Delaware Chancery: The Corporate Golem is Unmoved by Your Drama
A corporation is a “person” without an animating spirit created through a tacit bundle of contracts or some arcane alchemy of law, but it requires agents to act. The corporate form is akin to the Golem of Jewish mystic tradition. Created from dust, breath, and faith – the Golem has ruah (or “breath of bones”) but no “soul” or individual will. Its action is directed by those controlling it through written instructions left in its mouth accompanied by words of power. Similarly, the corporation is a creation of paper, breath, and social recognition. The board’s resolutions or written consents are the animating instructions, but their power depends on the catalyzing magic of valid approval under Delaware law and company’s governing documents.
In Delaware, a corporation must remain neutral in internal contests for control of the board when neither faction is able to act on the company’s behalf (e.g., neither side has a board quorum and the requisite votes). The “principle of neutrality” under Delaware corporate law requires that the company will not take a side where no one is authorized to act on its behalf. To use the analogy above, the written instructions are without power if approval is flawed. Even under the most exigent circumstances, in which the fate of the company is perceived to hang in the balance, action must be authorized under law and the requirements of the governing documents satisfied.
Two Takeaways
The conclusion seems intuitive in a moment of repose and armchair musing; however, in the fray and confusion of a fluid situation, the proper boundaries of action are often initially informed more by passion and apparent necessity than recourse to the terms of relevant agreements. The Court of Chancery’s recent grant of injunctive relief in In re Aerojet Rocketdyne presented the Court with textbook circumstances to apply the principle of neutrality under Delaware corporate law.[1]
The case provides two key take-aways for business owners, board members, and stockholders:
- No Even Number of Board Members & Think Ahead to Avoid a Deadlock. Avoid an even number of directors on the board (and plan for steps to address a director absence creating an even number). The eight-person board in Aerojet Rocketdyne was deadlocked 4 to 4.
- Action on the Corporation’s Behalf Must be Authorized. Taking action or making statements in the name of the company requires proper authorization under Delaware law and the corporation’s governing documents. This is true regardless of the stakes, the support of company officers, or the strength of one’s convictions on the matter.
The Principle of Neutrality in Delaware
The “principle of neutrality” is the principle that when the board is split such that no faction of the board can act or speak with the requisite quorum and relevant percentage vote required, the corporation must stay neutral. Neither party may purport to speak for the company or use its resources in the pursuit of pressing their claim. As the Court stated in Aerojet Rocketdyne, “Stockholders — not this court or either subset of directors — must now decide which faction’s vision will become that of the company.”
The principal stems from fundamental concepts in Delaware corporate law:
- In Delaware, the board is responsible for management of the company,[2]
- A board can only act on behalf of the corporation if its action is authorized and complies with all applicable law and the terms of the corporation’s governing documents (i.e., the Certificate of Incorporation and Bylaws);[3]
- Without such valid authorization, the board cannot speak or act for the corporation or expend company resources.[4]
Defense contractor Lockheed Martin was considering acquiring Aerojet Rocketdyne, a missile propulsion systems defense subcontractor. The merger agreement was signed, but the $4.4 billion acquisition was ultimately blocked by the Federal Trade Commission (“FTC”) on competition and national security grounds.[5]
Throughout the course of the star-crossed deal, the relationship between the CEO/Board Member (“Management”) and a private equity fund investor/Board Chair (the “Stockholder”) deteriorated. The two took different approaches to the merger and the likelihood that it would be blocked by the FTC’s review. Soon, it came time for regular director elections. The situation devolved and the eight-member board split into two equal factions (4 to 4) – one group backing Management (the “Management Group”) and the other backing the Stockholder (the “Stockholder Group”). Rather than agreeing to the Management Group’s proposed slate of director nominees, the Stockholder proposed his own candidates.
Because neither faction could obtain a quorum of the board, required to put the company’s weight behind its cause, a proxy fight began. This means that each side solicits shareholder votes with competing nominees. Ordinarily, one set would have the imprimatur of the company, but that was impossible given the board divide. When the Management Group announced its slate of nominees, the Management Group also caused the company to publish a press release without the required quorum. The press release, in the name of the company, expressed disappointment with the Stockholder Group’s decision to contest the election and suggested the Stockholder was motivated by hopes to derail an internal investigation focused on him. The press release was filed with a Form 8-K with the SEC, which is filed to report material events or actions between scheduled filings, and published on the SEC’s EDGAR online filing system.
The Stockholder Group filed an action in the Court of Chancery seeking a temporary restraining order preventing the Management Group from speaking on the company’s behalf in connection with the proxy fight.
The Court’s analysis was fulsome but came to a simple conclusion once the light of disinterested scrutiny burned off the thick, cloying fog of emotion, insecurity, and haste that accompanies high-stakes, internal business disputes. It is black letter law that a board must satisfy a valid quorum standard to act in the name of the company (or executed a unanimous written consent), whether the standard under Delaware corporate law (more than 50% of the board) or a bespoke requirement in the Certificate of Incorporation or Bylaws (as low as 33.3% permitted by law, can be higher).
The Management Group did not have a quorum when the four directors comprising the group voted to authorize the press release in the name of the company. Thus, the Court granted the requested equitable relief and enjoined the Management Group from acting or speaking on the company’s behalf.
This case is a timely reminder amidst market and world turmoil and changing economic fortunes – Delaware corporate law recognizes good faith and equity, but it does not brook a direct violation of bedrock principles by less than the required number of directors. As the Court stated, there was no “threat” to the corporation, as “corporate democracy is not an attack.”
[1] C.A. No. 2022-0127-LWW (Del. Ch. Jun. 16, 2022), available on Delaware’s website: www.courts.delaware.gov/Opinions/Download.aspx?id=334180 (last visited July 13, 2022).
[2] Delaware General Corporation Law, Subchapter 4, §141(a) (2021) (“The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors…”), available at www.delcode.delaware.gov/title8/c001/sc04/ (last visited July 12, 2022).
[3] Id. at §144(f).
[4] Applied Energetics, Inc. v. Farley, C.A. No. 2018-0489-JTL (Del. Ch. Aug. 3, 2020).
[5] Aerojet is the only independent supplier of certain missile propulsion technology used in advanced and critical missile systems. In blocking the merger, the FTC concluded the acquisition could unacceptably curtail competition in the market for missile propulsion systems, adversely affecting the U.S. Government’s access to the technology and, more broadly, a market where price discovery is not warped by anti-competitive vertical integration.
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