acquisition talks with CVS failed in October 2022 – causing the stock price to plummet even further – Sternlicht accused Hernandez of scuttling them by telling CVS (as well as another potential purchaser) that Cano was not for sale.
As the fracturing of the Board continued, Sternlicht threatened to resign if Hernandez was not fired and Cano did not seek to sell itself. In making his threat, Sternlicht made clear that he would disclose the reasons for his resignation, including those relating to Hernandez’s conduct. In response to Sternlicht’s threats, the Board formed a special committee comprised of the directors except for Plaintiffs and Hernandez. After several meetings, the special committee recommended that Hernandez be removed as chairman, but retain his position as CEO, subject to a probationary period. The full Board adopted the recommendations over Plaintiffs’ objection, and Plaintiffs resigned from the Board.
At the time of their resignation, Plaintiffs had already begun strategizing how to convince Cano’s Board to either buy out their equity or to sell Cano. During these discussions, Plaintiffs considered threats of noisy resignations, civil lawsuits, and a proxy contest as potential means to secure Board support for their desired outcomes. Plaintiffs were aware of the February 15, 2023 deadline to submit Board nominees under Cano’s advance notice bylaw; nonetheless, Plaintiffs delayed, hoping that the Board would notice the annual stockholder meeting for a later date that would automatically reopen the nomination period.
Plaintiffs were notified on April 5, 2023 that Cano’s annual meeting would be held on June 28, 2023. Plaintiffs waited 9 days to demand the nomination period be reopened, on April 14, 2023. Plaintiffs then waited an additional 14 days to file this suit on April 28, 2023. Cano ultimately moved the annual meeting forward to June 15, 2023.
Analysis
It is well established under Delaware law that stockholders have a fundamental right to vote for directors to manage the corporation. Part and parcel with this right is the right to nominate a competing slate of directors. Advance notice bylaws are typical among Delaware corporations and often require prior notice of stockholder proposals and nominations of directors. Courts have recognized that such bylaws promote orderly and efficient meetings and provide fair notice to corporations.
In Sternlicht, Plaintiffs argued that the “materiality” standard under Hubbard was equivalent to the materiality standard governing proxy disclosures to stockholders. The Court rejected this argument, citing AB Value as requiring a change that involves an extraordinary or fundamental shift to the corporation. Applying the three questions raised in AB Value, the Court rejected each of the “radical” or “material” changes proffered by Plaintiffs, finding that they were: (a) caused by Plaintiffs’ conduct rather than the Board’s; (b) neither unanticipated by Plaintiffs nor sufficiently material to constitute a radical shift; or (c) occurring or discovered after the advance notice deadline.
The Court also found that these alleged changes were pretextual in light of the Plaintiffs’ own conduct. According to the Court, the Plaintiffs had a clear objective: either force a buyout of their equity or force a sale of Cano. Plaintiffs were well aware of the nomination deadline, as evidenced by their previous nomination of a competing slate of directors before any of the alleged changes occurred. Nonetheless, the Court found that Plaintiffs strategically chose to delay in furtherance of their goals. Based on these findings, the Court concluded that Plaintiffs’ challenge to Cano’s advance notice bylaw did not have a reasonable probability of succeeding.
The Court also considered Plaintiffs’ conduct in holding that any harm they might suffer from application of the advance notice bylaw was self-inflicted. Plaintiffs’ decision to resign after they knew the nomination deadline had passed was part of a strategic plan to pressure the Board to agree to a buyout or to replace the CEO with someone aligned with Plaintiffs’ goals.
In essence, the Court found, “Plaintiffs must be forced to live with the consequences of their actions.” Given the inequities of Plaintiffs’ strategic choices, which caused Defendants to litigate on a burdensome, expedited basis, and forced Cano to incur additional costs in connection with its annual meeting, the Court denied Plaintiffs’ request to enjoin the advance notice bylaw.
Key Takeaways
Background
Cano is a Delaware health company that owns and operates medical centers and delivers healthcare services through affiliate relationships with other providers. Dr. Marlow Hernandez has been CEO since Cano’s inception. In June of 2021, Cano went public through a de-SPAC with a company for which Barry Sternlicht was the chairman. At the time of the merger, Sternlicht also personally invested $50 million in Cano and joined the Board. Plaintiffs collectively controlled stock representing 35.7% of Cano’s voting power. Following the merger, the Board consisted of Plaintiffs Sternlicht, Dr. Lewis Gold, and Elliot Cooperstone, and Defendants Hernandez, Solomon Trujillo, Angel Morales, Kim Rivera, Alan Muney, and Jacqueline Guichelaar.
In the year and a half following the merger, the price of Cano’s stock declined precipitously, from approximately $15 per share immediately following the merger to under $2 per share by the end of November 2022. During this time, disputes began to arise among Board members and Cano executives relating to loans taken out by Hernandez. In August 2021, Hernandez pledged approximately 22 million shares of Cano stock to secure a loan used to purchase Cano stock on margin. When the margin calls came, Hernandez ultimately borrowed $46 million from four individuals connected with companies either acquired by or otherwise in business with Cano.
Sternlicht was the most vocal critic of Hernandez throughout this time period, and pushed for investigation of Hernandez’s conduct, particularly related to the various loans. At the same time, Plaintiffs expressed a strong desire to see Cano sold. When potential acquisition talks with CVS failed in October 2022 – causing the stock price to plummet even further – Sternlicht accused Hernandez of scuttling them by telling CVS (as well as another potential purchaser) that Cano was not for sale.
As the fracturing of the Board continued, Sternlicht threatened to resign if Hernandez was not fired and Cano did not seek to sell itself. In making his threat, Sternlicht made clear that he would disclose the reasons for his resignation, including those relating to Hernandez’s conduct. In response to Sternlicht’s threats, the Board formed a special committee comprised of the directors except for Plaintiffs and Hernandez. After several meetings, the special committee recommended that Hernandez be removed as chairman, but retain his position as CEO, subject to a probationary period. The full Board adopted the recommendations over Plaintiffs’ objection, and Plaintiffs resigned from the Board.
At the time of their resignation, Plaintiffs had already begun strategizing how to convince Cano’s Board to either buy out their equity or to sell Cano. During these discussions, Plaintiffs considered threats of noisy resignations, civil lawsuits, and a proxy contest as potential means to secure Board support for their desired outcomes. Plaintiffs were aware of the February 15, 2023 deadline to submit Board nominees under Cano’s advance notice bylaw; nonetheless, Plaintiffs delayed, hoping that the Board would notice the annual stockholder meeting for a later date that would automatically reopen the nomination period.
Plaintiffs were notified on April 5, 2023 that Cano’s annual meeting would be held on June 28, 2023. Plaintiffs waited 9 days to demand the nomination period be reopened, on April 14, 2023. Plaintiffs then waited an additional 14 days to file this suit on April 28, 2023. Cano ultimately moved the annual meeting forward to June 15, 2023.
Analysis
It is well established under Delaware law that stockholders have a fundamental right to vote for directors to manage the corporation. Part and parcel with this right is the right to nominate a competing slate of directors. Advance notice bylaws are typical among Delaware corporations and often require prior notice of stockholder proposals and nominations of directors. Courts have recognized that such bylaws promote orderly and efficient meetings and provide fair notice to corporations.
- Schnell: In Schnell, the Delaware Supreme Court ruled that “inequitable action does not become permissible simply because it is legally possible.” The Schnell doctrine is to be applied sparingly, and only invoked in circumstances that “threaten the fabric of law” or when manipulation of the law, including the corporate machinery, “would deprive a person of a clear right.”
- Hubbard: In Hubbard, the Court of Chancery applied Schnell to hold that directors have a duty to waive the restrictions imposed by an advance notice bylaw when a “radical shift in position, or a material change in circumstances” occurs after the deadline for nominations had passed. In that case, a majority of directors shifted their allegiance following the notice deadline and sought to take the company in an entirely new direction. Since the stockholders could not have known of this shift before the deadline, the Court found that a radical change in circumstances had occurred, the directors caused the change, and enforcing the advance notice bylaw would be inequitable.
- AB Value P’rs, LP v. Kreisler Mfg. Corp., 2014 WL 710465 (Del. Ch. Dec. 16, 2014): The Court of Chancery in AB Value distilled the Hubbard framework to three questions: “First, did the change in circumstances occur after the advance notice deadline? Second, was the change ‘unanticipated’ and ‘material’? Third, was the change caused by the board of directors?” Under the Hubbard analysis as refined by AB Value, “the Court’s focus is on the board and material actions taken by the board that substantially alter the direction of the company” (emphases supplied by the Sternlicht Court).
In Sternlicht, Plaintiffs argued that the “materiality” standard under Hubbard was equivalent to the materiality standard governing proxy disclosures to stockholders. The Court rejected this argument, citing AB Value as requiring a change that involves an extraordinary or fundamental shift to the corporation. Applying the three questions raised in AB Value, the Court rejected each of the “radical” or “material” changes proffered by Plaintiffs, finding that they were: (a) caused by Plaintiffs’ conduct rather than the Board’s; (b) neither unanticipated by Plaintiffs nor sufficiently material to constitute a radical shift; or (c) occurring or discovered after the advance notice deadline.
The Court also found that these alleged changes were pretextual in light of the Plaintiffs’ own conduct. According to the Court, the Plaintiffs had a clear objective: either force a buyout of their equity or force a sale of Cano. Plaintiffs were well aware of the nomination deadline, as evidenced by their previous nomination of a competing slate of directors before any of the alleged changes occurred. Nonetheless, the Court found that Plaintiffs strategically chose to delay in furtherance of their goals. Based on these findings, the Court concluded that Plaintiffs’ challenge to Cano’s advance notice bylaw did not have a reasonable probability of succeeding.
The Court also considered Plaintiffs’ conduct in holding that any harm they might suffer from application of the advance notice bylaw was self-inflicted. Plaintiffs’ decision to resign after they knew the nomination deadline had passed was part of a strategic plan to pressure the Board to agree to a buyout or to replace the CEO with someone aligned with Plaintiffs’ goals.
In essence, the Court found, “Plaintiffs must be forced to live with the consequences of their actions.” Given the inequities of Plaintiffs’ strategic choices, which caused Defendants to litigate on a burdensome, expedited basis, and forced Cano to incur additional costs in connection with its annual meeting, the Court denied Plaintiffs’ request to enjoin the advance notice bylaw.
Key Takeaways
- Schnell remains a doctrine that the Court will use only sparingly. Particularly in the context of advance notice bylaws, the level of materiality necessary to invoke Schnell and Hubbard is a high bar, beyond that for disclosure claims. Absent sufficiently radical changes, caused by the Board itself, and occurring after the deadline, the Court is likely to enforce the advance notice bylaw in question.
- Equitable considerations remain an important aspect of any analysis under Schnell. The Court will not hesitate to deny relief where a plaintiff’s own conduct has caused the circumstances it later claims run afoul of Schnell. A party seeking equity’s aid must itself act equitably.