We prosecute and defend disputes involving the validity and due authorization of corporate acts under both the Massachusetts and Delaware Business corporation statutes.

Adherence to corporate formalities can be crucial. If corporate action is not duly authorized, it is void. Void actions cannot be ratified.

Suppose a corporation’s articles of incorporation authorize the company to issue up to 200,000 shares of stock.  The directors and the stockholders decide to increase the capital stock of the corporation.  Meetings of the directors and the stockholders are duly called and held; and properly drawn resolutions are adopted to increase the authorized shares to 500,000 shares. While the corporation’s articles of incorporation were not amended to so increase the capitalization of the company, 300,000 shares are issued and sold to new stockholders.

Because the corporation had no power to issue the stock, the 300,000 shares of stock are void. Corporations are creatures of statute whose very existence necessarily arises solely by grant of the sovereign. The state’s business corporation statute is a fundamental and inherent part of the corporation’s contract with its stockholders. The articles of incorporation adopted in strict compliance with that statute is also a contract between the state and the corporation as well as the corporation and its stockholders.  The corporation has the power to increase its capital stock but only by adhering to the requirements of the state’s business corporation statute.

The Delaware Supreme Court case of Staar Surgical Company v. Waggoner, 588 A. 2d 1130 (Del. 1991) demonstrates that equity cannot revive void stock. The corporation was facing severe financial difficulties and its lender was going to shut the company down if it did not receive the personal guaranty of Waggoner. The company’s articles of incorporation had granted the directors so-called “blank check” authority to issue preferred stock.  The minutes of a board of directors meeting stated that the board authorized creation of a series of convertible preferred stock to Waggoner in exchange for his $2 Million guaranty.  However the “the board never formally adopted the resolution and only Waggoner signed the minutes.” Acting on a certificate of designation for the new series of preferred stock, Staar Surgical issued the preferred stock to Waggoner who provided the guaranty and rescued the company from foreclosure. The certificate of designation also had been “never formally adopted.” Subsequently Waggoner exercised his conversion rights and received two million shares of common stock which made him the controlling stockholder.

In an ensuing litigation the Delaware Chancery Court held that the preferred shares were invalid for lack of due authorization. There simply was no statutorily required record made of the directors’ decision. There was no question that the board had authority to issue additional common stock and according to Waggoner all the directors had unanimously agreed “to issue Waggoner two million shares of common stock as compensation for his guaranty of” the company’s bank loan. But under the Delaware business corporation statute, even assuming the directors to have unanimously voted to issue the preferred stock, absent the requisite record the stock was invalid for lack of due authorization.

Because Waggoner had performed his end of the bargain and with his guaranty had rescued the corporation, the Chancery Court decided that as a matter of fairness and equity Waggoner was entitled “to own and vote the disputed two million shares of common stock which were derived from the invalid preferred stock.”  

The Delaware Supreme Court reversed. Because the preferred shares were void, the common stock “purportedly derived from the preferred also were invalid.” It was immaterial that the board of directors had the power to issue the common shares of stock. “Without validly issued preferred stock, there was simply no other legal mechanism by which the common shares could be issued.”  STAAR Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del. 1991).

Because void acts cannot be ratified, a Court may undo a transaction long after any otherwise applicable statute of limitations has run.

STAAR Surgical Co . v. Waggoner and others like it left the Chancery Court powerless “to validate stock,” even when” as in Mr. Waggoner’s case it would be inequitable not to do so. See In re Numoda Corporation, 128 A. 3d 991 (Del Sup. Ct. 2015 (unpublished decision).

Amendment of Delaware Corporation Statute

Effective April 1, 2014, the Delaware legislature added two new sections to the Delaware General Corporation Law, sections 204 and 205. The new law enables a board of a Delaware Corporation, under section 204, and/or the Chancery Court under section 205, to validate or ratify corporate acts such as the issuance of stock where the corporate action was within the actual authority of the actor but was defectively adopted as a technical matter. In re Numoda Corporation Shareholders Litigation, 2015 WL 402265 (Del. Ch. January 30, 2015).

In its unpublished Numoda decision, the Delaware Supreme Court explains that if it is equitable to do so the Court of Chancery has discretion under section 205 to “issue binding orders clarifying the capital structure of corporations when it is satisfied that a corporation’s board had the authority to, and intended to, authorize and issue stock.”

Sections 204 and 205 do not eliminate completely the distinction between void and voidable corporate acts. Unless a board of directors has actual authority under its Articles of Incorporation to issue the stock at the time in question there can be no equitable ratification of a “defective corporate act.” Section 204 is not a “license to cure just any defect.” Nguyen v. View, Inc., No. CV 11138-VCS, 2017 WL 2439074, at *10 (Del. Ch. June 6, 2017), reargument denied, No. CV 11138-VCS, 2017 WL 3169051 (Del. Ch. July 26, 2017).