Recent Shareholder Proposal Litigation Underscores the Need for Shareholder Proposal Reform

Shareholder Proposal Litigation

As in previous years, many shareholder proposals were rejected by companies this proxy season. In a handful of instances, the proponents sued the companies who excluded the proposals, asserting that the company did not properly apply Rule 14a-8. This produced three federal court decisions interpreting the "ordinary business" exclusion under Rule 14a-8(i)(7) and three settlements. The "ordinary business" exclusion provides that a company may exclude a proposal from its proxy statement if the proposal deals with a matter relating to the company's day-to-day operations. However, SEC guidance and limited case law provides an exception to this exclusion: If a proposal focuses on a "significant social policy" that "transcends" a company's ordinary business, the proposal must be put to shareholder vote.

Decades of SEC guidance has tried to clarify the application of the "significant social policy" exception, but with limited success given the highly politicized interpretations and inherently amorphous nature of the standard. This struggle is illustrated in the three decided cases this proxy season, as the courts reached seemingly different conclusions despite applying the same rule:

Fonds Des Missions v. UnitedHealth Group Inc.

The proponent, a Canadian charitable corporation, submitted a proposal asking UnitedHealth to prepare a report on the health care consequences of the company's acquisitions over the prior decade. The U.S. District Court for the District of Columbia held the proposal was excludable under the ordinary business exclusion because the expansive scope "could excessively sweep in mundane aspects" of UnitedHealth's day-to-day operations. The significant social policy exception did not apply because while the proposal raised the social policy of health care regulation, the policy was not the "focus" of the proposal.

As You Sow v. Chubb Limited

As You Sow, a climate change activist, submitted a proposal asking Chubb to assess pursuing subrogation claims against parties responsible for climate-related insured losses. The U.S. District Court for the District of Columbia denied the proponent's preliminary injunction motion and permitted exclusion under Rule 14a-8(i)(7), holding that subrogation decisions strike "the very core" of an insurer's ordinary course business decisions and therefore fall squarely within the Rule 14a-8(i)(7) exception. The significant social policy exception did not apply because As You Sow did not persuade the court that the proposal was sufficiently "focused" on climate change.

DiNapoli v. BJ's Wholesale Club Holdings, Inc.

The New York State Common Retirement Fund submitted a proposal asking BJ's to "conduct an assessment of risks of deforestation associated with its private-label brands within one year and provide a report summarizing the results." BJ's sought to exclude the proposal under Rule 14a-8(i)(7) as relating to ordinary business operations (specifically, supply-chain management), but the U.S. District Court for the District of Massachusetts held that because the proposal "focused" on the significant social policy of deforestation, it therefore transcended day-to-day operations.

The Tension Among the Cases

At first blush, BJ's appears to sit in direct conflict with UnitedHealth and Chubb. In each case, the proponent submitted a proposal relating to both a social policy and the company's ordinary business operations. Yet the BJ's court permitted the proposal to go to vote, while in UnitedHealth and Chubb courts did not. One explanation for these seemingly at-odds decisions is that courts are being asked to make fine line-drawing distinctions on undeveloped records and, consequently, reaching conflicting conclusions.

While this may seem like a criticism of the courts, it is actually a criticism of Rule 14a-8 itself and the SEC's inherent amorphous "significant social policy" standard. BJ's, UnitedHealth, and Chubb actually applied a consistent analytical framework, which is this: If a proposal plainly "focuses" on a social policy rather than just implicating it, then the proposal "transcends" the ordinary business of a company and can be put to shareholder vote.

Applying this standard, which would be consistent with other authority, the differing outcomes can be reconciled: The BJ's proposal was more focused on deforestation more than any unique or heightened risk to the company, whereas the United Health and Chubb proposals addressed their social issues—health care regulations and climate change, respectively—indirectly and through the lens of the companies' respective businesses.

The result is that a proposal with only an abstract connection to the company (risks of deforestation on BJ's supply chains) will be put to vote, but the proposals that actually relate more directly (health care regulation for UnitedHealth and insurance policy management for Chubb) will be kicked out. Taken to the logical extreme, these cases stand for the proposition that proposals with no relation to a company whatsoever should be allowed to be put to vote under Rule 14a-8. Surely that cannot be the right answer.

Together, these three cases highlight that Rule 14a-8 and the body of Frankensteinian SEC guidance is both counterintuitive and befuddling to apply in practice. It is no surprise that each of the three courts described the "ordinary business" exception as "perplexing." SLB 14M, the SEC's most recent guidance on the "ordinary business" exclusion, exemplifies just how confusing it is: It says that for a proposal's social policy to "transcend" a company's ordinary business, it must be significant in relation to the company. And presumably, if a policy is significant in relation to the company, the proposal will necessarily relate to the company, thereby likely implicating the issues that a company deals with on a day-to-day basis—i.e., ordinary business—making it excludable.

This underscores the fundamental issue: For many companies, ordinary business and social policies are one and the same—health care companies must navigate health care policymaking; insurance companies must consider ways to mitigate loss, whether it be from climate change or something else; and retailers must manage ever-evolving supply chains. In other words, any significant social policy that relates to a company inherently is the company's ordinary business, rendering virtually everything under the sun "ordinary business." If this is true, then everything should be excludable. Again, surely that cannot be the right answer.

This circularity is precisely the type of deficiency the SEC may use to buttress a position that Rule 14a-8 should be substantially revised or dropped altogether in its "Shareholder Proposal Modernization" rulemaking on its pending Spring 2025 Reg Flex Agenda.

Shareholder Proposals Under State Law: The Next Frontier

While some may applaud the absence of a federal shareholder proposal regime, the question of how to define and implement a shareholder's right to submit proposals will remain, with states serving as the arbiters and companies looking to chart a path through the uncertainty.

How exactly states choose to address this is not clear, but it would introduce a variable on which they could compete. Some may introduce a regime similar to Rule 14a-8, while some may defer entirely to private ordering, allowing companies to define shareholder proposal procedures and rights in their by-laws. Still others may introduce black-and-white procedural guardrails via legislation, such as share ownership thresholds. In the event that Delaware, where of course a large percentage of U.S. publicly traded companies are incorporated, chooses not to provide clarity through legislation, companies will need to establish their own governance of proposals through private ordering and, in all likelihood, test the bounds of such ordering through litigation.

In that event, we expect companies to adopt bylaws that, unlike their current advance notice bylaws, refine procedures for shareholder proposals and, in some cases, leave the question for decision by directors, who after all are responsible for their oversight as to essentially all other matters. It is also possible that companies may have rules that differ for a shareholder willing to submit a matter for shareholder vote and one that wants to access the company's proxy statement.

Regardless of the path that states ultimately take, this is not an issue as to which a one-size-fits-all solution is wise.