Analysis of the 2018 Amendments to the Delaware General Corporation Law
The 2018 amendments to the Delaware General Corporation Law (the "DGCL") were recently enacted.2 The amendments update the ratification statute, Section 204, to address recent case law. Nonstock or "membership" corporations are now also permitted to use the statutory ratification provisions to cure corporate defects. With respect to the avail- ability of appraisal rights in connection with medium-form mergers, the "market out" exception of the appraisal statute, Section 262, has now been extended to apply to medium-form mergers effected pursuant to Section 251(h). The 2018 amendments make several other minor updates to the DGCL, which are described below.
Contents of certificate of incorporation [§102]
Section 102 requires that a corporation’s name as set forth in its charter be distinguishable from the names of other Delaware entities. In 2018, amendments to the Delaware Limited Liability Company Act were adopted (and will be effective August 1, 2019) to permit the creation of a new type of series limited liability company called a "registered series," which requires a filing with the Delaware Secretary of State. Section 102 requires that the name of a Delaware corporation be distinguishable from any "registered series" of a limited liability company. This amendment will become effective on August 1, 2019.
Application of chapter to nonstock corporations [§114]
Section 114 governs the application of the DGCL to nonstock corporations - i.e., corporations that have "members" instead of stockholders. Section 114 sets forth a general rule that the DGCL’s provisions regarding stockholders and boards of directors of stock corporations apply to, respectively, "members" and "governing bodies" of nonstock corporations. Section 114 then excludes several DGCL sections from the general rule. When Delaware’s statutory ratification provision (Section 204) was initially adopted, Section 204 and the related Section 205 were included in the list of exceptions to the general "translator" rule of Section 114. The 2018 amendments permit nonstock corporations to use the ratification procedures of Sections 204 and 205 by deleting those sections from the list of exceptions in Section 114. The amendments to Section 114 became effective on August 1, 2018.
Ratification of defective corporate acts and stock [§204]
The 2018 amendments enact several changes to the DGCL’s statutory ratification provision, Section 204. The amendments to Section 204 are effective only with respect to defective corporate acts ratified pursuant to resolutions of a board of directors adopted on or after August 1, 2018.
The definition of "defective corporate act" in Section 204(h)(1) has been amended to confirm that the ratification procedures of Section 204 are broadly available for a corporation to ratify any act that a Delaware corporation has the power to take under the applicable provisions of the DGCL. This amendment was made in response to Nguyen v. View, Inc., C.A. No. 11138-VCS (Del. Ch. June 6, 2017), which could have been read to imply a narrower scope to Section 204 than was generally understood by Delaware practitioners.
- Nguyen focused on a preferred stock financing round completed several years before the litigation. Common stockholder approval was required to effect the financing. The holder of a majority of the common stock initially consented to the financing, but later purported to revoke his consent after the financing had closed. The corporation took additional corporate actions for several years relying on the validity of the financing. Subsequent arbitration proceedings concluded that the consent was validly revoked, and in response the corporation attempted to ratify the financing using Section 204. The common stockholder challenged the ratification. The corporation moved to dismiss the common stockholder’s complaint.
- The Court of Chancery denied the motion and distinguished between actions that are invalid due to "failures of authorization" and acts that are deliberately "rejected" by the stockholders at the time of the act. The Court then concluded that because the financing and related actions had been "deliberately rejected" by the holder of a majority of the common stock outstanding at the time of the financing, it could not be ratified through Section 204.
To address practitioners’ concern that the Nguyen case meant an act could not be ratified because it had not been properly approved by stockholders, the amendments clarify that an act or transaction is within the power of a corporation - and, therefore, subject to ratification under Section 204 - without regard to any "failure of authorization" identified in the resolutions adopted by the board of directors ratifying such act or transaction. Although a "deliberate rejection" of an act by stockholders will not prohibit ratification, the Delaware Court of Chancery still possesses the discretion to set aside, or qualify, a challenged ratification on equitable grounds, if the court determines to do so after reviewing the rejection and any competing considerations.
- The synopsis makes clear that the Court of Chancery retains the power to decline to recognize the ratification of an act purportedly ratified under Section 204 or to declare invalid any defective corporate act on the basis that the failure of authorization that rendered the act void or voidable involved a deliberate withholding of necessary consent or approval.
- The synopsis further notes that the amendments do not "limit, eliminate, modify or qualify" any of the powers granted to the Court of Chancery under Section 205 of the DGCL (which also includes the power, among other things, to declare that a ratification effected pursuant to Section 204 will be effective only upon certain conditions).
The 2018 amendments also clarify a minor point about when stockholder approval of a ratification is required. Under Section 204(c), stockholders must ratify a defective corporate act if the underlying act being ratified currently requires stockholder approval, or required stockholder approval at the time the act was purportedly taken, under the DGCL or certain of the corporation’s governing documents. Amended Section 204(c) clarifies that stockholder ratification is not required if, as of the record date for deter- mining the stockholders who would be entitled to vote on the ratification, there are no valid shares of stock outstanding and entitled to vote on the matter.
The notice requirements of Section 204 were also changed in two respects. Both changes relate to ratifications approved at a stockholder meeting, and both changes address the notice that must be given to holders of valid stock and putative stock as of the time the defective corporate act was purportedly taken.
- Amended Section 204(d) provides that if the defective corporate act involved the establishment of a record date, the notice to former stockholders may be given to the holders of valid and putative stock as of the applicable record date (rather than as of the act itself). The date of the act itself will frequently differ from any record date that may have been established in connection with the act and, particularly for publicly-traded corporations, it is frequently more practical to ascertain the former holders as of the applicable record date rather than the date of the act itself.
- Amended Sections 204(d) and 204(g) permit a corporation with stock listed on a national securities exchange to provide notice of ratification by public disclosure (instead of written notice) to the former holders of valid and putative stock as of the date (or record date) of the defective corporate act. Public disclosure can be effected by filing the notice of ratification with the Securities and Exchange Commission pursuant to § 13, 14 or 15(d) of the Securities Exchange Act of 1934.3
Importantly, both of these changes apply only to actions ratified by stockholders at a meeting (not by written consent) and only to notices to former holders of valid and putative stock (not to current holders of valid and putative stock).
Finally, Section 204(h) was amended to make clear that the failure of an act or transaction to be approved in compliance with the disclosure set forth in a proxy or consent solicitation statement constitutes a failure of authorization for purposes of Section 204. This amendment clarifies that such an act - e.g., an act that may be defective due to an inaccurate description in a proxy statement of the required stock- holder vote for approval of the act - may be ratified under Section 204. Following the ratification, the act is no longer void or voidable as a result of the failure to be approved in compliance with the disclosure. This amendment addresses recent claims about broker voting disclosures for public corporations. In certain instances, corporations asked stockholders to approve charter amendments, and mistakenly disclosed that brokers could not exercise discretionary authority to vote on the amendments. Contrary to that disclosure, brokers were ultimately able to vote on (and voted in favor of) the amendments. Amended Section 204(h) clarifies that the statute may be used to cure any claim that an act is invalid as a result of this type of mistaken disclosure.
Appraisal rights [§262]
Two amendments were made to Section 262 as it applies to mergers effected under Section 251(h). Section 251(h) permits so-called "medium form mergers": the acquisition of a publicly or widely held corporation through a first- step tender or exchange offer and follow-on merger. Under Section 251(h), if the shares tendered into the first-step offer equal at least the number of shares that would have been necessary to adopt a merger agreement at a stockholder meeting, then the corporation can effect the merger, after closing the first-step offer, without holding a stockholder vote to adopt the merger agreement. The 2018 amendments make the "market out" exception to appraisal rights applicable to medium-form mergers. Prior to the amendments, Section 262 provided that appraisal rights were available for any merger effected under Section 251(h) unless all of the stock of the subsidiary corporation (the target corporation being acquired) was owned by the parent corporation immediately prior to the merger. As a result, a corporation effecting a medium-form merger under Section 251(h) was effectively precluded from using the market out exception even if that exception would have been available if the merger were instead effected as a long-form merger adopted at a stockholder meeting. As amended, Section 262 makes the market out exception applicable to medium-form mergers by denying appraisal rights for shares of any class of stock that were listed on a national securities exchange or held of record by more than 2,000 holders immediately prior to the execution of a merger agreement relating to a merger to be effected pursuant to Section 251(h), so long as the stockholders are not required by the merger to accept for their stock anything other than: (i) stock of the surviving corporation (or depository receipts in respect thereof), (ii) stock of any other corporation (or depository receipts in respect thereof) that as of the date of the merger will be listed on a national securities exchange or held of record by more than 2,000 holders, (iii) cash in lieu of fractional shares or fractional depository receipts in respect of the foregoing, or (iv) any combination of the foregoing. The amendments should facilitate the use of Section 251(h) in instances where the first-step offer is an offer to acquire the target corporation’s stock in exchange for publicly listed stock of the acquiror.
In addition, a clarifying change was made to Section 262(e)’s requirement that a surviving corporation to a merger provide a statement, at the request of a dissenting stockholder, specifying the total numbers of shares not "voted" in favor of a merger and with respect to which demands for appraisal have been received, and the total number of holders of such shares. In the case of a medium-form merger, however, no shares are "voted" in favor of a merger; rather if sufficient shares are tendered for purchase or exchange pursuant to a tender offer that complies with Section 251(h), the parties may effect the merger without a vote of the target corporation’s stockholders. The amendment to Section 262(e) clarifies that in the case of a medium-form merger, the statement required to be provided by Section 262(e) must set forth the total number of shares not tendered into the offer instead of the number of shares not voted in favor of the merger.
The amendments to Section 262 are effective with respect to mergers consummated pursuant to an agreement entered into on or after August 1, 2018.
Revocation or forfeiture of charter; proceedings [§284]
Section 284 provides a process to seek an order from the Court of Chancery revoking or forfeiting a corporation’s charter for "abuse, misuse or nonuse" of its corporate powers. The amendments to Section 284 made three changes to this infrequently used process: (1) clarifying that an action under Section 284 may only be brought by the Attorney General of the State of Delaware, (2) eliminating, in light of the modern practice of electronic litigation filings, a requirement that the Attorney General file a complaint under Section 284 in the county in which the corporation’s registered office is located, and (3) expressly providing the Court of Chancery the authority to appoint a trustee to administer and wind up the affairs of a corporation whose charter has been revoked under Section 284. The amendments to Section 284 became effective on August 1, 2018.
Revival of certificate of incorporation or charter of exempt corporation [§313] and Annual franchise tax report; contents; failure to file and pay taxes; duties of Secretary of State [§502]
Two amendments became effective that are intended to conform two provisions regarding tax exempt corporations to the current practices of the Delaware Secretary of State. Section 313 sets forth the process by which an exempt corporation whose charter has become void as a result of the failure to file an annual report with the Delaware Secretary of State may "revive" itself. Section 313 was amended to eliminate a reference contemplating that the Delaware Secretary of State "issues" a certificate in connection with such a revival. In addition, Section 502 of Chapter 5 of Title 8 was amended to delete a clause contemplating that an annual report filed with the Delaware Secretary of State by an exempt corporation sets forth the "specific facts" entitling the corporation to exemption from taxation. The amendments to Sections 313 and 502 became effective on August 1, 2018.
1 This article supplements prior reports published by Aspen Publishers and its predecessor, Prentice Hall Law & Business, describing amendments to the Delaware General Corporation Law enacted in each of calendar years 1967; 1969-70; 1973-74; 1976; 1981; 1983-1988; and 1990-2017. The authors of one or more of the prior reports are: S. Samuel Arsht; Walter K. Stapleton; Lewis S. Black, Jr.; A. Gilchrist Sparks, III; Frederick H. Alexander; Jeffrey R. Wolters; and James D. Honaker.
2 All section references are to the DGCL. Any reference to a synopsis refers to the official synopsis accompanying the legislative bill enacting the 2018 amendments. "Charter" refers to a certificate of incorporation; "Delaware Secretary of State" refers to the Office of the Secretary of State of the State of Delaware; and "Court of Chancery" refers to the Court of Chancery of the State of Delaware.
3 The pre-2018 version of Section 204 already permitted publicly listed corporations to provide "disclosure only" notice in certain limited instances, mainly where Section 204 permitted board-only approved ratifications that do not require stockholder approval.
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Daniel D. Matthews, James D. Honaker, “Analysis of the 2018 Amendments to the Delaware General Corporation Law,” Wolters Kluwer Law & Business, October 1, 2018.
Reproduced with permission. Published October 1, 2018. Copyright © 2018 CCH Incorporated. All Rights Reserved. These materials have been prepared solely for informational and educational purposes, do not create an attorney-client relationship with the author(s) or Morris, Nichols, Arsht & Tunnell LLP, and should not be used as a substitute for legal counseling in specific situations. These materials reflect only the personal views of the author(s) and are not necessarily the views of Morris, Nichols, Arsht & Tunnell LLP or its clients.