The Delaware Supreme Court has recognized that the stockholder franchise is the “ideological underpinning upon which the legitimacy of the directors managerial power rests.” A proper balance between the stockholders’ right to elect directors and the board’s right to manage the company is dependent on the stockholders’ unimpeded right to vote in an election of directors. Accordingly, Delaware courts carefully scrutinize board actions that are designed for the primary purpose of interfering with or impeding the effective exercise of a stockholder vote, especially board actions designed to dilute an insurgent stockholder’s vote in an election of directors.
In Coster v. UIP Companies, Inc., No. 49, 2020, --- A.3d ---- (Del. June 28, 2021) (Seitz, C.J.), the Delaware Supreme Court reversed the Court of Chancery’s decision, which had found that the board’s approval of a stock sale satisfied entire fairness review, to address whether the board’s approval of the sale was for the primary purpose of interfering with the plaintiff stockholder’s voting rights, and even if the board had acted in good faith, whether the board had a compelling justification for the sale necessary to survive judicial scrutiny under its seminal decision in Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. 1988).
By way of background, the Court of Chancery found that based on the timing of the stock sale, the conflicted majority of the board had approved the stock sale to dilute the plaintiff stockholder’s voting interest to below 50%, which broke the stockholder voting deadlock for electing directors. In short, the stock sale allowed the directors to entrench themselves on the board and thwart the potential appointment of a custodian over the company. The Court of Chancery held that the board’s approval of the stock sale was at a fair price that was set through a fair process under entire fairness review. The Court declined further review, reasoning that the stock sale had already satisfied the most rigorous standard of review – entire fairness.
The Delaware Supreme Court held that even if the board acted in good faith in its approval of the stock sale, if the board approved the sale for the primary purpose of interfering with the plaintiff stockholder’s voting rights, the board must still demonstrate a compelling justification for the sale to survive judicial scrutiny under Blasius. The Supreme Court reasoned that even if the stock sale was at an entirely fair price, that was not a substitute for further equitable review when the plaintiff stockholder alleged that an interested board approved the sale to interfere with her voting rights and leverage as an equal stockholder. Accordingly, the Supreme Court remanded the matter to the Court of Chancery to review its factual findings under Blasius, and if the Court found that the board approved the stock sale for inequitable reasons, to cancel the stock sale, and decide whether a custodian should be appointed.
* Albert H. Manwaring, IV (firstname.lastname@example.org) is the Chair of the Corporate and Commercial Litigation Practice of Morris James LLP in Wilmington, Delaware. The views expressed herein are those of the author, and do not necessarily represent the views of the Firm or its clients.