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Blades v. Wisehart, et al., C.A. No. 5317-VCS (Del. Ch. Nov. 17, 2010) (Vice Chancellor Strine)

November 17, 2010

In this post-trial opinion in an action brought pursuant to 8 Del. C. § 225, the Court of Chancery resolved a dispute over the control of the board of directors of Global Launch, Incorporated. The Court found that a purported forward stock split was invalid due to the company’s failure to comply with corporate formalities, and, therefore, the only two stockholders of Global Launch were Rusty Blades (the founder) and The Ohio Company, the two initial stockholders of the company. The Court validated a written consent executed by Blades and The Ohio Company to remove the defendant directors from the board, elect a new board, and ratify actions taken at a procedurally suspect board meeting.

During the first year after Global Launch’s formation, the board recognized that it needed to sell stock to raise capital to run the business. The board and the company’s counsel, defendant Richard Wetzel (an Ohio lawyer), intended to increase the number of authorized shares from 10,000,000 to 50,000,000 and then consummate a 5-1 stock split. Wetzel created various investor materials, including a private placement memorandum, which was filed with the State of Ohio. The Court held that the stock split failed to conform with the required corporate formalities, and, therefore, both the stock split and certain stock transfers purportedly effected by Wetzel, were invalid and void.

The Court found that Wetzel failed to comply with the three steps that are required under 8 Del. C. § 242 for a corporation to amend its certificate of incorporation to split its outstanding shares. Citing to the Delaware Supreme Court’s decisions in STAAR Surgical Co. v. Waggoner, 558 A.2d 1130 (Del.1992) and Waggoner v. Laster, 581 A.2d 1127 (Del. 1990), the Court noted that Delaware law requires strict compliance with statutory requirements when a board purports to change the capital structure of a corporation and, therefore, refused to consider a number of equitable arguments advanced by the defendants.

Under the first requirement of Section 242, a board must adopt a resolution setting forth the amendment proposed, declaring its advisability, and either calling a special meeting of stockholders or directing the amendment to be considered at the next annual meeting. In an attempt to prove that this requirement was met, defendants pointed to a board resolution that authorized an increase in the number of shares from 10 million to 50 million and a resolution that authorized the board to amend the private placement memorandum on file in Ohio such that “the offering of stock shall reflect the 5 to 1 split.” The Court found that (i) the first resolution only increased the number of shares and was silent with respect to a stock split, and (ii) the second resolution merely “reflected” a purported prior action and did not constitute approval of the stock split.

Under the second requirement of Section 242, the board must give stockholders proper notice of the proposed amendment before the stockholders meeting to vote on the proposal (unless stockholders approve the amendment by written consent after the board’s action). The Court found that there was no evidence of any meeting whereby the company’s only stockholders, Blades and The Ohio Company, voted to approve a stock split amendment; nor was there evidence that they acted by written consent to approve such an amendment. The Court rejected defendants’ argument that, because both Blades and The Ohio Company “approved the concept” of a 5 to 1 split, the stock split should have been deemed effective. While it was unconvinced that the equities tilted in defendants’ favor, the Court held that it need not make any such determination because “law trumps equity” when determining a corporation’s capital structure.

Finally, the board is also required to file a certificate with the State of Delaware certifying that the amendment has been duly adopted in accordance with the statutory formalities and setting forth the amendment in full. Again, there was no evidence that the company met this requirement with respect to an amendment effectuating a stock split.

Having found that both the stock split and stock transfers were invalid, the Court held that the only stockholders of Global Launch were The Ohio Company and Blades — the company’s initial stockholders. Accordingly, those stockholders were able to act by written consent to remove all the members of the board and to elect a new board. The Court also found that this written consent was sufficient to ratify actions purportedly taken at a previous board meeting initiated by Blades, even though the directors acting at such meeting had not been validly elected by the stockholders, because the ratifying stockholders (Blades and The Ohio Company) had been informed of all reasonable facts related to the ratified actions, the ratification was not improperly coerced, and the ratified actions were voidable and not void. In a closing note of caution, however, the Court warned both Blades and The Ohio Company that its holding that the ratification was valid did not insulate any of the ratified actions from challenge in another lawsuit and noted that Blades and The Ohio Company might have to deal with potential claims from minority stockholders who hold invalid Global Launch shares.

The full opinion is available here