Curing Defects in Stock Issuances - American Bar Association

1150 The Business Lawyer; Vol. 63, August 2008
Likewise, if the board had the power to issue the shares in the fi rst place but
failed to comply with procedural formalities, stockholders have no reliance interest
in regard to the remedy of judicial invalidation. Absent inequitable circumstances,
there is no reason not to allow the board the opportunity to correct its prior error.
Such action puts all relevant corporate constituencies in the position for which
they had bargained.
In a dispute between a corporation and a stockholder whose stock is arguably
invalid because the corporation or its board failed to comply with procedural formalities,
the DUCC suggests the more effi cient result is for the corporation to be
permitted to deliver to the stockholder the valid stock for which the stockholder
had bargained, rather than leaving that stockholder with a rescission claim against
the corporation. Such a result avoids potential gamesmanship based on the increase
or decrease in the value of the stock post sale. 225
While it could be argued that mandating strict compliance affords certainty—that
stock not issued in compliance with law is void—and encourages vigilant compliance,
226 such argument assumes that errors are conscious and advertent and that
people will choose noncompliance if the consequences are not suffi ciently severe.
Our experience is to the contrary. It is a rare case where a defect in a stock issuance
was intentional. Virtually all cases we have seen involve unintentional errors
due to a mistaken understanding of law or fact, or an unintentional failure to
properly document or execute an action. In all these cases, the parties’ intent was
that the stock be valid, and the parties were under the impression that the stock
had been validly issued. In such cases, the in terrorem effect of a strict compliance
rule is not likely to produce more systemic compliance with corporate formalities.
Furthermore, where the compliance errors occurred in the past, the parties, the
corporate directors and offi cers, and the corporate records (board minutes, etc.)
involved are often long gone by the time the error is discovered. Given that the
evidentiary basis for establishing statutory compliance often hinges on the availability
of these people and records, a strict compliance rule injects uncertainty
into the process with no consequent benefi t.
As noted at the beginning of this Article, the Delaware Supreme Court has
stated that “[t]he issuance of corporate stock is an act of fundamental legal signifi
cance having a direct bearing upon questions of corporate governance, control
and the capital structure of the enterprise. The law properly requires certainty
225. See, e.g., Highland Crusader Offshore Partners, L.P. v. Motient Corp., No. 05-7996-E (Tex.
Dist. Ct. Nov. 30, 2007) (order granting summary judgment) (dismissing rescission claim by a stockholder
against issuing corporation where stock with no voting rights was issued to the stockholder at
its request to avoid regulatory review, but where the charter prohibited issuing nonvoting securities).
226. See Elizabeth A. Wilburn, Commentary, Jackson v. Turnbull: Is Statutory Compliance the Threshold
to Fair Dealing?, 20 DEL. J. CORP. L. 608, 608, 621 (1995) (noting that “[a]fter Jackson [v. Turnbull,
C.A. No. 13042, 1994 WL 174668 (Del. Ch. Feb. 8, 1994)], it appears that failure to conform with
statutory requirements may render harsh results for corporations seeking affi rmation of a merger. Such
mistakes may no longer be excused as simple technical errors,” and “a more vigilant judiciary . . . [may
in the future] confer statutory compliance the same level of deference as awarded the substantive
aspects of the Delaware laws of corporate governance,” thereby “encourag[ing] corporate compliance
with the DGCL”).