Do you own shares of stock? Are the stock certificates in a dusty bank box somewhere? Have you received communications from the company recently? If not, you should probably check in with the company to see if your shares have been escheated to the state. Please see here my recent article in the Delaware Business Court Insider discussing a recent Delaware opinion on the matter.
PRECISION IN DRAFTING–PART DEUX
A new decision of Delaware’s Court of Chancery addresses an interesting intersection of recent attention to entities potentially moving their places of incorporation from Delaware to some other jurisdiction–like Nevada–and 2022 amendments to Section 266 of the DGCL that changed the historic need for a unanimous stockholder vote to enact such a conversion to the need to seek and receive only the vote of a simple majority of the shares entitled to vote (matching the voting requirements for a merger or consolidation under Section 251 of the DGCL).
Last week on this blog I wrote about a new Court of Chancery decision demonstrating the need for precision in drafting LLC agreements–specifically in how those agreements might address information rights of LLC Members. Yesterday, in Gunderson v. The Trade Desk, Inc., et al. (C.A. No. 2024-1029-PAF)(Nov. 6, 2024), the court makes the same point, but in this instance it makes clear that need for precision applies to provisions in a certificate of incorporation that provide for supermajority voting rights by stockholders in voting on certain types of corporate events or questions. Here, the court finds, applying Delaware’s venerable “doctrine of independent legal significance,” that where a certificate of incorporation does not clearly provide that supermajority voting rights apply for a conversion of the entity (pursuant to DGCL Sec. 266) from a Delaware corporation to a Nevada corporation, the simple majority voting provision set by the statue applies.
The stockholder plaintiff in this litigation argued that a conversion from a Delaware entity to a Nevada entity necessarily would trigger a provision in the certificate of incorporation that required a supermajority vote for actions that would “amend or repeal, or adopt any provision of this Restated Certificate inconsistent with” certain “Protected Provisions” of that certificate. The defendants argued that the supermajority voting rights applied “only to action taken under Section 242 of the DGCL, which specifically applies to certificate amendments,” and therefore the proper lens through which to review this conversion was Section 266 of the DGCL governing such conversions–including Section 266(b)’s default provision that such a conversion could be approved by a simple majority vote.
The court adopted the position of the defendants by applying the doctrine of independent legal significance. That doctrine “holds that legal action authorized under one section of the corporation law is not invalid because it causes a result that would not be achievable through other action under other provisions of the statute.” As the court noted:
The doctrine of independent legal significance is a bedrock of Delaware corporate law and should not easily be displaced. An open-ended inquiry into substantively equivalent outcomes, devoid of attention to the formal means by which they are reached, is inconsistent with the manner in which Delaware law approaches issues of transactional validity and compliance with the applicable business entity statue and operative entity documents (internal quotations omitted).
The court discussed at length how the courts of Delaware, for over 20 years, have made clear in a number of opinions that drafters wanting to alter statutory default voting provisions (whether in count or by class) must use clear and direct language telegraphing that intent. Historically, those cases involved questions of whether to extend charter-based voting requirements to mergers and consolidations (governed by Section 251 of the DGCL). The court also highlights: “[T]he entire field of corporation law has largely to do with formality. Corporations come into existence and are accorded their characteristics, including most importantly limited liability because of formal acts. Formality has significant utility for business planners and investors.”
The court concludes its discussion with this admonition:
The court’s goal here is to give effect to the drafter’s decisions in selecting which words to use–and which words not to use. Where decades of case law provides express guidance to corporate drafters and emphasizes that our courts charge drafters with knowledge of that case law, giving effect to the drafters’ decisions entails adhering to that guidance at the judicial level as well.
So for all the transactional counsel out there to whom the closing remarks are directed, this case makes clear two things. First, if the parties intend to apply a supermajority voting provision to a corporate act where the statute provides only for a majority vote, make that intent clear by specifically enumerating that act (ideally by mentioning the sections of the statute that are being altered). Second, I should make a shameless plug for this Delaware Business Law Blog where we report on new authority coming out of the Delaware courts, so please subscribe below to stay informed about the new case law as it comes out!
Precision in Drafting–Information Rights of Members of LLCs
A recent order from the Court of Chancery highlights the need for precision in the drafting of LLC operating agreements, particularly in setting forth the rights that members of the LLC will have to information regarding the LLC. On August 21, 2024, Vice Chancellor Fioravanti issued his Order Addressing Motions to Dismiss in the matter of Potts, et al. v. SYFS Intermediate Holdings, LLC, et al., C.A. No. 2023-0557-PAF (copy below).
Plaintiffs in this action held Class B membership units in the LLC. One of their claims was that the LLC had breached the terms of the LLC operating agreement by failing to provide to them annual, audited financial statements for each fiscal year. It making their claim, the plaintiffs pointed to a provision in the operating agreement providing:
The Company will retain the Auditors to review, audit and report to the Members upon the financial statements of the Company for and as of the end of each Fiscal Year. The Auditors may be replaced or new auditors may be appointed at the discretion of the Board.
The Plaintiffs argued that the phrase “report to the Members” in this section created an obligation on the part of the LLC to send or provide copies of such audited financial statements to them as members of the LLC.
The Court of Chancery disagreed and dismissed this claim. It did so for two reasons.
First, the Vice Chancellor noted that one of the authorities that Plaintiffs relied upon did not support their position, as the limited partnership agreement at issue in that case provided that the general partner “shall prepare annual financial statements of the Partnership, and shall mail a copy of such statements to each Partner” (emphasis added) and that such statements were to be provided within 120 days of the end of the fiscal year. The court found that level of specificity trumped the less declarative “report to the members” language in the LLC agreement in the instant case.
Second, the Vice Chancellor pointed to a different provision of the LLC Agreement that did, indeed, provide specifically that certain audited financial statements were to be provided to certain members of the LLC:
The Company shall provide a copy of the most recent quarterly and audited annual financial statements of the Company to (i) each Class A Member, (ii) each Material SYFS Holder, so long as such Member continues to hold at least 50% of the Units held by such Member as of the date hereof, and (ii) [sic] so long as GPAC continues to hold at least 25% of the Units held by GPAC as of the date hereof, GPAC, in each case upon such Member’s request.
The Court of Chancery held that this section granted specific, but limited rights to information to the types of members noted. Given that Plaintiffs were neither the holders of the specified units noted in this section, nor had they made a request for the information, they could not look to the LLC agreement for contractual rights to LLC information.
That said, because the LLC Agreement was completely silent as to specific information rights that holders of Series B membership units might enforce, the Court of Chancery highligted that holders of those units could still resort to the default information rights as provided for in Section 18-305 of Delaware’s LLC Act.
As this Order demonstrates, counsel for both LLCs and their investors should be precise in their drafting to ensure that any rights to information in the LLC, whether specifically delineated or relegated to the statutory defaults, accurately reflect the intent of the parties to these agreements.
“Stockholder List” and “Stock Ledger”–the same thing? Not under Delaware law.
I have a confession. I know there have been times in my twenty-five years in practice as a Delaware lawyer where I have lapsed or gotten lazy and used the terms “stockholder list” (or “stocklist” for short) and “stock ledger” interchangeably. A short, letter decision by Chancellor McCormick ruling on motions for summary judgment in the matter of Mitchell Partners, L.P. v. AMFI Corp., et al., C.A. No. 2020-0985-KSJM (July 3, 2024) provides a crisp reminder–both to me and to other professionals advising Delaware corporations–that they are not the same thing given the clear language of Section 219(c) of the DGCL.
The letter decision is a quick-read at eight pages, so I commend it to the reader in its entirety. That said, three lessons emerge from this decision.
First, Section 219(c) is specific in its command that a Delaware corporation keep a stock ledger and enumerates the small list of information required to be including on the ledger. The Chancellor quotes from a 1956 decision of the Delaware Supreme Court noting that a stock ledger is “a continuing record of stockholdings, reflecting entries drawn from the transfer books, and including (in modern times) nonvoting as well as voting stock.”
That leads directly to the second lesson: the Chancellor notes that the stock ledger must record “all issuances and transfers of stock of the corporation” (emphasis in original). This includes non-voting shares of stock. The stock ledger in the matter being decided was found deficient because it excluded a class of stock that had been issued but was nonvoting in nature.
Finally, the third lesson–what information must a company record on a compliant stock ledger? The court, in a footnote, provides guidance to practitioners from a variety of sources, whose lists of required information differ slightly. That said, the following types of data should be recorded by corporations on their stock ledger: (1) the stock certificate number, (2) the name of the stockholder, (3) the stockholder’s full address, (4) the class of shares, (5) the date of purchase or transfer, and (6) the price or value of the shares. Other types of information that might be considered for inclusion are: the date shares were cancelled, and the date the board approved the stock issuance.
Given the court’s citation to an opinion from 1956, this does not appear to be an issue that has resulted in litigation with any frequency. But with the issuance of this letter decision, the matter is likely now front and center with stockholders (and their counsel) as a potential source for litigation going forward. Thus, this decision is a perfect catalyst for Delaware corporations, and those that advise them on a regular basis, to dust off the ol’ ledger and make sure it is up to snuff!
Weinberg Center for Corporate Governance holds its 2024 Distinguished Speaker and Panel
The John L. Weinberg Center for Corporate Governance of the University of Delaware recently put on a great program with two very timely and important presentations. One on how companies and their boards can navigate the turbulent waters surrounding calls for the entity to speak out on cultural and other “hot button” topics–some of which may be directly related to the business of that entity–some not. And second, a very lively panel discussion of the modern day use of special litigation committees to review derivative claims and litigation. Links to videos and other materials from this fantastic presentation may be accessed here.
How Do the New Texas Business Courts Stack up to Delaware’s Court of Chancery?
There has been much in the news recently about whether Delaware’s preeminence in the world of corporations and alternative entities is being materially challenged by other states–such as Texas or Nevada. Recently, Texas armed its challenge with the passing of legislation creating a new system of business courts designed to better address the needs of sophisticated, commercial litigants.
The Spring 2024 edition of The Advocate, the journal of the Litigation Section of the Texas Bar Association, contains a series of articles on many aspects of the new Texas business courts, including support for and challenges facing that legislation and the courts it created. My colleague (Mackenzie Wrobel) and I contributed an article titled: “Lessons Learned: What Can the New Texas Business Courts Learn from the Experience of Its Sister States.?” In that article we discuss how states such as Delaware, North Carolina, Georgia and Wyoming have approached the tasks of creating business courts that foster the stability and predictability that sophisticated commercial litigants seek in submitting their disputes to such tribunals.
It will be interesting to watch how Texas navigates the same ground as some of her sister states. Stay tuned.
Delaware Supreme Court Gives Additional Guidance on Scope and Mechanics for Applying MFW Framework to Conflict Transactions
Recently, the Delaware Supreme Court issued its much-anticipated decision in In re Match Group, Inc. Derivative Litigation, No. 368, 2022 (April 4, 2024), in which the Court reaffirmed certain venerable teachings on the standards of review that the Delaware courts will employ to review challenged transactions involving a controlling stockholder—including when and how controlling stockholders can deploy the “MFW framework” (from Kahn v. M&F Worldwide Corp, 88 A.3d 635 (Del. 2014) (“MFW”)) to shift the standard of review from “entire fairness” to “business judgement.” In general, the MFW framework reflects the Supreme Court’s ruling in that case that where a controlling stockholder conditions a going-private transaction (which would normally be reviewed under the exacting entire fairness standard), from the beginning, on (1) approval by a fully-functioning independent committee of directors and (2) a fully-informed vote of the unaffiliated minority stockholders, the Delaware courts will look to see if that transaction was within the business judgment of the fiduciaries presenting and approving it.
Since the ruling in MFW in 2014, transactional planners, stockholder plaintiffs, and corporate defendants have all probed the contours of the ruling in various ways. For instance, can the MFW framework be deployed outside a squeeze-out merger context or does the entirety of the special committee need to be independent and disinterested or can just a majority of the members of the committee be satisfactory?
In the Match opinion, the Supreme Court discusses in detail (1) the historical framework of the various standards of review that the Delaware courts will use to review challenged corporate transactions and conduct, (2) the history behind, and the nature of, the Court’s ruling in MFW, and (3) additional guidance for corporate constituencies (including controlling stockholders, boards of directors, and their advisors) on the scope of and mechanics for properly deploying the MFW framework to shift the standard of review from entire fairness to business judgment. Specifically, the Supreme Court held:
- Long-standing precedent holds that “in a suit claiming a controlling stockholder stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit, entire fairness is the presumptive standard of review”—this is not limited to going-private mergers, but rather applies to all transactions with a controlling stockholder that would historically have been reviewed for entire fairness.
- A “controlling stockholder can shift the burden of proof [to prove the transaction was not entirely fair] to the plaintiff by properly employing a special committee or an unaffiliated stockholder vote” (emphasis added). However, “the use of just one of these procedural devices does not change the standard of review” from entire fairness to business judgment.
- If “the controlling stockholder wants to secure the benefits of business judgment review, it must follow all [of] MFW’s requirements.” That is, the transaction must be conditioned on both the approval by an effective and independent special committee, and the informed vote of approval by the unaffiliated stockholders.
- For the special committee to be effective in “replicat[ing] arm’s length bargaining, all [special] committee members must be independent of the controlling stockholder.”
And . . . Yet Another Minute About Minutes
Over the years we have used this blog to highlight Delaware case law where the topic of corporate minutes has played a material role in the way the court has reviewed the actions of a board of directors. Those posts can be found here under the tag “minutes.”
Recently, The Honorable Leo E. Strine, Jr. (Ret.), the former Chief Justice and Chancellor of Delaware, posted a short summary on the Harvard Law School Forum on Corporate Governance of a more comprehensive paper he has written on this topic titled: “Minutes are Worth the Minutes: Good Documentation Practices Improve Board Deliberations and Reduce Regulatory and Litigation Risk” forthcoming in the Fordham Journal of Corporate and Financial Law.
Spending some time reading Chief Justice Strine’s article is well-“Worth the Minutes” invested, as he has done a great job of surveying the case law and highlighting the methods and means for generating corporate minutes that will most likely withstand scrutiny and give confidence to the court in the governance actions taken at such meetings.
Duty of Oversight of Officers–Post-McDonald’s Action in Court of Chancery
Nearly one year ago we reported in this blog on the Court of Chancery’s decision in In re McDonald’s Corp. S’holder Litigation, 289 A.3d 343 (Del. Ch. 2023), in which the court affirmatively held that officers of Delaware corporations owe duties of oversight (often called, Caremark duties), and specifically for matters that would fall within their managerial purview. In a recent decision granting a motion to dismiss in Segway Inc. v. Hong Cai a/k/a Judy Cai, C.A. No. 2022-1110-LWW (Del. Ch. Dec. 14, 2023), Vice Chancellor Will has provided practitioners counselling corporate officers with additional guidance on how the Court of Chancery will apply the duty of oversight to officers (as opposed to directors)—particularly when reviewing the sufficiency of claims pled against such officers.
This decision makes clear that “[d]espite a proliferation of modern jurisprudence, bad faith remains a necessary predicate to any Caremark claim.” This is so no matter whether the fiduciary whose conduct is challenged is an officer or a director. While the McDonald’s decision “emphasized that—barring extreme facts—an officer’s duty of oversight would only extend to matters within the officer’s remit,” that decision did not “craft a lower standard for oversight claims brought against officers.” Because the complaint in this case did not sufficiently plead “potential wrongdoing (much less within [the officer’s] purview),” the Vice Chancellor dismissed the claims.
In closing the Memorandum Opinion, Vice Chancellor Will summarized the current state of the law as it pertains to the Caremark duties owed by officers of Delaware corporations as follows:
The Caremark doctrine is not a tool to hold fiduciaries liable for everyday business problems. Rather, it is intended to address the extraordinary case where fiduciaries’ “utter failure” to implement an effective compliance system or “conscious disregard” of the law gives rise to a corporate trauma. These tenets of our law persist regardless of whether a Caremark claim is brought against a director or an officer. Officers’ management of day-to-day matters does not make them guarantors of negative outcomes from imperfect business decisions.
* * *
At a minimum, a plaintiff pursuing an oversight claim against an officer would need to demonstrate that the officer failed to make a good faith effort to monitor central compliance risks within her remit that pose potential harm to the company or others.
To the extent officers of Delaware corporations or their advisors might have read the earlier McDonald’s decision as creating an easier path to liability for duty of oversight claims for officers as opposed to directors, this recent decision should quiet those concerns.
Do New Delaware General Corporation Law Exculpation Amendments Trigger a Mandatory Class Vote for Changes to Charters?
In August 2022, a number of amendments to the provisions of the Delaware General Corporation Law (DGCL) went into effect. One amendment of note is the extension of Section 102(b)(7)’s exculpation provisions, which now permit corporations to eliminate or limit the personal liability of specified officers for direct claims of breach of the fiduciary duty of care. As a result, several Delaware corporations have amended their charters to extend the Section 102(b)(7) clauses to those senior corporate officers specified under the newly amended statute. Naturally, these actions bring a new issue for the courts to determine: What is the requisite stockholder approval to implement these charter amendments?
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