In Lions Gate Entertainment Corp. v. Image Entertainment Inc., 2006 WL 1668051 (Del. Ch. June 5, 2006), the Delaware Court of Chancery (i) struck down a provision contained in Image’s bylaws that attempted to give the directors power to amend the bylaws when that power was not conferred in the charter, (ii) voided a charter provision that attempted to give the Image directors the right to amend the charter without stockholder approval, and (iii) held that Image was not entitled to reformation of the charter and bylaws.
Lions Gate Entertainment, Inc. (“Lions Gate”) is a British Columbia corporation that produces and distributes motion pictures, television programming, and home entertainment. Image Entertainment, Inc. (“Image”) is a Delaware corporation and is a direct competitor of Lions Gate. At the time of the lawsuit, Lions Gate beneficially owned approximately 19 percent of Image’s outstanding shares, making it Lions Gate’s second largest stockholder at the time. Image is the surviving corporation of a reincorporation merger in which Image’s then-parent, Image Entertainment, Inc., a California corporation (“Image-California”), merged into Image.
Prior to the 2005 annual meeting of the stockholders of Image-California, its board of directors received a draft proxy statement describing a proposed merger that would result in the company becoming a Delaware corporation. The draft proxy was approved by the board July 12, 2005. Attached to the draft proxy was a merger agreement that included the charter and bylaws that would govern Image – the surviving Delaware corporation. Those documents contained the provisions that were the subject of this litigation. The most contentious of the provisions, the Classified Board Provision, provides:
The directors shall be divided into three classes, designated Class I, Class II, and Class III, as nearly equal in number as the then total number of directors permits. At the 2006 annual meeting of stockholders, Class I directors shall be elected for a one-year term, Class II directors for a two-year term and Class III directors for a three-year term. At each succeeding meeting of stockholders beginning in 2007, successors to the class of directors whose terms expire at that annual meeting shall be elected for a three-year term….
On July 12, 2005, pursuant to written consent, the Image-California board approved both the reincorporation and the merger agreement. On July 27, 2005, Image filed its definitive proxy statement with the Securities and Exchange Commission (“SEC”). The proxy statement summarized the terms and of the charter and bylaws to govern Image and attached the merger agreement, the charter and bylaws. On August 1, 2005, Image-California filed its charter with the Delaware Secretary of State, the Image board acted by unanimous consent to adopt the bylaws, and the Image-California board acted by unanimous written consent to approve the reincorporation merger.
On September 9, 2005, Image-California held its 2005 annual stockholders’ meeting. At the meeting, there was no mention of the board becoming classified at that time. When nominating the candidates for election to the board, Image-California’s President, CEO and Chairman of the Board, Martin Greenwald, stated that he was nominating individuals to serve until the next annual meeting. At the close of the meeting, Greenwald declared that the names of the six directors who had been elected as directors were to serve until the next annual meeting and until their respective successors are elected and qualified. On that same day, Image filed a Form 8-K disclosing that the stockholders had approved the election of six nominees to the board, and approved the reincorporation from California to Delaware.
On September 13, 2005, Lions Gate filed a Schedule 13D with the SEC disclosing its purchases of stock and an offer to acquire Image at a substantial premium to Image’s pre- and post-offer trading price. From September through November 2005, Lions Gate engaged in discussions with Image regarding a negotiated acquisition. The Image board ultimately rejected Lions Gate’s proposal and terminated discussions.
In December 2005, Lions Gate discovered the disputed language in the bylaws, which provides that the Image board will not become classified until the 2006 annual meeting. On March 26, 2006, Lions Gate filed an amendment to its Schedule 13D with the SEC, whereby it disclosed it had lost confidence in the ability of Image’s current board to maximize shareholder value and it was contemplating nominating a slate of six directors for Image’s 2006 annual meeting. On that same day, Lions Gate filed its lawsuit in the Delaware Court of Chancery seeking (i) a declaration that Image’s board will not become classified until the 2006 annual meeting and that all of the board seats are up for election at that meeting; (ii) a declaration that the board does not have the authority to amend Image’s bylaws; and (iii) a declaration that the board does not have the authority to amend Image’s charter without a stockholder vote.
Image answered the complaint, raised certain affirmative defenses and asserted a counterclaim seeking reformation of its charter and bylaws. Lions Gate moved for summary judgment on the three declarations it sought, and moved to strike Image’s affirmative defenses and its counterclaim. To the extent that the affirmative defenses and counterclaim survived Lions Gate’s motion to strike, Lions Gate sought summary judgment on Image’s affirmative defenses and counterclaim. Image eventually conceded that the Charter Amendment Provision was invalid and withdrew the allegations in its counterclaim that such provision was the result of drafting error and waived its related request for reformation.
As to the determination of whether the Classified Board Provision established a classified board that became staggered at the 2006 annual meeting, or rather, at the 2005 annual meeting, the Delaware Court of Chancery looked at the plain meaning of the provision. The Court found the Classified Board Provision to be clear and unambiguous that the board would become staggered at the 2006 annual meeting. The Court further expounded that even if the provision were not clear on its face, Lions Gate would be entitled to summary judgment because: [T]he presumption of annual director elections is an fundamental electoral right that exists under the default provisions of Delaware law. The implementation of a classified board is a fundamental governance change. The loss of a final opportunity to elect the whole board has an obvious disenfranchising effect, and any ambiguity in the Classified Board Provision must therefore be construed against the drafter, Image.
The Delaware Court of Chancery also held that provisions in corporate bylaws or charters that violate the Delaware General Corporation Law are invalid and void. The Court struck down Image’s bylaw provision that attempted to give the Image direcwas not conferred in the charter. The Court turned to Section 109 of the Delaware General Corporation Law on this issue, which states that a board of directors has the power to amend a corporation’s bylaws only if the charter “confer[s] the power to adopt, amend or repeal the bylaws upon the directors.” In the absence of such a charter provision, a bylaw cannot confer this power on the board of directors. Similarly, the Court also voided a charter provision that attempted to give the Image directors alone the right to amend the charter. Image’s Charter Amendment Provision purports to provide that the charter can be amended by the board or the shareholders. The Court held that pursuant to Section 242 of the Delaware General Corporation Law, an amendment to the charter “requires both (i) a resolution adopted by the board of directors setting forth the proposed amendment and declaring its advisability and (ii) the approval of a majority of the outstanding stock entitled to vote on the amendment.” The Court reasoned that because the Charter Amendment Provision purported to amend the charter unilaterally without a shareholder vote, it contravened Delaware law and was invalid.
Moreover, the Delaware Court of Chancery rejected Image’s affirmative defenses. In doing so, the Court upheld Delaware’s strict standard for retroactive application of a certificate of correction and rejected Image’s affirmative defense of reformation. In addition, the Court reiterated the Delaware Supreme Court’s holding in Staar Surgical v. Waggoner, 588 A.2d 1130 (Del. 1991), stating:
“[E]quitable principles cannot be employed to change the terms of authoritatively binding corporate documents. The law properly requires certainty in such matters.”
At the end of the day, the Delaware Court of Chancery concluded that the entire Image board would be up for election at the 2006 annual meeting and such could not be altered by the board, without proper stockholder approval. This decision demonstrates the need to carefully implement a staggered board provision. It also reiterates that limitations on voting rights are strictly construed in Delaware.