The Delaware Court of Chancery has denied a preliminary, mandatory injunction motion to compel Ocean Power Technologies, Inc. ("Ocean Power") to permit one of its stockholders' nominees to stand for election at the next annual meeting and require the Ocean Power board to grant a waiver to such stockholder from its rights plan. Paragon Technologies, Inc., v. Cryan, C.A. No. 2023-1013-LWW (Del. Ch. Nov. 30, 2023).

The case concerns a battle for control of the board of directors of Ocean Power, a renewable energy company. A month after Paragon Technologies, Inc. ("Paragon"), Ocean Power's largest stockholder, expressed concerns about Ocean Power's cash depletion and requested a seat on the board of Ocean Power, Ocean Power began considering amending its bylaws and adopting a tax benefits preservation plan to protect Ocean Power's net operating losses ("NOL Plan").

The amended bylaws ultimately adopted by Ocean Power contained revisions to the advance notice requirements for stockholder nominations of director candidates. As amended, the advance notice provisions required a stockholder seeking to nominate a director candidate to disclose, among other things, (i) a description of any plans to engage in the kinds of transactions enumerated in Item 4 of Schedule 13D, (ii) circumstances that could impede its nominee from receiving a security clearance, and (iii) business or personal interests that could create conflicts between a nominee and Ocean Power.

The amended bylaws further provided that any notice submitted pursuant to the advance notice provisions "may be deemed not to have been provided" if such notice was "determined to be inaccurate in any respect" by the Ocean Power board. Three weeks following the adoption of the amended bylaws, Ocean Power adopted the NOL Plan, which would be triggered if a person or group acquired beneficial ownership of 4.99% or more of Ocean Power's shares without the approval of the Ocean Power board.

Amid its preparations for a proxy contest, Paragon filed a Schedule 13D with the Securities and Exchange Commission, disclosing its 3.9% ownership in Ocean Power and attaching a letter to Ocean Power's stockholders. Criticizing Ocean Power's financial performance, Paragon stated it intended to nominate a slate of director nominees for Ocean Power's board and that it had "a plan to fix [Ocean Power]." Around the same time, Paragon sought an exemption request from the NOL Plan so that it could buy up to 19.9% of Ocean Power's shares, which exemption request was denied by Ocean Power's board.

Subsequently, Paragon submitted a notice of its intention to nominate five directors for election to the Ocean Power board at the next annual meeting. In evaluating whether the nomination notice ("Notice") complied with the advance notice requirements of the amended bylaws, the Ocean Power board identified numerous deficiencies^[1] in Paragon's submission a week prior to the close of the nomination window. In response, Paragon amended its Schedule 13D and disclosed additional information, including its intention to take control of the Ocean Power board and plans to reduce expenses and focus on industry growth. Later, Paragon submitted to Ocean Power a letter supplementing its original Notice in order to address the deficiencies previously identified by Ocean Power. One day prior to the close of the nomination window, Ocean Power sent Paragon a letter identifying additional deficiencies in the Notice and in the supplemental information provided. Ultimately, Ocean Power rejected Paragon's nominees because of Paragon's failure to comply with the advance notice provisions of the amended bylaws.

Ruling in favor of Ocean Power, the court concluded that Paragon failed to satisfy the heightened standard necessary to be established for a motion for preliminary injunction. The court first analyzed the Ocean Power board's decision to reject the Notice by considering whether Paragon had complied with the amended bylaws. Reviewing the preliminary record, the court noted that contemporaneous communications suggested that Paragon may have had undisclosed plans for Ocean Power's business and expressed concern regarding a Paragon principal's deleted text messages. Furthermore, the court noted, given that Paragon may have had plans that would have benefited Paragon at Ocean Power's expense if Paragon's proxy contest succeeded and it gained control of the board, the Notice might have also violated requirements under the amended bylaws to disclose potential future conflicts of interests of Paragon and its nominees. For these reasons, the court held that Paragon failed to show that the Notice undisputedly met the amended bylaws' requirements.

The court then engaged in an equitable review of the Ocean Power board's decision to reject the Notice, because technical entitlement to reject a nomination notice does not necessarily mean that equity will allow it to stand. The court began by noting that "advance notice bylaws are 'commonplace' tools for public companies to ensure 'orderly meetings and election contests.'" In applying enhanced scrutiny review, the court held that although Ocean Power adopted the amended bylaws after Paragon emerged and a potential proxy contest was looming, the amended bylaws were not unreasonable. The court explained that the Ocean Power board had legitimate reasons to want to know whether a nomination was part of a broader scheme to control the company. Such information, the court noted, would be important to stockholders in deciding which director candidates to support.

Considering whether the Ocean Power board's rejection of the Notice was a reasonable response in relation to these corporate purposes, the court found that the amended bylaws promoted disclosure of important information to stockholders when they are voting for directors in a contested election. Specifically, the amended bylaws aligned with disclosures related to the universal proxy rules, and promoted the disclosure function designed to ferret out potential conflicts and substantial interests of a prospective nominee who might seek to facilitate a transaction at the expense of the company. Therefore, the court concluded that the amended bylaws promoted disclosure requirements that allowed the Ocean Power board to "knowledgeably make recommendations about nominees" and achieve the legitimate goal of an orderly corporate electoral process.

Finally, the court considered whether the Ocean Power board had reasonable grounds to conclude that a threat to its net operating losses ("NOLs") existed and whether its response was reasonable in relation to the threat identified. Starting from the premise that adopting (and refusing to grant exemptions from) a rights plan serves a legitimate corporate purpose when a corporation is attempting to preserve its assets, the court found that there was evidence that the Ocean Power board, in reliance on advice from its tax and legal advisors, reasonably identified a threat to its NOLs and that granting Paragon's exemption request could threaten Ocean Power's ability to raise capital in the future. Next, the court concluded the Ocean Power board had acted reasonably because the NOL Plan did not preclude Paragon from winning a proxy contest had it submitted a compliant nomination notice. On those facts, the court ruled that mandatory relief ordering Ocean Power to grant Paragon's request for exemption from the NOL Plan would be inequitable.

Importantly, despite ruling in Ocean Power's favor, the court expressed suspicion about the timing and intention behind the adoption of the amended bylaws and the NOL Plan, and indicated potential concerns about aspects of the amended bylaws and Ocean Power's rejection of the Notice, notably:

1. the ambiguity of its advance notice bylaw requiring nominees to disclose known barriers to obtaining a security clearance, which leave stockholders guessing what circumstances may impact receiving such an undefined security clearance, particularly in light of the fact that Ocean Power's board did not oversee matters involving classified information and none of the incumbent board members had a security clearance.
2. the potential arbitrariness of enforcing its advance notice bylaw that allowed the board to dismiss a nomination notice for "inaccuracies" simply because the board disagreed with opinions voiced by a nominating stockholder, which the court noted may be preclusive in effect.
3. Ocean Power's failure to provide a complete list of deficiencies in the Notice as the closing of the nomination window loomed.
4. the "nitpicky" and "suspect" nature of certain purported deficiencies identified by the Ocean Power board, such as Paragon's filing of a fight letter under the cover of Schedule 13D and not as proxy soliciting materials.
5. the simultaneous adoption of the NOL Plan and amended bylaws by the Ocean Power board (with both being referred to under the same project name), which suggested that the NOL Plan adoption was pretextual and did not serve a legitimate corporate objective.

The decision is a reminder that Delaware courts will uphold advance notice bylaws and rights plans that are reasonable and in furtherance of a legitimate corporate purpose, but also a warning that they will continue to conduct an equitable review of an incumbent board's decision to adopt a rights plan or reject a nomination notice.

[1] The deficiencies identified by the Ocean Power board, among other purported deficiencies and inaccuracies, included Paragon's failure to disclose (i) any plans or proposals for Ocean Power, (ii) information with the potential to impact, impede, and/or delay any nominee from receiving a security clearance, and (iii) Paragon's "substantial interest" in a change of control of the Ocean Power board. Certain noted inaccuracies in the Notice also related to Paragon's criticisms that the members of Ocean Power's board allegedly violated their fiduciary duties, engaged in entrenchment, and were unfit to serve as directors.