Corporate & Securities Law

By Jim Hamilton

Delaware Corporate Law Does Not Permit Shrinking Board of Directors by a By-Law Amendment

A shareholder?s effort to shrink the board of directors by amending the corporate by-laws failed because the attempt conflicted with the Delaware Corporation Code. In a case of first impression, the Chancery Court held that the notion that the terms of the extra surplus directors would end conflicts with Section 141(b)?s mandate that directors hold office until their successor is elected and qualified or until their earlier resignation or removal. Delaware corporate law does not contemplate the continued board presence of seatless directors. Kurz v. Holbrook, Del Chan. Ct,, CA No. 5019, Feb 9, 2010.

Up to now, Delaware law has not addressed what happens when a bylaw amendment would shrink the number of board seats below the number of sitting directors. The Delaware Corporation Code does not address the issue, nor has any Delaware court considered it, and none of the leading treatises on Delaware law mentions it. Indeed, noted Vice Chancellor Laster, no one seems to have contemplated it.

The proposed by-law amendment would shrink the board to three directorships at a time when five directors are in office. There are two possible consequences for the suddenly surplus directors. One is that their terms would end. The other is that they would continue to serve, albeit without official seats, until their terms were ended by a statutorily recognized means. The court found that both possibilities conflict with the Delaware Corporation Code.

Section 141(b) recognizes three procedural means by which the term of a sitting director can be brought to a close: (1) when the director?s successor is elected and qualified, (2) if the director resigns, or (3) if the director is removed. Section 141(b) does not contemplate that a director?s term could end through board shrinkage. A bylaw that seeks to achieve this result conflicts with Section 141(b) and is void.

In light of the three procedural means for ending a director?s term in Section 141(b), said the Vice Chancellor, a bylaw could not impose a requirement that would disqualify a director and terminate his or her service. Section 141(b)?s recognition of the bylaws as a locus for director qualifications instead contemplates reasonable qualifications to be applied at the front end, before a director?s term commences, when the director is elected and qualified. The concept of a bylaw that would end a director?s service through disqualification thus lends no support to a bylaw that would accomplish the same thing through board shrinkage. Neither is valid under Section 141(b).

If a bylaw amendment reducing the size of a board could eliminate sitting directors, reasoned the court, then directors suddenly would have the power to remove other directors. For 89 years, he noted, Delaware law has barred directors from removing other directors.

Further, The Delaware Corporation Code says nothing about directors continuing in office in the absence of an underlying board seat. Delaware law simply does not contemplate a liminal state in which suddenly surplus directors might continue to exist, untethered from the statute or any constitutive corporate document. Moreover, the lingering presence of directors without board seats would create a direct conflict between the number of directors in office and the number of directors provided for in the bylaws.

Full post as published by Jim Hamilton's World of Securities Regulation on February 18, 2010 (boomark / email).