John Mark Zeberkiewicz, left, and Nathaniel Stuhlmiller, right, of Richards Layton & Finger.

In two recent opinions, The Cirillo Family Trust v. Moezinia, 2018 WL 3388398 (Del. Ch. July 11, 2018), and Charles Almond v. Glenhill Advisors, 2018 WL 3954733 (Del. Ch. Aug. 17, 2018), the Delaware Court of Chancery exercised its powers under Section 205 of the Delaware General Corporation Law (the DGCL) to validate acts that, due to technical problems in their authorization, may have otherwise been void or voidable. These opinions illustrate that the court, in reviewing petitions under Section 205, will use its equitable powers to ensure that technical defects in authorization do not result in plainly inequitable outcomes.

Cirillo involved Endo Pharmaceuticals, Inc.'s acquisition in 2014 of DAVA Pharmaceuticals, Inc., a closely held corporation with only 31 stockholders. Like many private company mergers, the stockholder approval was obtained by written consent pursuant to Section 228 of the DGCL, with DAVA's nine largest holders (representing approximately 95 percent of the outstanding stock) approving the merger by written consent shortly after the execution of the merger agreement. The stockholder plaintiff, which held less than 1 percent of DAVA's outstanding stock, declined to sign the consent and, after receiving a notice of merger and appraisal rights, filed suit, seeking, among other things, rescissory damages on the grounds that the stockholder consents were not properly dated, as was required by Section 228(c) as in effect at the time, thereby rendering the merger void. In response, DAVA asserted a counterclaim under Section 205, petitioning the court to validate the merger despite the defects in the consents.

Applying the factors set forth in Section 205, the court granted the defendants' motion for summary judgment. The court observed that the underlying purpose of Section 205 “'fundamentally concerns a company having taken an act with the intent and belief that it is valid and later petitioning the court to correct a technical defect and thereby remedy incidental harm,'” and indicated that the key issue before it revolved around the evidence of the parties' intent. In this case, the court found, no party had questioned the authority of the holders of more than 99 percent of the outstanding stock to adopt the merger agreement.

Addressing each of the specific factors enumerated in Section 205(d), the court found that the merger was effected with the belief that the stockholder consents adopting the merger agreement complied with the DGCL and DAVA's certificate of incorporation and bylaws. The court also noted that all parties—including the plaintiff—had treated the merger as having been validly accomplished. (Indeed, the plaintiff did not challenge the validity of the merger until six months after closing, when it amended its complaint to add the claim in respect of the deficiently dated consents.) Next, the court noted that no person would be harmed by the validation, rejecting the plaintiff's argument that the court's validation of the merger would leave it without redress for the alleged wrongs it suffered from the allegedly defective manner in which the consents had been obtained (and, in doing so, noting that Section 205(d) guides the court to exclude from such analysis any harm that would have resulted if the act had originally been validly approved). Finally, and perhaps most importantly, the court stated that its validation of the consents was consistent with Section 205's purpose, observing that the failure of the consents to have included individual dates—a requirement that was eliminated (albeit prospectively) from Section 228(c) in large part to avoid the types of “foot fault” arguments raised by the plaintiff in Cirillo—was the “epitome of a technical shortcoming that the Delaware General Assembly sought to address” in adopting Sections 204 and 205. In fact, the court noted that the subsequent amendment to Section 228(c) suggested that the dating requirement was a “superfluous condition” to the use of written consents.

The court in Glenhill likewise took a pragmatic approach to a challenge based on technical defects in authorization. The plaintiffs were former holders of common stock of Design Within Reach, Inc. that were cashed out in a short-form merger pursuant to which Herman Miller acquired DWR following its turnaround after the financial crisis. In an apparent effort to secure a larger portion of the merger consideration, the plaintiffs challenged, among other things, a 50-to-1 reverse stock split of DWR's common stock and Series A preferred stock effected in 2010, years before the merger. Due to a potential defect in the amendment effecting the reverse stock split, the charter's anti-dilution provisions were alleged to operate in a manner that would massively reduce the number of shares of common stock into which the Series A preferred stock were convertible. In essence, the charter included provisions that proportionately adjusted the conversion ratio of the Series A preferred stock upon a reverse split of the common, but did not include similar provisions to account for a reverse split of the Series A preferred stock. As a result, the reverse stock splits reduced the Series A preferred stock's conversion ratio by a factor of 2,500-to-1 rather than the intended 50-to-1.

Following the consummation of the merger in 2014, the plaintiffs sought rescissory damages in connection with the merger, claiming, among other things, that due to the defects in the reverse stock split and related transactions (including the conversion of the Series A preferred stock prior to the merger), the vote to authorize the merger had not been validly obtained. After the filing of the complaint, DWR's board and post-merger stockholder, acting pursuant to Section 204 of the DGCL, approved resolutions ratifying various defective acts and putative stock issuances relating to the reverse stock splits. Plaintiffs then stated their intent to challenge the ratification resolutions, precipitating DWR's counterclaim to validate the merger and related transactions under Section 205.

In a post-trial opinion, the court again reviewed each of the factors enumerated in Section 205(d), finding that each “weigh[ed] overwhelmingly in favor of judicial validation of the defective corporate acts” identified in the resolutions adopted pursuant to Section 204. The court found that the reverse split was originally approved with the belief that it complied with the relevant provisions of the DGCL and DWR's organizational documents, noting that if the alleged defect had not been corrected, it would have “gutted” the value of the Series A preferred stock, yielding an irrational result. The court also found that the parties treated the challenged acts as valid (without regard to the defect)—DWR had publicly disclosed them in press releases and with government agencies, and investors in both DWR and Herman Miller had publicly traded for years in reliance upon them being valid. Next, the court found that no party could be harmed by the ratification. While the validation would eliminate the plaintiffs' claim for damages, that particular harm was not cognizable under Section 205(d). To the contrary, the court found that Herman Miller and the former stockholders of DWR would be significantly harmed by any failure to validate the acts, as the plaintiffs were seeking damages on a theory that the merger by which Herman Miller had acquired DWR was void. Finally, the court held that “ratification is clearly the equitable outcome.” Among the factors the court considered was that the defendants, upon learning of the defects, took prompt action to correct them, whereas the plaintiffs were merely “seek[ing] an inequitable windfall for technical defects.” As a result, the court validated the merger and all of the related transactions previously ratified under Section 204 by DWR.

The Cirillo and Glenhill opinions demonstrate that the Court of Chancery, when considering challenges to technical defects in authorization, will hew closely to the factors in Section 205(d) in determining whether to validate the acts and, in appropriate cases, will use its power under the statute to avoid inequitable outcomes. In addition, the Glenhill opinion suggests that the court, in considering a defense based on Section 205, may look favorably upon the defendant's efforts to take advantage of the self-help measures available under Section 204 to ratify defective corporate acts.

John Mark Zeberkiewicz is a director, and Nathaniel Stuhlmiller is an associate, of Richards, Layton & Finger, in Wilmington, Delaware. Richards, Layton & Finger was involved in one of the opinions discussed in this article.