In a targeted proceeding pursuant to Section 225 of the DGCL with the limited purpose of determining whether members of the board of directors were properly removed, the Delaware Court of Chancery determined that the plaintiff did not establish its burden of proof to challenge the removal of board members. In Barbey v. Cerego, Inc., C.A. No. 2022-0107-PAF (Del. Ch., Sept. 29, 2023), the Court found that the removal of the entire board, and their replacement by a new sole director, was effective.
This gem of an opinion provides several key principles of Delaware corporate law, and corporate litigation, that can be applied in other Section 225 actions, and other litigation generally.
Very Brief Overview of Background
The factual background of this case is somewhat tortuous, but for purposes of these short highlights I will only provide a few key points for context. The case involves a corporate inversion effected through a tender offer whereby the subsidiary would swap its shares in exchange for the outstanding shares of the parent, with the goal of giving the subsidiary a supermajority of the parent’s outstanding shares. Once that was accomplished, the subsidiary took action to remove the existing board of directors of the parent. The subsidiary was a company formed in Japan. The parent was a Delaware corporation.
The plaintiffs challenged the removal based on the argument that the inversion was invalid. Specifically, the plaintiffs argued that the parent purported to authorize the subsidiary to commence a tender offer at a special meeting of the board for which adequate notice was not given according to bylaws of the parent.
The key factual and legal findings of the Court for purposes of this Section 225 action were: (i) although a regular meeting did not require notice under the bylaws, a special meeting did require notice which—based on the facts presented—was not properly given, thereby making the actions taken at the special meeting void.
Nonetheless, the Court found that, even though the plaintiffs did not anticipate or address the issue of whether the inversion and tender offer even required approval by the parent’s board, board action was not required to authorize the subsidiary’s tender offer that resulted in the subsidiary becoming the majority stockholder of the parent. Therefore, the actions taken by the new majority stockholder to remove the board and appoint a new sole director were effective.
Highlights of Key Legal Aspects of the Court’s Opinion
● Section 225 of the DGCL permits any stockholder or director to apply to the Court of Chancery to determine the validity of any election, appointment, removal or resignation of any director or officer of any corporation. These are “in rem proceedings” which only exert jurisdiction over the corporation, and may only provide relief concerning the corporate office. Slip op. at 15.
● Other types of ultimate relief beyond what is necessary to determine the proper holder of a corporate office may only be obtained through a plenary action through which the court would exercise jurisdiction over affected parties. Id.
● Notably, the party challenging the removal of a director bears the burden of proving by a preponderance of the evidence that a director’s removal was invalid. Id.
● In order to resolve the issues presented, the court had to determine whether a board meeting at issue was a regular meeting of the board or a special meeting of the board. Only a special meeting required notice. There is a useful and cogent analysis of the bylaws to determine whether the meeting held was properly described as a regular meeting or a special meeting, as well as the notice requirements under the bylaws.
● The Court instructed that: “The production of weak evidence when strong is, or should have been, available can lead only to the conclusion that the strong would have been adverse.” Slip op. at 20. As applied to the facts of this case, the Court determined that the dispositive original emails in their native format, with metadata, should have or could have been produced instead of a simple screen shot, which did not contain any metadata. The Court then applied an adverse inference that: if the stronger evidence were produced, it would have been harmful to the person with the burden of proof.
● The Court also reiterated the principle: “it is, of course, fundamental that a special meeting held without due notice to all the directors is not lawful, and all acts done at such meeting are void.” The Court emphasized that it was only making this determination solely for the purpose of determining the proper composition of the board, and noted that unlike a plenary proceeding, the issues that a court can address in a Section 225 proceeding are limited. Slip op. at 21-22.
● The Court explained that the burden of the proof was on the plaintiffs to determine that even if the board action was ineffective, the transaction which gave the subsidiary a majority ownership of the parent and the ability to replace the board was still not effective.
● The Court reasoned that the subsidiary was a separate legal entity from the parent and observed the truism that: Delaware law respects corporate separateness even when there is common ownership and even if there is total ownership and total control of one corporation by another, absent a showing of fraud or the existence of an alter-ego. Slip op. at 23.
● Interestingly, on a procedural but key note, neither of the companies involved entered an appearance in the case, and only one of the board members involved intervened.
In sum, the Court explained that the plaintiff merely focused its case on whether or not there was proper notice for a special board meeting and whether the actions taken at the meeting were void, but even though the Court found that meeting to be void, the Vice Chancellor also held that the corporate inversion making the subsidiary the majority stockholder properly authorized it to remove the all board members.
Lastly, the Court found that the plaintiff failed to timely raise the issue of foreign law under Court of Chancery Rule 44.1, therefore that argument was waived.