A recent Delaware opinion, In Re Numoda Corporation Shareholders Litigation, decided on January 30, 2015, appears to be the first opinion to resolve questions under the new Delaware statutes, Sections 204 and 205, which authorize ratification of defective corporate acts by the corporation and the Delaware courts, respectively.
The case involved a number of purported stock issuances, surrenders of shares, distributions and a spin-off; however, the parties had dispensed with the usual indicia of corporate acts, such as notice, signed board minutes and stock certificates, in favor of handling matters through informal processes — very informal. Unfortunately, since the parties attempted to ratify defects under Section 204 prior to the effective date of the statute, the Court found that the board was not then authorized to retroactively validate contested stock issuances and does not further address the application of Section 204. However, the ratification “did have some effect,” allowing at least all of the uncontested stock to be validly issued as of the date of the ratification (i.e., board action complying with corporate formalities could at least authorize newly issued shares). In addition, the Court took into account the attempted ratification in resolving some of the disputes under Section 205. (In addition, the Court notes that, under common law, validation would also have been possible with a unanimous shareholder vote.)
Section 205 authorizes the Court to retroactively validate a defective corporate act and to “[m]ake such other orders regarding such matters as it deems proper under the circumstances.” A defective corporate act includes an overissue, election of directors or “any act or transaction purportedly taken by or on behalf of the corporation that is, and at the time . . . would have been, within the power of a corporation . . . , but is void or voidable due to a failure of authorization.” In addition, Section 205(d) provides that, in deciding whether to exercise this authority, the Court may consider the following factors:
“(1) Whether the defective corporate act was originally approved or effectuated with the belief that the approval or effectuation was in compliance with the provisions of this title, the certificate of incorporation or bylaws of the corporation;
(2) Whether the corporation and board of directors has treated the defective corporate act as a valid act or transaction and whether any person has acted in reliance on the public record that such defective corporate act was valid;
(3) Whether any person will be or was harmed by the ratification or validation of the defective corporate act, excluding any harm that would have resulted if the defective corporate act had been valid when approved or effectuated;
(4) Whether any person will be harmed by the failure to ratify or validate the defective corporate act; and
(5) Any other factors or considerations the Court deems just and equitable.”
The legislation authorizes the Court “to grant an equitable remedy for corporate acts that once would have been void at law and unreachable by equity.”
Accordingly, the Court concluded that the statute “appears to confer substantial discretion on the Court and, absent obvious procedural requirements, does not set a rigid outer boundary on the Court’s power to validate defective corporate acts. Guidance on how to apply these new provisions in a contested situation is not developed in detail, and the Court proceeds with caution, keeping in mind that ‘[t]he goal of statutory construction is to determine and give effect to legislative intent.’”
In examining the legislative history, the Court found that it reflected “intent to allow ratification or validation of stock in the hands of a good faith purchaser for value and stock in an over-issue,” consistent with the commercial code. More importantly, the legislative history showed that one of the purposes of the legislation was to overturn the effect of two Delaware cases that held that “corporate acts or transactions and stock found to be ‘void’ due to a failure to comply with the applicable provisions of the General Corporation Law or the corporation’s organizational documents may not be ratified or otherwise validated on equitable grounds.” In one of the cases, the Delaware Supreme Court had overturned an award of an equitable remedy to shareholders because the shares had not been issued validly, notwithstanding evidence of reliance by the parties and documentation in the form of minutes, a certificate of designation and a board resolution that was, in fact, not formally adopted. In the other case, the Chancery Court recognized the harm to some of the investors that would result from a failure to validate. Nevertheless, the Court refused to recognize changes to a corporation’s capital structure where the board had not adopted a resolution, obtained shareholder approval or filed a certificate of amendment, even though documentation included two resolutions, a corresponding certificate of amendment, and a stock ledger referencing the changes. The Numoda Court concluded that “[l]egislatively overturning these cases would seem to allow equity to act even in situations where corporate formalities are barely recognizable. The legislative synopsis, therefore, suggests that the General Assembly drafted the law in hopes of creating an adaptable, practical framework for corporations and their counsel. An important goal was to facilitate correction of mistakes made in the context of a corporate act without disproportionately disruptive consequences. Part of this effort was to eliminate hyper-technical distinctions and the uncertain divide between void and voidable acts. The drafters, however, did not set a clear limit on the Court’s power to remedy defective corporate acts.”
Although the statutory language could be read broadly to give the Court “wide latitude to fashion equitable remedies,” the Court did “not read the legislation as a license to cure just any defect.” Rather, in articulating the basic principle at the core of the Court’s analysis, the Court observed that it “cannot determine the validity of a defective corporate act without an underlying corporate act to analyze.” The Court agreed that “Delaware law allows boards to act despite some technical defects, such as lack of notice of a board meeting. Even an ultra vires act can be a corporate act. However, there must be a difference between corporate acts and informal intentions or discussions. Our law would fall into disarray if it recognized, for example, every conversational agreement of two of three directors as a corporate act. Corporate acts are driven by board meetings, at which directors make formal decisions. The Court looks to organizational documents, official minutes, duly adopted resolutions, and a stock ledger, for example, for evidence of corporate acts.” (Emphasis added.) While not imposing a specific limitation on its powers under Section 205, the Court indicated that it would look “for evidence of a bona fide effort bearing resemblance to a corporate act but for some defect that made it void or voidable.”
Determining whether there were any “corporate acts” involved a fairly nuanced analysis of the facts of the case. In applying the statute to validate a number of defective corporate acts as of their original dates, the Court found that the underlying board approvals were corporate acts, looking to evidence such as defective stock certificates, unsigned minutes, actions suggesting that the parties had accepted the acts as having occurred and, significantly, the premature ratification attempt. (Here, the Court noted that it would “not set aside the parties’ agreement absent countervailing concerns.”) Assessing the factors in Section 205(d), the Court observed that the parties had operated for years assuming the capital structure was in place, the board members purported to take official action and that, while validation would not cause material harm, one of the parties would lose a significant voting interest absent validation. The Court validated another issuance where the evidence supported the conclusion that there was a board meeting at which directors, acting in their capacity as directors, approved the issuance. The Court observed that, while “the directors of the two corporations, as a matter of practice, did not hold formal meetings, take minutes, or issue certificates, this was not ‘a case of a passing conversation at the water cooler.’ [The directors] met with an intent to discuss board business, one item of which was retaining [an employee] by granting him significant ownership in the companies.” Applying the five factors, the Court found that the parties had not previously questioned the validity of the shares, and some of the parties relied on representations that shares would be issued and would be harmed if they were not issued.
In contrast, the Court refused to validate an issuance where the evidence of a corporate act consisted only of “testimony and sundry documents, none of which replaces official stock ledgers or effective resolutions.” The proponent of validation in that instance was not even able to establish when the board attempted to approve the purported issuance. As a result, the Court had “no corporate act to validate for those shares.” Similarly, with regard to the spin-off, the Court found that there was “little doubt” that the parties intended to effect the spin-off on a specific date, and there was some evidence of corporate acts in alleged issuances and purported agreements. However, the court refused to validate the spin-off because “the record (particularly the uncertainty about [one of the company’s] board meetings and the absence of any completed stock certificates) at most suggests that the boards vaguely agreed that issuances would be effectuated at some point in the future.” The “bare-minimum corporate acts,” together with the “variable equitable factors” was not enough to compel the Court to validate the spin-off. (Later in the opinion, the Court issued a declaratory judgment that the subsidiary was formed and remained under the control of the parent.)
One of the parties also pursued relief under several other theories, including breach of contract, unjust enrichment, promissory estoppel, intentional misrepresentation and negligent misrepresentation. None of these was successful. Notably, the Court observed that “if Section 205 does not support a grant of equitable relief for a defective corporate act or putative stock, a plaintiff in these circumstances will frequently find it difficult to succeed on an alternative equitable theory.”