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Reminder: Delaware Law Provides Statutory Basis to Ratify Defective Corporate Acts

4/15/2014

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Two new sections to the Delaware General Corporation Law took effect on April 1, 2014 (Sections 204 and 205), eliminating uncertainty with respect to the technical validity of “defective corporate acts” once they have been ratified in accordance with new Section 204 or approved by the Delaware Court of Chancery in accordance with new Section 205. Delaware corporations may seek to rely on these statutes, for example, when they need to “clean up” their records in connection with financings, acquisitions and other significant corporate transactions. Upon ratification or validation, the validity of the defective corporate act will be retroactive to the time of the defective corporate act.

For purposes of the new statutes, a “defective corporate act” means:

(1)  an “overissue” (which is generally defined as the issuance of shares of stock in excess of the number authorized or the issuance of a class or series of shares that is not then authorized for issuance);

(2)  the election of directors that is void or voidable due to a “failure of authorization” (which is generally defined as the failure to authorize or effect an act or transaction in compliance with the provisions of the DGCL, the certificate of incorporation or bylaws of the corporation, or any agreement to which the corporation is a party); or

(3)  any act or transaction purportedly taken by or on behalf of the corporation that is, and at the time such act or transaction was purportedly taken would have been, within the power of a corporation, but is void or voidable due to a failure of authorization.

The procedures set forth in the new statutes are not intended to preempt or restrict other traditionally valid means of ratifying any corporate act that otherwise would be voidable but not void. The new statutes also do not modify any fiduciary duties that would apply to the decision to ratify a defective corporate act.

Company Ratification

Under Section 204, the ratification of a defective corporate act requires (1) board approval and (2) under certain circumstances, stockholder approval. Stockholder approval is required if it would have been required (by the DGCL, the company’s certificate of incorporation or bylaws, or any agreement to which the corporation is a party) either at the time of the defective corporate act or at the time when the board ratifies the defective corporate act. If stockholder approval is not required, then notice of the board’s ratification must be given to all stockholders. Section 204 sets forth the quorum and voting requirements applicable to the adoption of the board resolution approving the ratification, the notice, quorum and approval requirements for the stockholder vote, if required, and the notice requirements for when stockholder approval is not required.

Once the applicable board and stockholder approvals are obtained, if the act would have required a filing under DGCL Section 103, the corporation must file a “certificate of validation” with the Delaware Secretary of State. Section 204 sets forth the requirements of the new filing.

The defective corporate act that is ratified in accordance with Section 204 will no longer be deemed void or voidable as a result of a failure of authorization and such effect is retroactive to the time of the defective corporate act.

As described below, a claim can be filed with the Delaware Court of Chancery to challenge the validity of a ratified act or to impose conditions or qualifications on its validity. Such claims must be commenced within 120 days of the “validation effective time,” which is the later of (1) the time stockholder approval is obtained, or if stockholder approval is not required, the time notice to the stockholders is given and (2) the time at which the certificate of validation, if applicable, becomes effective in accordance with Section 103.

Chancery Court Validation

Under Section 205, certain parties may request that the Court of Chancery determine the validity and effectiveness of any defective corporate act not ratified pursuant to Section 204 or the validity of any corporate act or transaction and any stock, rights or options to acquire stock.  This alternative to Section 204 ratification may be particularly useful where the board of directors may not be able to ratify a defective corporate act because the directors were elected by stockholders holding shares that may not have been validly issued.

The parties that may apply to the Chancery Court include the corporation (or any successor entity), any director, any record or beneficial holder of stock or any other person claiming to be substantially and adversely affected by a Section 204 ratification.

Such parties may also bring a claim challenging the validity and effectiveness of any defective corporate act ratified pursuant to Section 204 or the validity and effectiveness of the Section 204 ratification itself.
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