Void or Voidable? - Curing Defects in Stock Issuances Under Delaware Law
C. Stephen Bigler
Richards, Layton & Finger, P.A.
Seth Barrett Tillman
National University of Ireland, Maynooth (NUI Maynooth) - Faculty of Law
Business Lawyer, Vol. 63, pp. 1109-1151, 2008 (peer reviewed)
It is not unusual for practitioners reviewing a Delaware corporation's stock records to find omissions or procedural defects raising questions as to the valid authorization of some of the outstanding stock. Examples of such omissions and defects are limitless, but not infrequently found examples include the absence of board resolutions authorizing the issuance of stock shown by the transfer books as having been issued, the absence of evidence that issuances were properly authorized by the requisite votes of the board or, if required, by the stockholders, the absence of evidence that the consideration to have been received by the corporation in exchange for the stock was in fact received, the issuance of more shares than were authorized by the certificate of incorporation at the time, the issuance of stock prior to the filing of the charter amendment or certificate of designations authorizing or creating the stock, and similar procedural and substantive irregularities. Not infrequently, these defects occurred some time ago, and the stock in question may have changed hands multiple times since issuance.
Confronted with such irregularities, most corporate lawyers' first instinct would be to attempt to correct the defect through board and, if necessary, stockholder, ratification of the defective issuance, with the intent of putting the parties in the positions they thought they were in prior to discovering the irregularity. However, Delaware courts have not always viewed defects in stock issuances as being curable by ratification. In a number of leading cases, the Delaware Supreme Court has treated the statutory formalities for the issuance of stock as substantive prerequisites to the validity of the stock being issued, and has determined that failure to comply with such formalities renders the stock in question void. A finding that stock is void means that defects in it cannot be cured, whether by ratification or otherwise. Thus, practitioners finding defects in stock issuances are put in the uncomfortable position of having to make a judgment whether the defect is one that renders the stock void, in which case ratification is not an option, or voidable, in which case ratification is an option. Unfortunately, the decisions issued by the Delaware courts have not afforded certainty in this critical area. Indeed, a recent decision of the Court of Chancery acknowledges that although "Delaware law is replete with cases" discussing the void-voidable distinction, the law as to when and whether a defective stock issuance can be cured "is not as clear as it could be."
This article analyzes the reasons for this lack of clarity, and proposes some solutions which would benefit buyers and sellers of corporate stock. We begin by examining the legal requirements applicable to stock issuances. Next, we discuss the foundation of the doctrinal distinction between void and voidable stock. We then discuss the cases where courts have found stock to have not been issued in accordance with these legal requirements, and whether such finding has resulted in the stock being found void or voidable. We also consider the purposes, principles and policies of certain provisions of Article 8 of the Uniform Commercial Code, designed to validate, in most circumstances, certain defects in stock in the hands of innocent purchasers for value. Interestingly, these provisions of the UCC have not been frequently discussed in the court cases that have considered whether stock is void or voidable, and the cases that have discussed them refer to them as setting forth an equitable rather than a legal principle - which is ultimately not helpful to corporate lawyers who opine on legal, not equitable, matters.
In conclusion, we suggest that the policy underlying Article 8 of the Uniform Commercial Code to validate stock in the hands of innocent purchasers for value, notwithstanding technical defects in its issuance, should be recognized as a principle of law, not solely as a principle of equity, and should be applied by the Delaware courts as such. As a result, technical defects relating to statutory formalities should not lead to a finding of void stock, but at worst to voidable stock. Cure or ratification should be permitted except in cases where the issuance violates the directors' duty of loyalty or otherwise would be inequitable. Such a rule would allow practitioners to opine as to the validity of a corporation's outstanding stock where the stock was issued defectively but the defect cured, subject to a standard exception for fiduciary duties and other equitable matters, and would eliminate the risk that stock held in the trading markets or otherwise held by innocent purchasers for value might be deemed void.
The Business Lawyer is a peer reviewed journal. This article was reprinted in volume 11 of Joy Marlene Bryan & Simon M. Lorne's Acquisitions and Mergers: Negotiated and Contested Transactions § 3:64.76 (2010).
Number of Pages in PDF File: 44
Keywords: void, voidable, Triplex, Waggoner, Kalageorgi, Kamkin, Adlerstein, Superwire.com, MBKS, ReddyAccepted Paper Series
Date posted: August 12, 2008 ; Last revised: April 25, 2011
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