On March 20, 2013, legislation proposing to amend the Delaware General Corporation Law, 8 Del. C. §§ 1-101, et. seq. (DGCL) was submitted to the Corporation Law Section of the Delaware State Bar Association. If the proposed legislation is enacted, the amendments would make several significant changes to the DGCL. The proposed legislation seeks to: (1) clarify the board of directors’ authority to determine the consideration for a stock issuance; (2) provide a safe harbor procedure for ratifying corporate acts that are void because authorization of those acts failed to comply with the DGCL or the corporation’s organizational documents; (3) permit merger agreements to eliminate the vote requirement for certain second-step mergers; (4) add a new subchapter to the DGCL governing “public benefit corporations,” which are defined as corporations organized to promote, inter alia, charitable, artistic, social, or educational goals; and (5) deter the formation of “shelf corporations,” which are corporations formed with no directors or stockholders with the intent to use the entity several years in the future.
Board’s Power to Determine Consideration for Stock Issuance – Section 152
The proposed legislation amends Section 152 of the DGCL, which addresses the authorization and issuance of capital stock, to clarify that a board may determine the price of a stock issuance by reference to an approved formula that calculates the price. The proposed amendments clarify that the board may determine that consideration by utilizing a pre-approved formula, which could be useful in predetermining the consideration for stock and may utilize factors such as market price of the company’s stock over some period of time.
Ratification of Defective Corporate Acts - Proposed Sections 204 and 205
The proposed legislation adds two new sections to the DGCL to provide corporations a means of ratifying corporate acts that initially may not have been properly authorized. The proposed amendments are intended to overturn cases such as STAAR Surgical Co. v. Waggoner, 588 A.2d 1130 (Del. 1991) and Blades v. Wisehart, 2010 WL 4638603 (Del. Ch. Nov. 17, 2010), which forbid validation of corporate acts, by ratification or on equitable grounds, that are void because of a failure to comply with the DGCL or the corporation’s organizational documents. Proposed Section 204 provides a safe-harbor procedure for corporations to ratify corporate action that could be challenged as void or voidable because the authorization of that action did not comply with the DGCL, corporate organizational documents, or other corporate agreements. Section 205 would give the Court of Chancery jurisdiction to hear and determine cases regarding defective corporate acts, whether or not ratified under the self-help process.
Specifically, Section 204 provides the means to ratify “defective corporate acts.” A defective corporate act is broadly defined as any act or transaction that is within the corporation’s power, but is void or voidable due to a “failure of authorization.” A failure of authorization occurs where a corporation fails to authorize an act or transaction in compliance with the DGCL, the corporation’s certificate of incorporation or bylaws, or any other agreement to which the corporation is a party.
Under proposed Section 204, to ratify a defective corporate act, the board of directors must adopt a resolution that (1) describes the defective corporate act, (2) sets forth the date and time the defective corporate act occurred, (3) explain the nature of the failure of authorization; and (4) state that the board of directors approves the ratification of the defective corporate act. If the defective corporate act involved the over-issuance of “putative stock,”1 the resolution must also state the number and type of shares of putative stock issued and the dates that such putative stock were purported to have been issued. Section 204 also provides a mechanism for determining which shares constitute the “putative” shares. Ratification of a defective corporate act under this section will relate back to and retroactively validate the corporate act at the time it occurred.
Section 204 provides that the quorum and voting requirements applicable to a board resolution shall be the quorum and voting requirements that exist at the time of the initial adoption of the corporate act proposed to be ratified, even if the quorum and voting requirements that were in effect at the time of the defective corporate act would have required a greater vote. If directors were elected by specified classes or series of stock that are no longer in office because such classes or series of stock are no longer outstanding, Section 204 provides that the vote of such directors is not required.2
Within 60 days of board resolution, the corporation must provide a detailed notice to all current stockholders, including holders of putative stock, and both voting and non-voting stockholders as of the time of the defective act.3 The notice must (1) provide a copy of the resolution and (2) notify shareholders that challenges to the resolution must be brought within 120 days of the board’s approval of such resolution.
If the defective corporate act would have required a stockholder vote, the board must submit its resolution to the stockholders for approval. In addition, to avoid circumvention of Section 203, the DGCL’s principal anti-takeover provision, the board of directors must submit its resolution to a shareholder vote if the corporate act is defective because of a failure to comply with Section 203. Section 204 provides that the quorum and vote requirements necessary to ratify the act are those applicable at the time of such adoption for such defective corporate act unless the DGCL, the organizational documents of the corporation, or another plan or agreement in effect at the time of the defective corporate act would have required a greater vote. Similar to the board approval provisions, the stockholder and quorum provisions make exceptions for classes or series of stock that are no longer outstanding. To ratify the election of directors, holders of a majority of shares must vote for the ratification, unless a greater vote would have been required at the time of election. As such, Delaware’s default standard for electing directors, a “plurality,” would not be sufficient to ratify an election. In addition, ratification of a corporate act that is defective because the corporation failed to comply with Section 203 must be approved by a two-thirds vote of the voting stock owned by holders other than the “interested stockholder,” as required by Section 203.
If a resolution must be submitted for stockholder approval under this provision, the board must provide a detailed notice to all current holders of the corporation’s stock, including holders of putative stock, as well as holders of valid and putative stock as of the time of the defective corporate act, whether or not such shares are voting or nonvoting, provided that the former holders of stock or putative stock can be identified from the corporation’s records. The notice must be given 20 days before the stockholder meeting to approve the resolution and must provide the same information that would be provided to stockholders where a stockholders vote is not required, including a statement regarding the 120-day limitations period to challenge ratified acts. If the board gives notice under proposed Section 204(d), it satisfies its duty to give notice under proposed Section 204(h), as described above.
If the defective corporate act would have required filing a certificate with the Secretary of State, then, to ratify such act, the corporation must also file a “certificate of validation.” The certificate of validation must provide: (1) a copy of the resolution; (2) the date of the resolution; (3) the provisions of the certificate that would have been required to initially authorize the defective corporate act; and (4) if a certificate had previously been filed in conjunction with the defective corporate act, the title and date of such certificate.
Section 204 specifically provides that, unless determined otherwise by the Court of Chancery pursuant to proposed Section 205, the ratification would relate back to the time of the original act. As a result, issuances of putative stock would be deemed to be issued as of the original date of issuance upon ratification.
Unless notice was previously provided to stockholders, the proposed amendments also require notice of the ratification be provided to all current holders of the corporation’s valid and putative stock and also to holders of the corporation’s valid and putative stock as of the time of the defective corporate act to be ratified to ensure that no party is prejudiced.
Another mechanism to address ratification is proposed Section 205, which empowers the Court of Chancery, upon application, to: (1) determine the validity of defective corporate action, whether or not ratified by the corporation; (2) hear challenges to a board’s ratification under Section 204; and (3) modify or waive any of the procedures set forth in Section 204 to ratify a defective corporation act. Section 205 affords corporations the ability, through application for relief to the Court of Chancery, to ratify corporate acts that may not be ratified under Section 204, such as where there is no valid board. It also gives parties the power to challenge the defective corporate act or the board’s ratification of that act. As noted, challenges to a defective corporate act or ratification of that act must be brought within 120 days of board resolution or, if required, stockholder approval.
Notably, although the proposed amendments provide a corporation with significant authority to ratify defective corporate acts, the amendments do not affect directors’ fiduciary duties associated with approving such corporate acts or transactions.
Permitting Elimination of Required Vote for Particular Mergers – Proposed Section 251(h)
The proposed amendments include a new provision to Delaware’s merger statute. New Section 251(h) would permit corporations satisfying certain requirements to include a provision in merger agreements that would eliminate the requirement of a stockholder vote for approval of a second-step merger following a public tender offer. The new subsection would only apply to target corporations whose stock is traded on a national stock exchange or held of record by more than 2,000 shareholders immediately prior to the execution of the merger agreement.
Under proposed Section 251(h), a target corporation’s shareholders would not be required to vote on a second-step merger if: (1) the merger agreement contains a provision expressly subjecting the merger to Section 251(h); (2) the first-step tender or exchange offer is for any and all of the outstanding stock of the target corporation and on the terms provided by the merger agreement; (3) upon consummation of the tender or exchange offer, the acquiring corporation owns the amount of stock of the target corporation that would be otherwise necessary to approve the second-step merger; (4) no party to the merger agreement, at the time approved by the board, is an “interested stockholder,” as defined in Section 203(c) of the DGCL; (5) the acquiring and target corporation merge pursuant to the agreement; and (6) the holders of target shares that are not cancelled are paid identical consideration, in kind and amount, that was paid to the shareholders who tendered or exchanged their shares in the first step of the merger.
Proposed Section 251(h) also provides appraisal rights to the minority shareholders that are cashed-out under this section, unless the acquiring corporation owned all of the target corporation stock at the time of the merger. Notably, proposed Section 251(h) provides that a corporation may include a provision in its certificate of incorporation forbidding the corporation from using this subsection to circumvent a stockholder vote, even if the requirements of Section 251(h) are otherwise met. In addition, the proposed subsection does not alter directors’ fiduciary duties associated with approving a merger.
The proposed legislation would also amend Section 252 of the DGCL to provide for the usage of this provision in the context of a Delaware corporation merging with a non-Delaware corporation.
Public Benefit Corporations – Proposed Subchapter XV (Sections 361-368)
The 2013 proposed amendments would add a new subchapter XV to the DGCL (Sections 361-368). The new subchapter would authorize corporations to form as “public benefit corporations.” Public benefit corporations are for-profit corporations that are managed to benefit not only of stockholders but also other persons, entities, communities, or interests. This form of corporation allows the stakeholders to invest in an entity that may sacrifice some profit in order to benefit other interests.
Public benefit corporations would be subject to all applicable provisions of the DGCL, except as modified by Section 361-368. The proposed subchapter most notably would alter the fiduciary duties of officers and directors of public benefit corporations by allowing officers and directors to consider and balance the interests of stockholders, persons and entities affected by the corporation’s actions, and the public benefits that the corporation was formed to promote. Directors will be deemed to have satisfied their fiduciary duties with respect to balancing the interests of multiple parties, if their decisions are informed, disinterested, and not such that no person of ordinary judgment would approve.
Incorporators of every public benefit corporation would be required to specify, in the certificate of incorporation, their intent to form a public benefit corporation and the public benefits that the corporation is being formed to promote. The proposed legislation generally defines “public benefits” to include benefits that are artistic, charitable, cultural, economic, educational, literary, medical, religious, scientific, or technological in nature.
Proposed subchapter XV would require the corporation to provide periodic notices (at least every two years) to stockholders regarding the efforts taken to achieve the public benefits the corporation was formed to promote. Moreover, the proposed subchapter would authorize holders of at least 2 percent of the corporation’s stock (or for publicly traded corporations, the lesser of 2 percent of the corporation’s stock and stock having a market value of at least $2 million) to bring a derivative action to enforce, among other things, the corporation’s promotion of the public benefits in its certificate.
The proposed subchapter also requires a public benefit corporation to obtain a two-thirds stockholder vote to amend their certificate of incorporation or merge with other corporations if those actions would delete or amend the public benefits the corporation was initially formed to promote. In addition, to convert an existing corporation into a public benefit corporation, the corporation would be required to obtain a 90 percent vote of each class of stock, and the conversion of an existing corporation into a public benefit corporation would entitle dissenting shareholders to appraisal rights.
By using a Delaware corporation, entrepreneurs and investors who wish to pursue public benefit goals in addition to pecuniary goals will be able to rely on Delaware corporate law, the DGCL and Delaware’s judiciary to provide a measure of stability and predictability in an area of law that continues to evolve rapidly.
Deterring ‘Shelf Corporations’– Section 312(b)
The proposed amendments to Section 312(b) seek to restrict the ability to form “shelf corporations,” which are corporations organized without stockholders and directors and are intended to be used several years from formation. The amendments accomplish this goal by (1) clarifying that only a corporation’s directors or stockholders may authorize a renewal or revival of a corporation, (2) prohibiting an incorporator from signing an annual report, other than the initial report, and (3) prohibiting annual reports to specify “no directors,” other than the initial report or reports filed in conjunction with dissolution.
The amendments, other than the amendments dealing with ratification, would become effective on August 1, 2013. The amendments addressing ratification would become effective on April 1, 2014.
1 Section 204 defines as shares of any class or series of stock that: (a) but for the failure of authorization, would constitute valid stock or (b) cannot be determined by the board of directors to be valid stock.
2 If, due to defects, a corporation does not have a validly elected board, the parties would need to seek relief from the Court of Chancery pursuant to either new Section 205 or existing Section 225.
3 The notice requirement is waived with respect to stockholders as of the time the invalid act was taken if the identity of those stockholders cannot be determined from the corporation’s records.