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Rainbow Mountain, Inc. v. Terry Begeman, C.A. No. 10221-VCMR (Del. Ch. Mar. 23, 2017) (Montgomery-Reeves, V.C.)

March 23, 2017

In this memorandum opinion, the Court of Chancery analyzed the availability of an estoppel defense in the context of a nonstock corporation. The Court’s analysis turned on whether corporate action in contravention of the corporation’s bylaws is void or voidable. Similar to the Court’s in Klaassen v. Allegro Development Corp, 2013 WL 5739680 (Del. Ch.), the Court sought to “best…to harmonize” an area of case law that “has not always been consistent,” and held that when a board of directors takes action in contravention of a bylaw, that action is void and the equitable defense of estoppel is not available.

Rainbow Mountain, Inc. (“Rainbow Mountain”) is a nonstock corporation whose members include Mark Begeman (“Mark”), Cindy Dallwig (“Cindy”), Terry Begeman (“Terry”) and other members (by birth or marriage) of the Begeman family. Under the Rainbow Mountain bylaws, membership in the corporation can be terminated with cause following notice, a hearing, and a vote of expulsion by 2/3 or more of the full board of directors. The voting members of Rainbow Mountain may remove a director with or without cause by majority vote at a specially called meeting where the director subject to removal has an opportunity to be present and heard. The bylaws define “cause” to include several categories of misconduct. The bylaws also provide that “Members holding more than 50% of the votes that may be cast at any meeting shall constitute a quorum at a meeting of Members.”

Relations between the Rainbow Mountain members began to sour in 2005. In September of that year, the board of directors acted by unanimous written consent to terminate Mark and Cindy’s memberships. Then, in September 2008, the Rainbow Mountain members removed Terry as a director. In April 2009, the members filled the board vacancy Terry’s removal created, and the newly-composed board of directors terminated Terry’s membership. Rainbow Mountain treated Terry’s removal as a member as “automatically terminat[ing]” his positions as Rainbow Mountain’s secretary and senior vice-president.

Rainbow Mountain initiated this action, seeking a declaratory judgment that Terry had been properly removed as a director, officer, and member. Terry countered that Mark and Cindy’s memberships were improperly terminated in 2005, and that because the terminations were ineffective, the subsequent corporate acts that depended on the terminations – the member vote to remove Terry as a director, the board vote to fill his board seat, the board vote to terminate his membership – were also ineffective. Rainbow Mountain argued that Terry was “estopped from arguing that Mark and Cindy were never properly terminated because he proposed and signed” the unanimous written consent that purported to terminate their memberships.

On cross-motions for summary judgment, the Court first found that Mark and Cindy’s memberships were terminated without cause, which violated the Rainbow Mountain bylaws. The Court also noted that the directors’ attempt to provide Mark and Cindy with notice and opportunity to be heard was deficient.

The Court next considered whether Terry’s involvement in terminating Mark and Cindy’s memberships estopped him from relying on their defective removal to support his position in the present litigation. The Court explained that estoppel is a “valid defense to voidable corporate action, but not to void corporate actions.” Waggoneer v. Laster, 581 A.2d 1127, 1137 (Del. 1990).  Quoting from Klaassen, the Court noted that “traditionally, when a board took action in contravention of a mandatory bylaw, the board action was treated as void.” 2013 WL 5739680 at *19.  Yet, some decisions had held that equitable defenses apply “even if a bylaw was violated.” Id. at *24 n.10. Vice Chancellor Montgomery-Reeves followed the traditional approach, holding that Terry was not estopped from relying on Mark and Cindy’s defective terminations in his claim against Rainbow Mountain because the terminations were void actions.

Rainbow Mountain’s failure to properly terminate Mark and Cindy’s memberships created a domino effect that invalidated a series of corporate actions. Because Mark and Cindy were improperly removed as members, Rainbow Mountain incorrectly calculated the quorum for the September 2008 member meeting during which the vote to remove Terry as a director occurred. As a result of that error, the Rainbow Mountain members lacked a quorum for the vote, rendering the vote ineffective. Because Terry was not properly removed as a director in September 2008, there was no board vacancy to fill in April 2009, so the board of directors that voted to terminate Terry’s membership was improperly composed and failed to achieve the required 2/3-majority vote. Accordingly, the Court concluded that Terry remained a director and member of Rainbow Mountain.

The Court also held that the bylaws did not support Rainbow Mountain’s conclusion that Terry’s removal as a member automatically terminated him as an officer. Nevertheless, a valid quorum of directors had voted to replace Terry as secretary, such that Terry’s only remaining position was as senior vice-president.

The full opinion is available here