Chancery Allows Challenge to Director Election to Proceed

Gentili v. L.O.M. Med. Int’l, Inc., C.A. No. 7600-VCG (Del. Ch. Aug. 17, 2012).

Issue: Whether non-unanimous written consents of shareholders were sufficient to thwart a challenge to the election of directors at an annual meeting?

Short answer: No.

Background:

This is a summary proceeding pursuant to DGCL Section 225 to contest the election of directors at an annual meeting. The genesis of the dispute was an adjournment that was called at an annual meeting, as allowed by the company bylaws, by the President, Lionel Matthews. Apparently, Matthews is part of a group that is now challenging the election that followed the adjournment. After the adjournment, the company’s counsel announced that the meeting was “not truly adjourned”. Rather, the company counsel announced that “in reality” only a recess was being taken. Then, a company director purported to preside over the meeting. At the resumed meeting, a new group of challenged directors (the “Challenged Directors”), was allegedly elected. The Defendants assert that about 56% of the issued and outstanding shares voted in favor of the Challenged Directors.

In addition, after the meeting, written consents (the “Written Consents”) were solicited, and about 53% of the stockholders allegedly ratified the actions taken at the meeting, via the Written Consents.

A motion to dismiss was filed under Rule 12(b)(6) and attached to that motion were written consents of a majority of shareholders that purported to ratify the challenged election of directors. Also attached was an affidavit of a director purporting to support the motion. The Court focused on the nature of this case as a summary proceeding and observed that if it were to consider an affidavit attached to the motion to dismiss, it would convert it to a motion for summary judgment, and therefore give the plaintiff the opportunity for discovery before a ruling was made.  See footnote 25. The Court refused to consider the affidavit, but noted that even if it did so, it would not have changed the result of the decision.

Analysis

The standard in Delaware for a Rule 12(b)(6) motion to dismiss is whether the allegations in the complaint give sufficient notice of the claim, with reasonable inferences drawn in plaintiff’s favor, such that it is “reasonably conceivable” that a claim may prevail. The general rule is that in a motion to dismiss, matters extrinsic to the complaint are not considered, other than exhibits to the complaint, matters “integral” to the complaint, or facts such as public filings of which the court may take judicial notice. See footnotes 18 to 22.

The motion to dismiss in this case is based on the argument that the Written Consents ratified the action taken and therefore they arguably dispose of the plaintiffs’ argument that the votes for the Challenged Directors are defective.

Unanimous Written Consent Required 

The Court observed that the Written Consents in this case could not be effective to vote for the Challenged Directors because they were not unanimous. See footnote 28 citing DGCL Section 211(b) and Crown EMAK Partners, LLC v. Kurz, 992 A.2d 377, 401 (Del. 2010).

In addition, as noted in footnote 26, the record was too inadequate at this early stage of the case in order for the Court to determine what information accompanied the request for the Written Consents. This is important because it would have been necessary for the company to provide full disclosure of all relevant information to those from whom the Written Consents were requested, as a prerequisite for them to be valid as a ratification. See also footnote 29 citing Gantler v. Stephens, 965 A.2d at 714 (The ratification doctrine does not apply to transactions where shareholder approval is statutorily required.)

Nonetheless, the Court was sympathetic to the argument that a majority of the shareholders appear to have voted for the Challenged Directors, even if the technical statutory procedures were not followed. The Court emphasized the sacrosanct status that the stockholder franchise enjoys in Delaware.

In conclusion, the Court gave the Defendants two options: (I) They could schedule a prompt trial on the merits consistent with a summary proceeding, or (II) they could seek a new stockholders’ meeting, “done under the supervision of the Court, with appropriate safeguards in place to ensure that the meeting does not adjourn for improper reasons.” See generally, Portnoy v. Cryo-Cell, a Chancery decision highlighted on these pages here, that provided a remedy for a challenged election of directors that involved a long “recess” or “adjournment” that the Court concluded to have been done for the improper purpose of interfering with the election.