Delaware Supreme Court Requires Board To Demonstrate “Compelling Justification” For Stock Sale Primarily Intended To Interfere With Stockholder Voting Rights
On June 28, 2021, in an en banc opinion authored by Chief Justice Collins J. Seitz, Jr., the Delaware Supreme Court reversed a decision by the Delaware Court of Chancery, which had upheld a contested stock sale by the board of UIP Companies, Inc. (the “Company”). Coster v. UIP Cos., Inc., No. 49, 2020 (Del. June 28, 2021). Plaintiff was one of the Company’s two equal stockholders. Plaintiff alleged that defendant, the other stockholder, who was also the board chairman, and the two other directors voted to issue stock to one of them in order to dilute plaintiff’s ownership interest. The Court of Chancery found that the board approved the stock sale at a fair price and through a fair process. Reversing and remanding, the Delaware Supreme Court held that—although the sale may have satisfied its entire fairness review—“inequitable action does not become permissible simply because it is legally possible.” The Delaware Supreme Court further held that, if the board acted for the “primary purpose of thwarting” the stockholder’s vote or reducing her leverage as an equal stockholder—even in good faith—the board must demonstrate a “compelling justification.”
After the two stockholders reached an impasse with respect to director elections, plaintiff filed suit requesting the appointment of a custodian. In response, the other stockholder and the two additional board members engaged in a process to sell stock to one of those other directors, who was allegedly a friend of the defendant stockholder. According to the Supreme Court, it was “not seriously disputed that the defendants issued the stock to [the other director] to dilute [plaintiff’s] ownership interest below 50%, block her attempts to elect directors, and avoid a possible court-appointed custodian.”
Nevertheless, the Court of Chancery upheld the stock sale. It explained that, in its view, if the sale passed entire fairness review, the board’s motives were “beside the point.” Relying on the fact that the sale was consummated using the valuation of an outside expert, which the court found credible, the court concluded that the price was fair and had been set after a fair process.
The Delaware Supreme Court reversed and remanded. It explained that the Court of Chancery erroneously “bypassed a different and necessary judicial review where, as here, an interested board issues stock to interfere with corporate democracy and that stock issuance entrenches the existing board.” Instead, it held that, if the sale was approved for “inequitable” reasons or, even if in good faith, without a compelling justification, the sale should be cancelled and the Court of Chancery should consider whether a custodian should be appointed.