In a short letter opinion dated August 31, the Court of Chancery in SEPTA v. Volgenau dismissed a claim that a completed merger should be invalidated because it provided for different treatment of shares of the same class of stock, in violation of a charter provision that “holders of each class of Common Stock will be entitled to receive equal per share payments or distributions.” According to the complaint, the allegedly controlling stockholder rolled a portion of his shares into equity ownership of the ongoing company, an option not provided to holders of other shares of the same class.
The opinion declined to dismiss a claim that the directors breached their fiduciary duties by approving a transaction that violated the company’s charter. But the court concluded that the merger itself was beyond legal challenge by a stockholder, because of Delaware General Corporation Law Section 124, which precludes stockholder challenges to corporate acts based on “the fact that the corporation was without capacity or power to do such act,” except in proceedings to enjoin the acts. And because the plaintiff did not seek to enjoin the merger, Section 124 barred its claim to invalidate that transaction.
I admit that this application of Section 124 took me by surprise. Two main considerations drove that reaction. First, I always understood that this statute only addresses claims of ultra vires – i.e., claims that the corporation had purported to act beyond its powers as conferred by the State. I suppose, though, that one could conceive of a transaction that is invalid because if fails to comport with limitations in the charter (or the statute itself, for that matter) as ultra vires. I never thought of it that way myself, however, because I tend to think of the question of ultra vires in terms of corporate purpose, and I would have thought that the now ubiquitous and all-encompassing purpose provisions in charters, based on statutes like Section 102(a)(3), eliminate any question whether the corporation’s purposes include a merger like the one at issue in SEPTA. In short, I wouldn’t have thought that either Section 124 or the concept of ultra vires has anything to do with the disparate treatment claim advanced in SEPTA.
Second, and in any event, if the opinion is correct, a whole lot of case law seems to be placed in doubt. Take the landmark case of Moran v. Household, for instance, in which the Delaware Supreme Court first upheld the poison pill. In that case, the defendant company famously issued rights to acquire stock. That act drew a host of challenges, all aimed at setting aside the issuance. Among those challenges was the assertion that the issuance was not authorized by statute. The Supreme Court rejected those challenges on the merits; but if Section 124 really precludes a stockholder challenge to a completed corporate act, the Supreme Court could have made its life a lot easier by simply invoking Section 124 and dismissing the case, or at least any claim to set aside the pill.
Lots of other cases would similarly become off limits to stockholders. Suppose a charter required a supermajority vote for a merger, and it was discovered after purported consummation of the merger that the requisite vote was lacking. Would Section 124 bar a stockholder challenge? Or suppose that a stock issuance violated a covenant in a charter provision precluding issuance of senior stock without consent of a particular class of outstanding shares? Would Section 124 bar a holder of such shares from challenging the issuance?
I appreciate the value of predictability in commercial affairs, and doctrines of repose, like laches, usefully limit the scope of judicial relief that could impair desirable certainty in business affairs. I can’t resist thinking, however, that the SEPTA opinion goes too far, because it risks unmooring Section 124 from achieving its limited purpose of reining in the ultra vires doctrine, and letting it become an impossible hurdle to legitimate stockholder challenges to corporate actions that violate the provisions of governing documents or statutes. Or conversely, a stockholder’s irreparable harm argument on a motion for a preliminary injunction could become a lot stronger: while mergers or other transactions may often be viewed as “scrambled eggs” once consummated and thus beyond rescission, a robust application of Section 124 would arguably go even further and place all or most all transactions beyond the reach of rescissory relief, at least in stockholder actions.