Delaware Chancery Court Issues Opinion Offering Rare Interpretation Of Stock Transfer Restriction Provision, Delaware General Corporation Law Section 202
On July 10, 2017, Vice Chancellor Tamika Montgomery-Reeves of the Delaware Court of Chancery found plaintiff was not bound by stock transfer restrictions under which the company had sought to revoke his ownership and was therefore entitled to inspect the books and records of a company in which he held stock. Henry v. Phixios Holdings, Inc., C.A. No. 12504-VCMR (Del. Ch. Jul. 10, 2017). The opinion is one of few offering substantive guidance regarding Delaware General Corporation Law (“DGCL”) Section 202, 8 Del. C. § 202, a provision governing stock transfer restrictions. Applying the statute, the Court held that “in order for a stockholder to be bound by stock transfer restrictions that are not ‘noted conspicuously on the certificate or certificates representing the security,’ he must have actual knowledge of the restrictions before he acquires the stock” or “affirmatively assent to the restrictions, either by voting to approve the restrictions or by agreeing to the restrictions.”
Plaintiff was a stockholder and former employee of Phixios Holdings, Inc. When plaintiff joined Phixios as an employee, he agreed to defer the majority of his salary and accept stock in the company. The directors of Phixios had previously imposed stock transfer restrictions through a stockholder agreement that included the right of the company to revoke ownership if a stockholder engaged in certain acts damaging to the company, including competing for business. After plaintiff delivered a demand to Phixios pursuant to DGCL Section 220 for the production of books and records, the company held a special meeting of stockholders and purported to revoke all of the common stock held by plaintiff and a former Phixios director and officer, claiming they had improperly competed with the company.
Following a bench trial, the Court of Chancery determined that the revocation was ineffective. There was no dispute that the stock transfer restrictions were not noted conspicuously on the face of the certificate representing plaintiff’s stock, and the Court found that plaintiff did not have actual knowledge of the restrictions prior to acquiring his stock. Although the stockholder agreement was later provided to him, he never affirmatively assented to be bound by the restrictions. Relying on DGCL Section 202, the Court held that actual knowledge of a stock transfer restriction obtained after the acquisition of stock was insufficient to bind the stockholder. Instead, the Court held that “[a]n existing stockholder must affirmatively assent to the restriction in order to be bound either by becoming a party to an agreement or by voting in favor of the restriction.”
The Court explained that “[a] restriction cannot be retroactively imposed on a current stockholder without his express consent,” and, “[t]o allow otherwise” would enable a company “to entice an investor into purchasing securities with the expectation that transfer is unrestricted because no restrictions are noted on the certificate representing the securities, while withholding the existence of potentially value-reducing restrictions.” According to the Court, “[t]his absurd result would completely undercut the purpose of Section 202 to protect the stockholder’s bargained-for rights.”
Because the restrictions did not apply to plaintiff, the revocation of his stock was invalid and he thus remained a stockholder entitled to pursue a DGCL Section 220 demand. The Court also found that plaintiff’s books and records demand alleged proper purposes, including valuing his stock and investigating corporate mismanagement, and established a credible basis to infer wrongdoing. Accordingly, the Court held he was entitled to the documents requested.