Canmore Consultants Ltd., et al. v. L.O.M. Medical International, Inc., 2013 WL 5274380 (Del. Ch. Sept. 19, 2013)
This case presents an issue of first impression. Plaintiffs filed suit under Section 223(c) of the DGCL, an infrequently litigated statute, seeking a court-ordered stockholders’ meeting to elect directors to fill three vacancies on the board of directors of L.O.M. Medical International, Inc. (the “Company”). Section 223(c) provides in pertinent part:
If, at the time of filling any vacancy or newly created directorship, the directors then in office shall constitute less than a majority of the whole board (as constituted immediately prior to any such increase), the Court of Chancery may, upon application of any stockholder or stockholders holding at least 10 percent of the voting stock at the time outstanding having the right to vote for such directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in office as aforesaid, which election shall be governed by §211 or §215 of this title as far as applicable.
The vacancies that triggered the statute in this case resulted from the resignation of three of the Company’s five directors in May and June 2013. Those vacancies were filled by appointments made by the two directors remaining on the board following the three resignations.
The Court framed the issue before it, stating:
The statute commits the decision whether to grant a petition under Section 223(c) to the discretion of the Court, but is silent as to how that discretion is to be exercised, presenting a simple but until now unanswered question: which party bears the burden of persuasion under Section 223(c)?
The Court concluded that it is the plaintiff’s burden to demonstrate that a weighing of the equities supports granting a stockholder meeting under Section 223(c). Although there are no written decisions interpreting Section 223(c) and very few interpreting its predecessor statute, the Court explained that it views Section 223(c) as “providing only a limited exception to Section 223(a)’s grant of director authority to fill board vacancies.” Plaintiffs argued that Section 223(c) created a presumption in favor of ordering a new election and that because they had met the statutory requirements of Section 223(c), the election should summarily be ordered without further analysis. The Court disagreed, noting that such a presumption is not reflected in the statute’s language and that it is not enough to simply meet the statutory standing requirements.
In determining the extent of its discretion (the Court noted that the statute is permissive but “does not point to any factors as controlling in this exercise of discretion”), the Court analyzed Section 223(c) in conjunction with Section 223(a), which provides: “[u]nless otherwise provided in the certificate of incorporation or bylaws: (1) Vacancies and newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having the right to vote as a single class may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director . . . ”
The Court looked to the purpose of Section 223(c), which it described as:
Limit[ing] Section 223(a)’s grant of director authority by allowing Court intervention to prevent a minority of elected directors from appointing a majority of the board, where the holders of at least ten percent of the shares outstanding request a vote, and where the equities in favor of postponing such a vote until the next annual meeting do not outweigh the interests of the stockholders in an immediate exercise of their voting franchise.
The Court noted that its determination that Section 223(c) provides a limited exception to directors’ ability to fill vacancies is supported by the language of Section 223(a) permitting directors to fill board vacancies where doing so is not prohibited by a company’s certificate of incorporation or bylaws.
The Court also looked to the only written decision granting an election under Section 223(c)’s predecessor statute — McWhirter v. Washington Royalties Company, which was decided in 1930 — for guidance in determining the extent of the Court’s discretion under Section 223(c). In McWhirter, four directors resigned from a seven-member board of directors, leaving three remaining vacancies. The resignations prompted 43% of the company’s stockholders to petition the Court for a new election to fill the vacancies. The McWhirter Court concluded that the fact that 43% of stockholders supported the petition (well over the 10% required by Section 223(c)) was prima facie evidence that ordering a new election was appropriate even though the company had held an election three months prior. The Court also discussed Prickett v. American Steel & Pump Corporation, a 1969 case in which the Court ordered an election under Section 223(c), however, no annual meeting had been held the previous year in violation of Section 211(b) of the DGCL. Neither McWhirter nor Prickett were particularly instructive as the Plaintiffs in this case did not constitute such a large group as in McWhirter and the Company has held an election in the past year.
In weighing the equities, the Court focused on the specific facts of this case. In particular, the Court noted that the Company just held an election in March 2013, which the Court had ordered in a prior lawsuit involving some of the same parties brought pursuant to Section 225 of the DGCL. The Court also explained that it had permitted the Company to accept a loan of $200,000 from Plaintiff Woloschuk (formerly a director of the Company before the March 2013 election) based on representations that the Company lacked funds to pay for the March 2013 stockholder meeting. Those funds were subsequently used to pay legal fees while certain expenses associated with the March 2013 election were left unpaid. The Court also recognized that two of the plaintiffs — Woloschuk and Roteliuk — had been part of the incumbent board that was defeated at the March 2013 election. The Court further emphasized that Plaintiffs’ standing to bring this action under Section 223(c) “arises from simple fortuity” due to the 4 a.m. resignation of the third director, creating the third vacancy, on June 13, 2013, one day before the filing of the complaint on June 14, 2013.
The Court concluded that the main issue with ordering another stockholder meeting was that the Company lacks the necessary funds to hold another meeting. The Court explained that there was no reason to believe that the Company could raise additional funds to both pay its debts and pay for another meeting, nor was there any persuasive equitable reason to conclude that stockholder interests are not protected by the current board. The recent rejection of the slate of directors associated with the plaintiffs at the March 2013 meeting was also a reason for the Court’s final decision.
The authors of this article are attorneys at Cousins, Chipman & Brown, LLP in Wilmington, Delaware.
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