Court of Chancery Explains When a Stockholder’s Right to Remove Directors May Be Limited to “For Cause” Only Removals
Section 141(k) of the Delaware General Corporation Law (DGCL) contains the default rule that a corporation’s stockholders have the right to vote to remove directors from the board “with or without cause.” Section 141(k) contains two exceptions to the default rule where the removal of directors may be limited to “for cause” only removals: (1) where the board is “classified” under Section 141(d) (i.e., has multiple classes of directors with staggered terms of service, in contrast to the default “straight” board having a single class of directors), or (2) where the stockholders have cumulative voting rights for director elections under Section 214 (rather than the default plurality voting rights). In accord with Court of Chancery precedent interpreting Section 141(k), Rohe v. Reliance Training Network, Inc., 2000 WL 1038190 (Del. Ch. July 21, 2000), a recent bench ruling by the Court of Chancery, In re Vaalco Energy Stockholder Litigation, C.A. No. 11775-VCL (Del. Ch. Dec. 21, 2015) (Laster, V.C.) (Transcript Opinion), invalidated a company’s charter and bylaw provisions that purported to limit the stockholders’ right to remove directors to “for cause” only removals where the company had an unclassified board consisting of a single class of directors and the stockholders had plurality voting rights for director elections.
Vaalco Energy, Inc. (“Vaalco”) previously had a classified board of directors and, as expressly permitted by the first exception to Section 141(k) for classified boards, its charter and bylaws contained provisions preventing stockholders from removing directors during their term of service unless the removal was “for cause.” In 2009, Vaalco’s stockholders voted to amend the company’s charter to declassify its board, but Vaalco left in place its existing charter and bylaw provisions that limited removal of directors “for cause” only.
In 2015, an activist investor sought to remove a majority of Vaalco’s directors without cause. Vaalco asserted that the investor’s effort would fail because its directors were only subject to removal “for cause” under its charter and bylaws. The plaintiff stockholders subsequently brought an action in the Delaware Court of Chancery seeking a declaratory judgment that Vaalco’s director removal “for cause” only charter and bylaw provisions were invalid under Section 141(k) of the DGCL.
Vaalco’s Removal “For Cause” Only Charter and Bylaw Provisions Violated Section 141(k)
Ruling from the bench, the Court of Chancery granted plaintiff stockholders’ motion for summary judgment on the ground that the company’s director removal “for cause” only charter and bylaw provisions were invalid under Section 141 of the DGCL. The Court relied on the plain language of Section 141(k), which begins with the default rule that “[a]ny director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors ….” (emphasis added). Section 141(k) has only two exceptions to the default rule: (1) where the board is classified, or (2) where the stockholders have cumulative voting rights for director elections. The Court reasoned that if neither of these exceptions is satisfied, the default rule of director removal “with or without cause” applies, precluding corporations with unclassified boards and plurality stockholder voting rights from limiting director removal to “for cause” only removals.
Notably, in reaching this conclusion, the Court rejected Vaalco’s argument that Section 141(d) authorized the “somewhat oxymoronic concept of a single-class classified board” that fell within Section 141(k)’s first exception to the default rule of director removal “with or without cause.” Relying on expert commentary to Section 141(d), the Court explained that the language in Section 141(d) referencing a corporation’s option to create “1, 2 or 3” classes of directors did not authorize a single-class classified board, but rather, in combination with other language in that section, served to clarify that special stock directors appointed by the holders of a class or series of stock would not be considered an additional class of directors on top of an unclassified board. The Court also was not persuaded by Vaalco’s argument that the Court should validate its director removal “for cause” only charter and bylaw provisions under Section 141(k) because many other public companies (allegedly in the hundreds) had the same or similar charter or bylaw provisions and also could not satisfy either of Section 141(k)’s two exceptions to the default rule.
After the parties reached a negotiated resolution to their dispute, Vaalco did not appeal the Court’s bench ruling. The Vaalco ruling therefore stands as the latest court guidance to boards and their stockholders on removal of directors under Section 141(k). Companies in Vaalco’s situation, with unclassified boards and plurality stockholder voting rights but having director removal “for cause” only charter or bylaw provisions, should be aware that stockholders may seek to bring actions seeking compliance with the Vaalco ruling and then claiming an attorneys’ fee award for the purported benefit attributable to any conforming amendment the company makes to its organizational documents. Those companies might consider moving preemptively to avoid these stockholder actions and amend their charter or bylaws to comport with the Court’s bench ruling in Vaalco.Share