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Applying a Legal Bandaid to Defective Acts: Delaware Law Creates New Procedures to Ratify Defective Corporate Acts




by:
Lauren Lewis
Irene Lu
Stephanie L. Zeppa
Sheppard, Mullin, Richter & Hampton LLP - Palo Alto Office

 
March 28, 2014

Previously published on March 26, 2014

On June 30, 2013, the State of Delaware amended the Delaware General Corporations Law (the “DGCL”) to include two new sections, Section 204 and Section 205 (together, the “Ratification Provisions”). Set to take effect on April 1, 2014, the Ratification Provisions provide Delaware companies with two alternative processes to remedy defective corporate acts that may have previously been deemed void or voidable: by the company itself (under Section 204) or by the Delaware Court of Chancery (under Section 205). Upon the ratification or the validation by either the company or the court, the defective corporate act will be deemed retroactively effective and valid as of the time the defective corporate act was taken.

What is a “defective corporate act”?

The new law defines a “defective corporate act” as:

  • An overissue;

  • An election or appointment of directors that is void or voidable due to a failure of authorization; or

  • Any act or transaction taken by a company that is otherwise void or voidable due to a company’s failure to obtain proper authorization.

How have companies handle defective corporate acts in the past?

In the past, acts recognized as “voidable” could be ratified by companies on a later date. However, acts which were categorized as “void”, such as the issuance of stock in excess of the amount of shares authorized by a company’s organizational documents, were deemed invalid by Delaware courts. As such, companies had no remedial devices to fix such “void” corporate acts, even if the corporation’s failure to properly authorize the act was unintended or completely innocent.

Why are the Ratification Provisions valuable to Delaware companies?

Early stage and smaller-sized companies frequently need to conduct a “clean up” of their corporate records before received funding, being acquired, or engaging in another corporate transaction. The “clean up” process usually involves the adoption of resolutions by the company’s board of directors or shareholders to ratify past acts. Even larger and more established companies commonly ratify their actions in order to, among other things, ensure compliance with corporate governance laws and to perfect their capital structure.

As an example, prior to the addition of the Ratification Provisions to the DGCL, if a company issued unauthorized shares of its stock to investors, that stock issuance would be considered “putative stock” and deemed invalid. In turn, such stockholders’ votes would consequently be deemed invalid since they are not considered owners of the company. The initial over-issuance of stock could create a domino effect of invalid acts which could have adverse effects on a company.

How may a company ratify its defective corporate acts on its own?

A company that desires to ratify a defective corporate act under Section 204 must take the following steps:

  • The Board of Directors must adopt a resolution ratifying the defective corporate act. The resolution should contain certain information set forth in Section 204(b), including a description of the defective corporate act and the time in which it occurred; whether it involved the issuance of putative stock (and if so, the number and types of shares of putative stock issued and the date of such issuance); the nature of the failed authorization; and a statement that the Board of Directors approves the ratification of the defective corporate act.

  • If the company would have needed stockholder approval to authorize the corporate act, the company must submit the ratifying resolution for a stockholder vote. The company must provide stockholders with a 20-day notice of the stockholder meeting. Such notice must be provided to all stockholders (including holders of putative stock) of the company whether voting or nonvoting, unless the addresses or identities of such stockholders cannot be determined. The notice must contain a copy of the ratifying resolution along with a statement that any challenges to the defective corporate act’s ratification must be brought within 120 days of the ratification’s effective time.

  • If the company would not have needed stockholder approval to authorize the defective corporate act, the company must provide notice of the ratifying resolution’s adoption to its stockholders. Notice must be given to all stockholders (including holders of putative stock) of the company, whether voting or nonvoting, in addition to all stockholders (including holders of putative stock) of record at the time of the defective corporate act, unless their addresses or identities cannot be determined. This notice must also contain a copy of the ratifying resolution along with a statement that any challenges to the defective corporate act’s ratification must be brought within 120 days of its effective time.

What if the corporate act would have required some type of filing?

If the defective corporate act would have required some type of filing, such as a certificate of amendment or a certificate of merger, with the Delaware Secretary of State, the company must then file a certificate of validation with the Delaware Secretary of State. The company is required to file a certificate of validation even if the company had in fact filed the initial required document with the Delaware Secretary of State.

What if the company is unable to ratify its defective corporate act through the process described above?

If a company is unable or unwilling to ratify its defective corporate act through the process required by Section 204, Section 205 authorizes certain parties to request that the Delaware Court of Chancery validate the company’s defective corporate acts directly. This provides an opportunity for validation for companies who do not have a validly elected and appointed board of directors and thus would be unable to adopt a resolution under Section 204. Section 205 also grants the Delaware Court of Chancery jurisdiction to hear and determine all matters relating to the ratification of defective corporate acts.

Who may petition the Delaware Court of Chancery to validate a defective corporate act?

The following parties can bring a claim under Section 205: the company itself, any successor entity, any member of the board, any record or beneficial holder of valid stock or putative stock, any record or beneficial holder of valid or putative stock as of the time of a defective corporate act, or any other person claiming to be substantially and adversely affected by a ratification pursuant to Section 204.

How does this affect Delaware corporations?

The Ratification Provisions expressly codify the procedures for the ratification of defective acts and reverses the Delaware court’s previous decision that certain defective corporate acts are “void” and incapable of remedy. The Ratification Provisions provide companies with a greater degree of certainty with respect to the ratification of defective corporate actions and sets forth a formal process for challenging such ratifications.



 

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
 

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Author
 
Lauren Lewis
Stephanie L. Zeppa
Sheppard, Mullin, Richter & Hampton LLP
 
Palo Alto Office
Practice Area
 
Corporate Law
 
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