Claims Challenging Stock Issuance Validity Subject to Stay
The 2013 amendments to the Delaware General Corporation Law (DGCL) added new Sections 204 and 205, which set forth self-help procedures for a corporation to ratify, and vest the Court of Chancery with jurisdiction to validate, defective corporate acts, including the invalid issuance of stock, that might otherwise be void or voidable due to noncompliance with the DGCL or a corporation's organizational documents. These new sections were enacted in response and to overturn Delaware case law that held unauthorized corporate acts were void or voidable despite equitable considerations. (See, e.g., STAAR Surgical v. Waggoner, 588 A.2d 1130 (Del. 1991).) New Section 205 confers jurisdiction on the Court of Chancery to determine the validity of any corporate act or transaction, any stock, or right or option to acquire stock. Sections 204 and 205 became effective April 1.
The Court of Chancery recently had the opportunity to address whether plenary stockholder actions, challenging the validity of stock issuances under a corporation's organizational documents, should be stayed pending the disposition of a subsequent application brought by the corporation, seeking validation of the stock issuances by the court under new Section 205. In In re Cheniere Energy Stockholders Litigation, Consol. C.A. No. 9710-VCL, C.A. No. 9766-VCL (Del. Ch. Jun. 25, 2014) (Laster, V.C.) (Transcript Opinion), the Court of Chancery stayed plenary stockholder actions for breach of fiduciary duties against Cheniere Energy Inc. and its directors and officers, challenging the validity of stock allegedly issued in violation of Cheniere's bylaws, in deference to a subsequent application filed by Cheniere seeking validation of the challenged stock issuances pursuant to Section 205 of the DGCL.
In late May, stockholders of Cheniere commenced putative class and derivative actions against Cheniere and its directors and officers. The stockholder plenary actions alleged that directors, officers, employees and consultants of Cheniere were improperly awarded more than 17 million shares of Cheniere stock pursuant to an incentive compensation plan because the proposal to increase the stock available for issuance under the plan to make such awards did not receive approval by a majority vote of Cheniere's stockholders present at a stockholder meeting in accordance with Cheniere's bylaws. The stockholder plaintiffs asserted that Cheniere violated its bylaws under Delaware law by not counting stockholder abstentions as "no" votes in the stockholder vote to determine whether to increase the shares of Cheniere stock available for issuance under the plan. Had the abstentions been counted as "no" votes, the proposal to increase the stock available for issuance under the plan would not have received approval by a majority of the stockholders present at the meeting. Therefore, the stockholder plaintiffs asserted that because a majority of the stockholders present at the stockholder meeting did not approve the increase of stock available for issuance under the plan, Cheniere's subsequent issuance of stock awards of more than 17 million shares violated its bylaws.
In June, Cheniere and the defendant directors and officers moved to stay or dismiss the plaintiff stockholders' complaints during the pendency of Cheniere's Section 205 application, which was filed after the plenary stockholders' complaints. The Section 205 application sought a declaration from the Court of Chancery that the shares issued pursuant to the plan were validly approved by the stockholders. The defendants asserted the Section 205 application should be decided first because the court's validation of the stock awards under the plan would moot plaintiffs' plenary claims.
During a case-scheduling conference, the court heard argument on defendants' motion to stay or dismiss plaintiffs' complaints pending disposition of defendant Cheniere's later-filed Section 205 application.
Stay of Plenary Stockholder Claims Based on Section 205
Section 205 was developed to give the Court of Chancery the power to validate defective corporate acts that might otherwise be void or voidable under the DGCL or a corporation's organizational documents. Because the validation of the challenged stock awards would be dispositive of most of the issues in the stockholder plaintiffs' complaints, the court found that proceeding with the disposition of the Section 205 application first, and staying the plenary stockholder actions was the most efficient course of action. The court noted that there was no persuasive reason why the plenary stockholders' actions should proceed in advance or continue during the disposition of the Section 205 application. The court ruled that Section 205 allows validation of potentially defective corporate acts both as a matter of law, and also based on its consideration of the equities. The court indicated that the most efficient manner to proceed would be for the parties to make submissions on the "as a matter of law question" first. The court explained that if the stock awards were validated by the court as a matter of law, the Section 205 application would be complete, and significant aspects of the plenary stockholder actions would be mooted. If the court does not find that the stock awards were valid as a matter of law, the parties would then litigate whether the court should exercise its equitable discretion to validate the stock awards. The court pointed out the discretionary equitable validation question would likely require discovery and, therefore, the "as a matter of law question" should proceed first before the parties incurred the expense of discovery. Accordingly, the court stayed the plenary stockholder actions, and directed the parties to submit briefing on the "as a matter of law question" in the Section 205 application.
This is an important decision that provides another arrow in defendants' quivers to respond to and potentially stay plenary stockholder actions challenging the validity of a corporate act. The decision demonstrates the Court of Chancery may consider questions regarding the validity of corporate acts pursuant to new Section 205 in advance of plenary stockholder claims that challenge the validity of the corporate acts, which validation would potentially moot the stockholder claims.