Search results for: Section 225

A recent Delaware Court of Chancery decision is noteworthy for its analysis of a claim in a summary proceeding to determine the rightful directors of a company after learning that the claim was based on fraudulent corporate documents. The court rejected the requested relief in Berg v. Bar-Lavi, C.A. No. 2025-0959-LWW (Del. Ch. March 27, 2026).

Background

The closely-held interrelated entities involved in this matter had very poorly drafted or non-existent corporate records—and those that did exist were either back-dated or not accurate. The case involves a relationship between two former close friends and business partners that deteriorated as the company that they collaborated on became more successful.

Berg tried to convert a note into shares and based on that he initially claimed majority ownership  and called a board meeting. Berg relied on two written consents that he prepared and which purported to remove two directors and replace them with himself as the sole director and sole officer.

Procedural Posture

This case was filed in August 2025, only a few days after a related suit was filed in Israel by the Defendants in Delaware. This DGCL § 225 suit sought a ruling that Berg was the only lawful director and the other two directors were lawfully removed.

The court granted expedited scheduling and imposed a status quo order. Trial was held on December 16 and 17, 2025. Post-trial briefing was completed on February 2, 2026.

Analysis

DGCL § 225 allows for a determination in summary in rem proceedings regarding the validity of the seating of any officer or director.

The first step in such a lawsuit is to make a determination of who properly owns the stock and in what quantity.

DGCL § 227 allows the court to determine the rightful owners of stock at any meeting of stockholders in connection with a § 225 action.

The court concluded that: (1) Berg presented fabricated documents in this case; (2) His course of conduct undermined his claims; and (3) His failure to prove his status as a stockholder made the written consents invalid and also resulted in his lack of standing.

Basic Corporate Principles

  • Other than for cumulative voting or staggered boards, DGCL § 141(k) provides that holders of a majority of shares entitled to vote at an election can remove directors. Slip op. at 18 and n. 108.
  • Although a stock ledger typically is the only evidence of which stockholders are entitled to vote, id. at 19 and n. 109, trial revealed that it was not authentic. Slip op. at 28.
  • Extrinsic evidence is allowed in the absence of a stock ledger, for example post-formation conduct. Slip op. at 28.
  • DGCL § 108 requires an incorporator to hold an organizational meeting to elect directors after the Certificate of Incorporation is filed—unless the initial directors are named in the Certificate of Incorporation, which was not the case here.
  • Because § 108 was not followed in this matter, the later written consent to appoint a director was not effective.

Shifting of Attorneys’ Fees

Berg’s fabrication of corporate documents was bad-faith litigation conduct.

The defendants also admitted to making false statements in a sworn affidavit, but the court placed less emphasis on this criminal behavior because it did not affect the outcome of the case, although it still was “inimical to the integrity of this court.” Slip op. at 36. As a result, the court only shifted fees in the amount of 50% in favor of the defendants.

The Delaware Supreme Court recently affirmed a Chancery decision that was highlighted on these pages, which described the limited scope of a summary proceeding under DGCL Section 225 to determine who properly holds a corporate office.

In Barby v. Young, No. 391-2023 Order (Del. June 11, 2024), the high court described that among the limited related topics that can be addressed in connection with determining who properly holds a corporate office, are: the validity of stock issuances, stock transfers, and stock acquisitions to determine which vote should be counted in ascertaining proper board composition. See footnote 2.

The court emphasized that the limited scope of a 225 proceeding cannot include the rescission of a transaction procured through unlawful behavior, which is the type of relief that can only be obtained in a plenary action in a court that has in personam jurisdiction over necessary parties as opposed to an in rem Section 225 proceeding. 

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.

The Delaware Supreme Court affirmed this decision on June11, 2024.

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.

Conclusion

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.

The Delaware Court of Chancery opinion styled:  Zhou v. Deng, C.A. No. 2021-0026-JRS (Del. Ch. April 6, 2022), is notable for addressing two useful aspects of Delaware corporate and commercial litigation:

First, DGCL Section 225 is a very narrowly focused summary proceeding that is considered to be “in rem”.  This limits the ability to join others who might not be subject to the personal jurisdiction of the court.  See Slip op. at 8-9.

Second, this opinion features useful references to authority that describe when issues will be considered waived: for example, when they are raised for the first time in a pretrial brief, or only “generally addressed,” such as in background facts.  See footnotes 61 and 64.

A recent Delaware Court of Chancery decision provides noteworthy rulings on the limited scope of a Section 225 summary proceeding regarding the proper composition of the board of directors, as well as the notice requirements for a written consent in lieu of a stockholders’ meeting pursuant to Section 228 of the Delaware General Corporation Law (DGCL). See Brown v. Kellar, C.A. No. 2018-0687-MTZ (Del. Ch. Dec. 21, 2018). Many Section 225 cases and Section 228 cases have been highlighted on these pages over the last 14 years.

Three Important Topics Addressed:

Although the factual details of this case are necessary to understand the holding that denied in part the motion for summary judgment, for purposes of the most widespread applicability for those involved in corporate litigation, I will highlight the key takeaways that include memorable statements of Delaware law on three important topics:

(1) the circumscribed scope of Section 225 summary proceedings;

(2) the impact of not providing prompt notice of a written consent of stockholders under Section 228; and

(3) the impact, if any, on the effectiveness of a Section 228 written consent if the notice requirements under Rule 14c-2 of the Securities Exchange Act of 1934 are not complied with—assuming full compliance with Section 228.

Brief Background:

This case involved a stockholder who brought an action to determine the composition of the board of directors pursuant to Section 225 of the DGCL.

Procedurally, the opinion addressed a motion for summary judgment to determine the proper members of the board. As often happens in these matters, there is a parallel plenary action that raises issues regarding a breach of fiduciary duty and which also seeks a declaratory judgment.

At the heart of the dispute is whether certain written consents in lieu of a stockholders’ meeting to remove an incumbent director, then to replace him with another director, was valid and effective upon delivery.  The counterargument was that the court should not grant summary judgment in order to allow it to consider issues of inequitable conduct that would allegedly void the written consents.

In addition to the issue of whether prompt notice under Section 228(e) of the DGCL was a condition precedent to effectiveness of the written consent under Section 228, another issue addressed is whether or not the notice requirements under Rule 14c-2 of the Securities Exchange Act of 1934 supersede the notice requirements under Section 228.

Key Takeaways

Section 225 Principles:

  • Whether or not an issue other than the proper composition of the board should be considered by the court in a summary Section 225 proceeding turns: “upon a determination of whether it is necessary to decide in order to determine the validity of the election . . . by which the defendant claims to hold office.” See footnotes 41 through 44 and accompanying text.
  • Although the summary nature of a Section 225 proceeding limits the scope of issues that will be addressed, Delaware courts “reject the notion that rigid, inflexible rules preclude this court from hearing anything but the narrowest arguments in Section 225 cases.”
  • Rather, the court may adjudicate a claim that a director does not validly hold corporate office because that director obtained the office through fraud, deceit, or breach of contract . . . but only for the limited purpose of determining the corporation’s de jure directors and officers. See footnote 40 and accompanying text.
  • Section 225 proceedings are in rem, meaning that the defendants “are before the court, not individually, but rather, as respondents being invited to litigate their claims in the res (the disputed corporate office) or be forever barred from doing so.” See footnote 39 and accompanying text.
  • Prior decisions by the Court of Chancery exemplify the ability of the court to review appropriate claims of inequitable conduct within the boundaries of a Section 225 case. See footnotes 47 through 49 and accompanying text.
  • The court will review issues “that could infect the composition of a company’s de jure directors and officers under Section 225, notwithstanding formal compliance with the voting procedures and requirements for those offices.” See footnotes 50-51 and accompanying text.
  • The court explained that it may consider the well-known principle announced in Schnell v. Chris-Craft Industries, 285 A.2d 437, 439 (Del. 1971), that “inequitable action does not become permissible simply because it is legally possible.” Schnell, 285 A.2d at 439.
  • The court reasoned that Schnell empowers the court in a Section 225 case to look at both technicalities and equities notwithstanding the relatively narrow scope of a Section 225 proceeding.
  • The “twice tested principle” of Delaware corporate law applies in 225 cases. That is, under Delaware law: “in every case, corporate action must be twice tested: first, by the technical rules having to do with the existence and proper exercise of the power; second, by equitable rules.” See footnote 52.

Section 228 Principles:

The court quoted from subsection (e) of Section 228 which requires prompt notice of the taking of corporate action by less than unanimous written consent of stockholders in lieu of a meeting. The sub-issue involved in this case was whether the absence of that notice under Section 228(e) prevents an otherwise valid written consent from taking effect. Based on the facts of this case, the court answered that question in the negative.

  • Section 228 unambiguously permits a majority of the stockholders of a corporation to act immediately and without prior notice to the minority. See footnotes 58-59.
  • Section 228(a) provides as a condition precedent that pursuant to Section 228(c) the consents must be “properly delivered” in order to be effective. See footnote 60 and accompanying text. In contrast, Section 228(e) does not make notice to the minority a condition precedent to an effective written consent.
  • Section 228(e) is not a condition precedent or a prerequisite to a corporate action by written consent but, the court explained that it is: “rather an additional obligation resulting from that corporate action.” See Slip op. at 23.
  • Nonetheless, the court emphasized that “prompt notice to the minority stockholders is of critical importance. Failure to provide that notice has, in unique circumstances, compelled the Court to deviate from the default rule that written consents are effective upon delivery.” Id.
  • The court referenced cases where egregious failure to provide that notice to non-consenting stockholders for several months resulted in the effectiveness under the default rule being delayed until notice requirement was remedied. See footnotes 65 through 71 and accompanying text.
  • The court found based on the facts of the instant matter that the foregoing “extreme” exception to the default rule was an applicable. Slip op. at 25.

Interface of Section 228 and Rule 14c-2 of the Exchange Act:

The court referred to other Delaware decisions that addressed the interfacing between Delaware corporate law requirements and Federal securities law and regulations.

  • The failed argument in this case was that Rule 14c-2 of the Securities Exchange Act of 1934 provided an independent notice requirement that precludes effective written consents until notice is given but “at the same time prevents [the company in this case] from giving that notice.” See footnotes 72 through 79 and accompanying text.
  • The court explained that the parties did not brief the issue of the jurisdiction of the Court of Chancery to interpret Rule 14c-2, but the court assumed without deciding that it could address the impact of that Rule on the validity of the written consents at issue in this case—based on Delaware law.
  • The parties also agreed that the Exchange Act Rules did not preempt Delaware law. See footnotes 79-80.
  • The court wrote that important policies underlying the Internal Affairs Doctrine suggest that the power of the state of incorporation should not be lightly overturned, but in any event the court held that its application of Section 228 to the written consents at issue “is not affected by Rule 14c-2.” Slip op. at 29.
  • The court reasoned that “even if Rule 14c-2 imposes a notice requirement beyond that found in Section 228, the Director Consents would still be effective under Delaware law. This court has consistently found that corporations cannot avoid their obligations under Delaware law, like holding annual meetings, by pointing to additional or reportedly conflicting obligations under Rule 14 of the Exchange Act.” See footnotes 81-82 for supporting case law.
  • The court observed a fundamental problem with the argument made by the Director Defendants as it relates to the interaction between federal law and Delaware law. The federal rule was meant to reinforce management accountability to stockholders and it cannot be used as a tool to indefinitely deprive stockholders of the franchise. See footnote 88. The Director Defendants in this case offer Rule 14c-2 as a basis to avoid giving stockholders notice, and the court rejected that argument.
  • The argument that Rule 14c-2 and Section 228 operate together to prevent the company from making any disclosure to the stockholders in this situation “stands the purpose of corporate and securities law on its head.” See footnote 91 and accompanying text.
  • Ultimately, the court found that it need not make a ruling on the substance of Rule 14c-2, because Rule 14c-2 did not “inform” its rulings on Section 228.

The Delaware Court of Chancery in Kerbawy v. McDonnell, C.A. No. 10769-VCP (Del. Ch. Aug. 18, 2015), addresses whether written consents of stockholders were effective in replacing the board members of the company involved.  The case features the interplay between DGCL § 225 and § 228 in this corporate litigation over control of the company. DGCL § 228 is the provision that allows written consent of stockholders in lieu of a meeting and without prior notice to the minority stockholders.  DGCL § 225 is the provision that allows for summary proceedings on an expedited basis to determine who the proper directors of a company are, for example, when there is a dispute about the results of an election or, as in this case, the validity of written consents of stockholders purporting to remove directors or elect directors, or both.

This case provides a playbook of sorts on how to take control of a board via written consents.

Highlights from 59-page Post-Trial Decision

DGCL § 228(a), unless otherwise provided in the Certificate of Incorporation, allows stockholders to take action by written consent that might otherwise be taken at an annual or special meeting of stockholders.  The written consent is effective “without a meeting, without prior notice and without a vote.”  The written consents must be signed and bear the date of signature of each stockholder who signs the consent.  Action by written consent is effective only if the required number of consents are delivered within 60 days of the earliest date of consent.  See § 228(c).

The court observed that when a majority of stockholders have executed written consents to remove a board, the burden of proving that a director should not be removed or that an election is invalid, rests with the party challenging its validity.  This is a heavy burden, especially in light of “the importance Delaware law places on protecting the stockholder franchise, which has been characterized as the idealogical underpinning upon which the legitimacy of the director’s managerial power rests.”  See footnote 115.

The parties did not dispute the validity of the consents on technical grounds, but rather the argument was made that the court should set aside the otherwise valid consents on equitable grounds, based on allegations that: (1) the consents were based on misleading disclosures; (2) they were based on the misuse of confidential information; and (3) they were procured by tortious interference with an applicable agreement.

Key Principles

  • The court emphasized that a minority stockholder does not owe a fiduciary duty in general nor a duty of disclosure in particular.
  • Although directors of Delaware corporations have a duty to disclose fully and fairly all material information within the board’s control when seeking shareholder action, a party who is neither a director nor an officer, controlling stockholder or member of the control group has no such obligation. The court distinguished cases cited at footnote 118 where equitable relief was available for failure to disclose material facts in soliciting consents.
  • The court explained that: “Just as Delaware law does not require directors-to-be to comply with fiduciary duties, former directors owe no fiduciary duties.”  See footnote 127 (discussing the theoretical basis of the duty of disclosure).
  • But, if the written consents were procured by misleading disclosures, as opposed to the absence of any required disclosure, that fact could support an equitable claim to set those consents aside. One takeaway that a skeptic might extract from this opinion is that consent solicitations might more easily be performed by a person without a fiduciary duty.
  • The court describes the limited scope of a § 225 action and the limited relief available in such an action in light of its status as an in rem proceeding. See footnotes 148 through 149.
  • The court found that the sharing of confidential information that the fiduciary should have not shared was not ideal, but no harm was shown from the sharing of that information such that it would impact the analysis to set aside the written consents on an equitable basis.
  • DGCL § 228 enables stockholders to act independently of the board, and allows them to act without prior notice, and without discussion. By definition, that allows for a “secret compilation of consents” which might otherwise surprise the board when the board members learn of it.
  • In sum, there was no breach of fiduciary duty, fraud or other wrongdoing that “so inequitably tainted the election” for the court to intervene.

 

 

 Salvatore v. Visenergy, Inc., C.A. No. 10108-CB (Del. Ch. Oct. 6, 2014). This short letter ruling is noteworthy in passing as a reminder that in Section 225 cases, a trial date will often be scheduled within 60 days of filing a complaint. The substantive issue in this case surrounded a written consent of shareholders to elect board members, but this decision related to a request for a continuance of the trial

In this decision, the court refused to postpone a trial date set for 45 days from the complaint being filed. The “intervening holidays” and related excuses did not prevail. Nor did the fact that one party was pro se. DGCL Section 225 allows for expedited proceedings to determine the validity of board elections. This type of expedited proceeding is one of the “sweet spots” of Delaware corporate litigation.

Flaa v. Montano, C.A. No. 9146-VCG (Del. Ch. (Feb. 24, 2014). Takeaway: One point that can be taken from this pithy Chancery ruling is that it is not necessary for a director to be actually seated on the board in order to use DGCL Section 225 to ask the court to determine if that person should be deemed a validly elected director.

A prior Chancery decision in this case was highlighted on these pages.

Aequitas Solutions, Inc. v. Anderson, et al., C.A. No. 7249-ML (September 28, 2012).

Issue Presented:

Whether a Section 225 action fails to state a claim where plaintiff was not seeking relief against the defendant in his individual capacity and the defendant did not purport to be a director, officer or shareholder of the target company.

Answer:  No.  Motion for judgment on the pleadings denied.  

Background

This is a statutory proceeding pursuant to 8 Del. C. § 225 where plaintiff Aequitas Solutions, Inc. is seeking a judicial declaration that the director plaintiffs elected to the board of C Innovation, Inc. were validly elected and constitute the entirety of C Innovation’s board of directors.  Aequitas acquired 100 shares of C Innovation stock, which Aequitas contended constituted all of the duly authorized, issued, and outstanding shares of C Innovation.  Aequitas then removed the existing board of directors and filled the resulting vacancies by electing three new board members who in turn appointed new officers to manage C Innovation.  Aequitas alleged that Anderson and Loyd have refused to recognize the Aequitas directors, have interfered with efforts of Aequitas’s directors and officers to manage the company, and continue to assert that they control Aequitas and its assets. Defendant Loyd argued that Aequitas’s complaint did not state a cause of action against him, because Aequitas did not allege that Loyd is a director, officer, or shareholder of C Innovation, and did not seek any substantive relief against Loyd in his individual capacity. In response, Aequitas argued that Loyd has asserted “direct or indirect control” over C Innovation, and that it therefore properly named Loyd as a defendant in this action.

The Court noted that a Section 225 proceeding is not an in personam action but rather an in rem proceeding, where the defendants are before the court, not individually, but rather as respondents being invited to litigate their claims to the res (here, the disputed corporate office) or forever be barred from doing so.  Thus by filing this action, Aequitas invited Loyd to litigate any claim he may have to the corporate office.”  In denyng the motion, the Court found that “Loyd’s actions in refusing to recognize the Aequitas Directors, in inserting himself in C Innovation’s relationships with its customers, and in hiring counsel to represent C Innovation, as alleged in the complaint, fairly supports Aequitas’s allegation that Mr. Loyd has asserted control over the corporation.”

 In Johnston v. Pedersen, C. A. No. 6567-VCL (Del. Ch. September 23, 2011), read opinion here, the Court in a post-trial decision, found that that the defendant directors breached their fiduciary duties when issuing the Series B Preferred Stock and as a result, the holders of the Series B Preferred were not entitled to a class vote in connection with the removal of the incumbent board and the election of a new slate by written consent.

This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

Background

By way of background, on August 24, 2010, the Xurex board exercised its authority under the blank check provision of the Xurex certificate of incorporation to authorize the issuance of up to 20 million shares of Series B Preferred. Like the Series A Preferred, the Series B Preferred carries one vote per share and votes with the common stock on an as-converted basis. However, unlike the Series A Preferred, the Series B Preferred had a class voting right which required a majority vote approving any matter that is subject to a vote of the common stockholders.

In April 2011, DuraSeal Pipe Coating Company began soliciting proxies from Xurex stockholders to remove the incumbent Xurex directors and elect a new board. In May, the Xurex board learned of the solicitation and began a counter-solicitation. On June 14, 2011, the plaintiffs delivered written consents which purported to remove the defendants as Xurex directors, fix the number of directors on the board at five, and elect five directors including plaintiffs Johnston and Rose. Also on June 14, 2011, the plaintiffs initiated an action seeking an order pursuant to 8 Del. C. § 225 declaring that the written consents were valid and effective.

Plaintiffs contend that the written consents represent approximately 69% of the outstanding common stock, 51% of the outstanding Series A Preferred Stock, and 13% of the outstanding Series B Preferred Stock. The defendant directors contend that they could not be removed or a new slate elected without the consent of a majority of the Series B Preferred Stock.

Analysis

The Court reviewed the directors’ action under the enhanced scrutiny test because the directors facing a proxy contest face an inherent positional conflict – enhanced scrutiny mandates that the directors persuade the Court that: (i) their motivations were proper and not selfish; (ii) they did not preclude stockholders from exercising their right to vote or coerce them into voting in a particular way; and (iii) their actions were reasonably related to a legitimate objective. When the vote involves an election of directors or touches on matters of corporate control, the directors cannot claim that the stockholders may vote out of ignorance or mistaken belief about what course of action is in their own interests.

Here, the Court found that the defendant directors adopted the class vote provision in the Series B Preferred for the specific purpose of preventing holders of a majority of Xurex’s common stock and Series A Preferred from electing a new board. The directors admitted at trial that they believed another control contest would be detrimental to the company, and that they wanted two particular directors to have time to implement their business plan. The Court, however, was unpersuaded and stated:

As a result of his discussions with supportive investors, Pedersen decided that the Series B Preferred should have some type of “super vote right” that would prevent a change of board control without the approval of the holders of the Series B Preferred. The board then implemented the “super vote right” in an expansive form that gave the Series B Preferred a veto over any action submitted to stockholders. The directors have attempted to justify this provision by claiming that Xurex needed capital and that key investors wanted assurance that Pedersen and the incumbent board would remain in charge. But the directors also admittedly wanted to preserve the incumbent board in place. Under the circumstances, the defendants failed to carry their burden of persuasion that the class vote provision was adopted in furtherance of a legitimate corporate objective. The incumbent directors could not act loyally and deprive the stockholders of their right to elect new directors, even though they believed in good faith that they knew what was best for the corporation.

Even assuming that the directors subjectively intended only to raise capital, the Court found that was “not a sufficiently compelling justification for issuing the Series B Preferred with a class vote on any issue that could be submitted to the corporation’s stockholders.” In the end, the Court found that even though the board acted in good faith, the defendant directors breached their duty of loyalty by issuing the Series B Preferred. While the board may have honestly believed that “a period of “stability” (i.e. entrenched incumbency) would be in the best interests of Xurex,” the Court noted that “[a]n inequitable purpose is not necessarily synonymous with a dishonest motive. Fiduciaries who are subjectively operating selflessly might be pursuing a purpose that a court will rule is inequitable.”