Equity Has Its Limits: Chancery Rejects Bid For An “Equitable Eraser”
It may seem obvious that “[e]quity cannot bless th[e] deliberate violation of an explicit statutory prohibition,” but in the recent Delaware Court of Chancery decision, TS Falcon I, LLC v. Golden Mountain Financial Holdings Corp., Vice Chancellor Lori Will reminded us of this maxim in the context of setting record dates for annual stockholders’ meetings. As discussed herein, the court declined to bless the defendants’ deliberate violation of the express language of Section 213(a) of the Delaware General Corporation Law, and further rejected the defendants’ request that the court apply Section 205 to cure this “defective corporate act.”
Statutory Overview and Factual and Procedural Background
Section 213 of the Delaware General Corporation Law addresses the fixing of dates for determination of stockholders of record for annual meetings. Part (a) thereof states expressly that “the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors.” In other words, if the board meets on June 15 and passes a resolution on that same day to set a record date, the record date cannot precede June 15.
In TS Falcon, however, the defendant board members “set a retroactive date for the annual meeting—an undisputed violation of 8 Del. C. § 213(a),” and “did so intentionally.” This act was undertaken after a 35% stockholder provided notice of its intent to exercise a contractual option to increase its stake from 35% to 44.9%. The defendants did so to sidestep the plaintiff stockholder’s notice and, ultimately, to shortchange the plaintiff’s voting rights regarding board nominees. This effort was effective: at the annual meeting, the defendants’ preferred nominees won the vote.
Therefore, the plaintiff stockholder in TS Falcon commenced a lawsuit in Delaware (pursuant to 8 Del. C. § 225), alleging that the defendants violated Section 213(a) and requesting that the Court of Chancery order that the board “revert to [its] pre-election composition[] until successor directors are validly elected.”
Undeterred, the defendants’ response included “a petition for validation under 8 Del. C. § 205,” which provides that, in the event of a “defective corporate act,” the Court of Chancery may “[d]etermine the validity of any corporate act.” Thus, the defendants’ petition for validation asked Vice Chancellor Will to overlook the defendants’ deliberate violation of Section 213(a) and instead declare that conduct to be valid pursuant to Section 205.
The Decision
Vice Chancellor Will swiftly resolved the plaintiff’s Section 213(a) claim, holding that the defendants’ resolution to impose a retroactive record date unequivocally violated Section 213(a): “The statute is not optional. It is unambiguous. . . [and] provides ‘no discretion to depart from its evident command.’”
The court also rejected the defendants’ invitation to validate the retroactive record date under Section 205. In so ruling, the Vice Chancellor considered five non-exhaustive factors under Section 215(d)(1)-(5), including: (1) whether the board believed at the time that their actions complied with the Delaware General Corporation Law, (2) whether anyone had acted in reliance on the validity of the act, (3) whether anyone would be harmed by the validation of the act, (4) whether anyone would be harmed if the court declined to validate the act, and (5) any other factors the court deems just and equitable. The court weighed these factors, and held that due to the lack of “ambiguity or potential uncertainty” in Section 213(a), “I cannot conclude that the Director Defendants set the record date believing that they were following Section 213(a)” because defendants “purposefully” violated the DGCL with the goal of “set[ting] a record date of one day before Falcon sent notice of its intent to exercise” its option. The court also concluded that the remaining factors weighed against the defendants, including that granting validation of the record date would harm the plaintiff and other shareholders because “the record date was purposefully fixed in contravention of the DGCL to frustrate a large stockholder.” Accordingly, the Delaware Court of Chancery ordered that the prior directors be reinstated until the next stockholder meeting to elect successor directors.
Conclusion
TS Falcon is an important reminder that directors must seek to abide by statutory requirements when taking board action and should not conclude that courts will overlook deliberate violations pursuant to Section 205. As Vice Chancellor Will put it, “Delaware courts strive to prevent such gamesmanship” and “Section 205 is not an equitable eraser for purposeful violations of clear statutes.”
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.
