Delaware, Equitable Authority, and the Removal of Directors
Can the board remove directors? On the whole, the law says no, although the authority in Delaware is a particularly weak reed. A discussion of the issue is here. For the most part, this is the right answer. Directors are elected by shareholders. It should be up to shareholders, not other board members, to determine the continued tenure of a director. Of course, there is one inroad into this limit. Majority vote provisions mostly require losing directors to resign. This effectively leaves in the hands of the board the authority to remove an elected director.
But what about the courts? Can a court remove a director? This raises a different issue. Sometimes directors engage in harmful behavior and their continued tenure will result in harm to the company. Sometimes the offending director owns a controlling block of stock and cannot be removed. Appealing to a court does not raise the same inherent concerns that arise with directors removing directors.
Delaware has a statute that permits judicial removal of directors but only in exceedingly narrow circumstances. According to 8 Del. C. § 225(c):
If 1 or more directors has been convicted of a felony in connection with the duties of such director or directors to the corporation, or if there has been a prior judgment on the merits by a court of competent jurisdiction that 1 or more directors has committed a breach of the duty of loyalty in connection with the duties of such director or directors to that corporation, then, upon application by the corporation, . . . in a subsequent action brought for such purpose, the Court of Chancery may remove from office such director or directors if the Court determines that the director or directors did not act in good faith in performing the acts resulting in the prior conviction or judgment and judicial removal is necessary to avoid irreparable harm to the corporation.
Anything short of a felony or an adjudicated violation of the duty of loyalty will be insufficient for purposes of removal under the statute.
But the Chancery Court in Delaware is a court of equity, a source of authority typically read in a broad fashion. See Whittington v. Dragon Group, LLC, 2011 Del. Ch. LEXIS 63 (Del. Ch. April 15, 2011) ("This Court, as a court of equity, has broad discretion to form an appropriate remedy for a particular wrong."). Does equity, therefore, allow the Chancery Court to remove directors in cases other than those prescribed by statute?
That was the issue in Shocking Technologies, Inc. v. Michael, C.A. No. 7164-VCN (Del. Ch. March 26, 2012). In that case, the company sought the removal of a director. Not bringing the action under Section 225, the company appealed to the Chancery Court's equitable authority. The company claimed that the director had improperly "interfered with [the company's] efforts to raise additional capital." Moreover, the company alleged that the "actions, if they happened and are likely to happen again because it must raise funds to survive." The court found that the company "pled a colorable claim and the likelihood of irreparable harm."
The only issue was whether the court had the equitable authority to remove the director. While the court left the issue unanswered, it indicated that the factual circumstances at issue were not sufficient to trigger the court's "inherent equitable powers" even if the authority existed.
Without resolving the question of whether or not the Court has the power to remove a particular director outside of a § 225(c) action, the Court notes that the General Assembly set forth in § 225(c) the circumstances in which the Court is expressly empowered to remove a director. The Court concludes that this action is not so unusual and does not involve such pressing issues that the Court would be moved to exercise any inherent equitable powers (if, indeed, it has such powers) it might have to remove a director outside of a § 225(c) action.
But tucked in the opinion was a footnote indicating that there was "significant authority for the proposition that the Court does not have the power, other than as granted by statute, to remove a duly selected director who has breached the duty of loyalty." The one case cited by the court (in addition to secondary and legislative sources), was Ross Sys. Corp. v. Ross, 1993 WL 49778, at *17-18 (Del. Ch. Feb. 22, 1993) ("But the plaintiffs here do not ask the Court to appoint a receiver or trustee, and they are unable to point to any statute or other source of law that would empower this Court to remove a particular member of the corporation's board of directors.").
Thus while the issue is not entirely foreclosed, the courts in Delaware seem unwilling to apply equity in the case of director removal. Those on the board, therefore, do not generally have to worry that their term will be cut short when they act in an inequitable fashion.