Lawletter Vol 34 No 9, October 8, 2010
Charlene Hicks, Senior Attorney, Business Law
Because most of the nation's major corporations are either chartered in Delaware or in a state that uses Delaware statutory and case law as a guide, corporate law experts have hailed the Delaware Supreme Court's recent opinion in Crown EMAK Partners v. Kurz, 992 A.2d 377 (Del. 2010), as a seminal ruling, one that should be required study for practitioners and students alike. The case arose over control of an alternative-marketing firm and features issues of vote buying, attempts to shrink the size of a board through bylaw amendments, and the viability of shareholder action by written consent in lieu of a meeting. The dispute began when former EMAK Worldwide CEO Kurz and his dissident shareholder group, Take Back EMAK, began a proxy campaign to replace a majority of the company's incumbent directors. In this process, Kurz purchased the voting rights to a large block of shares from a third-party stockholder. Crown EMAK Partners ("Crown"), together with then CEO Holbrook and the incumbent board majority, fought back with a proxy campaign of their own. Because Crown's large block of preferred shares could not be voted to remove directors, it was proposed that the bylaws be changed to reduce the number of directors from 17 to 3. Given the fact that the company charter granted Crown the right to name two directors, a reduction of this magnitude in the number of directors would effectively guarantee control of the company to Crown and the incumbent board.
At the outset, the Delaware Supreme Court addressed the vote-buying issue. "Because transactions in which economic interests are fully aligned with voting rights do not raise concern, Delaware law does not restrict a soliciting party from buying shares and getting a proxy to bolster the solicitation's chances of success." Id. at 388 (internal quotation marks omitted). Using this principle as a guide, the court ruled that Kurz had not engaged in vote buying when he obtained the voting rights to a third party's block of stock. Id. at 389. The economic interests and the voting interests of the shares remained aligned because both sets of interests were transferred to Kurz by the purchase agreement. Id. Although Kurz did not take title to the shares, the purchase agreement provided that Kurz bear the economic risk of the shares. Id.
This did not, however, mean that Kurz was entitled to prevail on the voting issue. A restricted stock grant agreement signed by the third-party shareholder prohibited him from transferring his restricted shares until 2011. Kurz's purchase of those shares was accomplished in violation of that restriction and so was not legally valid. As a result, Kurz was not entitled to vote those shares. Id. at 392.
Next, the court examined the requirements for action by written consent of shareholders in lieu of a meeting under Del. Code Ann. tit. 8, § 228. Pursuant to §§ 219 and 228(c), only stockholders of record who appear in the stock ledger may vote. Id. at 395. Because the court had declared that Kurz's purchased votes were invalid, it stated that it need not decide whether a Cede breakdown should be considered part of the stock ledger. Id. at 398.
The court's third point of analysis addressed an issue of first impression, that is, "what happens when a bylaw amendment would shrink the number of board seats below the number of sitting directors." Id. at 400 (internal quotation marks omitted). In this regard, the court ruled that Crown's bylaw amendments, which reduced the number of directors from 17 to 3, were invalid because they conflicted with the statutory requirements of the Delaware General Corporations Law. Id. at 398-402. Shareholders could not "end an incumbent director's term prematurely by purporting to elect the director's successor before the incumbent's term ends." Id. at 402. Permitting such an action through a corporate bylaw amendment would conflict with Delaware statutes limiting and enumerating the "means in which a director's term can end under Section 141(b), the specific mechanism for director removal set forth in Section 141(k), and the concept of an annual meeting at which directors are elected under Section 211(b)." Id. (internal quotation marks omitted).
Under § 211(b), stockholders may remove directors by written consent if such consent is unanimous or all of the directorships are vacant. Id. at 401. "Stockholders cannot use a non-unanimous written consent to remove lawfully serving incumbent directors, and then elect successor directors, between annual meetings." Id. Instead of amending the bylaws, then, the court declared that Crown's incumbent board should have followed a three-step procedure: (1) removed the sitting directors by written consent; (2) reduced the size of the board; and then (3) elected successor directors. Id.
A practitioner confronted with any of the issues summarized above would be well advised to carefully scrutinize the Crown EMAK Partners case. Not only does the opinion contain a detailed analysis of the correlation between voting rights and economic rights in stock deemed necessary under Delaware law, but it also addresses the procedural requirements regarding stockholder action by written consent in lieu of a meeting, the removal of directors, and a reduction in the size of a board.