Recent Notable Changes To Delaware Corporate Law
This summer the Delaware legislature passed several amendments to the Delaware General Corporation Law (DGCL) which impact public and private companies incorporated in Delaware, and elsewhere, as many states follow the DGCL.
Mergers Using DGCL Section 251(h)
Section 251(h) was first enacted in 2013. Section 251(h) eliminates the need for shareholder approval to complete a merger, where such merger is completed following a tender or exchange offer and the acquirer owns at least the percentage amount of the target that is needed to approve the merger. That is, Section 251(h) eliminates unnecessary time and expense related to a vote on a merger when certain preconditions have been satisfied. These preconditions include:
- The merger must be consummated as soon as practicable following the tender offer or exchange offer;
- The underlying tender or exchange offer must be for all of the outstanding stock of the target, except for the stock owned by the acquirer or any person that directly or indirectly owns all outstanding stock of the acquirer, and any direct or indirect wholly owned subsidiary of any of the foregoing;
- The use of Section 251(h) can be a contractual election by the parties to the merger.
Section 251(h), when first adopted, prohibited its use when one of the merger parties was an “interested party”; however, a 2014 amendment eliminated this prohibition. DGCL Section 203 defines an “interested stockholder” to include any person who “has the right to acquire” 15 percent or more of the target’s voting stock.
The newest statutory change amends Section 262(b) governing shareholder appraisal (dissenter) rights to apply the “market out” exception to the availability of statutory appraisal rights for mergers consummated pursuant to Section 251(h) without a shareholder vote, following a tender or exchange offer. Prior to the amendment, Section 262(b) provided for appraisal rights in a 251(h) merger if not all the shares were held by the parent company.
Amended 262(b) aligns appraisal rights for Section 251(h) mergers to the same circumstances as one-step mergers where a vote of stockholders is required. That is, no appraisal rights are available for shareholders of any class or series of stock of a target corporation that is listed on a national securities exchange or held of record by more than 2,000 holders if the merger consideration for such shares consists solely of (i) stock of the surviving corporation or any other corporation (or depositary receipts in respect thereof) that is listed on a national securities exchange or held of record by more than 2,000 holders, (ii) cash in lieu of fractional shares or depositary receipts, or (iii) any combination of the foregoing. This provision is often referred to as the “market out” exception to appraisal rights.
Prior to this amendment, very few exchange traded companies relied on Section 251(h) to effectuate a merger after a tender offer or exchange involving stock consideration. With the amendment applying the market out provision to mergers under Section 251(h), the provision will likely gain in use.
In addition, the 2018 amendments modify Section 262(e) delineating the information which must be provided to dissenting shareholders in connection with a 251(h) merger. Section 262(e) previously required that the statement to dissenting stockholders include a disclosure of the aggregate number of shares not voted in favor of the merger, and for which appraisal rights were demanded and the aggregate number of holders of such shares. However, this provision was defective on its face, since the mechanics of Section 251(h) specifically eliminate the shareholder vote requirement and rather provides a mechanism by which a company can complete a merger following a tender or exchange offer without such shareholder approval. Amended Section 262(e) clarifies that the company must disclose the number of shares not purchased in the tender or exchange offer, and only upon request by a stockholder.
Appraisal rights are a statutory right whereby a company must offer certain dissenting or minority shareholders the right to receive the fair value of their shareholdings under certain circumstances, including merger transactions. That is, a shareholder can elect to be cashed out at the fair value of their equity instead of participating in a particular transaction. To elect their appraisal rights, a shareholder must follow very specific statutory formalities.
Section 262 of the DGCL governs appraisal rights for Delaware corporations. If a corporation is required to seek shareholder approval of a merger or consolidation, it must notify the shareholders that are entitled to vote on such merger or consolidation, of the availability of appraisal rights. Notice of the meeting and appraisal rights must be provided at least 20 days prior to the shareholder meeting. Moreover, the notice must include a copy of Section 262 of the DGCL itself for the shareholders to review.
In order to exercise their appraisal rights, a dissenting shareholder must (a) deliver a written demand to the company exercising their appraisal rights prior to the shareholder vote; (b) not vote in favor of the merger or consolidation; and (c) continuously hold their shares from the date of making the appraisal right demand through the date of the closing of the merger or consolidation. Thereafter, within 10 days of the closing of the merger or consolidation, the company must provide notice to all shareholders who properly delivered notification of appraisal rights that the transaction has closed.
Within 120 days of the effective date of the merger or consolidation, either the surviving corporation or any shareholder that has properly demanded appraisal rights and otherwise complied with Section 262, can commence an action in the Delaware Court of Chancery for the determination of the fair value of the shares held by such shareholder(s). Fair value is determined without including any added value from the merger or consolidation. That is, the dissenting shareholder is not entitled to vote against a transaction and request appraisal rights and get the increased (or decreased) value associated with the transaction.
For a more in-depth discussion of Delaware appraisal rights, see HERE.
Ratification of Defective Corporate Acts
Section 204 of the DGCL, which was first enacted in 2014, provides a method in which a corporation can ratify prior defective acts and stock issuances. Prior to the enactment of Section 204, courts had found that defective corporate acts or stock issuance could not be retroactively ratified. With the enactment of Section 204, the Delaware legislature allows a company to resolve defective corporate acts and uncertainties without disproportionately disruptive consequences. Section 204(a) sets forth a road map for a board to remedy what would otherwise be void or voidable corporate acts and stock issuances, and provides that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in [Section 204] or validated by the Court of Chancery in a proceeding brought under [Section] 205.” Pursuant to Section 204, a corporation’s board of directors may ratify one or more defective corporate acts by adopting resolutions setting forth the defective corporate act to be ratified, the date on which that act occurred, the reason why it is defective and that the board has approved the ratification of the defective corporate act or acts. A stockholder vote also is required to ratify the defective act if such a vote was required either at the time of the defective corporate act or at the time the board adopts the resolutions ratifying such act.
The 2018 amendments made several changes to Section 204. First, the amendments confirm that Section 204 remains available for ratifying defective corporate acts in circumstances where no shares of valid stock are outstanding. This amendment eliminates the need for any stockholder vote on the ratification of a defective corporate act in such circumstances, even if a vote of stockholders would otherwise be required under Section 204.
Second, the amendments provide that, in cases where a defective act involves the establishment of a record date for a vote of stockholders, and where a vote of stockholders will likewise be required for ratification of the act, the notice of the stockholder meeting for the ratification may be given to such holders as of the record date for the defective corporate act. This change will assist with a corporation’s ability to use the ratification mechanisms in Section 204 since most corporations, especially large ones, are likely to have a list of stockholders as of the record date for the defective corporate act. Furthermore, the amendments allow a public company that is listed on a national exchange to provide shareholder notice of a ratification through filings with the SEC under Exchange Act Sections 13, 14 or 15(d). As a reminder, Sections 13 and 15(d) provide for the general periodic reporting requirements of publicly reporting companies and Section 14 contains the proxy rules.
Third, the amendments confirm that a corporation may ratify a corporate act or transaction even if such act was void or voidable due to a failure of authorization. The amendment is intended to statutorily eliminate any implication arising from the court case of Nguyen v. View, Inc., which stated that an act or transaction may not be within the power of a corporation and therefore may not constitute a “defective corporate act” which could be cured by ratification, solely on the basis that it was not approved in accordance with the provisions of the DGCL or the corporation’s certificate of incorporation or bylaws. This amendment assumes that the failure to obtain proper authorization was not willful or purposeful. In the case where the failure to obtain authorization was deliberate, the subject corporate act could still be found to be void or voidable by a court.
Finally, the amendments allow for the ratification of an act or transaction that was consummated other than as disclosed in any proxy statement or consent solicitation. That is, if the disclosure that preceded the original shareholder approval was deficient in the first instance, Section 204 can be relied upon to cure the issue and ratify the act or transaction.
Forfeiture of Charter
The 2018 amendments modify Section 284 confirming that the Delaware attorney general has the exclusive authority to move for the revocation or forfeiture of a corporation charter for abuse, misuse or nonuse of its corporate powers, privileges or franchises by filing a complaint in the Court of Chancery. Section 284, as amended, provides that the Court of Chancery has the power to appoint a trustee to administer and wind up the affairs of a corporation whose charter has been revoked or forfeited pursuant to Section 284.
The recent Supreme Court of Delaware case, Eagle Force Holdings, LLC and EF Investments, LLC v. Campbell, has called into question whether Delaware will follow other states and allow representations and warranties to be enforced where the party seeking enforcement knew them to be false at the time of entering into the contract. Relying on the CBS v. Ziff-Davis case out of New York, most states do not require that a party prove reliance on representations and warranties in a claim for breach of such representations and warranties. Of course, if the party knew the representations were false at the time they were made and the contract entered into, they could not later claim that they relied on their truthfulness.
In a footnote, the Eagle case states:
We acknowledge the debate over whether a party can recover on a breach of warranty claim where the parties know that, at signing, certain of them were not true. Campbell argues that reliance is required, but we have not yet resolved this interesting question. See Genencor Int’l, Inc. v. Novo Nordisk A/S, 766 A.2d 8, 12 n.8 (Del. 2000) (noting that the Court did not need to decide whether detrimental reliance is an element of a claim for a breach of warranty because that issue was not squarely at issue in the case). And we observe that a majority of states have followed the New York Court of Appeals’ decision in CBS Inc. v. Ziff–Davis Publishing Co., 75 N.Y.2d 496, 554 N.Y.S.2d 449, 553 N.E.2d 997 (1990), which holds that traditional reliance is not required to recover for breach of an express warranty: the only “reliance” required is that the express warranty is part of the bargain between the parties. Id., 554 N.Y.S.2d 449, 553 N.E.2d at 1001 (“This view of ‘reliance’—i.e., as requiring no more than reliance on the express warranty as being a part of the bargain between the parties—reflects the prevailing perception of an action for breach of express warranty as one that is no longer grounded in tort, but essentially in contract.”); see also See Tina L. Stark, Nonbinding Opinion, Bus. Law Today, Jan.–Feb. 2006, at https://apps.americanbar.org/buslaw/blt/2006-01-02/nonbindingopinion.html (“Since the CBS case was decided, the majority of states have followed New York.”). We need not decide this interesting issue because such claims are not before the court. Further, Article IV, the “Representations and Warranties of Campbell,” begins by stating that “Campbell hereby represents and warrants to the Company that the following representations and warranties are, as of the Execution Date, and will be, as of the Closing Date, true and correct.” Executed Contribution Agreement, supra note 55, Article IV, at A668 (emphasis added). Thus, even though the parties apparently appreciated that the “reality” of not having signed releases in hand did not comport with certain representations at the time of execution, it appears the parties were willing to overlook any problem at signing and allow Campbell to strive to obtain any necessary releases by Closing.
To avoid an issue, I recommend adding an “anti-sandbagging” provision to all Delaware law-based contracts. Since courts will look to the plain language of a contract in the first instance, such provision expressly providing that there can be no waiver of an enforcement right, regardless of knowledge, will protect against the uncertainty of the court.
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