Certificate of Incorporation Provision Shielding Board’s Interference in Director Election Is Void as Contrary to Delaware Law

Certificate of Incorporation Provision Shielding Board’s Interference in Director Election Is Void as Contrary to Delaware Law

Delaware's corporate statute is widely regarded for its flexibility, as it allows for significant leeway in structuring the relations between managers and stockholders.

This flexibility is subject to relatively loose statutory constraints. One of these constraints is a prohibition on the limitation of director liability for breaches of the duty of loyalty. 8 Del. C. § 102(b)(7)(i).

This stands in contrast to Delaware’s statutes governing alternative entities, such as LLCs, which allow for limitation of such liability. In a recent case, the Supreme Court of Delaware held that a provision in a certificate of incorporation in effect served to exculpate directors from liability for breaching their duty of loyalty, and thus concluded that the provision was void as contrary to Delaware law.

The certificate of incorporation in question capped at 10% the stock that could be voted by a “person” in any stockholder vote. It also provided that any determination by the board as to the application of the 10% limitation made “in good faith and on the basis of such information and assistance as was then reasonably available for such purpose shall be conclusive and binding upon the Corporation and its stockholders.” During the 2021 annual meeting of stockholders, three directors were up for election.

A dissident slate of directors received more votes than the incumbent slate of directors. However, the incumbent board instructed its inspector of elections to apply the 10% limitation to the votes received by the dissident slate of directors. This limitation meant that around 37,000 votes in favor of the dissident slate would not be counted, resulting in the incumbent directors prevailing in the election.

The dissident nominees sued to invalidate the board’s instruction to the inspector of elections. After the Court of Chancery ruled in favor of the plaintiffs, the case made its way up to the Supreme Court of Delaware, which affirmed.

The Supreme Court rejected the defendants’ argument that the referenced “conclusive and binding” provision pre-empted legal and equitable review of the board’s actions in question and thus exculpated the board from liability.

The court explained that when a board improperly interferes with a director election, it breaches its duty of loyalty. As a result, under Delaware law and public policy, fiduciaries must be held responsible for breaches of the duty of loyalty.

On the merits, the Supreme Court also affirmed as not clearly erroneous the Court of Chancery’s finding that the stockholders whose votes were excluded were not acting in concert, which meant that the 10% limitation did not apply to them. Accordingly, the invalidation of the board’s instruction to the inspector of elections was affirmed.