A Management Friendly Philosophy Applied to Management Disputes: Klaassen v. Allegro Development (Part 2)
We are examining the decision in Klaassen v. Allegro Development.
In Klaassen, the Chancery Court conducted a tutorial on the developpment of notice requirements for directors. The early cases set out the black letter law in the area. Directors were required to receive advance notice of special meetings in order to have "the right to be heard upon all questions considered. . . ." Without notice, the actions at the meeting were void. At the same time, however, notice could not be willfully avoided. Thus, a director could not assert the lack of notice when refusing to permit the delivery of notice in the form of a registered letter.
The courts also recognized that a "quorum obtained by trickery" was invalid. This could occur where a director notified of the meeting failed to attend when told that it had been postponed. In effect, the approach eviscerated the requirement of notice by denying the director of an opportunity to attend and be heard. Trickery was not present, however, where a meeting was called on an impromptu basis (the directors were all present to attend the annual meeting of shareholders) and in a manner consistent with the bylaws.
These cases largely provided common sense rules of the road. Directors were required to have notice of special meetings. Notice was ineffective if they were tricked into not attending. Trickery, however, had to involve some type of misbehavior. These cases largely reflected the state of the law through the 1990s.
Beginning in the 1990s, however, the courts, as VC Laster put it, "took a very different approach to advance notice for special board meetings." Unlike the 1980s, when shareholders could occasionally win a major governance case (recall Van Gorkom or Unocal), the 1990s began a period of decision making where this was less likely to occur.
The "very different approach" with respect to board meetings and notice occurred in the context of efforts by non-management directors to remove the CEO. In one case, Koch v. Stearn, 1992 WL 181717 (Del. Ch. July 28, 1992),vacated as moot, 628 A.2d 44 (Del. 1993), the removed CEO, who was also a controlling shareholder, alleged that he had been "tricked" into attending the meeting. The "trick" was providing a notice that suggested a purpose of the special meeting that did not encompass his removal.
In Adlerstein v. Werthemer, 2002 WL 205684 (Del Ch. Jan. 25, 2002), two outside directors sought to raise additional capital and remove the CEO. Again, the CEO, a controlling shareholder, had no notice and again, the court invalidated the meeting (and his removal). As the court reasoned, in the case of a controlling shareholder, equity would not permit the withholding of advance notice when done “for the purpose of preventing the controlling stockholder/director from exercising his or her contractual right to put a halt to the other directors' schemes.”
In a third case, Fogel v. US Energy Sys., Inc., 2007 WL 4438978 (Del. Ch. Dec. 13, 2007), the doctrine was extended to directors who were not also controlling shareholders. The CEO (who also served as chairman) scheduled a special meeting of the board. In advance of the meeting, the three independent directors decided to fire the CEO. Before the meeting, the three directors told the CEO that “they had lost faith in him and wanted him to resign.” When he refused to resign, he was terminated.
The termination was ultimately invalidated. The Chancery Court found that “the directors deceived Fogel by not specifically warning him in advance about his potential termination.” Although not a controlling shareholder, the court reasoned that the CEO was disadvantaged because "had he known beforehand, he could have exercised his right under the bylaws to call for a special meeting before the board met."
In Klaassen, the Vice Chancellor described the decision as “dramatically expanding” the existing line of authority. The case essentially required advance notice to a CEO before termination. “If Fogel is correct, then a board with a Chairman/CEO cannot fire its CEO without first giving the CEO explicit advance notice and an opportunity to call a special meeting of stockholders at which the composition of the board might change, regardless of how few shares the Chairman/CEO owns.”
The Vice Chancellor tried to summarize the state of the law. He reasoned that:
- Delaware law distinguishes between (i) a failure to give notice of a board meeting in the specific manner required by the bylaws and (ii) a contention that the lack of notice was inequitable. In the former scenario, board action taken at the meeting is void. In the latter scenario, board action is voidable in equity, so equitable defenses apply. . . . this distinction fits with the general rule that the stockholders, through bylaws, may dictate the process that directors use to manage the corporation, so long as the restrictions are not so onerous as to interfere with the board's power to manage the corporation under Section 141(a). The distinction also recognizes that, traditionally, when a board took action in contravention of a mandatory bylaw, the board action was treated as void.
The Vice Chancellor found that the termination of the CEO in Klaassen was a voidable act subject to equitable defenses. He found equitable defenses applicable and declined to overturn the termination of the CEO. Recognizing the “unsettled questions” raised by the case, the court agreed to issue a stay pending appeal.
So what will happen on appeal? We will address that possibility in the next post.