Staggered Board Shenanigans at Phillips 66

Staggered terms for corporate directors, long a source of debate in corporate governance circles, have again moved from the wings to center stage thanks to a heated proxy contest launched by activist investor Elliott Investment Management L.P. for seats on the board of directors of oil giant Phillips 66. Funds managed by Elliott have a $2.5 billion stake in Phillips, giving it an ownership stake of about 5.7 percent of the company, and making it one of the company’s five biggest shareholders.

Phillips has gone to extraordinary lengths to use its staggered board to thwart shareholder democracy. Not content with a classified board of directors, with three director classes serving staggered three-year terms, it also is among the 9 percent of S&P 500 companies that require a supermajority shareholder vote to amend their charter so that they can join the mainstream of public companies and rid themselves of their classified board governance structure. This toxic combination of a staggered board and a supermajority-voting requirement to get rid of the staggered board has created a truly Orwellian problem for shareholders. Repeatedly in the recent past, in 2015, 2016, 2018, 2021, and 2023, shareholders have voted to amend the company’s charter to de-stagger the board. Most recently, in 2023, the proposal to jettison the staggered board received astonishing support, garnering 99 percent approval of the shares voting in that election. However, amending the corporate charter requires not merely the approval of the shares voting in a particular election, but approval of 80 percent of the outstanding shares. Unfortunately, even with 99 percent of shareholders approving, not enough shares voted to get the proposal past the required 80 percent threshold.

Elliott Management has devised a creative and effective work-around to the anti-majoritarian obstacle to removing the classified board structure. Elliot proposes that the Phillips board amend its Corporate Governance Guidelines to request that every sitting director, including those with more than a year left on their terms of office, voluntarily provide the Company with a letter of resignation effective before the start of the nomination process for elections at the next annual meeting. Any director who agreed to resign before the end of their three-year terms could still be nominated to be elected to “replace themselves” in the newly vacant board position created by their own resignation.

The relevant text of the Elliott shareholder proposal is simple: “RESOLVED, that stockholders request that the Board adopt an annual election policy for directors, requiring each incumbent director (including directors with terms not set to expire at the next annual meeting) to deliver to the Board a letter of resignation effective at the next annual meeting of stockholders, each year prior to the nomination of director candidates for election at the annual meeting.” This proposed process would provide a viable, democratic work-around for shareholders and enable all directors to be elected annually.

Phillips objects to the Elliot proposal, weakly arguing that it “contravenes well-settled principles of Delaware corporate law and would be highly unlikely to withstand scrutiny in Delaware courts. For example, Delaware courts have clearly held that a by-law cannot abrogate provisions of a company’s charter. Here, the Elliott Proposal Requiring Annual Director Resignations is not even implemented via a change to the by-laws, but rather an even lower order legal action, namely, the adoption of a policy ‘as part of the Company’s Corporate Governance Guidelines or otherwise.’ The Company’s Certificate of Incorporation and By-Laws would clearly prevail over such a policy, leading the Company’s attempt to adopt the Elliott Proposal Requiring Annual Director Resignations to be highly at risk of being rendered null and void, and potentially subjecting the Company to costly litigation and reputational damage. The Company’s Certificate of Incorporation is clear that the Company does not have the power or authority to ‘adopt any provision inconsistent with or repeal’ the classified board structure in the absence of the required shareholder approval.”

The problem with this argument is that it ignores the simple fact that directors are free to resign their board positions at any time, and nothing in the Phillips charter or bylaws possible can be construed as preventing directors from voluntarily offering to resign. In other words, Elliott is not proposing that directors be compelled to resign. Rather it merely is proposing that the company announce that it considers voluntary resignation to be a best practice that directors can elect to opt-into.

Facing a staggered board in the upcoming election Elliott proposed four candidates for election to Phillips board because the three-year terms of four of Phillips’ 14 directors were scheduled to end before the 2025 election. After receiving notice from Elliott that it would put a slate of four candidates up for election to the board, Phillips announced that two of its incumbent directors would not stand for reelection, and that it was proposing to shrink the Board from 14 directors to 12. The upshot of these maneuvers initially appeared to be that, absent judicial intervention, there would only be two seats up for election in the 2025 class, but five seats up for election in 2026 and in 2027. Specifically, the Phillips board currently has three classes of directors. There are four Class I directors, whose terms expire at the annual meeting in 2025, five class II directors, whose terms expire at the annual meeting in 2026, and five class III directors, whose terms expire at the annual meeting in 2027. Phillips proposed simply to eliminate two of the four Class I directors, without making any other adjustments to insure that roughly the same number of directors will stand for election each year.

This maneuver seemed clearly to conflict with provisions in both Phillips Certificate of Incorporation and bylaws, both of which require that each of the three classes of Phillips directors be “as nearly equal in number as is reasonably possible.” With 12 directors and three classes of directors, it seemed only reasonable for Phillips to elect four directors each year, not two in one year and five in other years as it proposed to do. Ultimately, Phillips backed down from this crazy plan and is now nominating four class I directors for election at the upcoming 2025 annual meeting; but it only backed down after Elliott filed a lawsuit in Delaware to nullify the scheme to elect only two directors in 2025.

It is worth noting that Elliott does not appear to be seeking any special advantages or deals in its engagement with Phillips.  Elliott’s goal is simply to increase the value of the company so that its equity investment, along with that of Phillips’ millions of other public shareholders will increase in value and perform on a par with major competitors like Valero and Marathon, rivals that Phillips has underperformed by 138 percent and 188 percent, respectively.

Nor can Elliott legitimately be accused of being a short-term investor. Elliott has been engaged with Phillips since September 2023. It has thoroughly studied cthe company and concluded that Phillips has underperformed its peers over the past several years because it has an inefficient conglomerate structure.

Shareholder voting is the cornerstone of corporate governance. It is routinely described in court opinions as “the ideological underpinning upon which the legitimacy of directorial power rests.” Failure to adopt the Delaware proposal and reducing the size of the board to undermine the shareholder franchise has made the incumbent Phillips board illegitimate. Their goal appears to be entrench incumbent management, and themselves, at the expense of the shareholders to whom they owe fiduciary duties.