Introduction
The General Corporation Law of the State of Delaware (the "General Corporation Law") empowers a corporation to create, define, limit or regulate, by charter provision, certain powers of its board of directors or stockholders so long as the charter provision does not violate the laws of the State of Delaware.[1] Practitioners, however, generally have been cautious when advising corporations with respect to the adoption of charter provisions limiting the power granted to the board of directors or the stockholders of a corporation by a provision of the General Corporation Law. In that context, practitioners typically have drawn a bright-line and have recommended that such powers only be limited if the relevant provision of the General Corporation Law contains express language contemplating such a limitation.[2] The recent decision by the Delaware Court of Chancery in Jones Apparel Group, Inc. v. Maxwell Shoe Co., Inc.[3] rejects a bright-line approach and concludes that discretion granted to directors by a provision of the General Corporation Law may be completely eliminated even if the relevant provision of the General Corporation Law does not contain the express language. The Court of Chancery's decision arguably increases flexibility by allowing enhanced private ordering by charter provision, but also causes some uncertainty with respect to which provisions of the General Corporation Law may be altered by charter provision without violating Delaware public policy.
The Relevant Statutory Provisions
Section 102(b)(1) of the General Corporation Law ("Section 102(b)(1)") provides the statutory authority for a corporation to adopt charter provisions creating, defining, limiting or regulating the authority of its board of directors or stockholders. Section 102(b)(1) provides, in pertinent part, that a charter may contain:
[a]ny provision for the management of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, or the members of a nonstock corporation; if such provisions are not contrary to the laws of this State.[4]
In addition, Section 141(a) of the General Corporation Law ("Section 141(a)") provides that a corporation may alter, by charter provision, the power of a board of directors to manage the business and affairs of a corporation. Section 141(a) provides as follows:
The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.[5]
The Law Prior to Jones Apparel
Prior to Jones Apparel, the Court of Chancery rarely examined whether certain charter provisions are permissible under Section 102(b)(1). In two separate decisions, the Delaware Supreme Court and the Court of Chancery have held that certain charter provisions were permissible under Section 102(b)(1).[6] Neither of these decisions addressed the issue of whether a charter provision may completely eliminate a power granted to the board of directors or to stockholders by a provision of the General Corporation Law. However, these cases have examined the meaning of the phrase "unless contrary to the laws of this State" in Section 102(b)(1), and have concluded that a charter provision will be permissible so long as it is not contrary to the express language of any statutory provision and is not violative of Delaware public policy.
In Sterling v. Mayflower, minority stockholders of Mayflower Hotels Corporation ("Mayflower") claimed that a provision in Mayflower's certificate of incorporation purporting to include "interested directors" for quorum purposes was invalid because it was contrary to the common law of the State of Delaware.[7] Plaintiffs pointed to the proviso at the end of the predecessor to Section 102(b)(1) and argued that the phrase "contrary to the laws of this State" included both statutory and common law.[8] Carrying their argument to its conclusion, plaintiffs cited a Delaware case purportedly standing for the proposition that a charter provision permitting an interested director to be counted for quorum purposes was invalid, and on that basis urged the Court of Chancery to find that the Mayflower charter provision was invalid.[9]
The Delaware Supreme Court rejected the plaintiffs' argument and held that "[s]uch a construction [of Section 102(b)(1)] unwarrantably narrows the scope of the enabling portion of that paragraph[,]" which permits broad latitude in crafting charter provisions for the management and conduct of a corporation's affairs.[10] Moreover, the Delaware Supreme Court held that although a precise definition of the meaning of "contrary to the laws of this State" was difficult to formulate, it was nevertheless clear that "stockholders of a Delaware corporation may by contract embody in the charter a provision departing from the rules of the common law, provided that it does not transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself."[11] Therefore, the Delaware Supreme Court held that because the Mayflower charter provision at issue was not contrary to Delaware public policy, the provision was valid and a quorum was present at the meeting at which a merger was approved.[12]
Almost forty years later, in Stroud v. Grace, the Court of Chancery addressed a charter provision that required a supermajority stockholder vote in order to authorize the issuance of stock. The plaintiffs argued that the charter provision at issue violated Section 161 of the General Corporation Law, which authorizes directors (under certain circumstances set forth in the statute) to issue shares of stock.[13] The Court of Chancery rejected the plaintiffs' argument and, relying upon Section 102(b)(1), held that the charter provision at issue was not "'contrary to' 8 Del. C. 161 because that section does not prohibit charter limitations upon the authority of a Board to issue stock."[14] Although it is true that Section 161 does not contain an express prohibition against a charter limitation of the authority granted therein, it also does not expressly permit such a charter limitation.[15] Importantly, the charter provision at issue did not completely eliminate the discretion of the board of directors, but conditioned that discretion on stockholder approval.
The Court of Chancery's Decision in Jones Apparel
In Jones Apparel, the Court of Chancery was presented with the issue of whether a charter provision may completely eliminate the discretion of the board of directors with respect to the setting of a record date for written consents under Section 213(b) of the General Corporation Law. Relying on the standard set forth in Sterling v. Mayflower, the Court of Chancery found that the charter provision was permissible despite the absence of express language in Section 213(b) of the General Corporation Law permitting the elimination of the discretion of the board of directors by charter provision.
In late 2003, Jones Apparel Group, Inc. ("Jones") approached Maxwell Shoe Co., Inc. ("Maxwell") about the possibility of a friendly negotiated acquisition of Maxwell by Jones. After months of negotiations, Maxwell announced on March 12, 2004 that its board had rejected a friendly acquisition by Jones. In response, Jones commenced a hostile tender offer, on March 23, 2004, to acquire all of the outstanding shares of Maxwell. Jones also filed a preliminary consent solicitation statement on that same date seeking consents to remove the Maxwell board.
On March 24, 2004, Maxwell announced that its board had set a record date of March 25, 2004 in connection with the consent solicitation. Article VII of Maxwell's charter described the procedures for setting a record date, providing as follows:
Any election of directors or other action by the stockholders may be effected at an annual meeting or special meeting of stockholders or by written consent in lieu of such a meeting. The record date with respect to the determination of stockholders entitled to consent in writing to any action shall be the first date on which a signed written consent setting forth the action to be taken or proposed to be taken is delivered to the corporation by delivery to its registered office in Delaware, its principal place of business, or an officer or agent of the Corporation having custody of the book in which proceedings of meetings of stockholders are recorded.[16]
Concerned that Maxwell may have caused a written consent to be delivered in order to commence the 60-day consent solicitation period authorized by Section 228 of the General Corporation Law, Jones demanded to inspect the books and records of Maxwell on March 26, 2004. After Maxwell refused to allow Jones to inspect its books and records, Jones commenced an action in the Court of Chancery on March 30, 2004 pursuant to Section 220 of the General Corporation Law and, thereafter, commenced another suit in the Court of Chancery on March 31, 2004 alleging, among other things, that the decision of the Maxwell board to set a record date before it had received a written consent violated Article VII of Maxwell's charter. Maxwell responded to the suits by verifying that it had not received any written consents, but that the Maxwell board had the discretion to set the record date pursuant to Section 213(b) of the General Corporation Law ("Section 213(b)") regardless of whether Article VII of Maxwell's charter purported to deprive the Maxwell board of that discretion. Section 213(b) provides, in pertinent part, as follows:
In order that the corporation may determine the stockholders entitled to consent to corporate action on writing without a meeting, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors, and which date shall not be more than 10 days after the date upon which the resolution fixing the record date is adopted by the board of directors. If no record date has been fixed by the board of directors, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the board of directors is required by this chapter, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation….[17]
Maxwell argued that because Section 213(b) provides the board with the statutory discretion to set a record date then either (i) Article VII of Maxwell's charter should be read to permit its board to retain that discretion or (ii) Article VII is invalid because it purports to divest the Maxwell board of that discretion. The Court of Chancery rejected Maxell's first argument and found that Article VII clearly sets forth a time for the setting of a record date, i.e., the delivery of the first consent, and does not permit an exception such as the setting of the record date by the Maxwell board. In addition, the Court of Chancery rejected Maxwell's second argument and found that Article VII was valid because it was specifically permitted by Sections 102(b)(1) and 141(a) and was not contrary to Delaware public policy.
When it is asserted that a charter provision is contrary to a statute, the Court of Chancery stated that it must "first apply the settled rules of statutory construction to determine whether the provision violates the statute, and, if those rules do not yield a clear result, the Court of Chancery must next carefully consider the statutory text at issue and the policy values at stake as reflected not only in the [General Corporation Law] but also in our common law, and only invalidate a certificate provision if it 'transgress[es]' – i.e., vitiates or contravenes – a mandatory rule of our corporate code or common law."[18] The Court of Chancery noted that the identification of what may be deemed a "mandatory rule" might be difficult at times, but that this approach left room for the private ordering of charter provisions as contemplated by Sections 102(b)(1) and 141(a).
In applying this reasoning, the Court of Chancery examined the text and legislative history of Section 213(b), finding that neither demonstrated a legislative intent to prohibit the elimination of a board's discretion. In addition, the Court of Chancery rejected an argument that the absence of express language in Section 213(b) providing for a limitation by charter provision, e.g., "unless otherwise provided by the charter," was dispositive. Rather, the Court of Chancery described such "magic language" as being a "bylaw excluder," meaning that such words make it clear that certain powers are subject to modification by charter provision only and not by bylaw.[19]
In reaching its decision, the Court of Chancery rejected an argument that a ruling in favor of the validity of Article VII would start a parade of horribles in which charter provisions will be drafted to alter the fundamental statutory power of directors and stockholders in any number of situations. The Court of Chancery indicated that its decision did not mean that every statutory grant of power to directors or stockholders may be altered by charter provision. Rather, the Court of Chancery designated itself as the authority to determine, "based on careful, context-specific review in keeping with Sterling, whether a particular certificate provision contravenes Delaware public policy, i.e., our law, whether it be in the form of statutory or common law."[20]
Implications of Jones Apparel
The Court of Chancery's decision in Jones Apparel raises a number of questions for practitioners. Although the Court of Chancery's decision purports to provide corporations with enhanced private ordering by charter provision and, thus, enhanced flexibility, the decision necessarily creates uncertainty with respect to the extent to which a corporation may alter the default powers of the directors and the stockholders set forth in the General Corporation Law. Although the Court of Chancery provides examples of certain charter provisions that may go too far,[21] the Court of Chancery emphasized a willingness to examine, on a case-by-case basis, any charter provisions attempting to limit the powers of the directors or the stockholders in order to determine whether the provision contravenes Delaware public policy.[22] As such, the Court of Chancery provides very little guidance to assist practitioners in assessing whether a particular provision is likely to violate Delaware public policy.
Although the Court of Chancery indicates, by way of example, that it is unlikely to conclude that statutory provisions that set forth fundamental powers of the directors or stockholders may be altered by charter provision,[23] many provisions of the General Corporation Law present closer questions making it difficult to predict where the line should be drawn between permissible and impermissible charter provisions. For example, may a charter provision eliminate a board's discretion with respect to dividends?[24] Likewise, may a charter provision eliminate the power of the stockholders to remove directors without cause?[25] Practitioners now are likely to reconsider these and other similar questions in light of Jones Apparel.
The Court of Chancery's decision raises other questions under Delaware law. In particular, the Court of Chancery's conclusion that the "magic language" is a "bylaw excluder" [26] suggests that statutory provisions that do not contain such magic language may be subject to alteration in a by-law provision. If this is in fact the case, the potential for a hostile stockholder to wage a proxy solicitation contest to amend the by-laws and alter the discretion or power of the board of directors may be enhanced.[27] Moreover, the Court of Chancery's decision further minimizes the importance of the statutory provisions in the General Corporation Law that provide for statutory close corporations. In particular, the utility of a statutory close corporation is minimized to the extent a corporation may be formed that provides the flexibility of, but would not be subject to the unique limitations imposed on, a statutory close corporation.
Conclusion
The Court of Chancery's decision in Jones Apparel may raise more questions than it answers. Although Jones Apparel sanctions increased private ordering by charter provision, which benefits Delaware corporations by increasing flexibility, it also raises questions as to where the line may be drawn between permissible and impermissible charter provisions. The Court of Chancery's willingness to review charter provisions on a case-by-case basis, although a potential boon to litigators, may prove troubling to transactional attorneys who are trying to provide their clients with clear guidance with respect to permissible and impermissible charter provisions purporting to limit the power of the board of directors or the stockholders.
Michael K. Reilly and Charles T. Williams, III are associates in the Wilmington, Delaware law firm of Potter Anderson & Corroon LLP. The views expressed are solely those of the authors and do not necessarily represent the views of the firm or its clients.
[1] See 8 Del. C. 102(b)(1) (allowing for a charter provision creating, defining, limiting or regulating the powers of the corporation, the directors and the stockholders "if such provisions are not contrary to the laws of this State"); 8 Del. C. 141 (providing that the business and affairs of a corporation shall be managed by its board of directors "except as may be otherwise provided in this chapter or in its certificate of incorporation).
[2] See, e.g., 8 Del. C. 141(c)(3) (stating that, "[u]nless otherwise provided in the certificate of incorporation, the bylaws or the resolution of the board of directors designating the committee," a committee of the board of directors may create one or more subcommittees); 8 Del. C. 151(g) (stating that, "[u]nless otherwise provided in the certificate of incorporation," the board of directors may amend the resolutions setting forth the terms of preferred stock it has designated if no shares of such preferred stock have been issued); 8 Del. C. 211(e) (stating that, "unless otherwise provided in the certificate of incorporation," the election of directors shall be by written ballot); 8 Del. C. 212(a) (stating that, "unless otherwise provided in the certificate of incorporation," each stockholder shall be entitled to one vote per share); 8 Del. C. 223(a) (stating that, "unless otherwise provided in the certificate of incorporation or bylaws," vacancies or newly-created directorships on the board of directors may be filled by a majority of the board of directors then in office, although less than a quorum, or by the sole remaining director); 8 Del. C. 228(a) (stating that, "[u]nless otherwise provided in the certificate of incorporation," stockholders may act by written consent).
[3] C.A. No. 365-N, Strine, V.C. (May 27, 2004).
[4] 8 Del. C. 102(b)(1).
[5] 8 Del. C. 141(a) (emphasis added).
[6] Sterling v. Mayflower, 93 A.2d 107 (Del. 1952) (interpreting the predecessor to Section 102(b)(1)); Stroud v. Grace, C.A. No. 10719, 1990 WL 176803 (Del. Ch. Dec. 11, 1990) (Hartnett, V.C.), aff'd in part rev'd in part on other grounds, 606 A.2d 75 (Del. 1992).
[7] Sterling, 93 A.2d at 117. Article XIII of the Mayflower charter provided in pertinent part that:
In the absence of fraud, no contract or other transaction between this Corporation and any other corporation or any partnership or association shall be affected or invalidated by the fact that any director or officer of this corporation is pecuniarily or otherwise interested in or is a director, member or officer of such other corporation or of such firm, association or partnership or is a party to or is pecuniarily or otherwise interested in such contract or other transaction or in any way connected with any person or persons, firm, association, partnership or corporation pecuniarily or otherwise interested therein; any director may be counted in determining the existence of a quorum at any meeting of the Board of Directors of this Corporation for the purpose of authorizing any such contract [or other] transaction with like force and effect as if he were not so interested, or were not a director, member or officer of such other corporation, firm, association or partnership…."
[8]Id.
[9]Id.
[10] Id.
[11] Id. at 118.
[12] Id. at 119.
[13] Stroud, 1990 WL 176803, at *11-12; see also 8 Del. C. 161.
[14] Id. at *12.
[15] See 8 Del. C. 161, which provides that:
The directors may, at any time and from time to time, if all of the shares of capital stock which the corporation is authorized by its certificate of incorporation to issue have not been issued, subscribed for, or otherwise committed to be issued, issue or take subscriptions for additional shares of its capital stock up to the amount authorized in its certificate of incorporation.
[16] Jones Apparel, slip op. at 4 (emphasis added).
[17] 8 Del. C. 213(b).
[18] Jones Apparel, slip op. at 18 (quoting Sterling v. Mayflower Hotel Corp., 93 A.2d 107, 117 (Del. 1952)).
[19] Id., slip op. at 23.
[20] Id., slip op. at 24.
[21] The Court noted, by way of example, that it is unlikely that a court would find that a charter provision may alter certain statutory grants of authority, including provisions purporting to eliminate the annual meeting requirement, limit the right of stockholders to inspect books and records or divest the board of the statutory power to approve a merger or a charter amendment. Id., slip op . at 24-25, 29-30.
[22] In fact, the Court stopped short of concluding that a charter provision may not divest a board of certain fundamental powers (such as the power to approve a merger agreement or a charter amendment) noting only that such charter provisions would "inarguably involve far more serious intrusions on core director duties than does Article VII." Jones Apparel, slip op. at 30.
[23] Id.
[24] See 8 Del. C. 170 (providing that "subject to any restrictions" in the charter, the directors may declare and pay dividends). The Court of Chancery's holding in Jones Apparel at least raises the question as to whether a charter provision could eliminate this discretion, for example by mandating dividends to holders of common stock without any prior determination by the directors.
[25] See 8 Del. C. 141(k) (providing that a director or the entire board may be removed, with or with out cause, unless the board is classified pursuant to Section 141(d) or if the corporation permits cumulative voting (where in both such cases stockholders may only effect the removal for cause)). Again, Jones Apparel raises the question as to whether a charter provision could provide that stockholders may only remove directors for cause regardless of whether the corporation has a staggered board or cumulative voting.
[26] Jones Apparel, slip op. at 23.
[27] For example, the Court of Chancery's reasoning suggests that the stockholders may be able to adopt a bylaw amendment to eliminate the discretion of a board of directors to set a record date because of the absence of a "bylaw excluder" in Section 213. The ability of a stockholder to adopt by-law amendments that limit the power of a board of directors -- a topic that has been debated by corporate practitioners -- is beyond the scope of this article. See, e.g., Lawrence A. Hamermesh, Corporate Democracy and Stockholder-Adopted By-Laws: Taking Back the Street?, 73 Tul. L. Rev. 409 (1998); Julian Velasco, Just Do It: An Antidote to the Poison Pill, 52 Emory L. J. 849 (2003). Suffice to say that Jones Apparel may lend additional support to the argument that a stockholder may adopt a by-law provision restricting certain powers of the board of directors.