Opinion ID: 1548673
Heading Depth: 1
Heading Rank: 17

Heading: Crown Bylaw Amendments Are Invalid

Text: The Court of Chancery held that the Crown Consents are ineffective because they purported to amend the Bylaws in a manner that conflicts with the DGCL. Section 109(b) of the DGCL provides that the bylaws of a Delaware corporation may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees. [48] Therefore, a bylaw provision that conflicts with the DGCL is void. Through the Bylaw Amendment to section 3.1, Crown tried to reduce the Board's size below the number of currently sitting directors. Generally, in a contested election, an insurgent first removes the challenged directors, then reduces the number of directorships, and then fills the vacancies. [49] We hold that was the legally proper sequence for accomplishing Crown's objective in this case. Crown could not follow that approach, however, because Crown was not entitled to vote the Series AA Preferred to remove directors. Under section 141(k) of the DGCL, shares can vote to remove directors only if they can vote to elect directors. [50] The Series AA Preferred does not vote to elect directors; consequently, it cannot vote to remove directors. Section 141(b) of the DGCL provides that [t]he number of directors shall be fixed by, or in the manner provided in, the bylaws, unless the certificate of incorporation fixes the number of directors, in which case a change in the number of directors shall be made only by amendment of the certificate. [51] The EMAK charter does not fix the number of directors, which instead is addressed in Section 3.1 of the Bylaws. Therefore, the defendants correctly assert that stockholders exercising a majority of EMAK's outstanding voting power, including the Series AA Preferred, can alter the size of the Board through a bylaw amendment. The DGCL addresses what happens with the newly-crated directorships where the size of the board is increased. Under section 223(a)(1), unless otherwise specified in the certificate of incorporation or bylaws, newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having the right to vote as a single class may be filled by a majority of the directors then in office, although less than a quorum. [52] Although EMAK's charter is silent on this point, Section 3.2 of its Bylaws provides that the Board may fill newly created directorships. Under Delaware case law, newly created directorships also may be filled by the stockholders. [53] The Court of Chancery recognized that this case  involving a reduction in the size of the board  presented an issue of first impression: Our law has not addressed what happens when a bylaw amendment would shrink the number of board seats below the number of sitting directors. The DGCL does not address it. No Delaware court has considered it. None of the leading treatises on Delaware law mention it. [54] Indeed, no one seems to have contemplated it. New Section 3.1 would reduce the Board to three directorships at a time when five directors are legally in office. The Court of Chancery identified two possible scenarios for the resulting surplus directors. One is that their terms would end. The other is that they would continue to serve without de jure official status, until their terms were ended by a statutorily recognized method. The Court of Chancery held that both possible scenarios conflict with the DGCL. We agree. First, the Court of Chancery concluded that the scenario in which the terms of the extra directors would end conflicts with section 141(b)'s mandate that [e]ach director shall hold office until such director's successor is elected and qualified or until such director's earlier resignation or removal. [55] Section 141(b) recognizes three procedural methods by which the term of a sitting director can be brought to a close: first, where the director's successor is elected and qualified; second, if the director resigns, or third; if the director is removed. Section 141(b) does not contemplate that a director's term can end through board shrinkage. Accordingly, the Court of Chancery properly held that a bylaw that seeks to achieve this result conflicts with section 141(b) and is void. The Court of Chancery also held that the presence of directors without board seats would create a conflict between the number of directors in office and the number of directors provided for in the bylaws. Section 141(b) states that [t]he number of directors shall be fixed by, or in the manner provided in, the bylaws, unless the certificate of incorporation fixes the number of directors. [56] Section 141(b) does not contemplate a board with more directors serving than the number . . . fixed by . . . the bylaws. New Section 3.1 fixed the number of EMAK directors at three. If the excess directors are not eliminated, then for some period of time, EMAK will have a greater number of directors serving than the number for which the Bylaws provide. Such an occurrence is contrary to section 141(b) and, therefore, the Court of Chancery properly concluded, is not legally possible. The Court of Chancery held that the existence of more incumbent directors than there are board seats also conflicts with the statutory quorum requirement for board action. Section 141(b) provides: A majority of the total number of directors shall constitute a quorum for the transaction of business unless the certificate of incorporation or the bylaws require a greater number. Unless the certificate of incorporation provides otherwise, the bylaws may provide that a number less than a majority shall constitute a quorum which in no case shall be less than 1/3 of the total number of directors except that when a board of 1 director is authorized under this section, then 1 director shall constitute a quorum. [57] [T]he universal construction of the above-quoted language has been that it refers to directorships, not directors actually in office. [58] The Court of Chancery explained why quorum requirements would be impossible to apply if the number of directors could exceed the number of directorships: Start with the statutory minimum quorum of 1/3 of the total number of directors and envision a bylaw amendment that converted a board of twelve directors into a board of three directorships, with nine continuing but seatless directors. A single director could satisfy the statutory one-third quorum requirement, despite twelve directors serving on the board. EMAK has a majority quorum requirement. If the Bylaw Amendments turned two of the directors into continuing but seatless directors, then a quorum would be two out of three seats. Yet there would be five directors in office. The concept of continuing but seatless directors thus conflicts with section 141(b)'s mechanism for determining a quorum. Once again, the Bylaw Amendments are void. The Court of Chancery held that new Bylaw Section 3.1.1 conflicts with the statutory framework of the DGCL by conflating what takes place at an annual meeting with what can take place in between annual meetings. The DGCL establishes an annual electoral cycle for directors who are not elected by the holders of a particular class or series of stock. [59] Except in the case of a properly classified board, the occupants of all directorships contemplated by the corporation's charter and bylaws are up for annual election. [60] Pursuant to this statutory framework, absent a specific charter or bylaw provision classifying a board, the term of office of each director is coextensive with the period between annual meetings. [61] Section 211(b) distinguishes between stockholder action at an annual meeting and stockholder action between annual meetings. Section 211(b) provides that stockholders can take action by written consent to elect directors in lieu of an annual meeting if (i) the action by consent is unanimous or (ii) all of the directorships to which directors could be elected at an annual meeting held at the effective time of such action are vacant and are filled by such action. [62] In this case, the action by consent was not unanimous and there were no vacant directorships. To operate in lieu of an annual meeting, a non-unanimous written consent thus must first remove all sitting directors and then fill the resulting vacancies. Stockholders cannot use a non-unanimous written consent to remove lawfully serving incumbent directors, and then elect successor directors, between annual meetings. New Section 3.1.1 provides that if the number of directors in office is greater than three, then a special meeting of stockholders will be called at which one director will be elected by the common stockholders who shall be the successor to all directors previously elected by the common stockholders of the Corporation. The Court of Chancery opined that: If the number of seats on the board was reduced in conjunction with the election of directors at an annual meeting such that only one seat was up for election, then this mechanism would be valid. In that scenario, stockholders would elect directors to all available seats, albeit only one, and the terms of the previously serving directors would expire in conjunction with the election and qualification of their singular successor. New Section 3.1.1, however, does not propose to alter the Board's size in conjunction with an annual meeting. It contemplates the calling of a special meeting at which stockholders would act to elect a successor director. The election of successors takes place at an annual meeting, not between annual meetings. Stockholders can act in between annual meetings to remove directors, to fill vacancies, or to fill newly created directorships. [63] They cannot end an incumbent director's term prematurely by purporting to elect the director's successor before the incumbent's term expires. As the Court of Chancery explained [p]ermitting such action would contradict the limited and enumerated means in which a director's term can end under Section 141(b), the specific mechanism for director removal set forth in Section 141(k), and the concept of an annual meeting at which directors are elected under Section 211(b). Accordingly, the Court of Chancery properly held that new section 3.1.1 is also invalid.