Fox Rothschild LLP

Directors' and Shareholders' Reference Guide to Summary Proceedings in the Delaware Court of Chancery

November 2012

Introduction

The Delaware Court of Chancery is internationally recognized as the preeminent state court forum for resolving disputes related to corporations and other business entities. A large part of its prominence stems from its extensive body of case law, which leads to predictability, as well as its judges whose knowledge offers the necessary confidence that litigants seek when deciding where to bring an action. Additionally, the Court provides litigants the opportunity to initiate certain proceedings and receive a final determination in less than a year. These types of actions are governed by statute and are known as summary proceedings. The purpose of this guide is to provide directors and shareholders with a general overview of the different types of summary proceedings that can be brought in the Delaware Court of Chancery.

Books and Records Demands

What Governs a Shareholder’s Rights With Respect to Inspection of the Books and Records of the Company?

Section 220 of the Delaware General Corporation Law (DGCL) establishes:

  1. the right of a shareholder or director to gain access to books and records of a Delaware corporation
  2. the procedural requirements to properly make a request to inspect the corporation’s books and records; and
  3. the right to file an expedited summary proceeding to compel the corporation to provide access to its books and records if it refuses to comply with its obligations.

What Are the Procedural Requirements for a Shareholder To Initiate a Demand for Books and Records?

Before bringing an action in the Court of Chancery, a shareholder must first make a demand to inspect the books and records of the company.  The demand must be in writing, under oath and sent to the company by or on behalf of the shareholder.  The shareholder must also include a power of attorney with the written demand if he or she wants someone to make the inspection on his or her behalf.  The demand must state the purpose for which the stockholder seeks inspection.  The shareholder must identify the type or category of documents that he or she is seeking.

What Are Some Common Purposes for Which Shareholders and Directors Seek Inspection of the Books and Records of a Company?

Some common and approved bases for which shareholders seek inspection of the books and records of the company are:

  • To value their stock 
  • To communicate with other stockholders in the company 
  • To investigate corporate mismanagement 
  • To solicit proxies 

When a director seeks to inspect the books and records of a company, it is usually because he or she is in the minority or has been precluded from information that is necessary to fulfill fiduciary duties to the company and its shareholders.

What Options Are Available to a Company That Receives a Shareholder’s Demand for Books and Records?

The company has several options when considering a demand:

  •  It may refuse on the basis that the form of the demand did not comply with the prerequisites identified above.   
  •  It may refuse on the basis that the demand fails to state a proper purpose or the books and records sought are not necessary to fulfill the stated purpose.   
  •  It may agree to provide the inspection subject to the shareholder agreeing to sign a confidentiality agreement. 

What Happens If the Corporation Refuses or Does Not Respond to the Demand?

The corporation has five days to respond to the demand.  If the company refuses the shareholder’s demand or does not respond within five days, then the shareholder can initiate an action in the Court of Chancery seeking access to the company’s books and records.

What Can a Shareholder Expect in a Litigation for Inspection of Books and Records?

The suit brought by the shareholder can be tried on an expedited schedule, usually six to eight weeks.  The trial generally lasts one day, and an oral ruling from the bench is not an atypical disposition of the case.  The issues in the case are limited to whether the stockholder’s stated purpose for seeking the inspection of the books and records is proper and whether the books and records sought are germane to that stated purpose.

Disputes Over Board Composition or Officer Position

What Mechanism Can a Shareholder or Director Use To Challenge the Propriety of the Composition of a Board of Directors or the Holding of Office by an Officer?

Section 225 under the DGCL provides the means whereby the Court of Chancery can adjudicate an action that challenges an election, appointment, removal or resignation of any director or officer.  The purpose of such a suit is to address and resolve the uncertainty that arises when the authority of corporate leaders and, thus the governance of a corporation, is in dispute. 

Is a Section 225 Action Limited to Disputes Over the Election of Directors and Officers?

No. In addition to disputes over the election of officers and directors, a Section 225 proceeding can be initiated to address the result of any vote of stockholders or members, such as a disputed stockholder vote over matters other than to the right of a director or officer or member of a governing body to hold office, as well as the right of any person to hold or continue to hold office. 

Can Corporate Wrongdoing Be Addressed in a Section 225 Action?

Because of the need to expeditiously determine the outcome of a disputed election, a proceeding under Section 225 is strictly limited to those issues necessary to the determination of the statute’s purpose.  Therefore, unless it is necessary to the determination of the proper composition of a board of directors or officers of the company, collateral issues such as breach of fiduciary duties or disputed share ownership will be deemed outside the purview of such an action

 Who Can Bring an Action Under Section 225? 

  •  Shareholders (both record holders or beneficial holders)   
  •  Directors (incumbent and putative)   
  •  Officers (only if his or her own title to office is in dispute)   
  •  Members of a corporation having no stock    

How Quickly Can a Petitioner Expect To Get a Resolution After Filing a Section 225 Action?

Section 225 actions are summary in nature, and thus the Court of Chancery hears such a case on an expedited basis.  These cases, depending on the issues raised in them, are heard within two to four months of filing the action.

Is There Any Protection Against Dissipation of Assets by the Incumbent Management While the Case Is Pending?

While a Section 225 case is pending, the parties usually enter into a status quo order that prevents the incumbent director, officer or member of a governing body from taking actions outside the ordinary course of business.  Such orders are typically agreed to among the parties prior to appearing before the Court, but sometimes when the parties cannot agree, the Court on its own enters such an order.

Demand for Appraisals of Shares

What Mechanism Can Shareholders Use To Appraise Their Shares in a Corporation That Is a Party to a Merger or Consolidation?

Section 262 of the DGCL provides appraisal rights to the holders of record of shares of any corporation that is a party to a merger or consolidation, subject to specified exceptions and to compliance with specified procedural requirements.

What Are Some of the Requirements To Making a Request for Appraisal of Shares Pursuant to Section 262 of the DGCL?

  • Shareholder must have continuous record ownership of the relevant shares from the date of the demand for appraisal through the effective date of the merger. 
  • Shareholder must not vote in favor of the merger or consent to it in writing. 
  • Shareholder must make delivery of a written demand for appraisal prior to the taking of the stockholder vote on the merger. 
  • Shareholder must file a petition with the Delaware Court of Chancery within 120 days after the effective date of the merger. 
      

What Are the Exceptions to the Availability of Appraisal Rights Under Section 262?

Exceptions to the availability of appraisal rights include the denial of appraisal rights when:

  1. the merger does not require the approval of the stockholders of such corporation; and
  2. shares of any class or series are listed on any national security exchange or held of record by more than 2,000 holders. 

These exceptions do not apply in certain circumstances, however.

Are Appraisal Rights Available to Shareholders of a Subsidiary of a Corporation That Is a Party to a Merger or Consolidation?

Yes, if all of the stock of such subsidiary corporation is not owned by the parent immediately prior to the merger.

How Does the Process Work for Obtaining an Appraisal of Shares?

After filing a petition under Section 262 demanding appraisal of shares, the surviving corporation must file with the Court a list of the names and addresses of all stockholders who have demanded payment of fair value for their shares and with whom agreements regarding such value have not been reached. 

Thereafter, the Court will hold a hearing on the petition and determine the stockholders who have properly perfected their appraisal rights under Section 262.  At the hearing, the Court will determine the “fair value” of the shares as well as the fair rate of simple or compound interest, if any, to be paid upon such fair value.  Following this determination, the Court will order the surviving corporation to pay the dissenting shareholders the applicable amount.

How Are the Shares Valued by the Court?

Under Delaware law, an appraisal petitioner is entitled to receive a proportionate share of fair value in the going concern on the date of the merger.  The Court of Chancery considers proof of value of the shares by any techniques or methods that are generally considered acceptable in the financial community and otherwise admissible in Court, and nearly always utilizes some type of discounted cash flow methodology. 

Demand for Appointment of a Custodian or Receiver of a Corporation

What Mechanism Can Shareholders Use To Appoint a Custodian or Receiver of a Corporation for Deadlock or Other Reasons?

Section 226 of the DGCL authorizes any stockholder to petition the Court of Chancery to appoint a custodian to manage the affairs of the corporation when the corporation is deadlocked.

Alternatively, Section 226 can be utilized in the event that the corporation has abandoned its business and failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets.  However, appointment of receivers of an insolvent corporation is generally made under Section 291 of the DGCL, given its broader and more permissive provisions.

Under What Circumstances Will the Court Appoint a Custodian or Receiver of a Corporation Under Section 226?

  • The stockholders are so divided they cannot elect successors.  
  • The business of the corporation is suffering or threatened with irreparable injury because the directors are so divided that the required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division. 
  • The corporation has abandoned its business and failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets.  

What Must Be Shown To Obtain a Custodian When There Is a Shareholder Deadlock?

It must be shown that the stockholders cannot reach a consensus as to those individuals who are to manage the day-to-day affairs of the corporation. 

What Must Be Shown To Obtain a Custodian When There Is Director Deadlock?

  • The corporation must be suffering or threatened with irreparable injury. 
  • The injury must result from the inability of the board to muster sufficient votes to take action as a result of the division of opinion. 
  • The deadlock of the board must not be one that can be terminated by action of the shareholders of the corporation

Who Can Be Appointed as a Custodian of a Corporation?

A judicial custodian should be impartial, and therefore he or she must not be a stockholder or a creditor of the corporation or any of its subsidiaries or affiliated companies.  He or she should have a proven business and executive background suited in particular to the corporation’s primary field of business.  

What Is the Scope of the Power of the Custodian?

The custodian is empowered to:

  • take charge of the corporate assets, estate, effects, business and affairs;
  • collect the outstanding debts, claims and property belonging to the corporation;
  • prosecute and defend, in the name of the corporation, all claims or suits; and
  • do all other acts that are necessary and proper.  

However, the powers given to the custodian will be limited and exercised only insofar as the goals of fairness and justice require.

What Is the Process for Appointment of a Receiver of an Insolvent Corporation Under Section 291 of the DGCL?

Under Section 291, whenever a corporation is insolvent, any creditor or stockholder of a corporation may petition the Court of Chancery to appoint one or more persons to be receivers of the corporation. 

What Are the Functions of a Receiver of an Insolvent Corporation Under Section 291 of the DGCL?

  • Take charge of the corporation’s assets, estate, effects, business and affairs;
  • Collect the outstanding debts, claims and property due and belonging to the corporation;
  • Prosecute and defend, in the name of the corporation or otherwise, all claims or suits, to appoint an agent or agents under them; and
  • Do all other acts that might be done by the corporation and be necessary or proper.

Dissolution and Winding-Up of a Corporation

How Does the Dissolution Process Work in a Corporation That Is Not a Joint Venture?

To dissolve a corporation in the state of Delaware, a majority of the corporation’s directors must make a resolution that states the intent of the corporation to dissolve. This resolution must then gain approval by a majority vote from the shareholders. After the shareholders approve the decision, a certificate of dissolution must be filed with the Secretary of State.

Dissolution of a corporation may also be authorized without action of the directors if all the stockholders entitled to vote consent in writing.  A certificate of dissolution is then required to be filed with the Secretary of State.

What Are the Requirements To Petition the Court To Dissolve a Joint Venture Corporation?

  • The corporation only has two stockholders, each owning 50% of the corporation.
  • The stockholders cannot agree on whether to continue to the joint venture.
  • A stockholder petitions the Court stating that it desires to discontinue the joint venture and dispose of its assets in a plan to be agreed upon by both stockholders, or, if no plan can be agreed upon, then to dissolve the corporation.

Can the Court Judicially Supervise the Winding-Up Procedure?

Yes. Under Sections 280 and 281(a) of the DGCL, the Court may oversee the winding-up process of a corporation.  This is a complex procedure, but it affords directors and stockholders with a greater overall level of protection by obtaining the Court of Chancery’s “stamp of approval.”

Can a Corporation Be Wound Up Without Court Supervision?

Yes, pursuant to Section 281(b) of the DGCL.  While this non-court-supervised procedure is less rigorous than the one posed under Sections 280 and 281(a) of the DGCL, it opens a director or stockholder up to potential liability if the distribution to the corporation’s creditors is not done properly, and a director may be deemed to have breached his or her fiduciary duty to creditors if he or she fails to cause the corporation to properly make distributions.

Does a Stockholder of a Dissolved Corporation Have Liability for Claims Against It?

If a dissolved corporation’s assets were wound up properly, a stockholder is not liable for any claim against the corporation in an amount in excess of such stockholder's pro rata share of the claim or the amount so distributed to such stockholder, whichever is less.

Will Directors Be Liable for Claims Against a Dissolved Corporation?

The directors of a dissolved corporation will not be liable to the claimants of the dissolved corporation if the corporation’s assets were wound up properly under the DGCL.

How Are Creditors Notified of a Dissolved Corporation?

A corporation must notify all of its creditors by mail and by publication that the company is dissolving and must state the procedures by which a creditor can make a claim against the corporation.

How Long Can a Corporation Sue or Be Sued After It Has Dissolved?

Pursuant to Section 278 of the DGCL, once a corporation has dissolved, either voluntarily or by operation of court order, it may prosecute and defend suits for a period of three years (unless the period is extended by the Court).  After this time period, the corporation can no longer sue or be sued in its corporate capacity.

Does a Corporation Have To Set Aside Funds for Contingent, Pending or Future Claims?

Yes. If the wind-up procedure is done judicially pursuant to Sections 280 and 281(a), then the Court will determine the adequacy of such security set aside by the corporation for certain types of contingent or pending claims.

In the event of an extra-judicial winding-up of the corporation, the directors shall make provision as will be reasonably likely to be sufficient to pay certain types of contingent or pending claims, with the exception that funds must be set aside for the third category of claims that are likely to arise or become known within 10 years of the date of dissolution.

Other Summary Proceedings

Section 145–Action for indemnification of and advancement of expenses to officers, directors, employees and agents and advancement of expenses.
Section 167 and 168–Action to compel issuance of new certificate or uncertificated shares.
Sections 211 and 215–Action to compel the holding of an annual meeting of stockholders or members of non-stock corporations.
Section 217–Action to break voting deadlock with respect to shares jointly held.
Section 223–Action to compel election to fill vacancies or newly created directorship.

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Attorney(s)

Neff, Carl D.

Practice Area(s)

Litigation

Office(s)

Wilmington, DE

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