Delaware Supreme Court Decides Case Regarding "Stockholders of Record," Crown EMAK Partners LLC v. Kurz

On April 21, the Delaware Supreme Court reversed in part and affirmed in part the much discussed case of Kurz v. Holbrook, in which the Chancery Court had held, among other things, that brokers and banks identified on the Cede breakdown were record holders for purposes of determining stockholders entitled to vote. (See the 2/18/10 news brief posting.) While the Chancery Court did "not foresee any headaches" arising out of its decision, it also acknowledged that the decision would have collateral impact on many other provisions of Delaware law and would "require future cases to work through particular issues." In its decision, however, the Delaware Supreme Court did not even reach the issue of whether banks and brokers are "record owners" for voting purposes. Instead, the Delaware Supreme court decided the case on other grounds, explicitly announcing that the lower court's decision regarding the stock ledger was purely dictum and "without precedential effect." The decision can be found online.   

As you may recall, the case involved competing consent solicitations in a contest for control of the board, beginning with an insurgent group that sought to remove and replace several directors to seat a majority. The insurgent group ultimately submitted consents it thought were sufficient, but only after it purchased some additional shares held by an employee. Because the employee shares were subject to certain transfer restrictions, the insurgents devised a work-around in which the employee transferred his future rights to the shares and provided an irrevocable proxy to vote those shares. The incumbent group sought, and submitted sufficient consents, to amend the company's bylaws to reduce the size of the board to eliminate unwanted directors and leave it with a majority (since it had the right to appoint a specified number of directors who would then constitute a majority). Because the company was public, a large proportion of its shares were held in street name. While the incumbents obtained direct signatures from DTC providing proxy authority for the few banks and brokers whose consents they needed, no one obtained the DTC "omnibus proxy" for the consents related to the shares of the banks and brokers held of record by DTC and submitted by the insurgents. (DTC is the depository that is the stockholder of record for all of the participating banks and brokers.) As a result, the transfer agent viewed a large proportion of the consents submitted by the insurgents to be invalid.

The issues involved whether shares necessary to win the consent solicitation were the subject of illegal vote-buying, whether the transfer of the interest in the critical shares was effective in light of transfer restrictions, whether the bylaw that purported to shrink the size of the board below the number of sitting directors was valid, whether failure to obtain an omnibus proxy from DTC was fatal with regard to written consents obtained for the shares held in street name or whether, instead, the banks and brokers who appeared on the Cede breakdown list of participants had the power to vote or act by written consent as record holders.

The Chancery Court had held that the insurgents did not engage in improper vote buying. Although title to the shares was not transferred, the Chancery Court concluded that all of the economic interest in the shares had been transferred, with the result that, under Delaware law, the insurgents were presumed to have the right to vote those shares. The Supreme Court concurred. Because both the economic interests and the voting interests of the shares were transferred, both interests remained aligned and, therefore, there was no improper vote buying.

The Supreme court also affirmed the Chancery Court's conclusion that the attempt to amend the Bylaws to reduce the number of authorized directors below the number of currently sitting directors was invalid because it conflicted with the DGCL: "Generally, in a contested election, an insurgent first removes the challenged directors, then reduces the number of directorships, and then fills the vacancies. We hold that was the legally proper sequence for accomplishing [the incumbent's] objective in this case."

Where the Supreme Court began to take a different path from the Chancery Court was on the issue of the share transfer restrictions. The Chancery Court held that the insurgents had successfully contracted around the sale and transfer restrictions because the restricted stock grant did not prohibit the employee from agreeing to sell or transfer his shares at a future date. According to the Chancery Court, the effect of the future title transfer was to immediately transfer to the insurgents the economic interest in the shares. However, the Supreme Court held that the purchase and immediate receipt of the full economic interest associated with the shares violated the restricted stock grant agreement because there was, in effect, an actual transfer of the shares in violation of the transfer restrictions. Relying on an academic study, the Supreme Court concluded that, by "reconnecting the voting rights to the economic ownership via the Irrevocable Proxy, the Purchase Agreement immediately conferred upon [the insurgents] the functional equivalent of ‘full ownership,'…." There was nothing to transfer in the future, other than the bare legal title. Moreover, this "divestiture of all voting and economic rights in his shares frustrates the purpose of the Restricted Stock Grant Agreement, because bare legal title, alone and without more, does not give [the employee] a stake in the corporation's future." Accordingly, because of the breach of the restrictions, there could be no legally valid sale or transfer of the shares, and the insurgents were not entitled to vote them.

As a result of that decision, the Supreme Court concluded that it need not reach the question of whether the banks and brokers who appeared on the Cede breakdown list of participants should be included as part of the stock ledger and accorded the power to vote or consent as record holders. The Supreme Court emphasized, quoting the Chancery Court itself, that the lower court's interpretation "represents a change in how Delaware practitioners understand the stock ledger for purposes of voting . .. ." and that the DTC system that normally relies on an omnibus proxy from DTC is usually effective. Since the Supreme Court's determination with regard to the restricted stock transfer was dispositive, it was unnecessary for the Supreme Court to decide this issue, "because a decision either way would not alter the result we have reached nor would a gratuitous statutory interpretation resolving this difficult issue be prudent. The human failures that occurred in this case are easily avoidable in the future and may be a one-time anomaly that may not again occur. Moreover, and in any event, a legislative cure is preferable. The DGCL is a comprehensive and carefully crafted statutory scheme that is periodically reviewed by the General Assembly. Indeed, the General Assembly made coordinated amendments to section 219 and section 220 in 2003. Any adjustment to the intricate scheme of which section 219 is but a part should be accomplished by the General Assembly through a coordinated amendment process. Therefore, the Court of Chancery's interpretation of stock ledger in section 219 is obiter dictum and without precedential effect."

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