In Coster v. UIP Companies, Inc., ___ A.3d ___, 2023 WL 4239581 (Del. Jun. 28, 2023), the Delaware Supreme Court affirmed the Court of Chancery’s post-trial holding that extraordinary circumstances justified a dilutive stock issuance intended to affect stockholder voting rights.
After the death of a co-founder, who also was one of two 50% stockholders, his shares transferred to his spouse. The parties were unable to agree on a buyout of her shares. Subsequently, the stockholders did not agree, and deadlocked, on electing new directors. The spouse then brought an action seeking the appointment of a custodian under 8 Del. C. § 226, with a mandate including broad rights to manage the business. The directors feared that the appointment of a custodian with such a broad mandate might cause key customers to exercise termination rights in their agreements, which would imperil the business. To preserve the business, the directors approved a stock issuance to a key employee, altering the 50/50 ownership structure. The directors did this to break the stockholder deadlock, to moot the request for a custodian, to further a succession plan that the co-founder had supported, and to honor a longstanding promise to provide the key employee an equity interest. In its post-trial decision, the Court of Chancery found that the directors were not ill-motivated, and in fact they had the requisite compelling justification for the disputed stock issuance.
On appeal, the Delaware Supreme Court reviewed certain controlling precedents—including Schnell v. Chris Craft Industries, Inc., 285 A.2d 437 (Del. 1971), Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. 1988). The Supreme Court reasoned that “… Schnell and Blasius review, as a matter of precedent and practice, have been and could be” analyzed within the Unocal framework. Under Unocal, defensive measures in response to a threat to control are subject to enhanced scrutiny, both for being well-motivated to protect important corporate interests, and also as not being unduly coercive or preclusive of stockholder voting rights. Here, the stock issuance was motivated by a need to protect important corporate interests, as discussed above. With respect to the effect on the voting rights, while the addition of a third stockholder may have “foreclosed [the plaintiff] from perpetuating the deadlock,” the new three-stockholder regime may have more effectively allowed her to exercise control, such as by casting a “swing vote” at stockholder meetings on matters where the other two were divided. Accordingly, the Supreme Court affirmed the Court of Chancery’s ruling that the defendant-directors sustained their burden to show that the stock issuance complied with their fiduciary duties.