Chancery Determines Effectiveness of Written Consents of Stockholders pursuant to DGCL Section 228

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.

Brief Overview

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.

Legal Analysis

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.

Conclusion
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.