Legislation is currently working its way through the Delaware legislature that, if approved, will make several substantive changes to the Delaware General Corporation Law, 8 Del. C. §1-101 et. seq. (the DGCL), that governs Delaware corporations. This article summarizes three of the most significant proposed changes: (1) the creation of procedures to ratify acts where valid authorization of the original act may be subject to question, (2) the authorization of back-end mergers following a successful tender offer or exchange offer without the need to obtain 90 percent ownership or a stockholder vote, and (3) the creation of public benefit corporations. These changes are contained in House Bill 127 and Senate Bill 47. You can obtain copies and check their status on the Delaware legislature’s website at http://legis.delaware.gov/.
Ratification of Defective Acts
Proposed DGCL Sections 204 and 205 are intended to address situations where corporate acts or transactions, including the issuance of stock, have been found to be “void” due to a failure by the company to comply with provisions of the DGCL or the corporation's organizational documents. Delaware courts have held that such acts are not subject to ratification or validation by any means. See e.g., STAAR Surgical Co. v. Waggoner, 588 A.2d 1130 (Del. 1991), and Blades v. Wisehart, 2010 WL 4638603 (Del. Ch. Nov. 17, 2010). Currently, if an act lacks proper corporate authorization, the question arises under Delaware law whether the act is “void” or “voidable.” Void acts cannot be ratified but voidable acts can. Unfortunately, the distinction under Delaware law between void and voidable acts can sometimes be confusing.
Section 204 establishes “self-help” procedures to ratify defective corporate acts. In general, ratification requires a resolution by the board of directors which contains certain specified information. Stockholders must ratify the defective corporate act if (1) a stockholder vote would have been required to authorize the defective act at either the time of the defective corporate act or at the time of ratification, or (2) the defective act results from a failure to comply with Section 203 of the DGCL. If stockholder approval is required, notice must be given to all current holders of the corporation’s valid stock and putative stock and all stock holders as of the time of the defective corporate act, unless such holders cannot be determined from the corporation's records. If stockholder approval of the ratification is not required, the statute still requires that the corporation provide notice of the adoption of the ratifying resolution to all valid or putative current stock holders and also to all valid or putative stock holders as of the time of the defective corporate act. The statute identifies specific information that must be included in the notice to stockholders including a statement that any action to challenge the ratification process must be brought within 120 days.
In general, the quorum and vote requirements necessary for ratification are those that would have applied to approval of the original act, except that (1) ratification of the election of a director requires the affirmative vote of the majority of shares present at the meeting and entitled to vote on the election absent super-majority voting provisions that may otherwise be applicable, and (2) ratification of a failure to comply with Section 203 requires the vote required under Section 203(a)(3).
New Section 205 establishes judicial procedures to address ratification issues and confers jurisdiction on the Court of Chancery to hear and determine the validity claims arising from attempted ratifications. Anyone having notice of a proposed ratification must file any claim challenging the ratification within 120 days from the date that the defective act is validated. After that time, a defective corporate act ratified pursuant to Section 204 may not be invalidated or subject to the imposition of conditions in an action under Section 205.
Back-End Mergers Without a Stockholder Vote
The proposed amendments also would add a new Section 251(h) which would eliminate the need for a stockholder vote to authorize a second-step merger after a public tender offer or exchange offer, subject to certain requirements. This provision is a response to, and will likely supplant, the current use of “top-up” options to facilitate short form mergers under Section 253 of the DGCL.
The provisions of Section 251(h) would be available only to target corporations that have shares listed on a national securities exchange or held of record by more than 2,000 holders immediately prior to the execution of the merger agreement. A vote of the target corporation’s stockholders would not be required to authorize a second-step merger if (1) the merger agreement specifies that subsection “(h)” applies and the second-step merger will be effected as soon as practicable following the consummation of the tender or exchange offer; (2) the acquiring corporation consummates the contemplated tender or exchange offer for any and all of the outstanding stock of the target corporation; (3) after consummation of the offer, the acquiring corporation owns at least the percentage of stock required to adopt the merger agreement if a vote were held; (4) at the time the merger agreement is approved by the target’s board, no other party to the merger agreement is a Section 203 “interested stockholder”; (5) the acquiring corporation merges with the target corporation pursuant to the merger agreement; and (6) the outstanding shares of the target corporation not canceled in the merger are converted into the same amount and kind of consideration paid for shares in the tender or exchange offer. New subsection 251(h) does not alter the fiduciary duties of directors in connection with such mergers or the level of judicial scrutiny that would apply to the decision to enter into such a merger agreement.
Public Benefit Corporations
The amendments would add a new Subchapter XV to the DGCL authorizing the creation of “public benefit corporations.” A public benefit corporation is a for-profit entity which is managed not only for the pecuniary interests of its stockholders but also for the benefit of other persons, entities, communities, or interests identified in the corporation’s certificate of incorporation. Approximately 17 states have passed some type of public benefit corporation statute and 11 others (including Delaware) are currently considering it. There are many variations among the statutes enacted by various states, but the Delaware statute balances Delaware’s historical approach of providing flexibility to investors and managers to structure relationships in the manner they deem most appropriate, with the need for transparency so that investors can meaningfully determine how their economic interests are being balanced with and affected by the corporation’s pursuit of its non-economic purposes.
To accomplish those ends, Delaware’s proposed statute would require a public benefit corporation to identify in its certificate of incorporation the specific public benefit or public benefits to be promoted. In addition, the statute would (1) require public benefit corporations, at least every two years, to issue to stockholders statements containing information that will allow stockholders to evaluate whether the objectives of the corporation are being accomplished, and (2) permit the corporation to impose additional requirements to facilitate stockholders’ ability to evaluate the public benefit corporation’s achievement of its purposes.
Because the statute requires directors to balance stockholders’ economic interests with the other intended benefits, the statute contains safeguards intended to prevent an investor from unknowingly, inadvertently, or involuntarily investing in a public benefit corporation. The certificate of incorporation and the name of the corporation must both clearly indicate that a corporation is a public benefit corporation. All stock certificates and notices of meetings must contain statements acknowledging that the corporation is a public benefit corporation. A 90 percent vote of stockholders in a regular corporation is required to convert that company to a public benefit corporation, and any stockholder in a corporation that elects to convert to a public benefit corporation is entitled to appraisal rights.
Recognizing the difficult balancing of interests that directors of public benefit corporations will be asked to undertake, the Delaware statute provides significant protections to directors. Only stockholders can assert claims against the directors. Non-stockholders who claim an interest in the specified public benefits or who claim to be materially affected by the corporation’s conduct lack standing to sue the directors. Directors also receive significant protections against claims by stockholders challenging disinterested decisions. Directors of public benefit corporations are deemed to have satisfied their fiduciary duties if the director’s decision is informed and disinterested and stockholders challenging such a decision show that no person of ordinary sound judgment would have approved the challenged action. The statute also permits public benefit corporations to include in their certificate a provision specifying that directors cannot be subject to monetary liability and must be entitled to indemnification in connection with any decision in which they are disinterested.
Stockholders of public benefit corporations are authorized to sue derivatively to enforce the directors’ duties, but only if at the time suit is filed those stockholders, individually or collectively, own (1) at least 2 percent of the corporation’s outstanding shares, or (2) as to corporations with shares listed on a national securities exchange, the lesser of 2 percent of the outstanding shares or shares with a market value of at least $2 million.
If enacted, the ratification amendments would become effective on April 1, 2014, and the public benefit corporation statute and Section 251(h) amendments would become effective on August 1, 2013. The proposed amendments also address other important topics including new requirements to discourage the formation of “shelf corporations.” Passage of these bills appears likely, so corporate lawyers should begin planning for their implementation now.