‘Robust' Practice Springing Up Around Delaware Statute to Fix Corporate De

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By Yin Wilczek

March 25 — A vigorous practice has developed around a one-of-a-kind statute recently enacted in Delaware that allows companies to go back in time and fix corporate mistakes, attorneys said March 25.

The statute—§§ 204 and 205 of the Delaware General Corporation Law—provides for a procedure through which corporations, either by themselves or through the Delaware Chancery Court, may ratify defective corporate acts. Section 205 is the first—and thus far only—provision of its kind in the country.

Since the provisions went into effect Apr. 1, 2014, there have been about 160 ratifications under § 204 as of March, said Emily Burton, an associate at Young Conaway Stargatt & Taylor LLP in Wilmington, Del.

There also has been one written opinion under § 205—In re Numoda Corp. Shareholder Litigation—as well as a number of court orders, said Burton, one of the primary drafters of the statute.

“It’s been a pretty robust practice that has developed since the statute went online,” said Young Conaway partner James Hughes Jr., co-author of Bloomberg BNA's portfolio on deal protection devices.

Speaking at a Practising Law Institute webcast, the attorneys also provided tips as to how companies may use the provisions.

Not Sole Remedy 

Hughes noted that the statute is not the only one available to companies that make mistakes. For example, he said the statute “does not replace or supplant” § 103(f) of the Delaware General Corporation Law, which allows companies to correct drafting errors commonly known as “scriveners' mistakes.”

In addition, common law ratification still is available to companies, Hughes said. However, given that common law ratification is available for “voidable,” but not “void” acts, there can be instances in which it is not clear whether that type of ratification may be used, he said.

“The hope is that with the statutory scheme that’s now in place, it will be much clearer to counsel what they can ratify” and how, Hughes said. “There is now a mandated statute that instructs how the court can assist in clarifying what actions are valid under Sections 204 and 205.”

Under § 204, companies may seek to ratify corporate defective acts without going through the courts—what the attorneys dubbed the “self help remedy.”

“Given the requirements for a 204 ratification, this is going to be useful mainly for either closely held corporations or situations where the defect is either relatively recent or relatively minor,” Burton said.

There are certain steps the company must take under the provision:

• the board must approve a resolution stating, among other things, the defective act to be ratified and the time of the defective act;

• the company must provide prompt notice to shareholders and putative shareholders;

• in certain instances, the company may have to put the ratification to a shareholder vote; and

• the company may be required to file a certificate of validation.

 

Board Approval 

With respect to board approval, Burton noted that the subject of the ratification must be clearly identified. Because the ratification is retroactive, it may affect the validity of numerous subsequent corporate acts, she noted.

Burton also observed that because the certificates of validation can be very complex for the Delaware Secretary of State to review, companies can make the process easier by:

• making clear in the certificate what specific defective act the certificate relates to;

• issuing multiple certificates of validation where numerous defective acts are being ratified through one resolution; and

• filing a copy of whatever certificate was or should have been filed as an exhibit to the certificate of validation.

 

To use § 204, companies must be able to identify their directors and shareholders, as well as the defective act, with a reasonable degree of certainty, Burton said. Where this is difficult, such as where the defect happened a long time ago, it may be better to go through § 205, which provides for court-supervised ratification, she said.

Under § 205, the Delaware Chancery Court may:

• issue a declaration as to the effectiveness of a corporate act;

• modify a ratification or the requirements of a § 204 ratification;

• ratify or invalidate a defective corporate act; or

• take any action necessary or related to any of the above.

 

‘Powerful' Option 

Section 205 provides “a much more flexible” and “powerful” option for companies with validity issues in their capital structure, Burton said.

Among other advantages, there are many more stakeholders that can pursue ratification under § 205, including putative shareholders and third parties adversely impacted by a § 204 ratification, Burton said. Importantly, a corporation bringing a § 205 action doesn't have to admit that its stock issuance was defective, only that there is a dispute as to its validity, she said.

Moreover, Burton said companies should heed the policy considerations that guided the adoption of the provision. She said companies should not be able to rely on § 205 to:

• willfully disregard corporate formalities;

• remake history; or

• harm innocent parties who relied on the corporate record.

 

“The whole structure of the statute is intended to avoid those three harms,” Burton said. By keeping these in mind, companies may find it a lot easier to predict how the court will come out on § 205 issues, she said.

To contact the reporter on this story: Yin Wilczek in Washington at ywilczek@bna.com

To contact the editor responsible for this story: Ryan Tuck at rtuck@bna.com