On January 30, 2015, the Delaware Chancery Court decided its first case involving Delaware General Corporate Law (DGCL) Sections 204 & 205 (In re Numoda Corp. S’holders Litig., C.A. No. 9163–VCN, 2015 WL 402265 (Del. Ch. Jan. 30, 2015)) (“Nomuda“). DGCL Sections 204 and 205 permit a corporation or the Court of Chancery to ratify defective corporate acts. Those sections of the law became effective on April 1, 2014, and provide in part:
“(a) …no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in this section or validated by the Court of Chancery in a proceeding brought under Section 205 of this title.
(b) In order to ratify a defective corporate act pursuant to this section, the board of directors of the corporation shall adopt a resolution stating:
(1) The defective corporate act to be ratified;
(2) The time of the defective corporate act;
(3) If such defective corporate act involved the issuance of shares of putative stock, the number and type of shares of putative stock issued and the date or dates upon which such putative shares were purported to have been issued;
(4) The nature of the failure of authorization in respect of the defective corporate act to be ratified; and
(5) That the board of directors approves the ratification of the defective corporate act…
(Full statutory language of DGCL Section 204 available here: http://delcode.delaware.gov/title8/c001/sc06/)
Scope of the Court’s Power to Ratify Past Acts
In the Nomuda decision, the Chancery Court was presented the issue of whether to it could retroactively validate certain issuances of stock which were disputed by the shareholders. In doing so, it made the first determination of the scope of the Court’s power to retroactively validate a purported corporate action. The Chancery Court noted:
- No fixed outer limit to court’s discretion: DGCL Section 205 grants the court broad discretion with “no rigid outer boundary.”
- Corporate acts may be ratified even if corporate formalities are almost nonexistent: The Delaware legislature’s intent in adopting Section 204 and 205 was to permit the court to fashion an equitable remedy, even when “corporate formalities were barely recognizable.”
- Court may only ratify acts which failed on a technicality: The Court’s power to retroactively ratify a corporate action is limited to curing technical defects only, without:
a. Authorizing a corporate act that the corporation wishes it took, but did not actually take in the past.
b. Changing the date that a valid act was taken.
- There must have been a past underlying act, not a current wish that action had been taken: In order to avoid exceeding its power to retroactively authorize a defective act, the Court must first find that there was an actual underlying act that was taken, rather than a current wish that the action had been taken in the past.
- The statute tells you how to plead for ratification by the chancery court: Parties requesting that the Chancery Court retroactively ratify a corporate act no longer need to plead general equitable theories.
How the Court Decides a Corporate Act may be Retroactively Ratified:
DGCL Section 205(d) contains factors that the Chancery Court may consider in determining whether a past corporate act actually took place which it may ratify. The factors below are listed in DGCL 205(d), together with a “catch-all” provision that allows the Court to consider “any other factors or considerations the Court deems just and equitable”:
(1) Whether the defective corporate act was originally approved or effectuated with the belief that the approval or effectuation was in compliance with the provisions of this title, the certificate of incorporation or bylaws of the corporation;
(2) Whether the corporation and board of directors has treated the defective corporate act as a valid act or transaction and whether any person has acted in reliance on the public record that such defective corporate act was valid;
(3) Whether any person will be or was harmed by the ratification or validation of the defective corporate act, excluding any harm that would have resulted if the defective corporate act had been valid when approved or effectuated;
(4) Whether any person will be harmed by the failure to ratify or validate the defective corporate act…
(Full statutory language of DGCL Section 205 available here: http://delcode.delaware.gov/title8/c001/sc06/)
The Court’s Determination in Nomuda:
Ultimately, the Nomuda Court ratified certain issuances of stock in question, but declared other issuances invalid, using the criteria set forth above. In particular the court answered the following questions:
- Did a past corporate action take place? Yes, a past corporate action had taken place for some stock issuances, but not others. The corporate attempts to issue stock that had taken place were defective upon a technicality: the Court ratified certain issuance of stock based on its findings that Nomuda Corporation’s board of directors took certain affirmative acts to issue the stock, including:
a. Attempting to issue stock certificates for these stock issuances, even though the stock certificates had not been properly completed or issued.
b. Minutes had been taken of a board meeting in which the stock issuance took place, even though those minutes were never signed or approved by the board.
c. The Board later passed a resolution in which it ratified these issuances of stock.
- Should the court validate the defective issuances of stock which had taken place? Yes, the court can validate some of the stock issuances because:
a. All parties had acted as if these stock issuances had taken place.
b. An independent shareholder would be harmed if the court were to validate these stock issuances.
c. The Board’s ratification of these stock issuances was effective.
- However, the court invalidated other claimed issuances of stock because:
a. The Party asserting that the stock had been issued could not point to any board meeting, resolution or other determination regarding that party’s claimed issuance of the shares. Since there was past no corporate act, the Court would not ratify the claimed issuance of shares.
b. There was conflicting evidence about the timing of the issuance of stock.
c. No harm would come to other shareholders because of the invalidation of these claimed issuances of stock.
The Take Away:
Corporate formalities are must be followed, but technical defects in these formalities can be ratified by a Company’s board by following the steps outlined in DGCL Section 204. If there is disagreement about whether a defective action may be ratified, the Chancery Court may hear the dispute under DGCL 205. In making its decision to retroactively ratify a corporate act, the Delaware Chancery Court has broad discretion, but it must first find that an actual act took place in the past, and then must find that the act was the true intention of the Company, taking into account whether other parties would be harmed and whether other parties had relied on the ratification.
The full Nomuda decision can be found here: http://courts.delaware.gov/opinions/download.aspx?ID=218990