Gorman v. Salamone (here) involves a long-running dispute over the control of Westech Capital Corp. which arose because a voting agreement was arguably unclear as to whether certain directors were to be elected per capita among certain key shareholders or per share.  The majority shareholder, John J. Gorman, IV, largely lost that battle in an earlier case that was decided by the Delaware Supreme Court in late 2014 (here) which left the CEO and Gorman’s nemesis, Salamone, in place, together with the board seat to which Salome was entitled as CEO under the voting agreement.

Undeterred, Gorman purported to amend Westech’s bylaws by written consent to allow the stockholders — Gorman with the majority of the shares — to remove and replace Westech’s officers.  The amended bylaw provided:

Section 6.2. Term of Office. The elected officers of the Corporation shall be elected annually by the Board at its first meeting held after each annual meeting of stockholders. All officers elected by the Board shall hold office until the next annual meeting of the Board and until their successors are duly elected and qualified or until their earlier death, resignation, retirement, disqualification or removal from office. Any officer may be removed, with or without cause, at any time by the Board or by the stockholders acting at an annual or special meeting or acting by written consent pursuant to Section 2.8 of these Bylaws. The Board shall, if necessary, immediately implement any such removal of an officer by the stockholders. Any officer appointed by the Chairman of the Board or President may also be removed, with or without cause, by the Chairman of the Board or President, as the  case may be, unless the Board otherwise provides. Any vacancy occurring in any elected office of the Corporation may be filled by the Board except that any such vacancy occurring as a result of the removal of an officer by the stockholders shall be filled by the stockholders.

Gorman then attempted to remove Salamone pursuant to Gorman’s new purported power and appoint himself as the new CEO.  Salamone and other board members refused to recognize Gorman’s actions and Gorman commenced a summary proceeding under Section 225 of the Delaware General Corporation Law (“DGCL”) to determine whether Salamone had been properly removed.  Gorman relied on both Section 142(b) of the DGCL which provides that “[o]fficers shall be chosen in such manner and shall hold their offices for such terms as are prescribed by the bylaws or determined by the board of directors or other governing body” and on Section 109(b) which generally gives the stockholders broad power to adopt and amend the bylaws “relating to the business of the corporation, the conduct of its affairs, and the rights or powers or the rights or powers of its stockholders, directors, officers or employees.”

However, the Court found that the general powers given to stockholders were trumped by Section 141(a) which specifies  that “[t]he business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certification of incorporation.”  Section 141(a) has been interpreted as a prohibition on stockholders directly managing the business affairs of a corporation, and the issue in Gorman v. Salamone was whether the majority stockholder’s removal and replacement of Salamone as CEO was tantamount to “managing” the corporation.  The Chancery Court concluded it was because it mandated how the board of directors  decided the substantive business decision of removing the corporation’s CEO.  The Court stated the test for whether a bylaw is proper as whether it defined the “process and procedures” by which a board decision is made or, instead, whether the bylaw mandates how the board should make specific business decisions, which the new bylaw certainly did.

Practice takeaways:

  • Control fights in closely held corporations are sometimes the product of poor drafting of corporate governance documents. Often, however, the lack of clarity and ambiguities in those documents are the product of negotiated compromises and “kicking the can” on potential control issues rather than sloppiness. If the corporate documents governing control go too far, the court may resort to a highly technical reading of the statute to preserve the board’s primacy to manage the business and affairs of the corporation, thus leading to unsatisfied expectations, hopeless deadlocks, and potentially lengthy and expensive litigation.
  • Imprecise corporate governance documents and their unintended or intended consequences can seldom be revised after the fact if there are classes of directors elected to protect certain control groups; one or the other of the control groups will object and there is often no way for one group to break the deadlock.  Gorman v. Salamone demonstrates one of number of ways that even a majority shareholder cannot break the deadlock.
  • Bylaws are by their nature only “rules of the road” governing process and procedures.  All too often stockholders attempt to pack precise corporate control provisions into bylaws and shareholder agreements, and in light of Gorman v. Salamone that approach may not hold up in a judicial challenge.
  • Choice of entity is very important in relation to control and the extent to which stockholders can inject themselves   into substantive business decisions. The DGCL already provides an avenue through which stockholders can restrict  the discretion of directors and implement stockholder management by electing to treat the corporation as a statutory “close corporation.”  See DGCL Sections 341 et seq. (including Section 350 (restricting director discretion) and Section 351 (management by stockholders) if close corporation status is elected in the certificate of incorporation). Also, these formalities do not necessary apply to limited liability companies, where member and manager roles can be more freely defined by contract. As the Gorman court noted, “a Delaware corporation is a board-centric entity. Other governance structures can be imposed on other entities, if that is what the stakeholders desire.”