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Canmore Consultants Ltd. v. L.O.M. Medical Int'l, Inc.: A Limited Exception To Directorial Authority To Fill Board Vacancies

November 19, 2013, Kevin R. Shannon and Christopher N. Kelly

Canmore Consultants Ltd. v. L.O.M. Medical International, Inc. 8 Del. C. § 223(c): 

A Limited Exception To Directorial Authority To Fill Board Vacancies

Section 223(c) of the Delaware General Corporation Law (the “DGCL”) provides that, if, at the time of filling any vacancy or any newly created directorship, the directors then in office shall constitute less than a majority of the whole board (as constituted immediately prior to any such increase), the Delaware Court of Chancery, upon application of any stockholder or stockholders holding at least 10 percent of the voting stock at the time outstanding having the right to vote for such directors, may summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in office.[1]

In Canmore Consultants Ltd. v. L.O.M. Medical International, Inc.,[2] the first decision to turn solely on the application of Section 223(c), Vice Chancellor Sam Glasscock, III, of the Delaware Court of Chancery, granted a defense motion for summary judgment and denied the plaintiff-stockholders’ request pursuant to Section 223(c) for an order directing the corporation to hold a special election so that the stockholders could fill the vacancies on the company’s board.  As further explained below, the Court held that the plaintiffs had failed to carry their burden of demonstrating that the equities required such an election.

Background Of Section 223

Historically, newly created directorships were filled by stockholder vote, as were board vacancies when a majority of the entire board was not then in office.[3] “[P]rior to 1927[,] …. vacancies on the board only could be filled when a majority of the whole board was present for voting purposes.”[4] And, before 1949, newly created directorships only could be filled by the stockholders.[5] However, over time, the DGCL has been amended to allow directors to fill newly created directorships and vacancies between annual stockholder meetings, “saving the expense and distraction of special meetings between annual meetings for purposes of filling board vacancies.”[6]

The current version of Section 223(a) states that, unless otherwise provided in the corporation’s certificate of incorporation or bylaws, vacancies and newly created directorships “may be filled by a majority of the directors then in office, although less than a quorum, or [even] a sole remaining director[.]”[7] The statute’s use of the word “may,” however, means that it “does not displace the inherent right of the stockholders to take such action, either by causing a special meeting . . . or by way of written consent,”[8] or by applying to the Court of Chancery for relief pursuant to Section 223(c).[9]   

Prior Case Law

While the Canmore Consultants case is the first to turn solely on the application of Section 223(c), there is one case that was decided based on the predecessor statute. In McWhirter v. Washington Royalties Co.,[10] decided in 1930, four directors of a seven-member board resigned, and the three remaining directors unanimously elected four new directors to fill the vacancies.[11] Thereafter, stockholders owning 43% of the company petitioned the Court of Chancery pursuant to Section 30 of the then-existing General Corporation Act for a new election to fill the vacancies.[12] The Court held that the support of such a large percentage of stockholders was prima facie evidence that such an election was appropriate and ordered a new election, despite the annual election being only three months away.[13] The Court stated, in pertinent part: The Court rejected the respondents’ argument (and refused to hear related testimony) that the four persons chosen to fill the vacancies “were competent to act as directors and were men of business experience and integrity.”[14] It reasoned that, “[w]hen [43%] of [the stockholders] ask for a meeting of all in order to see if the vacancies have been filled satisfactorily to a majority, I do not think that the court should deny the request simply because the court might think that the choices already made by the remaining minority directors were of competent and fit persons.”[15]      

The Facts Of Canmore Consultants

The Canmore Consultants case was a sequel to another action before Vice Chancellor Glasscock concerning the composition of the five-member board of directors of L.O.M. Medical International, Inc. (“L.O.M.”).[16] In that action, Gentili v. L.O.M. Medical International, Inc.,[17]twenty-three (23) plaintiffs representing a stockholder faction known as the “Gentili group,” which included the current directors of L.O.M., challenged the validity of incumbent directorships at the company’s annual meeting pursuant to 8 Del. C. § 225.[18] At the annual meeting, the then-incumbent directors accepted votes in favor of their election after L.O.M.’s president had adjourned the meeting prematurely.[19] In a letter ruling, the Court denied the incumbent directors’ motion to dismiss the Section 225 action and, to avoid the continuance of the litigation, suggested that they agree to hold a new stockholders’ meeting under Court supervision.[20] The incumbent directors followed the Court’s suggestion and the parties stipulated to conducting a second stockholders’ meeting to be overseen by a special master acting as chairman.[21]

The second meeting largely resulted in the rejection of the incumbent slate of directors, with only one of the incumbent directors being re-elected and four new directors being chosen.[22] Two months later, two of the newly elected directors resigned, one citing insufficient directors’ and officers’ insurance, the other for unspecified reasons.[23] Before any replacement directors could be appointed, a third director resigned without stating a reason for so doing, leaving only two elected directors in office.[24] Later that same day, the two remaining directors executed written consents appointing a third director to the board.[25] A few weeks later, the three directors appointed a fourth director to serve, and, two weeks after that, the four directors appointed a fifth director to the board.[26]

Thereafter, a group of L.O.M. stockholders owning more than 10% of the voting stock of the company and who were aligned with the displaced incumbent directors brought suit pursuant to 8 Del. C. § 223(c) seeking a Court order directing the company to conduct a special stockholders’ election to potentially replace the board-appointed directors, naming as defendants the company and the two directors remaining following the three resignations.[27] 

Despite agreeing that the plaintiffs satisfied the standing requirements to bring an action under Section 223(c)—i.e. that (1) the plaintiffs collectively owned at least 10% of the voting stock of the company, and (2) at the point in time when the individual defendants filled the first board vacancy, they constituted a minority of the entire board of directors—the defendants moved for summary judgment.[28]

The Court’s Decision

The Court granted the defendants’ motion for summary judgment and denied the plaintiffs’ request for a new election.  The Court rejected the plaintiffs’ contention that Section 223(c)’s grant of authority to the Court to hear such cases created a presumption in favor of ordering an election, and thus that plaintiffs’ satisfaction of the standing requirements entitled them to a special election.[29]  To the contrary, the Court adopted the view that Section 223(c) comprises “only a limited exception to the directorial authority to fill vacancies granted under Section 223(a).”[30]

The Court explained:  “Section 223(c) is permissive,” providing that, upon application, “the Court may exercise its discretion to order an election under these circumstances.”[31]  The Court bolstered its determination that Section 223(c) provides “only a modest constraint” on directorial authority by noting that, under Section 223(a), directors may fill board vacancies only where doing so is not prohibited by a company’s certificate of incorporation or bylaws.[32]  “Because a company has the ability to entirely eliminate the authority granted to directors under 223(a), the utility of 223(c) to constrain directorial authority is minimal; Section 223(c) merely creates a narrow avenue whereby the Court may prevent directors from filling board vacancies where doing so is necessary to avoid some identifiable inequity.”[33] 

According to the Court, because directors may (and usually do) fill board vacancies as they occur, Section 223(c) grants stockholders the opportunity, “in the limited instance circumscribed by the subsection,” to demonstrate that the equities of the case warrant divesting the directors of their power under Section 223(a) and “justify the expense and distraction of holding a special stockholder meeting to fill those vacancies instead.”[34]  

That is, once the plaintiff has satisfied the Court that the standing requirements to bring a Section 223(c) action have been met, the inquiry becomes whether the Court “should” exercise its discretion and order an election.[35] Because the statute does not identify any factors for the Court’s consideration, the Court “therefore [is] free to weigh the equities as they exist in the particular factual situation presented.”[36] Once placed in this context, the Court understood Section 223(c) as placing the burden on the plaintiffs to demonstrate that the equities weigh in favor of ordering an election.[37] Thus, the Court ruled:

In order to perfect the right to a special election under Section 223(c), the Plaintiffs must show (1) that only a minority of directors remained on the board at the pertinent time, (2) that the Plaintiffs represent at least ten percent of outstanding shares, and (3) that the equities support their request.[38]

The Court distinguished McWhirter on the basis that the Canmore plaintiffs, while owning more than 10% to satisfy Section 223(c)’s standing requirement, did not come close to “the near majority that requested an election in McWhirter.”[39]  As such, the analysis in McWhirter did not “shed[ ] much light on the current situation.”[40]

Turning to the balancing of the equities, the Court gave considerable weight to the facts that a stockholders’ meeting had been held only six months earlier, that the incumbent directors (whom the plaintiffs sought to have returned to their board seats) had largely been rejected at that meeting, and that there was “no indication that the outcome of a new election would be any different.”[41] The Court also noted that, had the third director not resigned her directorship only hours before a replacement could be appointed, the two remaining directors would have constituted a majority of a still three-member board.[42] As a result, they “would have had the authority under the company’s bylaws to appoint [a director] to fill a board vacancy, even if [the resigning director] had voted against that appointment.”[43] “Thus, the Plaintiffs’ standing to bring this action arises from simple fortuity.”[44] The Court also was persuaded by evidence that the company “lack[ed] the necessary funds to hold another meeting.”[45]

The Court was unmoved by the plaintiffs’ complaint that they were not included in the company’s recent private placement, which the plaintiffs argued “was offered only to allies of the Gentili group in an effort to bolster stockholder support before the next election[.]”[46] The Court rejected this argument, characterizing it as mere “suspicion” and “devoid of factual support.”[47] Consequently, the Court found that “the Plaintiffs can point to no persuasive equitable reason why stockholder interests are not protected by the current board[.]”[48]

The Court concluded:  “I cannot find that the equities favor ordering a new election to fill the board vacancies. . . .  The Plaintiffs have failed to demonstrate that the equities require forcing the cashstrapped company to repeat the same struggle for control that the stockholders have so recently addressed.”[49]  For these reasons, the Court granted the defendants’ motion for summary judgment and denied the plaintiffs’ request for a new election.

Conclusion And Take-Aways

The Court of Chancery’s ruling in Canmore Consultants is the first Delaware court decision to turn solely on the application of Section 223(c).  As a result of the Court’s decision,[50] plaintiffs filing suit under Section 223(c) not only will have to show that they represent at least 10% of the voting stock of the company and that only a minority of directors remained on the board at the time a vacancy or newly created directorship was filled, but now also will be required to convince the Court that the equities warrant the ordering of the requested election.[51]

While cases decided on a balancing of the equities inherently turn on their particular facts, the Court’s opinion does provide guidance as to what a Section 223(c) plaintiff must show in order to satisfy his burden of proof:   

  • The Court required the plaintiffs to show a “persuasive” equitable reason for why “stockholder interests are not protected by the current board” and favor “an immediate exercise of their voting franchise”;
  • The Court noted that, consistent with McWhirter, “as the percentage of stockholders supporting a new election approaches a majority, this itself may become an equitable factor supporting an election”;[52]
  • The Court also required the plaintiffs to justify the expense of the requested election, and was heavily influenced by the company’s weak financial position in ruling against the plaintiffs, considering it “the dispositive problem with ordering a new stockholder meeting in this instance”;
  • The Court was unmoved as an equitable matter by a transaction undertaken by the company subsequent to the challenged director appointments because, even if some wrongdoing did occur, “a new election would not remedy that wrong,” and Section 223(c) does not authorize the Court to rescind such a transaction; and
  • The Court noted that, in certain instances, the next annual election may be so near as to render a Section 223(c) claim moot, but approvingly cited to McWhirter, wherein the Courtordered a new election even though the next annual election was only three months away,[53] thereby indicating that fewer than three months’ time likely would be necessary in order to moot a Section 223(c) claim.

As a practical matter, to avoid suits under Section 223(c) entirely, corporations would be wise to adopt charter provisions vesting exclusive power in the board to fill vacancies and newly created directorships.  The Court of Chancery has upheld such provisions against stockholder challenges in the past.[54]       

[1] 8 Del. C. § 223(c).

[2] C.A. No. 8645-VCG, 2013 WL 5274380 (Del. Ch. Sept. 19, 2013).

[3] 2013 WL 5274380, at *3.

[4] Id. at *3 n.9 (citation omitted).

[5] Id. at *3 n.8 (citation omitted).

[6] Id. at *3.

[7] 8 Del. C. § 223(a).

[8] Donald J. Wolfe & Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery, § 8.07, at 8-168 (2012) (citing 8 Del. C. §§ 211(d) and 228).

[9] Id. at 8-169.

[10] 152 A. 220 (Del. Ch. 1930).

[11] Id. at 222.

[12] Id.

[13] Id. at 224.

[14] Id.

[15] Id.  In one other case, Prickett v. American Steel & Pump Corp., plaintiff-stockholders brought a cause of action under Section 223(c), alleging that three directors of the five-member board were elected by the two directors then in office (constituting less than a majority of the whole board).   251 A.2d 576, 577 (Del. Ch. 1969).  However, it is unclear whether the Court of Chancery ordered a stockholder meeting under Section 223(c) or under Section 211, because the corporation also had not held an annual meeting the previous year.  Id. at 578.  The Court relied heavily on its power under Section 211(c) to “summarily order a meeting” if one had not been held in 13 months.  Id.  Thus, the case appears inapposite. 

[16] 2013 WL 5274380, at *1.

[17] C.A. No. 7600-VCG, 2012 WL 3552685 (Del. Ch. Aug. 17, 2012).

[18] 2012 WL 3552685, at *1 (Del. Ch. Aug. 17, 2012).

[19] Id.

[20] Id. at *3.

[21] Gentili v. L.O.M. Medical Int’l, Inc., C.A. No. 7600-VCG (Del. Ch. Jan. 31, 2013) (Order).

[22] Canmore Consultants Ltd. v. L.O.M. Medical Int’l, Inc. 2013 WL 5274380, at *1-*2 (Del. Ch. Sept. 19, 2013).

[23] Id. at *2.

[24] Id.

[25] Id.

[26] Id.

[27] See id. at *1, *7.

[28] Id. at *2-*3.

[29] Id. at *3.

[30] Id. at *4 (emphasis in original).

[31] Id. at *3 (emphasis in original).

[32] Id. at *4.

[33] Id.

[34] Id.

[35] Id. at *3.

[36] Id.

[37] Id. at *4.

[38] Id. at *7.

[39] Id. at *5.

[40] Id.

[41] Id.

[42] Id.

[43] Id.

[44] Id.

[45] Id. at *6.

[46] Id.

[47] Id.

[48] Id.

[49] Id.

[50] Of course, the precedential value of the Court’s decision will turn on whether the case is appealed, and, if appealed, whether it is affirmed or reversed by the Delaware Supreme Court.  To date, the plaintiffs have not filed a notice of appeal.

[51] It is important to note that stockholders’ rights under Section 223(c) are in addition to their rights under Section 225, which provides to stockholders and directors (and officers whose title to office is contested) the right to contest the validity of “any election, appointment, removal or resignation of any director or officer of any corporation[.]”  8 Del. C. § 225(a).  Well-established Court of Chancery precedent expressly holds that director action under Section 223 may be contested pursuant to Section 225.  Grossman v. Liberty Leasing Co., Inc., 295 A.2d 749, 752 (Del. Ch. 1972).

[52] 2013 WL 5274380, at *4 n.14 (citing McWhirter v. Wash. Royalties Co., 152 A. 220 (Del. Ch. 1930)).

[53] See McWhirter v. Wash. Royalties Co., 152 A. 220, 224 (Del. Ch. 1930).

[54] See Siegman v. Tri-Star Pictures Inc., C.A. No. 9477, 1989 WL 48746, at *6 (Del. Ch. May 5, 1989) (“The permissive language of § 223, coupled with the more general authority of § 102(b)(1), is sufficient to authorize a certificate provision that vests exclusive power in the board to fill board vacancies and newly created directorships.”) (footnote omitted).  But see DiEleuterio v. Cavaliers of Delaware, Inc., C.A. No. 8801, 1987 WL 6338, at *6 & n.2 (Del. Ch. Feb. 9, 1987) (questioning whether a bylaw could validly vest exclusive power in the board to fill vacancies and newly created directorships).