Delaware Court Of Chancery Finds That Equitable Defenses To Board Composition Can Be Litigated In A Section 225 Action And Rules Actions By Majority Stockholder Written Consent Effective Even Without Notice To Minority Stockholders
01/08/2019On December 21, 2018, Vice Chancellor Morgan T. Zurn of the Delaware Court of Chancery denied plaintiff stockholder’s motion for summary judgment in an action to determine the board composition of SPAR Group, Inc. (“SGRP”) under 8 Del. C. § 255. Brown v. Kellar, et al., C.A. No. 2018-0687-MTZ (Del. Ch. Dec. 21, 2018). Plaintiff claimed that written consents delivered to the SGRP board by plaintiff and a fellow majority stockholder removed and replaced an incumbent director. The defendant directors asserted that the consents were ineffective for two reasons: (i) the majority stockholders were engaged in an inequitable scheme to divert corporate opportunities and entrench themselves as directors, and (ii) the company had not given notice of the written consents to minority stockholders. The Court rejected plaintiff’s assertion that Delaware law prohibited the Court from considering the alleged inequitable conduct because it fell outside the proper scope of a § 225 action. The Court also found, however, that the consents were effective upon delivery (unless inequitable conduct precluded replacement of the director) and ordered that trial proceed with respect to the equitable defenses raised by defendants.
Plaintiff and another stockholder, who together hold the majority of SGRP’s outstanding stock, executed and delivered to the board in July 2018 written consents that purported to remove and replace a director (“director written consents”). The company disclosed these written consents in a preliminary information statement filed with the SEC on July 31, 2018, but, before the SEC review period concluded, the majority stockholders filed amended Schedule 13Ds with the SEC describing bylaw amendments that they intended to adopt by written consent; the bylaw-related written consents were delivered in August and September 2018. The company did not notify the minority stockholders of the director written consents, arguing that the amended Schedule 13D rendered the preliminary information statement misleading. SGRP filed suit against the majority stockholders, alleging claims of conspiracy and breach of fiduciary duty and seeking a declaratory judgment negating the actions taken by written consent. Plaintiff then brought this action under 8 Del. C. § 255 to settle the composition of the board. The lawsuits are scheduled for consecutive trials in January 2019.
Regarding the scope of a § 225 action, the Court acknowledged that while such proceedings are “narrow” and summary so as to allow for expedited resolution, whether the majority stockholders had engaged in improper conduct was “germane to determining the composition of the board” and thus properly considered. In so holding, the Court relied upon Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971), which established the equitable principle that “inequitable action does not become permissible simply because it is legally possible.” Nevertheless, the Court granted the portion of plaintiff’s motion addressed to whether the written consents were effective upon delivery to the board. The Court disagreed with defendants’ assertion that notice to stockholders was a condition precedent to written consents taking effect under 8 Del. C. § 228. The Court further rejected the notion that Rule 14c-2 of the Securities Exchange Act of 1934 imposed a separate notice requirement that had to be met before the consents could be effective, observing that the company that controlled whether notice was provided could not use the Exchange Act as a sword to prevent written consents from taking effect.