Delaware Court of Chancery Rules on Unambiguous Director Removal Voting Requirements
In a recent decision of the Delaware Court of Chancery, the Court struck down a corporate bylaw provision of NutriSystem, Inc., a Delaware corporation (the “Company”), ruling the provision to be inconsistent with the Delaware General Corporation Law. See Fretcher v. Zier, No. CV 12038-VCG, 2017 WL 345142 (Del. Ch. Jan. 24, 2017). The Company’s bylaw provision, which had recently been adopted as an amendment to the Company’s bylaws, stated that the stockholders of the Company may remove directors, but only upon the vote of “not less than 66 and two-thirds percent…of the voting power of all outstanding shares” of Company stock. Id. at *1. This bylaw provision is in contravention of 8 Del. C. § 141(k) under which directors may be removed by a majority vote of corporate shares.
Plaintiff, a shareholder of the Company, brought a class action suit on behalf of the shareholders of the Company against Defendants, who were comprised of the Company and the Board of Directors of the Company. Id. Prior to the adoption of the subject bylaw amendment, the relevant bylaw allowed Company stockholders to remove directors only for cause and upon the affirmative vote of two-thirds of all outstanding shares of Company stock (the “Removal Provision”). Id. On January 7, 2016, the Company filed a Form 8-K with the Securities and Exchange Commission announcing that the Board had approved an amendment to the Company’s bylaws which removed the “for cause” requirement from the Removal Provision. Id.
The Plaintiff filed his Verified Class Action Complaint on February 24, 2016 (the “Complaint”) pleading two counts. Id. at *2. In Count I, the Plaintiff alleged a breach of fiduciary duty against the Defendants, contending that the directors breached the duty of loyalty by enacting an unlawful bylaw to entrench themselves in office. Id. In Count II, the Plaintiff sought a declaratory judgment that the Removal Provision violates Section 141(k). Id. The Defendants moved to dismiss the Complaint on May 27, 2016 and the Plaintiff moved for partial summary judgment on Count II on August 9, 2016.
The Defendants defense was centered on two legal issues. First, the Defendants focused their argument on 8 Del. C. § 216, which permits corporations to adopt bylaws specifying the required vote for the transaction of the business of the corporation, subject to other voting requirements necessary to take specific actions. Id. at *3. The Defendants conceded that the specific provisions of Section 141(k), addressing removal of directors, supersede this general permissive language, but argued that Section 141(k) “does not dictate a contrary result” because the Section “sets the rules only for the circumstances under which stockholders may remove directors without cause, and does not address the percentage of the vote that is required to remove directors.” Id. Second, the Defendants argued that the majority vote portion of Section 141(k) is a permissive provision, noting that Section 141(k) provides only that a majority of stockholders may remove directors, “thereby leaving the bylaws free to require a minority, a supermajority or even unanimity as a requisite for director removal.” Id.
The Court disposed of Defendant’s arguments using a plain language reading of the statute, ruling that “[Section 141(k)] provides that holders of a majority of stock may—not must—remove directors; that is, if they so choose, the section confers that power.” Id. at *4. Stated otherwise, the permissive portion of Section 141(k) is whether a director is removed — not the required vote for such removal.
The Court denied Defendant’s Motion to Dismiss and granted Plaintiff’s Motion for Summary Judgment with respect to Count II. Count I was withdrawn. Id.
This decision is a stark reminder that corporations should be mindful of statutory rules when drafting and adopting bylaws. While corporate statutes serve as guidelines in some circumstances, careful attention must be given to those provisions of a state’s corporate law that are to be literally, not figuratively, construed.
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