Recently, the Delaware legislature adopted and Delaware’s Governor signed into law several substantive amendments to the General Corporation Law of the State of Delaware (the DGCL), 8 Del. C. §§ 101 et seq.

New Provisions

Ratification of Defective Corporate Acts, Transactions and Stock (§§ 204 and 205) → These new Sections provide a procedure to ratify defective corporate acts, transactions and stock and vest the Court of Chancery of the State of Delaware (the Court of Chancery) with jurisdiction over disputes regarding such ratification, the validity of any corporate act, transaction or stock and the modification or waiver of any of the procedures for ratification of any corporate act, transaction or stock.

Elimination of Stockholder Vote For Certain Two-Step Mergers (§ 251(h)) → New Section 251(h) permits a merger agreement to eliminate the requirement of a stockholder vote for qualifying two-step mergers.

Public Benefit Corporations (§§ 361 – 368) → These new Sections authorize the creation of “public benefit corporations” — for-profit corporations formed to promote specific “public benefit(s).”

Amendments

Formula for Determining Consideration for Issuance of Stock (§ 152) → Section 152 was amended to clarify that the board of directors may establish a formula for calculating the consideration to be received for the issuance of shares.

Restrictions on “Shelf” Corporations (§§ 312(b) and 502(a)) → These amendments discourage the establishment of “shelf” corporations (i.e., corporations formed without directors or stockholders for the purpose of holding onto the corporation for later use).

All of the amendments to the DGCL became effective on August 1, 2013, with the exception of new Sections 204 and 205, which will become effective on April 1, 2014 and are contained in House Bill 127 and Senate Bill 47, which are available on the Delaware legislature’s website at http://legis.delaware.gov/. The amendments are discussed in greater detail below.

Ratification of Defective Corporate Acts, Transactions and Stock

New Section 204 provides a “safe harbor” procedure for ratifying defective corporate acts, transactions and stock.  Under new Section 204 a “defective corporate act” that may be ratified under the “safe harbor” procedure includes (i) a purported issuance of shares of capital stock in excess of the number of shares that the corporation has the power to issue or shares of capital stock that is not then authorized for issuance by the certificate of incorporation or the corporation (i.e., an “overissue”), (ii) an election or appointment of directors that is “void” or “voidable” due to a failure of authorization, or (iii) 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 the corporation under the DGCL, but is “void” or “voidable” due to a failure of authorization, including, with respect to the creation and issuance of shares of capital stock and shares issued upon the exercise of options, rights, warrants or convertible securities (such shares that but for such failure would have been validly issued and any other shares that the board of directors cannot determine are valid are defined in new Section 204 as “putative stock”).

Under Delaware case law, including the holding of the Delaware Supreme Court in STAAR Surgical Co. v. Waggoner, 588 A.2d 1130 (Del. 1991), and the holding of the Chancery Court in Blades v. Wisehart, 2010 WL 4638603 (Del. Ch. Nov. 17, 2010), corporate acts, transactions or stock that were found to be “void” due to a failure to comply with the DGCL or the certificate of incorporation or bylaws of the corporation could not be ratified, even on equitable grounds.  InSTAAR Surgical Co., 588 A.2d at 1136, the Delaware Supreme Court held that “[s]tock issued without authority of law is void and a nullity,” reversing the decision of the Court of Chancery granting equitable relief where the board of directors failed to formally adopt a resolution authorizing preferred stock.  More recently, in Blades v. Wisehart, the Court of Chancery held that a forward stock split was not validly implemented due to the failure of the board of directors to strictly comply with statutory requirements, and in turn, certain stock purportedly held by minority stockholders was “void.”  Further, in Noe v. Kropf, C.A. No. 4050-CC (Del. C. Jan. 15, 2009) (Transcript), the Court of Chancery suggested that even Section 8-202(b) of the Delaware Uniform Commercial Code, which provides that a security issued with a defect is valid in the hands of a purchaser for value without notice of the defect, could not validate stock that was “void” for failure to comply with the DGCL.  New Section 204 is expressly intended to overturn such Delaware case law and provide a mechanism to ratify even “void” acts, transactions and stock.
New Section 205 confers jurisdiction on the Court of Chancery to determine the validity of any ratification effected pursuant to new Section 204’s “safe harbor” procedure and to modify or waive any of the procedures of new Section 204, as well as to determine the validity of any other corporate act, transaction or stock.
The “safe harbor” procedure of new Section 204 and the Court of Chancery’s jurisdiction under new Section 205 do not, however, become effective and therefore available to ratify defective corporate acts, until April 1, 2014.

The “Safe Harbor” Procedure of New Section 204

New Section 204’s “safe harbor” provides a specific procedure to ratify or “cure” defective corporate acts that would otherwise be “void” or “voidable” under Delaware law.  This new procedure is only available if there is a valid board of directors.

In order to take advantage of new Section 204, the corporation’s board of directors first must adopt a resolution setting forth (i) the defective corporate act to be ratified, (ii) the time of the defective corporate act, (iii) if such defective corporate act involved the issuance of shares of putative stock, the number and type of shares of putative stock issued and the date or dates upon which such putative shares were purported to have been issued, (iv) the nature of the failure of authorization in respect of the defective corporate act to be ratified, and (v) that the board of directors approves the ratification of the defective corporate act.  The quorum and vote requirements applicable to the adoption of such resolution by the board of directors are those applicable at the time of such adoption for the type of defective corporate act proposed to be ratified, subject to certain exceptions.

Such resolution must then be submitted to the corporation’s stockholders for adoption unless (i) no other provision of the DGCL, the corporation’s certificate of incorporation or bylaws, or any plan or agreement to which the corporation is a party, would have required stockholder approval of the defective corporate act to be ratified, either at the time of the defective corporate act or at the time when the board resolution ratifying the defective corporate act is adopted, and (ii) the defective corporate act did not result from a failure to comply with Section 203 of the DGCL (i.e., Delaware’s “business combination” statute).

If adoption of the resolution by stockholders is required, notice of the time, place and purpose of the meeting of stockholders, containing a copy of the resolution and a statement that any claim that the defective corporate act or putative stock ratified under Section 204 of the DGCL is “void” or “voidable” due to the identified failure of authorization, or that the Court of Chancery should declare in its discretion that a ratification in accordance with Section 204 should not be effective or be effective only on certain conditions, must be brought within 120 days from the “validation effective time,” must be given at least 20 days before the date of such meeting to each holder of valid stock and putative stock, whether voting or nonvoting, and to the holders of record of valid stock and putative stock, whether voting or nonvoting, as of the time of the defective corporate act, subject to certain exceptions.  New Section 204(h) defines the “validation effective time” as the later of (i) the time the resolution is adopted by stockholders (if stockholder adoption is required), (ii) the notice required to be given to stockholders is given (if stockholder adoption is not required), and (iii) the time a certificate of validation filed pursuant to new Section 204 becomes effective under the DGCL.  The quorum and vote requirements applicable to the adoption of such resolution by stockholders are those applicable at the time of such adoption for the type of defective corporate act proposed to be ratified, subject to certain exceptions.

If the notice described above is not required to be given in connection with the adoption of the resolution by the corporation’s stockholders, prompt notice of the adoption of the resolution by the board of directors must be given to holders of valid stock or putative stock, whether voting or nonvoting, as of the date of the adoption of such resolution by the board of directors, or as of a date within 60 days after the date of the adoption of such resolution established by the board of directors, and to the holders of valid and putative stock, whether voting or nonvoting, as of the time of the defective corporate act, subject to certain exceptions.  Such notice must include a copy of the resolution adopted by the board and a statement that any claim that the defective corporate act or putative stock ratified under Section 204 of the DGCL is “void” or “voidable” due to the identified failure of authorization, or that the Court of Chancery should declare in its discretion that a ratification in accordance with Section 204 should not be effective or be effective only on certain conditions, must be brought within 120 days from the validation effective time.

If the defective corporate act ratified pursuant to new Section 204 would have required the filing of a certificate with the Secretary of State of the State of Delaware under the DGCL, then the corporation must file a certificate of validation containing the information required by subsection (e) of Section 204 in accordance with Section 103 of the DGCL.  A certificate of validation must be so filed whether or not a certificate was previously filed in connection with the defective corporate act ratified under new Section 204.

Consequences of Compliance with New Section 204

Unless otherwise determined by the Court of Chancery pursuant to new Section 205, from and after the validation effective time, (i) each defective corporate act set forth in the resolution will no longer be “void” or “voidable” as a result of failure of authorization identified in such resolution and will be retroactive to the time of such defective corporate act, and (ii) each share of putative stock issued or purportedly issued pursuant to such defective corporate act and identified in the resolution will no longer be “void” or “voidable” as a result of failure of authorization identified in such resolution, and in the absence of any failure of authorization not ratified, shall be deemed to be an identical share or fraction of a share of outstanding stock as of the time it was purportedly issued.

Court of Chancery Proceeding Pursuant to New Section 205

New Section 205 confers exclusive jurisdiction on the Court of Chancery to (i) determine the validity and effectiveness of any defective corporate act ratified pursuant to new Section 204, the ratification of any defective corporate act pursuant to new Section 204, and any defective corporate act not ratified or not ratified effectively pursuant to new Section 204, (ii) determine the validity of any corporate act or transaction and any stock, rights or options to acquire stock, regardless of whether such act, transaction or issuance could have been ratified under new Section 204, and (iii) modify or waive any of the procedures set forth in Section 204 to ratify a defective corporate act.  New Section 205 may therefore be used to ratify a defective corporate act where no valid board of directors exists to ratify such defective act pursuant to new Section 204.

Only the corporation (or any successor entity), any member of the board of directors, any record or beneficial owner of valid stock or putative stock, any record or beneficial owner of valid or putative stock as of the time of a defective corporate act ratified pursuant to new Section 204, or any person claiming to be substantially and adversely affected by a ratification pursuant to new Section 204, may apply to the Court of Chancery under new Section 205.

The powers of the Court of Chancery in connection with a proceeding pursuant to Section 205 are broad, and include the power to (i) declare a ratification pursuant to Section 204 not effective, or effective at a time or upon conditions established by the Court of Chancery, (ii) validate and declare effective any defective corporate act or putative stock, and impose conditions upon such validation, (iii) require measures to remedy or avoid harm to a person substantially and adversely affected by a ratification pursuant to new Section 204 or from an order of the Court of Chancery pursuant to new Section 205 (other than any harm that would have resulted if the defective corporate act had been valid when approved or effectuated), (iv) order the Secretary of State of the State of Delaware to accept an instrument for filing with an effective time specified by the Court of Chancery, (v) approve a stock ledger for the corporation, (vi) declare that shares of putative stock are valid stock or require the corporation to issue and deliver shares of valid stock in place of shares of putative stock, (vii) order a meeting of holders of valid stock or putative stock to be held and exercise the powers provided to the Court of Chancery under existing Section 227 of the DGCL, (viii) declare that a defective corporate act validated by the Court of Chancery is effective as of the time of the defective corporate act or another time as determined by the Court of Chancery, (ix) declare that putative stock validated by the Court of Chancery is an identical share or fraction of a share of valid stock as of the time of original or purported issuance or another time as determined by the Court of Chancery, and (x) make such other orders regarding such matters as the Court of Chancery deems proper under the circumstances.

Section 205 provides a list of factors that the Court of Chancery may, but is not required to, consider in connection with resolving the matters set forth in Section 205, including (i) whether the defective corporate act was originally approved with the belief that the approval was in compliance with the provisions of the DGCL and the corporation’s certificate of incorporation and bylaws, (ii) whether the corporation and board of directors treated the defective corporate act as valid and whether any person acted in reliance on the public record that such defective corporate act was valid, (iii) whether any person would be harmed by the ratification or validation, excluding any harm that would have resulted if the defective corporate act had been valid when approved or effectuated, (iv) whether any person will be harmed by the failure to ratify or validate the defective corporate act, and (v) any other factors or considerations the Court of Chancery deems just and equitable.

Common Law Ratification of Voidable Acts Remain Effective

Procedures available to ratify “voidable” acts under common law (as distinguished from “void” acts which cannot be ratified other than pursuant to new Sections 204 and 205) will remain effective and are not preempted by new Sections 204 and 205.

Elimination of Stockholder Vote for Certain Two-Step Mergers

From and after August 1, 2013, public Delaware corporations seeking to consummate a merger following a tender or exchange offer by an arm’s-length third party acquiror may utilize new Section 251(h) to effect the merger without a stockholder vote and without the issuance of a sufficient number of “top-up-options” to permit such acquiror do a “back-end” “short-form” merger.

In order to utilize new Section 251(h), the target Delaware corporation’s shares must be listed on a national securities exchange or held of record by more than 2,000 holders immediately prior to the execution of the merger agreement expressly providing that the merger is governed by new Section 251(h).  In addition, the merger agreement must expressly provide that the merger will be effective as soon as practicable after the consummation of the tender or exchange offer.

In addition to the above requirements, in order to utilize new Section 251(h), (i) the consummation of the tender or exchange offer must result in the third-party acquiror owning at least the number of shares that would be required to authorize the merger under the DGCL and the certificate of incorporate of the target corporation, (ii) the shares of the target corporation must be converted in the merger into or into the right to receive the same consideration paid in the tender or exchange offer, and (iii) at the time the target corporation’s board of directors approves the merger agreement, no other party to such agreement is an “interested stockholder” of the target corporation under Section 203 of the DGCL.

Notably, new Section 251(h) does not alter the fiduciary duties of the board of directors in connection with the approval of the merger or the merger agreement, or the level of judicial scrutiny applied to such action.

Public Benefit Corporations

On July 17, 2013, Delaware became the nineteenth state to enact benefit corporation legislation.  Effective as of August 1, 2013, the DGCL was amended to add new Subchapter XV (new Sections 361 through 368) permitting the creation of public benefit corporations.  Although Delaware isn’t the first state to pass benefit corporation legislation, B Labs, the most recognized national certification organization for benefit corporations, characterizes the impact of Delaware’s legislation as “seismic” given that Delaware is the “most important state for businesses that seek access to venture capital, private equity, and public capital markets.”
New Subchapter XV allows for-profit corporations organized under the DGCL to formally adopt a specific “public benefit” or specific “public benefits” to be pursued concurrently with the pecuniary interests of its stockholders.  New Section 362 describes a public benefit corporation as “a for-profit corporation … that is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner.”  As outlined by new Section 362, public benefit corporations are for-profit corporations that are required to be managed in a manner that balances (i) the financial interests of the public benefit corporation’s stockholders, (ii) the best interests of those materially affected by the public benefit corporation’s conduct, and (iii) the public benefit(s) as specified in the public benefit corporation’s certificate of incorporation.  Public benefit corporations are subject to all other applicable provisions of the DGCL, except as modified or supplanted by new Subchapter XV.¹

Notice of Public Benefit(s) and Public Benefit Corporation Status

A Delaware public benefit corporation’s certificate of incorporation must state in its heading that the corporation is a public benefit corporation and identify within its statement of business or purpose the “public benefit” or “public benefits” sought to be promoted by the corporation.  Section 362 defines a “public benefit” as “a positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in their capacities as stockholders) including, but not limited, effects of artistic, charitable, cultural, economic, education, environmental, literary, medical, religious, scientific or technological nature.”  The public benefit corporation’s name set forth in its certificate of incorporation must contain the words “public benefit corporation,” “P.B.C.” or “PBC”.

Reporting

Under new Section 366, Delaware public benefit corporations must provide stockholders with a statement “as to the corporation’s promotion of the public benefit or public benefits identified in the certificate of incorporation and of the best interests of those materially affected by the corporation’s conduct.”  This statement must be issued to stockholders at least every two years and include (i) the objectives established by the board of directors to promote the corporation’s public benefit(s) and interests, (ii) the standards adopted by the board of directors to measure the corporation’s progress in promoting the corporation’s public benefit(s) and interests, (iii) objective factual information based on such standards regarding the corporation’s success in meeting its objectives for promoting the corporation’s public benefit(s) and interests, and (iv) an assessment of the corporation’s success in meeting the objectives and promoting its public benefit(s) and interests.
New Section 366(c) permits the public benefit corporation’s certificate of incorporation or bylaws to require that such statements be issued more frequently, such statements be issued to the public at large, or third party standards be used in connection with, or that a third certification be obtained with respect to, the corporation’s promotion of the corporation’s public benefit(s) and interests.  Notably, new Section 366 itself does not require that such statement use a third party standard or require that such statement be available to the public.

Conversion to, or from, a Public Benefit Corporation

With certain exceptions, an existing corporation may become a public benefit corporation by amending its certificate of incorporation to identify the public benefit(s) it will promote or by merging or consolidating with another entity pursuant to which “shares in the corporation would become, or be converted into or exchanged for the right to receive, shares or other equity interests in a domestic or foreign public benefit corporation or similar entity.”  Such an amendment or merger or consolidation, however, requires the approval of ninety percent (90%) of each class of outstanding stock (whether voting or non-voting) of the corporation.  New Section 363 also gives those stockholders who neither voted in favor of the amendment or the merger or consolidation, nor consented thereto in writing, the right to an appraisal of such stockholders’ shares.

Once a corporation is a public benefit corporation, the approval of two-thirds of the outstanding shares of each class of outstanding stock (whether voting or non-voting) is required to amend the certificate of incorporation to delete the public benefit corporation provisions required by new Section 362 or permitted by new Section 366(c), or for the public benefit corporation to merge or consolidate with or into another entity “if, as a result of such merger or consolidation the shares in such corporation would become, or be converted into or exchanged for the right to receive, shares or other equity interests in a domestic or foreign corporation that is not a public benefit corporation or similar entity and the certificate of incorporation (or similar governing instrument) of which does not contain identical provisions identifying the public benefit or public benefits pursuant to § 362(a) or imposing requirements pursuant to § 366(c)….”

Fiduciary Duties

New Section 365(a) expressly provides that in managing the public benefit corporation, the board of directors is required to “balance” the pecuniary interests of the stockholders, the best interests of those materially affected by the corporation’s conduct, and the public benefit(s) identified in the corporation’s certificate of incorporation.  New Section 365(b), however, provides that the board of directors, by virtue of the public benefit provisions of the corporation’s certificate of incorporation or new Section 362, owes no duties to any person materially affected by the corporation’s conduct or having an interest in the public benefit(s) identified in the corporation’s certificate of incorporation, and that “with respect to a decision implicating the balance requirement…, [the board of directors] will be deemed to satisfy their fiduciary duties to stockholders and the corporation if the directors’ decision is both informed and disinterested and not such that no person of ordinary, sound judgment would approve.”

The certificate of incorporation of a public benefit corporation may include a provision that any disinterested failure by a director to satisfy new Section 365 shall not, for the purposes of eliminating or limiting director liability under existing Section 102(b)(7) of the DGCL or for indemnification under existing Section 145 of the DGCL, constitute an act or omission not in good faith, or a breach of the duty of loyalty.

Corporate Accountability and Derivative Actions

New Section 367 permits stockholders of a public benefit corporation to sue derivatively to enforce the directors’ duties under new Section 365(a), but only if at the time such a derivative suit is brought, such stockholders, individually or collectively, own at least two percent (2%) of the corporation’s outstanding shares, or, in the case of a public benefit corporation whose shares are listed on a national securities exchange, the lesser of at least two percent (2%) of the corporation’s outstanding shares or shares having a market value of at least two million dollars ($2,000,000).

Formula for Determination of Consideration for Issuance of Stock

Section 152 was amended to clarify that in determining the consideration adequate for the issuance of shares of stock of the corporation, the board of directors may use a formula for determining the price or prices for such issuance.

Restrictions on “Shelf” Corporations

Section 312(b), regarding the renewal or revival of a corporation whose certificate of incorporation has become void or forfeited or expired, and Section 502(a) regarding franchise tax reports required to be filed by Delaware corporations, have been amended to deter the formation of “shelf” corporations with no stockholders or directors with the intent of renewing or aging the corporation for use in the future.  In particular, Section 502(a) was amended to require that other than the initial annual franchise report, the annual franchise report filed by a Delaware corporation must list a director or directors, excepting a franchise report filed with a certificate of dissolution filed by an incorporator pursuant to Section 274 of the DGCL and a certificate of dissolution filed pursuant to Section 275(c) of the DGCL.