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Delaware Supreme Court Reverses Kurz v. Holbrook (In Part); Chancery's Stock Ledger Analysis is "Without Precedential Effect"

April 22, 2010

On April 21, 2010, the Delaware Supreme Court issued an opinion with substantial significance for corporate practitioners.  In Crown EMAK Partners, LLC v. Kurz, No. 64, 2010 (Apr. 21, 2010), the Supreme Court affirmed in part and reversed in part the Court of Chancery’s holding in Kurz v. Holbrook, 989 A.2d 140 (Del. Ch. Feb. 9, 2010).  The Supreme Court upheld the Court of Chancery’s analysis concerning what is, and what is not, impermissible vote-buying under Delaware law, and concerning the impermissibility of bylaw amendments reducing the size of a board of directors to a number less than the number of sitting directors between annual meetings without first removing directors.  The Delaware Supreme Court, however, disagreed with the Court of Chancery’s analysis of whether a restricted stock agreement was violated by a purchase agreement relating to the shares subject to the restricted stock agreement, invalidating the votes attributable to the purchase agreement on account of the purchase agreement violating the restricted stock agreement.  Given its ruling invalidating these votes, the Supreme Court declined to rule on, but labeled as “obiter dictum and without precedential effect,” the Court of Chancery’s much-discussed determination that the Cede breakdown is part of the stock ledger for purposes of 8 Del. C. § 219(c).

The dispute involved competing consent solicitations relating to control of the board of directors of EMAK Worldwide, Inc. (“EMAK”), which had seven authorized directorships, two of which were vacant at the relevant times.  An insurgent group of common stockholders, Take Back EMAK, LLC (“TBE”), sought to remove two directors and fill three of the four vacancies with TBE nominees.  Because one incumbent director, Donald Kurz, was a member of TBE, the TBE solicitation, if successful, would give TBE majority control of the EMAK board.  A competing solicitation was launched by Crown EMAK Partners, LLC (“Crown”), a large preferred stockholder.  Crown’s preferred stock had a contractual right to elect two directors and a right to vote together with the common stock on all matters other than the election of the other directors.  Crown sought to amend EMAK’s bylaws to reduce the number of authorized directorships from seven to three and, in the event the number of directors in office exceeded the authorized three, to require the calling of a special meeting of common stockholders at which the common stockholders would elect one director as the lone successor to all the incumbents other than the two appointed by Crown’s preferred stock.  However, Crown did not solicit consents to remove any of the directors pursuant to 8 Del. C. § 141(k). 

Crown secured and delivered consents in favor of its bylaw amendments from the holders of a majority of the outstanding voting power (with the preferred stock and common stock voting together).  TBE obtained consents from the holders of a majority of the common stock (i.e., of the shares entitled to vote in an election of directors other than those appointed by Crown), but the inspector of election invalidated consents representing over a million shares that were held in “street name” (i.e., held of record by Cede & Co., the nominee of Depository Trust Company) on the ground that TBE had not obtained and submitted an omnibus proxy executed by Cede, authorizing Cede’s participants to vote the shares that Cede held on their behalf.  Crown additionally challenged the validity of the consents as to 150,000 common shares signed by Kurz as proxy for Peter Boutros, the record owner of the shares and a former EMAK employee, who had signed a Restricted Stock Grant Agreement that prohibited him from selling or transferring the shares before March 2011.  Shortly before TBE delivered its consents, Kurz and Boutros had signed a Purchase Agreement under which Kurz paid Boutros a price in excess of the trading price, and Boutros gave Kurz all the shares Boutros owned and was then permitted to sell, plus all rights to receive all other shares that Boutros might later be permitted to sell, plus an irrevocable proxy to vote all the shares. 

After trial, the Court of Chancery found in favor of TBE.  The Court held that the transaction between Kurz and Boutros was not an invalid vote-buying transaction and did not violate the Restricted Stock Grant Agreement.  The Court rejected the Crown bylaw amendments as impermissible under the Delaware General Corporation Law.  Most notably, the Court reversed the inspector’s rejection of the consents delivered by TBE on behalf of the shares held in street name, on the ground that the consents delivered -- which evidenced authority from the participating banks and brokers who appeared on the Cede participant listing, but omitted the omnibus proxy from Cede -- had validly effected corporate action.  The Court’s ruling on this point depended on its holding that the Cede breakdown was part of the stock ledger for purposes of 8 Del. C. § 219(c), just as it is part of the stock ledger for purposes of 8 Del. C. 220(b).  Consequently, the Court of Chancery determined that the TBE slate had been elected and controlled the EMAK board.  An expedited appeal followed. 

On appeal, the Supreme Court affirmed the Court of Chancery’s analysis of the vote-buying issue and its determination that Kurz had not engaged in improper vote-buying.  The Court of Chancery had found no evidence of fraud in the transaction between Kurz and Boutros, and further found that Kurz’s voting interests and his economic interests in the Boutros shares were aligned.  The Supreme Court agreed on the ground that “the economic interests and the voting interests of the [Boutros] shares remained aligned since both sets of interests were transferred from Boutros to Kurz by the Purchase Agreement.” 

However, the Supreme Court reversed the Court of Chancery’s determination that Boutros and Kurz had successfully contracted around the sale and transfer restrictions imposed by the Restricted Stock Grant Agreement.  The Court of Chancery had noted that the Restricted Stock Grant Agreement prohibited sales and transfers of Boutros’s shares, but did not prohibit agreements to sell or transfer the shares in the future.  The Supreme Court held, however, that because Boutros conveyed both (i) all economic interest in the shares, and (ii) the right to vote the shares (via an irrevocable proxy), Boutros had “immediately conferred upon Kurz the functional equivalent of ‘full ownership.’…  There was nothing for Boutros to transfer to Kurz in the future, other than bare legal title.”  The Supreme Court concluded that this transaction violated the Restricted Stock Grant Agreement, and consequently held that the transaction “did not operate as a legally valid sale or transfer of Boutros’ shares, and that Kurz was not entitled to vote those shares.” 

Because the Supreme Court held that Kurz lacked the right to vote the Boutros shares, the TBE consent solicitation failed to garner the support of the requisite majority of common shares, regardless of whether the shares held in street name (as to which no omnibus proxy executed by Cede had been submitted) were properly counted in TBE’s favor.  The Supreme Court therefore expressly declined to review the Court of Chancery’s holding that the Cede breakdown constituted part of the stock ledger for purposes of 8 Del. C. § 219(c).  The Supreme Court wrote that a “gratuitous statutory interpretation resolving this difficult issue” would not be “prudent,” and indicated that a legislative cure by the Delaware General Assembly to resolve the question was preferable.  The Supreme Court concluded with the statement that “the Court of Chancery’s interpretation of stock ledger in section 219 is obiter dictum and without precedential effect.” 

Finally, the Supreme Court affirmed the Court of Chancery’s holding that the Crown bylaw amendments conflicted with the Delaware General Corporation Law and were void.  The Court of Chancery had held, and the Supreme Court agreed, that stockholders cannot end an incumbent director’s term between annual meetings by purporting to eliminate the director’s seat or by purporting to elect the director’s successor, without in either case first removing the incumbent director. 

The Supreme Court remanded the case to the Court of Chancery for further proceedings in accordance with the opinion.