Curbing Shareholders’ Right to Remove Directors—How Far Can Companies Go?

Delaware Court of Chancery

How far may companies go in setting parameters around the removal of directors? The Delaware Chancery Court is slated this month to hear argument in a case involving that issue.

The oral argument, scheduled for Sept. 26, involves a shareholder lawsuit challenging a director-removal bylaw of Pennsylvania-based weight-loss products provider Nutrisystem Inc. The bylaw states that Nutrisystem board members may only be removed if two-thirds of the stockholders vote in favor of the removal.

According to the shareholder’s complaint, the clause improperly entrenches the company’s directors, in violation of Delaware General Corporation Law Section 141(k). The section provides that any “directors or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors.”

Nutrisystem, on the other hand, argues that Section 141(k) simply states that a majority of shareholders can remove directors and the statute doesn’t specify the percentage of shares that must be voted for the removal.

The litigation explores a question left open from another chancery court rulingIn re Vaalco Energy Shareholder Litigation. In a bench decision issued in December, Vice Chancellor J. Travis Laster invalidated a Vaalco Energy Inc. charter provision providing that board members could only be removed for cause. The judge held that directors of nonclassified boards may be removed without cause no matter what their charters or bylaws say. The judge also found that there are only two exceptions to shareholders’ authority to remove directors under Section 141(k)—a classified board or cumulative voting.

The Vaalco ruling sparked a rush by many companies to amend their bylaws.

If the chancery court finds Nutrisystem’s bylaw valid, that will boost Delaware corporations’ ability to circumscribe the right of shareholders to remove board members. Conversely, if the court agrees with the shareholder plaintiff, it will make clear that companies can’t impose a supermajority requirement on that right.

This isn’t the only open question from the Vaalco decision. The ruling focused on nonclassified boards, or boards in which directors are elected annually rather than at staggered periods. The decision didn’t address single-class boards. It remains to be seen whether a shareholder will test this issue.