In Garfield v. Boxed Inc., the Delaware Court of Chancery held that a stockholder’s counsel was entitled to an $850,000 fee resulting from the benefit conferred upon the company by alerting its board of directors that an upcoming shareholder vote in conjunction with a merger transaction did not comply with Delaware law. The decision caused significant uncertainty among multi-share class Delaware corporations that have requested stockholder approval to amend their charters. Following a flood of petitions filed pursuant to Section 205 of the Delaware General Corporation Law, on February 20, 2023, the Delaware Court of Chancery validated several similar corporate actions, paving the way for similarly situated companies to restore certainty regarding their capital structures.
Many Delaware companies have capital structures with multiple share classes. Dual–share class structures are especially common among special purpose acquisition companies (SPACs), typically providing for Class A and Class B common stock, with the latter often being held by a minimal number of stockholders (typically, the founders) and converted automatically into Class A common stock following a business combination.
Often as part of the stockholder meeting to vote on the business combination between the SPAC and the target operating company, i.e., the de-SPAC transaction, stockholders are asked to vote on amendments to the charter that would increase the number of authorized shares, necessitated by the amount of shares needed to issue as consideration for the business combination.
Section 242(b) of Delaware General Corporation Law (DGCL) provides that if an amendment to a corporation’s charter would (1) result in an increase or decrease in authorized shares of a class of securities; (2) result in an increase or decrease to the par value of the shares of a class; or (3) adversely alter or change the powers, preferences, or special rights of a class, then the holders of the outstanding shares of the class are entitled to vote separately as a class on the amendment, unless the corporation has opted out of DGCL Section 242(b)(2)’s requirements in its charter. [1]
Prior to Boxed, the prevailing view among most corporate practitioners was that Class A and Class B common stock comprised different “series” and not “classes” of common stock. Therefore, a separate vote by the classes was not required under Section 242(b) of the DGCL.
In Boxed, the court upended that view and found that, based on the language employed in the subject company’s charter (the charter referred to “Class A” and “Class B” common stock) and other provisions of the DGCL, there were, in fact, two separate classes of common stock.
Since the Boxed decision was issued on December 22, 2022, dozens of companies have filed petitions pursuant to Section 205 of the DGCL in the Delaware Court of Chancery to remedy potentially defective votes held in connection with de-SPAC business combinations or otherwise though charter amendments. [2] On February 20, 2023, Vice Chancellor Will held hearings in connection with several such petitions and approved each in rulings from the bench, including the first such petition, which was filed by Lordstown Motors Corporation. [3]
Two days later, Vice Chancellor Will issued a written opinion in Lordstown that includes “reasoning [that] should prove instructive to other companies seeking the court’s assistance to validate similar corporate acts” and noting that specific reasoning applicable to each individual Section 205 petition will be addressed in bench rulings or orders as appropriate. Noting that “a contrary ruling would invite untold chaos,” Vice Chancellor Will observed that similarly situated companies might otherwise be unable to satisfy auditors, complete periodic filings with the US Securities and Exchange Commission (SEC), obtain financing, or remain listed on a national securities exchange.[4]
The Lordstown opinion reasoned that each of the factors that may be considered by the court under Section 205 supported relief. [5] For example, Vice Chancellor Will found that the subject company and its board approved and effectuated the amendment with the good-faith belief that it complied with the law, noting that the board sought, and relied upon, the advice of legal counsel. She also found that the company and its board consistently treated the corporate acts as valid and effective as evidenced by share issuances after the vote, and that third parties relied on the validity of the charter amendment through the purchase and acceptance of shares perceived to be validly authorized and issued pursuant to the amendment.
Vice Chancellor Will noted that there did not appear to be “any legitimate harm that would result from validating” the amendment and that “absent validation, a number of parties would face widespread harm.” Finally, she noted that relief under Section 205 was “the most efficient and conclusive – and perhaps the only – recourse available.” Vice Chancellor Will has scheduled hearings to handle tranches of similar Section 205 petitions in the near future.
Corporations should promptly and carefully review their historical and current capital structure. To the extent that a company has, or previously had, a multi-share class stock structure, the company should, in consultation with its legal advisors, identify whether any stockholder votes were conducted in potential violation of Section 242(b) of the DGCL.
While the implications of the Boxed decision extend beyond the SPAC context, it is important to recognize that Section 242(b)(2) is not implicated by all amendments to organizational documents, each of which should be evaluated under applicable law. If a company identifies a potential issue, it should consider filing a Section 205 petition.
As the Lordstown opinion demonstrates, the Delaware Court of Chancery is aware of the potential severity of the issues implicated and appears willing to provide swift and definitive relief. Moreover, companies that identify and seek to address arguably defective corporate acts on their own initiative will avoid paying fees to plaintiffs’ lawyers who “beat them to the punch” and cause the corporation to take corrective action—like the stockholder in Boxed, who was awarded $850,000.
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[1] There are similar requirements pursuant to the Model Business Corporation Act.
[2] Sections 204 and 205 of the DGCL were enacted in 2014 to permit corporations to ratify through a stockholder vote (Section 204) or validate through judicial action (Section 205) defective corporate acts that otherwise would be voidable or void. The Model Business Corporation Act also has provisions intended to permit ratification or judicial validation of defective corporate acts.
[3] Notably, Lordstown involved one of the handful of Section 205 petitions approved by the court on February 20 where the charter amendment would not have obtained the majority vote of the class if the Class A votes were counted separately.
[4] For example, in the Lordstown opinion, Vice Chancellor Will noted that impacted companies “face difficulties in filing Form 10-Ks and the possibility of stock exchange delisting.”
[5] Section 205(d) sets out five factors that the court “may consider” when determining whether to validate a corporate act: (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 the 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; and (5) any other factors or considerations the court deems just and equitable.