Ratifying Defective Corporate Acts in Delaware: Part 1

On April 1, 2014 Delaware amended the General Corporation Law (“DGCL”) to provide clear guidance on how a corporation could cure defective corporate acts. This post will provide a general overview of those amendments and some important items for you to consider.

1. What can be done if the Incorporator is unavailable to hold the Organization Meeting of Incorporators? 

• Section 108 of the DGCL was amended to provide that if any incorporator is unavailable, then any person for whom or on whose behalf the incorporator was acting, directly or indirectly, as an employee or agent, may take any action that such incorporator would have been authorized to take under Section 108 or Section 107 (Incorporators’ Powers).

• Any instruments signed by such other person must include the unavailability of the incorporator and the reason that incorporator was acting directly or indirectly as employee or agent for on behalf of such person, and that each person’s signature on such instrument or participation in such meeting is otherwise authorized and not wrongful.

• It is critically important that all corporate formalities are taken from the time of formation onward. Missing a simple action such as having the Incorporator appoint the Directors (if not named in the charter), may deem future actions invalid.

2. What can be done if a Delaware corporation identifies that certain stock has not been validly issued or directors properly elected? 

• Section 204 of the DGCL provides corporations with a means to ratify defective corporate acts including “administrative errors” resulting is stock not being validly issued if shares are not authorized in the corporation’s Certificate of Incorporation, or an election of a director that is void due to “failure of authorization.” (Failure of authorization is the failure to authorize or effect an act or transaction in compliance with the provisions of DGCL, the Certificate of Incorporation or by-laws.)

• Steps that must be taken to ratify defective corporate acts and stock include:
  1. A Board of Directors resolution that states the defective corporate act to be ratified, time of the defective act, if shares involved, the number, type and date of issuance of the shares, the nature of the failure of authorization and the approval by the Board of Directors of the defective corporate act.
  2. Stockholder approval if it was required at the time of the defective corporate act.
  3. Notice sent to the holders of all stock (including stock that may have been invalidly issued).The notice must contain a copy of the ratifying resolution, statement that any claim that the Court of Chancery should deem that a ratification is not effective must be brought within 120 days from the effective date of the validation.
  4. The filing of a Certificate of Validation to cure the defective corporate act being ratified if a filing with the Secretary of State was required but not filed (i.e., if a Certificate of Amendment increasing the authorized shares of a corporation was not filed, but the shares were issued). (Click here to view a sample Delaware Certificate of Validation.)

• Consequences for being unable to cure such defective corporate acts include (i) inability of the corporation to borrow money; (ii) voiding of shares sold and issued; (iii) a public company may be delisted; (iv) inability of a law firm to issue a legal opinion representing that all corporate formalities have been properly addressed.|

3. What remidies to directors, stockholders or any person adversly affected by defective corporate acts, or series of defective croporate acts, have?

• Section 205 of the DCGL, Proceedings Regarding Defective Acts and Stock, permits the corporation and related parties to apply to the Court of Chancery to determine the validity and effectiveness of defective corporate acts ratified pursuant to Section 204, or not ratified effectively pursuant to Section 204.

• The Court of Chancery may also modify or waive the procedures for ratifying defective corporate acts set forth in Section 204.
  
  
• The Court of Chancery has the power to:
  1. Declare ratifications pursuant to Section 204 not effective.
  2. Require measures to remedy or avoid harm to any person substantially affected by ratification.
  3. Order the Delaware Secretary of State to accept instruments for filing with different effective times.
  4. Approve corporation’s stock ledger.
  5. Order meetings of holders of valid stock.

• The first ruling by the Court of Chancery under Section 205 was In re Numoda. The issues in this case relate to a series of stock issuances by two related corporations that were not properly documented and which resulted in a dispute over the corporations’ capital structure. Click here to access a full summary of this case.

4. What is the timeframe to have an action related to defective corporate acts heard by the Delaware Chancery Court under Section 205 of the Delaware General Corporation Law ("DGCL")?

• The speed of the proceeding will vary depending on the equities. While a Section 205 action is not a summary proceeding by nature, a plaintiff can seek expedited treatment.
  
  
• Expedited treatment is routinely granted in disputes concerning stockholder voting rights where there is a pending transaction, provided the moving party: (1) demonstrates a “sufficiently colorable claim” and (2) shows “a sufficient possibility of threatened irreparable injury” to justify expedited proceedings.
  
  
• As the Delaware Supreme Court has observed, “Delaware courts are always receptive to expediting any type of litigation in the interests of affording justice to the parties,” and the Court of Chancery in particular is “renowned” for its “expedited decision making.” Box v. Box, 697 A.2d 395, 398-99 (Del. 1997) (citations omitted).

5. How many Certificates of Validation have been filed with the Delware Secretary of State to date?

• Just over 200 Certificates of Validation have been filed to date.
  
  
• In some cases, there have been multiple Certificates of Validation filings submitted for an affiliated group of entities because the defective acts of one corporation cause a domino effect in the effectiveness of acts for affiliated subsidiary corporations (i.e., not properly electing Directors of a corporation that is the parent to others in an affiliated group, thereby resulting in invalid elections for the affiliated corporations).
  
  
• The filing fee per Certificate of Validation is $2,500. This does not include franchise taxes that may become retroactively due if the authorized shares of the corporation are deemed increased retroactively.

6. Have any other states adopted similar provisions to cure defective acts?

We will continue to monitor the Nevada legislation and will provide updates regarding the process to validate noncompliant corporate acts. We are also monitoring all other states to determine if/when any propose similar amendments to their statutes.

For Part 2 of Ratifying Defective Acts in Delaware, please click here. 

This article is provided for informational purposes only and should not be considered, or relied upon, as legal advice.