Frechter v. Zier: Bylaw Requiring Supermajority Vote of Stockholders to Remove Directors Held Invalid under 8 Del. C. 141(k)

May 25, 2017

Publication| Corporate Transactions| Corporate & Chancery Litigation

In Frechter v. Zier, 2017 WL 345142 (Del. Ch. Jan. 24, 2017), the Court of Chancery denied defendants’ motion to dismiss plaintiff’s declaratory judgment and breach of fiduciary duty action challenging a bylaw of Nutrisystem, Inc. (“Nutrisystem” or the “Company”) that required a supermajority vote of the Company’s stockholders to remove directors. Also granting plaintiff’s motion for summary judgment in part, the Court held that the bylaw, in requiring greater than a majority vote of the Company’s outstanding shares to remove directors, violated Section 141(k) of the Delaware General Corporation Law (the “DGCL”), which the Court determined “unambiguously confers on a majority the power to remove directors.”

On January 7, 2016, the Company announced that its board had approved an amendment to Nutrisystem’s bylaws. Pre-amendment, the relevant bylaw had allowed Nutrisystem stockholders to remove directors only (i) for cause and (ii) upon the affirmative vote of two-thirds of all outstanding shares of Company stock. The amendment struck the “for cause” requirement in response to the Court’s bench decision in In re VAALCO Energy, Inc. Stockholder Litigation, C.A. No. 11775-VCL (Del. Ch. Dec. 21, 2015) (TRANSCRIPT), interpreting this requirement as unlawful, but left the supermajority voting requirement unchanged.

On February 24, 2016, a stockholder-plaintiff brought an action alleging that the Nutrisystem directors had breached their fiduciary duties by enacting an unlawful bylaw to entrench themselves in office, and seeking a declaratory judgment that the bylaw as amended violated Section 141(k) of the DGCL, which provides that “[a]ny director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors.” Defendants moved to dismiss the complaint. Plaintiff cross-moved for partial summary judgment as to his declaratory judgment claim, stipulating that if the Court found in favor of plaintiff on this claim, plaintiff would withdraw the fiduciary duty claim.

Defendants argued that Section 216 of the DGCL, which permits corporations to adopt “bylaws … specify[ing] … the votes that shall be necessary for … the transaction of any business,” implicitly permits corporations to adopt bylaws allowing directors to be removed by a greater or lesser vote than the majority of outstanding shares specified in Section 141(k). Defendants also contended that the lack of mandatory language in the statute evidenced a legislative intent to allow boards of directors to establish the vote required to remove directors.

The Court rejected defendants’ “unnatural” interpretation of Section 141(k), finding that it would render meaningless the statutory grant to the holders of a majority of the outstanding stock of the power to remove directors. The Court noted that defendants’ reading of Section 141(k) was further weakened by Vice Chancellor Laster’s finding in VAALCO Energy that the language of Section 141(k) providing that directors “may” be removed with or without cause prohibits bylaws barring stockholders from removing directors without cause. The Court therefore concluded that because Section 141(k) grants stockholders the power to remove directors by a simple majority vote, Nutrisystem’s bylaws cannot lawfully require a greater vote.

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