Corporate governance mistakes in Delaware companies can often by fixed by using the self-help remedy provided under Delaware General Corporation Law Section 204.
Many companies are formed in Delaware, although they do business elsewhere in the US, to take advantage of Delaware’s management-friendly and forward-thinking corporate law. One such advantage is the ability to use a self-help remedy under Delaware law to fix corporate mistakes that few other states offer. Mistakes often arise inadvertently, particularly in private companies that may not have inhouse lawyers on staff. These mistakes can become a major thorn in the side of the company when it is trying to raise funds or get a loan, since lawyers for the investors and lenders will thoroughly examine the company’s records before approving a loan or investment.
Prior to the enactment of Section 204, certain corporate mistakes could still be fixed later – so called “ratification” by the board or shareholders, but certain types of mistakes, for example issuing stock that the company did not have authority to issue (known as “putative stock”), could not be fixed after the fact by the board of directors and shareholders. Section 204 effectively overrules these cases and provides a fix.
The Company should carefully follow the steps laid out in Section 204 to fix the mistakes, which are referred to in the statute as “defective corporate acts”.
- First, the board should adopt a resolution describing the defective corporate acts including the information required in the statute and ratifying the defective corporate acts.
- Second,
- Shareholder approval by holders of valid stock and putative stock, whether voting or non-voting, is required if the defective corporate act would have required shareholder approval under Delaware law (e.g. increasing the number of authorized shares of the company, a stock split etc.).
- If the defective corporate act would not have required shareholder approval, then only notice needs be provided to the shareholders.
- Shareholders are required to be notified that any claim relating to the ratification must be brought within 120 days.
- Third, if the defective corporate act would have required a filing with the Delaware Secretary of State (e.g. an amendment of the articles), then the company is required to file a Certificate of Validation with the Delaware Secretary of State (with a significant filing fee – at least $2,579 at the time of writing).
- Important Limitation: Section 204 is designed to be used to fix mistakes, not to retroactively ratify acts that were deliberately not authorized by shareholders in the first place.
Please contact Edward Grenville at Inspire Business Law Group, PC (egrenville@inspirelawgroup.com; +415 279 0779) if you would like further information.