In December 2022, the Delaware Chancery Court entered a ruling sending the SPAC world spiraling, for what seems like the 10th time in the last couple of years. As is always the case in a SPAC (or at least 99% of the time), common stock is broken into two series, Class A and Class B. The Class A common stock is issued to the public shareholders in the underwritten initial public offering and the Class B common stock is issued to the sponsor. Upon closing a business combination transaction, the sponsor Class B common stock automatically converts into Class A common stock, leaving one Class of common stock. Also, in the majority of SPAC transactions, the shareholder approval for the business combination transaction involves other changes to the charter documents for the SPAC, including a name change, and changes in authorized capital stock, etc. The term “charter” in this blog refers to the certificate of incorporation and any amendments thereto. For more on SPAC structures, see HERE .
In Garfield v. Boxed, Inc., a common stockholder challenged the validity of a proposed shareholder vote approving a business combination transaction (a de-SPAC) and amendments to the company charter increasing the authorized Class A common stock. Prior to the vote, the plaintiff wrote a letter to the company arguing that the increase in authorized Class A common stock negatively impacted the Class A common stockholders such that under Section 242(b) of the Delaware General Corporate Law (DGCL), such Class A common stockholders should be entitled to vote on the proposal as a separate Class. The company obliged the plaintiff, and the Class A and Class B common stockholders voted as separate Classes on the proposals. The plaintiff then sued to recoup his attorneys’ fees and expenses “for the benefits he conferred on the company and its stockholders by facilitating statutorily compliant votes.”
Although the question as to whether the Class A common stockholders were entitled to vote separately from the Class B common stockholders was only indirectly in front of the court, in ruling in favor of the plaintiff, the court inferred that Section 242(b) would indeed be violated if the Class A was not provided the opportunity to approve the amendment as a separate Class. The company argued that under the charter documents, the Class A and Class B were two series of a single Class of common stock and that, although it appeased the plaintiff, the voting structure was already statutorily compliant. The court disagreed.
The ruling ended up calling several dozen (perhaps hundreds) post SPAC business combination transactions into question. In particular, if a vote to increase authorized shares was not valid and those invalid shares were issued in the business combination transaction, the business combination itself would not be valid. Since that time the Chancery Court has been inundated with DGCL Section 205 declaratory judgment actions seeking to validate and declare effective company charters as they stand at the time of the petition and to validate securities issued under the charter (i.e., securities issued following shareholder approval for a de-SPAC transaction and amendments to the charter).
In a series of rulings under Section 205, the Delaware Chancery Court has retroactively validated de-SPAC stockholder votes approving an increase in authorized Class A common shares. Although the Chancery court has provided a positive result for these companies, the entire scenario is an important reminder for practitioners to pay attention to Class voting rights under the DGCL 242(b) and concurrent certificate of incorporation drafting nuances.
DGCL Section 242
DGCL Section 242 governs amendments to certificates of incorporation. Whereas DGCL 242(a) sets forth the general right to amend a certificate of incorporation, and includes a list of allowable amendments, including increases and decreases to capital stock, splits, recapitalizations, creations of Classes of preferred stock, etc., Section 242(b) sets forth the manner in which such amendments may be effectuated.
Under Section 242(b)(1), to effectuate an amendment, the board of directors must adopt a resolution setting forth the amendment proposed, declaring its advisability, and either call a special meeting of the stockholders entitled to vote in respect thereof or directing that the amendment be considered at the next annual meeting.
Section 242(b)(2) specifically provides a Class vote on five types of charter amendments affecting that Class. In particular, Section 242(b)(2) states that “holders of the outstanding shares of a Class shall be entitled to vote as a Class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would increase or decrease the aggregate number of authorized shares of such Class, increase or decrease the par value of the shares of such Class, or alter or change the powers, preferences, or special rights of the shares of such Class so as to affect them adversely.” Although beyond the scope of this blog, there is plenty of precedence, and continued debate among practitioners, as to when a class’s “powers, preferences, or special rights” are adversely affected.
The Section continues to require a series vote if any three of the listed certificate amendments uniquely affects that series. That is, “[I]f any proposed amendment would alter or change the powers, preferences, or special rights of 1 or more series of any Class so as to affect them adversely, but shall not so affect the entire Class, then only the shares of the series so affected by the amendment shall be considered a separate Class for the purposes of this paragraph.” The Section does not require a series vote on an amendment increasing or decreasing the aggregate number of shares, or the par value of such series.
The Section continues to allow a company to opt out of Sections 242(b)(2)’s Class voting requirements for increases or decreases of authorized shares of a Class of stock, if the original certificate of incorporation or an amendment that created the Class in the first place, prior to the issuance of shares in that Class, provides for such right. If shares of a particular Class have already been issued, a vote of a majority of a specific Class may also approve an amendment that obviates the need for separate Class voting associated with future increases or decreases in authorized shares.
In the Boxed case, the original certificate provided that except as otherwise required by law, the Class A and Class B common stockholders would vote together as a single Class on all matters submitted to stockholders for approval. The original certificate did not have a provision specifically opting out of Section 242(b) and as such if the Class A and Class B were separate Classes, as opposed to just a series of the same Class, an increase in authorized shares would require a separate vote by the Class A.
The Boxed court went on to specifically find that if the Class A and Class B had not been allowed to vote as separate classes, the validity of the business combination, and any stock issued in the transaction, would be called into question.
As an aside, Section 242(b) also specifically provides that unless the certificate of incorporation provides otherwise, no stockholder vote is required to amend the certificate to change the corporate name or to delete such provisions: (i) of the original certificate of incorporation which named the incorporator or incorporators, the initial board of directors and the original subscribers for shares; or (ii) that contained in any amendment to the certificate of incorporation as were necessary to effect a change, exchange, reclassification, subdivision, combination or cancellation of stock, if such change, exchange, reclassification, subdivision, combination or cancellation has become effective. That is, a board of directors may directly effectuate such changes without stockholder approval.
As indicated, the Boxed decision revolved around whether the original certificate of incorporation authorized Class A and Class B as two Classes of common stock, or as series within a single Class. As a first point, the Chancery court interprets certificates of incorporation as contracts among stockholders. As such, Delaware courts apply the general rules of contract interpretation to disputes over the meaning of charter provisions.
Accordingly, Delaware courts interpret contract terms according to their plain, ordinary meaning, and attempt to give meaning and effect to each word in a contract, assuming that the parties would not include superfluous verbiage in their agreement. When a contract’s plain meaning, in the context of the overall structure of the contract, is susceptible to more than one reasonable interpretation, courts may consider extrinsic evidence to resolve the “ambiguity.” Stock voting rights must “be specified expressly and with clarity.” If charter provisions are unclear, Delaware courts “resolve any doubt in favor of the stockholders’ electoral rights.”
In the Boxed case, the Chancery court looked at the language of the authorized capital stock which referred to the “Class A” and “Class B” common stock, including enumerating the number of shares and par value for each. The word “series” did not appear in reference to the common stock. The court also noted that Section 102 of the DGCL requires that a certificate of incorporation that grants the authority to issue more than one class of shares, must set forth the number of shares of all classes and their respective par value. There is no such requirement for different series within a class.
In addition, the certificate must “set forth a statement of the designations and the powers, preferences and rights, and the qualifications, limitations or restrictions thereof, which are permitted by § 151 of this title in respect of any class or classes of stock or any series of any class of stock of the corporation and the fixing of which by the certificate of incorporation is desired, and an express grant of such authority as it may then be desired to grant to the board of directors to fix by resolution or resolutions any thereof that may be desired but which shall not be fixed by the certificate of incorporation.”
The Chancery court noted that the common stock was broken up by “class” and enumerated its authorized number and par value, whereas the preferred stock section specifically allowed for the issuance of different “series” and granted the board of directors the right to designate the rights and preferences of such different “series.” The conclusion was that the certificate allowed for the issuance of 2 “classes” of common stock and multiple “series” of preferred stock.
In the practice of law, attorneys tend to “rinse and repeat” and the SPAC practice is a perfect example of that mantra. The vast majority of SPAC certificates of incorporation are exactly the same with Boxed providing an excellent reminder that it is important to re-read and update form documents on a regular basis.
DGCL Section 205
Sections 204 and 205 of the DGCL, respectively, provide mechanisms for a corporation to unilaterally ratify defective corporate acts or seek relief from the Court of Chancery to validate any corporate act under certain circumstances. Section 204 is a self-help statute allowing a board of directors to remedy what would otherwise be void or voidable corporate acts and stock issuances and provides that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in Section 204 or validated by the Court of Chancery in a proceeding brought under Section 205.” Pursuant to Section 204, a corporation’s board of directors may ratify one or more defective corporate acts by adopting resolutions setting forth the defective corporate act to be ratified, the date on which that act occurred, the reason why it is defective and that the board has approved the ratification of the defective corporate act or acts. A stockholder vote also is required to ratify the defective act if such a vote was required either at the time of the defective corporate act or at the time the board adopts the resolutions ratifying such act.
Section 205 is a declaratory court process allowing a company to request that the court determine the validity of any corporate act, defective or not, or transaction and any stock, rights or options to acquire stock. Although SPAC’s impacted by the Boxed decision could avail themselves of either a Section 204 or Section 205 remedy, in light of the very real potential for third-party litigation, most entities have sought and are seeking Section 205 court relief.
Section 205 gives broad discretion to the Chancery court but also sets forth factors for the court to consider in reaching a resolution, including: (i) whether the defective corporate act was originally approved or effectuated with the belief that the approval or effectuation was in compliance with the provisions of the DGCL, the certificate of incorporation or bylaws of the corporation; (ii) whether the corporation and board of directors has treated the defective corporate act as a valid act or transaction and whether any person has acted in reliance on the public record that such defective corporate act was valid; (iii) whether any person will be or was harmed by the ratification or validation of the defective corporate act, excluding any harm that would have resulted if the defective corporate act had been valid when approved or effectuated; (iv) whether any person will be harmed by the failure to ratify or validate the defective corporate act; and (v) any other factors or considerations the Court deems just and equitable.
Following the Boxed ruling, several dozen former SPAC’s have filed Section 205 petitions. Although the wording has varied, in essence each of the companies have asked the Chancery court to (i) validate and declare effective the company’s current certificate of incorporation including the filing and effectiveness thereof and (ii) validate and declare effective the shares of the company’s Class A common stock, and other securities issued in reliance on the validity of the current certificate of incorporation.
Although the court rulings have varied slightly, most have (i) declared the company’s current certificate of incorporation including the filing and effectiveness thereof, as validated and effective retroactive to the date of its filing with the Office of the Secretary of State of the State of Delaware and all amendments effected thereby and (ii) ordering that the company’s securities (and the issuance of the securities) described in the Petition and any other securities issued in reliance on the validity of the current certificate of incorporation are validated and declared “effective, each as of the original issuance dates…”
In providing relief to these companies, the Chancery court found that such relief was “the most efficient and conclusive—and perhaps the only—recourse available” to the company. One Chancellor wrote that “[R]atification will restore confidence in the company’s capital stock and assuage market fears.” “A contrary ruling would invite untold chaos.”
The Chancery courts have almost uniformly declined to analyze the Boxed decision in detail, but have rather focused on the five factors for consideration in Section 205. That is: (i) the company and board approved the charter amendments in good faith; (ii) in most cases the board relied on the advice of counsel that a separate class vote was not required (and in some cases received a legal opinion stating same); (iii) the company and market participants had acted in reliance on the validity of the amendments; (iv) no legitimate harm would result from validating the charter amendment; and (v) absent validation, the company, its stockholders and market participants would face substantial damage and widespread harm.
Laura Anthony, Esq.
Anthony L.G., PLLC
A Corporate Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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