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Delaware Adopts Curative Procedures for Invalid Past Corporate Actions

February 25, 2015
Delaware Business Court Insider

Business lawyers frequently face mistakes their clients make in documenting what they want to accomplish in terms of corporate actions, such as issuing stock. Clients will ask for advice years after they have delivered stock certificates to investors, but without actually authorizing that stock in any formal way. That stock is not valid. What to do about that and similar miscues has long been a problem.

In 2014, Delaware adopted two new provisions to the Delaware General Corporation Law, Sections 204-205. These new statutes permit invalid past corporate actions to be cured by the board of directors and stockholders or the Court of Chancery. Exactly what mistakes may be "cured," however, has not been entirely clear. Thus, the Court of Chancery's recent decision in In re Numoda Shareholders Litigation, Consol. C.A. No. 9163-VCN (Jan. 30, 2015), is helpful.

Numoda involved an all-too-common set of circumstances. The organizers and even later investors failed to keep a formal stock ledger of who owned what Numoda stock. They failed to adopt formal board resolutions when stock was issued and they failed to be clear about what rights, such as voting rights, the stockholders were to receive. Of course, after a falling out among the "owners," this mess had to be sorted out. Moreover, under Delaware law, absent a cure to these mistakes, much of the Numoda stock was "void." That meant the stock simply did not legally exist and some investors who thought they owned Numoda or its subsidiary businesses did not have any rights as stockholders. Who controlled Numoda was thus at stake. And as one would suspect, the various witnesses who testified had conflicting stories of what was done or when regarding Numoda's stock. Litigation followed.

The parties asked the Court of Chancery to sort out their mess under 8 Del. C. Section 205—the statute adopted in April 2014 that gave the court authority to cure past "defective corporate acts." But what did that authority include? That question is not entirely answered by the statutory language.

The court first turned to the scope of its authority. Understandably, the court was concerned that it not be involved in creating corporate actions, such as issuing stock, that had not really occurred but that the parties for whatever reason now wanted ratified. For example, mere "water cooler" discussions about possibly issuing stock were not the type of circumstances the court wanted to become involved in when so much uncertainty surrounded what the parties really intended.

Therefore, the court first held that it was limited to ratifying only an actual corporate "action." This means that the parties intended some specific result to occur where the parameters are sufficiently definite so that the court would not be asked to, in effect, make the deal for the parties by defining its terms. For example, a mere discussion about issuing stock with no clear agreement on the amount or the recipient is not sufficient to ask the court for ratification.

In addition, the court required some clear evidence of the action it was asked to ratify. Stock certificates, informal minutes or the like are needed to supply this certainty. Vague documents that do not reflect actual resolutions or mere testimony on what was intended is not sufficient.

The court then turned to the five factors set out in Section 205(d) to guide the court's discretion. Of these, perhaps the two most important are actual reliance by an innocent investor on the corporate action sought to be ratified and whether any person will be harmed by the ratification or the failure to ratify a defective corporate act. The court will not permit corporate insiders to benefit by their own failure to follow corporate formalities to deny ownership of an investor. The various factors to be considered are interrelated, but most are a variation of the theme that harm to investors or others who relied on the purported corporate act is to be avoided.

In short, Sections 204 and 205 provide a statutory remedy for the common neglect of corporate formalities. Those rules governing what must be done to take valid corporate action exist for good reason. They foster certainty that provides the security that is necessary to assume the risks of engaging in any business. But given the frequency those rules are violated in practice, Sections 204-205 provide welcome relief.

Delaware Business Court Insider  |  February 25, 2015