Delaware Addresses Majority Voting: The 2006 Amendments to the General Corporation Law

By Michael B. Tumas, John F. Grossbauer, and Roxanne L. Houtman.  Mr. Tumas and Mr. Grossbauer are partners and Ms. Houtman is an associate at Potter Anderson & Corroon LLP, Wilmington, Delaware.[1] 

Legislation was recently introduced in the Delaware legislature to effect the now-annual amendments to the General Corporation Law of the State of Delaware.  While several of the amendments are technical in nature and serve to clarify the existing Delaware law, many of the 2006 amendments address significant substantive issues.  Most significantly, the proposed legislation represents Delaware's limited response to the majority vote movement through amendments to Sections 141 and 216. 

The legislation also addresses appeals for greater transparency with respect to corporate formation in a series of amendments to Section 132 and related sections.  The 2006 amendments also contain provisions clarifying the process by which a corporation may implement a classified board of directors and changes to certain of the provisions regarding the reservation of a corporate name.

Majority Vote Bylaw Provisions

Perhaps the most significant of the amendments introduced in the Delaware legislature are the amendments to Sections 216 and 141(b), which represent Delaware's response to the recent efforts by institutional investors to compel corporations to adopt and maintain majority voting provisions, the so called "majority vote movement."    The amendments enable stockholder introduction and adoption of irrevocable amendments to a corporation's director election bylaws and facilitate the adoption of corporate policies requiring the resignation of any director who fails to obtain a specified number of votes in favor of his or her election to the board.

The 2006 amendments address concerns expressed by institutional investors that, even if they proposed and adopted a bylaw requiring majority voting (which is already permitted under Section 216), the Board of Directors simply could amend the newly-adopted bylaw to restore plurality voting.[2]  The proposed amendment to Section 216 addresses this concern, providing that any stockholder-adopted bylaw that prescribes the requisite vote for the election of directors may not be repealed or further amended by the board of directors.  While institutional stockholders have called for the replacement of the default plurality vote standard with a majority vote default rule, the amendment to Section 216 ensures that if stockholders prevail in changing the applicable standard, the standard cannot be altered by unilateral action of the board of directors.

In addition, the 2006 amendments address the desire by many corporations to adopt a “modified plurality” standard.  Under such policies, adopted most famously by Pfizer, Inc., a director who receives more “withhold” than “for” votes in an election is required to submit his or her resignation to a board committee, which may accept or reject it.  It is far from clear, however, that such a resignation requirement would be enforceable against a director who asserts that his or her fiduciary duties (or perhaps other reasons) required the director to refuse to resign.  The new language in Section 141(b) permits corporations to address this issue by requiring directors to submit a resignation that is contingent upon the happening of a future event.[3]  The amendments also provide that resignations that are conditioned upon the failure of a director to receive a specified vote for reelection, e.g., more votes for than against, may be made irrevocable.[4]  The amendments thus address the potential restrictions of the "holdover rule," by permitting corporations to enforce the resignation of a director, whether under a majority vote or modified plurality vote standard. 

The amendments to Sections 216 and 141(b) are consistent with the General Corporation Law's enabling approach, as it will facilitate the adoption of corporate bylaws and policies imposing a specific voting standard for director elections and providing corporations with a means to enforce such policies.  While the plurality standard remains the default standard for the election of directors, as a result of the 2006 amendments, a corporation and its stockholders may implement and enforce alternative voting standards. Amendments to Section 216 and 141 are to take effect on August 1, 2006 if the bill is passed. 

Classified Board of Directors

The legislation contemplates that, effective August 1, 2006, Section 141(d) will be amended to permit the classified term of a director to commence after classification of the board becomes effective.  Accordingly, the charter or bylaws may provide for classification of the board of directors to become effective at a later point in time, and not immediately upon adoption of such provisions or amendment.   The amendments also clarify that a charter or bylaw provision providing for the classification of a board of directors may authorize the board of directors to assign members of the board already in office to a particular class at the point in time when such classification becomes effective.

These changes provide increased flexibility in implementing a classified board structure, and codify the practice of many corporations of permitting the incumbent board to determine the initial classification of its members.

Registered Agents

It is proposed that Section 132 provide for greater transparency with respect to the formation of corporations in Delaware, and also to grant to the Secretary of State the ability to enforce standards of conduct for registered agents of Delaware corporations.  The proposed amendments to Section 132(a) also expand the types of entities that may serve as a registered agent of a Delaware corporation to include general partnerships, limited liability partnerships, and limited liability limited partnerships.  The balance of the amendments to Section 132 set forth guidelines with respect to registered agents and enable the Secretary of State to enforce such rules and regulations.  In order to permit an orderly transition to the new rules, the amendments to Section 132 would not become effective until January 1, 2007.

Proposed Section 132(b) prescribes the duties and obligations of registered agents.  Such requirements include the maintenance of a business office that is generally open to accept service of process if the agent is an entity, and the authority to transact business in Delaware if the registered agent is a foreign entity.  If the registered agent is an individual, the registered agent must be available at a designated location to accept service of process.  Moreover, all registered agents are required to forward to all corporations for which the agent serves all communications directed toward the corporation by the Secretary of State and the annual franchise tax report or an electronic notification of such report.

The 2006 amendments also prescribe additional duties and qualifications for a "Commercial Registered Agent," which is defined as a registered agent serving more than 50 entities at any one time.  Among other things, commercial registered agents are required to maintain an office in Delaware that is open during normal business hours, have an officer, director or managing agent present at the office during business hours, maintain a Delaware business license, and provide the Secretary of State with identifying information. 

The proposed amendments to Section 132(d) require that all Delaware corporations or corporations qualified to do business in Delaware advise its registered agent of the name, business address and business phone number of an officer, director, employee or agent authorized to receive communications from the registered agent.  Such person shall be deemed the communications contact.  The registered agent is charged with maintaining such information regarding the communications contact for each corporation for which the registered agent serves. 

The second half of the 2006 amendments to Section 132 enable the Secretary of State to pass such rules and regulations as may be necessary or appropriate to enforce Section 132 and to take such actions as may be required to assure a registered agent's compliance therewith. 

Annual Franchise Tax Reports

Sections 502 and 503, which relate to the filing of an annual franchise tax report, have been amended in several aspects if the legislation is passed.  The two most significant changes to these provisions relate to a corporation's failure to file an annual franchise tax report.  Pursuant to the amendments to Section 502(f) and Section 510, respectively, if a corporation fails to file a completed annual franchise tax report, the Secretary of State may not issue a certificate of good standing, and the corporation's charter shall be declared void.  The Secretary of State does not currently possess the statutory authority to require corporations to file annual reports containing all required information (such as the names of directors).   In order to permit corporations to become aware of these requirements, the amendments to Sections 502, 503 and 510 will become effective on January 1, 2008. 

Sections 502 and 503 also have been amended to provide greater flexibility to the Secretary of State and to encourage corporations to provide information with respect to the capitalization of the corporation.  The amendments to Section 502(a) authorize the Secretary of State to require the filing of such additional information, schedules and attachments as are needed to ascertain the franchise tax due.  Any tax information that is provided pursuant to the aforementioned provision will not be deemed public.  In addition, the proposed amendments to Section 503(b) provide that unless a corporation submits information with respect to the number of shares of each class of stock actually issued and the amount of the total gross assets of the corporation when filing the annual franchise tax report, the corporation shall not be permitted to make use of the alternative method for calculating the annual franchise tax due (which is generally employed by corporations having in excess of 1,000,000 shares of capital stock), as permitted by Section 503(a)(2). 

Reservation of Corporate Names

If the 2006 amendments are effected, multiple sections will be amended to make the scheme for the registration of corporate names consistent with that utilized by alternative entities.  Section 102(a)(1)(ii) currently provides that all corporate names must be distinguishable from the names of other corporations or entities of record in the office of the Secretary of State.  The proposed amendments to Section 102(a)(1)(ii), however, require that all corporate names be distinguishable from all other names, whether of record or reserved, except with the written consent of the person who has reserved such name.  Similarly, pursuant to a technical amendment to Section 371(c), prior to a foreign corporation being granted the authority to transact business within the state, the name of the foreign corporation must be distinguished from the name of any other domestic or foreign entity, whether reserved or of record, except with the written consent of the person reserving the name.

The name reservation process itself also has been modified.  Pursuant to the amendments to Section 102(e), the reservation of a corporate name may only be accomplished through an application to the Secretary of State, certifying that the name is being reserved by or on behalf of an individual or a corporation that 1) is contemplating incorporation in Delaware, 2) intends to change its name, 3) intends to do business in Delaware, or 4) intends to organize a foreign corporation to do business in Delaware.   Additionally, the amendments to Section 391(a)(24) would permit the Secretary of State to charge up to $75 for any such application. 

The combined effect of the aforementioned amendments to Sections 102 and 391 is to confer upon the applicant for a corporate name, the exclusive use to such name for 120 days, and the ability to give or withhold consent for the transfer of such name to another individual or entity.  At present, reservation of a corporate name is effective for one month, and if the Secretary of State receives a filing using the reserved name, the individual or entity that reserved such name has three days to submit a filing in order to preserve the use of the reserved name.  The legislation contemplates that all amendments with respect to the reservation of corporate names will become effective on August 1, 2006.

Notes:

[1]       A version of this article will be published in the July/August issue of the Corporate Governance Advisor.  The views expressed are solely those of the authors and do not necessarily represent the views of the firm or its clients.

[2]       See 8 Del. C. § 109(b).  Under Section 109(b), the board may be given the power to adopt bylaws in the certificate of incorporation.  Because this authority is granted in the certificate, it is doubtful whether a bylaw may restrict this authority.   

[3]       This aspect of the amendment to Section 141(b) is not limited to director elections.  This may help transaction planners by, for example, having directors of a corporation being acquired in a merger to submit in advance resignations that become effective upon closing.

[4]       In contrast, the proposed amendments to the Model Business Corporation Act permit resignations tendered in any contest to be made irrevocable.  See Report of the Committee on Corporate Laws on Voting by Shareholders for the Election of Directors, March 16, 2006.