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Exploring how Sections 204 and 205 of the Delaware General Corporation Law allow for the validation of defective corporate acts and the adoption of ratification statutes in various states.
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Ratification of Defective Corporate Acts International Association of Commercial Administrators 2019 Conference May 22, 2019 John Mark Zeberkiewicz Richards, Layton & Finger, P.A.
Ratification Statutes • Sections 204 and 205 of the Delaware General Corporation Law (“DGCL”) were designed to allow for the ratification or validation of defective corporate acts—i.e., acts taken by or on behalf of a corporation that, but for a failure in the authorization of those acts, would have been valid acts. • Sections 204 and 205 became effective on April 1, 2014. • Broadly speaking, Section 204 is the “self-help” mechanism by which a corporation may engage in a process, initiated by its board of directors, to cure defective corporate acts. • Broadly speaking, Section 205 is the process by which one or more parties may petition the court to seek validation of defective acts, or to challenge the ratification of defective corporate acts.
Why Were the Ratification Statutes Adopted? • So-called “voidable” acts could be ratified at common law, but “void” actions could not be ratified. • No clear line between “void” and “voidable” acts. See, e.g., Blades v. Wisehart, 2010 WL 4638603 (Del. Ch. Nov. 17, 2010). • “Void” acts are void ab initio—and were therefore incapable of cure by ratification at common law, leaving no easy solutions for dealing with flaws in capital structures or in other areas. • Before the enactment of the ratification statutes, some “solutions” for dealing with void acts included: • Rescission • “Redos” • Sections 204 and 205 resolved these matters by allowing for the ratification or validation of both voidable and void acts.
Ratification Statutes—MBCA and Others • After the adoption of Sections 204 and 205, the Model Business Corporation Act (“MBCA”) was amended to include comparable provisions, and jurisdictions outside of Delaware have adopted (or are considering adopting) provisions allowing for the ratification or validation of defective corporate acts. • At the start of 2019, Connecticut, Delaware, Kansas, Nevada, North Carolina, Oklahoma, Texas and Virginia (delayed effective date of July 1, 2020) and Washington had adopted provisions. • Several states are considering legislation in 2019, including Alabama, Colorado, Idaho, Montana, Oregon and Virginia; with others making plans for 2020, including Maryland and Iowa.
Ratification Statutes—MBCA and Others • The MBCA provisions dealing with the ratification and validation of defective acts are conceptually similar to Sections 204 and 205, albeit with some variation. • This presentation only expressly addresses ratification under Sections 204 and 205 of the DGCL; however, most of the principles and topics addressed herein are equally applicable to ratification statutes that follow the MBCA.
Identifying the Defective Corporate Act • The first item to address in any ratification process is the identification of the defective corporate act. • Section 204(h)(1) defines “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 purportedly taken by or on behalf of the corporation that is, and at the time such act or transaction was purportedly taken would have been, within the power of a corporation under subchapter II of the DGCL (without regard to the failure of authorization identified in § 204(b)(1)(D) of the DGCL), but is void or voidable due to a failure of authorization.
Identifying the Defective Corporate Act • Section 204 allows for the ratification of “acts” that actually occurred (albeit without proper authorization)—not the ratification of acts that parties wished or hoped had occurred but that did not actually occur. • In re Numoda Corp. S'holderLitig., 2015 WL 402265 (Del. Ch. Jan. 30, 2015), the Court noted that, in assessing whether a defective corporate act has occurred, it would “look for evidence of a bona fide effort bearing resemblance to a corporate act but for some defect that made it void or voidable.”
Identifying Failures of Authorization • The second item in any ratification process is identifying the “failure of authorization”—which is essentially the reason the act is a defective corporate act. • Section 204(h)(2) defines “failure of authorization” as: • the failure to authorize or effect an act or transaction in compliance with • the provisions of the DGCL, • the certificate of incorporation or bylaws of the corporation, or • any plan or agreement to which the corporation is a party or the disclosure set forth in any proxy or consent solicitation statement, if and to the extent such failure would render such act or transaction void or voidable; or • the failure of the board of directors or any officer of the corporation to authorize or approve any act or transaction taken by or on behalf of the corporation that would have required for its due authorization the approval of the board of directors or such officer.
Common Failures of Authorization • Although the types of failures of authorization are endlessly variable, some common failures of authorization that tend to recur include: • Failure of the incorporator to elect the initial board • Failure to have valid board action due to lack of quorum • Failure to have valid board action due to less than unanimous board consent in lieu of a meeting • Failure to follow prescribed statutory sequences • Failure to obtain requisite stockholder vote or consent • “Late” charter filings
Board Approval of 204 Ratification • A ratification process is initiated by the board of directors. • Note: A Section 204 ratification must be approved by a board composed of valid directors. • In general, when the board is approving the ratification of a defective corporate act, the quorum and voting requirements are the greater of those (i) at the time of the act or (ii) at the time of the ratification, subject to certain specified exceptions.
Stockholder Approval of 204 Ratification • Depending on the nature of the act being ratified, the stockholders must also approve the ratification. • Stockholder approval of a Section 204 ratification is required if, under the DGCL, the certificate of incorporation, the bylaws or any plan or agreement to which the company is a party: • A stockholder vote is required at the time of the ratification; or • A stockholder vote was required at the time of the defective corporate act. • Where a stockholder vote is required, the vote that must be obtained is the greater of that required at the time of the act or at the time of the ratification, subject to certain specified exceptions.
Stockholder Approval of 204 Ratification • In cases where a stockholder vote is required, the only holders entitled to vote on the ratification are the holders of valid stock (i.e., stock that was authorized and issued in compliance with the certificate of incorporation, bylaws and DGCL). • Holders of putative stock (which is any stock that cannot be determined to be valid stock) are not entitled to vote. • NOTE: Even if a stockholder vote otherwise would be required for the underlying act, no stockholder vote is required to authorize the ratification if there are no shares of valid stock outstanding as of the record date for determining stockholders entitled to vote on the ratification.
The Certificate of Validation • After the ratification of a defective corporate act has been duly authorized, the corporation must file a certificate of validation if the initial act would have required the filing of an instrument with the Delaware Secretary of State for its validity. • Examples include ratifications of amendments to the certificate of incorporation (or acts whose valid taking would have required the filing of an amendment to the certificate of incorporation) and ratifications of mergers. • Generally, a separate Certificate of Validation must be filed for each act (but one certificate can be filed for multiple overissuances).
Contents of the Certificate of Validation • The Certificate of Validation must include: • each defective corporate act that is the subject of the certificate of validation, the date of such defective corporate act, and the nature of the failure of authorization in respect of such defective corporate act; • a statement that the defective corporate act was ratified in accordance with Section 204, including the date on which the board ratified the defective corporate act and the date, if any, on which the stockholders approved the ratification of the defective corporate act; and • Certain other information relating to the certificate that was or should have been filed with respect to the defective corporate act.
Contents of the Certificate of Validation • In general, certificates of validation fall into three broad categories: • Those that are filed in cases where an instrument has previously been filed and requires no change, in which case the original instrument is attached to the certificate of validation. • Those that are filed in cases where an instrument has previously been filed but requires a change, in which case the certificate sets forth specified information (including updated information required to give effect to the ratification of the defective act). • Those that are filed in cases where no instrument was previously filed, in which case the certificate includes specified information regarding the previously omitted instrument.
A Note on Certificates of Validation • Delaware has processed over 1,000 certificates of validation to date. • The Delaware Secretary of State follows a rigorous review process and processes filings in coordination with franchise tax department; accordingly, no expedited service is available. • Fees for filing certificates of validation are $2500 per certificate, plus other fees and charges. • Depending on the nature of the defective act ratified, the filing company may be required to file amended Delaware franchise tax reports for prior years and pay any “back” franchises taxes due as a result of retroactive changes to authorized shares.
Validation Effective Time • The ratification of a defective corporate act renders a defective corporate act valid as of the time it was originally taken for Delaware law purposes from and after the “validation effective time.” • Where the board has not fixed a future validation effective time, the “validation effective time” is the latest of: • The time at which stockholder approval is obtained or, where no stockholder approval is required, the time at which the board adopts the ratification resolutions; and • The time at which any certificate of validation becomes effective. • Where no certificate of validation is required to be filed, the board may specify a future time as the validation effective time.
Notice to Stockholders • Whether or not a stockholder vote is required, notice of any ratification must be given to holders of valid and putative stock, whether voting or nonvoting. • Notice must also be given to former stockholders as of the time of the acts ratified (or record dates fixed therefor) unless the identities and addresses of such stockholders cannot be determined from the records of the corporation. • 204 notices may be combined with “Section 228(e) notices” of actions by written consent of stockholders in lieu of a meeting. • Notices must be given by means recognized under the DGCL (although public companies may give notice via SEC filing). • The notice must contain the information required to be specified in the ratification resolutions adopted by the board. • The notice must contain an express statement regarding the 120-day period in which certain challenges must be brought. • If ratification is to be submitted to a vote of stockholders at a meeting, notice must be given at least 20 days in advance of the date of the meeting. • Typical for notice to attach the resolutions adopted by the board as well as copies of the certificates of validation (if any) filed with the Delaware Secretary of State.
Section 205: Court-ordered Validation • Section 205 has been used as an “in court” alternative when the “self-help” procedures of Section 204 are not available. See In re Trupanion, C.A. No. 9496-VCP (Del. Ch. Apr. 28, 2014) (validating corporate acts under Section 205 where the corporation was unable to satisfy the requirements of Section 204). • Section 205 also provides a process for stockholders to challenge a Section 204 ratification. • Section 205 provides a non-exhaustive list of factors for the court to consider when determining the appropriate remedy. These factors include whether the board approved the act with the belief that it was properly approved and whether the board and the public treated the act as valid. Ultimately, the court may consider “any factors or considerations the Court deems proper.”
This presentation and the material contained herein are provided as general information and should not be construed as legal advice on any specific matter or as creating an attorney-client relationship. Before relying on general legal information or deciding on legal action, request a consultation or information from a Richards, Layton & Finger attorney on specific legal needs.
