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Delaware Court of Chancery rules written consent of sole director invalid for lack of quorum

August 10, 2020 | By Patrick T. McCloskey

On August 3, 2020 the Delaware Court of Chancery held that a unanimous written consent executed by the sole director of a Delaware corporation with two vacant board seats was invalid under Section 141(f) of the Delaware General Corporation Law (“DGCL”), because the signing director—the only one then in office—did not constitute a quorum.1

Factual Background

In Applied Energetics, a series of resignations from the corporation’s board left George Farley as the sole remaining director. After unsuccessful attempts to fill the vacancies, Farley eventually signed unanimous written consents of the board and its compensation committee that purported to authorize significant stock issuances to himself and certain other service providers, as well as cash compensation to himself. The corporation sued Farley2 alleging, among other things, breaches of fiduciary duty, also seeking to invalidate the transactions due to lack proper authorization.3 Farley counterclaimed with an application to have the transactions validated by the Court of Chancery under DGCL § 205,4 as well as counterclaims for breach of contract and unjust enrichment.

DGCL 141(f) and the Quorum Requirement

While Vice Chancellor Laster acknowledged that DGCL § 141(f) does not explicitly reference a quorum requirement, he opined that it is implicit in the statutory language.5 Focusing on the words “taken at any meeting” used in DGCL § 141(f),6 Laster reasoned that since a quorum is required for a board to take action at a meeting, DGCL § 141(f) raises the voting threshold from a majority of a quorum (or greater number as required by the charter or bylaws) to unanimity, but it “does not dispense with the basic requirement that the number of directors acting unanimously must be sufficient to constitute a quorum.” Since Applied Energetics’ bylaws required a majority of the total number of directors for a quorum, the court held that Farley—as the sole director in office with two vacant board seats—did not satisfy the requirement.7

In support of his conclusion that DGCL § 141(f) implicitly requires a quorum, Laster cited other provisions of the DGCL that expressly permit action by directors that do not comprise a quorum, such as DGCL § 223(a)(1)8 and the recently adopted DGCL § 1109 and ruled that “[e]xcept for specific provisions that authorize actions by directors comprising less than a quorum in particular situations, the DGCL operates on the principle that the number of directors taking action must always satisfy the requirement for a quorum.” Laster also suggested that the permissive scope of DGCL § 141(f) is somewhat limited, writing:

Section 141(f) is not a vehicle for directors to avoid the requirements of a meeting. It is a vehicle for directors to use when they could satisfy the requirements for action at a meeting but the consensus is unanimous and thus a meeting is unnecessary.

Corporate Power vs. Corporate Authorization

Notwithstanding the ruling on Farley’s execution of the written consents, the court held that the purported authorizations were “defective corporate acts” that could be validated by the Court of Chancery under DGCL § 205. After a detailed and lengthy analysis of the distinction between corporate power and corporate authorization, Laster denied the corporation’s motion for summary judgment on this issue, rejecting the argument that Applied Energetics lacked the corporate power for the subject transactions and ruling “Farley’s issuance of shares and his approval of his compensation . . . are within the power of the corporation but are void or voidable due to failure of authorization. The acts fall squarely within the grant of authority provided by Section 205(a)(3).”

Although Farley will have an opportunity to persuade the court to validate the defective corporate acts pursuant to DGCL § 205, the court clarified that this would only remedy the technical validity of the transactions, not modify the applicable fiduciary duties.10

New York BCL

While the decision in Applied Energetics interprets the DGCL and is technically binding on Delaware corporations only, New York courts frequently look to Delaware case law when deciding New York corporate law issues.11 On the other hand, while the statutory provision authorizing directors to act by unanimous written consent in Section 708(b) of the New York Business Corporation Law (“BCL”) is similar to DGCL § 141(f), the BCL provision does not contain the phrase “taken at any meeting”, the words upon which Vice Chancellor Laster’s decision is principally based.12

Although the issue may not be clear under BCL § 708(b), New York corporations that seek board action via unanimous written consent without a quorum will be taking a significant risk that the act could be successfully challenged. Unlike DGCL §§ 204 and 205, there is no “do-over” escape hatch in the BCL where the corporation or its constituents can later validate or petition a court to validate a so-called “defective corporate act.”

While the quorum requirement is implicit in Delaware and unclear in New York, California’s corporate statutory provision permitting a board to act by unanimous written consent contains an express qualification that the directors then in office must constitute a quorum.13

Takeaways

Given the ruling in Applied Energetics, any corporation whose board is proposing to act by unanimous written consent should confirm that the signing directors collectively constitute a quorum.14 To serve as a reminder of this trap for the unwary, the customary boilerplate recital language that typically precedes the resolutions adopted in a unanimous written consent—"constituting all of the directors of the corporation”—should be supplemented with the phrase “which directors constitute a quorum”, or words to that effect.

Corporations should also take this issue into account when considering the number of directors that will constitute a quorum of the board under their applicable constituent documents. The default rule for a quorum in both Delaware and New York is a majority of the total number of directors (as mentioned in Applied Energetics, this means directorships, not directors in office),15  but corporations are permitted to increase it or decrease it, with a floor of one-third of the total number of directors.16

Increasing the quorum requirement above a majority will increase the risk that one or more vacancies will preclude the ability of the board to act by written consent, while decreasing it will reduce that risk. As an example, if Applied Energetics had a quorum of one-third of the total number of directors, Farley would have satisfied the quorum requirement by himself and the unanimous written consent at issue would have been valid under DGCL § 141(f).

Lawyers rendering legal opinions on due authorization on behalf of a corporation whose board is authorizing a transaction by unanimous written consent will also need to examine the certificate of incorporation and bylaws to ascertain the quorum requirement and confirm that the signing director(s) constitute a quorum.

This post is for general informational purposes only and does not constitute legal advice. No one should rely on the information in this blog post without seeking appropriate legal, accounting, tax or other appropriate advice from an attorney, accountant or other professional properly licensed in the applicable jurisdiction(s).

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1Applied Energetics, Inc. v. George Farley et al., C.A. No. 2018-0489 (Delaware Chancery Court) (August 3, 2020).

2AnneMarieCo, LLC, an entity owned by Farley’s wife and children, was also named as a defendant. Farley transferred a portion of the subject shares to this entity.

3The corporation’s initial complaint did not assert that Farley lacked authority to act as the company’s sole remaining director, but this claim was apparently added after the court granted an injunction enjoining any transfer of the shares by Farley and his transferee.

4Taken together, DGCL §§ 204 and 205 are the corporate governance equivalent of a “do-over.” DGCL § 204 essentially allows a board to validate a prior defective act by following certain procedures. DGCL § 205 allows the corporation and certain other parties to petition the Court of Chancery to validate a prior defective act.

5Applied Energetics, at 28 (“Section 141(f) does not state explicitly that the number of directors executing the written consent must be sufficient to satisfy a quorum, but that result is implicit in the statutory reference to ‘any action required or permitted to be taken at any meeting.’ For action to be ‘taken at any meeting,’ a quorum must be present, and a sufficient number of directors must vote in favor of the action to be taken to satisfy the applicable voting threshold.”)

6See  DGCL 141(f) (“Any action required or permitted to be taken at any meeting of the board of directors or any committee thereof may be taken without a meeting if all members of the board or committee, as the case may be, consent thereto in writing, or by electronic transmission.”) (Italics added).

7Laster also pointed out that “the ‘universal construction’ of the phrase ‘total number of directors’ is ‘that it refers to directorships, not directors actually in office.’” Quoting Crown EMAK Partners LLC v. Kurz, 922 A.2d 377, 400 (Del. 2010).

8DGCL § 223(a)(1) provides that “a majority of directors then in office, although less than a quorum” or “the sole remaining director” may fill vacancies or newly created directorships.

9DGCL § 110 provides that a board of directors may adopt emergency bylaws to be applicable during an emergency, “irrespective of whether a quorum of the board of directors or a standing committee can readily be convened for the action.”

10See Applied Energetics, at 71 (“Defective corporate acts, even if ratified or validated, ‘are subject to traditional fiduciary and equitable review.’” Quoting H.B. 127 syn., 147th Gen. Assem. (2013) (“Ratification of a defective corporate act under § 204 is designed to remedy the technical validity of the act or transaction; it is not intended to modify the fiduciary duties applicable to either the approval or effectuation of a defective corporate act or transaction or any ratification of such act or transaction.”)

11See, e.g., In re Kenneth Cole Productions, Inc. Shareholder Litigation, 2016 Slip Op. 03545 (NY May 5, 2016).

12See BCL § 708(b) (“Unless otherwise restricted by the certificate of incorporation or the bylaws, any action required or permitted to be taken by the board or a committee thereof may be taken without a meeting if all members of the board or the committee consent in writing to the adoption of a resolution authorizing the action.”)

13See California Corporations Code § 307(b) (“An action required or permitted to be taken by the board may be taken without a meeting, if all members of the board shall individually or collectively consent in writing to that action and if the number of members of the board serving at the time constitutes a quorum”). (Italics added).

14As mentioned above, although it is unclear whether BCL § 708(b) would be interpreted consistent with Applied Energetics, to avoid risk, New York corporations would be wise to confirm that the directors executing a unanimous written consent constitute a quorum.

15The reference to “total number of directors” in BCL § 707 has also been interpreted as a reference to directorships, as opposed to directors then in office. See Avien v. Weiss, 50 Misc.2d 127, 131 (Queens County Supreme Court 1966) (“under section 707 of the Business Corporation Law the Legislature has provided that a majority of the entire board shall constitute a quorum for the transaction of business except that the certificate of incorporation or by-laws may fix the quorum at less than the majority of the entire board but not less than one third thereof.”)

16See, DGCL § 141(b); BCL § 707.