Boris v. Schaheen, C.A. No. 8160-VCN (Del. Ch. Dec. 2, 2013).
Issue Addressed: Whether the written consents of stockholders pursuant to DGCL Section 228 effectively selected new board members.
This 51-page post-trial decision addressed the effectiveness of written consents of stockholders that were designed to select new board members. The two entities involved were controlled by family members who had an informal corporate governance system. The directors did not hold the proper board meetings and did not record proper board minutes. The directors did not formally document the issuance of shares and the official stock ledger was not maintained in a manner which allowed the number of shares issued to each stockholder to be free from doubt. The parties disputed what the exact number of shares were that each of them owned.
Written Consent of Stockholders
The two companies involved in this case are Numoda Corporation and Numoda Technologies, Inc. The Numoda Corp. bylaws allowed stockholders to act by written consent. First, the plaintiffs, John and Ann, delivered the Numoda Corp. Written Consents to the registered agent of the company and then filed the consents with the books and records of the company. Then, two days later, as the purported directors of Numoda Corp., John and Ann executed a unanimous written consent of directors in which they resolved, that “no officer of Numoda Corp. shall take any action on behalf of the company without the prior written consent of the board.”
Similar to the Numoda Corp., Numoda Technologies, Inc. (“Numoda Tech”) had a stock book in which most stock issuances were not properly documented nor did the corporate records include board approval of corporate acts. The parties understood Numoda Tech to be a wholly owned subsidiary of Numoda Corp. It was disputed whether Numoda Tech ever issued stock from the time it was incorporated to be a subsidiary of Numoda Corp. No Numoda Tech stock certificates were ever issued. The plaintiffs, John and Ann, took the position that because no stock was ever issued, Numoda Tech is a corporation with no stockholders. It was disputed who the original members of the board of Numoda Tech were.
The Numoda Tech bylaws also allow stockholders to act by written consent. Just as they did in connection with Numoda Corp., John and Ann, as purported majority stockholders, delivered a written consent of Numoda Tech stockholders.
This action was brought pursuant to Section 225 of the DGCL which allows any stockholder or director to petition the court to determine the validity of the removal or appointment of a director.
The Court explained that the DGCL contemplates, generally, a formal approach to corporate governance especially relating to changes in the capital structure. The DGCL implies an affirmative duty to maintain the stock ledger. See footnote 159. See also DGCL Section 219(c) (the stock ledger shall be the only evidence as to the stockholders who are entitled to vote in person or by proxy or by written consent).
If the corporation does not have a stock ledger then the Court may consider extrinsic evidence to determine stock ownership.
Stock is not validly issued unless the board of directors exercises its power to issue stock in conformity with statutory requirements. The Court addressed two related questions that are implicated: (1) whether the DGCL requires a written instrument evidencing board approval to issue common stock; and (2) whether, if a written instrument is required, the lack of such approval by a written instrument renders the issued stock void or voidable. Although these issues have been addressed in Delaware as they relate to preferred stock, no cases have been presented previously to the Court involving a common stock issue. See footnote 166.
The Court discussed the recent amendments to the DGCL, adding Sections 204 and 205, that address the ability to correct defective corporate acts and to clarify the distinction between void and voidable acts. The Court discussed public policy reasons behind the strict requirement of a written instrument for a stock issuance implicated by DGCL Section 151(a), among other provisions. One of the reasons for such a bright line rule is that it promotes certainty that facilitates investments in stock.
The Court cited established Delaware law for the position that: “Stock issued without authority of law is void and a nullity – - and this includes stock that is not issued pursuant to a written instrument evidencing board approval. That the stock is void means that it cannot be remedied by equity . . ..” See footnote 176. The Court explained that: “Put simply, for changes to the corporation’s capital structure, law trumps equity.” See footnote 179.
The Court concluded as a matter of law that under the case of Waggoner v. Laster, 581 A.2d 1127 (Del. 1990), and the current DGCL, “that it may not apply estoppel in this context. Equitable estoppel may apply ‘when a party by his conduct intentionally or unintentionally leads another, in reliance upon that conduct, to change position to his detriment.’” In Waggoner, the Supreme Court addressed the stockholders’ equitable argument that a board, which had previously issued preferred stock with super-majority voting rights, should be prohibited under equitable estoppel from contesting the validity of the voting rights, even though there were void from want of authorization in the corporation’s charter. In conclusive terms, the Supreme Court held that estoppel
“has no application in cases where the corporation lacks the inherent power to issue certain stock or where the corporate contract or action approved by the directors or stockholders is illegal or void. Neither can a board ratify void stock. Only voidable acts are susceptible to these equitable defenses. In brief, because equity cannot directly remedy void stock, neither should equity be able to indirectly remedy void stock.” See footnotes 186 through 191.
Based on the lack of written instruments and lack of equitable power of the Court to remedy these statutory defects, the Court determined that Mary did not establish her burden and as a result John and Ann were held to be the majority stockholders of the Numoda Corp Class B voting stock. The Court relied on the presumption that John and Ann were the holders of a majority of the Class B voting stock based on the stock ledger, which shifted the burden to Mary to establish a different ownership structure for Numoda Corp.
Regarding the Numoda Tech’s stock ledger, which was blank, the Court had to look beyond it to determine the shareholders.
The Court determined that all of the stock of Numoda Tech is void. No Numoda Tech stock had been validly issued and Mary was not able to rebut that position because a Numoda Tech board never approved, by written instrument, any stock issued.
The Court determined that because all the Numoda Tech stock is void, equity was not able to remedy the defect in the context of this case, nor were equitable defenses applicable. Because the Court concluded that Numoda Tech is a corporation with no stockholders, a written consent of Numoda Tech stockholders based on the proposition that John and Ann were majority stockholders, is invalid.
Regarding the directors of Numoda Tech, it was not disputed that Mary was a director immediately preceding the delivery of the written consent of Numoda Tech stockholders.
The Court explained that DGCL Section 141(b) has been interpreted to allow a director to orally resign and that subsequent actions consistent with an oral resignation can support finding a resignation without written notice.
The Court relied on annual franchise tax reports submitted to the Delaware Secretary of State under oath, as well as related evidence that supports the position that Mary was the sole director of Numoda Tech. The Court found the testimony that sought to discredit statements in the annual franchise tax which listed Mary as the sole director to be unreasonable and therefore not credible.
The only issues in this Section 225 action were the validity of the written consents to determine the directors of Numoda Corp and Numoda Tech. In order to make this determination, the Court had to determine whether certain stock was validly issued.
The Court concluded that John and Ann comprised the board of Numoda Corp. because they were found to have a majority of the valid shares of voting stock. However, the Court concluded that Mary was the sole director of Numoda Tech because John and Ann had previously resigned as directors and Numoda Tech had no validly issued stock.
Postscript: On Nov. 27, 2013, in The Ravenswood Investment Co., L.P. v. Winmill, the Court of Chancery also addressed an issue involving DGCL Section 228, in connection with the date of the signature on the written consent and if the date of the signature complied with the statute.
Anderson v. Krafft-Murphy Company, Inc., Del. Supr., No. 85-2013 (Nov. 26, 2013).
Issue Presented: Delaware’s Supreme Court addresses issues of first impression in this opinion, including: does Delaware’s corporation dissolution scheme (8 Del. C. Sections 278 to 282) have a “general” statute of limitations for claims by third-parties against dissolved corporations? Short Answer: No.
[Editor's note: Yes, the case name does have a double "f" in Krafft.]
Short Overview: This opinion is must reading for anyone who seeks to file a claims against a corporation in dissolution or anyone who seeks to understand the multi-faceted statutory framework related to the procedure to dissolve a corporation. As usual, the structure of the court’s opinion makes it easy to discern the essence of the court’s holding as the following introductory quote demonstrates:
We conclude that under 8 Del. C. § 279, contingent contractual rights, such as unexhausted insurance policies, constitute “property” of a dissolved corporation, so long as those rights are capable of vesting. We further hold that Delaware’s dissolution statutes impose no generally applicable statute of limitations that would time-bar claims against a dissolved corporation by third parties. Finally, we hold that the existence of the “body corporate” continues beyond the expiration of the statutory winding-up period of 8 Del. C. § 278 for purposes of conducting litigation commenced before the expiration of that period. But, for litigation commenced after the expiration of that statutory period, a dissolved corporation may act only through a receiver or trustee appointed under 8 Del. C. § 279.
Because the judgment of the Court of Chancery rests on legal determinations inconsistent with these holdings, we reverse the judgment and remand the case for further proceedings in accordance with this Opinion.
Any attorney counseling a client on the less than obvious alternate procedures for dissolving a corporation, especially when seeking a non–judicial or judicial safe harbor for shareholders and directors, needs to read this exemplary overview of the Delaware statutory provisions. In addition, anyone advising a client who seeks to file claims against a dissolving or dissolved corporation needs to read this opinion in order to learn the latest iteration, and perhaps the best iteration of Delaware corporate law on these issues.
Darby Emerging Market Fund, L.P. v. Ryan, Consol. C.A. No. 8381-VCP (Del. Ch. Nov. 27, 2013).
This Chancery decision addressed whether the Court had equitable jurisdiction over a dispute among shareholders of a foreign entity. Delaware’s court of equity relied on the well-worn “clean up doctrine”, which allows it to exercise equitable jurisdiction over an entire case even if less than all of the claims are equitable in nature.
In addition to outlining the historical basis for its limited jurisdiction, this opinion examined DGCL Section 111 which gives it jurisdiction over disputes regarding the terms of a corporation’s charter and related disputes among shareholders. The synopsis of the legislative bill that became Section 111 was reviewed to support the view that the statute was intended to deal with disputes regarding the charters of Delaware corporations. See footnote 31. But for purposes of a motion to dismiss under Rule 12(b)(1) the court did not definitely or conclusively rule on the issue of whether it might apply to non-Delaware corporations in other cases.
Section 111 was not the basis for the court’s exercise of jurisdiction. Rather, the clean-up doctrine enabled it to retain the case and address claims for specific performance and related contract issues. In connection with those issues, the Court denied a motion to dismiss under Rule 12(b)(6) based on the reasonable conceivability (possibility) standard.
An unusual procedural aspect of this case was that a related, similar suit involving the same parties was filed the same day in Delaware Superior Court. The Superior Court determined that it did not have jurisdiction over that companion case, which it viewed as seeking equitable relief, and therefore that related case was transferred to the Court of Chancery pursuant to 10 Del. C. Section 1902 , where it was consolidated with the instant case.
ENI Holdings LLC v. KBR Group Holdings, LLC, C.A. No. 8075-VCG (Del. Ch. Nov. 27, 2013).
This Chancery decision reiterated the settled Delaware law regarding freedom of contract which includes allowing parties to agree to a shorter statute of limitations than would otherwise apply to claims between parties to the agreement. Thus, an agreement could serve to shorten the typical three-year limit on contract claims or the two-year typical limit on tort claims.
Lake Treasure Holdings, LLC v. Foundry Hill GP, LLC, C.A. No. 6546-VCL (Del. Ch. Nov. 21, 2013)
This Chancery decision determined that the filing of a UCC statement may serve to satisfy two elements of the 5-part test to establish personal jurisdiction in Delaware based on the well-settled “conspiracy basis of personal jurisdiction”, and in light of Section 3104 which refers to a specific act related to imposing jurisdiction as compared to a “general basis”.
Widener University School of Law announced that Guhan Subramanian, the Joseph Flom Professor of Law & Business at Harvard Law School, delivered the 2013 Annual Francis G. Pileggi Distinguished Lecture in Law. This is the 29th year of this Lecture Series.
The title of this year’s lecture was, “Delaware’s Choice,” and was presented on Friday, Nov. 22 in the du Barry room of the Hotel du Pont at 11th and Market Streets in Wilmington. The Institute of Delaware Corporate and Business Law provided a synopsis of this year’s lecture.
Subramanian, who also serves as the Douglas Weaver Professor of Business Law at Harvard Business School, discussed Delaware’s antitakeover statute, DGCL Section 203, its constitutionality and the merits of amending it to strengthen it against a possible legal challenge.
Subramanian is the first person in the history of Harvard University to hold tenured appointments to both the law school and the business school. His research explores topics in corporate governance and negotiations, and he has published articles in the Stanford Law Review, the Yale Law Journal, the Harvard Business Review and the Harvard Law Review. His work has been featured in the Wall Street Journal, the New York Times and The American Lawyer. His book “Dealmaking: The New Strategy of Negotiauctions” has been translated into five other languages. Prior to joining the Harvard faculty he spent three years at McKinsey & Company.
The annual Pileggi lecture is presented by Widener Law and the Delaware Journal of Corporate Law. The series has attracted many renowned speakers in the area of corporate law since the first Pileggi lecture in 1986. As in the past, this year’s program has been approved in Delaware for one continuing legal education credit and in Pennsylvania for one substantive continuing legal education credit.
The event each year is made possible by the generosity of Francis G. Pileggi, a founding attorney of Pileggi & Pileggi and father of Widener Law alumnus Francis G.X. Pileggi, who conceived of the idea while he was on the law review in order to create a corporate law forum for practitioners, judges and academics.
Klaassen v. Allegro Dev. Corp. et al., No. 8626, 2013 (Del. Ch. Nov. 7, 2013).
This Chancery decision is the subject of an appeal to the Delaware Supreme Court. Among the issues to be addressed by Delaware’s high court is whether the actions of a board to dismiss the CEO, who also had voting power over a controlling percentage of shares, are void — as compared to voidable?
The trial court opinion considering a motion for a stay pending appeal provides a mini-treatise on the Delaware law applicable to notice requirements for board meetings and the consequences of ineffective notice. The opinion is also must-reading for anyone interested in the proper approach to contests for control among warring factions of dissident directors and competing shareholder groups.
The Court of Chancery, in this second trial court opinion in this matter, also recognizes the importance of prompt rulings and status quo orders in proceedings pursuant to DGCL Section 225, which are summary proceedings that involve disputes over the right of a director to hold office, or contests regarding the proper membership in, or who properly constitutes, the board of directors.
The first brief was recently filed in the expedited appeal to the Delaware Supreme Court.
The initial post-trial opinion, issued prior to the most recent opinion addressing the issues raised in the motion for stay pending appeal, is styled as: Klaassen v. Allegro Dev. Corp. et al., No. 8626, 2013 WL 5739680 (Del. Ch. Oct. 11, 2013).
For my regular ethics column for the current issue of The Bencher, the national publication of the American Inns of Court, I wrote an article about a recent federal court decision that upheld the enforceability of a waiver, in advance, of future conflicts, and discussed the prerequisites for the validity of such a waiver.
In connection with the Chancellor for the Court of Chancery and others this week, the Governor of Delaware announced the launching of a website to promote the advantages to businesses who form their entities in the First State and the related benefits of using Delaware courts as well as enjoying the annual updates and refinements to the Delaware General Corporation Law and related statutes for alternative entities and similar laws that impact businesses.
Chancery Allows Claim for Breach of Fiduciary Duty for Approval of Stock Options in Violation of Stock Option Plan
Pfeiffer v. Leedle, C.A. No. 7831-VCP (Del. Ch. Nov. 8, 2013).
Issue Addressed: Whether the approval of stock option grants that exceeded the maximum number of stock options allowed under the stock incentive plan was the basis for a breach of fiduciary duty claim against both the board that approved it and the executive who received the stock option grants?
Short Answer: Yes.
The Court denied a motion to dismiss under both Court of Chancery Rule 12(b)(6) and Court of Chancery Rule 23.1. The Court found that there was a prima facie showing of a clear violation of the stock option plan and that the board either knowingly or deliberately exceeded its authority by granting options in excess of the number allowed under the plan. That knowing or deliberate violation of the stock option plan implicated a duty of loyalty, the breach of which cannot be exculpated by a charter provision adopted pursuant to Section 102(b)(7) of the Delaware General Corporation Law.
Moreover, the Court found that there was a reasonable inference that the executive who received the options in excess of those authorized by the plan knew or should have known that his receipt of those options was in violation of the plan, which also supported a claim for a breach of his fiduciary duty.
This 26-page opinion provides an excellent overview of the reason for the pre-suit demand requirement as well as the two major tests for determining pre-suit demand futility under Aronson and Rales.
The Court explained the high threshold that needs to be met under the second prong of the Aronson test which in essence requires that one rebut the business judgment rule presumption. That high threshold was met in this case. See footnotes 24 and 25.
The opinion includes a concise reiteration of the business judgment rule as well as a reminder that the business judgment rule does not only protect “correct” decisions. Rather, it also protects “reasonable decisions made by a board that is informed and acting in good faith,” even when those decisions are ultimately incorrect. See footnote 28.
The Court emphasized that the business judgment rule will not be rebutted and demand will not be excused when a plaintiff only alleges that a board merely failed to follow the terms of a stock incentive plan. Such an allegation fails to address the critical question of how the board reached the result that it did. However, when a board knowingly or deliberately failed to adhere to the terms of a stock incentive plan, a plaintiff can sufficiently circumvent the business judgment rule presumption by demonstrating that the action of the board was a clear and unambiguous violation of a stock incentive plan. The Court explained a prior decision which involved those facts. That decision was Sanders v. Wang, 1999 WL 1044880 (Del. Ch. Nov. 8, 1999) [coincidentally that decision was issued on the same day in November as the instant decision, albeit 14 years earlier].
The Sanders decision determined that it was not a valid exercise of business judgment for a board to exceed the number of authorized shares allowed by a plan. The Sanders case does not support pre-suit demand excusal whenever the terms of a stock plan are violated, but rather, Sanders teaches that when a plaintiff presents particularized allegations that indicate that the board clearly violated an unambiguous provision of the stock plan, it is proper to infer that such violation was committed knowingly or intentionally and, therefore, that demand should be excused. See footnote 38.
In the instant case, the Court concluded that there were sufficient allegations that the board clearly violated the unambiguous provisions of the stock plan, and therefore pre-suit demand was excused. Although the Sanders case granted judgment on the pleadings for the wrongful authorization of awards under the stock incentive plan, the pleadings in the instant case were not advanced enough for that type of motion.
The Court explained that because the allegations survived Rule 23.1, by necessity they would survive the less stringent standard under Rule 12(b)(6). The Rule 12(b)(6) standard is one of “reasonable conceivability” which asks whether there is a “possibility of recovery” under any reasonably conceivable set of circumstances.
The Court also allowed an unjust enrichment claim against the executive who received the options in excess of those authorized by the plan.