In Espinoza v. Zuckerberg, 2015 WL 6516691 (Del. Ch. Oct. 28, 2015), the Delaware Chancery Court held that a disinterested controlling stockholder may not ratify a transaction approved by interested directors by expressing assent to the transaction informally. Instead, ratification requires either holding a vote at a stockholders meeting or executing a written consent. This case highlights the importance of following the corporate formalities imposed by Delaware law.

The board of directors of Facebook approved a compensation plan for outside directors, who held six of  the eight seats on the board. Ernesto Espinoza, a Facebook stockholder, brought a derivative claim challenging the board’s action as a self-dealing transaction subject to judicial review under the entire fairness standard, rather than under the comparatively lenient business judgment rule. After the suit was filed, Mark Zuckerberg, who then held a 61.6% voting interest in Facebook, purported to ratify the board’s decision through statements made in a deposition and an affidavit.

Under Delaware law, the business judgment rule applies in lieu of the entire fairness standard if an interested transaction is ratified by a fully informed, disinterested majority of the stockholders. Under Section 228 of the Delaware General Corporation Law, ratification may be accomplished by holding a vote at a stockholders meeting or by executing a written consent. While Section 228 allows for ratification via written consent by a majority stockholder without a meeting or a vote, subsection (e) of Section 228 requires such majority stockholder to notify non-assenting stockholders promptly after the written consent has been given. Zuckerberg argued that his affidavit and deposition each ratified the compensation plan, as though informal approval were a valid alternative.

The Delaware Chancery Court, however, disagreed. It ruled that the requirements of Section 228 must be strictly complied with to render ratification of an interested transaction effective. Thus, in this case, Zuckerberg was required either to vote at a stockholders meeting or execute a written consent. In reaching this ruling, the court expressed its concern that disregarding Section 228 requirements may lead to a slippery slope of informal approvals, such as clicking “like” on a company’s Facebook page. In addition, the court emphasized that formal procedures protect the corporation and its stockholders by promoting transparency for non-assenting stockholders.

Espinoza v. Zuckerberg emphasizes that controlling stockholders must heed the formalities required under Delaware corporate law. Given that adhering to such procedures is remarkably less expensive than defending against a shareholder claim such as this one (as the court remarked), implementing steps to ensure that legal formalities are observed is a worthwhile investment of effort.