This post was prepared by Delaware lawyer Evan Williford, an experienced corporate litigator, who practices with The Williford Firm LLC.
In re Forum Mobile, Inc., C.A. No. 2020-0346-JTL (Del. Ch., Feb. 3, 2022), a recent Chancery ruling, suggests that the Court may grant future valid petitions which revive defunct corporations with publicly traded stock to be sold and merged into existing companies via “reverse mergers”. In that case, however, as a matter of first impression, it ruled that the authority of custodians appointed under 8 Del. C. § 226(a)(3) is limited to liquidating the company.
As the Court has recognized, a corporation’s ability to publicly trade stock “gives the company value” even if it is otherwise defunct. Plaintiffs with stock in such corporations periodically petition the Court to allow such transactions, such as by appointing a custodian or ordering an annual meeting. The Court has issued opinions denying several such petitions over the past two decades.
Last April in one such case, In re Forum Mobile, Inc., C.A. No. 2020-0346-JTL, the Court appointed an amicus curiae, Mark Gentile of law firm Richards Layton & Finger, P.A., to consult with the SEC and provide his independent view. Forum Mobile was one of ten before the Court seeking similar relief. The Court expressed concern about “the use of Delaware entities to circumvent the federal securities laws.”
In October, the SEC submitted a letter to the Court. In response to the Court’s concern, the SEC stated that “a reverse merger is not per se illegal under the federal securities laws.” Nevertheless, the SEC expressed concern that where federal laws did not require periodic public filings, lack of information could “pose a significant risk to investors” and “contribute to incidents of fraud and manipulation”.
The amicus recommended that the Court grant the petition. According to the amicus, granting the petition would further “Delaware public policy goals” including “avoiding the waste of corporate assets” and “permitting accretive transactions”. The amicus listed existing protections for stockholders and creditors, including under federal securities laws and Delaware fiduciary duties.
The amicus proposed that the Court further protect stockholders by requiring the custodian to:
- Have power limited to enabling stockholder appointment of directors at an annual meeting;
- Nominate an independent director;
- Via affidavit promise not to violate securities laws and disclose prior accused violations; and
- Disclose significant additional information any agreements between nominated directors and the custodian or company.
The Court noted that the SEC’s submission “easily could have supported” the Court’s prior reverse merger policy, but instead “took no position on the Petition”. According to the Court, “the SEC Letter made clear that granting Synergy’s requested relief would not enable the Company to circumvent federal securities laws.” The Court therefore reasoned that the Court’s prior policy “provides no basis for denying relief.” The Court noted the stockholder protections the amicus had proposed.
Rather, the Court as a matter of first impression, ruled that the authority of a custodian appointed under 8 Del. C. § 226(a)(3) was limited to liquidating the business. Section 226(a)(3) applies where a corporation “has abandoned its business”. Under Section 226(b), the authority of the custodian is to continue the business and not “to liquidate its affairs” – except “in cases arising under paragraph (a)(3)”. The Court therefore reasoned that the authority for Section 226(a)(3) custodians “is limited to liquidating the affairs of the abandoned corporation and distributing its assets,” which did not allow petitioner’s proposed course of action. The Court noted commentary questioning this limitation and commented that the Delaware legislature was “free to eliminate” it.
The Court’s reasoning implies that a future petition to enable a reverse merger by permissible means, perhaps by requesting an annual meeting under 8 Del. C. § 211, may be granted. If and when such a petition is considered, the Court may consider additional appropriate stockholder protections. The Court noted that the outcome of the case provided it no opportunity to consider the recommendations of the amicus “or discuss additional conditions that the court might have imposed.”