Curing Defects in Stock Issuances - American Bar Association

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1130 The Business Lawyer; Vol. 63, August 2008 actions such as the granting of super-majority voting rights. We see no logical basis for adopting such a limitation [on the holding of Triplex] as a matter of law. 113 *** In Staar Surgical Co. v. Waggoner (“Waggoner II”), 114 the Court of Chancery and the Delaware Supreme Court reached an issue that they had not addressed in Waggoner I—the validity of the preferred stock to which was attached the supermajority voting rights that had already been determined to be void in Waggoner I. The Waggoners converted their preferred stock into 2,000,000 shares of common stock and brought a section 227115 action to determine whether they had the right to vote the common stock at the next annual meeting. 116 In the Court of Chancery, Staar took the position that section 151(g) 117 of the DGCL mandates that in creating preferred stock, the board must adopt a resolution setting forth the stock’s attributes and that resolution must be set forth in a certifi cate of designations. 118 Here the board failed to “formally approve or adopt” 119 the resolution (although it seems to have had been put on notice of and to have agreed to the resolution’s major terms). Additionally, the resolution in the certifi cate of designations differed “materially” 120 from the resolution that, according to the minutes, had been agreed to by the board. 121 Given these defects, Staar argued that the preferred stock was invalid and could not be converted into voting common stock. 122 The Waggoners argued that even if the issuance were technically defective, the contract—the exchange of the Waggoners’ guarantee and pledge in return for the preferred stock—should be given effect in equity. In other words, the Waggoners argue that they are validly entitled, on contractual grounds, to two million validly issued common shares, and that, because they have fulfi lled their part of the bargain, they are entitled to a decree validating the two million shares that STAAR issued to them. The Waggoners contend that they guaranteed STAAR’s debt with the specifi c understanding that the two million shares would be the quid pro quo for those guarantees. Stated differently, the Waggoners assert that even if the issuance of those shares were technically invalid as a matter of corporate law, they are equitably entitled 113. Id. at 1137 (citations omitted) (third omission in original). The Waggoner I court did not fi nd the stock void. Instead, it only found that the supermajority voting rights at issue were void because such rights could not be granted by the board under the certifi cate. See supra note 111. 114. 588 A.2d 1130 (Del. 1991), rev’g C.A. No. 11185, 1990 WL 28979 (Del. Ch. Mar. 15, 1990) [hereinafter “Waggoner II”]. 115. See DEL. CODE ANN. tit. 8, § 227(a) (2001) (“The Court of Chancery, in any proceeding instituted under [§]§ 211, 215 or 225 of this title may determine the right and power of persons claiming to own stock . . . .”). 116. Waggoner v. Staar Surgical Co., C.A. No. 11185, 1990 WL 28979, at *1 (Del. Ch. Mar. 15, 1990). 117. See DEL. CODE ANN. tit. 8, § 151(g) (2001) (mandating process for the exercise of a board’s blank check authority). 118. Staar Surgical, 1990 WL 28979, at *2. 119. Id. 120. Id. 121. Id. at *1–2. 122. Id. at *2.
Curing Defects in Stock Issuances Under Delaware Law 1131 to an order, akin to specifi c performance, treating the common stock as if it were validly issued, and declaring them entitled to vote those shares. 123 The Court of Chancery adopted the Waggoner’s legal position and held that “for [the] purposes of this proceeding under 8 Del. C. § 227,” the 2,000,000 shares of common stock had been “validly issued.” 124 The Court of Chancery did not actually declare the stock (preferred or common) valid; rather, it “grant[ed] equitable relief to vindicate established principles of contract law.” 125 On appeal, the Delaware Supreme Court reversed. Citing Triplex, the court held that “[s]tock issued without authority of law is void and a nullity.” 126 Thereafter, the court explained that Staar failed to comply with DGCL section 151 and that such non-compliance cannot be trivialized as “mere technicalities,” 127 and the court held that “[s]tock issued in violation of 8 Del. C. § 151 is void and not merely voidable.” 128 Finally, the court concluded that because the stock was void, there was no basis for the Court of Chancery to grant equitable relief. 129 Indeed, the Court of Chancery in a later decision restated the holding of Waggoner II as: “our case law has refused to overlook the statutory invalidity of stock even in situations when that might generate an inequitable result.” 130 Perhaps because the Court of Chancery had determined after trial that the equities supported validating the stock, a determination which would have been subject to an abuse of discretion review on appeal, 131 the supreme court’s analysis 123. Id. at *3 (emphasis added) (footnote omitted). 124. Id. at *6. 125. See Jacobs, supra note 23, at 13. 126. Waggoner II, 588 A.2d at 1136. 127. Id. (internal quotation marks omitted). 128. Id. at 1136 –37. In Hildreth v. Castle Dental Centers, Inc., 939 A.2d 1281, 1283 (Del. 2007), the Delaware Supreme Court restated the holdings of Triplex and Waggoner as: “stock issued without satisfying the requirements of 8 Del. C. § 151 is void.” Similarly, in Starring v. American Hair & Felt Co., 191 A. 887, 890–92 (Del. Ch.), aff’d, 2 A.2d 249 (Del. 1937), the Court of Chancery preliminarily enjoined the redemption and immediate reissuance of stock where the redemption, as contemplated by the transaction, was not in compliance with Rev. Code 1935, section 2059, the predecessor to the now in-force section 151(b). It appears that the injunction was authorized prior to any redemption or reissuance, thus obviating the need to determine the validity of any outstanding stock. 129. See Waggoner II, 588 A.2d at 1137. Notwithstanding reversal by the Delaware Supreme Court in Waggoner II, Vice Chancellor Jacobs several years later suggested that equitable relief in similar circumstances might be permissible. See Kalageorgi v. Victor Kamkin, Inc., 750 A.2d 531, 539 n.10 (Del. Ch. 1999), aff’d, 748 A.2d 913 (Del. 2000) (unpublished table decision); see also Liebermann v. Frangiosa, 844 A.2d 992, 1006 (Del. Ch. 2002) (holding that although equitable claims will not validate stock “issued and sold” absent statutory compliance, “the claimant might . . . have other recompense, if, for example, he believed he had purchased valid stock and had not in fact done so. The claimant might have a claim for equitable rescission or other damages . . . .” (emphasis added)); id. at 1009 (suggesting viability of an unjust enrichment claim against company and “perhaps its directors” in such circumstances); cf. supra notes 38, 39 & 218–21. 130. Liebermann, 844 A.2d at 1004; id. at 1000, 1006 –07 (holding preferred stock “invalid” for failure to comply with section 151(g), i.e., absence of board vote approving certifi cate amendment or certifi cate of designations). 131. See In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 48 (Del. 2006). The court in Walt Disney stated: On appeal from a decision granting summary judgment, this Court reviews the entire record to determine whether the Chancellor’s fi ndings are clearly supported by the record and whether the conclusions drawn from those fi ndings are the product of an orderly and logical reasoning
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