Delaware courts will use their equitable powers to invalidate otherwise valid board actions tainted by inequitable deception. Where a director is “‘tricked or deceived into attending a board meeting … the general rule is that actions taken at such a meeting are void.’” Delaware law requires that directors be truthful and candid in their interactions with their fellow directors, and does not permit inequitable sandbagging by fellow board fiduciaries. In short, even if the board action is legally authorized under a company’s organizational documents, deceiving fellow directors to procure their attendance at a board meeting under false pretenses, may be grounds for invalidating board actions taken at that meeting under equitable principles.
In Bäcker v. Palisades Growth Capital II, No. 156, 2020, — A.3d —- (Del. Jan. 15, 2021) (Montgomery-Reeves, J.), the Delaware Supreme Court clarified the circumstances left unanswered in its seminal decision in Klaassen v. Allegro Development, 106 A.3d 1035 (Del. 2014), in which Delaware courts may invalidate board actions based on deception, trickery, or inequitable conduct of fellow directors.
By way of background, a co-founder, majority common stockholder and board member, who had been recently terminated as CEO, appeared to accept his termination, and to support the candidacy of his proposed replacement as CEO and to appoint the new CEO to the board. But, based on the trial record, the court found that the co-founder, together with his father, who also served as a director, took advantage of an unexpected independent director’s resignation on the eve of a board meeting. The sudden resignation gave the co-founder and his father a board majority, enabling them to reverse the board’s course and reappoint the co-founder as CEO. The third director appointed by the preferred stockholders was deceived as to this secret counter board agenda to reappoint the co-founder to the CEO position and seize control of the board. The Supreme Court accepted the lower court’s finding that the co-founder and his father tricked the preferred director into attending the board meeting under false pretenses that the board was going to appoint the replacement to the position of CEO and appoint the new CEO to the board. If the preferred director had known the true board agenda, he could have chosen not to attend the board meeting, which in turn, would have left less than a quorum of three directors necessary for valid board action under the company’s organizational documents. In short, the preferred director could have defeated a board quorum by not attending the meeting, and prevented the co-founder from reobtaining his CEO position and control of the board.
The Delaware Supreme Court affirmed the Court of Chancery’s decision to invalidate the actions taken at the board meeting based on inequitable sandbagging of the preferred director, who was duped into attending the board meeting under false pretenses to meet quorum requirements necessary for valid board action under the company’s organizational documents. The Supreme Court found that the Court of Chancery did not impose an equitable notice requirement at a regular meeting of the board, where Delaware law does not require notice of an agenda. Instead, the “source of inequity” was the co-founder and his father’s “decision to secretly plan an ambush after feigning support for the planned governance items.” Importantly, the Supreme Court ruled that the attendance-by-deception prohibition applied to a regular meeting of the board, even though the rule arose from prior decisions involving special meetings. The Supreme Court reasoned that “regardless of the type of meeting or form of communications, Delaware law does not countenance deception designed to manufacture a quorum or otherwise induce director action.”
Notably, because the defendants had not raised the issue before the Court of Chancery in a timely manner before discovery closed and the trial was completed, the Supreme Court did not address whether the preferred director’s continued participation in the board meeting after realizing the deception may have precluded invalidation or waived the ability to challenge the validity of the board actions under the rule in Koch v. Stearn, (Del. Ch. July 28, 1992), overruled on other grounds by Klaassen v. Allegro Development, 106 A.3d 1035, 1047 (Del. 2014). Also, while the board actions in Bäcker were found void based on the alleged inequitable conduct, the decision did not address whether the board action was “void” because the deception rose to a level of fraud or bad faith, or was merely “voidable” if performed in the interests of a company, but beyond the authority of management—board actions that are voidable, as opposed to void, remain subject to equitable defenses, such as estoppel or laches.
Delaware Business Court Insider l February 10, 2021
If you have questions or would like more information, please contact Albert Manwaring (amanwaring@morrisjames.com; 302.888.6868).
