Curing Defects in Stock Issuances - American Bar Association

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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”).
Curing Defects in Stock Issuances Under Delaware Law 1151 in such matters.” 227 For this reason, Delaware courts require “strict adherence to statutory formality in matters relating to the issuance of capital stock . . . . Delaware’s statutory structure implements these policies through a clear and easily followed legal roadmap of statutory provisions.” 228 No one doubts the centrality of stock issuance to corporate governance, and no one doubts the desirability of certainty. However, the harsh and unforgiving application of legal standards to stock issuances with unintentional statutory violations, without regard to the equity of the consequences, has resulted in less certainty rather than more. Given that the state legislature has spoken by addressing this issue in the Delaware Uniform Commercial Code, there is no good reason to continue down the path of judicially mandated strict compliance. The Court of Chancery appears to have recognized this in Waggoner II, Kalageorgi, and MBKS, and hopefully the Delaware Supreme Court will agree the next time it has an opportunity to do so. 229 227. Staar Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991), rev’g C.A. No. 11185, 1990 WL 28979 (Del. Ch. Mar. 15, 1990). 228. Grimes v. Alteon, Inc., 804 A.2d 256, 260 (Del. 2002) (internal quotations marks omitted). 229. Cf. MBKS Co. Ltd. v. Reddy, 924 A.2d 965, 974 n.30 (Del. Ch. 2007) (failing to address either the void-voidable distinction in detail or the DUCC), aff’d, 945 A.2d 1080 (Del. 2008).
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