Chancery to Directors: Don’t Play Dirty

The Delaware Court of Chancery recently provided a powerful reminder of the Court’s equitable purpose, and how it will not countenance bad faith or duplicity. In Ghatty v. Mudili et. al., three board members of a five-member board voted at a special board meeting to remove the remaining two directors from their officer positions, and later sued under 8 Del. C. § 225 to seek confirmation that the two directors had been validly removed from their officer roles. The Defendants challenged their removal on a number of grounds. The Court of Chancery considered one argument dispositive: that the meeting notice was inherently deficient because the meeting agenda omitted the removal action effectuated at the meeting, and indeed misleadingly suggested that one Defendant’s officer role would be expanded. The Court condemned the notice as “duplicity,” voided the vote, and held that the Defendants remained officers of the Company.

The Meeting Notice

The stated purpose of the meeting was to discuss how to bring “better governance and transparency” to the Company, and the agenda included the following items:

• Review of requests for financial statements, bank records, and supporting documentation;
• Discussion of alleged unauthorized transactions or approvals;
• Proposal for new signatory protocols and centralized finance email;
• Proposed recognition and role expansion for one of the Defendants; and
• Any additional matters raised by board members or shareholders in good faith.

Following the notice, there were additional communications amongst the directors detailing the items for discussion at the meeting. Notably, the removal of the Defendants as officers was never mentioned. In fact, although one Plaintiff director raised certain “potential areas of concern,” he specifically said that the meeting notice was not “an accusation of wrongdoing against any individual,” but was instead “a formal invitation to clarify and remedy any potential governance shortfalls,” and he invited the directors to “submit any ‘contrary evidence’ and ‘additional agenda items’ ahead of the meeting.” He also mentioned one Defendant’s “notable contributions,” and proposed that he be appointed Chief Revenue Officer and given enhanced compensation.

Before the board meeting, however, there was a “falling out” between that director and the Defendants. The latter then said that they would be unable to attend the meeting due to their “tight schedules.” The meeting went forward as planned, with only the three Plaintiff directors in attendance. Later resolutions state that, at the meeting, the three Plaintiff directors removed the Defendants as officers of the Company.

The Court found that the meeting notice technically complied with the Company’s bylaws, but nevertheless voided the vote taken at the meeting because the notice was not equitable. Instead, the Court considered it a “bait and switch that concealed the Plaintiffs’ intention to remove [the Defendants] as officers.” In holding that the Defendants remained officers of the Company, the Court stressed that “[e]quity will not abide such duplicity toward fellow directors.” The Court also rejected the argument that notice was not required where the targeted directors lacked the power to block the action, stressing that “[f]air notice fosters a genuine deliberative process – a purpose that was subverted here.”

Lessons Learned

Ghatty offers some important lessons about the value of good governance when taking board action:

• Directors are entitled to a “fair and non-misleading notice of the agenda for a special meeting,” even if the notice technically complies with the bylaws. When drafting agendas, consider whether the agenda adequately describes the discussion points and decision items for the meeting.
• Holding Regular Meetings. This meeting was the Company’s first in-person board meeting in three years. This fact was relevant to the determination of whether the meeting was a “regular” or “special” meeting. That distinction can be significant, particularly in instances where the company’s bylaws have different notice requirements for regular versus special board meetings.
• Clear Bylaws. The Court began its analysis by turning to the Company’s bylaws. In support of their argument that the meeting notice was deficient, the Defendants cited to a stockholder meeting provision in the bylaws that required a specific statement of the meeting’s purpose. Because the bylaws lacked an analog requirement for board meetings, the Court found that the notice was technically sufficient, and had to rely instead on its equitable power to reach its result. Consider whether there are unintentional gaps or inconsistencies in your company’s bylaws that can be clarified or corrected to provide more certainty and consistency across governance items. Also remember that bylaws set the rules for the game, but, as seen in Ghatty, can’t protect against bad faith.
• Records and Meeting Minutes. The Court referenced the fact that there were no contemporaneous minutes or evidence of the meeting, only a resolution dated a couple of weeks later stating that, at the meeting, “appropriate resolutions were adopted, changing certain officer and signatory roles within the Company.” Although the Court did not rely on this fact in its holding, it is a helpful reminder of the importance of appropriately and timely documenting actions taken at a meeting.

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.