Section 141(d) of the Delaware General Corporation Law enables corporations to create “classified” (or, “staggered”) boards, only a fraction of whose seats can be filled by shareholder voting in a given year.
That Section also allows certificates of incorporation to designate certain seats on the board to be filled by the vote of specified classes or series of a companies’ stock, and to indicate the voting powers of those directors, which “may be greater than or less than those of any other director or class of directors.”
(By default, each director casts one vote, under Section 141(c)(4): “The vote of the majority of the members of a committee or subcommittee present at a meeting at which a quorum is present shall be the act of the committee or subcommittee. . . .”)
Finally, under Section 141(d), “the certificate of incorporation may confer upon 1 or more directors, whether or not elected separately by the holders of any class or series of stock, voting powers greater than or less than those of other directors. Any such provision conferring greater or lesser voting power shall apply to voting in any committee or subcommittee, unless otherwise provided in the certificate of incorporation or bylaws.”
(For instance, one company’s certificate of incorporation “provides that the total votes possessed by this eleven-member Board is fifteen. [The director designated by a private equity fund] is entitled to exercise five of the fifteen votes and each of the other directors is entitled to exercise one vote.” Marchand v. Barnhill, 2018 WL 4657159 (Del. Ch.), at *13.)
In Carmody v. Toll Brothers, Inc., 723 A.2d 1180 (Del. Ch. 1998), the Delaware Court of Chancery examined Section 141(d) in the context of a “dead hand” poison pill rights plan, adopted as a takeover defense: a third party’s acquisition of 15% or more of Toll Brothers’ outstanding common shares would entitle all other stockholders “to buy two shares of Toll Brothers common stock or other securities at half price,” thereby “massively dilut[ing] the value of the holdings of the unwanted acquiror.”
Moreover, if Toll Brothers were acquired, or were “the surviving corporation and its common stock [were] changed or exchanged,” id., each of the other stockholders would be “entitled to purchase common stock of the acquiring company, again at half-price, thereby impairing the acquiror’s capital structure and drastically diluting the interest of the acquiror’s other stockholders.” Id. at 1183-84.
The “dead hand” feature called for the rights to be redeemed only by a vote of the “Continuing [i.e., pre-acquisition] Directors” and of any new directors whose “nomination for election or election to the Board is recommended or approved by a majority of the Continuing Directors.” Id. at 1184.
Although these provisions appeared in a separate Rights Agreement, rather than, as required by Section 141(d), in the company’s certificate of incorporation, the directors argued that they were still valid because they effectively created a special committee of the board empowered to redeem the rights, and whose powers would not have to be enumerated in the certificate of incorporation. Id. at 1190.
In a case of first impression in Delaware, the Court of Chancery held, id. at 1191-1192, that the provision violated Section 141(d) in two ways:
To begin with, the different voting powers of the directors did not appear in the certificate of incorporation. See also Sinchareonkul v. Fahnemann, 2015 WL 292314 (Del. Ch.), at *8 (invalidating, because it did not appear in the certificate of incorporation but only in the bylaws, a provision that granted a “deciding vote” to the board chair in the case of a director deadlock).
In addition, Section 141(d) authorizes only the shareholders, not some or all of the directors, to create such differently-voting groups of directors.
The Court dismissed the analogy to a special committee, whose creation “would not impose long term structural power-related distinctions between different groups of directors of the same board. The board that creates a special committee may abolish it at any time, as could any successor board. On the other hand, the Toll Brothers ‘dead hand’ provision, if legally valid, would embed structural power-related distinctions between groups of directors that no successor board could abolish until after the Rights expire in 2007.” Id. at 1192.
(The Court also held that, because the replacement of some of the board would diminish, and of all the board would negate, the board’s opportunity to redeem the rights, the Rights Plan would impermissibly interfere with the board’s general power under Section 141(a) to manage the corporation’s business and affairs.)
However, seven years after its Carmody decision, the Court of Chancery upheld the validity of a variation of the dead hand provision.
In California Public Employees’ Retirement System [CalPERS] v. Coulter, 2005 WL 1074354 at *1, “change of control payments” would be made to senior officers “if a majority of its board of directors ceased to be ‘Existing Directors.’ ‘Existing Directors’ were those directors in office at the time of the change of control agreements and those new directors who were ‘approved’ by [a majority of the] Existing Directors. The views of new directors who were not approved as ‘Existing Directors’ would not be considered in determining whether subsequent new directors would be considered ‘Existing Directors.’”
The Court reasoned that, “If the directors in office at the time of the Change of Control Contracts approve a new director and, thus, the new director is classified as an Existing Director, all directors had the same input, and the concerns motivating the Carmody Court are not implicated. Similarly, if those directors fail to support another new director, that director will not be deemed an Existing Director, but there still has been no exercise of differential voting power. [The more difficult situation is] when the next director comes to the Board and the director who is not classified as an Existing Director will not be considered in the subsequent determination of whether the next director is to be considered an Existing Director.” Id. at *5.
But even that situation did not violate the Carmody holding, or Section 141(d), because “A new board member who is not considered an Existing Director is not denied the right to vote in any instance. . . . Thus, the Existing Directors provision neither limits nor expands the voting powers of any director.” Id.
In other words, the only differences between the Existing Directors and other directors (“Non-Existing Directors”? “Existential Directors”?) were: (1) only the votes of Existing Directors were counted in determining whether a new director would herself qualify as an Existing Director; and (2) if the proportion of Existing Directors on the board fell below a majority, the change of control payments would be authorized.
The Court concluded, “It is reasonable that a change of control agreement have some mechanism by which the corporation’s obligation to make such payments can be avoided if the composition of the Board has changed in name only. The definitional approach [examined in this decision] is an acceptable methodology; it may not be the only one.” Id. at *6.
It also warned that “incumbent directors may not employ a similar device, in a different context, to deprive various directors of their voting power or to deprive them of the capacity to exercise that power when necessary[, which could] constitute a breach of the fiduciary duties owed by the board to the shareholders.” Id. at *5 n.25.
Boards reviewing or updating their governance documents, and shareholders interested in proposing amendments to those documents, might consider:
First, should the certificate of incorporation grant special voting powers to the chair—for example, an additional vote, to break a tie vote among the directors?
Or, perhaps, the ability to break only a “deadlock”—possibly defined in the certificate of incorporation as a continuing (over what period of time?) tie vote of directors addressing (which specific) issues?
Second, could some directors have special voting powers that would be triggered by the occurrence of specific events, internal or external to the company? What would those powers, and those events be? Would an emergency be among them? What type of director vote would determine whether such a condition had been satisfied?
Third, could a director lose her special voting powers, and/or some or all of her regular voting powers, under certain conditions—for instance, if she engages in conduct that, though entirely legal, embarrasses the corporation? What type of director vote would determine whether such a condition had been satisfied?
Fourth, should a certificate of incorporation grant more than one vote, on specific issues or on all issues, to independent directors (however those might be defined)— and/or less than a full vote, on specific issues or on all issues, to a chair who also serves as CEO?
Fifth, should directors who have served for longer terms on the board have greater voting powers in some ways than other directors? Cf. Williams v. Geier, 671 A.2d 1368, 1370 (Del. 1996) (upholding “a form of ‘tenure voting’ whereby holders of common stock on the record date would receive ten votes per share. Upon sale or other transfer, however, each share would revert to one-vote-per-share status until that share is held by its owner for three years.”).
Or would “tenure voting” for directors conflict with a concern that long-tenured directors might be seen as less than “independent,” and might thereby be deserving of fewer voting powers than the default? Would there be some type of arc (default, to greater, to default, to lesser voting powers) over the course of a director’s tenure on the board?
Sixth, could a board approve a committee charter that itself, without a corresponding provision in the articles of incorporation or bylaws, purported to grant greater or lesser voting powers than the default to one or more of the directors serving on the committee (for instance, greater voting powers to the committee chair)?