03/30/2010
In Kurz v. Holbrook, No. 5019-VCL (Del. Ch., Feb. 9, 2010), the Delaware Chancery Court addressed for the first time whether a bylaw amendment may reduce the size of a board of directors, redefined the meaning of "stockholder of record" and clarified "vote buying" under Delaware law.The case involved competing claims regarding the control of the board of directors of EMAK Worldwide, Inc. (EMAK). EMAK had a seven member board of directors with two vacancies. However, two opposing groups of stockholders ran competing consent solicitations to gain control of the board.
The first consent solicitation was run by Take Back EMAK, LLC (TBE), which sought to obtain consents from a large number of individual EMAK stockholders. Upon learning the consent solicitation was approximately 100,000 votes short, a TBE member purchased the voting and economic rights of 150,000 EMAK shares. The plaintiffs argued that TBE delivered sufficient consents (TBE Consents) to remove two sitting directors without cause and fill three of the vacancies with newly elected directors. A significant number of TBE Consents were from shares held in street name. Shares are held in street name when they are registered on a company's books in the name of "Cede & Co.," the name used by the Depository Trust Company (DTC), rather than the name of the beneficial owners. The second consent solicitation was run by Crown EMAK Partners, LLC (Crown), which held all of the issued and outstanding shares of Series AA Preferred Stock. As a preferred stockholder, Crown had the power to elect two directors to the board. As a result of its consent solicitation, Crown delivered sufficient consents (Crown Consents) to amend the bylaws to (1) reduce the size of the board to three directors and (2) provide that if the number of sitting directors exceeds three, then the EMAK CEO would call a special meeting to elect a new director to serve as the singular successor to his multiple predecessors.EMAK's inspector of elections concluded the Crown Consents, representing 50.90 percent of EMAK's outstanding voting power, were sufficient to amend EMAK's bylaws. However, the inspector of elections stated that more than 1 million street votes were invalid because DTC failed to provide its omnibus proxy. Without these street votes, the TBE Consents were insufficient to remove or elect any directors. TBE challenged the inspector of elections' decision to invalidate the TBE Consents held in street name. TBE also argued that Crown's attempt to amend the bylaws was invalid. Crown sought to invalidate the 150,000 shares purchased by the TBE member.The court decided that "stockholders of record" includes banks and brokers that appear on the DTC participating list. Therefore, the absence of the DTC's omnibus proxy had no effect on the validity of the street votes cast in favor of removing and replacing the directors. The court also held that the bylaw amendments adopted through the Crown Consents were invalid. The court reasoned that proposed bylaw amendments would conflict with Section 141(b) of the DGCL's requirement that "[e]ach director shall hold office until such director's successor is selected and qualified or until such director's earlier resignation or removal." 8 Del. C. §141(b). Section 141(b) recognizes only three ways by which a sitting director's term may end: (1) the election and qualification of the director's successor; (2) the resignation of the sitting director; (3) removal of the sitting director. As Section 141(b) does not contemplate that a director's term could end through board shrinkage, the court reasoned that a bylaw seeking to achieve such a result conflicts with both Section 141(b) and Section 141(k) and is void.Finally, the court ruled that third-party vote buying only merits review when it disenfranchises stockholders by delivering swing votes or critically altering the voting pattern. The following factors are of particular importance in determining whether or not a transaction constitutes illegal vote buying: existence of fraud, informational disparities, and misalignment between the voting interest and economic interest. The court found that the TBE member's purchase of shares was disenfranchising and therefore should be examined closely, but the court ultimately held that the transaction did not constitute a legal wrong because there was no evidence of fraud, informational disparities, or misalignment of the voting and economic interests.